Washington policeman Bill Norton measuring the distance between knee and suit at the Tidal Basin bathing beach after Col. Sherrell, Superintendent of Public Buildings and Grounds, issued an order that suits not be over six inches above the knee
Ilargi: Part of the never-ending saga of inflation vs deflation -never mind that we're already deflating with a vengeance, and global loss of wealth outpaced the entire 2008 world GDP - centers on currencies. Which one to hold, which one will sink fastest, how strong is the US dollar, and how weak is the Euro? Here's Stoneleigh on The Theory of The Special Relativity of Currencies.
Stoneleigh: People often ask us which currency they should hold and whether or not we think the US dollar is about to plummet, so I thought it would be a good topic for a primer. Basically, the value of a currency can be looked at in two ways - relative to other currencies internationally and relative to goods and services domestically. It is the former that people are generally concerned about, but it should be the latter. Deflation is already outpacing the ability of central bankers and governments to 'print money' (monetize debt), and in a deflation, cash is king, relative to goods and services.
You need liquidity, and you need it in a form that will be accepted in your locality, whatever that currency is worth relative to others. As a fully liquid cash equivalent, you could also consider short term bonds (30-90 days) issued by your own government, as long as your government isn't Zimbabwe or anywhere comparable. Our horizons will contract drastically as we move towards a far more local world - a world where trading one currency for another might not be possible at all for most people. For most people, the time to think internationally is over. Credit expansion effectively shrank the world and turned it into a global village, but the world is about to get much larger again.
In the past, most people were born and lived and died all within about a five mile radius, and that is the world we are returning to. What good would a foreign currency be under those circumstances? If you are caught with foreign currency you can't legally trade, you would lose either all or most of its value (depending on the availability of a black market, but that has its own risks). Also, in a world that will be increasingly jingoistic and xenophobic, with the unfolding of an inevitable blame game, holding foreign currency could also be construed as unpatriotic, and that could be dangerous.
If you have liquidity, then you will be able to purchase necessities, and also the hard assets you will eventually need. Deflation will force down the prices of almost everything, hence preserving your purchasing power now will give you options in the future that very few will have. All fiat currencies are eventually inflated away, and in this case that will happen once the credit bubble has finished deflating and the international debt financing model is well and truly broken. I would expect that to be quite some time, as deflation and depression are self-reinforcing, and during that downward spiral it will be impossible to inflate.
During the deflationary phase you will need liquidity, but once it is over you will need to switch to hard assets. I would suggest waiting for very substantial price falls in order to hang on to as much of your wealth as you can, but not to wait for the bottom. The risks of spending a lot of money when no one else has any will grow with time, and you will need time to climb the learning curve associated with any self-sufficiency assets you buy. My guess is that deflation could last for a number of years, and that the best time to shift to hard assets (from a purely financial point of view) should be at least a couple of years away. Others with more resources may make the shift sooner, knowing that they will lose money, but having the luxury of being able to do so in order to buy time to learn new skills.
As for the value of your currency relative to others, that is less important for ordinary people, but may be important for those who are lucky enough to have far more wealth to begin with. Deflation is currently pushing up the value of the US dollar on a flight to safety (temporary pullbacks notwithstanding), and we are on the verge of an unwinding of the yen carry trade, which should also increase the value of the yen substantially. I would expect the euro to fall (temporary rallies notwithstanding) as the internal pressures build in Europe, and currencies that were on the opposite side of the yen carry trade should also fall as the yen rises.
Commodity currencies should do poorly as commodity demand falls and global trade is greatly scaled back, but could recover if we see a supply collapse and commodity prices rise again. This would probably depend on the commodity in question. Beyond a certain point, however, I am expecting currency relationships to become very volatile, if not chaotic. We are likely to see a series of beggar-thy-neighbour competitive devaluations as countries attempt to secure an advantage for themselves, if only temporarily. Where many currencies are falling, relative value depends on which one falls the fastest, or where a perceived safe haven may lie this week. My guess is that we will move into this kind of environment within the next two years, and quite possibly sooner rather than later.
As bets on relative currency values form a large part of the derivatives market (along with interest rate bets), sudden bursts of volatility are likely to generate large losses that could further destabilize an already precarious situation. Betting on specific currency swings under such circumstances would amount to very aggressive gambling and is generally a recipe for losing your shirt. At some point we are likely to see a relatively sudden dislocation in the bond market as we see international borrowing become more difficult, with continuous bailouts making the bond market nervous. Essentially, bailouts will be overtaken by events. That would involve bond prices falling substantially and interest rates soaring - quite possibly into the double digits.
People frequently worry that this will be inflationary, but it would actually precipitate an enormous amount of deflationary credit destruction. Interest rates on all debts would rise with bond rates to crippling levels, leading to a huge wave of defaults. This would amount to hitting the 'emergency stop' button on the economy, and is one reason we point out that holding debt can easily be financially fatal during deflation. In addition to a default tsunami, we would see governments cut back services drastically in order to reduce terribly expensive borrowing. This means being on your own in a pay-as-you-go world, which is why we emphasize the need for you to hold cash in hand. For many people, the only way to achieve no debt and cash in hand is to sell property and rent. For others, pooling resources may achieve the same thing.
Whatever the fate of the dollar relative to other currencies during a bond market crisis, its value relative to available goods and services domestically should still be increasing. Of course some goods may not be available at this point if they are sourced from abroad and trade has collapsed. There may therefore be some goods that would be worth purchasing at today's prices, in order to secure items that could be very useful while all it takes is the internet and a credit card.
When we eventually do see inflation, it will not come from the initial havoc in the bond market, but from the aftermath of its destruction. Once deleveraging is over and countries must function in financial isolation, there will be nothing to prevent them from printing actual cash, as opposed to desperately trying to expand credit in a double-or-nothing gamble as they are currently doing. Down that road lies a currency hyperinflation on a Zimbabwean scale, but we are nowhere near that point now. You must survive deflation in order to have to worry about hyperinflation.
The US Can't Unilaterally Inflate
Many people are either worried that all the excessive money creation and bailouts will create inflation, or hope that the Fed will create the necessary inflation to gradually reduce the burden debtors face. There is little chance either will come to pass right now. The US can't create or sustain moderate inflation without a little help from its friends. This insight falls more into the category of "accounting identity" than "brilliant reasoning".
There are many countries that peg their currencies to the dollar in some form, but China is by far the biggest, most important, and most notorious. But even Japan has a ceiling beyond which they won't let the JPY rise. These pegs are not difficult to defend because their currencies are pegged too cheap, rather than too rich. In fact, China absorbs massive amounts of USD in their interventions to enforce that peg. Should they ever need to fight the other way, they can sell off USD and buy CNY until the crisis has passed, and the permanent, underlying current account surplus takes care of the problem.
Japan and China do not have any lasting inflation problem either, though both caught an inflationary wave during the commodity bubble. They have certainly both experienced deflation in the recent past. The economies survived, with a little discomfort. There is very strong structural deflation in both economies, with extraordinarily deep capital, and in China's case at least, virtually limitless labor. Deflation appears to be returning and it probably doesn't present a severe threat to either economy. Deflation does pose a dire threat to the US economy. With immense debt outstanding to GDP, far higher than anything seen before, the US economy may have approached the Chandrasekhar limit of debt. Debt-deflationary spirals are not fun. Even worse, we have very large, persistent trade deficits and a poor NIIP.
The US has also invested very little in tradeable sectors. When we had all the cheap funding in the world, we built houses in the Inland Empire and bought a lot of cars. Why did America choose to consume or invest in residential real estate, rather than a machine shop in Michigan? Many ascribe that to avarice or stupidity, but it's unfortunately more likely a result of American workers and capital being totally uncompetitive at current and envisioned pricing. As evidence, American exports did finally start to respond a bit when the dollar index sunk a long way, but they've begun to fall again now during the recession, while the dollar's rising again. American goods and services need to be cheaper in other countries to be desirable.
