Commodore H.M. Gillig's racing sloop Vencedor on Lake Erie
Ilargi: As Bush 'saves' more bankrupt industry with a $17.4 billion package for GM and Chrysler, Obama can no longer escape being sucked into a giant hole in Detroit that he will have a very hard time crawling out of. And maybe that's good. His entire economic team is now made up of guys and galls who were in the thick of things when the creative financial instrument scam was unleashed. If that's all Obama has, then he deserves to go down with them.
Meanwhile, both Stranded Wind and the British press question what exactly the difference is between Bernie Madoff’s Ponzi pyramid and the ones executed by the respective governments. A Ponzi scheme relies on neverending future payments, on a limitless stream of new 'clients' coming in. How does that differ from governments spending today what only our children, and their children, can pay back (if they can at all)? Well, except for the scale, of course. When it comes to sheer amounts, Madoff is an amateur compared to Paulson and Bernanke.
Stranded Wind: Marc Drier, founder of Drier LLP, seems to personify the behavior of those in power here at the dawn of the Greater Depression. The firm, a two hundred fifty lawyer behemoth with six offices from Manhattan clear to Los Angeles, has a clutch of specialties that ought to have them working nonstop in this environment. Instead of being buried in bankruptcy and securities work the firm is now disbanded, unable to meet payroll after the SEC froze Mr. Drier's assets.
Drier was arrested last week in Canada trying to sell $33 million in bogus securities to a Toronto pension fund. He spent a short stint in jail there and was immediately arrested when he stepped off the plane in New York, facing charges of securities and wire fraud. It seems before the Canadian arrest he'd walked into the offices of a New York City real estate developer, cajoled a receptionist into letting him use a conference room, and sold hedge fund executives $113 million in bogus securities supposedly backed by the unwitting firm hosting the meeting. The funds remain missing at this time.
Drier's behavior has been described as reckless and full of hubris. He was brought down by the CEO of the real estate developer who had noticed the use of the conference room and managed to get an employee to record the transaction. Bernard Madoff, a former chairman of the NASDAQ and a "respected leader on Wall Street" two weeks ago admitted to running a massive Ponzi scheme, with losses estimated to be fifty times what Drier caused.
Madoff was investigated and cleared by the SEC in 1992 for his part in an unregistered securities scheme. He was involved but innocent of wrong doing and there was no loss associated with the $441 million that another business had raised. A whistle blower now claims to have attempted to overturn the current scheme in 1999, and the accounting firm of Friehling & Horowitz seems certain to come under scrutiny. How billions in assets came under the direct control of a single advisor with the only check being an apparently captive auditor is an interesting proposition for regulators and law enforcement. The SEC is supposed to inspect such operations in their first year and then again at five year intervals but it would appear that they didn't think Madoff needed such attention; the oversight is somewhat understandable – he helped develop the regulations they failed to enforce on his operation.
Madoff seems to have borrowed at least a little from Vincent Gigante, the famous mob boss who feigned mental illness by roaming New York wearing a bath robe and mumbling to himself. His recent confession to FBI agents that there was "no innocent explanation" came in his bathrobe at the door of his upper east side condo. Unlike Gigante it was a family member who gave him up after learning of the fraud. Already the whispers begin … Madoff sacrificing himself to save his two sons who worked in the 'family business'. This story isn't over, not by a long shot, not for the Madoff crime family and definitely not for the ever increasing number of people, hedge funds, and municipalities found to be caught up in it.
Last, largest, and at the moment not (yet) broadly viewed as a criminal act is the $700 billion bank bailout under the supervision of Henry Paulson. Half of the funds have simply vanished, handed out without supervision to 'friends of Hank'. Now Congress, stampeded into committing the full faith and credit of the United States to an exercise that was doomed from the outset have begun to ask questions. And well they should, for how are the behaviors of Pickpocket Paulson and his accomplice Bubbles Bernanke any different than Drier and Madoff?
The full faith and credit of the U.S. has been committed; we don't repudiate this immoral debt, as Ecuador has recently done with theirs, not without crashing the global finance system even harder than it already is. This being said, something will happen from this. We can't push two million Detroit union employees out into the cold in the context of a national economic crash without someone being to blame. The Drier business is revelatory of the character (disorder?) of Wall Street and the open criminality. The Madoff affair reveals both the prodigious scope of fraud and the need to place principles ahead of personalities, no matter whom might be in a position of respect or authority
Bernanke has presided over something similar to Madoff's Ponzi scheme – a massive, speculative bubble that should have been headed off by regulation. In the same vein as Drier's cheeky use of a client's conference room, Paulson marches right into the halls of Congress and demands the nation's checkbook and none shall gainsay him. How are the activities of Drier and Madoff any different than those of Paulson and Bernanke? If you guessed Congressional involvement in the scam I think you're on the right track.
GM and Chrysler Get $17.4 Billion in U.S. Loans
General Motors Corp. and Chrysler LLC will get $13.4 billion in initial government loans to keep operating in exchange for a restructuring under a rescue plan announced by President George W. Bush. A bankruptcy is unlikely to work for the automakers at this time and can’t be allowed, Bush said at the White House. “These are not ordinary circumstances,” Bush said. “In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action.” The money will be drawn from the Troubled Asset Relief Program and the automakers will get an additional $4 billion from the fund in February for a total of $17.4 billion in assistance, according to a statement from the Bush administration. The funds would allow GM and Chrysler to keep operating until March.
Winning the assistance is a reprieve for GM, the biggest U.S. automaker, and No. 3 Chrysler after they said they would run out of operating funds as soon as this month. Bush is stepping in after Senate Republicans’ refusal last week to take up a House-approved rescue raised the prospect of a company failure costing millions of jobs. GM is reeling from almost $73 billion in losses since 2004 and a 22 percent slump in U.S. sales this year, while the drop at Auburn Hills, Michigan-based Chrysler is 28 percent, the steepest among the major automakers. Under the terms of the plan, if the companies can’t demonstrate financial viability by March 31 the loans will be called and the money must be returned, the statement said. The government’s debt would have priority over any other debts.
In exchange for the money, the automakers must provide warrants for non-voting stock, accept limits on executive pay, give the government access to financial records and not issue dividends until the debt is repaid. The government will have the authority to block transactions larger than $100 million.
The automakers much cut their debt by two thirds in an equity exchange, make half of the payments to a union retirement fund in equity, eliminate a program that pays union workers when they don’t have work and have union costs and rules competitive with foreign automakers by Dec. 31, 2009. The requirements could be modified by negotiations with the union and debt holders. Government officials will examine all financial statements and records of the car companies.
The package is intended for GM and Chrysler initially; Ford Motor Co. has said it can continue operations under current circumstances. GM soared 15 percent to $4.22 at 9:04 a.m. before regular New York Stock Exchange composite trading, while Ford gained 11 percent to $3.15. GM’s 8.375 percent bonds due in July 2033 rose 3 cents to 18.6 cents on the dollar, yielding 45 percent, according to Trace, the bond-pricing service of the Financial Industry Regulatory Authority. Ford’s 7.45 percent bonds due in July 2031 gained 2 cents to 27 cents on the dollar, yielding 27.8 percent, Trace data showed. The Bush administration agreed Dec. 12 to consider options, including use of the TARP, after Senate Republicans turned aside the House-backed plan. The Republicans sought more specific automaker conditions, such as pay in line with foreign manufacturers’ operations in the U.S.
United Auto Workers leaders agreed this month to suspend a program that pays laid-off employees after their jobs end, and to postpone automakers’ contributions to new union-run trusts that will take on responsibility for retirees’ medical care. The dispute in Congress reflected the tension between Republicans from Southern states that have plants owned by Asian and European automakers, and the UAW, which primarily supports Democrats in political campaigns. The next Congress will have a bigger Democratic majority.
Car Bankruptcy Cited as Option by White House
The White House raised for the first time on Thursday the prospect of forcing General Motors and Chrysler into a managed bankruptcy as a solution to save the companies from financial collapse. President Bush’s spokeswoman, Dana Perino, confirmed growing speculation within legal circles that the president and Treasury Secretary Henry M. Paulson Jr. were considering the step. "There’s an orderly way to do bankruptcies that provides for more of a soft landing," Ms. Perino said. "I think that’s what we would be talking about. That would be one of the options." A senior administration official, however, later described that option as a last resort, to be used only if an agreement for a voluntary overhaul of the industry could not be reached.
These officials said the preferred solution would be to force a restructuring of the industry outside of bankruptcy court, extracting concessions that would make the companies more cost-competitive with foreign automakers. In return, the Treasury would tap the financial rescue fund, called the Troubled Asset Relief Program, to make loans to the companies. After a week of talks between the automakers and the Treasury Department over the terms of a possible bailout, Ms. Perino on Thursday said, "we’re very close."
President Bush, speaking at the American Enterprise Institute, an organization dedicated to free market principles, said that he had determined that the economy was too fragile to allow G.M. and Chrysler to fail. The companies have warned that will happen if they do not receive financial aid soon.
In his speech Thursday, Mr. Bush made clear that he wanted to avoid a "disorderly bankruptcy" because of "what it would do to the psychology of the markets." But he also said he was "worried about putting good money after bad," and suggested he would only approve a plan that allowed the auto companies to "become viable in the future." Mr. Bush’s comments, a month before he leaves office, made clear that he was worried by the idea of returning to Texas amid more economic chaos and the surge in unemployment that a collapse of the companies could cause. "The autos obviously are very fragile," he said. He added that he was concerned about what President-elect Barack Obama would face on Jan. 20. "I believe that good policy is not to dump him a major catastrophe in his first day of office," he said.
What the White House appears to be envisaging is a package deal of concessions — and an injection of money from the TARP, the $700 billion financial bailout fund — to keep credit flowing for G.M. and Chrysler. Taxpayer loans, the White House has said, would have first priority over all other debt. Ms. Perino said the goal was to "try to come up with something that would protect the taxpayers but not allow a collapse that would hurt everybody in America." But for Mr. Bush, that could be difficult to negotiate. If the autoworkers’ unions conclude they are likely to get a better deal from Mr. Obama, they are likely to stall negotiations and settle for a shorter-term loan. After the White House raised the possibility of a bankruptcy, G.M.’s shares fell to $3.66.
Investors may have also been reacting to a report in The Wall Street Journal that said G.M. had restarted merger discussions with Chrysler. But a G.M. spokesman, Tony Cervone, said the automaker had not held any talks with Chrysler since late October, when G.M. suspended discussions because of its bleak financial condition. "Nothing has changed," he said. G.M. declined to comment on the Bush administration’s suggestion that an "orderly bankruptcy" was under consideration. But the company was surprised by the White House statements, according to G.M. officials who asked not to be identified because the discussions with the administration were not yet final. The automaker’s senior executives have said repeatedly that bankruptcy was not a viable solution because consumers would be reluctant to buy a vehicle from a bankrupt automaker.
In July, CNW Marketing Research said a survey it conducted showed that 80 percent of prospective car buyers would not consider purchasing a vehicle from a bankrupt company. A more recent survey found that 51 percent of the people it interviewed said they would not buy a car from G.M. even if it received a government bailout. "G.M. cannot afford to lose half of its prospective customers," said Art Spinella, CNW’s president. Spokesmen for Chrysler and Ford also declined to comment specifically on the inclusion of bankruptcy as an alternative. Chrysler’s chairman, Robert L. Nardelli, has said that getting financing to reorganize in bankruptcy would be difficult given tight credit conditions. Ford is not seeking immediate government help. There was no immediate comment from the United Automobile Workers union.
In a traditional bankruptcy proceeding, the U.A.W.’s contracts could be voided and the union forced to renegotiate benefits like health care. The union’s president, Ron Gettelfinger, has said the U.A.W. is willing to make concessions if G.M. or Chrysler gets government loans that help them survive. But Mr. Gettelfinger has said he believes that bankruptcy would cripple either company’s ability to sell cars. "There’s no question in my mind that people would not buy their vehicles," he said in an interview. Both companies are cutting production to stretch their available cash. On Friday, Chrysler will begin an unusual monthlong shutdown of all of its North American manufacturing plants in a bid to save money.
Legal experts said Thursday that despite discussion of an out-of-court solution, a revamping of G.M. and Chrysler might be difficult to accomplish outside of bankruptcy court, given the significant steps an overhaul would require. "It’s not going to be easy, it’s not going to be pleasant, or palatable, but it’s the only solution that makes the least bit of sense," said Hugh M. Ray, head of the bankruptcy practice at the Houston law firm Andrews Kurth, who has participated in major bankruptcy cases. If the companies were to file for bankruptcy, major banks would provide financing, with federal funds as security for the bank loans for the companies to operate. Some lawyers have suggested that the two companies could receive $25 billion, using $5 billion in federal funds to guarantee the banks’ loans, although auto industry analysts said the companies might need more.
G.M. has retained Harvey R. Miller, a longtime bankruptcy lawyer, as its adviser. It is also being advised by William Repko, an expert in restructuring with Evercore Partners who has worked with companies like United Airlines. G.M. is also working with Arthur B. Newman of the Blackstone Group. Chrysler has retained the law firm of Jones Day to provide revamping expertise. Mr. Ray said that a number of airlines went through bankruptcy protection earlier this decade, using federally backed loans awarded by the Air Transportation Stabilization Board, which was set up to aid the industry after the September 2001 attacks. The board turned down United’s request, however, and the airline subsequently restructured under bankruptcy protection without federal money. "United is still flying, and G.M. is not doing very well," Mr. Ray said. "Their chickens have come home to roost, and now it’s inevitable" that G.M. seek bankruptcy protection, he added.
Bush considering 'orderly' auto bankruptcy
The Bush administration is looking at "orderly" bankruptcy as a possible way to deal with the desperately ailing U.S. auto industry, the White House said Thursday as carmakers readied more plant closings and a half million Americans filed new jobless claims. With General Motors, Chrysler and the rest of Detroit anxiously holding its breath and waiting for a federal rescue, White House press secretary Dana Perino said, "There's an orderly way to do bankruptcies that provides for more of a soft landing. I think that's what we would be talking about." President George W. Bush, asked about an auto bailout, said he hadn't decided what he would do but didn't want to leave a mess for Barack Obama who takes office a month from Saturday.
