Accident at 12th and K., Washington, DC
Stoneleigh: Ilargi is traveling back from Europe today, so our daily post will be shorter than usual. Here's another contribution from DanW at Ashes Ashes.
DanW: I was listening to Fresh Air last night on NPR. I love Terry Gross. Anyway, her guest was economist Dean Baker. Over the course of her 40 minute interview, Baker made what on the surface appeared to be a strong case in support of the Obama and Bernanke “stimulus” plans. Like most economists whom I have recently heard, Baker parroted the party line: create jobs, don’t worry about deficit spending, get credit flowing, save the banks, spend as much as is needed to “reinflate” the economy, create more jobs, stem foreclosures, buy up toxic assets from banks, etc. There was no opposing view offered. In this post, and as briefly and succinctly as is possible, I will offer the opposing view. My goal here is to explain not only why the Obama and Bernanke spending plans will not lead to an economic recovery, but why, in fact, they will further exacerbate our current situation.
Most banks are holding billions in toxic assets. The government is “lending” these institutions money so that they can pay down these liabilities AND begin lending money to individuals and other businesses again. Banks are sitting on this capital and not paying down debts and not lending because (1) they fear that illiquidity will leave them in the lurch should any counterparty risk be exposed down the road, (2) they want to be able to say that they are trying to bring their reserve ratios in line with expectations, and (3) there’s really no one out there to lend the money to. In short, the money that banks are receiving is not stimulating economic growth. And Dean Baker and other economists who agree with Baker err in asserting that eventually this stimulus will lead to growth and recovery. There are many reasons for this. Here are but a few: Financial institutions are currently allowed to valuate assets as they so choose, not as the marketplace values them.
Therefore, asset valuation is both unknown and unreliable; Off-balance sheet assets are not accounted for in the process of evaluating a company’s “health”. “Off-balance sheet assets” is simply a polite way of saying that banks and other such institutions have inaccurate accounting of their assets; Banks and other financial institutions simply refuse to open their vaults and show the world exactly what their liabilities are. The government supports them. Our financial institutions are in serious distress. Ben Bernanke states we must save them (at ALL cost). We honestly have no idea how much it would cost to save them. More importantly however, saving these banks has virtually nothing to do with saving the economy. In fact the opposite is true: Allow the banks and other insolvent businesses to fail NOW, and spend money on taking care of those who suffer through the terrible years to follow, and eventually we come out on the other side wounded but not destroyed. Continue to spend trillions to keep the system from falling apart, and somewhere down the road, when it falls apart, which it must, the devastation will be complete.
Jobs in the production sectors will not grow in the United States because it is cheaper for major corporations to set up shop overseas. The Obama plan calls for 4 million jobs to be created building roads and bridges, and fixing infrastructure, etc. But understand that the states and municipalities who will be the recipients of these funds are not at all unlike the banks I just discussed. The states are insolvent: they don’t have money to pay for pensions and unemployment insurance and necessary social services, etc. They too are going to take the capital infusions and, to a great extent, are going to reroute them to places in which the monies can immediately be used plug the holes in the metaphorical dike. The trillion dollar stimulus is not going to create jobs: it, like the trillions going to the banks, is going to be used to stave off the creditors. Does Mr. Obama return to Congress in July and request another trillion? And one other note: since we have been hearing murmurs in Washington vis-a-vis "spending American", should the U.S. Government decide to fight against the “outsourcing” of production to overseas operations by creating major protectionist legislation, the world would quickly respond by embargoing American goods and all but abandoning the US Bond Market.
The only reality-based solution to dealing with bankrupt, insolvent institutions is to let them fail and let them file for bankruptcy protection. Once this has happened their debt is largely discharged. To not do so, or as Ben Bernanke’s plan would have it, to give all of these insolvent institutions billions of dollars to keep them afloat, means that (1) a multi-trillion dollar deficit becomes the tax burden of future generations of Americans, (2) those who became rich on their own excesses are not held to account and retain their individual wealth while the majority of Americans struggle to get by, and (3) the speculators and gamblers who went into debt are released from any responsibility---they are free to find new ways to exploit the system, and they know that if, in the near future, they run up bad debts again, relief awaits in the form of help from the government. Hence there is no deterrent to this type of behavior. And so Ben Bernanke’s plan, at best, creates an enormous tax burden for future generations of Americans while simultaneously doing nothing to deter would-be speculators and Ponzi-schemers from plying their trade time and time again. In other words, the Bernanke and Obama plans are not solutions, they are obfuscations. They do nothing to change the system that has brought us to this point.
We are fighting wars in Iraq and Afghanistan. “…According to a Congressional Budget Office (CBO) report published in October 2007, the U.S. wars in Iraq and Afghanistan could cost taxpayers a total of $2.4 trillion dollars by 2017 when counting the huge interest costs because combat is being financed with borrowed money...” (wiki) The Taliban is resurgent throughout Afghanistan. Eight years of cries from the Bush Administration about the disaster that would follow were we to abandon these “just wars” make it difficult to “cut and run”. But how can we pay for these wars? Some might argue that these wars and others may in fact be the route that our nation takes to turn our economy around. That the creation of the war economy will be our ticket out of depression. If in fact that does come to pass, does that mean that the Obama and Bernanke plans were a success?
Unemployment numbers are under-reported. The real number of unemployed or part-time employed is closer to 12%, not the 7.2 % currently being reported. The under-reporting of unemployment numbers is but one example out of thousands of how accurate and honest information about our economy is hard to come by. The rationale for such misrepresentation is twofold: (1) The profit motive---In order to be a mainstream reporting organization or news source, you cannot appear contrary or skeptical with regard to the words of the "pundits". (2) Economists and policymakers believe that if they can create the illusion of confidence, people will fall in line and will participate in the economy in a “confident” manner.
What the policymakers fail to understand or accept is that current sociological dynamics have changed the rules of the game: (A) Every day millions of ordinary people see pictures on the Internet of the mansions and estates of bankers and others in the financial industry, while at the same time half a million people a month lose their jobs and millions struggle to put food on the table and cloths on their backs. (B) In the wake of Enron, everyone understands that accounting scandals are virtually impossible to uncover. Every institution is cooking the books, and everyone knows it. (C) Despite claims to the contrary, proper and effective oversight of any monies provided to the federal government do not exist. The Fed refuses to allow granular oversight of the TARP funds, claiming that releasing detailed information would be unfair to the institutions receiving such funds. There is no way to keep track of the funds once they have been dispersed.
Meanwhile members of Congress and our President elect continue to call for more stringent oversight. People have become acutely aware of the gap that exists between rhetoric and reality, because they see what is happening on the ground and then they compare that to what they see on the web and on FOXNEWS. They hear about Henry Paulson’s ill-gotten short-selling millions, about Tim Geithner’s alleged tax evasion, about Bernie Madoff's 50 Billion dollar ruse (and out on bail, mind you). They see Congressmen in their fancy suits and living in their big houses and having their month-long recesses. And frankly, from what I can tell, people are getting frustrated and angry. Trust in the system has all but evaporated. And without trust, the system cannot recover.
Growth is not a measure of wealth creation because as we have seen, wealth creation over the past two decades has been based upon debt creation. Many have become fantastically wealthy, and many others have done “well”, but not as a result of production. Their wealth has been created through the collateralization of debt. Virtual dollars created through myriad Ponzi schemes (Derivatives trading in particular) have been used essentially as collateral to purchase mansions and boats and cars and HD TVs and all manner of stuff that was not produced in the United States. But since this virtual wealth was based solely upon increasing leverage, to make the claim that wealth was created is not true. In other words, the roughly 3% per annum GDP growth in the U.S. from 2005 -2008 is false. And the Obama and Bernanke strategy of providing liquidity to the system to stimulate growth is equally false.
All that the trillions of dollars are doing is adding to an exploding deficit---which of course must be paid down eventually through taxation---and, at best, creating the illusion of growth: wealth that goes directly into the pockets of the bankers, who in fact produce nothing. And the wealth of these men does not “trickle down” to the middle and working classes, because as I stated earlier the goods that are purchased with these monies are for the most part produced overseas. In addition, in this economic climate, the super-wealthy are far more prone to sit on their capital and wait until the worst of the crisis has passed. And rich people getting richer does not stimulate economic growth.
Years of out-and-out fraud in the mortgage industry, combined with the banking industry’s securitization model, has created more than simply a bubble market. In fact, the current crisis in the housing market, in concert with increasing numbers of unemployed, means that no matter what efforts are undertaken—whether in earnest or not---to save people from losing their homes, the foreclosure rate is going to explode over the next 12-24 months. 500 Billion dollars in mortgage relief for “upside down” borrowers today may give millions of homeowners a 3 month reprieve, possibly 6 months, but no income means eventual default. It’s just simple math.
Additionally, banks are holding tens of billions of dollars in mortgage backed securities, bundled and re-bundled, with no paper trail. Where are these mortgages? Are banks going to open their vaults for inspection to try and untangle this mess? Of course not. And will the Bernanke plan of buying up all of these toxic securities mean that the housing market will stabilize and people will begin buying and building new homes? Of course not, because the mortgage industry will still be corrupt and because valuation will still be subject to fraud and because cheaters always find ways around even the most earnest of "policemen" and because people do not trust the system that so recently destroyed their investments and because unemployed people don’t buy homes.
In summary, the plan being put forth by agents of our government will not work. Spending trillions of dollars to capitalize banks will not lead to real growth. Saving companies who are insolvent by loaning them billions of dollars that they will never be able to repay does not lead to economic recovery. Deficits in fact do matter. They matter because they represent debt that must be serviced or be defaulted upon. How does a nation, that cannot grow its REAL GDP and that is suffering from high unemployment, service such debt? Taxation?? Would the super-wealthy agree to pay 50+% of their riches to the government in order to service such a debt? The super-wealth of those in the financial industry does not “trickle down” into the economy and create ancillary wealth based upon REAL production. Pumping trillions of dollars into the economy to try and get people lending and borrowing again does nothing to address the route cause of the problem: at best it delays the coming of the time when bankruptcy and liquidation must arrive. Unfortunately for all of us, the Dean Baker’s of the world hold the floor, and our voices are stifled.
There is a way out. It is not easy, but it is true. The government must stop spending money in an effort to stimulate growth, and must instead spend money on taking care of the people during what promises to be a terrible time. Banks and other financial institutions must be allowed to default. It then becomes the responsibility of the government to care for the poor and the homeless and the hungry during the years that follow, and to create a system whereby those responsible for this crisis are held to account. I would suggest a truth and reconciliation model, but that's for another post. If we do these things, the nation will survive. If we do not, and if we follow the plans put forth by our current leaders, the United States of America, and its citizens, will never fully recover.
Blood in the Streets? Nope. Red Ink.
The phrase, "blood in the streets," refers to economic panic. Wise investors say they will buy stocks when there is blood in the streets. This means panic. It refers to a final sell-off, when fear trumps greed.
We are nowhere near that stage today.
What about a bull market? The Dow Jones Industrial Average peaked at 14,000 in October 2007. How long will we have to wait for (say) Dow 17,000 – twice what it is today?