The dollar can't weaken against major competitors, though. China, Japan, and other pegging nations prevent it. China probably can't really break their peg without bankrupting the PBoC, which holds dollars as assets and yuan as liabilities. Much of the world, if revalued, could no longer rely on exports to America and Europe for growth, sinking into deeper -- more deflationary -- recessions of their own. They will probably not revalue any time soon. China has also demonstrated the ability to sterilize, effectively or at least marginally so, extremely high levels of intervention. Enough for real exports and hot money when the global economy was fine, and certainly enough in our trade depressed world. I believe that through greater bond issuance and raised required reserves, they can effectively sterilize a really, really big pile of yuan. Japan has started running a trade deficit.
Now, let's imagine Bernanke has a magic wand that he can wave to set the US inflation rate to 12%, in order to increase wages and revenues and make debt and prices manageable. A year passes. Everyone charges 12% more dollars for everything: labor, haircuts, cheeseburgers, and so on. That's okay, because everyone earns more too. But every USD is still worth 6.83 CNY, and there was no inflation in China. That means the price of US labor, haircuts, and cheeseburgers is 12% higher in real terms in China. They can't buy as much. That also means the price of Chinese t-shirts is 10.8% seems lower than it was last year, because Americans are all earning more. I'll be more likely to buy things made in China.
China now exports much more to the US. With the proceeds from these exports and the intervention, they would buy more US assets, but less relatively expensive US goods and services. The trade balance worsens, the imbalances worsen, US workers and plants become even less competitive, China invests more in tradeables, US consumers go further into debt, and so forth. Less employment, less exports, more debt, stronger deflationary forces. Next year, things grow exponentially worse. Unless the US miraculously becomes more efficient and productive, to avoid this scenario, the US must have a weakening real exchange rate (REER). Because currency pegs prevent revaluation, that means China and Japan must run higher inflation rates than the US. Twisting it around, in current conditions, the US cannot run a higher sustained inflation rate than China, Japan, and others. The US must either:
- Persuade China, Japan, and others to allow their currencies to appreciate dramatically so the US can abruptly default on some of its debt to them, and reduce their exports considerably;
- Persuade China, Japan, and others to allow high domestic inflation. If the US wanted 12% inflation domestically, it might ask for 16% or 17% inflation in China, if not a bit more;
- Do something crazy, like enact Smoot-Hawley Mark II and beat each other up at the WTO;
- Suffer through deflation.
Crisis creates threat of a new lost generation
The kids are not alright. Old timers - and I suppose, since I can remember the 1980s, I am one of them - are prone to pontificating, with a touch of smugness, about how no one under 35 has the first idea about a recession. They are about to find out: as the Organisation for Economic Co-operation and Development has said recently, the position of the young deteriorates much more than that of fully fledged adults when adverse economic conditions unfold. Children of the boom, who spent their formative years in a period of extraordinary apparent prosperity, may have thought it perfectly normal to have easy credit, plenty of jobs and an abundant supply of financial support from the Bank of Mum and Dad, but they are having rapidly to adjust to a more austere reality.
The credit crunch is the economic equivalent of the Mosquito security device - which emits a repellent high-pitched whine audible only to young ears - in that it is likely to have a particularly painful effect on the under-25s. The risk is that this youth-seeking missile, combined with pre-existing social and demographic trends, could trigger generational conflict. No wonder Gordon Brown has been worried by the unrest in Greece; he can remember the Brixton and Toxteth riots. The downturn will be difficult for people of all ages, from pensioners receiving derisory interest on their savings to middle-aged, over-mortgaged parents. Young people, however, are particularly vulnerable because it threatens to block their path into the job market, as credit-starved companies freeze recruitment.
And if delayed entry into work turns into long-term unemployment, as it did for many in the 1980s, it can blight lives for years, pushing some to the margins of society and leaving them vulnerable to a cluster of social and health problems. Despite Gordon Brown's preoccupation with youth employment and Tony Blair's mantra of "education, education, education" the UK is entering this recession from a poor position. Middle-class youngsters will be affected; for the first time in years, graduates face worries about finding work when they leave university. Insouciance about student debts, which averaged £12,000 for the class of 2007, will be harder to sustain, and all but the richest parents will be less eager to help now the family home no longer doubles as a piggy bank.
The deeper worry, however, is that the ranks of the "Neets" - young people "not in education, employment or training" - will be swelled by the crunch, with heavy social, economic and personal costs. A recent report by the OECD found that more than 14 per cent of 16-to-24-year-olds in the UK are unemployed - more than double the proportion in the working population as a whole - and that the prospects for this age group have worsened at a time when the average OECD unemployment rate has been falling . Separate research by the CBI suggests that young people outside formal education and training are significantly more likely to suffer poor health, to become involved with crime, and, in the case of young women, to become teenage mothers.
These problems, left unchecked, will replicate in future generations and lead to clusters of deprivation where worklessness is entrenched. It is no surprise that the highest proportion of Neets in the English regions is in the north east; many of them will be the children of the teenagers shunted on to the dole queues in the Thatcher era. All sorts of reasons have been proffered as to why the Neet problem remained intractable even in the boom years, from the arrival of migrant workers to the alleged failings of the education system, but the key thing now is to stop the situation getting even worse. The government is beefing up its commitment to apprenticeships, though burger chain McDonald's aim to become the UK's biggest provider will inevitably lead to jibes about McJobs.
But employers can't provide apprenticeships if they go out of business, so the suggestion by shadow universities secretary David Willetts of a clearing house to provide apprenticeships for young people whose employers have gone bust is a sensible one. Bringing forward plans to raise the school leaving age would also help; there is a good argument that all 16-to-18-year-olds should still be in education or training. Of course, this will cost money, but so will neglecting the problem. We will be relying on young people, as future taxpayers, to foot the bill for rescuing the UK economy from the credit crunch, a crisis they played no part in creating.
They are the ones who will be driving forward the new green-tech industries we hope will provide future prosperity and a cleaner planet. And as the population ages, we will be looking to them to support a much heavier pensions and elder-care burden - though, unlike their parents or grandparents, today's twentysomethings are highly unlikely to enjoy a decent final salary scheme when they eventually retire. Older generations always have a responsibility to the young, but the credit crunch has made ours a pressing one - particularly towards the disadvantaged teenagers prosperity forgot.
Recession will fuel racial tensions, Hazel Blears admits
Cabinet minister Hazel Blears has warned the recession could fuel community tensions. Increasingly hard times can give rise to "myths" about immigrants' entitlements which must be challenged if they are not to take hold, she said. "It could go either way," the Communities Secretary said. "You either end up as a fragmented society, or you come out of it stronger." She also voiced concern about the uphill task facing the Government in getting some people back into work.
"What worries me is that some people are no longer active participants in their own lives," she said. "We've done a lot of the physical regeneration, estates have changed, and things have improved, but it's the people bit. I just worry that that sense of ambition that people had...it's not there." Ms Blears went on that there was a danger that community resentments could grow as the economic conditions got worse. "The evidence is that where resources are scarce, then unless you make positive attempts to bring people together, to get information out, for people to understand entitlement and who gets what, then these myths can grow up and become received wisdom," she told the Sunday Times. "The far right use it to get divisions between people."
It's got so horrible that we ought to be revolting
In retrospect, one of the most remarkable things about the events of 2008 is that there weren't any. In 1968 the streets of Paris and London rang with protests over the Vietnam war and class solidarity; in 1984 the miners went on strike for more than a year. By contrast, over the past year, banks, jobs and money in colossal quantities have disappeared with barely a murmur of dissent, let alone the explosions of outrage that you might expect.This apparent fatalism is no doubt partly numbness in the face of figures that are truly incomprehensible. Where the liabilities of high-street banks are multiples of GDP, and a single hedge fund is responsible for write-offs that equal the UK's defence budget, it's hard to feel anything other than helpless.
More insidiously, it is also a measure of how completely the message of "One Market under God" (to quote the title of an entertaining and telling polemic by Thomas Frank) has been internalised. Yet outrage and contempt are sometimes in order, not least to ensure that we don't get fooled again. Even now, some would argue that the crunch is the result of a bold experiment in financial innovation gone wrong; a mistake, certainly, but justifiable in the sense that, if it had come off, the resulting era of ultra-cheap money would have led to the prospect of capitalist prosperity without end. Another view would be that the reasons why it nearly came off also meant that it couldn't - the reliance on personal incentives untrammelled by any wider sense of responsibility left the system permanently teetering on the knife-edge where risk shades into outright fraud.