Bush, like Perino, spoke of the idea of bankruptcies orchestrated by the federal government as a possible way to go — without committing to it. "Under normal circumstances, no question bankruptcy court is the best way to work through credit and debt and restructuring," he said during a speech and question-and-answer session at the American Enterprise Institute, a conservative Washington think tank. "These aren't normal circumstances. That's the problem." Perino said the White House was "very close" to a decision — though she wouldn't give a timetable. She emphasized there were still several possible approaches to assisting the automakers, including short-term loans from the Treasury Department's $700 billion Wall Street bailout program. The Big Three automakers said anew that bankruptcy wasn't the answer, as did an official of the United Auto Workers who called the idea unworkable and even dangerous. GM said a report that it and Chrysler had restarted talks to combine was untrue.
House Speaker Nancy Pelosi said on Capitol Hill that grim new unemployment data heightened the urgency for the administration "to prevent the imminent insolvency of the domestic auto industry."
The California Democrat said Bush has the legal authority to act now, and should attach the accountability standards that were included in a $14 billion House-passed and Bush-supported carmaker bailout that died in the Senate last week. That plan would have given the government, through a Bush-appointed "car czar," veto power over major business decisions at any auto company that received federal loans. Pelosi spoke after the government announced that initial claims for unemployment benefits totaled a seasonally adjusted 554,000 last week. The comments in Washington came a day after Chrysler LLC announced it was closing all its North American manufacturing plants for at least a month as it, General Motors Corp. and Ford Motor Co. await word on government action. General Motors also has been closing plants, and it and Chrysler have said they might not have enough money to pay their bills in a matter of weeks. Prices of GM and Ford stocks were down sharply Thursday after the remarks out of the White House. Ford, unlike General Motors and Chrysler, is not seeking billions in federal bailout loans, but a collapse of the other two could hurt Ford as well.
Alan Reuther, the United Auto Workers' legislative director, said the union urged the administration during a meeting this week to follow the provisions included in the House-passed auto aid bill. Congressional aides in both parties who have been closely following the discussions suggested the talk of bankruptcy could be a tactic to extract more hefty concessions from the companies and union in exchange for granting short-term loans from Treasury's financial industry rescue fund. Perino said one factor preventing an announcement of action by the administration is that discussions continue with the various sides that would have to sign on to a managed bankruptcy — entities such as labor and equity holders in addition to the companies themselves. A senior administration official said the talks between Bush officials and the Big Three and their stakeholders amount to information-gathering, not negotiating.
The White House has repeatedly emphasized its opposition to "disorderly bankruptcy" — presumably a Chapter 7 filing that would effectively shut down a company and require liquidation of assets. That has left on the table the possibility of forcing one or more automakers into a Chapter 11 bankruptcy, which allows a firm to keep operating while under a court's purview. Harlan Platt, who teaches corporate turnarounds at Northeastern University in Boston, said the government may be waiting for an offer of an ownership stake in the companies, much as it received in return for capital plowed into banks. "You really have to ask the question: If this is good enough for Wall Street, why isn't it good enough for Detroit?" he said. On Thursday, spokesmen for Chrysler, GM and Ford generally referred to their previous comments that bankruptcy was not a workable solution. The car companies argue that no one would buy a vehicle from a bankrupt company for fear that the company might not be around to honor warranties.
"We continue to work with the administration to find a solution to this liquidity crisis," said GM spokesman Tony Cervone.
Chrysler spokeswoman Shawn Morgan noted previous statements against bankruptcy by CEO Robert Nardelli. Financing for even a prepackaged bankruptcy would be difficult to get in the current tight credit market, Chrysler has said. The National Automobile Dealers Association also spoke out against bankruptcy for car companies "in any way shape or form, orderly or disorderly, prepackaged or unpackaged, managed or unmanaged," said spokesman Bailey Wood. Bush said the auto industry is "obviously very fragile" and he is worried about what an out-and-out collapse without Washington involvement "would do to the psychology" of the markets. "There still is a lot of uncertainty," he said. At the same time, the president said anew that he is worried about "putting good money after bad," meaning taxpayer dollars shouldn't be used to prop up companies that can't survive the long term. He revealed one other consideration — that Obama will become president in just over a month. "I thought about what it would be like for me to become president during this period. I believe that good policy is not to dump him a major catastrophe on his first day in office," Bush said.
Paulson: 'Orderly' Auto Bankruptcy May Be Necessary
"This is a time when it makes sense to be prudent" and rescue the automakers. Treasury Secretary Henry Paulson said Dec. 18 that the government should exhaust all other options before allowing troubled U.S. automakers to fall into bankruptcy. But Paulson said bankruptcy might end up being the right solution if other measures fail. Speaking at a BusinessWeek-sponsored Captains of Industry forum at the 92nd Street Y on Manhattan's Upper East Side, Paulson showed mixed feelings about how to deal with General Motors (GM) and Chrysler, which are seeking emergency government assistance to stay in business. Paulson said he generally prefers free-market solutions, but said he agrees with President Bush that it would be imprudent to allow a disorderly failure of the automakers. Said Paulson: "This is a time when it makes sense to be prudent." The Treasury Secretary added, "If the right outcome is bankruptcy, then it's better to get there through an orderly process."
In other news, Paulson said he favors regulation of any institution whose failure could jeopardize the financial system, and that includes hedge funds, which traditionally have been lightly regulated. "The [Federal Reserve] should have oversight over hedge funds," he said. Paulson was interviewed by BusinessWeek Editor-in-Chief Stephen Adler as part of the 10-year-old Captains of Industry series, which features leading newsmakers. Among other points, Paulson said:
- An economic downturn remains much more of a risk than inflation from the money that's now flooding the system. "That'll be a high-class problem when we can start worrying about growth and inflation again," Paulson said, adding: "The real cost would be to not do enough and then have the economy go into a free fall."
- Banks that took U.S. funding should lend more, but he defended the Treasury's emphasis on getting them money right away without strings. "Our first priority was always, and we were clear from the day we went to Congress, to prevent the collapse of the financial system." He said, "There was literally a wave, just a string of financial institution failures or near-failures." Paulson added: "They need to lend more. We don't want them hoarding, we want them lending." However, he also said, "It is not in my judgment practical or prudent to have government…saying 'Make this loan, don't make this loan.'"
- He defended the amount of disclosure by Treasury on the Troubled Asset Relief Program, or TARP. Paulson said, "We have been moving with lightning speed," and added, "We're building this organization as we're going."
- The No. 1 thing we need to do is stem the housing correction."
- The government lacked the authority to prevent the failure of Lehman Brothers, the investment bank that went under in September. But he said that Lehman's failure was "in my judgment a symptom, not a cause" of the financial turmoil.
- President Bush "is very current and he's on top of everything we've done." He said, "I know that's not conventional wisdom among some people but it's absolutely true."
- China and the U.S. should be good partners. "We won't always have the same view, but engagement in my view is exceptionally important."
Adler's final question to Paulson was what advice he would give his successor, Timothy Geithner, who is now president of the Federal Reserve Bank of New York. Paulson said Geithner doesn't need his advice, but added, "It's important when you're going through a time like this to define your job expansively."
Ilargi: The influence on future US economic policy in the hands of Goldman Sachs and Citigroup is alarming, as evidenced by Obama’s appointment of Geithner at the Treasury and now Gensler in a "clean up derivatives" role. They are all linked to Robert Rubin and the whole cabal that made immense fortunes through derivatives trading. And now we should believe that one of them will clean up the mess they themselves made? No, what will happen is that losses are transferrred to the public, while any links to illegal activity will be buried. the boys are taking care of their own.
Geithner is spelled P-a-u-l-s-o-n
President-Elect Barack Obama has received surprising praise from some conservatives for his economic team. After running a successful populist campaign against Wall Street and financiers, Obama has chosen to staff his administration with centrists, a few of whom championed some of the very policies of tax cuts and financial deregulation for which Obama's supporters on the Left castigated Republicans. Obama indeed deserves praise for most of these choices, such as former Treasury Secretary Larry Summers and economic historian Christina Romer, both distinguished Center-Left thinkers. However, principled conservatives and liberals should take strong exception to Obama's selection of Timothy F. Geithner, president of the Federal Reserve Bank of New York, to be the new Secretary of Treasury. It's not a case of Geithner being too liberal; there are choices to the Left of Geithner that would not be cause for the specific concerns his nomination raises. Rather, the problem with Geithner is that appointing him appears to be scarcely different from reappointing Treasury Secretary Henry Paulson.
Based on his orchestration of much of this year's financial bailouts in his current post, Geithner would be "more of the same" of the worst aspects of the Bush administration — more bailouts, more lack of transparency in the bailouts, and more corporate welfare. As head of the New York Fed, Geithner has been, in The Washington Post's words "a primary architect of the Bush administration's response to the financial crisis," and "has worked closely with [Paulson] to devise responses to the most critical events of the market turmoil." Other than organizing bailouts, however, Geithner's resume is quite thin compared to that of others who have held the office for which he has been nominated. As liberal columnist Robert Kuttner noted recently in The American Prospect, Geithner "has neither a doctorate in economics nor an M.B.A."
Also, Geithner has never been a corporate leader, nor an economics professor with a trail of published academic papers. Instead, Geithner's career has been almost entirely in the bowels of the bureaucracy. He started at the Treasury Department in 1988 as a career civil servant before being appointed under-secretary of the Treasury for international affairs in 1999. Geithner would not have even been under consideration had he not come to prominence in circumventing rules to arrange the bailout of Bear Stearns' creditors earlier this year, with $29 billion in backing from U.S taxpayers. According to accounts from both conservative columnist Robert Novak and the financial magazine Conde Nast Portfolio, Geithner was the main instigator of the bailout, getting Paulson and Fed Chairman Ben Bernanke to sign on to his handiwork.
The Bear deal faced criticism from the Left and Right as both a stretch of the Fed's power and a precedent that spread "moral hazard," thus leading to the further bailouts down the line — bailouts that Geithner would be heavily involved in, working hand-in glove with Paulson. But in addition to the questionable results of bailouts in saving the economy, also troubling has been the Federal Reserve's lack of openness when it has put taxpayer money on the line, an area where Geithner shares much of the blame. A recent editorial in The Wall Street Journal noting that "Geithner was the driving force behind the government takeover of insurance giant AIG" also criticized "the New York Fed's lack of transparency, both about the nature of the 'systemic risk' that required the takeover and why it was superior to bankruptcy."
Geithner's judgment has also been questioned with recent reports of alleged favoritism toward Citigroup -- the financial firm where Geithner's mentor, former Treasury Secretary Robert Rubin, serves as a director and senior counselor. According to a Bloomberg News report, Geithner unsuccessfully pushed for Citi to take over troubled banker Wachovia Corp. with government guarantees of billions of dollars, even after Wells Fargo & Co. offered to take over the company at no cost to taxpayers and a higher price for Wachovia shareholders. Considering Citi's recent need for a second bailout from the Treasury Department, one can only imagine the additional troubles for the U.S. financial system had it been allowed to take over Wachovia as Geithner desired. Given that bailouts are just about his only significant policy accomplishment, confirming Geithner without heavy scrutiny would be giving the Bush-Paulson bailouts a free pass. And that would be a blatant dereliction of the Senate's constitutional duty to give President-Elect Obama its best advice and consent.
Obama Names Insider to Commodities Post
Nine years ago, Gary Gensler played a central role in fending off tough regulation for exotic financial instruments for hedging against risk. On Thursday, President-elect Barack Obama picked him for a central role in cleaning up the wreckage that some of those instruments caused. Mr. Obama named Mr. Gensler, a former Treasury official under President Clinton, to take over a seemingly obscure backwater of regulation, the Commodity Futures Trading Commission. But the commission, which regulates the exchanges that trade futures contracts for products as varied as oil, wheat and instruments for betting on interest rates, will be a major battleground over reining in the trillion-dollar markets for credit-default swaps and other "derivative" financial instruments that greatly aggravated the damage caused by the subprime mortgage meltdown.
In 1999, Mr. Gensler worked alongside Robert E. Rubin, then the Treasury secretary under President Clinton, and Alan Greenspan, then the chairman of the Federal Reserve, to block proposals by the commission to regulate the new instruments. In the past year, as the mortgage crisis metastasized into a collapse of the broader financial system, instruments like credit-default swaps and so-called synthetic collateralized debt obligations produced hundreds of billions of dollars of losses that have forced the federal government to bail out the financial industry at a possible cost to taxpayers that could reach trillions of dollars. Mr. Obama has vowed to reverse the deregulatory stance of the Bush administration and overhaul the entire system of financial supervision. Though Mr. Obama’s team has not mapped a specific plan, advisers on his transition team said reining in derivatives would be one of the biggest and most complicated parts of that effort.
Advisers to Mr. Obama said Mr. Gensler, 51, would bring immense expertise to the challenge and said it would be a mistake to think that he would oppose tough regulation just because he did so in the 1990s. Mr. Gensler, who became a partner at Goldman Sachs at the age of 30, is a staunch Democrat who was a top adviser to Paul S. Sarbanes, then a senator, in drafting the Sarbanes-Oxley law in 2002. That law, which provoked howls of protest from business groups at the time and in the years since, imposed strict rules and oversight of corporate accounting after the bookkeeping scandals at companies like Enron and Worldcom. "They were absolutely intent on writing a tough bill," said Michael Paese, who was a senior counsel to Democrats on the House Financial Services Committee at the time and is now a lobbyist for the securities industry.
Other Democratic staff members on the Senate Banking Committee said Mr. Sarbanes and Mr. Gensler had been so worried about diluting the proposed regulations that they excluded Harvey L. Pitt, Mr. Bush’s chairman of the Securities and Exchange Commission, during most of their work to draft the legislation. At the heart of the coming political battle are credit-default swaps, which are essentially insurance contracts to protect investors if a particular bond defaults. They were used to insure hundreds of billions of dollars worth of securities backed by subprime mortgages, but they also became a huge speculative tool in their own right. As the subprime mortgage market reached a frenzied peak from 2005 through the summer of 2007, Wall Street firms used the swaps to create vast numbers of synthetic collateralized debt obligations, which were securities that modeled the performance of pools that contained real mortgage-backed securities. When default rates on subprime mortgages soared in 2007, companies that had written credit-default swaps were potentially on the hook for hundreds of billions of dollars. Mr. Gensler could not be reached for comment about how his views about financial regulation have evolved.