Let me review a long-forgotten time period. On February 6, 1966, the Dow Jones Industrial Average exceeded 1,000 briefly and closed just below 1,000. It then started down. It closed at 777 on August 13, 1982. During that time, consumer prices tripled. So, the comparable Dow figure was about 260.
Yes, there had been dividends, but these were taxed as ordinary income. Top marginal tax rates were 70% until 1981. So, the stock market was a gigantic sinkhole for 16 years. It lured in the suckers by going up and down, but through the Presidencies of Johnson, Nixon, Ford, and Carter, the stock market went down.
The supposed experts in the stock market today are bullish. This is the report of Mark Hulbert, who makes his living by reading investment newsletters and reporting on them. (If I believed in reincarnation, I would conclude that Hulbert was a very bad person is his previous life . . . or else a very good tortoise.)
The Dow Jones Industrial Average closed at 7,552 on November 20. Experts are now saying that this was the bottom. Hulbert offered this analysis on January 6.
To give you an idea how quickly this emerging consensus has been formed, consider the Hulbert Stock Newsletter Sentiment Index (HSNSI). This index represents the average recommended stock market exposure among a subset of short-term stock market-timing newsletters tracked by the Hulbert Financial Digest.
On Nov. 20, HSNSI closed at minus 18.9%, which meant at that time that the editor of the average short-term market timing newsletter was recommending that his clients allocate 18.9% of their equity portfolios to shorting stocks. As of Tuesday night, in contrast, the HSNSI stood at 43.5%, or 62.4 percentage points higher.
Hulbert says that he is skeptical that this is a new bull market. There are too many bulls in the newsletter industry. They switched from bears to bulls too fast.
Blood in the streets? In the big banks, yes. In the financial services industry, yes. But not where the investing public lives. Not yet.
Most stocks are owned by retirement funds, mutual funds, and individual investors. Most Americans do not have retirement programs. Only about 20% invest in stocks directly. The general public does not shape the capital markets directly. Then who does? People with discretionary income. So, I like to find indicators for how well they are doing.
Here is one indicator I watch: yuppie restaurants. These became upscale family restaurants when the yuppies got married. This shift in marketing began over 20 years ago. I mean places like Chili's, Red Lobster, Olive Garden, and TGI Fridays. There are places nobody needs to go to eat a meal. They are social gathering places. They are family restaurants for people with extra money. It's not like going to lunch at McDonald's to save time. It's a way to pay more than you need to in both money and time. Bennigan's went bust last August, but I have thought Bennigan's stank for two decades. I stopped going there 20 years ago when, every time I ordered a particular Mexican meal, it was cold.
Consider Chili's stock. It has the best ticker symbol on the New York Stock Exchange: EAT. It was $15 a year ago, $24 last June, $22 in September, a little under $5 in December, and is now a little over $10. In other words, it crashed for two months. It has come back. A similar pattern exists for Darden, which owns Red Lobster and Olive Garden. Its symbol is DRI. It was at $38 last May, bottomed at about $13 in November, and is at $26 today.
The American investing public is not in panic mode or anything like it. Yes, they are discouraged. They have seen their investments fall. If they were willing to face reality, they would conclude that they will not be able to retire. They would be saving like mad. But they aren't. In the second quarter of 2008, there was a reversal of the trend, which was zero household thrift or even borrowing. That has changed. American households are now saving, at maybe 3%. This is not where it ought to be: at least 10%, where it was in 1982. But there has been a reversal.
They are not cutting back on entertainment spending. If the economy were in a serious crisis, middle-class family restaurants would be upper middle class. They would be nearly empty except for singles on the weekends. They would be on the road to Benniganland.
A stock market bull would conclude that happy days are here again, and never really departed. "The recession has been long, but it is not deep. It will be over soon."
Is the crisis over? Was it merely a matter of a few bad months for restaurant shares? I don't think so.
The stock market bull should be able to identify sectors that are ready for a major turnaround. What might these be?
The experts are silent. They tell us that stocks in general are going to rise. This means that the economy in general is going to rise. But business sectors do not rise at the same rate. Some begin rising first. So, which sectors are these?
The interviewers on Tout TV and in the investment magazines are always trying to get something specific out of the experts who are silly enough to consent to an interview. "Which stocks should people be buying?" They asked this in late 2007, and everyone had lots of suggestions . . . most of them wrong. These days, they are almost closed mouth. They are all tentative. They just aren't sure.
How can the stock market in general rise unless some specific stocks rise faster than others? Which are these? Nobody knows.
Then why should we believe that the market indexes will rise?
These people think in aggregates. "A government deficit in general will push up the economy in general leading to stock market increases in general." Yet it is relative prices that matter – in every area of the capital markets.
If the economy has bottomed, then we should buy financial shares. These have been hammered. A few speculators are saying this. But which financial institutions? Are all of them out of the woods? Or is there another Wachovia on the horizon? Another Washington Mutual? Another Citigroup in need of a bailout?
If the financial sector is about to rebound, why are we still being told that banks will not lend? If the bankers are in panic mode, where will they invest any new money? Treasury bonds? Probably. But how does that get the economy booming again?
As I have said repeatedly, Nancy Pelosi will be the ramrod of Keynesian deficits this year. Obama will not set the agenda. Over the weekend, he said as much. In a Sunday interview with George Stephanapoulus on ABC TV, he said he will not dictate to Congress. It will be a joint effort.
Consumer confidence is low, but consumers are still spending. They have not yet begun to stop all new discretionary spending. They will. First, this recession must get worse. Unemployment must rise. They will.
The pundits before said unemployment might rise to 8%. Now, with unemployment at 7.2%, they say it may peak at 9%. When it is at 8%, they will predict "over 9%." The really gutsy ones will say 10%.
I have been saying 10%. It may go higher.
The consumers cut back at Christmas. The experts said this would happen, but there was actually a decline over 2007, which was not expected. The discounts were not enough. Now the bills for December are coming due. This month will be the month when consumers finally say, "We've got to cut back." It's like saying on January 2, "I've got to take off ten pounds." It's easier said than done. If they are serious, January will be a bad month for retail sales, and February will be worse.
The word on the state of manufacturing in December is grim. This is from the Institute for Supply Management. The situation is worse than anything since 1980, and before that, we have to go back to 1949 to find anything comparable.
Consider Ford Motor Company, the sole member of the Big 3 that did not take funding from the government. Ford's senior economist says that the forecasts on falling car sales are "a little below us." Then where is the good news? The coming stimulus, she says. But why should anyone buy a new car with any tax rebate? Because the average age of a car on the road is nine years, she says. "There is replacement demand out there that is being put off. There is an economic cost to operating an older vehicle."
So, I went to Google and looked up "cars," "average age," and "wiki." I got to "Passenger Vehicles in the United States." There, I learned that the median car age was 8.9 years in 2005. So, there is no significant different between then and now.
Is this woman serious? Does she believe that anything has changed in terms of the age of cars? Doesn't she know, as the Wiki article reports, that median age has increased for a decade? People drive their cars longer.
Does she want us to believe that paying (say) $2,000 a year in repairs is a burden, but paying $17,000 to $37,000 for a new car isn't? What kind of fantasy world is she living in?
The automobile market is in a depression – the word she says she does not want to use. It does not matter what her vocabulary preferences are, the auto market is in a worldwide depression except in China, where sales are still rising at 6% – lower, but positive.
The auto market is rivaled by the housing market. Mortgage rates are falling, but the money is being loaned mainly to people with good credit who are re-financing their homes. A re-financing loan does nothing to increase the sale of homes.
How bad is the housing market? Bad, and getting worse. One site covers this best, Patrick.net. From all over the country, Patrick posts articles on housing. I think it is safe to predict that housing prices nationally will fall another 20%. It depends on the region. But with a major recession in progress and no light at the end of the tunnel for 2009, what else should I predict? The housing market is not expected to recover until sometime in 2010. The optimists hold this view. The pessimists stretch it out to 2012.
There is no panic yet. There is no blood in the streets. There will be. Be patient.
Red ink is everywhere, all over the world. Governments are running huge deficits, though none so huge as the United States. Central banks are buying debt of all kinds and thereby are expanding their balance sheets. These serve as legal reserves for the commercial banks. This high-powered money will be used by the banking system to make loans. The money will be lent. Bankers pay interest to depositors. They must earn interest.
The result will be monetary inflation, which will produce price inflation. Consumers today are cutting back. They are adding to their savings, slowly. They are putting money into banks. This will force bankers to lend.
At some point, probably before 2009 is over, price inflation will revive. The only way that Keynesians think is "deficits," and then they look for lenders. This means central banks. Today, they worry about price deflation. They do not worry about the consequences of vast increases in the monetary base.
Economists of every school except the Austrian School are recommending huge public spending programs. At the most recent annual meeting of the American Economic Association, where academic economists meet to try to get better jobs and listen to boring lectures, the message was clear: spend, spend, spend. The New York Times reported:
At their last annual meeting, ideas about using public spending as a way to get out of a recession or about government taking a role to enhance a market system were relegated to progressives. The mainstream was skeptical or downright hostile to such suggestions. This time, virtually everyone voiced their support, returning to a way of thinking that had gone out of fashion in the 1970s.
"The new enthusiasm for fiscal stimulus, and particularly government spending, represents a huge evolution in mainstream thinking," said Janet Yellen, president of the Federal Reserve Bank of San Francisco. She added that the shift was likely to last for as long as the profession is dominated by men and women living through this downturn.
There will be no criticism from economists about the $1 trillion Federal deficit, any more than there has been criticism of the trillion dollars in new monetary base expansion created by the Federal Reserve System.
Red ink is being funded by green digits. The Federal Reserve System has pulled out the stops. The Federal government has, too.
Red ink is flowing because politicians, economists, and central bankers believe that boondoggles are better than unemployment. They believe that fiat money is a substitute for capital creation. Capital creation requires increased thrift, and we have been told by Keynes that thrift is destructive in a recession, let alone a depression. We must spend ourselves into prosperity.
It will not work. The unemployment rate will rise, home prices will fall, sales of new cars will fall, and the manufacturing sector will continue to decline.
At some point, there will be blood in the streets. Investors will give up hope of ever getting their money back in the stock market. That will be a time to buy . . . Asian stocks.
The bulls think that the worst is behind us. But they cannot point to any sector of the economy and say, "That's the engine that will pull us out of the recession." There is vague confidence that the market will rise, but no confidence that the sectors that provide job growth will rise. So, they want public works projects as a stop-gap. This is a replay of the Great Depression. It took World War II to persuade people to put up with price controls, thereby allowing the FED to inflate.
What will it take this time?
Beige Book Spurts Red Ink
Economic indicators went from bad to worse on Wednesday, when dismal retail and inventory reports were compounded by the Federal Reserve's Beige Book showing that the United States had fallen deeply into recession.The Beige Book, a survey of the 12 Federal Reserve banks about activity in their home districts, showed that manufacturing fell in most districts, with four -- Kansas City, St. Louis, Cleveland and Dallas -- citing slumps in auto-related manufacturing.