As such, the disasters of 2008 are not an aberration but the culmination of a rewriting of the management project that now leaves many companies with a vacuum at their centre. What's been lost over the last three decades is only now becoming clear. Some of the warning signs were already visible in the succession of increasingly frequent panics and scandals of the last decade and a half - Enron, the dotcom boom, LTCM. Less obviously, the last 30 years have seen a steady erosion of balance between stakeholders. While layoffs of staff - "the most important asset" - were once a last resort for employers, they are now the first option. Outsourcing is so prevalent that it needs no justification. And the company's welfare role is now so attenuated that it barely exists. First to go was the notion of career; more recently, the tearing-up of company pension obligations is another unilateral recasting of the conditions of work - a historic step backwards - that has aroused barely a ripple of objection.
The justification for this behaviour is, of course, the pressure of the market. But this is to disguise a betrayal. As a class, ever since the separation of ownership and management in the 19th century, managers have always occupied a neutral position at the heart of the enterprise - neither labour nor capital, but charged with combining the two for the benefit of both the company and society itself. Everything changed in the 1980s, however, with the advent of Reagan, Thatcher and Chicago School economists who preached the alignment of management with shareholders in the name of "efficiency". In effect, "efficiency" came to mean short-term earnings to the detriment of long-term organisation-building; what was touted as "wealth creation" was actually "wealth capture", from suppliers, clients and employees as well as competitors, on the grandest scale since the robber barons. Its purest expression was private equity.
Managers never looked back. As late as the 1980s, a multiple of 20 times the earnings of the average worker was perfectly adequate CEO pay. But under the compliant gaze of shareholders and remuneration committees, performance-pay contracts boosted the ratio to 275 times by 2007. As we now know, "performance pay" was a misnomer, an incentive for financial engineering that has destroyed value on a heroic scale. But it's not just shareholder value that has suffered. By severing any common interest between top managers and the rest of the workforce, fake performance pay has fatally undermined the internal compact that makes organisations thrive in the long term.
Perhaps the most poignant emblem of this dereliction is the British pub. The pub is the archetypal small business - the simplest, most rooted organisation there is. Pubs have thrived for centuries. But they are now closing at a rate of around 30 a week. Part of this is due to changing social habits. But it is also the case, not to put too fine a point on it, that pubs have been rogered frontwards, backwards and sideways by financial whizzkids who piled them with complex debt and left them desperately underinvested - at the same time extracting exorbitant fees for the privilege. The death of the local is a fitting monument to a bankrupt management model. It's time to get angry.
China Imports, Exports Tumble
China's exports and imports both fell for the second consecutive month in December, with an accelerated contraction in trade offering a bleak outlook for the world's third-largest economy and highlighting the need for Beijing to rely more on potent fiscal stimuli. The weak trade data, especially that of imports, showed China isn't just suffering from a global economic slowdown but also from a deterioration in local demand, an engine that the authorities have hoped would keep the economy going and unemployment in check. China's exports in December fell 2.8% from a year earlier to $111.16 billion, while imports in the month fell 21.3% to $72.18 billion, a person familiar with the data said.
China's trade surplus in December totaled $38.98 billion, the person said. That was down from a record $40.09 billion in November. The fall in December exports was lower than the median forecast of a 3.8% drop by 12 economists surveyed by Dow Jones Newswires but was higher than the 2.2% decline in November, the first monthly drop since June 2001. The rate of decline for imports in December was sharper than the 19.1% expected by the economists and the 17.9% fall in November, the first decline since February 2005. While the falling value of imports in December partly reflects declining international commodity prices, it also indicates "a sharp deceleration of economic growth in the fourth quarter and poor growth momentum in the first quarter," said Stephen Green, an economist at Standard Chartered Bank.
Machinery imports were weak in November and likely continued into December, showing that "there is a real downturn in domestic investment...and manufacturing," he added. Beijing's recently unveiled four-trillion-yuan fiscal stimulus package, which will raise public spending on infrastructure and social welfare, will likely give some support to imports of commodities such as iron ore and metals this year, Mr. Green said. The weak trend for imports could start stabilizing in the second half of this year as Chinese firms finishing running down their inventories and global commodities prices rebound, said Xu Jian, an analyst at China International Capital Corp.
China's exports in 2008 rose 17.2% to $1.43 trillion and imports last year rose 18.5% to $1.13 trillion, said the person familiar with the trade data. The country's trade surplus in 2008 was a record $295.46 billion, the person said, up from 2007's surplus of $262.2 billion. The market had expected a 17.3% rise in 2008 exports, a 19.3% rise in imports and a full-year trade surplus of $289.2 billion, according to the survey of economists. China's exports will fall around 5% in 2009, extending the weakness from the past two months, said Mr. Xu.
Mr. Xu added that Beijing will likely raise export-tax rebates on more products and ease trade financing but is unlikely to use a weak yuan as a tool to help exporters. As for China's trade surplus, despite a narrowing in December, it stayed near historically wide levels. While ordinarily trade surpluses would be welcome, the performance in the past two months was of a different and worrying nature: the strong numbers were driven by a sharper decline in imports rather than faster growth in exports as in previous months and years.
The Last Pillar Of The Chinese Economy Falls
The way that the Chinese GDP was going to roll forward to become the No.1 economy in the world was relatively simple. An expanding global need for cheap goods would drive a massive export machine. An expanding middle class would become rabid consumers of items made both overseas and within China. The system was fool-proof. Even remarkably intelligent economists and journalists talked and wrote about "the Chinese Miracle." In 2007, the nation's GDP was $3.2 trillion, but was growing at 11%. US GDP was well over $14 trillion that year, but its growth rate was 3%. It was only a matter of time before the lines crossed.
China has been able to draw upon a huge reserve of rural labor. People have been moved from rural China to a number of large industrial cities in the interior of the country, many of which now have populations in the millions. Factory complexes were built in these same areas. As long as demand for output moved up, the labor forces in these regions grew. China created its own middle class which served the dual purpose of making and consuming goods at record rates. The central government has believed that as the demand for exports softened recently due to the global recession, the country's new middle class would continue to help GDP growth through consumption.
The plan has fallen apart like a cheap watch. According to The Wall Street Journal, "China's exports in December fell 2.8% from a year earlier to $111.16 billion, while imports in the month fell 21.3% to $72.18 billion." What was unimaginable a year ago has now happened. China has entered a recession and it may end up being deeper than the one in the US. It is not clear that the government can mount and manage a plan to create what would have to be in the range of ten million new jobs. This will be an even more difficult task if exports continue to fall sharply. China does not have a service industry which is anywhere close to being as large a part of the GDP as it is in the US.
The illusion developed over the last decade that China had become an independent power with a population which could make and consume goods at levels which have never been seen before. During the last two quarters, it has become clear that the the opposite is true. China's economy may be the most dependent large economy on earth. If GDP in the US, EU, and Japan contract at 5% this year, China's economy is very likely to shrink faster. It will be faced with a sharp drop in what it makes and exports.
More importantly, large numbers of Chinese are leaving the huge new industrial cities and going back to rural regions where they can at least find work growing their own food. What is more than a trickle now could become a flood. Those who have gone back to non-industrialized sections of the country will not be net consumers at all. With a short-lived and dwindling middle class, China no longer has the economic core to continue the "miracle". China has just become another big country in trouble.
Obama Calls for Sacrifice, Scaling Back Campaign Promises
President-elect Barack Obama said turning around the U.S. economy will require cutting back on some campaign promises and personal sacrifice from Americans. "I want to be realistic here, not everything that we talked about during the campaign are we going to be able to do on the pace we had hoped," Obama said in an interview on ABC’s "This Week" program, scheduled to air tomorrow. ABC posted excerpts of the interview, Obama’s first since returning to Washington as president-elect, today on its Web site.