For Barack Obama, It's All About Credibility
Trying to figure out what to say after this past week is a challenge, so we asked various friends and family what they thought. In the wake of the Madoff financial scandal and the revelations of the carnage from same, one spouse merely replied: "Will Wall Street ever again have credibility? Write about that." The road back to credibility for the US financial system starts with hard choices. Last week, Sanderson State Bank, Sanderson, TX, was closed by the Texas Department of Banking. The FDIC was named receiver and entered into a purchase and assumption agreement with The Pecos County State Bank of Fort Stockton, TX, to assume all of Sanderson State Bank's deposits, including those that exceeded the deposit insurance limit.
At the time of the closure, $38 million asset Sanderson had an overall score of 21.0 vs. the industry average of 1.5 on the IRA Bank Stress Index, equaling an "F" rating on IRA's new quintile based ratings methodology. Sanderson had displayed above-peer risk scores for some time, while its operational efficiency was likewise below peer. At the time of the closure, Sanderson had 8.8% leverage, again illustrating the approach by state regulators and the FDIC of targeting institutions for resolution before they become visibly insolvent. Pecos County is a strong institution with an overall score of 0.8 vs. industry average of 1.5 on the IRA Bank Stress Index. That's an "A+" rating in IRA's new quintile based ratings methodology we just released. Keep up the good work Pecos.
In Georgia likewise the triage process continues. The $560 million asset Haven Trust Bank, Duluth, GA, was closed last week by the Georgia Department of Banking and Finance, and the FDIC was named receiver. The FDIC entered into a purchase and assumption agreement with Branch Banking & Trust, lead unit of BBT, to assume all of Haven Trust's deposits, including those that exceeded the insurance limit. The FDIC estimates that the cost to the Deposit Insurance Fund will be $200 million. Haven had a score of 21.5 on the IRA Bank Stress Index vs. the industry average of 1.5 on the IRA Bank Stress Index, equaling an "F" rating on IRA's new quintile based ratings methodology. A 21.5 is a bit more than one order of magnitude above the peer benchmark mean for the Stress Index of 1.5, so once again it is seen that a Stress Score greater than 10 is dangerous territory for banks.
Note the courageous stance taken at the local level with smaller institutions, where the state regulators and the FDIC work together to put the good assets into strong hands, thereby improving the overall stability of the system and in particular its ability to re-leverage and provide new credit to the private economy. It's not a happy task to resolve a bank and wipe-out bank shareholders, but that purifying process of closure and resolution by the FDIC enables new investors with new capital to make the failed banks assets productive and work for the entire economy. Then we have the example of the cowardly bailout model embraced by Treasury Secretary Designate Tim Geithner, Secretary of Treasury Hank Paulson, and the Federal Reserve Board in Washington. The rescue and subsidy of the Bear Stearns shareholders and creditors, as well as the ongoing and expanding support for AIG and dozens of other borrowers, are all examples of not dealing with the problem. Indeed, the Geithner/Paulson bailout model ensures a deep recession in the US and globally.
And Fed officials, in their myopia and political naïveté, are refusing to disclose to the public the details of the loans or even who the borrowers are! Hello? Memo to Bernanke and Geithner: The Fed is now the center of a three-ring political circus. The days when Fed operations could be shielded from full public disclosure, at least equal to the standard of openness mandated by law with respect to the TARP, are over. The Fed needs to get ahead of the issues raised by the Bloomberg News lawsuit seeking to force the central bank to disclose the identity of entities that have received Fed loans. The mounting congressional inquiry regarding executive compensation at AIG is just the tip of the iceberg of a political scandal that could engulf the Fed and destroy what remains of the central bank's credibility. Rep. Elijah E. Cummings (D-MD) claims of a "pattern of deception" at AIG may soon be made against the Fed itself unless Bernake et al "come clean."
As we noted in a comment in The Times of London, neither Geithner nor Bernanke have any authority legal to spend tax dollars, but that is precisely what the bailout model of political economy embraced by the Fed entails - expenditure without authorization nor deliberation by Congress. Some or all are of the loans made by the Fed could result in losses to the central bank, losses that must come out of the of revenues due to the Treasury. The Congress may even be forced to appropriate new capital for the reserve banks due to losses generated by the Geithner/Paulson bailout model. The open bank support for Citigroup is another case in point of the bailout model of political economy. What is the long-term plan for C? Does the Fed and/or OCC have a road map for how this open bank assistance will be concluded?
Q: Do you suppose that Bob Rubin finally will step down from C's board before the bank is placed into a resolution by the FDIC? Wouldn't it be remarkable if Rubin and the other Friends of Barack Obama on the C board of directors ended up as targets in an FDIC enforcement action after the Deposit Insurance Fund takes a loss on C? By law, when the FDIC takes a loss on a resolution and apparent malfeasance is involved, the bank directors usually face an enforcement action. Instead of hiding areas of weakness in the financial system from scrutiny, the Obama Administration should demand that C be broken up and sold, that AIG be placed into bankruptcy, and that any banks/dealers left insolvent by AIG's filing should be sold or resolved as well, including Goldman Sachs.
This is why we think that Barack Obama needs a new candidate for Treasury Secretary, We just don't think that Geithner has the integrity or the independence of mind to close and sell C, GS and the rest of the larger Wall Street banks if necessary, and pursue sanctions against the management and directors. If the President-elect wants a Treasury Secretary who understands what must be done to fix the US economy, we suggest FDIC chief Sheila Bair. Part of the reason we put the role of the FDIC and local regulators in such stark contrast to the loathsome and conflicted behavior we see in Washington and on Wall Street is that the Congress is rapidly approaching a crossroads when it comes to the next phase in the bailout, namely where and how to apply the further $350 billion in funds to help stabilize the banking system and then expand the aggregate supply of credit to support an economic rebound.
The good news is that the Fed's efforts to provide liquidity to the markets has stabilized the situation with respect to most financial institutions. This calm allows policy makers and regulators to make some informed judgments about the portions of the financial system that can be recapitalized and rebuilt, and those which should be resolved. We then need to move forward purposefully dealing with these two tasks, rebuilding and resolution. As Eric Hovde discussed in our recent interview ('On the Prime Solution: Interview with Eric Hovde', December 11, 2008), the place where the Congress needs to put the next $350 billion and more is supporting the real economy and the portion of the US banking system that can support risk and create new loans to support private business. We're not big fans of a bailout for the automakers, but in relative terms, literally giving away money to Detroit is better for the economy than "investing" a dollar more of further public funds in the large zombie money center banks like C and JPMorgan Chase.
As and when these two institutions again become capital constrained, in our view sometime next year, the FDIC should take them over, appoint new boards and then conduct an orderly liquidation. But if Barack Obama and the Congress want to get the US economy off its knees before the next election, then they must act more quickly and decisively when it comes to questions of solvency. Strong banks and companies can support a strong economy, but zombie banks with balance sheets polluted by OTC derivatives, subprime debt and other toxic waste are a drag on the taxpayer and the economy. The prime solution of driving the bad banks out of the system means a quicker recovery from the spreading economic malaise. But don't bet on Barack Obama taking such a road until he gets Bob Rubin, Larry Summers et al off his back. Until these architects of the policies which led to the current misery are sent packing, Barack Obama's recovery plan will have no credibility.
Ilargi: As I've noted, OPEC is an organization that cannot function in a crisis. The immediate needs of its members take priority over anything coming out of negotiations. "A glut is emerging": yes, they are all selling like mad men.
OPEC Losing Its Muscle
Despite its bluster about cutting production, the cartel has been unable to marshal its members to halt oil's sliding price.
OPEC's oil chiefs were almost begging to be taken seriously on the eve of their conference in Oran, Algeria. When Saudi Oil Minister Ali al-Naimi arrived at the Sheraton, a big glass-and-steel building in the hills above the city, he told the waiting scrum of reporters that OPEC planned to cut production by a big number. Sure enough, on Dec. 17, OPEC announced cuts that amounted to 2.2 million barrels a day. Unimpressed, the market for crude drifted lower, to around $40 (€28). This was the fourth meeting of OPEC since September. Two of them were hastily convened emergency sessions. Before Oran, the organization had announced 2 million barrels in cuts over the last three months. None of this has been enough to stem a plunge from the July peak of $147 per barrel. Despite the big cuts of Dec. 17, OPEC's hopes are modest. Its target may be $75 a barrel, but a delegate from the Gulf doubted the price would exceed $55 in the first half of 2009. "OPEC is turning into an increasingly irrelevant organization," said Sanford C. Bernstein analyst Neil McMahon on a recent conference call.
Why is OPEC's reputation taking such a hit? The market views it as having let things get out of control when prices were surging. Now the cartel can't seem to contain a downward slide, either. "I don't think they even have compliance on [the cuts] they've already done," says John Hall, a London-based analyst attending the conference. OPEC adopts production quotas for each of its members, but it rarely adheres to them. OPEC delegates reckon the 1.5 million- barrel-per-day cut announced in October reduced production by only 1 million barrels -- nearly all of it from Saudi Arabia. The situation recalls the late 1990s when a fractious OPEC watched prices hit record lows. Today the organization is trying to present a united front, but profound differences exist. On the one hand are the Saudis and other Persian Gulf states. They are the only countries with enough production capacity to make big cuts. Yet they don't want to inflict further damage on the global economy by forcing prices too high. Then there are the hardliners like Iran and Venezuela that want sharply higher prices to support their social programs. Crude prices are well below the $100 per barrel and $86 per barrel Venezuela and Iran need to pay their bills, according to Washington consultant PFC Energy.
As OPEC strives to retain its clout, a glut is emerging that could drive prices even lower. Off Iran's Kharg Island oil terminal are seven supertankers laden with Iranian crude. Iran is storing oil on board in hopes of higher prices later, according to an industry source. Worldwide, an estimated 21 ships are holding about 40 million barrels. At the end of October there were just five. That means producers have been churning out 750,000 to 1 million barrels a day for which there are no ready buyers. With the production cuts, OPEC is simply trying to avoid swamping the world with oil.
Credit-Card Users Feel Pain as U.S. Banks Reap Gain
Credit-card companies, facing an increase in defaults and a decline in consumer spending, are raising some rates, adding fees and cutting credit lines as the Federal Reserve makes the most sweeping changes to the industry in 30 years. The provisions, approved by the Fed today and effective July 1, 2010, may curtail lenders’ ability to raise interest rates on current balances, require they apply payments to charges with higher interest rates first and extend the time customers have to pay bills before incurring late fees. The Office of Thrift Supervision, which regulates savings and loans, and the National Credit Union Administration approved the rules today. The new rules come on the heels of a $700 billion federal bailout of the financial system, including $125 billion invested in the nine largest U.S. banks.
Recent moves by JPMorgan Chase & Co., Citigroup Inc. and other firms to add charges and decrease the amount of money cardholders can borrow at the same time they’re taking taxpayer dollars have angered some customers. "People are totally confused," said Mark Zandi, chief economist at Moody’s Corp.’s Economy.com. "The taxpayer is essentially a big owner in JPMorgan, Bank of America and Citigroup, and these are the folks who make credit-card loans. Many are asking, ‘So why is it that my credit-card loan got pulled? Why am I being charged a higher rate?’" A decline in spending by consumers and a rising number of defaults are leading Citigroup, JPMorgan and other lenders to increase fees and interest rates for some customers and cut the amount others can borrow. The changes are intended to reduce risk and raise revenue.
Among the new charges are those for transferring balances from one credit card to another. Many lenders cap the amount they charge for this service. Now some are doing away with that limit and charging a percentage of the total, said Bill Hardekopf, chief executive officer of Lowcards.com, a Web site for consumers. Some banks are increasing fees for making purchases abroad. Financial institutions also are expected to slash $2 trillion in credit-card lines in the next 18 months, Oppenheimer & Co. analyst Meredith Whitney wrote in a Nov. 30 report. The changes are angering customers like Craig Marx, who has had a Chase card for 10 years and recently saw his minimum monthly payments climb to 5 percent from 2 percent and a monthly $10 service charge added to his bill. The bank also raised his rate from 3.99 percent above prime to 7.99 percent for the next two years, after which time it would become variable. "I’m incensed," the 52-year-old Palo Alto, California, resident said. "I feel like they’re making a calculated decision to make me go away as a customer."
Stephanie Jacobson, a spokeswoman for JPMorgan’s card unit, declined to comment on a specific customer. In general, the situation Marx described involved a choice of either accepting the rate change or the service fee, she said. JPMorgan, which received a $25 billion capital infusion from the Treasury Department in October, says its credit-card lending increased by 3 percent in the third quarter from the previous quarter. CEO Jamie Dimon, 52, said in a Dec. 11 interview on CNBC that the company was using government money to "do exactly what they want us to do, make more loans, help the economy grow." Citigroup spokesman Samuel Wang said in an e-mailed statement that the bank is adjusting rates for customers who haven’t been repriced in at least two years and that cardholders can choose not to accept the changes. If they do so, the bank can take the card away when it expires. The Fed rules, proposed in May, were offered in response to criticism from Congress that the central bank was neglecting its authority to prevent abusive lending and strengthen consumer protections. It mirrors congressional efforts to curb practices that lawmakers say are harming consumers. Plans have been introduced by Senate Banking Committee Chairman Christopher Dodd and Representative Carolyn Maloney, a New York Democrat.
Rules curtailing some of the lending practices could hurt bank performance. Although many banks have other sources of revenue, a decrease in credit-card income "would seriously weaken a bank’s ability to absorb other shocks," Gregory Larkin, senior banking analyst at Innovest Strategic Value Advisors in New York, wrote in an October 2008 research report. "Fees are a very, very important part of how issuers make money," Hardekopf of Lowcards.com said. "Issuers make over a third of their money on the fees that are charged." Innovest said that credit-card charge-offs could hit $18.6 billion in the first quarter of next year, and $96 billion by the end of the year, forcing banks to search for other ways to generate revenue from customers. Delinquencies tend to follow unemployment, which were 554,000 first-time claims in the week ended Dec. 13, near a 26- year high reached the week before. Net worth for U.S. households and nonprofit groups fell $2.81 trillion from July to September, the most since tracking began in 1952. That means consumers are more strapped for cash, contributing to a slowdown in spending, which accounts for two-thirds of the economy.