Virtually all districts reported "grim and depressing" conditions for real estate, commercial and residential, with most citing tight credit and reduced bank lending as part of the cause. As expected, the Fed found new layoffs, hiring freezes and weaker labor markets. Separately, Charles Plosser, president of the Philadelphia Federal Reserve Bank, told an economic outlook conference at the University of Delaware that the Fed needs a clear exit strategy from its lending plans to ensure market stability beyond the turmoil. He added that he expects economic growth in 2009 to be under 2.0%. "Our aggressive lending, while intended to help the economy and financial crisis recover, poses its own set of challenges," Plosser said.
The Philly Fed president's words pushed long-term bond yields down as investors continue to flock to the safety of government debt. The yield on the benchmark 10-year note fell to 2.21%, from a close Tuesday of 2.30%, while the 30-year yield dropped to 2.9%, from 3.01% on Tuesday evening. The iShares Barclays 10-20 year Treasury Bond exchange-traded fund, which tracks long-term government maturities, was up 0.9%, or $1.12, to close at $120.67. As the retail report indicated earlier in the day, the Beige Book showed that shoppers were staying away from stores despite deep holiday-season discounts.
Earlier, the Commerce Department also reported that retail sales in December fell 2.7% as consumers limited spending due to the increasing number of Americans who have lost their jobs. Sales in December dropped a record 9.8% from the year-ago period, the largest drop on the books. Gasoline sales tumbled 15.9%, after diving by a record 18.3% in November, while sales in department stores fell 2.3%. Clothing stores sales dropped 2.5%, and sporting-goods sales were down 0.4%.
The U.S. Commerce Department also reported Wednesday that businesses slashed inventories 0.7% in November, the steepest decline since November 2001. This is more than the 0.5% decline that analysts surveyed by Thomson Reuters had expected. Inventories were down among all business types, with retailers trimming inventories 1.3%; auto dealers cutting 1.7%; furniture and building material 5.7%; and manufacturers 0.3%.
Stimulus Nears $850 Billion as Plan Focuses on Job Growth
The price tag of the economic-recovery plan sought by President-elect Barack Obama has risen to nearly $850 billion, as congressional Democrats prepared to release a draft of the spending-and-tax-cut initiative as soon as Thursday. Lawmakers and Obama officials have cobbled together details of the plan in a series of closed-door negotiations on Capitol Hill. After it is unveiled, the plan is likely to see vigorous debate, and could come under intensified criticism by Republicans. The higher price tag is the result of negotiators' decision to put a greater emphasis on investments designed to spur job creation and to soften the impact of the economic downturn on families and local governments, people familiar with negotiations said. Obama aides had initially estimated the package would cost $775 billion when they approached Congress a few weeks ago.
Congress is also debating a request by the White House on behalf of Mr. Obama for the release of the second half of the $700 billion financial-industry rescue fund known as the Troubled Asset Relief Program. The Senate could vote on the issue Thursday or Friday, with a "resolution of disapproval" pending there. Top Obama aides, including Rahm Emanuel, the White House chief of staff-designate, have been pushing Senate Republicans to support the request for the remaining $350 billion, and to reject the resolution. Mr. Obama's stimulus plan, which the president-elect hopes will pass by mid-February, could face some complications on Capitol Hill. The House and Senate could each introduce stimulus packages, with differences to be ironed out in talks next month, said congressional aides and others familiar with the negotiations.
One center of action will be the tax-writing House Ways and Means Committee, chaired by Rep. Charles Rangel. The New York Democrat is pushing for limits on an Obama-backed proposal to allow businesses to claim new tax refunds by carrying current losses against profits from previous years, said individuals familiar with negotiations. Rep. Rangel is also pressing to add a $70 billion provision that would protect some middle-class families from having to pay the alternative minimum tax. The AMT was designed to prevent wealthy individuals from avoiding their tax liability, but without a legislative fix, millions of middle-income Americans could be hit.
The spending side of the stimulus package is expected to total more than $500 billion, and Wisconsin Rep. David Obey, chairman of the House Appropriations Committee, is spearheading efforts to finalize details. Congress is expected to begin formal action on the plan next week, after Mr. Obama is sworn into office. Democratic leaders hope to pass it by mid-February, though Mr. Obey cautioned the deadline could slip. "I always have hopes rather than expectations around this place," he said in an interview. On Wednesday, Mr. Obey held a 45-minute briefing for committee members to outline the contents of the package. "This is on a real fast track," Rep. Jim Moran (D., Va.) said, leaving the session. "They need to make it available quickly, so we can take our hits from the opposition and make our case."
A spokeswoman for California Rep. Jerry Lewis, the top Republican on the House Appropriations Committee, said Republicans haven't received a draft. "It's almost impossible for us to say if we have serious concerns when we haven't seen anything," said the spokeswoman, Jennifer Hing. "There have been some conversations between Mr. Obey and Mr. Lewis, but we haven't seen anything on paper." Negotiations are now coming down to final details, with top Democrats likely to cut or curtail a special tax credit for businesses that create jobs that has been proposed by Mr. Obama. The centerpiece of the tax portion will be a "Making Work Pay" credit, which would effectively provide working Americans with a payroll tax holiday. That proposal accounts for half of the $300 billion set aside for tax cuts.
Seniors and individuals receiving Social Security disability payments would receive a one-time tax benefit, and eligibility for the child tax credit would be broadened. The package would extend special write-offs in the tax code designed to encourage businesses to make capital investments. About $25 billion would be spent on energy tax incentives. Also under discussion is a proposal to provide incentives for development of low-income housing. The program being put together by House tax writers would send money directly to local housing authorities, with the aim of ensuring that there are no gaps in construction, individuals familiar with the negotiations said. House tax writers are also working on a proposal to ease repayment requirements for taxpayers claiming the tax credit for first-time home purchases.
The spending section also is likely to include a mix of direct appropriations, such as $39 billion for highways and mass transit, and increased commitments to social benefit programs, including unemployment insurance and Medicaid, the federal-state program that provides health care to the poor. State and local governments would benefit from a substantial portion of the spending, receiving more than $160 billion in federal aid, said individuals familiar with the negotiations. "Governors and local officials will be very pleased," said Mr. Moran, without confirming the figure. "This will relieve a lot of their fiscal pressures. There's something in it for everyone."
Global Default Rate Will Jump to 15.1% by Year-End
Defaults by corporate borrowers worldwide may rise to 15.1 percent in the next 12 months as the economy turns “perilous,” according to Moody’s Investors Service, boosting its earlier forecast by almost 50 percent. About 300 companies will fail to meet their obligations this year, equivalent to a rate of 25 a month, New York-based Moody’s said in a report today. The speculative-grade default rate was 4 percent at the end of 2008. Moody’s last month predicted a default rate of 10.4 percent for the end of 2009.
“Global economic conditions are now substantially weaker and more perilous than they were in the two previous credit cycles of 1990-91 and 2001-02,” Kenneth Emery, Moody’s director of corporate default research, wrote in the note today.
About $1 trillion of credit losses and writedowns at financial institutions worldwide have combined with the deepest economic slowdown since World War II to weaken company finances and slash the cash flow they can use to pay their debts. Nortel Networks Corp., North America’s biggest maker of telephone equipment, filed for bankruptcy protection today in the U.S.
Defaults in the U.S. will rise to 15.3 percent at the end of the year and the rate in Europe will increase to as much as 18.3 percent, Moody’s said. The soaring default rate predicted by Moody’s model is driven by “unprecedented” corporate bond yields relative to government debt, the lowest average ratings ever and expectations the U.S. unemployment rate will increase to 9 percent by year-end from the current 7.2 percent, the ratings company said. “Because the model drivers are outside of recent historical experience and future economic conditions remain highly uncertain, the default forecast is subject to some margin of error in this environment,” Emery wrote in the note.
While the rate may seem “outlandish,” given that there’s been “nothing like” a 15 percent default rate since the Great Depression, in fact it makes sense, said Marty Fridson, the chief executive officer of New York-based Fridson Investment Advisors. Fridson said his analysis gives a default rate of 17.25 percent. Issuers in the lowest ratings categories make up about 22 percent of the market, compared with 2 percent in the 1990-1991 recession, according to Fridson. “The surprise has been that default rates didn’t escalate earlier,” Fridson said. “The peak in defaults would seem to be some way off and some boards that should have filed already are clearly in denial.”
The speculative-grade distress index that Moody’s started in 2006 rose to a record 53.1 percent at the end of 2008. The index began to increase at the end of 2007 and “spiked sharply” in the final three months of 2008, Moody’s said. There were 104 Moody’s-rated corporate defaults last year, of which 22 took place in December. Of the companies that defaulted last year, 86 were from the U.S. and Canada and 12 were from Europe, Moody’s said. In 2007, 18 companies defaulted, 15 from North America and three from Europe.
Governments add to risks facing investors
Chronic uncertainty over the impact of massive government stimulus efforts to battle the global recession is creating a new kind of political risk for investors and discouraging financial market recovery. Different from the traditional concern about government stability, this new risk is about dealing with increasingly more hands-on governments. It has made financial market players more cautious than they already were, keeping money out of the very assets that governments want to see refloated, such as the equities that took a historic hammering last year. There is also widespread concern about the so-called law of unintended consequences, the notion that actions to achieve one goal often end up doing something else -- and not necessarily a positive something else.
"We have considerable uncertainty about the political initiatives that will be taken over the next few months," said Andrew Milligan, head of global strategy at Standard Life Investments. "For the moment, it is postponing some of the big decisions." First the credit crunch and then the global economic downturn have prompted governments and central banks across the world to nationalise banks, slash interest rates to next to nothing and impose new regulations on the financial sector. It has also brought a flurry of stimulus packages -- with easily more than $1 trillion (688 billion pounds) alone in the works in the United States.
Although many investors welcome such measures in the face of the worst economic downturn in decades, there is widespread concern that few people know what it all means. "Governments are not economists," said Gary Dugan, chief investment officer of Merrill Lynch's wealth management arm. "They don't always work things through." The result for investors? "You just take so much less risk in your portfolio," Dugan said. That may be one reason for the struggle equities are currently having to keep up a rally that began in late November. Once up 26 percent from a 2008 low, the MSCI all-country world stock index .MIWD00000PUS is now up only 17 percent.
On one level, the risk thrown up by governments is simply a question of the efficacy of their proposals. Asked recently for his outlook on oil and commodities, for example, Standard Life's Milligan was unable to take a firm stance because he could not predict the economic climate. If government stimuli work, then an economic recovery may get under way relatively soon, raising demand for commodities and other asset prices along with them. But if they don't, if policy errors appear, then investors and economists may be clamouring for further packages before the year is out. Related to this is the question of what will actually happen to the stimulus plans. Their announcement has generally been accompanied by vague targets, such as infrastructure spending or tax cuts, without any details.