Obama is pressing Congress to act quickly on a two-year economic stimulus plan of about $775 billion that includes new government spending and tax cuts. In appearances last week the president elect warned that failure to pass legislation enacting his proposals within the next few weeks risks letting the U.S. fall into a deeper and more prolonged recession. The Labor Department reported yesterday that the U.S. lost almost 2.6 million jobs in 2008 and that the unemployment rate jumped to 7.2 percent in December, the highest level in almost 16 years. The losses were widespread, with manufacturers, builders, retailers and temporary-help agencies axing positions.
All Americans will have to sacrifice to put the economy back on track, Obama said. "Everybody’s going to have to give," Obama said. "Everybody’s going to have to have some skin in the game." Even before the stimulus plan is crafted, the Congressional Budget Office forecasts that the recession and government outlays for bailouts will push the budget deficit to at least $1.18 trillion this year. Obama said Jan. 6 that he expects similar shortfalls "for years to come." Some congressional Democrats have criticized the portion of the plan devoted to tax cuts, while Republicans have voiced concern about the size of the proposal and its effect on the deficit.
Obama Says Stimulus Package Creates 4 Million Jobs
President-elect Barack Obama said his two-year plan to boost the U.S. economy will generate as many as 4 million jobs, higher than his previous estimates, the biggest portion of them in construction, manufacturing and retail. The plan would also result in the U.S. gross domestic product increasing by 3.7 percent more by the end of 2010 than it would without the stimulus, according to a study compiled by Obama’s economic advisers. The study gives a forecast based on a package of spending and tax cuts totaling "slightly over" the $775 billion that has been discussed by the transition team with members of Congress.
"The jobs we create will be in businesses large and small across a wide range of industries," Obama said in his weekly radio address today. "And they’ll be the kind of jobs that don’t just put people to work in the short term, but position our economy to lead the world in the long term." The address and the forecast are being released together a day after the government reported that the nation lost 2.6 million jobs in 2008, just shy of the 2.75 million decline at the end of World War II. The unemployment rate hit 7.2 percent in December, the highest since January 1993. Even with the stimulus plan, Obama’s advisers say the jobless rate will remain at about 7 percent by the end of 2010.
Yesterday, companies including Boeing Co., the world’s second-largest commercial-plane maker, CSX Corp., the third- largest U.S. railroad, and General Dynamics Corp., the second- largest shipbuilder for the U.S. Navy, announced job cuts. The Standard and Poor’s 500 Index has lost 37 percent in the past 12 months and the Dow Jones Industrial Average fell 33 percent. Obama’s report is part of a campaign by him and his transition team to build support for his stimulus plans with Congress and the public. While his advisers have been meeting with lawmakers, Obama every day this past week has spoken about the economy and warned that the U.S. faces a deep and prolonged recession unless action is taken.
"It’s not too late to change course -- but only if we take immediate and dramatic action," Obama said today. "Our first job is to put people back to work and get our economy working again." Even with the GDP improvement forecast in the report, the unemployment rate is forecast to be about 7 percent, according to its authors Christina Romer, the President-elect’s pick to head the White House Council of Economic Advisers, and Jared Bernstein, economic policy director for Vice President-elect Joe Biden. The single biggest job gains would be in construction, according to the report, with 678,000 created by the fourth quarter of 2010. Another 604,000 jobs would be created or saved in the retail sector and 408,000 in manufacturing. Most of the jobs created by government spending on infrastructure, education, health and energy would come in 2010 and 2011 because of the time it would take to carry out programs in those areas, the report said.
Thirty percent of non-residential construction workers could lose their jobs this year without the stimulus investment, the Associated General Contractors trade association said two days ago. About two thirds of U.S. non-residential construction companies plan to cut jobs this year, the Arlington, Virginia- based group said, citing a survey of its members. Romer and Bernstein stress that their study’s estimates are based on the broad outlines of the Obama plan and may change based on the final legislation passed by Congress. They add that "uncertainty is surely higher than normal now because the current recession is unusual both in its fundamental causes and its severity."
Obama reiterated some of the details that he originally provided in a speech earlier in the week, saying he would aim to double the production of alternative energy in the next three years, modernize 75 percent of federal buildings, and improve the energy efficiency of two million homes. He also promised that the investments would go toward making all medical records computerized within five years. As part of infrastructure spending, Obama would expand broadband lines across the country, and he has called for a "smart grid" that would allow users and producers of electricity to communicate with an eye toward reducing energy use.
The stimulus plan already has drawn some criticism in Congress from lawmakers of both parties. Some Democrats in Congress, including North Dakota Senator Kent Conrad, chairman of the Budget Committee, have expressed doubt about whether the tax cuts for individuals and businesses would do enough to boost the economy. Republicans have voiced concern about the size of the proposal and its effect on the deficit. Obama has said his plan will widen the federal budget deficit, which the Congressional Budget Office this week forecast would hit $1.18 trillion this year. Obama said today "it’s likely that things will get worse before they get better." In addition to spending to create jobs, Obama is promising aid to states and assistance to those hit hardest by the recession.
"That means bipartisan extensions of unemployment insurance and health care coverage; a $1,000 tax cut for 95 percent of working families; and assistance to help states avoid harmful budget cuts in essential services like police, fire, education and health care," he said. The report says the tax cut portion of Obama’s plan, while doing less to spur employment than direct government spending, is "crucial" because there is a limit to how much money the government can spend efficiently in a short period. While construction and manufacturing industries are likely to experience "particularly strong job growth" under the recovery package, it says, the "more general stimulative measures, such as a middle class tax cut and fiscal relief to the states," will help job creation throughout all the sectors of the economy.
Obama: TARP needs overhaul
President-elect Barack Obama urged a revamping of the government's $700 billion financial bailout, saying in an interview broadcast on Sunday it had to increase the flow of credit to families and businesses. "I, like many, are disappointed with how the whole TARP process has unfolded," Obama said, referring to the Troubled Asset Relief Program. "There hasn't been enough oversight," Obama said in an interview on ABC's "This Week with George Stephanopoulos." "We found out this week in a report that we are not tracking where this money is going." Stephanopoulos pressed Obama on whether he wanted U.S. President George W. Bush to request permission from Congress to use the second half of the bailout funds.
Obama, who takes over from Bush on January 20, did not answer directly but said he wanted to see the program changed to do more to help families stave off foreclosures and to increase the flow of credit for small businesses. "What I've done is asked my team to come together, come up with a set of principles around how we are going to maintain transparency, what are we going to do in terms of housing, how are we going to target small businesses that are under an enormous business crunch?" Obama said.
The White House said on Friday that Bush administration officials were in discussions with the Obama team on the possibility of Bush making a request for the second $350 billion of the bailout funds. Both the White House and an Obama transition official said no final decision had been made but The Washington Post said a request could come as early as this weekend. The aim would be to ensure that the funds were in place on January 20, when Obama takes office. The program, which has used mainly to bail out financial firms, is unpopular on Capitol Hill. Some of the funds also were used to help distressed U.S. automakers.
Obama said his team plans to "lay out very specifically some of the things that we are going to do with the next $350 billion of money." "And I think that we can gain -- regain the confidence of both Congress and the American people that this is not just money that is being given to banks without any strings attached," Obama said.
Some Obama aides once had qualms about econ ideas
Several proposals in Barack Obama's mammoth economic recovery plan will result in only modest or even uncertain benefits if they become law. Says who? A pair of the president-elect's top economic advisers -- at least that was their view, in previous roles, before they joined his team. Those assessments, plus recent complaints from Democratic lawmakers, underscore the challenges Obama faces in selling the merits of his nearly $800 billion package of tax cuts and spending initiatives. He may indeed prevail, especially because critics have not coalesced behind an alternative and the economy is so troubled that many former skeptics now embrace huge efforts, proven or not, to try to fix it.
If nothing else, the comments and articles point to the spotty track record of using government tax-and-spend policies in hopes of preventing or ending recessions. For example, giving more federal aid to states, one of Obama's proposals, falls in the "medium" range of cost-effectiveness and carries much uncertainty about its impact on the economy, Peter R. Orszag told Congress a year ago. He headed the nonpartisan Congressional Budget Office then, and now is Obama's pick to direct the Office of Budget and Management. Other Obama proposals such as giving businesses more leeway to write off losses from 2008 and 2009 "have little effect by themselves," Orszag testified at the time. "The historical record on the effectiveness of efforts to provide discretionary fiscal stimulus is mixed," he concluded.
