Ilargi: The new unemployment numbers out of the US are in a word insane. 533.000 jobs lost in one month leads to an annualized number of 6,5 million. Of course many pundits will claim that the drop will ease, but don't you believe a word they say. These same pundits claim that "nobody could foresee" the 533k figure. Well, it’s not exactly nobody. I said yesterday that millions of jobs will be lost in the first quarter of 2009 alone, which in one swoop also answers the question of the easing. Job loss numbers are going to get much worse soon.
Perhaps December will be a bit of a lull, but after that it's women and children first. There is nothing left in the economy that might function as a shield. There's only the government and the central bank, and they have so far categorically refused to help the citizens of the country. There is no reason to believe that attitude will change anytime soon, and besides it wouldn't matter anymore: it's too late. What's coming now is solidly in the pipeline, and as unstoppable as gravity itself. We are already caught in the throngs and tentacles of deflation and depression, and through denial of the Fed variety, we’ve wasted all our chances to escape.
How do we know this? Well, perhaps the best indicator is the fact that the Fed says it just ain't so. All through 2008, Ben Bernanke and his (12?!) disciples have shunned the term recession for the US economy, denied it, called it preposterous and impossible. The Treasury chimed in along the way. Then, last week, the NBER, the government agency that is supposed to be the only one deciding whether or not there is a recession, said the Fed had been either wrong or lying through its teeth for the entire year.
A few days later, the Fed thinks it’s at bat again, undoubtedly all set to go for another year of being dead utterly wrong. Philadelphia Federal Bank Reserve President Charles Plosser and his St. Louis counterpart James Bullard hint that deflation of the Great Depression or Japan type is, let's paraphrase it, preposterous and impossible. Bullard:
"Look at PCE (personal consumption expenditures) inflation measured from one year earlier. It smoothes out some of the fluctuations. It is still over two percent. It would take a lot to drag that down to a deflationary level. [..] So I don't think the risk is that high right now. I do think that the inflation expectations are very fluid right now. The big challenge for the Fed is to keep these under control and keep people reassured that we are intending to stay near target,"
Yeah, I know, reading that makes me want to run away and drink heavily too, you're not alone. But to cut through the bull: PCE inflation is a nonsense term, and all government inflation numbers as gathered and massaged by the Bureau of Lousy Statistics are meaningless. They just set targets and make the numbers fit them. Bullard says that the Fed must keep very fluid inflation expectations under control and make people believe they intend to stay on target (which I guess is a 3% inflation rate). Emptier words were seldom spoken. Here’s another favorite of mine:
Plosser said it was "not unreasonable" to describe the Fed's recent balance sheet expansion [Ilargi: to $3 trillion from under $1 trillion in less than year] as "a form of quantitative easing."I’ll leave that ditty without further comment.
Other indications for the fact that we are already deep in a depression, not just a recession, comes from a group of bearish market voices. Meredith Whitney says $3 trillion has vanished from credit windows in a year, and $2 trillion more will go from credit card lines alone in 2009. This may seem like chump change in the midst of all the other stats, but there's something here we need to remember. Banks don't play the credit game at a $1 for $1 level, they lend out 10 or 20 times more than what they have in assets, equity, whatever fancy and false name they choose. So the $3+$2 trillion that turns from hot into cold air, takes $50 to $100 trillion out of available credit. And don't forget, the $2 trillion "poof" for 2009 is only credit cards, not anything else. As for the valuation of assets -I told you thems fancy names- Whitney says:
"As I wrote a week ago, Citi has $2.1 trillion of on-book assets and $1.2 trillion of off-balance sheet assets compared to less than $10 billion of tangible common equity."
When I read that, I’m almost sorry I already used the word "insane" in this article. me and my readers by now have a sort of an idea what those so-called assets are: the stuff you can find in any gambling den's bathroom.
Yet another voice is Gerald Celente, lauded Nostradamus –for some- of the markets, who talks about "tax revolts, food riots, squatter rebellions and job marches". I think he's quite accurate in that, but there are also a few ifs and buts with regards to his words. Celente tries to put a positive spin on things by claiming a new, less centralized economy will occur (something Whitney also mentioned with regards to banking). What Celente does not address is the price that will be paid to get to that Utopia, and he's vague on the timeline as well. His main "OOPS, I Did it Again" moments, though, are a statement that Credit Default Swaps amount to a total $335 trillion (in reality it's $62 trillion), but most of all his claim that we'll see hyper-inflation in 2009. Look, Gerald, Meredith states that $100 trillion or -much- more in credit is disappearing -just like that-, and you mean to make me believe a few trillion from a printing press will not only compensate for that, but will actually outdo it so much that we'll have hyper-inflation? I ain't getting this one single bit. Celente sees a bunch of trends correctly, but the fog sets in on poor him in seconds. There will be hyper-inflating nations in 2009, but not the US: it's too dependent on international money- and bond markets. I think Russia looks like a lot more likely candidate.
Finally, let's look at the best, the most solid sign, that we're in a depression. As always it's the reality of the markets that is the best guide. Corporate debt, and the cost of insuring against its default, lead the way. Bloomberg reported this week:
The cost of protecting corporate debt from default jumped to a record in Europe and neared a high in the U.S. amid concern that the global recession will sink into a depression. Credit-default swaps on a benchmark index tied to below-investment grade companies in Europe reached levels considered distressed for the first time.
Philip Gisdakis, credit strategist at UniCredit SpA, Italy’s biggest bank, says:
"Markets are pricing somewhere between a recession and a depression, and that is what we are faced with. We are already in a recession. The next economic phase will not be recession, but depression."
And it’s not only corporate debt that is being squeezed by the reality-check boa-constrictor. Bloomberg again:
Credit-default swaps on U.K. gilts and U.S. Treasuries also rose to records. Five-year contracts used to hedge against losses on U.K. government debt increased 6 basis points to 113.5 and 10-year contracts climbed 9 to 116.5. Five-year contracts on Treasuries rose 2.5 basis points to a record 60.5 [..].
Today’s dismal job loss numbers will have an almost too-easy-to-predict effect on debt insurance policies. They will reach levels that are for all intents and purposes unmanageable. And that, in turn, will spell the end of the road for many companies. And jobs.
Brace yourselves. And don’t listen to Bernanke and Paulson anymore. Paint a Groucho mask on their pictures. And talk all this over with your families when you sit around the tree. You’ll need them and they’ll need you. If you find that hard to believe, look at Canada, where democracy itself was suspended yesterday. Events will move fast. Maybe not as fast as Santa, but still.
OC: Prorogue: To discontinue a session of parliament, such as the 40th session of the Canadian Parliament that ended in dispute yesterday. At stake is the possible defeat of the Conservative minority government (comprising the 28th Canadian Ministry) elected on October 14, 2008, and its replacement by a Liberal Party-New Democratic Party coalition government, with support from the Bloc Québécois on confidence issues.
On December 4, 2008, Governor General Michaëlle Jean granted the request of Conservative Prime Minister Stephen Harper to prorogue (suspend without dissolving) Parliament until January 26, 2009, thereby staving off the prospect of a possible change in government. On November 27, 2008, Finance Minister Jim Flaherty provided the House of Commons with his fiscal update. In a plan to cut government spending, the Conservatives planned to suspend the right of public employees to strike until 2011, sell off some crown assets to raise capital, and to eliminate political party subsidies in which parties receive $1.95 for each vote they win.
The document was fiercely rejected by the opposition on economic grounds for not fiscally stimulating the economy during the economic crisis of 2008, for suspending the right of federal civil servants to strike, and for suspending the right of recourse of women to the courts for pay equity issues. Another suspected reason for rejection was the elimination of public subsidies, as this would have disproportionately worsened the financial situations of the opposition parties compared to the Conservatives. The Conservatives received 37% of their funds from public funding in 2007, the NDP 57%, the Liberals 63%, the Green Party 65% and the Bloc Québécois 86%
See also: Banana Republic
Earlier this year, in explaining to my friends - no, not Ilargi or Stoneleigh - one of the reasons we were moving from Ontario, I stated that Ontario would probably feel the downturn first and worst. But even I'm surprised by the implosion there; 66, 000 jobs lost last month...and this is before the auto industry numbers show up significantly. Prorated to the population of the US, this is over 1.6 million jobs lost. The Golden Horseshoe is turning to lead in this alchemy of Armageddon.
US job losses steepest since 1974
The US economy lost a stunning 533,000 jobs in November – the largest monthly drop in more than three decades – as the unemployment rate jumped to 6.7 per cent, the labour department said on Friday. The non-farm payroll data were far worse than expected by many economists, whose median forecast was that employers would shed about 340,000 positions in November. The report marked the 11th consecutive month of job losses in the US economy, underscoring the severe impact the downturn is having on the labour market. “Today’s figures seem awful – but we would stress that they are merely in line with what a number of indicators have been pointing to for months, and there could be an even bigger negative lurking out there in the months ahead,” said Rob Carnell, analyst at ING Financial Markets.
A leading economic authority in the US declared that the economy has been in recession since December last year but Friday’s data, the latest in a string of grim economic data, suggest conditions are getting worse. With upward revisions to both September and October showing sharper job cuts than previously reported, the economy has lost more than 1.2m jobs in the last three month alone, bringing the total tally for the year to more than 2m, the data showed. October’s job losses were revised to show a fall to 320,000 compared with a previously reported loss of 240,000 while September’s losses were revised up to 403,000 from 284,000 previously. November’s job losses are the highest since December 1974. The month’s employment rate, which rose to 6.7 per cent from 6.5 per cent in October, was slightly lower than expected but still the highest reading since 1993, having risen 1.7 percentage points since December last year.
Service sector employment fell 370,000 in November while retail cut 91,000 jobs – further underlining the slowdown in consumer spending. But the job losses cut across a broad range of sectors, from manufacturing to construction to services. However, in contrast to most industries, healthcare added jobs in November, with jobs rising 34,000, an increase of 341,000 so far this year. Grim news on the health of the US economy has emerged throughout the week. On Wednesday, other data showed that US service industries contracted by the biggest margin on record in November, while the private sector shed the most jobs in six years, data on Wednesday showed. The situation reinforces already widespread expectations that the US Federal Reserve will cut the federal funds target rate, now currently 1 per cent, even further, when it meets later this month.
Mortgage Delinquencies, Foreclosure Rise to Record in Recession
One in 10 Americans fell behind on their mortgage payments or were in foreclosure during the third quarter as the world’s largest economy shed jobs and real estate prices tumbled. The share of mortgages 30 days or more overdue rose to a seasonally adjusted 6.99 percent while loans already in foreclosure rose to 2.97 percent, both all-time highs in a survey that goes back 29 years, the Mortgage Bankers Association said in a report today. The gain in delinquencies was driven by an increase of loans with payments 90 days or more overdue.
“We’re seeing more loans build up in the 90-days bucket as lenders work to modify loans and states put in place programs that delay foreclosures,” said Jay Brinkmann, chief economist of the Washington-based bankers group, in an interview. The U.S. economy has shed 1.91 million jobs this year, while falling home prices have made it difficult for people who can’t pay their mortgages to sell the properties. Payrolls declined in each month of 2008 through November, the Labor Department said today in Washington.
Home resales in the U.S. dropped in October and prices fell by the most on record, signaling a deepening housing recession going into 2009. Purchases of existing homes slid to an annual rate of 4.98 million, lower than forecast, the National Association of Realtors said on Nov. 24. The median price fell 11.3 percent from a year earlier, the most since the group began collecting data in 1968.
Yesterday Federal Reserve Chairman Ben S. Bernanke urged using more taxpayer funds for new efforts to prevent home foreclosures, saying the private sector is incapable of coping with the crisis on its own. The Fed chief outlined four possible options, including buying delinquent mortgages and providing bigger incentives for refinancing loans. He called for addressing the “apparent market failure” where lenders aren’t modifying mortgages even in cases where it’s in their own economic interest to do so.
Bernanke’s proposed changes would go beyond those announced last month by Housing and Urban Development Secretary Steve Preston, who oversees the FHA. The agency will lower the amount of the loan a lender must forgive, allow banks to extend mortgage. The Mortgage Bankers report is based on a survey of 45.5 million loans by mortgage companies, commercial banks, thrifts, credit unions and other financial institutions.
Canada loses most jobs in 26 years
Canadians lost 71,000 jobs in November – almost triple expectations – and the unemployment rate crept up to 6.3 per cent, as Ontario employers felt the harsh impact of the U.S. recession. That's the biggest month of job losses since the recessionary period of 1982, and puts the unemployment rate at its highest point since November, 2006. In percentage terms, it's the biggest month of job losses since February, 1991, also a time of recession. It comes after three months of solid job creation in Canada, but widespread job losses elsewhere in the world, especially the United States, mired in recession.
“Deteriorating global job markets have arrived on Canada's doorstep,” said economists at Scotia Capital Inc. “The country is no longer bucking the general trend of lost jobs in most major economies.” Economists had been expecting the job market to shed 25,000 jobs in November, and they quickly warned that Canada's job market is poised to deteriorate further. “Sadly, more jobs cuts are coming,” said Jennifer Lee, economist at BMO Nesbitt Burns, pointing to the announcement on Thursday that AbitibiBowater was closing a mill in Newfoundland, and reports on Friday morning that General Motors will be temporarily laying off 700 workers in Oshawa in February.
Ontario was the hardest hit area in November, with the manufacturing sector responsible for most of the cuts. Manufacturing and construction are poised for sharp job losses in the months to come, warned the Scotia economists. “In our opinion, this is the start of a volatile trend that will see U.S. supply chain hits trickling across the border more aggressively in the coming months,” they said in a note to clients.
The November losses were divided between full-time and part-time jobs. Ontario took the brunt of the job losses, with 66,000 fewer positions, mainly full-time. Manufacturing was particularly weak, with employers eliminating 42,000 factory jobs in Ontario, a worsening of a downward trend that has characterized the sector since 2002. Ontario's unemployment rate jumped to 7.1 per cent in November from 6.5 per cent the month before – putting the Ontario rate far above the national average. Nova Scotia also saw jobs losses totalling 4,400, but other provinces were stable.
By sector, manufacturing was the hardest hit, seeing a national drop of 38,000 positions. Public administration shed 27,000 positions as hiring associated with the federal election in October was reversed. With political stability in Ottawa over how to manage the economy threatening to cause another election at any time, “perhaps this is the solution for delivering stimulus!” joked Mark Chandler, fixed income strategist at RBC Dominion Securities.
Goods industries decreased employment by 33,000 jobs, while services cut 38,000 positions. That's a change from earlier this year, when services employment was stable.
Over all, Canada saw 32,000 fewer full-time positions, and 38,000 fewer part-time positions in November, compared with a month earlier. Still, wages were on the rise, with the year-over-year growth in the average hourly wage at 4.6 per cent – far higher than inflation, which was 2.6 per cent in October.
By gender, men were harder hit than women in November. Employment fell by 40,000 for men over the age of 25, while women saw little change. Employment for women has been double that of men since the start of the year. So far this year, employment has increased 0.8 per cent or 133,000 jobs – a far slower pace than the 2.2 per cent growth or 361,000 positions seen during the first 11 months of 2007, Statscan noted.
While the unemployment rate of 6.3 per cent is low by historical standards, it is 0.5 percentage point above the 5.8 per cent seen at around the end of 2007 and the beginning of 2008. The employment rate, which shows the portion of the working-age population that has a job, dropped to 63.3 per cent in November from 63.7 per cent in October. The jobs numbers will probably strengthen the Bank of Canada's resolve to cut interest rates by half a percentage point next week, economists said, especially since the unemployment figures have a strong influence on consumer confidence.