But there is also a new, unfamiliar ground being prepared on the micro level for specific assets. Consider, for example, the HBOS/Lloyds merger. Not only will the government own more than 43 percent of the combined company -- itself putting a big question mark over management -- but trading in the two shares has already been disrupted because of the current ban on short selling. Investors wanting to take advantage of the difference in prices between the two shares could not easily hedge their bets because of the ban, imposed as a reaction to tumbling financial sector shares. So their risk profile had to rise. Sovereign debt, meanwhile, is being boosted by a wall of fresh money being released by central banks, making yields artificially low. While this might be what authorities are after, the rush for relative safety is draining investments from other assets and arguably setting up troubles for investors in the future. The cost of protecting U.S. and British debt, for example, has soared recently, suggesting that governments are seen as a growing source of risk.
On top of all this, investors are also having to deal with a new form of country risk. This is not the traditional risk of, say, rising unemployment threatening government stability. Rather it is the risk of an array of different countries responding to a global crisis in different ways and at different speeds. For investors, there is complexity at best and danger at worst in the scatter-shot approach of unlinked local responses to interlinked global problems. In its annual take on global perils, the World Economic Forum designated this as one of the key risks facing the world as it struggles to get out from under the severe global economic downturn. It concluded that the absence or lack of effective and inclusive ways of dealing with risk was a risk itself.
Fault lines emerge at Fed
Key fault lines are emerging at the Federal Reserve over the central bank's journey into uncharted monetary policy. In a speech on Tuesday, Philadelphia Fed Bank president Charles Plosser publicly took issue with positions advocated by Fed chief Ben Bernanke. In a breathtaking innovation in monetary policy, the Bernanke Fed since the fall has not only expanded its balance sheet from $900 billion to well over $2 trillion in its efforts to restore the credit markets to health but has stopped offsetting the expanding bank reserves. The Fed has begun purchasing commercial paper, mortgage-backed securities, and other assets to keep the markets from collapsing. Bernanke signaled on Monday that it was full speed ahead with these new purchases. See full story.
He even talked about an expansion of the plan - saying the Fed's plan to purchase consumer and small business loans with the help of the Treasury was a model "that can be expanded to accommodate higher volumes or additional classes of securities as circumstances warrant. He said he sees no near-term problem with inflation.
On the other hand, Plosser urged the Fed to "proceed with caution" with the new policy. Others outside the Fed are much more strident and want plans in place immediately to reverse it. They believe an inflation storm is already in train.
"It is a huge disagreement," said Robert Brusca, chief economist at FAO Economics. While the Fed chairman has made it a practice to run a more democratic central bank, the disagreements come at a crucial time when the Fed is striving to appear on top of the current financial market crisis and steep recession.
Bernanke argued that focusing on the size of the balance sheet misses the point, arguing the Fed's various asset purchase programs are not easily summarized in a single number.
But Plosser said that the growth of the Fed's balance sheet was a key metric.
"It is not appropriate to ignore quantitative metrics in this new policy environment," Plosser said. On the surface, the debate is about how the describe the programs. Bernanke and Fed officials have gone to great lengths to say that the new policy is not "quantitative easing" similar to the Bank of Japan's actions in the 1990s. Instead, Bernanke called the new program "credit easing" and tried to put the focus on "the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses." But Plosser is bringing the spotlight right back to the Fed's balance sheet. "The size of the balance sheet does offer a possible nominal anchor for monitoring the volume of our liquidity provisions," Plosser said.
Underneath the surface is a real concern about how and when the Fed tries to exit from its new monetary policy.
Fed officials who pay attention to the money supply believe that the Fed's current policy of printing money never ends well and the danger of inflation is very high. They believe the Fed must withdraw the stimulus before there is any sign of inflation or it is too late. Bernanke's remarks indicate he wants the flexibility and doesn't want to tie his hands. William Poole, who recently left his post as president of the St. Louis Fed, says it is crucial that the Fed set a target for cutting its balance sheet. Poole said the expansion of the Fed's balance sheet is unprecedented and research suggests that a surge of inflation is sure to follow. "I would say if the policy is not reversed, there is a high probability that the unpleasant risk (of inflation) materializes," Poole said in an interview. "I believe that the Fed should set a hard number - a target that they take seriously for the overall size of the balance sheet," he said.
Plosser also argued that the Fed has put its independence at risk by buying long-term assets. He worried that some "interest groups" will try to use political persuasion to stop the Fed from selling these longer-term assets even if the central bank has decided it makes sense. "We will need to have the political fortitude to make some difficult decisions about when our policies must be reversed or unwound," Plosser said. Bernanke said that he would watch this situation closely but didn't expect it to be a "significant problem." Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint. In the Soviet Union and Eastern Europe during the Cold War era, economies were inefficient because they had a soft-budget constraint. If a firm got into trouble, the banking system would give them more money, Poole said.
The current situation at the Fed seems eerily similar, he said. "What is discipline - where are the hard choices - when does Fed say our resources are exhausted?" Poole asked.
Why Obama’s plan is still inadequate and incomplete
Last week, President-elect Barack Obama duly unveiled his American recovery and reinvestment plan. Its title was aptly chosen, for Mr Obama spoke, astonishingly, as if the policies of the rest of the world had no bearing on the fate of the US. He spoke, too, as if a large fiscal stimulus would be enough to restore prosperity. If that is what he believes, Mr Obama is in for a shock. The difficulties he confronts are much deeper and more global than that. I have little doubt that his advisers are telling the president-elect just this. The points they are – or should be – pressing on him are these.
First, the Japanese policymakers who told everyone the US was in danger of falling into a prolonged period of economic weakness were right. To understand why this is true, you need to read a brilliant book by Richard Koo of the Nomura Research Institute*. In this, he explains how the combination of falling asset prices with high indebtedness forces the private sector to stop borrowing and pay down debt. The government then inevitably emerges as borrower and spender of last resort. Because the Japanese government knew this at least, the country suffered a prolonged recession rather than a slump.
It has long been argued that the US could not suffer like Japan. This is wrong. It is true the US has three advantages over Japan: the destruction of wealth in the collapse of the Japanese bubble was three times gross domestic product, while US losses will surely be far smaller; US non-financial companies do not appear grossly overindebted; and, despite efforts by opponents of marking assets to market, recognition of losses has come far sooner.
In other respects, however, the US is still more vulnerable than Japan, after its recent debt binge. The rest of the world’s economy was big and dynamic enough to sustain Japan’s exports, but the whole world is now in recession; moreover, the US is both a deficit and a debtor country. Mrs Watanabe trusts her government. How far does she trust Uncle Sam? How far, indeed, does Hu Jintao? Any complacency about US recovery prospects is perilous. Moreover, the fact that the US has a structural current account deficit has bearing on the second point Mr Obama’s advisers must make. Fiscal stimulus is a necessary palliative for a debt-encumbered economy afflicted by falling asset prices. But the likely longevity and scale of the needed fiscal deficits are quite scary.
I recently argued that the debt-encumbered US private sector would now be forced to save . The excess of income over expenditure in the private sector might be, say, 6 per cent of GDP for a lengthy period. If the structural current account deficit remained 4 per cent of GDP, the overall fiscal deficit would need to be 10 per cent of GDP. Moreover, this would be the structural – or full employment – deficit.
The Congressional Budget Office forecasts that US output will be 7 per cent below potential over the next two years, on unchanged policies. If so, the actual deficit should now be much larger than the structural one. It is easy to see, therefore, why the critics argue that the Obama plan for an additional fiscal stimulus of 5 per cent of GDP over two years is too small, even though the CBO forecasts a baseline deficit of 8.3 per cent of GDP this year. It is also easy to understand why many object strongly to tax cuts, since the more likely cuts are to be saved the larger the package must be – and, in addition, taxes will clearly have to rise in the longer term.
The bigger point, however, is not that the package needs to be larger, although it does. It is that escaping from huge and prolonged deficits will be very hard. As long as the private sector seeks to reduce its debt and the current account is in structural deficit, the US must run big fiscal deficits if it is to sustain full employment. That leads to the third point Mr Obama’s advisers must make. This is that running huge fiscal deficits for years is indeed possible. But the US could get away with this only if default were out of the question.
At the end of the Napoleonic wars, the UK had a ratio of public debt to GDP of 270 per cent. This was brought down over a century: growth, the gold standard and the commitment to balanced budgets did the trick. The question is how much debt the US (or UK) can accumulate now. My guess is that the US could hope to run large deficits for years if these were used to finance the creation of high-quality assets. But the policy could not safely endure throughout a two-term presidency.
Yet, contrary to widespread belief in the US, a swift return to small fiscal deficits, high employment and rapid growth will not occur spontaneously. It is necessary to make structural changes in the US and world economies first. This is the last point Mr Obama’s advisers must make. What then are these changes?
First, there must be a credible programme for what Americans call “deleveraging”. The US cannot afford years of painful debt reduction in the private sector – a process that has still barely begun. The alternative is forced writedowns of bad assets in the financial sector and either more fiscal recapitalisation or debt-for-equity swaps. It also means the mass bankruptcy of insolvent households and forced writedowns of mortgages.
All this would also lead to big one-off increases in public debt. But those increases would probably be much smaller than those generated by a decade of huge fiscal deficits. The aim is to have a slimmer and better-capitalised financial system and a healthier non-financial private-sector balance sheet, sooner rather than later. The troubled asset relief programme should be used for these purposes. It will need to be bigger.
Second and most important, the structural current account deficit has to diminish. The US private sector is no longer in a position to run huge financial deficits as an offset to the demand-draining external deficits. The public sector can do so only for a few years. In the long run, the world economy must be sustainably and healthily rebalanced. This is a huge challenge for international economic diplomacy. It is also an essential element of sound domestic policy.
Mr Obama must be fully persuaded of these last points. If the fiscal deficits are to fall sharply in the medium term, as they need to, the new president needs effective programmes for private sector deleveraging and global reform and adjustment. The fate of the US cannot be determined in isolation. What this should mean will be the subject of next week’s column.
The Bernanke Chronicles
Here is Bernanke's Speech yesterday at The Stamp Lecture in London, and note that while I understand Mish Shedlock has written something on this, I have not read it; any similarities are due to Ben being a total idiot.
I actually watched him present this tome along with the questions and Ben looked like he had sat on a Rhino horn a few minutes prior. Maybe it was still in there. In any event, I feel it is necessary to translate some of the FedSpeak into a common language called English for the benefit of Ticker readers, since FedSpeak is a curious dialect and can be difficult to understand.
Here we go!
"....although the subprime debacle triggered the crisis, the developments in the U.S. mortgage market were only one aspect of a much larger and more encompassing credit boom whose impact transcended the mortgage market to affect many other forms of credit. Aspects of this broader credit boom included widespread declines in underwriting standards, breakdowns in lending oversight by investors and rating agencies, increased reliance on complex and opaque credit instruments that proved fragile under stress, and unusually low compensation for risk-taking."
In English: We had the responsibility to monitor banks, set reserve requirements and keep leverage ratios reasonable. We abdicated all of the above on purpose and got in on the scam because our various Fed Boards are all made up of former, current, or wanna-be-future bankers who make lots of money by cheating the rules of sound banking. This produced a huge credit boom, and it was entirely intentional. Oh, and we knew it would go bust too - we didn't care.