Christina Romer, who will head Obama's Council of Economic Advisers, held a similar view in 1994, when she co-wrote an essay, "What Ends Recessions?" "Our estimates suggest that fiscal actions," which are what Obama is proposing, "have contributed only moderately to recoveries," she and her husband, David, wrote. "Economists seem strangely unsure about what to tell policy makers to do to end recessions." Now, 15 years later, Romer is a principal shaper and defender of Obama's strategy. She says plenty of uncertainty remains, and some proposals are more promising than others. "Tax cuts, especially temporary ones, and fiscal relief to the states are likely to create fewer jobs than direct increases in government purchases," says an analysis of the Obama plan co-written by Romer and released Saturday. But government spending takes time to have an impact, the report says, whereas "tax cuts and state relief can be implemented quickly," and therefore "they are crucial elements of any package aimed at easing economic distress quickly."
The analysis predicts that Obama's plan would create 3.5 million jobs over the next two years. Under the plan, about $300 billion would go to tax cuts. Hundreds of billions more would go to job-creation efforts including public works, and to investments in green technology, education and other long-term projects. Many lawmakers have praised the plan's outlines, but some indicate they want changes. Senate Budget Committee Chairman Kent Conrad, D-N.D., opposes using the plan for permanent spending increases. That puts him at odds with House Democrats who hope to broaden eligibility for unemployment insurance and boost education spending on a long-term basis. The idea of a $3,000 business tax break for each new job created is drawing particular criticism from lawmakers who call it impractical and subject to abuse.
Some Republican leaders have gone further, attacking the very premise that ramped-up government spending, and the resulting deficits, are justified when the economy is tanking and millions of people are losing their jobs. "The empirical evidence overwhelmingly rejects federal government deficit-spending as the best method for stimulating the economy," Indiana University economist Justin Ross said in a statement distributed by House Minority Leader John Boehner, R-Ohio. Obama said Friday he welcomes input from lawmakers of both parties. "If members of Congress have good ideas," he said, "if they can identify a project for me that will create jobs in an efficient way that does not hamper our ability over the long term to get control of our deficit, that is good for the economy, then I'm going to accept it." Some aspect of his plan seem more likely to help the economy than do others, according to economists and the January 2008 analysis by Orszag, now a chief architect and explainer of Obama's efforts.
Obama wants to give tax credits of $500 a year to individual workers and $1,000 to couples if at least one is employed. Such flat-rate credits give proportionally bigger income boosts to low-wage workers, who are more likely to spend the extra money and spur the economy, whereas wealthier people might simply save it, economists say. Still, Orszag suggested a year ago, even low-income Americans might hoard their extra dollars and thereby defeat the stimulus plan's purpose. "In a period of high uncertainty," he told Congress, "fiscal stimulus may have a more modest effect because households are reluctant to spend. A household's consumption also varies for other reasons that are little understood," Orszag said in his 27-page testimony. Obama wants to spend as much as $200 billion to help states pay for Medicaid and education. Such efforts can have merit, Orszag testified a year ago. But he warned that if federal aid to states "merely provides fiscal relief by paying for spending that would have occurred anyway," it may provide little or no stimulus to the economy.
Obama proposes to pour billions of dollars into infrastructure and public works projects, including roads and bridges. He favors those that are ready to break ground right away. Orszag said a year ago, however, "even those that are 'on the shelf' generally cannot be undertaken quickly enough to provide timely stimulus to the economy." Obama wants the economic package to greatly increase the production of renewable fuels and to make federal buildings more energy efficient. Such efforts would have immediate as well as long-range benefits, Obama says. Orszag, in early 2008, seemed to think only half of that was true. Some public works proposals, "such as grant-funded initiatives to develop alternative energy sources are totally impractical for countercyclical policy," he testified, using a term for trying to reverse harmful economic trends promptly.
Is the U.S. Solvent?
There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place. -Telegraph 1/6/09That quote comes courtesy of Professor Willem Buiter of the London School of Economics. As you know, little comes from the world of academic economics that I agree with. We have an exception here although Professor Buiter and I disagree on how we'll get there. The "dollar demise" story is one that has been beaten to death up until now. It's been covered, denounced, called un-American, and with the recent dollar strength, it's been all but dismissed. The problem with all the coverage is that the overwhelming majority of analysts, just like Professor Buiter, have the means wrong. They don't understand how this process will shake out.
The fundamentals of the dollar's weakness are apparent and discussed everyday. The problem is that they're discussed in some other context. Let's start by taking an issue I've covered extensively in prior issues of B&B. If you are a reader of mine, and/or can figure logic beyond a 5th grade level, the bearish fundamentals surrounding the treasury market are blatant. Let's take a look at this -- keeping the dollar in mind. Our budget deficit, like Clifford the dog, is big and red. We are already looking at a $1.2 trillion budget deficit, and that doesn't include Obama our savior's stimulus package that will probably increase our deficit by another 2/3. I promise you it won't stop there. Our new left of left fiscal policies are set to only loosen further as this fiscal irresponsibility grows in mass.
As our nation's liabilities grow, it becomes ever more constraining and difficult to make payments. Look at it this way. If you were racking up the credit card debt, it is more expensive in the long run to make the minimum payment, than it is to simply pay off the debt. That is what we're currently experiencing. One way to ease the burden of our massive debt is to decrease its real value. In other words, regulators can inflate the money supply. In theory, the Federal Reserve could inflate the value of our deficit to zero if they wanted. It obviously worked well for the likes of Zimbabwe and Weimar Germany.
Contrary to the past several months, inflation hasn't been the notable "flation" discussed. Obviously it's the deflation that regulators have been worried about, or at least want you to worry about. Just as inflation reduces the value of our nation's debt, deflation does the exact opposite. This is one of the main reasons deflation will not be tolerated. The end game here would simply be default on an unpayable deficit. Then there's the other scenario: reflation. With deflation scaring the pants off our nation's leaders, regulators are doing everything in their power to combat it.
In prior issues of B&B, we looked at the alarming numbers regarding the recent monetary inflation. Let's revisit some of those statistics. The Federal Reserve has already lent over $2 trillion through its different lending facilities. The recipients of this money have not been released. Bloomberg has recently filed a suit under the U.S. Freedom of Information Act to find out who this money was going to. The Fed has denied access to the information. This does not pertain to the topic of inflation, but is another example of outright criminal behavior undertaken by the authorities. Anyway, from the middle of September to the beginning of November, the Fed has increased facilities lending by $1.23 trillion marking an increase of some 138%...in just 12 weeks!
After Lehman Brothers went bankrupt, regulators entered panic mode. For those who don't know, when regulators panic, they hop in their expensive Mercedes, or Lincoln, or whatever fancy car they drive, and head straight to the printing presses. They flip the switch from "Jesus was printing a lot of money" to "Holy Hell warp speed," and that's exactly what they did. By the end of October, year over year money supply growth was 38%. For those of you who don't know, when everything is shaken out, money supply growth exactly equals price inflation. The last time the money supply was growing at something remotely close to the 38% figure was in 1939 when money supply growth was 28%.
Little did we know that we were just getting started. Once the first week of Dec. rolled around the Federal Reserve really kicked it into gear. In Dec. 2007, the monetary base was $836 billion. In Dec. 2008, the monetary base is $1,479 billion. That's a growth of 76% year over year. There's an interesting little twist here. Leading up to the Lehman Brothers collapse, the Federal Reserve held the monetary base relatively steady. This means that the majority of the staggering 76% money supply growth has taken place in the last three months. That's an annual rate of approximately 300%. (Some figures and statistics provided by William Engdahl) If that isn't enough, I guess pictures speak louder than words.