"Banks are getting hit on several fronts right now from the losses in their investments, losses around mortgages and even generally from a consumer-confidence perspective," said Eva Weber, an analyst at Aite Group LLC in San Antonio who follows bank regulatory and compliance issues. "Banks will need to reconfigure their business strategies and their risk-management strategies to account for the losses that they’re going to incur from the rules on interest rates and fees." Cardholders had $962 billion in unpaid balances on general purpose and proprietary cards at the end of 2007, an 8.6 percent increase from the previous year, according to the Nilson Report, an industry newsletter. That figure is expected to climb to $1.2 trillion by the end of 2012, or $6,373 per cardholder. "Credit card rules, which we all understand address consumer concerns, the Fed recognizes that it will decrease the amount of credit available," Edward Yingling, chief executive officer of the American Bankers Association, said in an interview yesterday.
Three analysts in the past week have recommended selling shares of American Express Co., while only four of 24 analysts have "buy" ratings, according to Bloomberg data. Friedman Billings Ramsey & Co. analyst Scott Valentin lowered his share- price target on Dec. 16 and reiterated his "underperform" rating, in part, he wrote, because of a "regulatory burden from increased oversight." American Express spokeswoman Joanna Lambert said that while the new rules will have an impact on the company’s business, only 20 percent of its sales come from interest on loans. Most of its revenue is generated by fees from transactions between consumers and merchants and from commissions, which aren’t being addressed by the Fed. "We are in a better position than many of our competitors because we are less reliant on the credit end of our business," Lambert said in an interview. Some say the Fed rules will be good for credit-card companies as well as consumers. "It will force them to be smart about who they make credit available to," said Chris Armbruster, an analyst at Al Frank Asset Management in Laguna Beach, California, which oversees about $550 million, including shares of JPMorgan, Citigroup, America Express, Capital One Financial Corp. and Advanta Corp. "It should, over time, create fewer nonperforming assets, fewer charge-offs."
The Fed's Fierce Battle Plan
This is war. On Dec. 16, the Federal Reserve announced it was stepping up what amounts to a shock-and-awe campaign against the most dangerous economic downturn in decades. In an unprecedented move, the Fed cut its short-term interest rate target to essentially zero while committing to buy mortgage bonds and other assets on a massive scale. The goal: to provide cheaper credit to every part of the economy, starting with housing. Fed Chairman Ben Bernanke initially underestimated the fast-moving crisis, but now he's deadly serious. As a student of the Great Depression, Bernanke does not want to go down in history as the Fed chairman who allowed the U.S.—and possibly the world—to slip into the worst slump since the 1930s.
Will the new battle plan work? Most likely yes—eventually. The Fed's monetary weaponry, in combination with the fiscal artillery of the incoming Obama Administration, are so potent that if they are used to their full extent they can almost certainly generate an economic recovery, potentially starting in the second half of 2009. The problem is that today's all-out attack on recession may well generate a surge of unwanted inflation in 2010 or after. But the Fed seems to regard that as an acceptable price to pay to avoid disaster now. True, the Fed has finally reached the end of the line on cutting rates—they can't go below zero. But it remains essentially unlimited in how much it can stimulate the housing market and broader economy by buying up mortgage-backed securities, Fannie Mae and Freddie Mac corporate debt, and other assets. The Fed's early efforts are already showing some success. Since it said in late November that it would buy such securities, 30-year mortgage rates have fallen to 5.2% from 6%, and refinance applications have more than tripled. The Dec. 16 announcement will greatly expand these purchases.
What's more, starting in early 2009, the Fed will pump money into markets for student, auto, credit-card, and small-business loans in hopes of helping those parts of the economy. All told, the Fed's assets—a measure of how much the Fed has lent, directly and indirectly—could go as high as $5 trillion, says Ed Yardeni of Yardeni Research. That's up from $2.2 trillion now. And the range of assets the Fed is permitted to acquire in an emergency is almost unlimited. "It could buy a herd of cattle in Texas if it so desired," says Paul Ashworth, senior economist in the Toronto office of consultant Capital Economics. These moves are so sweeping that they almost overshadow what would ordinarily be the biggest news of all: the Fed's Dec. 16 cut in its target federal funds rate to a range from zero up to 0.25%, the lowest in its history. The funds rate is what banks charge each other for loans to meet reserve requirements. In fact, the Fed's target had become irrelevant in recent weeks because what banks actually charge each other for those loans had already fallen to almost zero. That's because of the huge surplus of reserves that the Fed has injected into the financial system.
Critics of the Fed say the central bank is running unacceptable risks of losses by itself and ultimately by taxpayers while propping up an unsustainable reliance on debt. "It's 100% wrong. It's going to make the situation worse," says Peter Schiff of Euro Pacific Capital, a brokerage in Darien, Conn. "In the short run, it does postpone some of the pain, but the economy is going to be in worse shape a year from now. Eventually we will have hyperinflation, where the dollar loses almost all its value." That, however, is a minority view. Most economists think that inflation is the last thing the Fed needs to worry about right now. According to New York University economist Mark L. Gertler, who collaborated with Bernanke on research during the Fed chief's Princeton years: "We are in an incredibly dangerous situation. Now is the time to be aggressive. There's no danger of inflation. It's almost insane that people are talking about it now." Even with all the Fed's heroic measures, predicts Merrill Lynch senior economist Drew Matus, "the recession is going to be a long one, and the recovery is not going to be a big one."
One reason for optimism—mild optimism, anyway—is that Bernanke has learned from the mistakes committed by the Fed during the Depression and the Bank of Japan during that nation's Lost Decade of the 1990s. In 1999, when he could afford to be undiplomatic, Bernanke asked in a book he contributed to whether Japan's monetary policy was "a case of self-induced paralysis," and he praised President Franklin D. Roosevelt's "willingness to be aggressive and to experiment." When the economy does begin to recover, perhaps in the second half of 2009 or possibly later, the Fed will have a very different problem on its hands: how to soak up all of the excess liquidity it has created so it doesn't stoke inflation or some new asset bubble. In a Dec. 17 research note, Yardeni wrote: "After one bubble bursts, the only way to get out of the resulting recession, and to avoid a depression, is to create another bubble." That's not what anyone wants, but it's certainly better than the alternative—a downturn that would rival the Great Depression.
Federal Reserve is damned either way as it battles debt and deflation
We know what causes a recession to metastasize into a slump. Irving Fisher, the paramount US economist of the inter-war years, wrote the text in 1933: "Debt-Deflation Theory of Great Depressions". "Such a disaster is somewhat like the capsizing of a ship which, under ordinary conditions is always near stable equilibrium but which, after being tipped beyond a certain angle, has no longer this tendency to return to equilibrium, but a tendency to depart further from it," he said. Today we call this "Gladwell's tipping point". Once it goes, you can't get back up. This is why the Federal Reserve has resorted to emergency measures that seem mad at first sight. It has not only cut rates to near zero for the first time in US history, it is also conjuring $2 trillion of stimulus out of thin air. This is Quantitative Easing, or just plain 'QE' in our brave new world. The key is the toxic mix of high debt and deflation. An economy can handle one at a time, but not both.
The reason why it "departs further" from equilibrium is more or less understood. The burden of debt increases as prices fall, creating self-feeding spiral. This is what Fisher called the "swelling dollar" effect. Real debt costs rose by 40pc from 1929 to early 1933 by his count. Debtors suffocated to death. Brian Reading from Lombard Street Research has revived this neglected thesis and come up with some disturbing figures. US household debt is now $13.9 trillion, down just 1pc from its peak last year. Meanwhile household wealth has fallen 14pc as property crashes, a loss of $6.67 trillion. The debt-to-wealth ratio is rocketing. Clearly the US is already in the grip of debt-deflation. "The obvious conclusion is that the Fed should print money to purchase private sector assets so as to drive up their price," he said.
Fed chief Ben Bernanke does not need prompting. He made his name as a Princeton professor studying the "credit channel" causes of depressions. Now fate has put him in charge of the channel. Under his guidance, the Fed has this week pledged to "employ all available tools" to stave off deflation - and damn the torpedoes. It will purchase "large quantities of agency debt and mortgage-backed securities." It will evaluate "the potential benefits of purchasing longer-term Treasury securities," i.e, printing money to pay the Pentagon. Put bluntly, the Fed is deliberately stoking inflation. At some point it will succeed. Then the risk flips quickly to spiralling inflation as the elastic snaps back. There will be a second point of danger.
By late 2009, if not before, the bond vigilantes may start to fret about the liquidity lake. They will worry that the Fed may have to start feeding its holdings of debt back onto the market. The Fed's balance sheet has already risen from $800bn in September to $2.2 trillion this month. It will be $3 trillion by early next year.
"The bond markets could go into free fall," said Marc Ostwald from Monument Securities. "The Fed went into this all guns blazing just as the Neo-cons went into Iraq thinking it was a great idea to get rid of Saddam, without planning an exit strategy. As soon as we get the first uptick in inflation, the markets are going to turn and say this is what we feared would happen all along. Then what?" he said. New Star's Simon Ward said all three measures of the US broad money supply are flashing recovery. M2 has risen at annual rate of 17pc over three months. "It has all changed since the Fed began buying commercial paper in October. If the money supply is booming at 20pc in six months, inflation will become a concern. Given that public debt ratios are already on an explosive path, we risk a debt trap," he said. For now, the bond markets are quiet. Futures contracts are pricing five years of deflation in the US. Yields on 10-year US Treasuries have halved since early November to 2.09pc, the lowest since the Fed's data began. Three-month dollar LIBOR has plummeted to 1.53pc.
It is the same pattern across the world. 10-year yields have fallen to 1.27pc in Japan, 3pc in Germany, 3.2pc in Britain, and 3.49pc in France. The bond markets seem to be betting that emergency action by central banks will take a very long time to work, if it works at all. By cutting to zero, the Fed has come close to shutting down the US 'repo' market that plays a crucial role in providing liquidity. It has caused havoc to the $3.5 trillion money markets - as the Bank of Japan, burned by experienced, had warned. It has become even harder for banks to raise money. Some argue that extreme monetary policy is already doing more harm than good. Mr Bernanke is known for his "helicopter speech" in November 2002, when he nonchalantly talked of the Fed's "printing press" and said it was the easiest thing in the world to "reverse deflation." Less known is his joint-paper in 2004 - "Monetary Policy Alternatives at the zero-bound". By then doubts were creeping in. He admitted to "considerable uncertainty" as to whether extreme tools will actually work. Liquidity could fail to gain traction. Put another way, the Fed is flying by the seat of its pants. It should never have let debt grow to such grotesque levels in the first place.
Credit Suisse to pay bonuses in toxic debt
Credit Suisse has hatched a cunning plan to avoid public condemnation over executive bonuses this year: it is going to pay top managers not in cash, but in the toxic mortgage assets that caused the credit crisis. Thousands of managing directors and directors will be handed a slice of a new internal hedge fund, into which the bank is transferring some of its $5bn (£3.3bn) in illiquid investments. These are the complex mortgage derivatives and leveraged loans whose collapsing value has cost the global finance industry $800bn in writedowns in the past 18 months, triggered recessions around the world and caused a public outcry over Wall Street excess.
Credit Suisse is the first bank to use the debt to pay employees, who were told about the plan in a memo from Brady Dougan, the chief executive, and Paul Calello, the head of the Zurich-based investment bank. "While the solution we have come up with may not be ideal for everyone, we believe it strikes the appropriate balance among the interests of our employees, shareholders and regulators and helps position us well for 2009," they wrote. The new Partner Asset Facility is expected to be run as a mini-hedge fund and could take on debt of its own from Credit Suisse. If the troubled assets rebound in value, employees stand to gain from future payments; if they decline, it will be the value of employee bonuses that will be eroded – Credit Suisse will not have to book the losses.
This makes the scheme particularly attractive for a bank that has been struggling to offload tens of billions of dollars of illiquid credit instruments. Participants in the fund will receive a small twice-yearly interest payment on the bonus, but will only be able to get their hands on the cash in five years, if the fund has any value left. Credit Suisse's move is the biggest shock so far in an already-traumatic bonus season for Wall Street employees. Most banks are significantly scaling back the size of their payouts, even for relatively junior employees, and the payments are more likely to be made in shares than in cash this year.
Goldman Sachs was reported yesterday to have slashed the value of bonuses to its partners by 80 per cent after reporting its first quarterly loss since the Great Depression. Credit Suisse said earlier this month that it would cut 5,300 jobs and cancel bonuses for top executives after saying it suffered new losses totalling $2.8bn in October and November.
Nationalisation looms for Britain's banks as they face 'Prisoner's Dilemma'
"I am in no doubt that the single most pressing challenge to domestic economic policy is to get the banking system lending in any normal sense. That is more important than anything else at present." Tax cuts, interest rate stimulus, a public spending binge – none of it, in the mind of Bank of England Governor Mervyn King, is as important to hauling Britain back from the abyss as getting the banks lending again. Moreover, his opinion is rapidly becoming the consensus. Chancellor Alistair Darling and his opposite number George Osborne agree, albeit acrimoniously, on the issue. Peter Mandelson wants "bankers to start being good, plain bankers again". Even the venerable UBS economist George Magnus, who predicted the financial crisis, concurs. "It is very important that those credit flows be kept open," he said. "Restructuring of debt is a critical part of the healing process. Debt forgiveness might even be necessary."
The thinking goes that by extending credit lines, banks can keep viable but limping businesses and households alive through the recession. Fewer jobs will be lost and the economy will recover more quickly. Arguably, such behaviour is better for banks, too, as a recovering economy will mean fewer defaults. Higher levels of lending, though, risk more bad debts – reviving concerns about capital despite the £50bn round of fundraisings, £37bn from the state. In the context of fending off another great recession, however, those fears are a side show. Charlie Bean, the central bank's new Deputy Governor, said: "It may well turn out that further capital injections are required." Tossing such loaded comments around so freely demonstrates there is little resistance to the idea among policymakers. The private sector could be asked to chip in, but banks are more likely to come back to the taxpayer a second time. Tellingly, Mr King has refused to rule out full nationalisation.