"The abrupt end of the credit boom has had widespread financial and economic ramifications. Financial institutions have seen their capital depleted by losses and writedowns and their balance sheets clogged by complex credit products and other illiquid assets of uncertain value. Rising credit risks and intense risk aversion have pushed credit spreads to unprecedented levels, and markets for securitized assets, except for mortgage securities with government guarantees, have shut down. Heightened systemic risks, falling asset values, and tightening credit have in turn taken a heavy toll on business and consumer confidence and precipitated a sharp slowing in global economic activity. The damage, in terms of lost output, lost jobs, and lost wealth, is already substantial."
In English: CRAP! We were supposed to have gotten all the profits out of the country and into Paraguay, along with numbered Swiss Accounts before this thing went pear-shaped, but we blew it. Those jackass Americans ran out of money to make the payments with before we could complete our scheme.
"The global economy will recover, but the timing and strength of the recovery are highly uncertain."
In English: I'm lying.
"Government policy responses around the world will be critical determinants of the speed and vigor of the recovery. "
In English: Ok, I'm lying unless I can get the taxpayer to take all this crap on and not lynch me. Ok, ok, ok damnit, even then I'm lying, but that way I can get the money out to Paraguay (those bastards at UBS are turning in the people with the Swiss accounts!)
" I will also explain why I believe that the Fed still has powerful tools at its disposal to fight the financial crisis and the economic downturn, even though the overnight federal funds rate cannot be reduced meaningfully further."
In English: The most powerful tool I have is the BS that spews from my mouth, and that happens whenever my lips are moving. See?
"The Federal Reserve has responded aggressively to the crisis since its emergence in the summer of 2007. "
In English: We sure as hell knew it was coming; after all, we created it.
"These policy actions helped to support employment and incomes during the first year of the crisis. Unfortunately, the intensification of the financial turbulence last fall led to further deterioration in the economic outlook. The Committee responded by cutting the target for the federal funds rate an additional 100 basis points last October, with half of that reduction coming as part of an unprecedented coordinated interest rate cut by six major central banks on October 8. In December the Committee reduced its target further, setting a range of 0 to 25 basis points for the target federal funds rate."
In English: We can't possibly let the game end until we get the money out of the United States (and ourselves too.) We got the BLS to lie about employment and incomes have been declining in real dollars since 2000; heh, remember what I said about my lips moving?
"The Committee's aggressive monetary easing was not without risks."
In English: We knew it wouldn't work.
"However, the Committee also maintained the view that the rapid rise in commodity prices in 2008 primarily reflected sharply increased demand for raw materials in emerging market economies, in combination with constraints on the supply of these materials, rather than general inflationary pressures.
In English: We're good at creating bubbles, but not so good at figuring out where they will emerge. We pumped liquidity to try to pump up another bubble to take over from the housing mess, but unfortunately what we got was a bubble in commodities, especially oil. That totally screwed the economy instead of hiding the exploded housing bubble. We suck, and we hope you don't figure it out.
" As you know, commodity prices peaked during the summer and, rather than leveling out, have actually fallen dramatically with the weakening in global economic activity. As a consequence, overall inflation has already declined significantly and appears likely to moderate further."
In English: The bubble popped. Again. Damn.
"However, that offset has been incomplete, as widening credit spreads, more restrictive lending standards, and credit market dysfunction have worked against the monetary easing and led to tighter financial conditions overall. In particular, many traditional funding sources for financial institutions and markets have dried up, and banks and other lenders have found their ability to securitize mortgages, auto loans, credit card receivables, student loans, and other forms of credit greatly curtailed. "
In English: We prompted everyone in the banking system to lie. Therefore, nobody trusts anyone, especially us. Would you loan a $3 hooker $500,000 to buy a house? Me neither.
"One important tool is policy communication. Even if the overnight rate is close to zero, the Committee should be able to influence longer-term interest rates by informing the public's expectations about the future course of monetary policy."
In English: We lie a lot. If we lie often enough, some people might believe us. This is helped materially if we can keep our story straight, but that's difficult. Thank God for computers and the <DELETE> key, but may the Good Lord damn to Hell Google, which never loses anything!
"Other than policies tied to current and expected future values of the overnight interest rate, the Federal Reserve has--and indeed, has been actively using--a range of policy tools to provide direct support to credit markets and thus to the broader economy. As I will elaborate, I find it useful to divide these tools into three groups. Although these sets of tools differ in important respects, they have one aspect in common: They all make use of the asset side of the Federal Reserve's balance sheet. That is, each involves the Fed's authorities to extend credit or purchase securities."
In English: We have, will, and do buy crap at full price so that banks can continue to lie, sticking the taxpayer with the bill. This will continue so long as people believe in our fabled "authorities" and don't notice that Oz is a scrunchy old man behind a curtain who badly needs to change his Depends. Oh, that's how Toto found me. The entire rest of this section is simply to misdirect."Importantly, the provision of credit to financial institutions exposes the Federal Reserve to only minimal credit risk; the loans that we make to banks and primary dealers through our various facilities are generally overcollateralized and made with recourse to the borrowing firm. "
In English: Lehman was a great example of this. Oh wait; they blew up. Uh, don't ask about all those billions in clearing lines that we can't seem to find - I think they were in the smoking hole where Lehman once was.
"On the other hand, the provision of ample liquidity to banks and primary dealers is no panacea. Today, concerns about capital, asset quality, and credit risk continue to limit the willingness of many intermediaries to extend credit, even when liquidity is ample. "
In English: All the banks know they're holding a ton of worthless crap. Of course that means they know the rest of the banks are too. When everyone's a $4 hooker (I know, it was $3 a few minutes ago, but inflation is a bitch) in the room would you sleep with any of them?
" This facility will provide three-year term loans to investors against AAA-rated securities backed by recently originated consumer and small-business loans. Unlike our other lending programs, this facility combines Federal Reserve liquidity with capital provided by the Treasury, which allows it to accept some credit risk."
In English: The best ratings you can buy. Literally.
" For example, we recently announced plans to purchase up to $100 billion in government-sponsored enterprise (GSE) debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. "
In English: They're garbage. Bet on it; if they weren't, private investors would buy them. They won't, so you will - at gunpoint.
"The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing (QE), the policy approach used by the Bank of Japan from 2001 to 2006."
In English: It didn't work in Japan and won't work here.
"Importantly, the management of the Federal Reserve's balance sheet and the conduct of monetary policy in the future will be made easier by the recent congressional action to give the Fed the authority to pay interest on bank reserves. "
In English: Banks are supposed to hold actual money as reserves, but the other part of that action, which I'm not going to tell you about here, is that it allows me to unilaterally give the banks the ability to operate with no reserves at all. This of course could cause a catastrophic implosion of the entire monetary system as it is nothing more than a gross exaggeration of the intentional policy decisions that led to the serial credit bubbles in the first place. Heh, what's that thing ticking on the podium?
"And we will take all necessary actions to ensure that the unwinding of our programs is accomplished smoothly and in a timely way, consistent with meeting our obligation to foster full employment and price stability."
In English: We'll cock it up at least as well as we did the last dozen times, and probably worse.
"In my view, however, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system. History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively."
In English: Most of the banks are in fact bankrupt and we're helping them hide it.
"However, with the worsening of the economy's growth prospects, continued credit losses and asset markdowns may maintain for a time the pressure on the capital and balance sheet capacities of financial institutions. Consequently, more capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets. A continuing barrier to private investment in financial institutions is the large quantity of troubled, hard-to-value assets that remain on institutions' balance sheets."
In English: I said they're broke. Got it? All this garbage on their balance sheets is used toilet paper. How many times do I have to tell you?
"Another is to provide asset guarantees, under which the government would agree to absorb, presumably in exchange for warrants or some other form of compensation, part of the prospective losses on specified portfolios of troubled assets held by banks. "
In English: You'll eat it, and we'll make sure you choke it down. We have co-conspirators at Treasury.
"The public in many countries is understandably concerned by the commitment of substantial government resources to aid the financial industry when other industries receive little or no assistance. This disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt. "
In English: We blew serial bubbles by encouraging the irresponsible granting of credit we knew could not be paid back. This allowed our cronies to steal trillions of your dollars, and you're still too stupid to figure it out. It is critical that we not admit this, or stop it, because if we do the public will run us out of town on a rail.
"Even as we strive to stabilize financial markets and institutions worldwide, however, we also owe the public near-term, concrete actions to limit the probability and severity of future crises. We need stronger supervisory and regulatory systems under which gaps and unnecessary duplication in coverage are eliminated, lines of supervisory authority and responsibility are clarified, and oversight powers are adequate to curb excessive leverage and risk-taking."
In English: We did it this time, and now we're going to do our level best to sucker you into allowing us to do it again. Have a great year!
Is the US trade deficit sustainable? Is China’s trade surplus?
China’s December trade figures came out and, following November’s lead, everything is moving in the wrong direction. Exports were down 2.8% (versus up 21.7% in December 2007) which although bad at least is better than the average forecast of over 4%. Within overall trade exports to Europe were down 3.5% and to the US 4.1%. Given how quickly things are deteriorating in both countries, with rising unemployment likely to cut further into consumption, I suspect that this isn’t the last of the poor export numbers. As recently as three months ago most economists were forecasting export growth in 2009 of over 15%, but now most seem to be forecasting a contraction of over 10%.
Imports were way down, by 21.3%. I am still having trouble reconciling some of the other numbers for consumption, but generally speaking people who know more about this than I do say that of all the macro data produced in China, trade numbers are usually the most reliable. This suggests that Chinese consumption is dropping quickly, and it is probably no good blaming this on declining exports (about half of China’s exports are processed imports) or declining commodity prices since the decline in imports is much too large for either explanation to cover.
For the first time in six months China’s monthly trade surplus did not hit a new world record, but at $39.0 billion it is just a whisker below November’s $40.1 billion, and it is easily the second highest monthly trade surplus ever, beating out number three (China’s October trade surplus) by well over 10%. For those who are counting, the trade surplus in 2008 was $297.5 billion. The second half of 2008, at $197.6 billion, accounts for two-thirds of the total and the last quarter, at $114.3 billion, accounts for nearly two-fifths of the total. This is not a picture that the rest of the world, struggling with overcapacity and too little demand, is going to be happy to see.
Yesterday Peter Morici, former chief economist at the U.S. International Trade Commission and currently a professor at the University of Maryland, called on President-elect Barack Obama to press China to allow the yuan to appreciate because weakness in the currency is hurting U.S. jobs and manufacturing. According to an article in yesterday’s Bloomberg:Ending Chinese currency market manipulation and other mercantilist practices are “critical” to reducing the U.S. trade deficit and creating jobs in the U.S., Morici said. “Obama must address the huge cost of imported oil and the trade deficit with China,” he said. “Otherwise, any effort to resurrect the economy is doomed to create massive foreign borrowing, another round of excessive consumer borrowing, and a second banking crisis that the Treasury and Federal Reserve will not be able to reverse.”