Ontario sheds 66,000 jobs
Ontario shed 66,000 jobs last month, leading the country to the largest decline since the deep recession of 1982. The province's losses pushed the unemployment rate to 7.1 per cent from 6.5 per cent the previous month. Overall, 70,600 jobs were chopped across the country.
The battered manufacturing sector was mostly responsible for the job bleeding in Ontario with a decline of 42,000. That took the factory sector's share of employment in the province to 13 per cent – down from 18.2 per cent six years ago. Ontario's jobless rate now matches Quebec's, which has historically been higher although Statistics Canada noted that the numbers have been edging closer in recent years.
Statistics Canada said Friday the job losses lifted the official national unemployment rate to 6.3 per cent, from 6.2 per cent in October. The labour force had been holding out against the deteriorating economy – which many believe has entered a recession – but November's rout came as somewhat of a surprise. The consensus among economists had been for a 20,000 labour force retreat, and even the most pessimistic had put the losses in the 40,000 range.
November's result cut deeply in the job creation record for the year, bringing the accumulated gain to 133,000, well below's last year's 361,000 January-through-November improvement. Overall, there were 38,000 fewer factory workers in Canada, as there was a slight net gain in the category in other provinces. "This brings manufacturing declines to 388,000 since the peak in 2002," Statistics Canada said.
The other major employment drop came in public administration, with the layoff of 27,000 people who had been temporarily hired to help run the Oct. 14 federal election. Other industries hit with employment decreases last month included transportation and warehousing, which lost 26,000 workers, education (16,000) and agriculture (10,000).
A slight majority of the net job losses came among full-time workers and among men and youth, although most categories were affected. Employment gains occurred in the health care and social assistance categories, and in professional and technical services. The weaker labour market has yet to be reflected in wages, however, which remained 4.6 per cent higher in November than a year earlier. That is well ahead of the current 2.6 per cent inflation rate.
Canadian personal bankruptcy filings soar in October
The number of personal bankruptcies in Canada rose by more than 20 per cent in October as individuals came under increased pressure from deteriorating economic conditions, according to a report released yesterday. The Office of the Superintendent of Bankruptcy Canada said a total of 9,468 bankruptcies were filed in October by consumers and businesses – a 7.2 per cent increase from September and a hefty 21.1 per cent jump from the same month in 2007.
According to the report, the majority of filings came from individual Canadians, who saw world stock markets plummet during October as the global financial crisis gathered momentum. The report showed 8,972 consumers filed for personal bankruptcy in October. That was up 7.5 per cent from September and 22.8 per cent higher than in the same month a year earlier. Bankruptcies filed by businesses totalled 496, just 1.4 per cent higher than September's number and actually down 3.3 per cent from October 2007.
Among businesses, the construction sector led the way with 97 filings, which was 32.9 per cent above October 2007. The retail trade sector was next with 68 filings, 5.6 per cent below last year. Compared with October 2007, the total bankruptcies filed in October rose 50.9 per cent in Alberta, 37.4 per cent in British Columbia and 36.5 per cent in Newfoundland and Labrador. Bankruptcies in the manufacturing heartland provinces of Ontario and Quebec rose 21.6 per cent and 13.6 per cent respectively.
Too Big Not To Fail: Eliot Spitzer
We need to stop using the bailouts to rebuild gigantic financial institutions. Last month, as the financial crisis and the government rescue plan dominated headlines, almost everyone overlooked a news item that could have enormous long-term impact: GE Capital announced the acquisition of five mid-size airplanes—with an option to buy 20 more—produced by CACC, a new, Chinese-government-sponsored airline manufacturer. Why is that so significant? Two reasons: First, just as small steps signaled the Asian entry into our now essentially bankrupt auto sector 50 years ago, so the GE acquisition signals Asia's entry into one of our few remaining dominant manufacturing sectors. Boeing is still the world's leading commercial aviation company.
CACC's emergence—and its particular advantage selling to Asian markets—means that Boeing now faces the rigors of an entirely new competitive playing field and that our commercial airplane sector is likely to suffer enormously over the coming decades. But the second implication is even bigger. The CACC story highlights the risk that current bailouts—a remarkable $7.8 trillion in equity, loans, and guarantees so far—may merely perpetuate a fundamentally flawed status quo. So far, at least, we are simply rebuilding the same edifice that just collapsed. None of the investments has even begun to address the underlying structural problems that are causing economic power to shift away from the United States, sector by sector:
- Our trade deficit has ballooned from about $100 billion to more than $700 billion annually in the past decade, and our federal deficit now approaches $1 trillion. These twin deficits leave us at the mercy of foreign-capital inflows that may diminish as Asian nations, in particular, invest increasingly at home.
- Our household savings rate has been close to zero—and even negative in some years—not permitting the long-term capital accumulation required for the investments we need; China's savings rate, by comparison, is an astonishing 30 percent of household income.
- U.S. middle class income has stagnated over the past decade, while the middle class in China—granted, starting from a lower base—has seen its income growing at about 10 percent annually.
- Our intellectual advantage could soon turn into a new "third deficit," as hundreds of thousands of engineers are being created annually in China.
- We are realizing that the service sector—all the lawyers, investment bankers, advertising agencies, and accountants—follows its clients and wealth creation. This, not over-regulation, is the reason investment-banking activity has begun to migrate overseas.
The great irony is that our new place in the global economy is a direct consequence of our grand victory over the past 60 years. We have, indeed, converted virtually the entire world into one integrated capitalist economy, and we must now bear the brunt of serious and vigorous competition. In the immediate aftermath of World War II, the United States was essentially the only nation with financial capital, intellectual capital, skilled labor, a growing middle class generating consumer demand, and a rule of law permitting safe investment. Now we are one of many nations with these critical advantages.
This long-term change frames the question we should be asking ourselves: What are we getting for the trillions of dollars in rescue funds? If we are merely extending a fatally flawed status quo, we should invest those dollars elsewhere. Nobody disputes that radical action was needed to forestall total collapse. But we are creating the significant systemic risk not just of rewarding imprudent behavior by private actors but of preventing, through bailouts and subsidies, the process of creative destruction that capitalism depends on. A more sensible approach would focus not just on rescuing pre-existing financial institutions but, instead, on creating a structure for more contained and competitive ones. For years, we have accepted a theory of financial concentration—not only across all lines of previously differentiated sectors (insurance, commercial banking, investment banking, retail brokerage, etc.) but in terms of sheer size.
The theory was that capital depth would permit the various entities, dubbed financial supermarkets, to compete and provide full service to customers while cross-marketing various products. That model has failed. The failure shows in gargantuan losses, bloated overhead, enormous inefficiencies, dramatic and outsized risk taken to generate returns large enough to justify the scale of the organizations, ethical abuses in cross-marketing in violation of fiduciary obligations, and now the need for major taxpayer-financed capital support for virtually every major financial institution. But even more important, from a structural perspective, our dependence on entities of this size ensured that we would fall prey to a "too big to fail" argument in favor of bailouts.
Two responses are possible: One is to accept the need for gigantic financial institutions and the impossibility of failure—and hence the reality of explicit government guarantees, such as Fannie and Freddie now have—but then to regulate the entities so heavily that they essentially become extensions of the government. To do so could risk the nimbleness we want from economic actors. The better policy is to return to an era of vibrant competition among multiple, smaller entities—none so essential to the entire structure that it is indispensable.
The concentration of power—political as well as economic—that resided in these few institutions has made it impossible so far for this crisis to be used as an evolutionary step in confronting the true economic issues before us.
But imagine if instead of merging more and more banks together, we had broken them apart and forced them to compete in a genuine manner. Or, alternatively, imagine if we had never placed ourselves in a position in which so many institutions were too big to fail. The bailouts might have been unnecessary. In that case, vast sums now being spent on rescue packages might have been available to increase the intellectual capabilities of the next generation, or to support basic research and development that could give us true competitive advantage, or to restructure our bloated health care sector, or to build the type of physical infrastructure we need to be competitive.
It is time we permitted the market to work: This means true competition with winners and losers; companies that disappear; shareholders and CEOs who can lose as well as win; and government investment in the long-range competitiveness of our nation, not in a failed business model of financial concentration and failed risk management that holds nobody accountable. This point will be all too well driven home when the remaining investment bankers in New York board a CACC jet to fly to Washington to negotiate the terms of a government bailout of yet another U.S. financial institution that was deemed too big to fail.
Paulson Considers New Plan to Resuscitate US Housing Market
Treasury Secretary Henry Paulson is considering a new plan to reduce mortgage rates in another bid to revive the U.S. housing market, a government official said. The Treasury, which already has a program to buy mortgage- backed securities issued by Fannie Mae and Freddie Mac, could step up those purchases to drive down interest rates on some loans to 4.5 percent, the official said on condition of anonymity. The plan is preliminary and could change. The deliberations come as President-elect Barack Obama pledges fresh action to help American homeowners, and follow a $600 billion initiative announced by the Federal Reserve last week to buy mortgage debt.
Mortgage applications surged by a record last week and the average rate on a 30-year fixed-rate loan dropped to 5.47 percent, the lowest level since June 2005, the Mortgage Bankers Association said yesterday. “Lower mortgage rates will allow households to fortify their balance sheets, and we will likely see consumer spending come back a little quicker than it would otherwise,” said Mark Vitner, a senior economist at Wachovia Corp. in Charlotte, North Carolina. At the same time, “it’s not going to be an instant panacea for what ails the economy,” he said. While lowering mortgage rates to 4.5 percent would allow most homeowners to refinance into a cheaper loan, far fewer will actually qualify, said Rajiv Setia and Nicholas Strand at Barclays Capital in New York.
“Over 90 percent of the mortgage universe out there would be refinancable, but you can’t force banks to lend to people,” said Setia, a fixed-income strategist for Barclays. The Bush administration has been faulted by Democrats and consumer advocates for failing to take sufficient steps to stem record home-loan foreclosures this year. Federal Housing Finance Agency Director James Lockhart has been prodding private mortgage servicers and bond investors to cooperate with government efforts to modify or refinance loans for troubled borrowers. Treasury “keeps nipping at the edges to come up with a wholesale response, but always ends up with a partial response,” said John Taylor, president and chief executive officer of the National Community Reinvestment Coalition in Washington. “Regardless of whatever rhetoric Paulson keeps throwing around, foreclosures continue to go up.”
Paulson last December brokered a deal with banks and mortgage servicers to fix interest rates on some subprime loans for five years. He put together an industry-led coalition called “Hope Now” to help Americans at risk of losing their homes. He first resisted, then accepted, foreclosure relief as part of the $168 billion economic-stimulus package passed in February. House prices in 20 U.S. cities declined in September at the fastest pace on record. The S&P/Case-Shiller home-price index dropped 17.4 percent from a year earlier. Foreclosure filings in October were up 25 percent from a year ago, according to RealtyTrac Inc., a seller of default data. Washington-based Fannie and McLean, Virginia-based Freddie, seized by FHFA on Sept. 6 after examiners found the companies’ capital to be too low or of poor quality, own or guarantee about $5.2 trillion of the $12 trillion U.S. home-loan market.
Strand, Barclay’s head of agency mortgage bond strategy, said between 20 percent and 25 percent of U.S. loans originated in 2006 and 2007 are currently under water and wouldn’t qualify for refinancing through Fannie and Freddie, which require borrowers to maintain at least 3 percent equity in their homes. “So this would help, but it only helps agency borrowers,” Strand said. “I don’t see how this would help other non-agency borrowers who essentially can’t even get a mortgage at this point.” Agency mortgage securities are guaranteed by federally chartered Fannie or Freddie, or by government agency Ginnie Mae. Yields over benchmarks on agency mortgage bonds have widened as mortgage rates tumbled. The difference between yields on Washington-based Fannie’s current-coupon 30-year fixed-rate mortgage bonds and 10-year Treasuries widened to as high as 208 basis points yesterday, the closing level the day before the Fed’s announcement. A basis point is 0.01 percentage point.
Bloomberg current-coupon indexes represent the average of yields for the two groups of mortgage bonds with prices just above and below face value, the ones lenders typically package new loans into. The spread helps determine the rates offered to homeowners on new prime mortgages of $417,000 or less in most areas, and up to $625,500 in high-cost locations. When taking over Fannie and Freddie, the largest U.S. mortgage-finance companies, Paulson said that he would direct the firms to increase their $1.5 trillion mortgage-asset portfolios and have his department start buying their home-loan bonds to help lower the cost of home financing. Last week, the Fed announced plans to buy as much as $500 billion of agency mortgage securities, as well as $100 billion of Fannie, Freddie and Federal Home Loan Bank corporate debt.
Amid Congressional criticism of “Hope Now,” Paulson asked lawmakers in July to authorize him to purchase equity stakes in Fannie Mae and Freddie Mac as a way of boosting confidence in the mortgage lenders and expanding credit. At the time, he told Congress he wouldn’t need to use the authority because simply having it would be enough -- less than two months later he was forced to take the two over.
Paulson then pushed Congress to pass a $700 billion plan to buy toxic mortgage investments from banks, recognition that previous plans to aid the financial and housing markets had failed. He has used almost half of the Troubled Asset Relief Program to inject capital into financial firms, which has yet to result in an increase in bank lending.
Lawmakers criticized his announcement last month to abandon the original intent of the TARP, saying Paulson had failed to use the funds to aid homeowners. The Treasury chief last week reiterated that his department was studying ways to use TARP money to stabilize the housing market.
Fed Takes a $3 Trillion Gamble to Spur Lending
Federal Reserve officials are throwing everything they have into the fight to stabilize financial markets and restore economic growth. In the process, the Fed balance sheet is ballooning to $3 trillion, if not more. It's a risky approach because all the cash piling up in the banking system might spark rising inflation down the road. The alternative -- just relying on traditional interest-rate cuts -- might leave markets and the economy mired in the mud for years. Fed Chairman Ben S. Bernanke and his colleagues know that when the markets stabilize and the economy turns around, they will have to move fast to take back the extra cash and shrink the central bank's balance sheet.
A second risk -- that the Fed ends up losing billions on some of the assets accepted as collateral for loans -- is of small importance compared with what's at stake. All the Fed's work hasn't prevented a deepening of the recession. Bernanke made it plain in a Dec. 1 speech that the Fed will expand efforts to deal with the crisis while waiting for the big dose of fiscal stimulus promised early next year by President-elect Barack Obama and congressional leaders. So far this year, the Fed has aggressively reduced its overnight lending rate target to only 1 percent, and it probably will trim it by another 50 basis points at a Dec. 15-16 Federal Open Market Committee meeting.
It has also pumped unprecedented amounts of liquidity into the banking system using loans and new auction techniques. And recently the central bank began providing credit directly to businesses and financial institutions by buying commercial paper and other assets. As a result, the Fed's balance sheet has ballooned to $2.1 trillion from less than $900 billion a year ago. On Nov. 25, it said it would buy another $800 billion worth of asset-backed securities, expanding the balance sheet to almost $3 trillion. The Nov. 25 announcement knocked about 50 basis points off rates on conventional 30-year fixed-rate mortgages, leaving them at about 5.5 percent, a full percentage point lower than at the end of October. That in turn sparked a surge in mortgage applications.