The problem is, as Mr King told the Treasury Select Committee last month, that a lending-led economic rescue plan only works if banks act "collectively" – anathema to free market capitalism. As he describes it, lenders are effectively trapped in a classic Prisoner's Dilemma. "Individually, it makes sense ... to behave defensively and reduce the size of their balance sheet," Mr King said to MPs on the select committee. "Collectively, it makes no sense at all because if all banks behave in that way not only will the economy go into a steep recession but the banks themselves will see even bigger losses on their pre-existing loans. "The challenge we have to confront in dealing with the banks is to find a way in which their individual incentives do not lead to a collective outcome that is clearly adverse."
From the banks' perspective, all this must be pretty confusing. Pilloried for their reckless lending before, they are now being actively encouraged to load faltering businesses with credit on a scale far greater than that mapped into their business plans at the time of the recapitalisation in October. The request goes against all the basic principles of good banking. Going into a downturn, banks need to conserve their capital because they have no idea how long the recession will last. Every bad loan made today piles on top of the shoddy lending in the books already, eroding reserves and weakening the lenders. Having just been recapitalised at punitive cost to both the taxpayer and shareholders, it might seem forgivable that the banks want to make the money last as long as possible. Particularly given the unknown dangers still lurking in the shadow banking market, the murky financial world where sub-prime monsters – disguised as collateralised debt obligations – roamed.
Credit defaults swaps (CDSs) – insurance products against companies going bust – are the shadow banking market's "bête noire", according to Mr Magnus. The value of all derivatives, including CDSs, last year was around $600,000bn (£387,000bn) – 10 times the size of the global economy. Although the default risk is a tiny fraction of the total, it is impossible to calculate the black hole of potential losses because no derivatives are exchange traded. Economic historian Niall Ferguson, author of The Ascent of Money, fears CDSs will cause a financial crisis next year the likes of which will make 2008 look like a training session. He is an increasingly lone voice but nobody is wholly comfortable with the opaque derivatives market. Even if CDSs don't blow up, the banks face a possible leveraged finance crisis. In 2006, the volume of leveraged buy-outs around the world peaked at $753bn. Much of the lending was done on a five-year timescale, with vast quantities due to be refinanced in 2010 and 2011. By then, these over-indebted companies will look far less enticing prospects. If banks want the debt off their books, they will have to take much deeper writedowns than they have to date.
Britain's banks have less exposure than their US rivals, but the numbers are still jaw-dropping. At the half year, the Royal Bank of Scotland had £10.8bn and Barclays £7.3bn of leveraged loans outstanding. In a variance of the "mark-to-market" accounting policy, one banker described the two banks' current provisioning as "mark-to-myth". Running in tandem with these potential risks is the very real cost of a recession. HBOS last week gave some warning of just how dire things may get by revealing £3bn of bad debts in the past two months alone. Given the potential pressure on balance sheets, it is no surprise the banks want to hoard their capital. Small businesses and households will not be utmost in their minds. The problem is that banks have outgrown themselves. They are now so vital to the economy, politicians believe, that they can not be allowed to operate in their own myopic, commercial interests. It is no surprise that RBS, now 58pc-owned by the state, has taken the lead on lending to small businesses and homeowners, and is brandished by the Treasury as an example to the industry.
Politicians are making little effort to disguise their belief that banks are a tool of economic policy. John McFall, chairman of the Treasury Select Committee, has urged the Prime Minister to get the banks "into a room and collectively and simultaneously ensure that they resume lending". For Willem Buiter, a former member of the Bank of England's Monetary Policy Committee, new regulation could reduce banks to little more than a utility, like gas and electricity. If the dogma holds that they must do "their bit" for the economy and the feared crises do manifest themselves, he may be proved right sooner than expected.
Sterling slide is worst since 1931
The pound is suffering its worst slide since Britain was forced off the gold standard in 1931. Sterling dipped closer to parity against the euro, with the single currency now worth more than 95p for the first time ever. The pound's fall came amid fast-growing disquiet about the fate of the UK economy and consumer sentiment next year. The pound has now fallen by 23pc against a basket of other currencies, according to figures from the Bank of England. The fall is sharper than the devaluations in 1992, after leaving the Exchange Rate Mechanism, 1976, when the International Monetary Fund was forced to intervene, and 1949, when a host of countries slumped against the dollar.
The devaluation is only matched by the moment in 1931 when, under Ramsay MacDonald, the UK was forced to abandon the gold standard, plunging by more than 24pc against the dollar. The parallel is significant, since many economists have attributed the gold standard exit as one of the main reasons the UK enjoyed a relatively mild depression in the 1930s, while the US suffered mass unemployment and saw its economy shrink by a third. The pound had fallen more than 1? pence against the euro yesterday and was trading at 93.57 by late morning on Friday. Late last night it fell as low as 95p, with the pound buying €1.047. Traders are increasingly convinced that the Bank of England will follow in the Federal Reserve's footsteps and cut interest rates all the way to zero by early next year.
Such suspicions were underlined as the Bank's deputy governor, Charlie Bean, said: "We have to recognise that [zero interest rates are] a possibility... the bank rate, is still at 2pc, so we still have some margin to go yet, but of course we may find ourselves getting them all the way to near zero." Shadow Chancellor George Osborne pointed out that in 1992 Gordon Brown himself said: "A weak currency arises from a weak economy which in turn is the result of a weak Government." Mr Osborne said the apparently relentless fall in sterling was "the verdict of the international markets on this Government's economic record." Although some are warning of a full-blown sterling crisis, the Bank believes that the fall in the pound, provided it does not accelerate, could benefit the economy by pushing up exports and boosting UK revenues in the coming years.
It may also prevent rates from having to fall to zero, since a weaker currency tends to generate inflation. Importantly, investors are not shunning UK government bonds, indicating that they have not yet lost faith in the authorities' ability to deal with the economic crisis. However, Simon Ward, economist at New Star, warned that the depreciation would not necessarily be the boon politicians hoped. Although the economy recovered significantly in the wake of the ERM exit in 1992, he warned that this time around the UK banking sector's reliance on foreign funding could prove an Achilles heel. If the pound's fall triggers an exodus of investors from the financial sector, he said, the UK could find itself in a similar position to Thailand, which had to submit to the IMF after the baht collapsed in 1997.
Gordon Brown says Britain to be 'beacon of hope' amid credit crisis
Gordon Brown called for Britain to be a "beacon of hope" amid the turmoil of the global economic downturn. In his final Downing Street press conference of 2008, the Prime Minister said he would be setting out ambitious plans in the New Year so that Britain is ready when the economy picks up again. "These are uncertain and difficult times but Britain can and must be a beacon of hope and opportunity for the future," he said. "The scale of the challenges that we face is matched by the strength of my optimism that Britain can rise to meet these challenges. "With our fighting spirit and our can-do attitude, I am confident that we can meet all the challenges ahead."
Mr Brown said the Government would be bringing forward measures for "smart investment" in "green" jobs and the digital economy. There would also be investment in transport, with a decision on a third runway at Heathrow in the New Year, and on alternatives to oil, including nuclear power. There would be measures too on retraining, social mobility, and reform of the banking system. "An economic slowdown must not be an excuse to slow down the pace of investment and reform to strengthen our country for the future," he said. "The countries that invest through the downturn will be the countries that emerge stronger in the future. "There is no credible plan for getting out of this downturn that is not also a plan for building a better long-term British economy."
Mr Brown blamed international factors for the slump in Britain, insisting the country had been "the victim of a global downturn". He said it was "unfortunate" that the UK had been "unable to avoid being affected" by events elsewhere. "We face problems, many of which we have not control over," he said. The Prime Minister also took a swipe at commentators who had written him off earlier this year amid dreadful poll ratings and internal strife in the Labour party. "In my view what 2008 has taught us is that the public has less interest in the minutiae, the trivia of everyday events, of the personalities and the conflicts, in Westminster," he said. "What they really want are governments that can actually get on with the job and do what they intend to do, and that's give real help to families and businesses."
The biggest Ponzi scheme: Bernard Madoff's or the British Government's?
Just as Bernard Madoff is alleged to have relied on payments in from new investors to pay out returns and promote a $50 billion (£33 billion) fund that scarcely existed, our Government continues to issue promises which it hopes future generations will honour. Christmas came early this week for 95,000 public sector pensioners. After questioning in the House of Commons, Cabinet Office Minister Liam Byrne admitted that they had been overpaid a total of £126m since 1978 but emphasised that they would not be required to pay the money back. Particularly at this time of year, it makes a pleasant change to see some pensioners actually gaining from the sort of bureaucratic bungling with which we are now so wearily familiar and utterly fed up.
All things considered, most people will be willing to set aside any Scrooge-like tendency to ponder upon who is paying for the politician to pose as Santa. However, a slight chill is placed on this cheery scene when you consider the uncertainty which these pensioners now face over what they will have to live on next year after their incomes are cut to the correct level. Perhaps equally galling, from the point of view of the majority who live in England, is the news from Scotland that the minority who are in receipt of overpayments north of the border will continue to be overpaid for as long as they live. Good for them, you may very well say. After all, students receive grants in Scotland which are no longer available in England and the elderly receive free long term care up there, while means tests force tens of thousands of family homes to be sold south of the border.
English voters and taxpayers seem quite happy to put up with our Scottish rulers, Prime Minister Gordon Brown and Chancellor Alistair Darling, applying different fiscal regimes to different parts of the United Kingdom. "Yo ho ho!", we seem to say, as they grimly raise taxes in the south and cheerily spend them in the north. Or perhaps it is all an inevitable result of having a parliament in Edinburgh as well as London. Speaking as a deracinated Jock, I have no wish to start a row with the rest of the Cowie clan just a few days before Hogmanay. Instead, I will merely risk irritating my wife by pointing out how this case demonstrates – once again – how differently pensioners are treated in the public and private sectors. There would have been no question of airily writing off or agreeing to forget the trivial sum of £126m had the good old taxpayer not been available to pick up the bill.
Steve Bee, head of pensions at – appropriately enough – Scottish Life, told me: "These pensioners are lucky that public sector schemes are not covered by the same legislation that governs private sector schemes, which are required by law to pursue any overpayment of more than £250. "If a private sector pension failed to pursue the overpayment – or did so unsuccessfully – then a minimum 40pc unauthorised payment surcharge would be levied by HM Revenue & Customs on the member but that could rise to 55pc." Over at wealth managers Hargreaves Lansdown, Tom McPhail - yes, another deracinated Jock, we really are everywhere - cites several cases where companies have pursued pensioners for overpayments and others where the Ombudsman has intervened on the side of compassion. He added: "But mistakes in the calculation of a few tens of thousands of pensions pale into insignificance when you consider this week's estimate by the Confederation of British Industry (CBI) that public sector pensions will cost taxpayers in future £1 trillion - or £1,000 billion - to deliver."
Regular readers will know that the explanation is these are final salary or defined contribution pensions, which are so expensive to fund that they are rapidly disappearing in the private sector. Because these public sector schemes are either inadequately funded or completely unfunded - that is, having insufficient or no money set aside to pay pensions in future - children who have not yet been born will have to pay more tax decades hence to deliver promises already made to people on the public payroll now. Put like that, Bernard Madoff, the alleged fraudster arrested in New York this week, is nowhere near running the biggest Ponzi scheme ever; that dubious title would have to be awarded much closer to home. Just as he is alleged to have relied on payments in from new investors to pay out returns and promote a $50 billion (£33 billion) fund that scarcely existed, our Government continues to issue promises which it hopes future generations will honour. If the whole bill for public sector pension rights already accrued fell on today's taxpayers, it would amount to £32,000 per person.
I have been banging on about this scandal for more years than I care to remember but it is good to see the CBI doing its bit to raise awareness. When I called it a form of "financial apartheid" in a journalistic attempt to turn up the volume on a complex subject several years ago, I may even have been the first to do so. Either way, it was pleasing to see Conservative leader David Cameron use that phrase when he tackled the topic last month and said the two-tier system must end. However, as my wife - a proud civil servant - never fails to remind me when I am reckless enough to stray onto this topic, many people working in the public sector do so for modest wages and risk-free pensions help to make up for that fact. Certainly, if Mr Cameron wishes to reduce their contractual rights in any way he would have to lead by example. MPs have some of the most lavishly-funded, index-linked, final salary schemes in existence and so it would be unwise to hold your breath.
Now I think about it, when I suggested to two senior Tories that they could demonstrate the difference between them and the Government by asking for Opposition MPs' pensions to be calculated on the same money purchase or defined benefit system which is rapidly becoming the norm for their constituents. Both MPs reacted in the same way. They laughed. Here and now, the important point is that far too many people spend the final years of their lives in poverty. Many more will do so in future if current trends continue. Widespread and understandable cynicism about savings and investments rather misses the point that you can opt out of saving but you cannot opt out of growing old. The Government must stop loading stealth taxes on savers - most outrageously the £5bn a year tax on retirement funds' dividend income but also the age allowance clawback and 10pc tax trap on trivial income from deposits, described here last week. Means-tested benefits disguised as tax credits are a pointless paperchase which fail to reach millions of those who need them most. The simplest way forward is for all pensioners to be allowed to receive tax-free income from savings.
Wall Street insiders had shunned Madoff for years
Numerous investors and banks across Wall Street refused to deal with Bernard Madoff for several years before his ultimate arrest on fraud charges, amid widespread rumours of suspect activity at his broking and fund management business, it is becoming clear. And in an explosive new revelation, Wall Street's chief regulator, the Securities and Exchange Commission, actually investigated the rumours and discovered that Mr Madoff had lied to its officials – but gave him no more than a private rap on the knuckles. As more investors in Europe and the US came forward yesterday to admit losses in the finance industry's biggest-ever fraud, investigators are hearing numerous tales from market participants who had long believed that Mr Madoff's impressive track record was being faked. Astonishingly, many of these participants invested with Mr Madoff.
According to documents sent to the SEC in 2005 by Harry Markopolos, the Boston accountant who first raised red flags about Mr Madoff in 1999 and finally got the regulator to launch an investigation more than six years later, several hedge fund managers who were funnelling money into Madoff Investment Securities said they thought the Wall Street veteran was "subsidising" investment returns in down months and "eating the losses" to make his results seem smoother and less risky. Mr Madoff was arrested last Thursday after confessing to two sons who worked in the broker-dealer arm of the family business that his investment management returns were "all just one big lie", saying his fraud could have cost investors $50bn. That would make it the biggest-ever so-called Ponzi scheme. In such a fraud, a money manager simply pays existing clients with money coming in from new ones.