So here's the deal. The U.S. is growing both its budget deficit and money supply on exponential levels. Once all of this money starts to show up in the prices of goods -- look out. When inflation takes grip it is going to move fast. The problem is that this massive growth in the monetary base will make it more difficult and more expensive to finance our nation's debt at a time when we need more financing than ever. When we begin to struggle financing our debt, the next step is to monetize. This step is one that the Fed and Treasury have already embarked on. Monetizing the debt is simply when the Treasury write the notes and the Federal Reserve prints the money to buy them. Obviously, pending the size of the unfinanced debts, this is very destructive on the domestic currency.
Here's the deal. The U.S. needs to finance a lot of debt. Their monetary looseness is beginning to limit their ability to do so. This will only worsen significantly. The more debt we can't pawn off to foreigners, the more we must monetize. When we monetize, we finance our debt at a great cost to our currency. This will only make it more difficult to sell debt, therefore we will monetize. It's starting to snowball now. It's very simple. The longer the treasury market bubble goes, the more immediate destruction is done to the U.S. dollar. There is only one end game here. Analysts love to discuss whether or not the financial system or Detroit is solvent. Let me tell you, we got bigger problems. The next big question will be: is the U.S. solvent?
Why Big Tax Cuts Are Essential
Let’s get this straight right away. I’m not a dogmatic supply-sider, who believes that tax cuts are the solution to all economic ills. But I believe that Obama’s $300 billion tax cut is essential to ‘recapitalize’ the American consumer, just like the banks are being recapitalized. Think about it this way. This economic crisis consists of three parts:
- Mountains of bad loans, which are weighing down banks and other financial institutions
- Rapid retrenchment by businesses, which is causing them to cut jobs and investment
- Trillions of dollars in excess consumer debt, which is forcing households to cut back on spending.
These three factors together are feeding on each other. Because banks are lending less, it’s harder for businesses and consumers to spend. Because businesses are cutting workers so quickly, loan defaults are rising and it’s harder for consumers to pay back debt. And because consumer debt has risen from 96% of disposable income in 2000 to 130% of disposable income today, Americans are completely maxed out. As a result, any job cuts immediately mean more loan defaults. All three of these problems need to be addressed in order to keep the economy afloat. First, the purpose of the $700 billion in TARP money was to help ‘recapitalize’ the financial system, through injection of money directly into banks and other financial institutions. That must continue until it’s clear that defaults have peaked, which may not be until 2010.
Second, the rising unemployment rate can be directly addressed by government spending programs which create or preserve jobs. Giving money to hard-pressed state and local governments can avoid unnecessary job cuts in education and health care. Infrastructure programs can add construction jobs. And the variety of energy programs that Obama is proposing can goose up an essential sector. That leaves the consumer. The conventional economic wisdom these days seems to be that tax cuts or tax credits are bad because people save the money, rather than spending it. For example, an article in today’s New York Times says: "But economists said the tax credit could have drawbacks as an economic stimulus measure, mainly because people usually save part of the money or use it to pay down debt. That makes good sense from an individual’s standpoint but does nothing to increase economic activity."
But this conventional argument misses the whole point. Consumers have a massive hole in their balance sheets these days. Home prices are plunging, incomes are slowing, and many families have huge debts. Americans are staggering. From this perspective, the main purpose of the tax cuts and tax credits is to help repair consumer balance sheets, just like the TARP is helping repair bank balance sheets. I don’t want consumers to spend the tax cuts—I want them to save the money, as much as possible, and get their debt back to reasonable levels. That’s the only to ensure that consumers will be on solid ground when the recession is finally over.
Edmund Phelps, the Nobel Prize winner, made a similar point at his talk at the recent economics meeting in San Francisco. He said: "Stimulating household consumption is not the best remedy for the fallout of the financial crisis…Weren’t we all saying that households are overconsuming?" So the three prongs of the stimulus package serve distinctly different purposes. The TARP recapitalizes the banks, with $700 billion. The tax cut, at $300 billion, recapitalizes the consumer. And the government spending program—say, $500 billion—provides the missing demand and jobs. Now, all of these numbers, though huge, are probably just a downpayment. My best guess is that we’ll have to do it at least one more time. But in any event, a tax cut—even if it is saved—is an essential part of any recovery package.
U.S. Payrolls Hemorrhage Is Likely to Persist After 2008 Drop
The hemorrhaging of the U.S. job market looks likely to persist into the new year after employers slashed payrolls in 2008 by the most since 1945, increasing pressure on President-elect Barack Obama to stanch the decline. The nation lost 524,000 jobs in December, bringing the total drop for last year to 2.589 million, just shy of the 2.75 million decline at the end of World War II, the Labor Department reported yesterday in Washington. The unemployment rate climbed to 7.2 percent, the highest level in almost 16 years.
"The labor market has deteriorated sharply, and it’s telling us the economy is exceptionally weak right now,’ said Jim O’Sullivan, senior economist at UBS Securities LLC in Stamford, Connecticut. "The first quarter will be pretty rough again, with big declines in payrolls and higher unemployment." Obama, who takes office on Jan. 20, urged lawmakers on Jan. 8 to pass his economic recovery program "in the next few weeks," warning that "if nothing is done, this recession could linger for years." His plan, which has met with mixed reception in Congress, may exceed $775 billion and aims to save or create 3 million jobs.
Job losses last month were widespread, with manufacturers, builders, retailers and temporary-help agencies axing positions. Companies also cut back employees’ working hours, which economists said could be a harbinger of more job declines. The average work week shrank to a record-low 33.3 hours. Manufacturers including Alcoa Inc. have said they will cut output and staff, and retailers from Wal-Mart Stores Inc. to Macy’s Inc. slashed profit forecasts after the worst holiday- shopping season in almost four decades. Payrolls were forecast to drop 525,000 last month, after a previously reported 533,000 decline in November, according to the median estimate of 73 economists surveyed by Bloomberg News. Revisions subtracted 154,000 from payroll figures previously reported for November and October.
The jobless rate was projected to jump to 7 percent from a previously reported 6.7 percent in November, according to the survey. "Consumers are now going to get more and more scared at the prospect of losing their jobs," said Nariman Behravesh, chief economist at HIS Global Insight in Lexington, Massachusetts. The report showed the most rapid deterioration in the labor market over a six-month period since 1975, according to Michael Darda, chief economist at MKM Partners LP in Greenwich, Connecticut. "Policy makers will go full throttle" until "the labor market starts to turn," he said. Obama is pressing for a stimulus plan including tax cuts and spending on everything from roads and schools to the energy network, to help pull the world’s largest economy out of a slump that’s in its second year.
The payrolls report was "a stark reminder about how urgently action is needed," Obama said at a press briefing yesterday in Washington. "What we can’t do is drag this out when we just saw half a million more jobs lost." He added that he will "make sure that Congress stays focused in the weeks to come" to pass the stimulus bill. Fed policy makers are planning to start a new program next month aimed at shoring up the market for financing car purchases, credit-card loans and student debt. Officials announced the effort in November at the same time as initiating a $600 billion program to purchase debt issued or backed by government-chartered housing finance companies.
The central bank has already lowered its benchmark interest rate to a range of zero to 0.25 percent, aiming to bring down borrowing costs. Officials’ main focus now is taking unorthodox steps, termed by analysts as quantitative easing, to boost the supply of credit in the economy. "For policy makers, there is a message" in the payrolls figures, said Kurt Karl, chief U.S. economist at Swiss Re in New York. "The Fed will continue to do quantitative easing." Obama’s economic aides and lawmakers are also discussing ways to deploy the second half of the Treasury’s $700 billion financial-rescue fund. House Financial Services Committee Chairman Barney Frank favors using some funds to stem mortgage foreclosures, aid issuers of municipal bonds and help homebuyers.
The Labor Department also issued revised figures from its household survey, which includes the unemployment rate, going back five years. Benchmark revisions to the payroll figures will be announced in February. Last month’s decline was the 12th consecutive drop in payrolls. The economy created 1.1 million jobs in 2007. During President George W. Bush’s two terms in office, the economy generated a net 3 million jobs, compared with 22.8 million created during the eight years when Bill Clinton was president. Bush leaves office with unemployment at 7.2 percent, compared with the 4.2 percent rate he inherited from Clinton in January 2001. Unemployment was 7.3 percent when Clinton took office in January 1993, the last month that the jobless rate was higher than now.