Mortgage rates were affected because of the $800 billion, the Fed planned to use $100 billion to buy debt from Fannie Mae, Freddie Mac and the Federal Home Loan Bank System. Another $500 billion would be used to purchase mortgage-backed securities from Fannie, Freddie and Ginnie Mae. The remaining $200 billion would finance a new facility to buy assets backed by student loans, car loans and other consumer loans. "This is an outside-the-box response to our credit problems that will eventually prove successful," said a Dec. 3 memo from Wells Fargo Bank economists. The question is how many of those applications will result in offers of mortgages, given the tightening in lending standards this year.
More broadly, all the interest-rate cuts and additions of liquidity haven't spurred a significant resumption of lending by financial institutions or new commitments by risk-adverse investors. A significant chunk of the added cash is piling up in the form of excess reserves on deposit at Federal Reserve banks. Normally, the Fed keeps overnight rates close to its chosen target through the daily addition or subtraction of reserves. An increase in reserves gives banks the ability to increase lending, adding to the money supply and spurring economic growth. When loans are withheld, this process is truncated.
"All these reserves could stimulate the economy, but for that to happen, you have to have lending," said economist Ray Stone of Stone & McCarthy Research Associates. "Right now, the Fed is taking the horse to water but can't make him drink." The Fed announced yesterday which bonds it plans to buy, beginning today, as part of the $100 billion in debt it will acquire. Those purchases, and the mortgage-backed securities it will also buy, likely will further increase the amount of excess reserves. The key point, though, is to bring down longer-term interest rates, which the Fed can't control as closely as overnight rates. In his Dec. 1 speech, Bernanke said the Fed could also influence financial conditions by purchasing "longer-term Treasury or agency securities on the open market in substantial quantities."
Just the hint the Fed might do that drove yields on 30-year Treasury bonds down to a record low of 3.17 percent. While the Fed can't lower its overnight lending target much more, there's hardly any limit to the amount of liquidity it can add to the market. As Peter Fisher of BlackRock, Inc., who for several years directed the Markets Group at the New York Federal Reserve Bank, said in a Dec. 2 interview, when the economy begins to recover "there's going to be an exit problem. We hope the Fed is going to be as agile when they have to shrink their balance sheets and pull back." We all should be relieved when they have to try.
Washington's New Tack: Helping Homeowners
After pouring vast amounts of money into financial institutions of almost every type, and having little to show for it, the Bush administration and the Federal Reserve are suddenly taking a new look at ordinary homeowners. Ben S. Bernanke, chairman of the Federal Reserve, warned on Thursday that the soaring number of foreclosures threatened the economy. He then proposed some ideas — government-engineered loan modifications, and more taxpayer money to help people refinance — to keep people in their homes.
"The public policy case for reducing preventable foreclosures does not rely solely on the desire to help people who are in trouble," Mr. Bernanke said. "More needs to be done." At the Treasury Department, meanwhile, top officials continued to work on a plan to bolster the housing market by subsidizing 30-year home mortgages with rates as low as 4.5 percent — a level that home buyers have not seen since the early 1960s. Both actions highlighted how economic policy makers have come almost full circle. Since the financial crisis began last summer, both the Fed and the Treasury had focused almost exclusively on patching up the financial system — propping up banks, Wall Street firms, money market funds and issuers of commercial debt.
But the new focus on helping individuals could create a bitter split between those who want to buy homes and those who already own them. It has already opened up a rift between the real estate industry, which wants to increase sales, and the banking industry, which wants to get out from under staggering volumes of troubled mortgages. Under a plan that top Treasury officials are weighing, the Treasury Department would underwrite tens of billions of dollars worth of 30-year, fixed-rate mortgages at rates far lower than most Americans have ever seen.
According to Bankrate.com, the 30-year, fixed-rate mortgages fell on Thursday to 5.58 percent, down from 5.76 percent last week. The 10-year Treasury note fell to 2.55 percent late Thursday, a new low. But the cheap mortgages would be available only for people buying houses, not the roughly 50 million families that already have mortgages and would want to refinance at a lower rate. As a result, the plan offers no direct relief to the millions of people who face foreclosure because they took out exotic mortgages that they could not afford. Nor would the plan offer any benefit to people who have stayed current on their mortgages and would simply be interested in taking advantage of a lower rate. As envisioned by Treasury officials, homeowners who now pay 6 percent would be watching new neighbors arrive whose monthly payments were almost one-third lower.
"At this point, our view is that such a program may do more harm than good," said Camden R. Fine, president of the Independent Community Bankers of America, which represents about 8,000 small banks. "You have thousands of banks that made loans and have them sitting on their books, and whose borrowers have worked their rear ends off to make the payments," he said. "Those people are going to go to their banks and tell them their neighbor just got a 4.5 percent loan, and the banks aren't going to be able to help them. They're going to have extremely angry and disgruntled customers."
But the National Association of Realtors, whose members want to bolster home sales, is lobbying hard for the idea. "We believe that the only way to really address the housing situation is to increase sales," said Lawrence Yun, chief economist for the association. "Home prices will not stabilize until we address the inventory problem, and the only way to bring down the inventory of houses on the market is to bring in a new set of buyers. We think this would do the trick."
Mr. Yun estimated that a one-year program to provide home buyers with an interest rate of 4.5 percent would cost the government about $50 billion. It would result, he predicted, in about 500,000 home sales — an increase of slightly more than 10 percent over today's depressed sales rate. If the program were extended to people who simply wanted to refinance, Mr. Yun warned, the government's cost could easily be 10 times higher. Neel T. Kashkari, the assistant Treasury secretary who is overseeing the $700 billion bailout plan, publicly confirmed on Thursday that the mortgage plan was under consideration but offered no other details.
People familiar with the discussions said Treasury officials were still debating the exact mechanism for financing the cheap mortgages. The main idea is to allow Fannie Mae and Freddie Mac, the government-controlled mortgage-finance companies, to buy up and guarantee 30-year, fixed-rate mortgages paying 4.5 percent interest. The Treasury would provide the money by buying up the mortgage-backed securities from Fannie and Freddie.
The plan closely resembles a proposal developed by Christopher J. Mayer, vice dean at the Columbia Business School. "This really is the opportunity of a lifetime," he said. "If you ask someone if this is the time to come into the market, I think anyone who would have bought a house in 2007 and was sitting on the sidelines, or who wants to buy this year or would buy in 2010, would want to take advantage of this." Mr. Mayer said long-term Treasury rates are so low right now that the government could actually make a profit on the cheap loans. The Treasury can sell 10-year bonds right now and pay only 2.7 percent a year, far below the 4.5 percent that it would be charging home buyers.
But he said his own preference was to make the mortgages available to existing homeowners as well as home buyers. "I think there are additional benefits one could have by extending the program for people who refinance," Mr. Mayer said. "At 4.5 percent, you might be looking at 25 million people who could refinance and the average savings could be $400 to $500 a month." In the past, Treasury and Fed officials often pleaded that their rescues of Wall Street were crucial to the well-being of Main Street. But the new Treasury idea would amount to directly helping Main Street.
Meanwhile, Mr. Bernanke all but reversed the rhetoric of recent months by arguing that helping homeowners avoid foreclosure were critical for the whole economy. "Steps that stabilize the housing market will help stabilize the economy as well," Mr. Bernanke said. "Reducing the number of preventable foreclosures would not only help families stay in their homes, it would confer much wider benefits." Mr. Bernanke, speaking at a Fed conference on housing, outlined proposals for bolder government action. He suggested that the Treasury subsidize lower fees and interest rates on a new program, Hope for Homeowners, that is intended to help troubled homeowners refinance at much lower rates. At the moment, lenders pay an upfront insurance premium of 3 percent of the loan value and borrowers face fairly high interest rate of 8 percent.
Mr. Bernanke also supported a proposal by the Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, to have the government engineer as many as 1.5 million loan modifications. The Treasury and White House have fought the idea for months. Finally, Mr. Bernanke proposed that the government share the cost when a mortgage servicer reduces a borrower's monthly payment. Preventing foreclosures, he said, "should be high on the agenda."
Bernanke: 'Work It Out. Now.'
We may be in the information age, but nobody in the U.S. mortgage industry seems to have a firm grip on the ownership of much the country’s outstanding home loan debt, much less how to go about renegotiating the terms of mortgages that are about to go bust.
On Thursday, Federal Reserve Chairman Ben Bernanke said that the U.S. foreclosure rate remains “too high,” creating “substantial social costs” as the subrime mortgage mess, made worse by the financial crisis it triggered, continues to wreak havoc on the economy. The Fed chief said "more needs to be done" and called for a more streamlined approach to loan modifications in a bid to stem any further “unnecessary” bank repossessions.
Bernanke's support for debt relief is a departure from February, when he told a U.S. Senate Banking Committee meeting that a bill allowing bankrupcty judges to modify mortgages to save people's homes would be more of a cost to the U.S. economy than a benefit.
Some homeowners may have been comforted, but investors scuttled to the safety of U.S. government debt Thursday. The yield on the benchmark 10-year note fell to 2.54% from 2.86% late Wednesday. The shorter 2-year eased to 0.83% from 0.89%.
Meanwhile, Atlanta Fed President Dennis Lockhart was more matter of fact than proactive when he said that the U.S. is in the middle of a long, painful crisis and sees a further rise in unemployment figures, according to TradeTheNews.com. On the upside, he said the U.S. is experiencing the "worst of the downturn" now and that falling home prices are necessary in order to correct an asset bubble.
Bernanke’s most recent call to adjust ARMs cleverly avoids the crux of the loan modification issue: Who is supposed to take the loss when these debts are reduced? Servicers don’t have any skin in the game, beleaguered lenders who originated the poorly underwritten loans often quickly sold them and the investors who ended up owning many mortgages through sliced and diced securities called collateralized loan obligations would probably be better off with a foreclosure. Bernanke did briefly note that loan modifications raise “the risk of investor lawsuits.” Indeed, on Monday, one investor filed a lawsuit against Bank of America for tinkering with debt agreements that were not its to adjust.
The behind the scenes debate over who should take the loss on mortgage workouts is one of the most important issues that U.S. policymakers and lenders are faced with, and one that they are most loath to discuss. This is because unjustly hurting investors would create an alarming precedent that the American government no longer considers a business contract sacrosanct, which runs the grave risk of alienating those abroad who have looked to the U.S. as an investment haven governed by the predictable rule of law.
Some bailout holdings down $9 billion
Stock intended to eventually earn taxpayers a profit as part of the Bush administration's massive bank bailout has lost a third of its value — about $9 billion — in barely one month, according to an Associated Press analysis. Shares in virtually every bank that received federal money have remained below the prices the government negotiated. Most of the Treasury Department's investments since late October have been in preferred bank stocks, more than $180 billion worth, with investments in giants like Citigroup and JPMorgan Chase, and many small community banks. But the government also negotiated options to buy up to 1.2 billion shares of common bank stock that was valued at $27 billion.
The Treasury Department said it did not expect these common stock options to be profitable immediately and negotiated them so taxpayers could share in the wealth if the bank stocks recover. Now, however, the value of that common stock is worth less than $18 billion. If the government exercised all its warrants to purchase the stock today, it would lose money on 51 of its 53 agreements. Taxpayers would be out $9.1 billion. The government can exercise its options to buy the common stock anytime over the next decade, but the options were "immediately exercisable," according to banks' securities filings.
"The markets are saying this plan isn't going to work for the banks," said Ross Levine, Tisch professor of economics at Brown University. "They're asking where this plan is going." Potential losses among these common stocks include more than $3 billion for the administration's biggest deal, a $45 billion injection into Citigroup Inc. The government gave the New York-based giant $25 billion on Oct. 28. In addition to preferred stock worth $1,000 per share, the deal included warrants to pick up 210 million shares of common stock at $17.85. In late November, the White House put together a plan to give Citibank another $20 billion. The deal also included warrants to pick up 254 million shares, with the price set at $10.61.
Citigroup stock has since fallen below $8. The government would only earn a profit if the share price eventually exceeds the negotiated warrant price. Under the bailout plan, the common stock warrants — effectively treated as stock options for non-employees — would allow taxpayers to share the wealth as banks recover. "We're not exercising the warrants today," Treasury spokeswoman Brookly McLaughlin said. "We have 10 years to exercise the warrants, so it's more accurate to look at what the market believes are the 10-year prospects for these banks."
The Treasury Department projects that the $180 billion in preferred stock will generate roughly $9 billion per year during the first five years and $16.2 billion per year afterward, assuming the banks remain solvent. The preferred stock has a fixed value of $1,000 per share, and a 5 percent annual dividend for the first five years of the investment. Treasury Secretary Henry M. Paulson Jr. describes the cash infusion as "an investment, not an expenditure."
So far, however, only two of the 53 banks can be considered a good investment. The AP's analysis found that only HF Financial Corp. of Sioux Falls, S.D., and First Niagara Financial Group of Lockport, N.Y., would make money for taxpayers if the common stock options were exercised today. According to records filed with the Securities and Exchange Commission, both are small banks, far removed from the wheeling and dealing of federally insured giants that ravaged the global economy by making bad bets on subprime mortgages.
The South Dakota bank, for example, has a market value of $54 million, a fraction of the size of JPMorgan Chase, the nation's largest. The Treasury Department gave $25 million to HF Financial on Nov. 21 in exchange for 25,000 shares of preferred stock and warrants that allow taxpayers to buy 302,000 shares at $12.40 within the next decade. For now, it's a good deal; the bank's stock is trading around $13. If the government exercised its option to buy HF stock today, taxpayers would collect $63,500.
More companies would be in the black, but the government used a 20-day stock price average to set the warrant price, meaning it willingly negotiated to pay roughly 25 percent more than the stock was worth on the day it signed the deals on behalf of taxpayers. Nara Bancorp, created in 1989 to serve Southern California's growing Korean-American community, borrowed $67 million from taxpayers on Nov. 21, when its stock was trading at $7.50 per share. But the government negotiated the option to buy 1 million shares of Nara common stock at $9.64, higher than its stock is currently trading.
"It's a complete mistake to think this is a good investment for us," said Paola Sapienza, a finance associate professor at Northwestern University's Kellogg School of Management, who spearheaded a September protest of the bailout by more than 200 of the nation's leading economists. "It's a gamble. It's like going to Las Vegas."
Treasury Tries to Re-Inflate Housing Bubble
Treasury Secretary Hank Paulson is hoping he's found the magic bullet to solve the US housing market's seemingly never-endless woes. He hasn’t. By throwing around the weight of recently nationalized mortgage giants Fannie Mae and Freddie Mac, the Treasury Department is considering a plan to push interest rates on purchase money mortgages down to 4.5% - well below the current market rate of around 5.75%. Artificially lowering rates so buyers can afford more house led us into this mess; it’s doubtful the same tactics will lead us out.
According to the Wall Street Journal, the plan is in the early stages of development, but officials expect the initiative to spur buying activity. The aim is to prop up home prices by enabling borrowers to afford more expensive houses. Columbia University economists believe such a program could help between 1.5 million and 2.5 million Americans buy new homes. In order to qualify for the low rate, borrowers have to meet Fannie and Freddie’s now-stricter loan underwriting requirements. But even with more affordable monthly payments -- the lower rate amounts to savings of $150 per month on a $200,000 loan -- precious few prospective buyers are willing and able to pony up the tens of thousands dollars still required for a down payment.