A Wall Street veteran for almost 50 years, and a founder and former chairman of the Nasdaq stock exchange, Mr Madoff was widely respected. But there were many who were suspicious of the secrecy with which he guarded his investment technique. The system he said he used, buying shares and trading options, could not mathematically have produced the returns he claimed, many people thought. According to one widespread rumour, he was using insider trading at his broker-dealer business to juice returns. The SEC investigated that rumour, among others, in 2005, in an inquiry that took in concerns that Mr Madoff operated as a "white label" hedge fund, running money on behalf of other funds without that fact being disclosed to their investors. The SEC also took extensive testimony from Mr Markopolos, who had told them years earlier that – most likely – Mr Madoff was running "the world's largest Ponzi scheme". The conclusion was that Mr Madoff was indeed evading disclosure rules, and the SEC forced him to register formally as an investment adviser, which would open him up to regular inspections by the organisation – but it did not subpoena documents or dig further.
In his testimony, Mr Markopolos had warned the SEC: "I've found that wherever there is one cockroach in plain sight, many more are lurking behind the corner out of plain view." The SEC has launched an internal investigation into its failures in the Madoff case. Donald Langevoort, law professor at Georgetown University and a former special counsel at the SEC, said the latest revelations were "dumbfounding". He said: "What we've learnt is that the SEC actually investigated whether Mr Madoff was running a Ponzi scheme. They took aim at exactly the right target. And they missed." The SEC and the FBI were continuing to examine documents at Mr Madoff's offices in Midtown Manhattan yesterday. They are focusing on the role of his wife, Ruth. Mrs Madoff, who has a degree in nutrition, co-edited a cookbook in 1996 called The Great Chefs of America Cook Kosher, but she was also involved in the family business and investigators are examining if she kept secret records tracking payments. Her lawyer said she had not been charged with any wrongdoing.
New SEC chief gave Bernard Madoff's son a job
Mary Schapiro, Barack Obama's choice to lead the Securities and Exchange Commission (SEC), previously appointed one of Bernard Madoff's sons to a regulatory body that oversees American securities firms. It has emerged that in 2001, Ms Schapiro, currently chief executive of the Financial Industry Regulatory Authority (Finra), employed Mark Madoff to serve on the board of the National Adjudicatory Council — the division that reviews disciplinary decisions made by Finra. Last week, Mark Madoff, with his brother, Andrew, were understood to have approached the authorities after their father apparently confessed to orchestrating a $50 billion securities fraud. Mr Madoff is under house arrest in his $7 million Manhattan apartment and will be electronically tagged after he failed to secure further signatories to guarantee his $10 million bail. Both sons have emphatically denied any involvement in what could be the biggest fraud perpetrated by an individual. However, the link with Mark Madoff may prove controversial for Ms Schapiro and the President-elect, who has moved fast to replace Christopher Cox, the current head of the SEC. The watchdog has came under fire for failing to detect Mr Madoff's activities.
Earlier this week, Mr Cox admitted the regulator had repeatedly failed to follow up on tip-offs about Mr Madoff's business dealings. At the time of Mark Madoff's appointment, Ms Schapiro was serving as president of the National Association of Securities Dealers (NASD), according to the Wall Street Journal, which was consolidated with the New York Stock Exchange Member Regulation in 2007 to form Finra. She has served as a commissioner of the SEC under three administrations since the 1980s: President Reagan appointed her in 1988, she returned for the first President Bush in 1989, and she was named acting chairman by President Clinton in 1993. Ms Schapiro chaired the Commodities Future Trading Commission in the mid-1990s, during the downfall of Barings Bank, and first joined NASD in 1996 as president of regulation. Mr Madoff was himself closely involved in NASD, the self-regulatory organisation for brokers and dealer firms, in the 1970s.
The NASD went on to found Nasdaq, the screen-based equity exchange, in 1971, and Mr Madoff became its chairman in 1990. Mark Madoff began working at his father's firm, Bernard L. Madoff Securities, in 1986. He was the third member of Mr Madoff's family to join the business, following his uncle, Peter Madoff, and his cousin, Charles Wiener, son of Bernard's sister, Sandra. Andrew Madoff, his younger brother, followed in 1988, and Roger and Shana, children of Peter Madoff, joined in the 1990s. It emerged yesterday that Shana Madoff's relationship with her husband, Eric Swanson, is at the centre of an SEC probe. Mr Swanson is a former SEC attorney. In a profile of the Madoff family, published in 2000, Mark Madoff said: "What makes it fun for all of us is to walk into the office in the morning and see the rest of your family sitting there. That's a good feeling to have. To Bernie and Peter, that's what it's all about."
Tax Break May Have Helped Cause Housing Bubble
"Tonight, I propose a new tax cut for homeownership that says to every middle-income working family in this country, if you sell your home, you will not have to pay a capital gains tax on it ever — not ever."
— President Bill Clinton, at the 1996 Democratic National Convention
Ryan J. Wampler had never made much money selling his own homes. Starting in 1999, however, he began to do very well. Three times in eight years, Mr. Wampler — himself a home builder and developer — sold his home in the Phoenix area, always for a nice profit. With prices in Phoenix soaring, he made almost $700,000 on the three sales. And thanks to a tax break proposed by President Bill Clinton and approved by Congress in 1997, he did not have to pay tax on most of that profit. It was a break that had not been available to generations of Americans before him. The benefits also did not apply to other investments, be they stocks, bonds or stakes in a small business. Those gains were all taxed at rates of up to 20 percent.
The different tax treatments gave people a new incentive to plow ever more money into real estate, and they did so. "When you give that big an incentive for people to buy and sell homes," said Mr. Wampler, 44, a mild-mannered native of Phoenix who has two children, "they are going to buy and sell homes." By itself, the change in the tax law did not cause the housing bubble, economists say. Several other factors — a relaxation of lending standards, a failure by regulators to intervene, a sharp decline in interest rates and a collective belief that house prices could never fall — probably played larger roles. But many economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade than it would have been without the law.
Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for "fueling the mother of all housing bubbles." By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than as a place to live. It helped change the national conversation about housing. Not only did real estate look like a can’t-miss investment for much of the last decade, it was also a tax-free one. Together with the other housing subsidies that had already been in the tax code — the mortgage-interest deduction chief among them — the law gave people a motive to buy more and more real estate. Lax lending standards and low interest rates then gave people the means to do so. Referring to the special treatment for capital gains on homes, Charles O. Rossotti, the Internal Revenue Service commissioner from 1997 to 2002, said: "Why insist in effect that they put it in housing to get that benefit? Why not let them invest in other things that might be more productive, like stocks and bonds?"
The provision — part of a sprawling bill called the Taxpayer Relief Act of 1997 — exempted most home sales from capital-gains taxes. The first $500,000 in gains from any home sale was exempt from taxes for a married couple, as long as they had lived in the home for at least two of the previous five years. (For singles, the first $250,000 was exempt.) Mr. Wampler said he never sold a home simply because of the law’s existence, but it played a role in his decisions and also became part of his stock pitch to potential customers who were considering buying the homes he was building in the desert. He would point out that the tax benefits would increase their returns on a house, relative to stocks. "Why not put your money on the highest-yielding investment with the highest tax benefit?" he said recently. During the boom years, he prospered. But today he owns 80 acres of land on the outskirts of Phoenix that he cannot sell. He owes $8 million to his banks, which may soon foreclose on his land. "I am literally dying on the vine," he said.
The change in the tax law had its roots in a Chicago speech that Senator Bob Dole, Mr. Clinton’s Republican opponent in the 1996 presidential election, gave on Aug. 5 of that year. Trailing Mr. Clinton in the polls, Mr. Dole came out for an enormous tax cut, including an across-the-board reduction in the capital-gains tax. The proposal made Mr. Clinton’s political advisers more nervous than almost anything else during the campaign. The campaign’s chief spokesman, Joe Lockhart, traveled to Chicago to stand outside the ballroom where Mr. Dole was speaking and make the case that the Dole tax cut would cause the deficit to soar. At the same time, Mr. Clinton’s aides began scrambling to come up with their own tax proposal. Dick Morris, the president’s chief outside political adviser, argued that Mr. Clinton could assure his re-election by matching Mr. Dole’s call for a big cut in the capital-gains tax.
But members of Mr. Clinton’s economic team, led by Treasury Secretary Robert E. Rubin, disliked that idea. They thought it would undo the tough work the administration had done to reduce the budget deficit. So they instead went looking for smaller tax cuts that would allow their boss to campaign as both a fiscal conservative and a tax cutter. Getting rid of capital gains on most home sales seemed like the perfect idea. Treasury officials had become interested in that provision earlier in Mr. Clinton’s term after Jane G. Gravelle, an economist at the Congressional Research Service, had called it to their attention, according to Eric J. Toder, an official in the tax policy office at the time. He and his colleagues were looking for ways to simplify the tax code, and Ms. Gravelle told them that eliminating capital-gains taxes on houses was an excellent candidate.
The tax forced homeowners to keep track of all their renovations over many years, because the cost of those renovations could be subtracted from their taxable gain. Even renovations on previous homes often qualified, as long as people had deferred the tax in the past by buying a new house at least as valuable as their old one. "It was very hard for people to keep track of that information," said Leslie B. Samuels, the assistant Treasury secretary for tax policy from 1993 to 1996. People could also avoid the tax under a one-time exemption, for profits of up to $125,000, if they were older than 55. Thus, the tax raised relatively little revenue — perhaps just a few hundred million dollars in today’s terms. "It was the worst kind of tax system," Ms. Gravelle said recently. "It raised very little revenue, but it caused all these distortions and compliance problems." Three weeks after Mr. Dole’s speech, with support from top Treasury officials, the proposal made it into Mr. Clinton’s speech at the Democratic convention. During the presidential debates that followed, he used it to parry Mr. Dole’s calls for a big tax cut. The following summer, Mr. Clinton signed the provision into law.
At the time, Realtors and home builders lobbied for the provision and there was only scant opposition. Grover Norquist — a conservative activist and adviser to Newt Gingrich — said home sales did not deserve special treatment. But Republicans ended up voting for the bill by even wider margins than Democrats. Today, it is the subject for considerably more debate. Ms. Gravelle and Mr. Samuels said they thought the law had done more good than ill. And William G. Gale, director of economic studies at the Brookings Institution, said he did not think that the change in the law was central to the bubble. Low interest rates, he said, were far more important. The law’s defenders say that it also removed at least one tax incentive that had pushed homeowners to trade up. Before 1997, people had to buy a house that was at least as valuable as their previous one to avoid the tax, or else take the one-time exemption. Now they could buy a smaller property or move into a rental.
But many economists say the net effect of the law was clearly to inflate the real estate market. Dean Baker, co-director of the Center for Economic and Policy Research, a liberal policy group in Washington, criticized the exemption as "a backward policy" that "helped push more money into housing." A spokesman for Mr. Clinton declined to comment for this article. Perhaps the most detailed analysis of the provision has been the study by a Federal Reserve economist, Hui Shan, who did the analysis while at M.I.T. Ms. Shan looked at homeowners with significant equity gains, before and after 1997, and compared the likelihood of their selling their house. Her study covered 16 towns around Boston and took into account a host of other factors, like the general rise in home prices at the time.
Among homes that had appreciated less than $500,000, she concluded that the change caused a 17 percent increase in sales in the decade after 1997. Before the law changed, many people apparently avoided paying the tax by simply staying in their homes. Ms. Shan also found that sales actually declined among homes with more than $500,000 of gains after the law passed. (Under the new law, couples have to pay taxes on gains above $500,000, even if they roll all those gains into a new house.) Nationwide, however, less than 5 percent of home sales over the last decade had gains of more than $500,000, according to Moody’s Economy.com. Despite the criticism, there has been little political support for trimming the tax breaks for housing. In 2005, a bipartisan panel of tax experts, which was appointed by President Bush and included Mr. Rossotti, concluded, "The tax preferences that favor housing exceed what is necessary to encourage homeownership." Among other things, it recommended increasing to three years the amount of time people had to stay in homes to claim the tax break on a sale. But Mr. Bush and other policy makers largely ignored the panel’s report.
Geo Hartley, a lawyer who has lived in Los Angeles and Washington over the last two decades, captures the divergent effects that the law appears to have. Mr. Hartley, who is 59 and single, said he found the old law "weird," because it led him to buy bigger houses than he wanted. Since the law changed, Mr. Hartley has bought smaller homes. But he has also moved more frequently, knowing that most of the gains on his houses would not be taxed. He lived in one house in Los Angeles for a full decade before 2000. Since then, he has moved three times, making a handsome — and mostly tax-free — profit each time. "It’s part of the thinking that gets you more motivated to buy and sell property," said Mr. Hartley, who now lives in a town house in Washington that he is trying to sell, "and have the American dream of owning a home."
San Francisco Area Home Prices Drop Record 44 Percent
Home prices in the San Francisco Bay Area plunged a record 44 percent in November and the median fell to the lowest since September 2000 as foreclosure sales pushed down values, according to MDA DataQuick. A total of 5,756 new and resale houses and condominiums sold in the nine-county region last month, a 12 percent increase from a year earlier. The median fell to $350,000, down 7 percent from October and down 47 percent from the peak set in June, July and August of 2007, the San Diego-based research firm said today in a report. The Bay Area median has fallen 12 consecutive months on a year-on-year basis.
"The median measures what is selling in the region, and recently the hottest sellers have been discounted, distressed homes, mainly inland," John Walsh, president of DataQuick, said in a statement, referring to counties such as Contra Costa and Solano. Values in San Francisco and coastal locations including Marin County "showed more signs of price weakness," he said. Home values are tumbling in the most populous U.S. state amid efforts to stimulate the national housing market. The Federal Reserve this week cut its main interest rate to as low as zero, increasing chances that mortgage rates will fall, and the U.S. has announced an $800 billion plan to buy mortgage-backed securities and a $700 billion pledge for a financial-system rescue.