Workers’ average hourly wages rose 5 cents, or 0.3 percent, to $18.36 from the prior month. Hourly earnings were 3.7 percent higher than December 2007. Economists surveyed by Bloomberg had forecast a 0.2 percent increase from November and a 3.6 percent gain for the 12-month period. Factory payrolls shrank 149,000, the biggest drop since August 2001, yesterday’s report showed. Economists had forecast a drop of 100,000. The decrease included a loss of 21,400 jobs in auto and parts industries. Manufacturing, which makes up 12 percent of the economy, shrank in December at the fastest pace in 28 years, Institute for Supply Management figures showed. Service industries, which include banks, insurance companies, restaurants and retailers, subtracted 273,000 workers. Retail employment dropped by 66,600. Government payrolls increased by 7,000 after falling 3,000 the prior month. Builders fired 101,000. Financial firms reduced payrolls by 14,000.
Analysts said the economy may be in danger of a reinforcing cycle of rising unemployment and declining household spending, what policy makers call a negative feedback loop, which is difficult to snap once it’s begun. Fed staff last month cut projections for gross domestic product and the job market, stating the unemployment rate was "likely to rise significantly into 2010," according to minutes of policy makers’ December meeting. Wal-Mart, the world’s biggest retail chain, this week said fourth-quarter profit will miss its earlier forecasts after sales rose less than analysts anticipated. Macy’s said December revenue slipped 4 percent and announced it would close 11 stores. Sales at stores open at least a year dropped 2.2 percent in the last two month months of 2008, the biggest holiday-season decline since the International Council of Shopping Centers started keeping records in 1970, the group said this week.
"These are extraordinary times, requiring speed and decisiveness to address the current economic downturn," Klaus Kleinfeld, chief executive officer of Alcoa, said in a Jan. 6 statement announcing 13,500 job cuts worldwide. The world’s largest aluminum producer said it will trim an additional 1,700 contractor positions and froze hiring and salaries in some areas. Some companies have taken other steps to lower costs. Caterpillar Inc., the world’s largest maker of construction equipment, will put 814 workers on an "indefinite" layoff, shipper FedEx Corp. cut the pay of Chief Executive Officer Fred Smith and other employees, and auto-parts supplier Visteon Corp. said it will trim the workweek and some salaries.
Social services see recession's toll
Inglewood resident Michael Brown has a master's degree in counseling and has spent 20 years working as a mental health professional. He lost his job at Kedren Community Health Center last March because of a cutback in state funds. On Friday, Brown, 43, made his first visit to a food pantry. He and his 9-year-old daughter had nowhere else to turn. "The unemployment checks aren't enough to cover the rent, the food, the car insurance," Brown said while awaiting a bag of free groceries at St. Margaret's Center off Hawthorne Boulevard. "The money runs out every month." Government officials reported Friday that 2.6 million jobs were lost in 2008. The nation's unemployment rate is at a 16-year high of 7.2%. California's is 8.4%.
But such statistics hardly do justice to what millions of people are now going through, many for the first time in their lives."It's humbling," Brown said. "I'm doing whatever I can. I pick up cans and sell DVDs on the street corner." He acknowledged that after a long career providing help to troubled people -- many living on the streets -- he's now not far from their position. "I'm a spiritual person," Brown said after a moment's reflection. "I can only wonder why God has led me here." Maybe God. Or maybe just a lousy economy that's been hammered by housing and financial markets that for too long have gone without sufficient oversight. Whatever the reason, few are immune from the worst downturn in decades.
"This is hitting high-level professionals as well as less-skilled workers," said Claudia Finkel, chief operating officer of Jewish Vocational Service in Los Angeles. "There isn't a person that I talk to who doesn't know someone looking for work." Lancaster resident Alisha Wright, 23, was laid off nearly a year ago from her job as an assistant manager at a Denny's restaurant. "I have applied for maybe 70 or 80 jobs," she said. "Either I don't meet the criteria or they're just not hiring." Wright said she was getting by on assistance from the county. She said she no longer shops for clothes, no longer goes to movies. She canceled her cable TV service months ago. The hardest part of being jobless, Wright said, is shielding her 5-year-old son from what she's experiencing. "I try to keep everything as normal as possible," she said. "But sometimes he asks me who took my job away from me. He tells me I have to go get my job back.
"I get sad sometimes. I really want to get back on the ball." The rising number of people losing their jobs and homes has caused a surge in calls to suicide hotlines. The Didi Hirsch Community Mental Health Center, which operates L.A.'s busiest crisis-prevention line, says calls are up as much as 60% from a year ago. The recession is also placing an unprecedented strain on food pantries as more people struggle to make ends meet. The L.A. Regional Food Bank, which distributes groceries via a network of hundreds of religious entities and nonprofit groups, says demand at food pantries is up by about 40% from a year ago. "Food pantries are seeing people who never had to seek assistance before," said Michael Flood, president of the regional food bank. "With the latest unemployment numbers, we're bracing for continued elevated levels."
L.A. resident Rachael Brecher, 32, was laid off from her job as manager of a furniture store in September. After three months of hunting for work on the Craigslist website, through word of mouth and by knocking on doors, she said she's still nowhere close to finding a new job. "Companies are either not hiring or they're hiring only part-time staff, or they're hiring people at much, much lower rates than I'm accustomed to," Brecher said. And it's not like she's making outrageous salary demands. In her previous job, Brecher said, she made about $65,000 a year in pay and commissions.
"I'm willing to take a $20,000 cut in pay," she said. "But I still can't find a job." President-elect Barack Obama cited the dismal unemployment stats in pushing Friday for a massive stimulus package. "Clearly the situation is dire," he said. "It is deteriorating, and it demands urgent and immediate action." It also demands that we tough it out, one way or another. As Brown received his groceries from the St. Margaret's food pantry, I asked if he was having trouble being strong. "I'm here with my head up," he replied. "I see light at the end of the tunnel. There's always light."
U.S. Drivers Hold On to Autos, Shun Showrooms on Job-Loss Risk
Drivers rattled by the worst U.S. labor market since World War II are hanging on to old autos longer instead of buying new models, threatening to crimp sales again in 2009 after demand plummeted to a 16-year low. Used vehicles being traded in at dealerships averaged 6.3 years of age after the Wall Street meltdown in late 2008, about 6 months older than before the crisis, according to forecaster J.D. Power & Associates in Troy, Michigan. "The bankruptcy of Lehman Brothers in September and other financial catastrophes have completely broken consumer confidence," said Chief Executive Officer Mike Jackson of AutoNation Inc., the biggest U.S. new-car retailer. "People are losing money in ways never thought possible. They’re shook up."
Yesterday’s unemployment report deepened the industry gloom before next week’s Detroit auto show, with 2008 U.S. job losses marking the biggest annual drop in payrolls in 63 years. General Motors Corp. and Chrysler LLC, which just won $13.4 billion in U.S. loans, are at risk of collapse should sales fall further. "The key statistic affecting car sales now is job loss," said Ken Goldstein, an economist for the Conference Board. The New York-based research group’s index of consumer confidence fell to the lowest in 40 years of record keeping in December. U.S. industrywide sales plunged 18 percent last year to 13.2 million, heralding a possible 2009 slide for automakers including GM, Chrysler and Ford Motor Co. GM reiterated Jan. 5 it expects a U.S. market of 10.5 million to 12 million units.
"If the industry sells fewer than 12 million vehicles this year, the government will have to write more checks" to bail out automakers, said John Casesa, a partner at consulting firm Casesa Shapiro Group in New York. "Otherwise GM, Ford and Chrysler will be gone, bankrupt." Kimberly Rodriguez, co-leader of the global automotive practice for consulting firm Grant Thornton, said the U.S. market may shrink 10 percent to 15 percent more in 2009. As many as 20 GM, Ford and Chrysler assembly plants "are at risk of further downtime or outright closure," said Rodriguez, who is based in Southfield, Michigan. Ford expects industry sales of 12.5 million units, keeping the automaker "above minimum cash levels, nothwithstanding further degrading of the economy that could cause other factors, like weak pricing," spokesman Mark Truby said.