Combined with the Federal Reserve’s recent $200 billion lending program for securities backed by newly originated mortgages, bureaucrats are pulling out all the stops to buoy falling property values. This is the latest in a series of botched attempts to re-inflate the housing bubble. And like the others before it, the plan fails to address the root causes of ongoing home price declines: Negative equity, over-supply and mounting job losses. The flood of recent loan modification programs championed by FDIC Chairman Sheila Bair and rolled out by JPMorgan, Citigroup and Bank of America also miss the point. Like any distressed market, the housing market badly needs price discovery. And like any other asset class, the true price of a house is only discovered when someone buys it on the open market.
By creating unnaturally low interest rates and allowing buyers to purchase bigger homes than they could normally afford, Paulson and Bernanke are preventing home prices from falling back to where responsible, fiscally minded Americans can buy without the crutch of government subsidies. These continued distortions of the free market end up running in contrast to their intended goals: As long as the charade continues, as long as the real estate market is prevented from finding a natural bottom, home prices will continue to fall.
The silver lining -- for those brave enough to uncover their eyes and look -- is that just as it overshot on the way up, the housing market will likewise overshoot on the way down. A protracted period of stabilization will ensue, during which time the opportunity to purchase high-quality residential real estate below its long-term intrinsic value will be extraordinary. Savvy investors with the ability to identify attractively priced properties will, eventually, have the buying opportunity of a lifetime.
Dodd, Frank Say Treasury May Not Get More TARP Funds
Senate Banking Committee Chairman Christopher Dodd said he opposes giving the Bush administration the second half of the $700 billion financial rescue plan, joining Republicans upset with how it is being managed. “I would be a very hard person to convince that this crowd deserves to have their hands on the next $350 billion,” Dodd, a Connecticut Democrat, told reporters today in Washington after a hearing on whether automakers should get government aid. “I am through with giving this crowd money to play with.” Dodd, who is trying to forge a compromise in Congress that would give automakers assistance, also criticized the Federal Reserve for not sending a representative to the hearing. He wrote Fed Chairman Ben S. Bernanke yesterday asking what’s preventing him from lending to the companies, an idea rejected this week by at least two central bank officials.
House Financial Services Committee Chairman Barney Frank also faulted the Treasury for ignoring the “clear congressional intent” of the Troubled Asset Relief Program to reduce home foreclosures. He said Paulson may be blocked from accessing the money. Under the terms of the law, lawmakers have 15 days to reject a request for TARP funds. “At the very least, he’d have to agree that some of that money was going to be used for foreclosure relief,” Frank, a Massachusetts Democrat, told reporters after a speech at a Consumer Federation of America conference in Washington.
Frank and Dodd echoed House Republicans, who yesterday sent a letter to Paulson and Bernanke saying they oppose releasing any more TARP money without more clarity over past spending. Paulson, who has committed all but $20 billion of he first half of the funds, is also under fire for abandoning the original TARP plan to buy toxic mortgage assets. “The government has burned through nearly $350 billion” of funds and “is pledging trillions of dollars more through other programs, yet little is understood about how these investments are contributing to the nation’s economic recovery,” said the letter by House Minority Leader John Boehner and a11 other Republicans.
The rising opposition comes as Congress debates how to help General Motors Corp. and Chrysler LLC. House Speaker Nancy Pelosi favors using TARP funds, something Paulson opposes. In his letter to Bernanke yesterday, Dodd asked whether the Fed might be able to lend financial assistance to the car companies, something officials are unwilling to do.
Richmond Fed Bank President Jeffrey Lacker and St. Louis Fed President James Bullard said this week that legislators, not the central bank, should come up with a solution. “Congress will have to decide how they want to play this,” Bullard said in a Dec. 2 Bloomberg Television interview. Fed officials have an aversion to extending the too-big-to- fail doctrine beyond financial institutions. The premise of the central bank’s $85 billion rescue of American International Group Inc. in September was that the
insurer’s failure posed a threat to the system through its role in the derivatives market.
Other obstacles involved in lending to carmakers might be finding large pools of collateral for the Fed to loan against. Officials are also unlikely to grant bank holding company status to auto-firm subsidiaries as a potential conduit for aid to the parent. Transactions between banks and affiliates are strictly regulated by the Fed.
Paulson has repeatedly said he hasn’t decided whether he will ask for the remaining funds with less than two months left in the Bush administration. Most of the money has gone to injecting capital into financial firms in exchange for preferred shares and warrants. He also pledged $20 billion into a Fed facility to boost consumer credit. “We have no timeline for drawing down the next tranche,” Paulson said at a Nov 25 press conference. “When the time is right, we’ll avail ourselves of the congressional process.”
Citigroup Needs to Confess Its Writedowns Now
Now that Citigroup Inc. has secured yet another taxpayer bailout, where are the writedowns? You don't have to be that smart to figure out there's still a lot of rot on Citigroup's $2.1 trillion balance sheet. If there wasn't, the New York-based lender wouldn't have needed last week's government rescue, which included a new $20 billion investment by the Treasury Department, plus a guarantee covering about $306 billion of the bank's assets against most losses. And yet, something's missing: a proper confession.
Let's say a company's board or management concludes mid- quarter that big charges to earnings are needed to write down impaired assets. Under the Securities and Exchange Commission's rules, that must be disclosed within four business days in an SEC filing. If the size can't be determined, disclosure is still required; the company just has to say it's unable to make a good-faith estimate of the amount. It's been more than a week since Citigroup reached its Nov. 23 welfare deal with the government. Since then, it has made no such disclosure filing, though it did issue a press release on Nov. 19 divulging $1.1 billion of new investment losses.
That leaves a couple of possible explanations. Somehow, the people running Citigroup have imagined a way to avoid concluding that massive writedowns are needed, even after determining the bank might not survive without another bailout. Or -- and here's the odds-on favorite -- Citigroup's bosses operate as if the rules don't apply to them. One reason we know Citigroup is anticipating huge losses is that the terms of its latest bailout agreement envision them. Citigroup is responsible for the first $29 billion of losses in the government-guaranteed portfolio, which includes loans and securities backed by residential and commercial real estate. The government will assume 90 percent of any other losses, with Citigroup taking the rest.
In return, Citigroup is handing the feds $7 billion of preferred stock. How sweet is that? Imagine an insurance company offering to charge you a $7,000 premium with a $29,000 deductible to insure your $306,000 house, knowing full well that the master bedroom is on fire. That's more than a helping hand. It's a gift. The spillover benefit for the world at large is that a global financial meltdown is averted again, for now, and Saudi billionaire Prince Alwaleed bin Talal's 4 percent stake in Citigroup is saved. Citigroup's deal might be less offensive if the bank and its protectors were being transparent about what they're up to.
Start with the basics. The Nov. 23 term sheet released by Treasury said as much as $306 billion in assets will be guaranteed. What did that dollar figure mean? There's no way to tell. The term sheet, which also was approved by the Federal Reserve and the Federal Deposit Insurance Corp., said it will be based on a valuation agreed upon by the parties later. We don't know if that valuation will be what the holdings were worth last week, at the end of last quarter, or on some other date. We also know little about what the assets are. In addition to the stuff backed by real estate, the term sheet said they include "other such assets as the U.S. government has agreed to guarantee." That could be anything.
Whatever Citigroup's writedowns will be this quarter, there are many obvious candidates. For instance, as of Sept. 30, Citigroup had $63.1 billion of intangible assets, including $39.7 billion of so-called goodwill, which is worth nothing to a company on the verge of collapse. By comparison, Citigroup's stock-market value yesterday was $42.6 billion. Citigroup also had deemed $7.9 billion of paper losses on mortgage-backed securities as "temporary," as if the housing bubble is coming back soon. The designation, which is an old Freddie Mac and Fannie Mae trick, meant Citigroup didn't have to include the losses on its income statement or in its regulatory capital.
Under the SEC's rules, if a company "concludes that a material charge for impairment to one or more of its assets" is required by generally accepted accounting principles, then it must make the necessary disclosure, using a filing known as a Form 8-K. The exception is if "the conclusion is made in connection with the preparation, review or audit" of the company's periodic financial statements. In that case, the company can wait until its next quarterly report to disclose the information. Citigroup's fourth quarter doesn't end until Dec. 31. The company's finance whizzes don't need to start drafting their year-end balance sheet to know Citigroup has lots of damaged goods.
If Citigroup Chief Executive Officer Vikram Pandit hasn't concluded this already, it's because he prefers not to. Same goes for director and senior counselor Robert Rubin, the former Treasury secretary. When I asked a Citigroup spokeswoman, Shannon Bell, last week why the bank hadn't disclosed any significant impairment charges for this quarter, she replied: "Citi follows all reporting requirements." When I asked again this week, she declined to elaborate. Her statement speaks volumes, nonetheless.
At the Bailoutpalooza, everybody knows the rules: There are no rules. This has to stop somewhere.
High Anxiety About High Yield
Junk bond peddlers should have taken a vacation in November. That’s because there were no — count ‘em, zero — high-yield corporate bond
deals done last month on the entire planet, according to data from Thomson Reuters. That is the worst showing since March 1991, when the market for junk debt, more politely known as high yield, was in ashes. The drought is understandable: Investors, it seems, have no appetite
for risk. The yields, or returns, that investors demand to hold high-yield bonds is now so high that they imply a default rate of 21 percent, according to Moody’s. That’s higher than the record of 15.4 percent set in 1933 during the Great Depression. That might seem extreme, considering that the default rate on high-yield debt worldwide in October was just 2.8 percent. (It was 3.3 percent in the United States.) But Moody’s forecasts the default rate on junk bonds will increase to 4.3 percent worldwide (5 percent in the United States) this month, and 10.4 percent (11 percent in the United States) by November 2009. An 11 percent default rate hasn’t been seen in years, but it is still a far cry from the 21 percent default rate implied by current bond yields.
The disconnect may be related to forced deleveraging by financial institutions, which makes the risk of default appear far greater than it is. But a worsening economic climate could force Moody’s to raise its default forecast. If banks continue to cut consumer credit limits and hold back on lending, 21 percent may go from far-fetched to realistic — or maybe even optimistic.
Back on Capitol Hill, Auto Executives Still Find Skeptics
The chief executives of America's foundering automobile manufacturers returned to Capitol Hill on Thursday and found themselves confronting years of pent-up anger, the harsh politics of a recession and the realization that even their strongest supporters might not be able to muster the votes to save them. Fiscal hawks are worried that taxpayers will lose billions. Pro-labor lawmakers are furious that union workers are being blamed for causing the automakers' problems, even as tens of thousands face layoffs. Environmentalists like House Speaker Nancy Pelosi are fed up after years of battles over fuel-efficiency rules. And Congress, as a whole, is suffering from acute bailout fatigue.
"I don't want to raise expectations that that is going to be easy at all given the climate in the country," Senator Christopher J. Dodd, Democrat of Connecticut, said after Thursday's hearing before the banking committee, which he leads. "That's a tall order." In a sign of the growing pessimism among the Democratic leadership, Mr. Dodd; Ms. Pelosi; Representative Barney Frank of Massachusetts, the chairman of the House Financial Services Committee; and the Senate majority leader, Harry Reid of Nevada, wrote to President Bush after Thursday's hearing urging him to rescue the auto industry.
Mr. Dodd supports a taxpayer rescue but called on the Bush administration or the Federal Reserve to save the automakers because Congress might not do so. Mr. Dodd said that he would persist in trying to reach a legislative agreement, even as it continued to be clear that Democrats in Congress, furious over how the administration has handled the $700 billion bailout of the country's financial system, were reluctant to put more taxpayer money on the line.
There were almost as many reasons as there were lawmakers. Republican fiscal hawks, like Senator Bob Corker of Tennessee, suggested that the companies might be doomed after years of trailing their foreign competitors and might not be worthy of taxpayer expense. Mr. Corker, whose state is home to Nissan's North American headquarters, also asked why taxpayers should give Chrysler money when Cerberus, the private equity firm that owns 80 percent of Chrysler, was unwilling to invest any more of its own cash.
Confirming fears that taxpayers could lose out, the economist Mark Zandi, of Moody's Economy.com, said that automakers probably needed much more than their requested $34 billion and perhaps as much as $125 billion. He predicted that the automakers would ask for more money by next fall.
Even among lawmakers who have supported government interventions in the past, bailout fatigue is now gripping much of Capitol Hill. Mr. Dodd and Senator Charles E. Schumer, Democrat of New York, said they favored helping the automakers but only with strict oversight by a board or special trustee, perhaps a Cabinet secretary, to be sure the companies used the money as intended. But that proposal would require writing and passing complicated new legislation that could be difficult to achieve, given the tight calendar.
Senator Richard C. Shelby, the senior Republican on the panel, whose home state, Alabama, has sizable Toyota and Honda operations, has consistently voted against government interventions in private industry, including the Chrysler bailout in the 1970s and the recent rescue. But his criticism of Detroit was merciless. "The firms continue to trail their major competitors in almost every category necessary to compete," he said.
Senator Bob Casey, Democrat of Pennsylvania, and other pro-labor lawmakers, said they resented that the United Automobile Workers union was being blamed for causing the automakers' financial problems. "There wasn't much discussion about the upcoming sacrifice and concessions that labor is making, and I was trying to point out some of the previous concessions they have made," Mr. Casey said. "They are substantial."
The White House said it stood ready to aid the auto industry by speeding up access to $25 billion in loans approved as part of a 2007 energy bill, an idea Ms. Pelosi has resisted, and accused the Democrats of trying to pass the buck after failing to win support for their own plan. "They can't get Congressional support for their idea," said Tony Fratto, the deputy White House press secretary. "So they want us to do it instead."
After being sent home to Detroit empty-handed two weeks ago, the chief executives of General Motors, Ford and Chrysler made a show of contrition: driving to the Capitol in some of their most fuel-efficient vehicles to deliver the detailed reorganization plans that Congressional leaders had said were lacking last time. But within moments of the opening gavel it was clear that even a flawless presentation might not be enough.
Mr. Shelby grilled the executives about how they got to Washington, suggesting he regarded driving as a stunt. "Did you drive or did you have a driver? Did you drive a little and ride a little? And secondly, I guess are you going to drive back?" That prompted Mr. Dodd, laughing, to interject: "Where did you stay? What did you eat?" "The chairman wants to make light of this," Mr. Shelby said. He was not smiling. And he got his answers. It was hardly the only uncomfortable moment for the executives, Rick Wagoner of G.M, Alan R. Mulally of Ford, and Robert L. Nardelli of Chrysler.
G.M., in particular, is in dire straits with some predicting that the company might be forced into bankruptcy. From the start, the executives took an apologetic tone in making their cases for the government-financed bailout: G.M. asked for $12 billion in loans and a $6 billion line of credit; Ford for a $9 billion line of credit that it can draw on if needed; and Chrysler for an immediate $7 billion loan.
"We're here today because we made mistakes, which we are learning from, and because some forces beyond our control have pushed us to the brink," said Mr. Wagoner. "Most importantly, we're here because saving General Motors, and all this company represents, is a job worth doing."
Ford is not seeking loans for now. But its chief executive, Mr. Mulally, echoed the comments of his counterparts at G.M. and Chrysler that an automobile company could not survive a bankruptcy filing. "Any threat of a company going into bankruptcy would really, really hurt sales," Mr. Mulally said. "Sales would fall off so fast that you couldn't restructure fast enough."
Much of the questioning from senators zeroed in on whether the companies were simply seeking loans to forestall inevitable failure. But over the course of nearly six hours of questions, some lawmakers belittled or dismissed aspects of the companies' plans. In a reminder that the automakers are seeking help after a long line of banks before them received taxpayer funds, many with few strings attached, a large chart stood just to the side of the dais titled, "Taxpayer-Funded Bailouts."