Southern California home prices fell a record 34 percent last month to a median $285,000 as foreclosures pushed sales up 27 percent from a year earlier, MDA DataQuick reported yesterday. In the Bay Area, sales of discounted foreclosure properties accounted for almost half of all sales, up from 44 percent in October and up from 10 percent a year ago, MDA DataQuick said. Foreclosures were 64 percent of sales in Solano, 63 percent in Contra Costa, 52 percent in Sonoma, 44 percent in Alameda, 41 percent in Napa, 39 percent in Santa Clara, 23 percent in Marin, 22 percent in San Mateo and 10 percent in San Francisco.
The most expensive counties accounted for about a third of transactions in November, also driving the median price down. Marin, San Francisco, San Mateo and Santa Clara historically average 43 percent of sales, according to MDA DataQuick, a unit of Richmond, British Columbia-based MacDonald, Dettwiler and Associates Ltd., whose records go back to 1988. Prices fell in all nine Bay Area counties last month, led by a 50 percent drop to $265,000 in Contra Costa. Price dropped 38 percent to $234,500 in Solano, 37 percent to $356,500 in Alameda, 34 percent to $450,000 in Santa Clara, 34 percent to $310,000 in Solano, 28 percent to $625,000 in Marin, 28 percent to $406,500 in Napa, 26 percent to $580,500 in San Mateo and 21 percent to $648,000 in San Francisco, MDA DataQuick said.
Sales increased 90 percent in Solano, 62 percent in Contra Costa, 24 percent in Solano, 20 percent in Alameda and 15 percent in Napa. Sales fell 29 percent in San Francisco, 25 percent in Marin, 21 percent in San Mateo and 15 percent in Santa Clara, according to MDA DataQuick. Loans greater than $417,000, known as jumbo loans, were used to finance 23 percent of sales in November compared with an average 63 percent of sales before August 2007, when credit standards became stricter, MDA DataQuick said.
Discover-ing The Treasury's Money
Discover is close to becoming a bank holding company, but it might not have made it this far in decent shape without a little help from its frenemies. "Discover has to be thanking the heavens for the timing of antitrust litigation settlement payments," said Celent analyst Red Gillen. "Without the $863.0 million received for this settlement in November, Discover would have a fourth-quarter loss. Such settlements are fine for near-term, extraordinary income boosts but certainly are not the foundation of a solid business model." The Riverwoods, Ill.-based credit card company saw rising delinquency rates and charge-off rates as people continue to slack on payments. But Discover Financial Services earned a profit in the fourth quarter, boosted by a lawsuit settlement with Visa and Mastercard.
"Our results and financial position reflect our conservative orientation toward growth, credit risk and capital management as we position Discover to weather the economic downturn," said Chief Executive David Nelms. The decline in sales for Discover and the rising delinquencies have pushed the credit card company to take action: It has asked the Federal Reserve to approve its status as a bank holding company so it can qualify for funds under the Troubled Asset Relief Program. "As part of our capital management, we are seeking to participate in the Treasury's Capital Purchase Program, which will further support our consumer lending operations," added Nelms. Earlier in the year, American Express applied to become a bank in hopes of scoring access to TARP funds. "Discover's announcement that it has applied for TARP funding increases the likelihood that it will weather the economic downturn, but government funding is also not the foundation of a solid business model," said Gillen. "Yet it gives Discover breathing room to improve performance and prepare for the longer term." Nelm told Reuters that the credit card company could get between $400.0 million to $1.2 billion in funds from TARP. Discover would pay a 5.0% rate, plus warrants on the loan.
The company would not need to buy a bank to qualify--and has no plans to--since it already offers money-market funds, IRAs and certificates of deposit. In September, Goldman Sachs and Morgan Stanley sought and won bank holding company status from the Federal Reserve in an expedited weekend process. Hoping to avoid the fates of Lehman Brothers, Bear Stearns and Merrill Lynch, the newly minted banks have agreed to trade freedom of operations--as well as the high risks and multibillion-dollar paychecks that come along with it--for the strict standards and accountability of Federal Reserve oversight. Shares of Discover jumped 7.9%, or 68 cents, to close at $9.26, on Thursday.
The delinquency rate for loans 30 days late increased to 4.6%, from 3.6% a year ago. The charge-off rate--loans that are written off due to nonpayment--grew to 5.5% of total loans from 3.9% a year ago. The company increased provision for loan losses 89.0%, or $521 million, to $714.2 million. Discover earned $432.3 million, or 89 cents per share, during the quarter ended Nov. 30, compared with a loss of $56.5 million, or 12 cents per share, in the year-prior period. Analysts surveyed by Thomson Financial expected, on average, earnings of 13 cents per share. The world's two largest credit card distributors agreed to pay $2.75 billion to settle anti-trust litigation in a suit filed by Discover in 2004. Discover received an $863.0 million payment in November and expects the rest in 2009 on a quarterly basis. The settlement follows a similar accord with American Express by Visa and MasterCard. Amex and Discover claimed the other companies illegally blocked them from issuing cards through its network banks.
TARP Rule Could Mean Retroactive Limits, Executive Salary Caps
Regional lenders, insurers and financial companies clamoring to get into the Treasury’s $700 billion rescue fund may not know what they actually signed up for until long after they’ve pocketed the money. As financial firms race against a Dec. 31 deadline to become eligible for federal funds, they must decide if they can live with rules allowing the U.S. to "unilaterally amend" any part of its Troubled Asset Relief Program securities-purchase agreement. Bank officers and trade groups asked the government to delete the "open-ended obligation," said Mark Tenhundfeld, regulatory-policy director at the American Bankers Association. "It’s inconsistent with safe and sound banking practices," Tenhundfeld said in an interview. "Treasury is saying, in essence, ‘Sign up, but we can’t tell you exactly what you’re signing up for."
The government could increase the dividend it’s being paid for preferred shares, require caps on executive compensation or force banks to halt foreclosures, said David Baris, executive director for the American Association of Bank Directors, in a Nov. 3 letter to Treasury Secretary Henry Paulson. At least 148 regional lenders received preliminary approval for more than $61.7 billion in TARP funds, according to data compiled by Bloomberg. Another $13.4 billion may be doled out to 45 other companies.\ "This provision grants carte blanche for this or any other Congress to change any of the terms of the agreement," said Baris. "Congress could do just about anything it wanted." Some lenders that can qualify for TARP might not participate because of the amendment, he said. More than 30 banks refused to sell preferred shares and warrants to the government under TARP. Joe Conners, chief financial officer of Philadelphia-based Beneficial Mutual Bancorp Inc., said his bank declined TARP money in part because of the amendment.
"You’re signing a contract with a counterparty, and the counterparty in this case is going through a complete management change," Conners said in an interview. "You’re basically signing away your right to have any kind of remedy if in fact they do change the rules." Publicly held financial firms have until year-end to gain bank or lender holding company status to qualify for TARP money, the Treasury said on its Web Site. Closely held companies have until Jan. 15. Under TARP, the government set aside $250 billion to recapitalize banks. It allocated $125 billion to nine larger firms, then invited banks, lenders, and any other company that could claim bank or savings and loan status to apply for the balance. Banks participating in TARP aren’t commenting on the amendment, and Tenhundfeld said it’s "unlikely" the amendment will be changed. Calls to Treasury spokeswoman Jennifer Zuccarelli weren’t returned. The government has "already entered into a lot of deals that have that provision in there," Tenhundfeld said. "They would have to go back and amend those agreements to limit their flexibility."
Conners said the government wants to avoid facing lawsuits as it did amid the savings and loan crisis of the 1980’s. More than 120 lawsuits were spawned by a 1989 law that wiped out the value of a paper asset known as supervisory goodwill, sending many savings and loans into insolvency. The government won most of the suits, and fewer than 20 are still active. "The government changed the rules after the fact," Conners said. "Now they’ve learned their lesson. They’ve put it in writing." Astoria Financial Corp., the biggest New York-based savings and loan, in October lost its appeal to the U.S. Supreme Court asking for a reinstatement of a $436 million award it won after the supervisory goodwill case. The Lake Success, New York-based lender on Dec. 8 received approval to sell the government a $375 million stake and said it was weighing "costs and benefits" before deciding whether to participate. Spokesman Peter Cunningham didn’t return calls for comment.
Fifth Third Bancorp, which is selling a $3.5 billion stake to the government, declined to comment, spokeswoman Debra DeCourcy said. Minneapolis-based U.S. Bancorp, which got $6.6 billion from Treasury and bought failed savings and loans Downey Financial Corp. and PFF Bancorp, wouldn’t comment, said company spokesman Steve Dale. "Nothing in the form documents has caused PNC to change its decision" on TARP, PNC Financial Services Group Inc. spokesman Fred Solomon said in an e-mailed statement. The Pittsburgh-based bank sold the government $8.8 billion in preferred shares and warrants and agreed to acquire National City Corp. in October. Only banks and lenders with the "luxury" of being able to turn down money would have been dissuaded by the amendment, said Sean Ryan, an analyst with Sterne Agee & Leach Inc. in New York. "Most banks look at it and say, ‘If we’re going to get hosed we’re going to get hosed, and whether or not we get the TARP money is not going to save us,’" he said. "As opposed to in the 1980s, at least this time they’re being considerate enough to tell you up front."
Europe's 'Unloved Stability Pact'
'Spend, spend, spend' is the maxim adopted by many European governments during the economic crisis. But splurging comes at a high cost: debt. German pundits on Thursday asked how much debt is a good thing. Is it prudence or political misjudgement? Sharp criticism is being fired at Chancellor Angela Merkel for not doing enough to bolster the spluttering German economy. This week Nobel-prize winning economist Paul Krugman joined the fray, saying in an interview with SPIEGEL that Merkel and Finance Minister Peer Steinbrück were "failing to appreciate the severity of the slump" and were "wasting crucial time." Amid the pressure, Merkel said on Tuesday she was planning a new round of stimulus measures, reigniting the national debate on how the euros should be best spent. Press reports have said Berlin is gearing up to pour another €30 billion ($42 billion) into Europe's biggest economy. The package would follow a stimulus program passed in November. That package, advertised as being worth €32 billion, has been widely panned for including few measures that hadn't already been agreed on.
Reflecting fears of a prolonged downturn, German Labor Minister Olaf Scholz will on Friday host a crisis meeting with the bosses of the 30 companies listed in Germany's blue-chip DAX index. But building up debt via expensive bailout plans does not come easily to Germany, which has worked hard to reduce its public deficit. The country's deficit is now well within rules imposed on those countries part of the euro single-currency zone. Rules require countries to have a deficit worth less than 3 percent of their gross domestic products. German officials are wary of transgressing that limit by indulging in massive spending programs. Meanwhile, a number of European neighbors are arguing that now is the time to loosen the stringent rules of the stability pact. Thursday's Süddeutsche Zeitung cited European Union sources saying that France, Italy, Greece and Ireland all want to relax the limits. German editorials on Thursday agreed that swift action is needed to aide the economy but took differing stances on the merits of stability versus splurges.
The business daily Handelsblatt writes:
"In recent years, economic stimulus packages were rightly shunned because they boost debt. It is simply too high a price to pay during a normal downturn. But the current recession is no normal downturn -- rather the consequence of the steepest slump in demand since World War II. That definitely justifies boosting investments as far as is possible. The credit is rewarded in the form of roads and new buildings and the outlay is a one off. But it is harder to see the value in handing money to consumers. Is it really worth it to take on more debt in order to provide a round of consumer vouchers? Is it worth it to cut taxes, thus pushing the state's incoming funds permanently into the red? It is well possible that given the limited effect of such measures, the cost turns out to be simply too high."
The center-left Süddeutsche Zeitung writes:
"It would be wrong to simply give up on the stability pact in the face of the crisis, as France, Italy and other usual suspects want. The euro zone has weathered the financial crisis as well as it has because it is seen as a refuge of stability -- not a group of debtors. It was to be expected that some governments would attack the unloved pact which Germany once forced on Europe. Many politicians want to have a free hand when it comes to spending money. They are annoyed by the European requirement that in normal times new debts should be limited to a maximum of 3 percent of the economy's performance. Their displeasure does not change the fact that this rule is right, because in a currency block the debts of one member become a burden on all members. Germans shouldn't suffer because of spendthrift Greeks, nor should Greeks face the cost of splurging Germans. Only if all states have solid economies will the euro remain intact and continue to have such a beneficial effect as it is seeing in the financial crisis at the moment, where it prevents speculative attacks on individual countries' currencies -- something which would boost the chaos. The arguments of the pact's detractors are wrong -- the rules are flexible enough to permit more spending during exceptional times, as is necessary at present. The German government must stand firm."
Left-wing Frankfurter Rundschau writes:
"Everyone knows that a supplementary budget is needed. But the government continues with its vehement denials and is basing its figures on assumptions of growth which even it no longer believes in. Debt is leaping to unforeseen heights. Finance Minister Steinbrück is using all his power to fight the inevitable and is wasting the opportunity to use political action to soften the downturn. At the end of the day Steinbrück will have a similar experience (to his predecessor) -- the budget will be ruined and the economy paralyzed."
Kremlin Sidelines Oligarchs in Taking Norilsk Control
Russia auctioned its biggest mining company a decade ago when it was strapped for cash. It’s using the global credit crisis to regain control of OAO GMK Norilsk Nickel as economic turmoil forces U.S. and European governments to bail out their own corporations. Without buying a single share, the government is to appoint its own man as Norilsk chairman this month, replacing the company’s largest owner, Vladimir Potanin. The move comes as the economic crisis saps oligarch funds and Kremlin bailouts help Prime Minister Vladimir Putin secure control of industries where Russia can compete globally, such as energy and arms. Norilsk is the Kremlin’s candidate in mining. Potanin, 47, is handing over the keys after ending a feud with Oleg Deripaska, the billionaire owner of United Co. Rusal, that turned the world’s biggest nickel producer into a battleground of ambitions. The dispute "irritated" government officials, Potanin said Nov. 26 at a briefing with Deripaska, 40, in Moscow to mark the truce.