Morici is making the point that if demand leaks out the US trade account at anywhere near current levels, US government borrowing required to create the demand needed to boost employment in the US will be much greater than otherwise. Instead of requiring the US to initiate debt-funded policies to boost employment in the US, China, and everywhere else, it is politically much easier for Americans to demand that the US government borrow to fund employment in the US, and let China and other countries generate employment by their own fiscal borrowing. It is hard to dispute this logic. Others will make the same argument in the US, the UK, France, Italy, Spain, Australia and many other countries with large deficits.
I want to digress a little here. My fears about the hard-to-combat logic of trade friction in a world of collapsing demand and large trade imbalances seem to have thrown me into a group of analysts with whom on the issue of trade I do not always agree. For the record, I do not have a problem with secular trade deficits and I do not believe in “balanced trade”, whatever that means. This means I have never been a trade-deficit hawk. In the days when everyone complained about the sustainability of the US trade deficit, they always argued that it was unsustainable either 1)because the continued foreign financing of the US trade deficit was unsustainable, or 2)because trade deficits represented the “giving away” of the US to foreigners. I did not agree with either of those arguments. I am not worried at all about the “giving away” argument for a bunch of reason that are probably obvious to most of my readers.
As for the other claim, given the huge size, efficiency and flexibility of the country’s financial system (and no, the current crisis does not change my view at all), I never doubted the ability of the US to receive net capital inflows for very long periods of time. Furthermore I believe that given the terrible demographics that Europe, China and Japan face (not to mention Russia) and the relatively benign US demographics, it makes sense for all of these countries to run up claims now against the US – which they can only do by running trade surpluses with the US – since they will need to liquidate those claims over many decades (and so run trade deficits against the US) to pay for their demographic adjustment.
Surprisingly whenever I say this there is always some one who howls (for some reason this is a subject on which polite disagreement is difficult) that the US faces its own demographic crisis and if I don’t believe this why don’t I offer to guarantee the payments needed to resolve the upcoming pension crisis. Aside from the fact that my guarantee would not be credible, the point is largely irrelevant. The fact that the actuarial assumptions underlying the US pension system turned out to be wrong does not indicate a demographic crisis like that facing Europe, Japan and China, who also have their own pension crises in addition to their aging problems. Unlike the US, these countries are facing a sharp drop in the size of the working population relative to the total population which, as I see it, creates a demographic bias to trade deficit (I think of total population as a proxy for consumption and working population as a proxy for production).
This is not nearly as serious a problem in the US, and in the US would likely anyway simply lead to a relaxation of immigration restrictions. The US has a very different sort of demographic problem – one that represents intergenerational transfers, and these have almost no bearing on the global balance of payments. What was unsustainable about the current global balance, in my opinion, was not the fact of a US trade deficit (although by 2006 and 2007 it had gotten too high to last very long), but rather the level of household borrowing needed to sustain it. These are not unrelated things, of course, but I would argue that if the US trade deficit had been funded by equity inflows that resulted in an increase in domestic investment, there would not be a trade-sustainability problem.
If it was funded by a household borrowing binge, then trade-deficit sustainability is necessarily constrained by the household balance sheets. This is why I have argued that a program of massive fiscal spending to replace household demand is not going to solve the current problem. It simply replaces one kind of unsustainable behavior with another, and still has to be resolved at some point with massive deleveraging.
To get back to China and current issues, the problem with the US trade deficit now is sort of a “Keynesian” problem. US demand has the impact of generating both US production (and employment) as well as foreign production (and employment), and in a world of contracting demand, it is natural that countries that export demand – i.e. trade deficit countries – are going to be a lot less eager to do so. Anything that brings imports closer into balance with exports is likely to have a demand-enhancing impact similar to fiscal expansion, with the benefit that this isn’t achieved by running up fiscal debt. On the other hand it will have a demand-reducing impact for trade surplus countries.
That is why trade disputes are likely to be very attractive to trade deficit countries who have – I will continue to insist but it seems recently that this has become a much less “surprising” claim – the upper hand in any dispute with the “virtuous” countries with high savings rates and trade surpluses. There is a lot of other recent news that I wanted to discuss, especially about reserve accumulation and the banking system – the recent closing of a bunch of informal banks, for example – but this post is long enough and I will postpone the discussion for later this week.
Shipping rates hit zero as trade sinks
Freight rates for containers shipped from Asia to Europe have fallen to zero for the first time since records began, underscoring the dramatic collapse in trade since the world economy buckled in October.
"They have already hit zero," said Charles de Trenck, a broker at Transport Trackers in Hong Kong. "We have seen trade activity fall off a cliff. Asia-Europe is an unmitigated disaster."
Shipping journal Lloyd's List said brokers in Singapore are now waiving fees for containers travelling from South China, charging only for the minimal "bunker" costs. Container fees from North Asia have dropped $200, taking them below operating cost.
Industry sources said they have never seen rates fall so low. "This is a whole new ball game," said one trader.
The Baltic Dry Index (BDI) which measures freight rates for bulk commodities such as iron ore and grains crashed several months ago, falling 96pc. The BDI – though a useful early-warning index – is highly volatile and exaggerates apparent ups and downs in trade. However, the latest phase of the shipping crisis is different. It has spread to core trade of finished industrial goods, the lifeblood of the world economy.
Trade data from Asia's export tigers has been disastrous over recent weeks, reflecting the collapse in US, UK and European markets.
Korea's exports fell 30pc in January compared to a year earlier. Exports have slumped 42pc in Taiwan and 27pc in Japan, according to the most recent monthly data. Even China has now started to see an outright contraction in shipments, led by steel, electronics and textiles.
A report by ING yesterday said shipping activity at US ports has suddenly dived. Outbound traffic from Long Beach and Los Angeles, America's two top ports, has fallen by 18pc year-on-year, a far more serious decline than anything seen in recent recessions.
"This is no regular cycle slowdown, but a complete collapse in foreign demand," said Lindsay Coburn, ING's trade consultant.
Idle ships are now stretched in rows outside Singapore's harbour, creating an eerie silhouette like a vast naval fleet at anchor. Shipping experts note the number of vessels moving around seem unusually high in the water, indicating low cargoes.
It became difficult for the shippers to obtain routine letters of credit at the height of financial crisis over the autumn, causing goods to pile up at ports even though there was a willing buyer at the other end. Analysts say this problem has been resolved, but the shipping industry has since been swamped by the global trade contraction.
The World Bank caused shockwaves with a warning last month that global trade may decline this year for the first time since the Second World War. This appears increasingly certain with each new batch of data.
Mr de Trenck predicts Asian trade to the US will fall 7pc this year. To Europe he estimates a drop of 9pc – possibly 12pc. Trade flows grow 8pc in an average year.
He said it was "illogical" for shippers to offer zero rates, but they do whatever they can to survive in a highly cyclical market.
Offering slots for free is akin to an airline giving away spare seats for nothing in the hope of making something from meals and fees.
Breaking Up the Citi
Citigroup's negotiations to merge its Smith Barney brokerage unit with Morgan Stanley's stockbroker force looks like the first step in what will be a well-deserved break-up of the financial conglomerate. The proposed deal would have Citi sell a majority stake in the business to Morgan Stanley, which would combine it with its own brokerage force and chip in $2.5 billion. Over time, Morgan Stanley would have an option to buy out Citi's stake altogether. That deal, as this newspaper reported on its Web site Tuesday, may be only the beginning. Citi is reportedly weighing the sale of its consumer-finance division, its private-label credit-card business and much of its proprietary trading operations.
This is a turnaround from a couple of months ago, when Citi CEO Vikram Pandit said he "loved" Smith Barney's business and saw no reason to break up the bank. But Citi has since taken $45 billion in taxpayer cash and secured a $249 billion taxpayer guarantee for lousy assets on its balance sheet. The bank is due to report fourth-quarter results next week, and the latest losses could total $10 billion, so Mr. Pandit no longer has the luxury of indulging Citi's old ambitions if he wants to keep his job. Director Richard Parsons, the former CEO of Time Warner, insists that Mr. Pandit has the full confidence of the board. To be fair, Mr. Pandit has not been at Citi, or at the bank's helm, long enough to bear the blame for the bank's woes. By contrast, the Friday exit of director and senior counselor Robert Rubin was overdue, as is that of Chairman Win Bischoff, who could be shown the door soon.
Mr. Rubin encouraged the bank to leap into the mortgage-finance abyss and he was paid some $115 million despite his insistence that he had "no operational responsibilities." As chairman Mr. Bischoff is by definition responsible and needs to leave as a matter of accountability. He should take the rest of the board with him, allowing a new slate of directors to decide if Mr. Pandit has their confidence, and oversee the new structure. The larger issue is whether Citigroup in its current form deserves to survive at all. This is no longer merely a matter of business judgment but of public policy. Even before the current panic, Citibank was the model of a bank that was "too big to fail," though it sure has tried. Citi was propped up amid the sovereign debt crisis of the 1980s. It stumbled again in the 1990s, the last time the real-estate market went south. Earlier this decade, regulators barred it from major acquisitions until it got its internal controls under control. So much for that hope. Today the bank has the distinction of having been bailed out twice by the Treasury's Troubled Asset Relief Program.
A bank that consistently has to be rescued by taxpayers lest it take down the entire financial system is too big to succeed. The only way to protect taxpayers is to reduce the size and scope of the bank so that it no longer poses a systemic risk. The planned asset sales reported yesterday are a step in the right direction. Citibank was born as a financial roll-up of sorts, and there's nothing wrong in principle with growth by acquisition. But Citi's repeated brushes with death prove that its management has never figured out how to run the business.
Our own encounters with Citi reinforce this view. When we first suggested that Citi was one of the banks most exposed to the housing debacle, in October 2007, we received an angry demand for a retraction. Citi, we were told, had a mere "$70 million in indirect exposure to subprime assets." Not long after, Citi took the first of its multibillion-dollar writedowns. A year and billions more in writedowns later, we suggested the feds might have tried to orchestrate the ill-fated Citi-Wachovia merger as much to save Citi as to rescue Wachovia. Citi officials again protested that we were unfair and that the bank needed no public help. Six weeks later, the government backstopped Citi's securities portfolio.
We have no reason to doubt that the officials sent to upbraid us were well-intentioned, and perhaps they simply didn't know the bank's true situation. But that merely proves our management point. Once the government has to rescue an institution that is "too big to fail," the bank loses the presumption of innocence. In return for saving Citibank, taxpayers need to see some discipline imposed on the officials who created the mess and that the bank is reduced to a manageable business. If the current executive team doesn't have the stomach to see this downsizing through, taxpayers deserve replacements who will.
Banking crisis deepens as U.S. mulls Bank of America aid
Bank of America Corp and Citigroup, two of America's largest banks, faced a crisis of confidence as their shares sank and investors questioned whether they have enough capital to cover losses from toxic assets and the contracting global economy. Bank of America is close to receiving billions of dollars of support from the U.S. government as it tries to digest Merrill Lynch, the investment bank and brokerage it bought on January 1. Merrill has billions in troubled assets -- ranging from commercial real estate to subprime mortgages -- that suffered during the brutal fourth quarter. Although many banks have already received billions of dollars in government bailout funds, they are likely to go back to the well, experts said.