With large blue bars, it showed $300 billion for Citigroup; $200 billion for the mortgage giants, Fannie Mae and Freddie Mac; $150 billion for the insurance conglomerate, American International Group; $29 billion for the failed investment bank, Bear Stearns. At the bottom of the chart were three more blue bars, each with a red question mark after them: $18 billion for General Motors; $13 billion for Ford; $7 billion for Chrysler.
Perhaps the only consensus at the hearing was that the automakers, particularly G.M., were in grave trouble and that the government might have no good options at this point. Mr. Zandi, of Moody's, said allowing one or more of the companies to fail would be disastrous. "Bankruptcy at this point in time would be cataclysmic for the economy," he said. "So I think you need to help them now."
But some conservative lawmakers have called for letting one or more of the Big Three fail. Senator Mike Crapo, Republican of Idaho, repeatedly pressed the question about bankruptcy as an option during Thursday's hearing.
Senator Robert Bennett, Republican of Utah, raised a new idea that would call on financial firms receiving assistance under the Treasury's $700 billion program to convert any auto company debt that they hold into equity stakes, easing the cash liquidity problems of the Big Three, and potentially allowing additional infusions of government cash into the financial firms.
Mr. Casey said that Congress must act. "For me, this debate is pretty simple: as complex as the financing, as complex as the challenges are, it's about jobs," he said. "The atmosphere in America today is frankly pretty negative for any kind of assistance," he said. "We have some work to do to get the votes that we need." "Nothing concentrates the mind like a death sentence," Mr. Dodd said. "And we're looking at a death sentence here if we don't respond."
The Bank of Canada's mystery assets
For most Canadians, bringing up the goings-on at the Bank of Canada is enough to inspire yawns or changes in conversation. And with a slew of vague acronyms like SPRA, TLF and SLF dominating the bank's public documents, who can blame them?
Ignore it at your peril though, because our central bank is embarking on one of the largest and fastest revisions of its asset structure in history. Like a company, the bank has a balance sheet; assets on the one side and liabilities on the other. The majority of the bank's liabilities are circulating notes held by the Canadian public. Pull $20 out of your wallet and you are holding not just a pretty piece of paper that buys stuff but a liability of our central bank. Collectively, there's about $51-billion worth of cash circulating in the economy, all of which the bank is liable for.
A liability is only as good as the asset that backs it up. The $20 you're holding is backed by various assets held in the vaults of the Bank of Canada in Ottawa. In times past the asset side of the bank's balance sheet had a large gold component. Over the years gold lost its popularity with central banks and was replaced by government bills and bonds. As late as August of this year, the bank held assets of $22-billion in government T-bills and $31-billion in long-term bonds to back the cash in Canadians' wallets, under their beds and in their deposit boxes.
This has all changed. Over the last three months, the bank has sold off a large part of its government T-bill portfolio and replaced it with assets classified as "other." In August this "other" category comprised a miniscule 0.4% of the bank's total assets, or about $200-million. It has since ballooned in size to an impressive $32.4-billion. Last week "other" surpassed government bonds to become the largest component of the bank's assets, about 42% of the total. At the same time the bank has sold off $11-billion worth of government T-bills, which now make up just 15% of the bank's assets, down from a hefty 41%.
The assets in the fast growing "other" category have been acquired through term purchase and resale agreements from the Big Six banks and other participants in Canada's financial system. What is the category comprised of? No one really knows, but given the Bank of Canada's disclaimer on such transactions, they could include any combination of government-guaranteed mortgages, asset-backed commercial paper, corporate bonds and anything classified as a non-mortgage loan, which could presumably include items like working capital loans and credit card debt.
The bank's move mirrors some of the actions taken by the U.S. Federal Reserve since 2007. U.S. T-bills and bonds comprised 88% of the Fed's assets last December. Since then they have been sold off and replaced by a range of unnamed assets, as well as questionable items like the remainder of Bear Stearns. Bills and bonds now make up only 21% of the Fed's total assets.
From the perspective of Canada's financial firms, the bank's move brings cheers since it allows bankers to swap all sorts of financial assets off their balance sheet for cash, rather than having to offload them in often-illiquid markets. For the average Canadian who holds the Bank of Canada's cash, the move may not be in their best interests. Our central bank has swapped a sure thing; a large chunk of liquid and non-volatile AAA-rated government debt, for a slew of "other" assets whose nature remains uncertain to everyone but bank insiders, assets which are inherently more volatile and less liquid than government debt.
When the nature of any institution's assets becomes "murkier" and more volatile, the nature of its corresponding liabilities is compromised. In sum, while the big banks may be happier, those dollar liabilities we all hold in our wallets don't look so good anymore, thanks to the Bank of Canada's massive balance sheet alteration.
The best way to understand what the Bank of Canada has done to its balance sheet is to imagine a private institution doing the same in a free market. If a manufacturing firm sold off 42% of its assets, say some factories, and replaced them with assets classified as "other," you can be sure the holders of that firm's liabilities — bankers, bondholders and the like — would raise the alarm bells, maybe even selling off their holdings. If the Royal Bank sold 42% of its performing loans and replaced them with mystery assets, it's probable that a portion of depositors would get nervous, close their accounts, and go to the Bank of Montreal to do business.
Likewise, the Bank of Canada's decision to lower the stability and transparency of its balance sheet may incite people to sell Bank of Canada liabilities. The result would be a drop in these liabilities' value, which is just a different way of saying inflation, or a decline in the purchasing power of money.
Of course the bank doesn't operate in a free market. As a monopoly provider of currency, Canadians are forced to hold some of its liabilities as a means of paying for the things they need. When the quality of the assets behind these liabilities is being degraded they can only bite their tongue rather than turn to another provider. This is unfortunate. Increased transparency and reassurances from the central bank that it is not sacrificing the integrity of our dollar with mystery assets just to help the big banks would help restore some trust. If not, its time to remind the bank that monopolies that don't help Canadians deserve to be broken up.
The chaos factor
Well, enough political crud for now. Let’s rejoin our regular programming, already in progress.
One goal of this twisted little blog is to hold up a mirror to the real economy so we might know what to expect, how to react, how to profit from change, and how to protect ourselves from it at the same time. I think we all understand these days are without precedent. Oh sure, the economy has been rotten in the past, people have lost jobs and houses and financial markets have tanked. But, this is different, in a terrifying new way.
For example, can you fix your car? Could your local service station pump gas if the power was off? Do you know if the Loblaws you shop at depends on just-in-time delivery? Can your neighbourhood bank dispense cash if it’s offline? Do you have a vegetable garden? A horse? A generator? A well?
The answer to each of those questions is ‘No’ for more than 90% of the population. And while the connection with today’s financial stories (CIBC profit drops by 50%, AT&T cuts 12,000 jobs, oil collapse costs Ottawa $6.5 billion in lost taxes, crude hits $44, Chrysler Canada going bankrupt, Abitibi closes a Newfie mill after 100 years) may seem tenuous at first, it’s not.
Unlike in the 1930s, or others times of financial stress, investor losses and deflationary decline, today we are all helpless. Most families have no backup systems, no savings, no reserve, no plan, no place to get food or fuel if the stores are closed, no water or power if infrastructure cracks, even for a few weeks.
This means relatively small disruptions in the way things normally work have the potential to cause chaos. Take money, for example. Most middle-class people don’t carry any. In fact, it’s almost become a sign of lower socio-economic status to buy a tank of gas or pay for a hotel room or purchase new shoes, with cash. Instead, the vast majority of us use credit or debit to get through our days, with trips to the bank actually being few and far between.
Unfortunately, debit and credit only work when the lights are on. In a power outage, bar code readers don’t function, electronic cash registers go dark and online authorizations cease. In other words, no cash, no sale – if you can even find a store open. And the only gasoline around will be at rural stations which park a generator in the back. This means on the day when the first dimming occurs, you will be SOL if you don’t have a full tank and a wad in your purse. But, sadly, nine of ten people will not.
And why should we worry about failing infrastructure? Because of the financial crisis, which shows every sign of deepening and lengthening. Unemployed people and failing companies do not pay federal or provincial taxes. Falling property values will result in lower municipal revenues. More families without stable incomes will boost the demand on governments. Collapsing commodity prices mean a big hit for governments who depend on royalties.
Look south to see the results. More than a few American towns and cities have gone bankrupt. California is on the verge of financial collapse. The US government is sinking into an unthinkable abyss of debt. Public finances are disintegrating, and yet politicians know it is impossible to raise personal or corporate taxes. So, this is not going to end well.
Expect cuts in services, lower levels of response and public sector layoffs. This could mean the next ice storm has the lights out for 12 days, instead of 24 hours. And if things start to spiral into deflation, then reduced government support will become the norm. Meanwhile a credit crunch can prevent the grocery store from borrowing enough on its line to stock its shelves, or the trucking company from getting insurance or enough diesel, or – God forbid – convince a faltering bank to cancel revolving credit, and turn your card balance into a demand loan.
Many may dismiss my cautions, saying a rerun of the Thirties is impossible. And they`re right. This time we`d be screwed.
German manufacturing orders collapse
German manufacturing orders plunged in October after a record decline the previous month, pointing to a deepening recession in Europe’s biggest economy. Orders fell 6.1 per cent in October, led by a sharp downturn in demand from Germany’s euro zone trading partners, preliminary economy ministry data showed on Friday. Economists had forecast a rise of 0.4 per cent in a Reuters poll. Compounding the bad news, which helped to send the euro to a session low against the dollar, was a downwards revision to the September result to show a decline of 8.3 per cent. ”German industry seems to be drowning in the financial crisis,” said Carsten Brzeski, an economist at ING Financial Markets. ”What started off as a relatively normal correction from very high levels has developed into serious collapse.”
Domestic orders fell 6.1 per cent, with foreign orders down 6.2 per cent, led by a drop in demand from the euro area. ”Industrial production will decline further in coming months due to the persistent weakness in orders,” the ministry said. German business sentiment is near its lowest level in 16 years, and a survey of manufacturing firms showed the outlook for new orders got worse in November. Further highlighting the economy’s woes, premium carmaker BMW said global sales plunged by a quarter in November as even wealthy consumers cut their spending. A survey by the Ifo economic think tank showed a growing number of German firms are finding banks’ lending conditions restrictive, particularly larger ones.
The German economy is already in recession and fears are mounting the country could be facing its biggest economic downturn next year since the second world war. Deutsche Bank chief economist Norbert Walter told a newspaper that German gross domestic product could contract by up to 4 percent in 2009. This would be four times as bad as its previous worst one-year performance since West Germany’s creation in 1949. The ministry data showed orders for capital goods fell 8.2 per cent in October, with those for intermediate goods down 4.5 per cent. Consumer goods orders fell by 1.6 percent.
Bank of England mulls "nuclear option" of cash injection
The Bank of England is working on radical plans to inject cash directly into the economy - the nuclear option to be used only when interest rates approach zero. In what would be a major departure for British monetary policy, the Bank is considering pressing the button on printing presses by engaging in a so-called policy of quantitative easing. It emerged after the Monetary Policy Committee cut borrowing costs by 1pc to just 2pc - the lowest level since 1951. In the statement published alongside its decision, the Bank warned that "it was unlikely that a normal volume of [bank] lending would be restored without further measures."
The measures under consideration include direct purchases of assets, such as government debt or commercial investments, by the Bank or the Treasury, as well as expanding the Bank's balance sheet, a means of pumping extra cash into the banking sector. The radical proposals, which are currently being explored by Bank experts, could be put into action within weeks, although they would have to be vetted by the Treasury, which is thought to remain sceptical. The main obstacle is that the policy could be found to conflict with European Union laws on how governments manage their budgets. However, added weight was given to the proposals by European Central Bank President Jean-Claude Trichet, who seemed to hint in the press conference to announce the ECB's 75 basis point rate cut yesterday that it may also consider "nuclear options". "We will look at what is necessary at any period of time," he said. "If new decisions are needed, we will take new decisions."
If the plans do go ahead it would be the first time since the 1970s that the Bank of England has effectively attempted to target the volume of cash in the economy, by using its balance sheet, rather than the price of money through interest rates. The news underlines the fact that despite having slashed rates from 5pc this year, and put around £500bn of money behind schemes aimed at kick-starting the mortgage lending market, it has failed to arrest the financial crisis. Danny Gabay of Fathom Consulting said: "There has been a seismic shift at the Bank of England. I think [quantitative easing] is a natural progression from where we've got to now. The Bank has reached a tipping-point with interest rates. With a target rate for inflation of 2pc, this cut means that real interest rates are now at zero. "It's quite sensible for them to start thinking about what other things to do. The easiest thing that they could do is to under-fund the fiscal deficit."
This would involve using the Ways and Means bank account at the Bank to buy government securities and would, in effect, amount to printing cash. In normal times such a move would be highly inflationary, but with the UK facing deflation next year such a plan is now thought to be valid. A number of other central banks, including the Riksbank in Sweden, the Danish central bank and the Reserve Bank of New Zealand also slashed rates as the global economic slowdown took hold. With experts speculating that the MPC might contemplate another 1.5pc cut, the pound dropped sharply ahead of the decision, but it later recovered to close down 1.32 cents at $1.4690 against the dollar. Halifax reported that house prices dropped by 2.6pc in November alone, while the Society of Motor Manufacturers and Traders announced that new car sales plummeted at the fastest rate since 1980. The total number of new car registrations last month was 100,333 - down 36.8pc on last year's level.
Sarkozy's 'Bewildering Mish-Mash of Measures'
French President Nicolas Sarkozy on Thursday unveiled a scheme to spend €26 billion to energize the flagging French economy. But German editorials look beyond the big number -- and warn it is far from a magical economic elixir. France has become the latest European Union country to dig into its pocket to try to halt the economic slide. President Nicolas Sarkozy's €26 billion economic lifeline hopes to encourage recovery by funding investment projects rather than direct boosts for consumers. And while the French economy is predicted to veer into recession, the government says that the new package will expand gross domestic product by 0.6 percentage points in 2009.
Speaking in Douai, Northern France, near a Renault factory, Sarkozy said almost €3 billion will be injected into the all-important automobile and housing sectors. The construction industry will be helped by a €6.5 billion investment plan to upgrade railways, schools and hospitals. Meanwhile, infrastructure projects will be accelerated, investment will be encouraged and small firms will be rewarded for new hiring: "Our answer to the crisis is investment," he told journalists. The French scheme follows announcements of bail-out plans by its European neighbours -- but the tactics differ. While Sarkozy plans to spend, spend, spend, Britain will focus on slashing consumer taxes and Germany is prioritising guaranteeing loans and stabilizing the banking sector. But German commentators said the package was no panacea for France's enduring problems -- not least its hefty debt pile accrued over decades.
The business newspaper Handelsblatt writes:
"French president Nicolas Sarkozy presents himself in the unfortunate tradition of predecessors like Francois Mitterrand and Jacques Chirac: we'll spend today and deal with the debt mountain tomorrow when times are better… France has been living beyond its means for more than 30 years. Unlike in Germany, successive governments have avoided hard measures like raising taxes for restructuring. So now France doesn't have the same leeway for an economic stimulus package. The new program doesn't change anything about France's chronic competitive weakness: Too little investment in research and development led to a weakness in exports by French companies. Politically, Sarkozy has no choice but to match Britain, Spain and Italy. But what will happen should the program not have the desired effect? In that case, France would be left sitting on huge debts. History teaches that well-ordered finances are important -- even in good times. Why should it be any different this time round?"