"The Kremlin wants to see global champions in the industries most important to the country and the feud lost track of that goal," said Chris Weafer, chief strategist with Moscow- based investment bank UralSib Financial Corp. Presiding over the only Russian metals maker among the top 200 companies in the MSCI Emerging Markets Index gives the Kremlin a close handle on the supplier of half the world’s palladium and a fifth of its nickel, key to the global auto and steel industries. It has also alienated investors. "From an investor standpoint, it’s basically a big mess," said Kevin Dougherty, fund manager with Pharos Financial Group in Moscow, which doesn’t own Norilsk. A weak metals price outlook and the battle with Deripaska, coupled with "deteriorating corporate governance make investing in Norilsk like stepping into a casino." Norilsk shares are down 40 percent since Nov. 5, when the government approved a $4.5 billion loan to help refinance Rusal, Norilsk’s second-largest shareholder. The Micex Index, a measure of 30 large Russian companies, has dropped 17 percent.
The state took a 25 percent stake in Norilsk as collateral for that loan. When Norilsk shareholders meet Dec. 26 to elect a new board, the remaining intrigue is how many of the 13 seats the Kremlin will win. The bailout also means two government officials will join Norilsk as managers. Putin, in a Dec. 4 address, said Russia’s role in Norilsk is about providing stability and isn’t much different from assistance other countries have provided to their troubled financial institutions. Without state aid Norilsk may be unable to support its production, company officials have said. "There’s no direct policy to de-privatize" Norilsk, said Dmitry Peskov, a spokesman for Putin, who opposed the state’s auctions of the country’s major industries and spent the last eight years reasserting government control. "How this situation will play out, only time will tell," Peskov said. Russia is "willing" to buy stakes in companies where owners request aid with the aim of later selling out on fair terms, Putin said on Dec. 4. "This is not a way to nationalize the economy," he said.
The state sold Norilsk to Potanin’s bank in 1997. Putin’s predecessor as Russian president, Boris Yeltsin, auctioned stakes in the country’s biggest enterprises to help his cash-strapped administration. As then deputy prime minister, Potanin became a Norilsk board director in 1996 and helped organize the auctions. Reasserting state control at Norilsk revives the potential for it to become a platform for mergers in Russia’s metals industry, with the aim of creating a rival to Melbourne-based BHP Billiton Ltd., the world’s largest miner. It would also assert state influence in an industry that lags behind only oil and gas in terms of export volumes and budget contributions. A state-run Norilsk may help Russia’s government expand ties with anti-U.S. states such as Venezuela and Cuba, which has one of the biggest nickel resources. Norilsk is ready to develop a nickel mine in Cuba should Russia lend the Caribbean island $1.5 billion for the project, Chief Executive Officer Vladimir Strzhalkovsky, a former officer in the KGB Soviet-era security agency, said Nov. 20. Norilsk could operate the Cuban mine without taking an equity stake in the project, the CEO said. The company currently only manages mines it controls.
"If Norilsk has aspirations of being in the same league as the likes of BHP Billiton, it should start behaving as such and show the necessary respect to capital markets," UralSib metals analyst Michael Kavanagh said in a report today. UralSib cut the company’s 12-month price target to $58 from $285 per share on a lack of strategy, poor disclosure and weak metal demand. Norilsk traded in Moscow today at $64. Uralkali, a potash miner controlled by billionaire Dmitry Rybolovlev, might also be folded into a state mining giant based on Norilsk after Putin’s deputy, Igor Sechin, reopened a probe into a 2006 flood at the company’s mine. Potanin said Aug. 8 that the arrival of Strzhalkovsky at Norilsk was likely to spur mergers with iron ore, potash, coal and copper assets. Deripaska had opposed Norilsk combinations with companies other than Rusal. After Rusal acquired its Norilsk stake in April, the nickel company’s merger talks with billionaire Alisher Usmanov’s iron ore producer OAO Metalloinvest stopped.
At the "truce" briefing with Potanin, Deripaska only shook his head when asked if he would block a Norilsk merger with Metalloinvest. "The invisible hand of the state could have seriously contributed to such an idyllic agreement," Mikhail Stiskin, an analyst at Troika Dialog, Russia’s oldest investment bank, said of the settlement between the billionaires. "The state is playing first violin" and will support Norilsk mergers, he said. Russia’s upper hand, with $437 billion in international reserves built up during Putin’s presidency from high commodity prices, is reinforced by the global market turmoil. Deripaska, the country’s richest man according to Forbes magazine, ceded stakes in Canadian auto-parts maker Magna International Inc. and German builder Hochtief AG to banks in October after shares used as collateral to finance the acquisitions lost value. When Rusal’s 25 percent stake in Norilsk, pledged against a $4.5 billion loan from foreign lenders, faced the same risk in October, Russia stepped in. Norilsk CEO Strzhalkovsky, 54, formerly the country’s tourism chief with no experience in the metals industry, said that he asked the state to buy Rusal’s shares. The Kremlin chose to refinance Rusal’s loan for one year and took Norilsk shares as collateral.
Among the loan conditions, the state has the right to at least one Norilsk board seat. One of two government nominees is Sergei Chemezov, who like Putin and Strzhalkovsky is a former KGB officer. Chemezov is now CEO of state holding company Russian Technologies Corp., which controls OAO VSMPO-Avisma, the world’s biggest producer of titanium, and has 49 percent of Erdenet, Mongolia’s largest copper miner. Chemezov said Dec. 12 that he has already asked Potanin and Deripaska to consider a combination with the copper assets of Russian Technologies, which are jointly held with Metalloinvest. Meanwhile, Usmanov of Metalloinvest has acquired about 5 percent of Norilsk as a prelude to consolidation. "Norilsk Nickel is creeping toward becoming a state-run entity, in practice if not formally so," Stratfor, a U.S.-based risk advisory group, wrote clients last month.
Berlin Plans to Spend €40 Billion More to Fight Recession
After resisting weeks of pressure to spend their way out of a crisis, the German government has decided on a second stimulus package. The plan involves massive infrastructure spending but has unleashed controversy over whether money should flow to the East or the West. German Chancellor Angela Merkel has had to weather some tough criticism in recent weeks, both at home and abroad, over her government's handling of the economic downturn. Now it seems Berlin has decided to spend its way out of the crisis after all, and intends to launch a second stimulus package. Government sources have told SPIEGEL it will be worth almost €40 billion ($56 billion). Together with the first stimulus package, Berlin is now set to invest a massive €50 billion in its bid to beat the recession and stave off huge increases in unemployment in 2009 and beyond. According to government sources, the two packages combined will be worth up to 2 percent of Germany's gross domestic product and are expected to have a "macroeconomic effect."
The vast majority of the new government investment will be spent on improving roads, schools, universities and sports facilities. Chancellor Merkel told the Neue Presse newspaper, in comments published on Friday, that extending broadband networks would also be included in the package. The funds will also be spent on encouraging private consumption, although there is still no agreement on whether that will be achieved through income tax cuts, something the Christian Social Union -- the Bavarian sister party to Merkel's Christian Democrats -- are pushing for. Merkel has so far opposed tax cuts before next year's September parliamentary elections. The plan will include proposals to increase the state's subsidies of the health insurance system, so that contributions made by employees and employers could be reduced. Merkel told the Neue Presse that she wanted the measures to make Germany "more modern and sure of the future in the long term." She said that her aims were to encourage growth and employment, emphasizing that she wanted the "development on the labor market" to be at "the center of our efforts."
Merkel met with the governors of Germany's 16 states on Thursday to discuss the package but the details still have to be ironed out and the politicians will meet again next Tuesday. However, the final decisions on where exactly the investments will be channelled won't be made until mid January when an inter-ministerial working group presents its plan. Berlin also wants to wait until Barack Obama is sworn in as US President on Jan. 20 so that it can assess the extent of Washington's economic stimulus measures. The German government has come in for withering criticism for its reluctance to take sweeping measures in the face of the economic downturn which threatens to be the worst since the Great Depression. In fact Merkel's foot-dragging on backing a Europe-wide stimulus package suggested by the European Commission has seen Germany marginalized in efforts within the 27-member bloc to combat the effects of the global economic downturn. Merkel was pointedly not invited to a top-level meeting with business leaders in London a few weeks ago hosted by British Prime Minister Gordon Brown and attended by French President Nicolas Sarkozy and EU Commission President Jose Manuel Barroso. Her Finance Minister Peer Steinbrück's ability to rub most other European leaders up the wrong way -- for example by attacking their "crass Keynesianism" -- had further alienated Berlin from the rest of Europe.
After Chancellor Merkel met with a group of advisers and ministers at the weekend to discuss the extent of the crisis there has, however, been something of a change in tone in Berlin. And as the prognoses for the coming year have steadily worsened, even Germany has been shaken into action. On Tuesday the Economics Ministry announced that the German economy could shrink by more than 3 percent in 2009, something that is likely to force Berlin to massively increase its borrowing next year. Current budget plans had envisaged net borrowing of €18.5 billion, but that was based on growth predictions of 0.2 percent. Now the government has admitted that this could double to as much as €30 billion, as tax yields fall and spending on welfare for the jobless increases. In fact some media reports predict that sum could swell to as much as €50 billion. Merkel is still clinging to the hope that in the end Germany will one day be able to balance the federal budget, something that Berlin had hoped to do by 2011. "A balanced budget remains our target because the demographic changes in Germany will increasingly have an effect from the middle of the coming decade," she told Neue Presse. "We must not overburden the younger ones."
The Chancellor, has however, triggered something of a controversy at home, over where exactly these new stimulus billions will flow. In an interview with the political magazine Cicero, published Thursday, Merkel said that the package would not specifically target eastern Germany but also help communities in the West, and after Thursday's meeting in Berlin she hammered home the point, saying: "It is not a program that will prefer the East." Billions of euros have been pumped into the former East Germany, where Merkel hails from, to modernize its infrastructure since the fall of the Berlin Wall in 1989, but the region still suffers disproportionately from poverty and unemployment. Carsten Schneider, a politician with Merkel's coalition partners the Social Democrats (SPD) slammed her comments as divisive. "The chancellor has written off the East," he told the Leipziger Volkszeitung on Friday, adding that "in this cheap way (she) is hoping to win points in the West ahead of the federal elections."
World Coal Reserves Could Be a Fraction of Previous Estimates
A new calculation of the world's coal reserves is much lower than previous estimates. If validated, the new info could have a massive impact on the fate of the planet's climate. That's because coal is responsible for most of the CO2 emissions that drive climate change. If there were actually less coal available for burning, climate modelers would have to rethink their estimates of the level of emissions that humans will produce. The new model, created by Dave Rutledge, chair of Caltech's engineering and applied sciences division, suggests that humans will only pull up a total — including all past mining — of 662 billion tons of coal out of the Earth. The best previous estimate, from the World Energy Council, says that the world has almost 850 billion tons of coal still left to be mined.
"Every estimate of the ultimate coal resource has been larger," said ecologist Ken Caldeira of Stanford University, who was not involved with the new study. "But if there's much less coal than we think, that's good news for climate." The carbon dioxide emitted when humans burn coal to create usable energy is primarily responsible for global warming. Leading scientists think that the stability of Earth's climate will be dictated by how the world uses — or doesn't use — its coal resources. And the thinking has been that the world has more than enough coal to wreak catastrophic damage to the climate system, absent major societal or governmental changes. So the new estimate, which opens the slim possibility that humankind could do nothing to mitigate carbon dioxide emissions and still escape some of the impacts of climate change, comes as quite a shock.
Rutledge argues that governments are terrible at estimating their own fossil fuel reserves. He developed his new model by looking back at historical examples of fossil fuel exhaustion. For example, British coal production fell precipitously form its 1913 peak. American oil production famously peaked in 1970, as controversially predicted by King Hubbert. Both countries had heartily overestimated their reserves. It was from manipulating the data from the previous peaks that Rutledge developed his new model, based on fitting curves to the cumulative production of a region. He says that they provide much more stable estimates than other techniques and are much more accurate than those made by individual countries. "The record of geological estimates made by governments for their fossil fuel estimates is really horrible," Rutledge said during a press conference at the American Geological Union annual meeting. "And the estimates tend to be quite high. They over-predict future coal production."
More specifically, Rutledge says that big surveys of natural resources underestimate the difficulty and expense of getting to the coal reserves of the world. And that's assuming that the countries have at least tried to offer a real estimate to the international community. China, for example, has only submitted two estimates of its coal reserves to the World Energy Council — and they were wildly different. "The Chinese are interested in producing coal, not figuring out how much they have," Rutledge said. "That much is obvious." The National Research Council's Committee on Coal Research, Technology, and Resource Assessments to Inform Energy Policy actually agrees with many of Rutledge's criticisms, while continuing to maintain far sunnier estimates of the recoverable stocks of American coal.
"Present estimates of coal reserves are based upon methods that have not been reviewed or revised since their inception in 1974, and much of the input data were compiled in the early 1970’s," the committee wrote in a 2007 report. "Recent programs to assess reserves in limited areas using updated methods indicate that only a small fraction of previously estimated reserves are actually mineable reserves." And don't look to technology to bail out coal miners. Mechanization has actually decreased the world's recoverable reserves, because huge mining machines aren't quite as good at digging out coal as human beings are. With Rutledge's new numbers, the world could burn all the coal (and other fossil fuels) it can get to, and the atmospheric concentration of CO2 would only end up around 460 parts per million, which is predicted to cause a 2-degree-Celsius rise in global temperatures.
For many scientists, that's too much warming. A growing coalition is calling for limiting the CO2 in the atmosphere to 350 parts per million, down from the 380 ppm of today, but it's a far cry from some of the more devastating scenarios devised by the Intergovernmental Panel on Climate Change. "Coal emissions really need to be phased out proactively — we can't just wait for them to run out — by the year 2030," said Pushker Kharecha, a scientist at NASA's Goddard Institute for Space Studies. "There is more than enough coal to keep CO2 well above 350 ppm well beyond this century." The Intergovernmental Panel on Climate Change uses economic models that assume that the world will not run out of coal. Some IPCC scenarios show 3.4 billion tons of coal being burned just through 2100. That's more than five times what Rutledge thinks will be possible — and a good deal higher than the WEC's estimate for recoverable coal reserves, too.
On the other hand, if the world were really to encounter a swift and steep decline in accessible coal resources, it's unclear how humans could retain our current levels of transportation, industry and general energy-usage.So, even if coal were to run out and the most dangerous climate change averted, the imperative to develop non–fossil-fuel energy sources would remain. "Peak Oil and peak gas and peak coal could really go either way for the climate," Kharecha said. "It all depends on choices for subsequent energy sources."