"The large banks in the U.S. are not lending, and they're desperate to conserve capital. They're acting like they're insolvent. The markets think they are insolvent. Banks only remain going concerns because the federal government is topping up their equity," said Dan Alpert, an investment banker at Westwood Capital in New York. Earlier, Citigroup shares plunged 23 percent, driving the stock below $5, their lowest level since a government rescue in November. The bank faces growing concern it will struggle to rebound from punishing losses.
More bad news is expected on Friday, when the bank plans to report quarterly results, six days ahead of schedule, and analysts are looking for a fifth straight multibillion-dollar loss. The bank is also widely expected to provide details of a comprehensive downsizing designed to ensure its survival. Rival JPMorgan Chase, now the largest U.S. bank by market value, also moved up its earnings report by six days to Thursday. There's little hope of a turnaround anytime soon, JPMorgan CEO Jamie Dimon told the Financial Times in an interview. "The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009," Dimon told the paper. "In terms of our sector, we expect consumer loans and credit cards to continue to get worse."
Once the world's largest bank but now only the U.S. No. 3, Citigroup is expected to shrink by about one-third as it focuses on corporate, investment and retail banking and trims trading operations, a person familiar with the plan said. Citigroup will also put unwanted businesses and assets into a separate structure, with an eye towards their eventual sale, the source said. The U.S. Treasury Department rescued Citigroup by giving it $20 billion (13.7 billion pounds) of extra capital from the Troubled Asset Relief Program in November. As part of that deal, the government agreed to share losses on a $306 billion portfolio with the bank. The bailout prevented a collapse on the heels of the Lehman Brothers Holdings Inc's bankruptcy on September 15.
That was the same weekend that Bank of America agreed to buy Merrill Lynch, then the owner of the country's top retail brokerage, which had been hobbled by its exposure to toxic mortgage assets. Now Bank of America appears to need taxpayer help to digest that deal. The U.S. government is close to pledging billions of dollars of additional aid to Bank of America with the acquisition, a person familiar with the situation told Reuters. Bank of America told the government in December that it was unlikely to complete its purchase of Merrill Lynch because of the losses, a person familiar with the matter said. The bank and the government have been speaking since then. The deepening problems at the two banks have shaken confidence in their CEOs, who have struggled to respond to the deepening meltdown in the housing market that hammered mortgages and now threatens other products like credit cards.
Critics have said Citi CEO Vikram Pandit, known from his days as a top Morgan Stanley executive as a brilliant but cautious leader, was not aggressive enough in tackling the morass that Citigroup's $2 trillion-plus balance sheet had become. Bank of America CEO Kenneth Lewis had long been well regarded for helping to transform Bank of America into a national powerhouse through acquisitions like FleetBoston Financial Corp and credit card issuer MBNA Corp. But the need for further TARP money, along with the continued rout in the shares, may change that viewpoint. Bank of America shares, which closed the main trading session 77 percent off their 52-week high, fell further in after-hours trading, hitting their lowest level since December 1991.
Bank of America may receive more bailout money
The U.S. Treasury Department is moving to provide Bank of America billions of dollars in additional aid as the bank struggles with mounting losses at Merrill Lynch, which it recently acquired, a person briefed on the talks said Wednesday. It would be the second bank after Citigroup to receive an additional lifeline from the government. U.S. regulators and executives at Bank of America, which has already received $25 billion from the Troubled Asset Relief Program, have grown increasingly concerned at greater-than-expected losses in the fourth quarter at Merrill, said the person, who spoke on condition of anonymity because he was not authorized to disclose the information. The move to help shore up Bank of America comes on the heels of greater U.S. government intervention in Citigroup. After pumping more than $45 billion in Treasury money onto its balance sheet, the government has put pressure on the bank to dismantle the troubled empire in an effort to stem losses and curb capital injections.
While Bank of America was viewed not that long ago as a pillar of strength in the banking sector, it has seen its stock plummet as investors worry that it has acquired companies with their own set of financial baggage. Besides the Merrill acquisition, which closed at the beginning of 2009, Bank of America also acquired troubled mortgage lender Countrywide last year. Meanwhile, losses are mounting in the bank's huge consumer credit-card and home-equity businesses as the economy continues to sputter leaving some analysts to wonder whether, in order to shore up its balance sheet, the bank would be forced to either try to raise capital, slash its dividend or try to sell assets. Details of the new government capital infusion are expected to be made known next week when the bank, based in Charlotte, North Carolina, reports fourth-quarter results. In recent weeks, analysts have slashed their earnings forecasts for the bank, expecting various losses, provisions and charges in the quarter to come in anywhere from $3 billion to $6 billion.
As Bank of America struggles to integrate the two key acquisitions of Countrywide and Merrill Lynch, some analysts warned that the next two years could be challenging for the bank and its leaders. "Citi is being unwound because it's too big and the government wants it smaller," said Paul Miller, an analyst with Friedman Billings Ramsey & Company. "I think Bank of America, either a year or two out, is going to be dismantled also because its returns are going to be too weak. No management has the expertise or brain power to provide the right required return for investors with institutions that are this size."
Since taking the reins of Bank of America in 2001, the chief executive, Kenneth Lewis, has made several purchases, including the 2006 acquisition of credit-card giant MBNA, which made Bank of America a dominant players in consumer banking. The sharp contraction in the economy is causing losses in those businesses to climb, warn analysts. "We know that losses are going to increase in Bank of America's consumer book, including credit cards, home equity loans, first mortgages," said Jefferson Harrelson, an analyst with Keefe Bruyette & Woods. "They'll have to add to their reserves to reflect the consumer environment, which has gotten worse."
Fed Officials Say Ailing Banks Require More U.S. Funds
Top Federal Reserve officials said Tuesday that the incoming Obama administration must pump more money into ailing financial institutions and might need to take bad assets off the hands of banks, a stance that injected the central bank into a tense political debate. President-elect Barack Obama visited Capitol Hill Tuesday to lobby Senate Democrats for the remaining funds in the financial-rescue plan passed in October, amid deep concerns among lawmakers about the program's effectiveness. Lawmakers are pushing for new conditions as well as substantial new spending to prevent foreclosures, while some would like to scrap the program altogether. On Monday, President George W. Bush requested, on Mr. Obama's behalf, the second half of the $700 billion approved by lawmakers for the Troubled Asset Relief Program. The request comes as banks show new hints of strain. Bank stocks are down more than 15% so far this year.
Fed Chairman Ben Bernanke made a push Tuesday for a new effort to help banks get bad loans off their balance sheets, the TARP's original purpose. In a speech at the London School of Economics, he warned that while TARP funds helped prevent a global financial meltdown last year, bad assets continue to clog the balance sheets of financial institutions. Fixing that problem, he said, is paramount.
"The public in many countries is understandably concerned by the commitment of substantial government resources to aid the financial industry when other industries receive little or no assistance," Mr. Bernanke said. "This disparate treatment, unappealing as it is, appears unavoidable." Mr. Bernanke said repairing financial institutions is critical because the economy is dependent on the credit they provide.
The debate about the financial-rescue funds comes alongside efforts to craft Mr. Obama's proposed stimulus package. Pressure is mounting among lawmakers, especially in the House, to drop an Obama-backed proposal to let businesses carry back losses to prior tax years, which would lead to windfalls in refunds from the government. Some House members are instead pushing a plan to hold middle-income families harmless from the alternative minimum tax, which was designed to ensure the wealthy don't avoid tax liability but now hits millions of working Americans.
Plans to stimulate the economy with tax cuts and government spending "are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system," Mr. Bernanke said.
Donald Kohn, the Fed's vice chairman, delivered a similar message in testimony before the House Financial Services Committee Tuesday. Both men also talked about the need to aid homeowners, but their emphasis was on securing the workings of the banking system. Lawmakers have been highly critical of the TARP, arguing that taxpayer funds haven't led to more bank lending as planned and that the Bush administration failed to use the funds as it promised it would, such as to advance programs to prevent mortgage foreclosures. During Tuesday's meeting, Mr. Obama's pitch for release of the bailout funds framed the issue as something that could help define "our ability to govern together," said Connecticut Sen. Joseph Lieberman, an independent who caucuses with the Democrats.
The request for the remaining TARP money has set in motion action on a resolution of disapproval, which could block the funds' release. The Obama team and top Democratic congressional leaders have little hope of defeating the resolution in the House, where wariness of the program runs high. But they hope to derail it in the Senate. A vote on the issue could come by week's end. The Bush administration has used half of the TARP funds, almost entirely to pump capital into banks and to finance bank rescues. Several senators said the president-elect and his aides need to detail their plans for the remainder and how they would improve accountability in the program. New York Democratic Sen. Charles Schumer said one proposal would require banks to demonstrate that they have begun lending before they can use certain tax breaks in the stimulus package being developed on Capitol Hill. Banks' lending has been constrained because many are sitting on large losses and others are fearful that new losses could emerge.
A Goldman Sachs study updated late Tuesday estimates that investors and financial institutions could lose $2.1 trillion on bad loans, but that only half of those losses have been realized. The presence of bad loans on banks' balance sheets "may inhibit both private investment and new lending," Mr. Bernanke said. He laid out three approaches to get bad assets off banks' books. One is to buy them outright. Another is to provide guarantees under which the government would agree, for a fee, to absorb losses if these assets fall further. A third is to help set up "bad banks," which would purchase bad assets from financial institutions in exchange for cash or equity in the bad bank.
Merrill Lynch Turns into a Black Hole for BofA
Bank of America's equity is now too low to meet regulatory standards, so it's likely to get another capital infusion from Treasury.
One deal too many. That could be the epitaph of many CEOs—Jerry Levin of Time Warner and Ken Thompson of Wachovia come to mind—who built their companies through ever-bigger mergers and then watched those crowning acquisitions become their downfall. Now the question is: Will Merrill Lynch come to represent Bank of America CEO Ken Lewis' Waterloo as well?
The Wall Street Journal reported Jan. 14 that the Treasury Dept. is close to committing billions more in financial assistance to Bank of America, which was said to be stunned by Merrill's unexpectedly large losses in the fourth quarter. Bank of America—which has already received $25 billion in taxpayer funds—privately warned Treasury in mid-December that it might walk away from the Merrill deal before shareholders voted, amid concerns that Merrill was becoming a financial black hole, the newspaper reported, citing people familiar with the situation. According to the report, Treasury promised to provide BofA with additional capital, for fear that if the deal unraveled it could trigger another panic on Wall Street.
For the 61-year-old Lewis, the Merrill Lynch deal wasn't one he had to have. Thanks to Lewis' past deals for MBNA, U.S. Trust, and Countrywide Financial, Charlotte (N.C.)-based BofA had built an impressive banking franchise with leading positions in checking accounts, credit cards, and mortgages. But there was a certain poetic justice in acquiring Merrill Lynch, given that New York banks had long derisively viewed their North Carolina rival as the financial equivalent of a dinner theater troupe that didn't have the talent to play Broadway.