The left-leaning Die Tagezeitung writes:
"It is a paradox of the current European predicament that it is a continental problem -- but answers are provided nationally. The current crisis could be an ideal opportunity to develop common European economic politics -- along the lines which Sarkozy now proposes for France: big European infrastructural measures could include, for example, high-speed links between Paris and Berlin and Berlin and Warsaw or the construction of more flats and other job-intensive investment schemes. That would not only serve to boost a continent in crisis but would also, at the same time strengthen the European identity and sense of belonging. Instead, every country is homing in on local concerns and the crisis increases the competition between individual European countries. An economic programme like Sarkozy's stands for the re-nationalization of politics. The fact that Sarkozy, national president -- and at the same time the current European president -- ended his speech with 'vive la France' without 'vive l'Europe' is symptomatic."
The center-left Süddeutsche Zeitung writes:
"The president knows how to embellish (the details). His big talent lies in his ability to make himself and his measures appear bigger than they really are. He is an engaging speaker who is particularly arresting for people who hear his rhetorical phrases for the first time. That and his effervescent temperament separates Sarkozy from Angela Merkel. Because of the strong power base he enjoys in the French political system, he can also take a stronger position than the German chancellor. His party's big majority in parliament helps him as does the dominance of the loyal media. Additionally, Sarkozy will only face elections in 2012, the European elections in 2009 will probably hardly affect him; the French opposition is weak and, thus far, there has been no big public debate on how to deal with the crisis. But to believe that Sarkozy therefore, has a free hand, would be a mistake. That is demonstrated by the bewildering mish-mash of measures he has adopted. Because of France's high budget deficit, its room to manoeuvre is extremely limited. This also separates France from Germany -- and explains why he has to restrict himself to talking rather than acting. Sarkozy knows that because of the high budget deficit, Frances recovery after the crisis is likely to be slower than that of Germany. Any additional debt burden will only serve to postpone the upturn."
Morose In Moscow: "Anti-Crisis" Parties
The streets and shops are being spruced up with pine trees and tinsel. But for many Russian families, there will be precious little to celebrate this New Year. In Barnaul, a Siberian industrial city 1,800 miles east of Moscow, schoolteacher Tatiana Saveleva will be buying few presents for her family. In October Tatiana's husband, Dmitry, an engineer at a local railway repair factory, saw his and other employees' pay slashed by a third. By November the plant had switched to a four-day workweek. "A lot of people are suffering," Tatiana says. "It's all negative."
Russians of all ages and classes are struggling to understand the krisis. "It has spread to the regions much faster than could be expected," says Andrei Kuznetsov, a strategist at investment bank Troika Dialog. "Companies are complaining of low demand, payment arrears, and limited financing." That's a sharp change from just a few weeks ago, when the Kremlin played down talk of a systemic problem and most Russians assumed the downturn was mainly an issue for Western economies. Then the freezing of international credit markets exposed the heavy dependence of Russian banks and companies on Western loans. Russia is also being hammered by the fall in commodity prices: Oil, gas, and metals account for some 80 percent of exports.
Now advertising banners and billboards offer "anti-crisis" discounts on everything from mattresses to Lada sedans. Nightclubs stage "anti-crisis" parties. Jokes about the crisis are legion: "Daddy, is it true we're facing a crisis?" "No, Son. It's the oligarchs who are facing a crisis. We are facing oblivion." In a recent survey by Ernst & Young, a third of major companies in Russia said they were planning job cuts, while 11 percent had already made them. On Dec. 1, TNK-BP, an oil company 50 percent-owned by BP, revealed that it was eliminating 390 of its head-office staff and leaving 200 job slots unfilled, equivalent to around 19 percent of head count.
The World Bank expects Russian growth of just 3 percent next year, while others warn the economy could shrink. In November, Russia's Purchasing Managers' Index of business activity was just 39.8 percent, the worst level ever in the index's 11 years of existence. Yes, worse even than in 1998, the year of Russia's colossal financial meltdown. Could history be about to repeat itself? In the space of just four months, Russia has burned its way through $150 billion (€117.5 billion), a quarter of its total reserves, to support the ruble. Although the government has been pumping cash into the banks and has extended $50 billion in emergency credit to large companies, the package is doing little to kick-start lending.
As the ruble slides, Russian banks, companies, and households are converting their cash into dollars. The capital flight may force a precipitous devaluation of the currency. "The markets have concluded the ruble is at the wrong level," says Rory MacFarquhar, chief economist at Goldman Sachs in Moscow, who sees a 20 percent fall in the currency. A sharp devaluation would recall 1998 and risk an even more dramatic deterioration in confidence. Is there any hope? "It's not going to change anyone's desire to be in Russia in the long term," says David Thomas, president of Volvo Cars in Russia. A lot depends, however, on factors outside of Russia's control, not least the price of oil. For families such as the Savelevs, the bleakness of the New Year may linger.
The Downturn Hits Dubai
With plummeting oil prices causing the Persian Gulf economy to shrivel, Dubai's push to become a global financial hub is in jeopardy. For a year or so, the movers and shakers of the small but oil-rich United Arab Emirates have watched the unfolding of the credit crisis in the West with a mixture of dismay and denial. It won't happen here, was their view. And for a long time it didn't.
But now it is. The price of oil, the lifeblood of the Persian Gulf economy, has fallen more than 60 percent since its mid-July peak. Real estate, the other mainstay, especially in oil-poor Dubai, has been quick to follow. An industry source in Dubai estimates that prices, which rose about 14.4 percent in the first eight months of this year, have suddenly dropped by 20 percent to 30 percent, with some developments seeing 50 percent declines.
With prices for villas and apartments falling and sales grinding to a halt, big developers such as Nakheel, which is building the iconic palm frond-shaped projects on fill dredged from the sea bottom, are halting construction and laying off staff. Jobs, though on a lesser scale, also are being lost at investment banks such as Morgan Stanley and Goldman Sachs, which have seen the Gulf as one place business was not drying up.
They are now trimming staff, to the alarm of the local authorities, who have staked their future on the Gulf's becoming a global financial center. A chill wind is blowing through the Gulf. Credit has dried up; stock exchanges have crashed; and the region's once-vaunted Sovereign Wealth Funds, set up to save for a future when oil reserves are exhausted, have instead sustained huge losses, potentially in the hundreds of billions of dollars.
The diciest situation is unfolding in the UAE, where the sheikhs of Dubai -- the second-largest of seven emirates -- are at last realizing that they need to call time on a decade-long, debt-fueled building and acquisition spree. That admission came most explicitly in the recent naming by the ruler of Dubai, Mohammed bin Rashid al Maktoum, of what looks like a war council composed of nine of the top executives of what is known as Dubai Inc. That's the network of companies such as Dubai World, Emirates Airline, and Dubai Holding that are controlled by the ruling family and the government. "Yes, we recognize the new reality," said the Council's Chairman Mohamed Alabbar on Nov. 24. "Make no mistake."
It has long been assumed that if Dubai got into trouble, it would be bailed out by its neighbor, Abu Dhabi, one of the great oil powers and the deep pockets behind the UAE. Already there are signs of a rescue process beginning. It's being handled at the UAE federal level, with Abu Dhabi likely providing whatever funding is needed. Trading in the shares of two publicly traded but partly state-owned mortgage finance companies, Tamweel and Amlak Finance, was suspended on Nov. 20.
The two companies, which account for about 50 percent of the mortgage market, with $5.5 billion (€4.3 billion) in assets, are to be merged into a little known federal government entity called the Real Estate Bank of the UAE. In addition, the UAE has guaranteed all bank deposits for three years and has earmarked about $33 billion for support of the banking system. Nominally, the capital is coming from the central bank and the UAE Ministry of Finance, but, as one analyst put it, "All money in the UAE comes from Abu Dhabi."
What bankers and other executives are trying to work out is how costly the rescue of Dubai is going to be and how it will be paid for. The Dubai elite are hoping they can restructure their businesses largely on their own without major support from next door. Alabbar said that the big Dubai real estate developers, Emaar Properties (which he chairs), Nakheel, and Dubai Properties, which together command 70 percent of the market, would now work together to control supply.
He also promised that there would be no major defaults. "The government can and will meet its obligations," he said. For the first time, Alabbar provided some disclosure on Dubai Inc.'s debt. He pegged Dubai's state obligations at $10 billion and said the debt of affiliated companies was $70 billion. That's roughly equal to the emirate's $80 billion GDP. He also said Dubai's assets are about $350 billion. Analysts, though, say that only a fraction of that could be quickly turned into cash.
Analysts have applauded the straight talk, though some grouse that there is still little disclosure on matters such as cash flow. "This is precisely what everyone was looking for," said Mushtaq Khan, regional economist at Citigroup. Some credit analysts are relatively comfortable that Dubai can manage through the downturn. "Our analysis is that their interest payments are covered approximately 10 times by cash flow today," says Farouk Soussa, an analyst at Standard & Poor's. Soussa notes, however, that in the current climate those flows could fall.
But the problems in Dubai may be only just beginning -- and could get very expensive. Real estate industry insiders note that the downturn could be especially messy because the property market in Dubai is relatively new and hasn't yet been tested by a slump. The market is turning sour very fast. Many small developers are likely to get in trouble. Speculators, a big factor in Dubai real estate, are likely to walk away from properties they have bought on small deposits with the intention to resell them quickly. It's also not clear that the banks will be able to enforce foreclosures, particularly against property owned by UAE citizens.
Certainly, stock prices and credit metrics are showing signs of distress. Credit default swaps for Dubai Holding, the umbrella company for the ruler's hotels, real estate, financial firms, and other assets, have soared to a point where it would cost $1 million to guarantee $10 million in debt against default, according to financial researcher Markit. Dubai Holding recently said it had paid off $653 million in loans and bonds.
Emaar Properties shares have fallen by about 85 percent so far this year. Just about all of the big Dubai companies have real estate at their core, so a crash in real estate prices rather than the "healthy correction" Alabbar spoke of on Nov. 24 could be extremely costly. And how much money does Abu Dhabi really have? Analysts are coming around to a more conservative figure in the $450 billion to $500 billion range, rather than the much higher numbers circulating earlier this year. Whatever the big number is, it is likely smaller than it used to be. Brad Setser, Geoeconomics Fellow at the Council on Foreign Relations in New York, estimates that the Abu Dhabi Investment Authority has lost $100 billion or more in recent months as its global holdings of equities, real estate, and alternative assets have taken big hits.
Of course, Abu Dhabi ultimately has the capital to meet the needs of Dubai and other problems in the UAE, but a massive bailout could be uncomfortable even for one of the wealthiest countries in the world. "It's an interesting question whether Abu Dhabi has sufficient liquid assets to cover all of the emirates' needs next year if oil prices remain low," Setser says. What will be the cost to Dubai? Sources in the emirates say that sales of crown jewels such as Dubai Aluminum and the port at Jebel Ali have been discussed. While Abu Dhabi heavyweights sometimes criticize Dubai for its fast and loose culture and helter-skelter building, they don't seem to want to humiliate their neighbors or see them fail. After all, a meltdown in Dubai would hurt Abu Dhabi as well. "They don't want to embarrass them," says one financier. "Projects will stop, but they may not say so. That's the way things are in this part of the world."
China, U.S. pledge cooperation after "robust" talks
China and the United States pledged on Friday to boost efforts to tackle the turmoil engulfing global markets and to continue high-level cooperation when President-elect Barack Obama takes office. Among the few concrete results of the two-day meeting, the governments agreed to make an extra $20 billion of credit available to finance U.S. and Chinese exports to developing countries that are struggling to get access to trade credit.
U.S. Treasury Secretary Henry Paulson, who led the U.S. delegation, described the talks as productive and said he was proud that the "Strategic Economic Dialogue" he had instituted had strengthened bilateral relations. But there were tell-tale signs that the two sides had not seen eye-to-eye, with the United States worried that China might be losing the stomach to let its currency keep rising and China anxious over Washington's management of the U.S. economy.
In a closing statement, Paulson described the cabinet-level talks as "robust," while a senior Chinese official urged the United States not to neglect its biggest creditor as it strives to stabilize its banking system and revive growth. "We hope the U.S. side will seriously consider the Chinese side's concern and protect the interests of Chinese investors," Assistant Chinese Finance Minister Zhu Guangyao told reporters.
Beijing holds more than 60 percent of its $2 trillion of reserves in dollar assets, with a big chunk in debt issued by the Treasury and troubled mortgage lenders Fannie Mae and Freddie Mac, which have effectively been taken over by the government. Worried that the value of China's bonds are vulnerable to a sharp sell-off in the dollar, academics and some policy makers in Beijing say China should not put so many eggs in one basket.
But Paulson played down the risk that China might diversify its bond portfolio. "It is a fact that China is an investor in U.S. securities," he said. "I don't see any countries with holdings so large that I view as a threat." Paulson, on his last official visit to Beijing, praised China for its responsible stance during the crisis, including its plans to spend 4 trillion yuan ($586 billion) over two years to prop up growth in the world's fourth-largest economy.
"The Chinese government is prepared to work with the U.S. government and the international community to play a useful and constructive role in the face of the crisis," Premier Wen Jiabao told Paulson in talks that followed the formal meetings. But friction over exchange rate policy was not far from the surface after China's central bank startled markets this week by letting the yuan, also known as the renminbi (RMB), fall modestly against the dollar after engineering a steady 20.3 percent rise since July 2005.
Some economists read the central bank's action as a warning to Washington -- and to the Obama administration in particular -- not to press Beijing too hard on currency policy given the dire straits of many Chinese exporters. But Paulson stood his ground, singling out the importance of a market-driven currency in promoting domestic demand-led growth in China that would contribute to a healthy global economy.
"While recognizing that currency movements will be uneven over shorter periods, the United States encouraged China to continue, and accelerate, RMB appreciation and flexibility," a fact sheet issued after the talks added. Speaking to reporters, he said his Chinese interlocutors agreed with the need for greater exchange rate flexibility.
Wang, the vice-premier, said the current priority for policy makers must be to restore market confidence to avert recession. Both governments, he said, thought highly of the twice-yearly cabinet-level talks and had agreed to maintain the exchanges when Obama takes over from President George W. Bush on January 20. "We are looking forward to continuing the candid and pragmatic dialogue with the new U.S. administration," he said.
Chinese President Hu Jintao told Paulson after the talks that the mechanism for high-level dialogue between the two countries should be strengthened. "The dialogue helped the two nations increase mutual trust, narrow their differences and properly address the problems arising from the cooperation," the official Xinhua news agency quoted Hu as saying.
Among the other results from the meetings, China will help foreign banks in China that find themselves strapped for cash due to the credit crunch by temporarily waiving limits on how much they can borrow from abroad. "This action helps maintain investor and depositor confidence so that U.S. banks can continue to grow their business in China," the U.S. government said in a fact sheet.
Yuan's Ebb Prompts U.S. Anxiety
It is hardly going to please Washington, yet some degree of yuan depreciation looks probable, as Chinese leaders scramble to stem mounting layoffs in the country's primary manufacturing belt. Falling commodity prices act as a safeguard, ensuring that a sliding yuan will not significantly erode domestic Chinese consumer spending power. The yuan's long-term trend of appreciation is unlikely to be seriously interrupted, though, even as Beijing aims to convert the economy from export reliant to domestic demand driven.
The yuan's ebb against the dollar this week sparked speculation that Beijing wants give exporters a boost to counter the country's sharper than expected slowdown. The development worried those on the opposite side of the Pacific eager to narrow the U.S. trade deficit, just as Treasury Secretary Henry Paulson wrapped up annual cabinet-level economic talks Friday with Beijing. The timing of the move may signal a warning to President-elect Barack Obama, who said during his campaign that China manipulates its currency.
After having appreciated by 20.3% since it was unpegged from the dollar in July 2005, the yuan fell sharply against the dollar this week. The dollar strengthened to 6.8722 yuan Friday morning, compared with 6.8349 last Friday. The central bank has let the yuan gain more than 6.0% vis-a-vis the dollar this year but less than 0.1% in the second half, according to official news agency Xinhua.
At the end of the two-day talks, Paulson said at a press conference that he pressed Chinese officials on "the importance of a market-determined currency in promoting balanced growth in China."
China's Deputy Finance Minister Zhu Guangyao said Friday that China intends to keep the yuan stable and will stick to "gradual" yuan reform. On Thursday, Commerce Minister Chen Deming attributed the yuan's drop to the strength of the dollar and insisted that the foreign exchange movements were not unusual. The yuan needs to depreciate to stem the tide of factory closures in China's southern coastal areas, said Shaun Rein, head of China Market Research Group. Beijing is concerned that armies of laid-off and unemployed migrants will breed instability.
Drooping prices for essential industrial inputs like steel and oil will make it easier to allow the currency to depreciate, preserving factory margins and Chinese consumers' purchasing power with regard to imports. China will likely act to keep the yuan's drop mild, though, to avoid inflaming tensions with trading partners. Though Paulson extracted no commitments on the yuan from Chinese officials, the two countries agreed to have their export-import banks inject $20.0 billion into trade financing since exporters are facing difficulties obtaining short-term financing. China also pledged that foreign banks will be able to trade bonds on the same terms as Chinese banks.
Trouble In The World's Factory: Slowing Economy Spurs Disquiet in China
An eerie quiet has descended on the world's factory, especially in places where machines are suddenly at a standstill. In Dongguan in southern China's Pearl River Delta, hundreds of workers from the bankrupt Weixu shoe factory march silently through the city, causing traffic jams on wide streets usually crowded with a constant stream of heavily loaded trucks. Dongguan is an important motor in the Chinese export machine. The city, not far from Hong Kong, is home to row after row of low-wage factories. The streets are normally empty during the day. At Weixu, for example, migrant workers lived in dormitories directly on the factory grounds, crowded into small, multiple-occupancy rooms.
But now the drudges are out in public, staging street demonstrations somewhere in Dongguan almost every day. Many factories are running out of money and work now that China's consumers in Europe and the United States are buying less. The 2,000 Weixu workers do not carry protest signs or use whistles. China does not permit unions that could organize the protests. The men and women, many of them looking young enough to be teenagers, are driven by rage, demanding wages which haven't been paid in months. Their boss, a Taiwanese, fled the city at night.
One worker, who calls herself "Little Li," affixed shoe-size labels to boxes until recently. One day at noon, as she reports, she and other workers overheard suppliers at the factory gate loudly demanding payment for their goods. "We stopped work immediately," she says. By working overtime, which is common, 24-year-old Li earned up to €130 ($102) a month, twice as much as the paltry minimum wage. But now she lacks the money for a rail ticket back to her native Yunnan Province. She is anxious to leave the Pearl Delta region and is pinning her hopes on promises made by the local government to pay each worker.
The woman is in luck. With the Chinese authorities fearing major unrest, municipalities in the region have been paying workers their outstanding wages with a surprising lack of bureaucracy. It is a program that China can easily afford. It has the world's largest foreign currency reserves: about $1.9 trillion (€1.5 trillion). The crowds jostling at train stations in the Pearl River Delta are almost as thick as they are during the traditional Chinese New Year festival. Migrant workers are returning to rural areas in large numbers, going home to their families to weather the crisis by growing crops in their own fields once again.
The global economic crisis is hitting China with such force that the government and party have been completely taken by surprise and are increasingly overwhelmed. Even though the police are under strict orders not to provoke demonstrators, friction is growing in Dongguan. At Kaida Toys, a toy factory owned by investors from Hong Kong, 500 angry workers stormed the administration building last week, smashing windows and computers. Then the crowd tangled with about 1,000 police officers, even turning over squad cars. More and more protests are flaring up around the country. In the capital Beijing, angry workers picketed the corporate headquarters of liquor-maker China Resources, holding signs demanding the payment of their outstanding wages. Taxi drivers went on strike in Chongqing and other cities.
The protests may be just the beginning. The People's Republic of China, whose economy grew at an astonishing 11.9 percent in 2007, is suddenly feeling the extreme extent to which it depends on the global economy. Until recently, many Chinese economic experts took a completely different view of the situation. Encouraged by Western economists, they believed that China was in the process of economically "decoupling" itself from the West. Sounding almost generous, Prime Minister Wen Jiabao noted that China's greatest contribution to the world will continue growing strongly and smoothly. But he failed to explain how that will happen if the main buyers of Chinese mass-produced goods, most of all the United States, are ailing.
Meanwhile, "Grandpa Wen," as the Chinese call their premier, is traveling hastily through the country, and he is apparently horrified by what he sees. "Factors that harm social stability will increase," he warned in the party publication Qiushi (Seeking Truth). In the past, Wen and his Communist Party strategists viewed growth of eight percent as a magical minimum to preserve social stability and, with it, party control. But last week the World Bank announced its forecast of only 7.5 percent growth for China next year. It sounds like a lot -- by Western standards. The economies of the major industrialized countries can only dream of such growth rates, even during economic booms.
But it is not a lot, given the double-digit growth rates of the last five years and the country's problems. For this reason, the Chinese government is determined to take decisive counter-measures. It plans to invest about €450 billion ($563 billion) in new projects, including bridges, railways and airports, to stimulate flagging growth. It will be nearly impossible to verify how much of this giant sum China ends up spending. But the party's principal aim is to broadcast a calming message, which President Hu Jintao announced to the world in time for the G-20 summit in Washington: Look at us, we have the situation under control.
Symbols of confidence are in demand. Local officials in Shanghai unveiled plans for a new skyscraper last week. The bold design is modeled on the image of a dragon, and at 632 meters (2,073 feet) it will be China's tallest building. It will tower over the World Financial Center, which recently opened in Shanghai and, as a result of the crisis, remains half-empty. Things could get a lot worse, economists at the People's University in Beijing warned in a recent report. The Chinese economy, they wrote, will adjust to the new environment by progressing as unevenly as the letter "W," with growth declining next year to a greater extent than feared, a slight recovery in 2010 and another sharp decline after that.
Beijing, anxious to avert this horrific scenario, announces new economic stimulus measures almost daily. Last Wednesday, the central bank reduced interest rates by more than one percentage point for the fourth time in a row. China has not taken such radical action since the 1997 Asian financial crisis. China's current economic policy is looking like a roller-coaster ride. Beijing raised interest rates several times until this spring, hoping to curb inflation. Prices were stimulated by raising the exchange rate of the yuan to the dollar, as well as by rising costs of raw materials and food. But no one mentions inflation these days. In fact, the world's factory is now trembling at the prospect of deflation, or a consistent decline in prices. Premier Wen's crisis managers are fighting on several fronts. Even before the global financial crisis, they did their best to prevent a loud popping of the country's overinflated economic bubble. This led to a decline in prices on the Shanghai Stock Exchange by more than half, and a sharp drop in the real estate market.
Wen and his team are also faced with an enormous structural challenge. Three decades after the legendary reformer Deng Xiaoping opened up the People's Republic to capitalism with his reform policies, the Chinese low-cost factory appears to have reached the end of its useful life. The strategists in Beijing sense that a system in which China produces obsessively and the rest of the world does little more than consume cannot function in the long term. To address this new reality, planners in Beijing have cautiously begun to lift their country to the level of a high-tech nation. With a more stringent labor law, and by temporarily repealing export tax rebates and imposing stricter environmental protection requirements, the government was partly responsible for the shuttering of about 67,000 low-cost factories in the Pearl River Delta, including shoe and textile plants. Some operations moved to countries where costs are even lower, like Vietnam and Bangladesh.
But then change came far more rapidly than planned. First, a devastating snowstorm wreaked havoc on the government's industrial policy plans, and then there was the earthquake in Sichuan Province. Finally, there were the Olympic Games. The Olympics were suppoed to give a powerful boost to China's continued industrial ascent. Japan and South Korea had seen booms after their respective Olympics, in 1964 and 1988. But in China the Games actually curbed growth. To keep the skies blue over Beijing, authorities ordered countless factories in northern China to be closed weeks before the Games began. And, fearing terrorist attacks, they banned the transport of chemicals and other hazardous goods. Many companies still have not recovered from the temporary shutdown. The world financial crisis, which now threatens to expand into a global recession, is taking care of the rest.
China is far from being in an actual recession -- that is, a shrinking economy. Nevertheless, the country must provide new jobs for an additional 10 million migrant workers flooding into the major cities each year. To offset declining demand from abroad, Beijing is now trying to stimulate domestic consumption, as the Communist Party eyes the country's 800 million farmers as potential new consumers. It plans to allow farmers greater control over the government-owned land they farm. But private consumption, which now contributes to only 40 percent of China's gross domestic product, cannotbe created by fiat. Beijing will have to improve the social welfare system to encourage the Chinese to spend more and save less. Most rural residents have neither health insurance nor retirement pensions.
The current crisis is also likely to intensify trade tensions between the world's factory and its biggest customers, the European Union and the United States. In October, China's trade surplus climbed to a record $35 billion, mostly because China, as a result of the crisis, imported drastically fewer goods than in the previous month. There is plenty of material for bilateral talks, and yet Beijing, angry over French President Nicolas Sarkozy's plans to meet with the Dalai Lama, called off its summit with the EU in Lyon that had been planned for this Monday. Despite the crisis, China remains undeterred in pursuing its global ambitions. In the presence of President Hu, the heads of the state-owned Chinese shipping company, Cosco, signed an agreement with Greece last week. Cosco plans to build its own container terminal at the Athens port of Piraeus -- as a strategic launching pad for Chinese trade with Eastern Europe.
Death by a thousand price cuts
It's the worst-case scenario for home sellers: To endure price cut after price cut until their houses become stigmatized and hungry buyers smell blood. But how can you avoid this unpleasant scenario in today's troubled housing markets? The answer, experts suggest, is to put your home on the market at the right price, and if it doesn't sell quickly, cut the price deep and fast, so you won't be caught in a downward spiral of price reductions. Not surprisingly, few sellers want to hear that advice. They'd rather price their homes aggressively and then hope buyers will take the bait.
But testing the market simply isn't a good strategy with home prices depressed, sales at a slower pace in many markets and buyers on the hunt for good deals, says Mark Reitman, Chicago sales manager for real estate brokerage Redfin in Schaumburg, Ill. Buyers today are "looking at every aspect in so much more detail and trying to find out how they can get a lower price," he says. The high-and-hope strategy is so ill-advised that some brokers won't accept listings they think are overpriced. Among them is Tony Marriott, an associate broker with Keller Williams Realty Professional Partners in Phoenix. Marriott says he shies away from sellers who aren't realistic or won't commit to an automatic price reduction if no offer has been accepted within a few weeks after the home has been put on the market. "We go into it with a fairly aggressive discussion upfront, saying, 'We are listing your property to sell the property, not to go fishing,'" he says. "We need to have a game plan in place to take the emotion and hand-wringing out of it."
Pricing is especially crucial today because a trend toward lower home prices "prevailed throughout 2007 and has continued through the first half of 2008," according to Standard & Poor's, a New York-based financial company that publishes the S&P/Case-Shiller home price indexes. Economists have debated the relative merits of home-price indexes, and while there is little agreement on which measures are most credible, there is an undisputed consensus that home prices have fallen and may continue to do so, albeit perhaps at a slower downward pace. There is "no national turnaround" in home prices, though it's "possible that we are seeing some regions struggling to come back, which has resulted in some moderation in price declines at the national level," says David M. Blitzer, chairman of the S&P Index Committee.
House prices have fallen more sharply and quickly during this downturn than they did during previous downturns, according to "Downward Stickiness in Prices," a paper by Karl E. Case, professor of economics at Wellesley College and co-creator of the S&P/Case-Shiller indexes. Case attributes this diminished "stickiness," to use a bit of economist-speak, of home prices to foreclosure sales and the use of adjustable-rate mortgages during the recent housing boom. Yet homeowners still cling to outdated beliefs about the value of their own home. A survey by real estate information Web site Zillow.com found that 62 percent of homeowners believed their home had appreciated or held steady in the past year, even though 77 percent of U.S. homes lost value during that period.
"Our survey reveals a wide gap between the perception homeowners have about their own home's value and the realities of a market in which three-quarters of homes declined in value in the past year. We attribute this gap to a combination of inattention and a fair bit of denial that causes people to believe their home is insulated from the woes of the market that affect others, but not them," says Stan Humphries, Zillow's VP of data and analytics. A collective delusion may be but cold comfort for home sellers who suffer the consequences of mispricing their home. Overpriced home listings start out behind the market, which forces the seller to drastically cut the price or follow the market down through multiple price reductions.
Buyers, who are well aware of that dynamic, will request a history of asking prices before they make an offer, Reitman says. A series of price cuts acts as a "code" that signals to buyers that the seller is extremely motivated, and that knowledge empowers buyers to make lower offers and "stick to their guns," he warns. A December 2007 study, "Seven Tactics for Selling a Home," published by Redfin, states this same point: "Once a property fails to sell at its debut price, the time it spends on the market can encourage buyers to become more aggressive in negotiating. Price reductions can further encourage aggressive bargaining." The difficulty is that while all homes are unique, comparable homes compete with one another for buyers' attention. If your neighbors reduce the price of their home, those homes are more likely than yours to be sold. "You have to keep up and down with the Joneses," Reitman says.
If your home has been on the market for several weeks without an accepted offer, you should reassess your assumptions and rethink your strategy, experts say. Price cuts should be meaningful, so your home will "get the market's attention again," Reitman advises. A series of smaller cuts, rather than one big one, can result in a slower sale and lower price. Sellers and listing agents sometimes try to entice buyers with incentives such as a buyer's agent bonus, big-screen TV or brand-new car. But experts say those extras don't work. Bonuses are ineffective because the cash doesn't accrue to the buyer, and it's unethical for agents to deliberately show higher-compensated listings in lieu of or before other homes a buyer might want to purchase. And as for buyers, given "a choice between $15,000 off the price or a new car, (they) want the cash," Reitman says. "Price is the No. 1 incentive."
The bottom line is that lower asking prices and price reductions are a painful, yet unavoidable reality of selling a home today. In some cases, the pain is so severe that the seller has to bring cash to closing or sign a personal note to pay off an existing mortgage. "If they are serious about selling, they have to adjust the price to whatever it has to be to get the property sold," Marriott says. "If you're upside down, but you can get out of it for $10,000 today, do you want to wait six months and get out for $25,000? That's what they need to think about." "No one wants to make these tough decisions, so they do it in increments," he says. "But eventually, you get to the same place."
Baltic dry, global trade continues to collapse
Metal prices fall further than during Great Depression
The price of key industrial metals has fallen further over the last four months than occurred during the worst years of Great Depression between 1929 and 1933, according to research by Barclays Capital. Kevin Norrish, the bank's commodities strategist, said the average fall in the price of copper, lead, and zinc has been roughly 60pc since the peak in July this year. All three metals were traded on the London Metal Exchange in the inter-war years so it is possible to make a comparison.