While Lewis couldn't resist the opportunity to acquire Merrill Lynch's massive brokerage force—the legendary Thundering Herd of Wall Street—the question is whether Lewis will get to enjoy the fruits of the deal before he retires, or worst case, were to be eased out by the board. Already, some shareholders are grumbling that Lewis' deals for Countrywide and Merrill were poorly timed and may be cases of good money chasing bad.
After a 66% drop in its stock price last year, BofA's shares are down another 27% in January and are now trading just above their 52-week low of 10.01. Bank of America's directors have already cut the company's once-lush dividend in half, and Citi Investment Research analyst Keith Horowitz issued a report earlier this week predicting further cuts ahead. Horowitz, who now believes BofA could lose $3.6 billion in the fourth quarter, is only modestly sanguine about 2009. Horowitz lowered his estimates for 2009 earnings to just 25¢ a share—making it unlikely that BofA could sustain the current quarterly payout of 32¢ a share at a time when it's already scratching for capital.
According to a report by Friedman Billings Ramsey analyst Paul Miller, the bank's tangible common equity ratio is now around 3.2%—a little more than a third the level that regulators will demand in the future. Even with the Treasury infusion, that could necessitate an additional issue of stock, which would dilute existing shareholders even more.
For a sign of how deep Lewis may think Merrill's problems run, even as he was negotiating with Treasury, the Mississippi native was already raising cash. Lewis recently raised $2.8 billion from selling his treasured stake in China Construction Bank. Analysts at Deutsche Bank are now predicting that Lewis could be looking to sell BofA's stake in Banco Itau Holding Financeira, Brazil's largest bank by assets, for as much as $2.5 billion. "If BAC is selling its equity stake in CCB, could it sell its equity stake in Itau?" Deutsche Bank analyst Merio Pierry wrote in a note. "We believe it could, although management has not formally commented about it."
Apart from the unexpected losses at Merrill, there were previous signs that friction was building between the BofA and Merrill camps. While executive departures aren't uncommon after mergers, Lewis was counting on Merrill CEO John Thain to retain his top lieutenants to oversee the combined company's investment banking and wealth management divisions, two areas where Bank of America has never performed well. But the troops at Merrill, a gregarious lot by nature, have never cottoned to Thain and his stiff management style. Moreover, the departures of Greg Fleming and Bob McCann—Merrill's top investment banking and brokerage executives, respectively—suggest Bank of America is losing the very managers it had counted on to keep Merrill's best brokers from jumping ship.
Already, a number of Merrill's best-producing brokers have left to hang out their own shingles, and rival Morgan Stanley has been quietly wooing away the remaining Merrill brokers. What's more, Morgan's deal to combine its brokerage force with that of Citigroup's could create even more of a threat to BofA and Merrill Lynch. When McCann left, credit analysts at Standard & Poor's (like BusinessWeek, a unit of The McGraw-Hill Companies) called his exit a "cause for concern," given that "Merrill's brokerage unit was likely the main attraction for [BofA] in completing the acquisition, and if brokerage attrition picks up, the acquisition becomes less valuable."
At some point, Lewis' vision that the combined BofA-Merrill Lynch will be a financial juggernaut is almost certain to be realized. In a Jan. 13 report, Ladenburg Thalmann banking analyst Richard Bove noted that if Lewis can stem the recent losses in its investment banking, lending, and trading operations, BofA "has $5 per share in earnings power without any growth in its franchise." While noting that investors "are rightly focused on the near-term…at some point they will look beyond the valley and what they are likely to see is a relatively high profit mountain," Bove wrote.
But for Lewis, reaching that pinnacle could be a Sisyphean task over the next several years.
Foreclosures up 81 percent: RealtyTrac
U.S. foreclosure activity jumped 81 percent in 2008, with one in every 54 households getting at least one filing notice, suggesting various state laws and private programs to slow the process have been ineffective, RealtyTrac reported on Thursday.
Nearly 3.2 million foreclosure filings on 2.3 million properties were made last year, the Irvine, California-based research firm said. Filings include notice of default, auction sale or bank repossession.
"Clearly the foreclosure prevention programs implemented to date have not had any real success in slowing down this foreclosure tsunami," James J. Saccacio, chief executive officer of RealtyTrac, said in the report.
Foreclosure activity did slow in the fourth quarter overall, declining 4 percent from the third quarter, but jumped nearly 40 percent from the fourth quarter of 2007.
And foreclosure activity last year was up 225 percent from 2006, the year home prices began a deep slump that prevented many homeowners from selling or refinancing.
Home prices have plunged more than 20 percent from the summer of 2006, according to Standard & Poor's/Case-Shiller measures.
Filings leaped by 17 percent in December from November.
"State legislation that slowed down the onset of new foreclosure activity clearly had an effect on fourth-quarter numbers overall, but that effect appears to have worn off by December," Saccacio said. "The recent California law, much like its predecessors in Massachusetts and Maryland, appears to have done little more than delay the inevitable foreclosure proceedings for thousands of homeowners."
California required lenders to provide written notice of their intent to start foreclosure proceedings 30 days prior to issuing a notice of default.
Nevada, Florida, Arizona and California, respectively, posted the highest state foreclosure rates last year, RealtyTrac said.
These are states where home prices soared the most during the five-year housing boom earlier this decade.
Foreclosures also rose as interest rates jumped last year just as hundreds of billions of dollars of adjustable-rate mortgages reset, sending loan payments sharply higher.
And lenders that had seldom turned potential borrowers away clamped down, curbing access to new funds, as foreclosures shot to record highs.
RealtyTrac has said that foreclosure activity would spike without a broad permanent fix for troubled mortgages in what economists are calling a deep recession.
Some relief may come from January's tumbling home loan rates, spurred by the promise of massive government purchases of mortgage bonds.
Average 30-year loan rates have fallen under 5 percent, the lowest in some four decades, by several measures. Requests to refinance have soared to the highest level in more than five years, according to the Mortgage Bankers Association, which could cut borrowing costs and help keep some borrowers in their homes.
Nevada had the highest rate of foreclosure, with more than 7 percent of Nevada housing units, or one in every 14, receiving at least one foreclosure notice in 2008. There were foreclosure filings on 77,693 properties, up nearly 126 percent from 2007, RealtyTrac said.
California had the highest number of foreclosure filings, at 523,624 properties, followed by Florida and Arizona.
Among the 100 largest metropolitan areas, Stockton, California, had the highest rate of foreclosure, at 9.46 percent. Las Vegas was close behind in second place.
Cities in California and Florida accounted for seven of the top 10 metro foreclosure rates, RealtyTrac said. Economically challenged Detroit was in 10th place, with one of every 22 housing units receiving a filing notice last year.
China's sovereign fund in 'no hurry to invest overseas'
In the face of the global financial crisis, China Investment Corporation (CIC), the country's sovereign fund, has no interest in an imminent overseas expansion, said Wang Jianxi, CIC deputy general manager.
Wang was quoted by China Business News that right now, in major developed countries around the world, risks are high and policy trends uncertain.
Sovereign funds are also facing some special obstacles and are denied access to invest in such things as crude oils and strategic minerals.
Wang also noted that developed countries tend to regard sovereignty funds as controlled by foreign governments and therefore likely to cause more problems when they come to compete with private capital.
Amid the global financial crisis, many other sovereign funds have left the overseas market and turned to invest domestically. However, CIC, which manages $200 billion of China's foreign exchange reserves, is not allowed to invest in the domestic market, Wang said.
But Wang did not say what investment strategy CIC is to follow in the current market conditions.
Meet Lady Subprime
The French have the comely Marianne, the British have the fetching Britannia, and we have the welcoming Lady Liberty. May I now suggest, at least for the duration of the current recession, a new feminine emblem of our times: Marvene Halterman of Avondale, Ariz. At age 61, after 13 years of uninterrupted unemployment and at least as many years of living on welfare, she got a mortgage.
She got that mortgage less than two years ago. She got it even though at one time she had 23 people living in the house (576 square feet, one bath) and some ramshackle outbuildings. She got it for $103,000, an amount that far exceeded the value of the house. The place has since been condemned.
This tale, unfortunately as American as apple pie, was recounted recently in the Wall Street Journal. Since the story ran over a long, holiday weekend, it is possible that you, not to mention the occasional member of Congress or, God forbid, the various government regulatory agencies, missed it. It is the only possible explanation for why there have been no executions, never mind arrests.
Halterman's house was never exactly a showcase -- the city has since cited her for all the junk (clothes, tires, etc.) on her lawn. Nonetheless, a local financial institution with the cover-your-wallet name of Integrity Funding LLC gave her a mortgage, valuing the house at about twice what a nearby and comparable property sold for.
According to the Journal, Integrity Funding then sold the loan to Wells Fargo & Co., which sold it to HSBC Holdings PLC, which then packaged it with thousands of other risky mortgages and offered this indigestible porridge to investors. Standard & Poor's and Moody's Investors Service took a look at it all, as they are supposed to do, and pronounced it "triple-A." "Double-A" must mean no running water.
At each step of this mortgage process, a moral crime was committed. Halterman's interest rate would have ballooned to 15.25 percent, when in all likelihood 1 percent would have been a reach for her. (Her welfare and disability payments totaled about $3,000 a month.) After paying off all her debts and the usual fees, Halterman got $11,090 at the closing. After processing her mortgage, Integrity cleared nearly as much: $9,243.
We turn now to Bernard Madoff, the accused swindler who allegedly ran a $50 billion Ponzi scheme. The English language lacks sufficient words of contempt for this man who leveraged the teachings of Maimonides -- the sacred obligations of philanthropy -- to swindle charities of money for the poor. His victims were rich and not so rich, one-time Masters of the Universe and one-time schoolteachers, now equally broke, a leveling of wealth that not even Lenin could have envisaged. The wreckage is immense.
But think: Was there a better Ponzi scheme than the one that ensnarled countless underfinanced homeowners? Who has gone to jail? Nobody. Who has paid back the huge amounts of money made in financial services? Nobody. Where's the former financial genius who has vowed to return his bonus -- or donate it to charity -- because he was overseeing a huge dream factory that produced nothing more than a stack of three-dollar bills as high as the sky? "Here, sorry, I didn't earn it." Words you will never hear.
How was Madoff's alleged scheme so different? He could go to jail. The other guys are scot-free. But they had to know that Halterman could not pay off her mortgage. They had to know that she could not afford a 15.25 percent interest rate. It didn't matter. One institution sold to another, taking its fees, passing along this Ponzified paper like it was a hot potato -- don't hold it for too long or you'll get burned -- and then offering it to the vaunted, all-knowing and downright perfect Market, our secular god.
Ah, Halterman, you are our unintentional Marianne, our Britannia. You represent the consequences of a Congress that was both deluded and bought. You personify succeeding presidencies (Clinton, Bush) that sniffed the glue of deregulation. You embody a public that fervently believed in the free lunch of ever-rising housing values and a financial system that figured out that the buck didn't really ever have to stop . . . until it did.
The little house on West Hopi Street is slated to be torn down. Pity. For as little as $18,000, its apparent value at the moment, it could be bought by the government and turned into an appropriate monument to our era: The American Museum of Greed. Don't bother joining. We are all charter members.