Prices for the three metals fell 40pc from their highs in 1929 before touching bottom in 1933, with the bulk of the fall in 1930 as the slump spread worldwide. "Lead and zinc have already lost more than they did in the 1930s," he said. Copper was hit hardest during the Depression, despite the electrification drive in the US and the Soviet Union, falling 70pc at one stage before creeping back in the mid-1930s. The reason was an 85pc fall in US construction, then the biggest user of the metal.
Barclays Capital said the broader equity markets are already discounting the sorts of "savage declines" in corporate profits that were last seen in the Slump. It said (trailing) price to earnings ratios are actually lower now than they were the early 1930s, with moves in credit spreads that suggest investors are anticipating depression-era levels of economic contraction.
The credit markets continued to exhibit signs of extreme stress yesterday. The iTraxx Crossover index measuring default risk on low-grade European bonds punched above 950 for the first time. The investment grade index hit 188. The spreads are now flashing the sort of danger signals seen before the collapse of Lehman Brothers in September. Each episode of the financial crisis over the last eighteen months has been preceded by a big jump in the iTraxx indexes.
Oil to hit $25 a barrel as global recession deepens, Merrill Lynch predicts
Oil prices could tumble below $25 a barrel next year if the global recession reaches China, investment bank Merrill Lynch has predicted. The prediction that the crude prices could revisit lows last seen in 2002 led to a plunge in energy shares on Wall Street and sent the Dow Jones index down 215 points - or 2.5pc.
"With demand vanishing across all key oil consuming regions, benchmark crude oil prices continue to plummet," Merrill said in a research note. "A temporary drop below $25 a barrel is possible if the global recession extends to China." Oil fell below $43 barrel overnight as crude oil heads for its biggest weekly decline since March 2003. Since the US was declared to be in recession earlier this week the price has fallen 19pc.
"The connection is pretty clear - fewer people in jobs is a clear sign of a weakening economy,'' said Toby Hassall, a research analyst at Commodity Warrants Australia in Sydney. "As unemployment rises, GDP falls and oil demand falls. It's not likely to show much hope for the economy.'' However, low prices are not expected to last. Qatar's oil minister said earlier this month that the Organization of Petroleum Exporting Countries will "definitely'' cut output at its next meeting in Algeria on December 17. If the supply cut is big enough it could push up prices.
Floor Plan Credit Crisis Will Hit Country Dealers Hardest
The crisis affecting ‘floorplan’ credit to new car dealers is wider and deeper than many industry commentators realise. The withdrawal of credit services by GE and GMAC puts at risk potentially 30 percent or more of new car dealers in Australia. This problem has the potential to compound further as the future of other financiers to the sector is uncertain. There are doubts about Ford Credit’s intentions and future in this market. Its parent is in dire difficulty in the US, and flagging Ford sales here (and large dealer inventories of slow-moving stock) will not be helping.
Loss of another financier would turn crisis to disaster. This is a grim time for the sector and for the families and the family businesses caught up in the credit meltdown. Country car dealers, who traditionally do not write as much consumer finance (or ‘retail paper’) on the cars they sell as larger metropolitan dealerships, are particularly exposed. This is why. The provider of the wholesale finance (the floorplan) to dealers has traditionally taken a low return on this financing – often around the 90 day ‘bank bill’ or ‘commercial bill’ rate plus 1%- 2% (though for many, this has now risen to 3.0% - 3.5% above commercial bill rates). The financiers do this because they then benefit from the ‘retail paper’ the dealer writes; that is, the finance the dealer sells to you and I should we choose to finance through the dealership. There is a good margin in that finance for the financier, and, when things are good, and cars are bolting out of showrooms, profits to the financier are high.
Country dealerships however are not such cash-cows for financiers. The amount of retail paper they write is generally significantly less than city dealerships, as a proportion of sales. Thus, for the financier, country dealerships provide less access to the more profitable consumer finance market while also, because they rely on smaller markets, represent greater risk in downturn. The credit problem for dealers is further compounded because their contracts with manufacturers usually (read: always) stipulate minimum stock levels and also contain enforcement provisions requiring them to take deliveries as per their franchise agreement. So, if sales are slow, dealers have the dual problem of carrying floorplan finance on unsold stock, at the same time as yet more new car deliveries arrive at the door for which they then have to find finance.
Every unsold vehicle, especially those unsold beyond the term of the ‘floor plan’ and for which they may have had to ‘pay down’ part of the loan, chips away at profitability and threatens to drive them to the wall. A dealership with slowing sales, and growing unsold inventory and overheads, looks increasingly like a bad risk to financiers. Many of those dealers who were with GE and GMAC have a real problem on their hands finding alternative financiers. (A middle-rung dealership can carry upwards of $5 million in new car floorplan, plus $2 million or so in used car floorplan, and may have to turn over upwards of $800k a month - through parts, servicing and showroom sales - to break even.) Can you see why dealers are between such a rock and a hard place at the moment? And why country dealerships who have been abandoned by their financiers are particularly exposed?
Industry bodies such as VACC and FCAI are calling for time, Government intervention and a “temporary fund pool” (The Australian, 12/11) to give affected dealers time to find alternative floorplan providers. Some dealers have been with GMAC for decades and were given only 60 days notice of its intention to abandon ship, leaving many of their dealers up that well-known creek without a paddle. The Government appears to have noticed. Senator Steven Conroy, in answer to a question in parliament (12/11) said, “The government is certainly aware of the difficulties that finance companies, including automotive finance companies, have been facing this year as a result of the financial crisis. That is why Treasury and regulators are examining, in consultation with the industry, the impact of the financial crisis on finance companies and will provide advice on what actions might be appropriate to support this sector of the economy.”
Many regional and rural communities may be asking the Government to get cracking. Car dealers are often large employers in regional towns and cities. This is not a time for another committee; country businesses and regional communities have suffered enough over the past five years from extended drought and declining rural incomes. It is time for action.
Credit crisis 'fuelling bad behaviour at school'
Jim Knight, the schools minister, said head teachers should offer counselling sessions to parents to help them through the economic downturn. Heads admitted support was often needed in "the leafy lane schools" where many families were struggling to cope. The comments come amid growing fears that behaviour in the classroom is increasingly dictated by pupils' home lives. Mr Knight said: "There will be uncertainty for those families going through redundancy, and for those families going through stresses around an uncertain future for their housing. Those stresses potentially, I'm sure - if they haven't already - will start to be reflected in behaviour in schools."
He said he had already been warned of a deterioration in classroom discipline in areas with high numbers of local redundancies. "It stands to reason," he told the Times Educational Supplement. "It reinforces the need to ensure that the relationship between home and school is sharp and positive." Teachers have warned that schools are finding it harder to control pupils as bad habits picked up at home "spill over" into the classroom. Heads said that at the height of the last recession in the early 90s many schools witnessed a behaviour downturn. Jane Lees, president of the Association of School and College Leaders, said: "There was no doubt about it. When a family went into crisis because of the economic impact on the father or mother, the children often didn't want to let parents know their concern, so they took it out on the school and even on their friends."
Increasingly, ministers are urging schools to involve parents in their children's education to boost standards. They believe mothers and fathers should play a bigger role in school life to break down the traditional barriers between home and school. Mr Knight said support staff could also be employed to offer emotional support to parents. He cited a primary school in his Dorset constituency which regularly works with "very emotional parents, giving them support, that in turn helps them in the parenting of their children". Mick Brookes, general secretary of the National Association of Head Teachers, said that middle-class families were likely to be particularly hit. "I think the economy will cause stress in homes that are not the usual suspects," he said. "Behaviour support services tend to be aimed at deprived areas. We need to make sure the leafy lane schools are helped as well."
Recession slashes consumer meat demand
As the recession deepens, people are eating less beef, pork and poultry, leading to the biggest per capita decline in meat consumption since 1982, an industry analyst told the Kansas Livestock Association. Hundreds of cattlemen gathered here for the group's annual convention amid fears over a global credit crisis and concerns about stricter environmental regulation under the Obama administration. Consumers have already begun buying cheaper cuts of beef this year, CattleFax analyst Randy Blach said. Per capita consumption of chuck was up 10 percent, while consumption of more expensive loin was down 7 percent so far this year, his statistics showed. "This is one of the absolute worst years," Blach said.
Cattlemen on average lost $130 a head for their cattle this year, he said. "I was surprised by the magnitude of losses this year, but I am not surprised we lost money," Blach said. His outlook for next year was also grim. Blach forecast livestock inventories to continue shrinking and per capita meat consumption to decline. He also expected costs to remain high, with tighter profit margins. The global demand for beef will outstrip supplies, although the recession may slow that demand, he said. The global credit crisis will take months to stabilize but he said he thought the dollar has already bottomed out.
However, Blach also anticipated U.S. beef exports to increase next year by 27 percent because of a full year of access to Korean markets. U.S. cattlemen now have the smallest cattle herd they have had since 1962 and it is expected to shrink another 2 percent next year, he said. But beef production remains strong because of heavier carcass weights due to improved genetics and nutrition. "We don't need as many cattle as we have had in the past," Blach said.
Other Thursday sessions focused on climate change and what the prospect for tighter regulations may mean to cattle producers. Dennis Avery, global food issues director for the conservative Hudson Institute, a think tank in Washington D.C., claimed man is not contributing to the earth's climate cycles. He also claims that the earth is now cooler than it was in 1940, and that glaciers actually grew this year in Alaska and Norway. Antarctic has been cooling since the 1960s and ice there has been growing by 45 billion tons a year, he said.The government is pressuring the livestock industry to discuss curbing carbon dioxide emissions but Avery contended that would be "just economic suicide" for the industry. "My advice to the Kansas Livestock Association is to keep asking, 'where's the warming?,'" he said.
But Sara Hessenflow Harper, representing The Clark Group, advised the industry to not ignore the climate issue as Congress drafts regulations to contain greenhouse emissions. Her company, which focuses on climate change and carbon markets, told producers that ignoring the climate issue could affect whether agriculture would benefit from the sale of carbon credits to offset greenhouse emissions from other industries. "This is a market that could exist for you or this bill could be written in a way that is very costly for the economy," she said.
Point of No Return for the Arctic Climate?
For years, scientists have been watching the Arctic Ocean with a mounting sense of unease. Sea ice on the very northern tip of our planet is melting -- and it has been doing so much more quickly than expected. By September 2007, in fact, the area in the Arctic covered by sea ice was only half as big as Europe, a 40 percent reduction from the mid-1990s, as calculated by the National Snow and Ice Data Center in the US. Glaciers on Greenland are likewise disappearing at an alarming rate.
And the Arctic Ocean itself has been warming up since 1995, a trend that has only accelerated since the beginning of this decade. In the summer of 2007, water temperatures in the Bering Sea between Alaska and eastern Siberia were 5 degrees Celsius (9 degrees Fahrenheit) higher than average -- warmer than ever before. So much for the data. The question has long been: why is the Arctic heating up so fast? Climate models project what ought to be a much slower rise in temperature for the Arctic region. An increase in greenhouse gas emissions and the resulting warming of the Earth's atmosphere is not enough to explain the phenomenon.
A new study completed by a team of US, Norwegian and German researchers may now provide some clues. Published in the scientific journal Geophysical Research Letters in November, the study posits that a dramatic change in atmospheric circulation patterns has taken place since the beginning of the decade, with centers of high pressure in winter shifting toward the north-east. The new pattern of sudden climate change is characterized by "poleward atmospheric and oceanic heat transport," the authors write in the study, a transport which drives temperature increases in the Arctic. The discovery was made using specialized filters that allow one to follow changes to high pressure centers over time.
Behind the complex language and impenetrable calculations upon which the study is based, however, is a frightening possibility: climate change in the Arctic could already have reached the point of no return. Climate researchers have long been warning of such "tipping points," and that crossing them could mean irreversible developments for eco-systems and humanity. In the case of the Arctic, that could mean a complete disappearance of ice in the region during the summer months. Such an eventuality would then further magnify global warming, due to the fact that bright white ice reflects sunlight back into the atmosphere whereas dark colored land and ocean absorbs heat.
"In the case of Arctic Sea ice, we have already reached the point of no return," says the prominent American climate researcher James Hansen, director of the Goddard Institute for Space Studies at NASA. The waters around the North Pole are heavily influenced by the currents coursing through the Atlantic and Pacific Oceans. Those currents are driven by conflicting pressure systems in each ocean: in the Pacific, the low pressure zone located near the Aleutian Islands extending west from Alaska is doing battle with a subtropical high pressure zone further south; in the Atlantic the currents are determined by the Azores High and the Icelandic Low.
Winter in the Arctic has long been determined by what researchers refer to as a "tri-polar" pattern. The interaction among the Icelandic Low, the Azores High and the subtropical high in the Pacific led to primarily east-west winds, a pattern which effectively blocked warmer air from moving northward into the Arctic region. But since the beginning of the decade, the patterns have changed. Now, a "dipolar" (bipolar) pattern has developed in which a high pressure system over Canada and a low pressure system over Siberia have the say. The result has been that Artic winds now blow north-south, meaning that warmer air from the south has no problem making its way into the Arctic region. "It's like a short-circuit," says Rüdiger Gerdes, a scientist at the Alfred Webener Institute for Polar and Marine Research and one of the five authors of the study.
The influx of warm air from the south was especially intense during the winter of 2005-2006, the study says. During that period, 90 terawatts of energy flowed into the Artic Ocean from the North Pacific -- an amount that far exceeds the needs of the entire industrial world. Gerdes has no doubt that the ice will "quickly disappear if the new pressure patterns stay the way they are." He says that the Arctic Ocean would still freeze during the winter, but the ice pack would be too small to survive the warmer summer months.
James Overland from the Pacific Marine Environmental Laboratory in Seattle agrees. In the scientific journal Tellus the oceanographer, together with colleagues, also points to the new north-south flow patterns in the Arctic. "If the current flows stay the way they are, then we will see the disappearance of Arctic sea ice 40 years earlier than we would as a result of greenhouse-gas emissions alone," Overland told SPIEGEL ONLINE. Even if the Arctic circulation were to return to normal and would switch to the "dipolar" pattern just once in a decade, the situation would look grim, he said. "Each time we would see a loss of so much ice that it would be impossible to return to the initial state."
Overland says that the dramatic disappearance of Arctic ice observed in 2007 was no exception. The summer of 2008 was just as bad, he says. The progression is clear: sooner or later the ice cap will become so small that it will not be able to survive the warm summer months. Gerdes and his co-authors fear that the changes in the Arctic could mean that a "new era of global-warming-forced climate change" has begun. The volume of greenhouse gas emissions like CO2 and methane into the Earth's atmosphere could have resulted in a permanent change in the global climate system.
The series of warm winters experienced in the Arctic this decade, it should be noted, is not the first time in recent history the region has been visited by mild weather. In the 1930s, there was a similar "dipolar" pattern that pushed warm air into the Arctic, as researchers now know. Back then, though, it was air from the North Atlantic and not from the North Pacific. Furthermore, says Gerdes, the warm air did not penetrate beyond 75 degrees north latitude, which roughly marks the previous limits of the ice cap. Today, the heat spreads through the entire Arctic.
It could be that the new patterns of air circulation in the Arctic are caused by natural climate variations. But given the dramatic ice melt currently being observed, such an explanation is not enough to satisfy researchers. The American scientist Overland, for his part, has no doubts: the dramatic change in pressure systems in the Northern Hemisphere combined with Arctic warming is, he says, "a clear signal of warming."