A GM spokesman, Greg Martin, said the Treasury Department’s pledge for U.S. loans and $6 billion to prop up lender GMAC LLC will meet "our liquidity needs under the scenarios outlined in our December plan to Congress." GM and Chrysler face a March 31 deadline to give the government with survival plans to prove that they can repay their loans. They’re counting on paring payrolls, shedding plants and brands, and closing dealers to help keep operating until new, cost-saving labor accords kick in next year. Buyers skittish about an unemployment rate at 7.2 percent in December, a 15-year high, put that strategy in peril. "The two big issues for car buyers are concern about future income and job prospects," said Richard Curtin, director of consumer surveys for the University of Michigan in Ann Arbor, which works with Reuters to track consumer sentiment.
South Korea’s Hyundai Motor Co. is trying to allay that sense of alarm with a promotion unveiled Jan. 6 to buy back newly purchased autos from U.S. customers who lose their jobs. At Suburban Chevrolet in Stuart, Florida, monthly sales are about 80 vehicles, instead of 125 as would be expected without a recession, General Manager Don Miller said. "Most people who come in want to buy and can buy," Miller said. "But there are fewer coming in, so I’m fishing in a smaller pond." U.S. vehicle sales began to weaken in mid-2007, amid a drop in leading economic indicators, signs of tightening credit and falling home values. The auto-market contraction accelerated in mid-2008 as gasoline surged to a record $4.11 a gallon in July. Buyers also switched to smaller cars from higher-profit full-size trucks such as Chevrolet’s Silverado pickup and Ford’s Expedition sport-utility vehicle. The average transaction price of new vehicles in December was $26,743, almost 6 percent less than a year earlier, according to J.D. Power.
A 69 percent collapse in oil prices by year’s end from the July peak couldn’t jump-start new-vehicle demand, as U.S. sales tumbled at least 25 percent in each of the last four months of 2008. "Even with a drop in the price of gasoline, families aren’t changing their decision to keep running the old car," said the Conference Board’s Goldstein. Nor will steps such as an easing of credit standards at lender GMAC be enough on their own to revive showroom traffic, said Tom Libby, a J.D. Power analyst. "Just because GMAC has become a bit more lenient, it’s not like a light switch," Libby said. "It will take economic stability to reignite car buying, it will take some calm. That’s what a shopper needs for the confidence to spend $26,000."
Risks of deflation (wonkish but important)
There’s been some talk abut risks of deflation, but there’s one alarming comparison I haven’t seen made. The figure above shows that the CBO is currently projecting an output shortfall from the current slump comparable to the slump of the early 1980s. Actually, it’s very close: if you compare the CBO’s projections of unemployment from 2008 through 2012 with its estimate of the natural rate, we’re looking at cumulative excess unemployment of 13.9 point-years; that compares with 13.7 point years from 1980 through 1986. (If the natural rate — the unemployment rate that keeps inflation unchanged — is 5 percent, and the actual unemployment rate averages 7 percent over a year, that’s 2 point-years of excess unemployment.)
Now here’s the thing: the slump of the early 1980s produced the Great Disinflation, which brought the core inflation rate down from about 10 to about 4. This time, however, we entered the slump with a core inflation rate of about 2.5 percent. If we experienced a disinflation comparable to that of the 1980s, that would mean ending up with deflation at a rate of -3.5 percent. And bear in mind that neither the CBO nor the Obama team really explains where recovery comes from; it’s just assumed. So tell me why we aren’t looking at a very large risk of getting into a deflationary trap, in which falling prices make consumers and businesses even less willing to spend. Tell me why this risk wouldn’t remain high, though lower, even with the Obama plan, which as far as I can tell is expected to reduce cumulative excess unemployment by about a third.
Economic crisis to delay other Obama goals
Confronted by the worst financial crisis in generations, President-elect Barack Obama and his Democratic allies in Congress are preparing to delay some of the promises he made on the campaign trail to avoid political distractions and focus on reversing the economic slide. Although Obama has not publicly identified which priorities will have to wait, advisers and allies have signaled that they may put off renegotiating the North American Free Trade Agreement, overhauling immigration laws, restricting carbon emissions, raising taxes on the wealthy, and allowing gay men and lesbians to serve openly in the military. Other signature promises may be addressed in piecemeal fashion in the opening weeks of the Obama administration but then put on a long track toward more comprehensive resolutions. For example, Obama plans to include what aides call "down payments" on his promises to expand health care coverage and promote energy independence in the economic recovery package he is developing, as a sign of dedication to the broader goals.
The priority-setting as next week's inauguration approaches offers a window into the emerging presidency, one shaped perhaps less by the campaign he ran than by the troubles he is inheriting. Surrounded by veterans of Bill Clinton's White House, Obama is determined to avoid the mistakes of the last Democratic transition 16 years ago, when secondary issues and a rush for change undercut Clinton's presidency from the start. The economic tumult provides Obama an opportunity as well as a challenge. While he may have to cast aside some of his goals for the moment, the magnitude of the problem awaiting him in the Oval Office has grown so overwhelming that he has a ready reason for delaying or slowing some initiatives. And as he assembles his economic package, he has the chance to tackle some of his highest priorities all at once under the rubric of restoring growth and preparing the nation for the future.
Obama's aides said he still planned to pursue the full agenda that undergirded his presidential campaign later this year or perhaps later in his term. "Our intent is to follow through on all of our commitments, but obviously we have to prioritize," said David Axelrod, the senior adviser to Obama. "When you have the worst job loss since World War II, pretty obviously we have to focus on trying to slow down this trajectory and turn it around, and that's job No.1." Rahm Emanuel, the incoming White House chief of staff, said that on domestic policy, only one thing matters. "Our No.1 goal: jobs," Emanuel said. "Our No.2 goal: jobs. Our No.3 goal: jobs." The strategy has unsettled some constituency groups and advocacy lobbies on the left that have been agitating for quick action on their top goals after eight years of a Republican administration. Advocates and lawmakers said they understood that Obama needed to concentrate on the economy at first and have tempered their grievances so far. But many expressed concern that priorities deferred may become priorities abandoned.
"A lot of people are anxious, they're impatient," said Representative John Larson of Connecticut, chairman of the House Democratic Caucus. "They're wondering, 'Is this the only thing that's going to happen?"' he added, referring to the economic recovery program. Yet Larson also detected a willingness to be patient. "It's understandable that all of the priorities they had on the campaign trail may be leapfrogged," he said. Representative Chris Van Hollen of Maryland, chairman of the Democratic Congressional Campaign Committee, said supporters were giving Obama the benefit of the doubt. "They understand we have to engage in triage," he said. The issue of gay men and lesbians in the military may echo most for those who served under Clinton and remember how he stumbled over the matter early in his tenure and wound up compromising with the "don't ask, don't tell" policy that permits them to serve only if they do not discuss or act on their sexual orientation.
Even if there were no economic problems, some Democratic strategists said Obama would be wise to take his time repealing that policy. But opponents of the policy said Obama had a moral commitment to act relatively soon. Many gay rights advocates were already disheartened by Obama's selection of the Reverend Rick Warren, an opponent of same-sex marriage, to deliver the invocation at his inauguration. "I'm not talking about a first-100-days initiative," said Aubrey Sarvis, executive director of the Servicemembers Legal Defense Network, which represents those kicked out of the military. "I am suggesting this is very doable in 2009." Robert Gibbs, the incoming White House press secretary, responded Friday to a question posted by "Thaddeus from Lansing, Mich.," on Obama's Web site, www.change.gov, asking if the president-elect would repeal "don't ask, don't tell." "Thaddeus," Gibbs answered, "you don't hear a politician give a one-word answer much. But it's yes." Thaddeus did not ask, and Gibbs did not tell, when that might happen.
Obama has likewise pledged to follow through with a new immigration policy, but several allies on Capitol Hill said it was not at all certain that could happen this year. Janet Murguia, president of the National Council of La Raza, said Emanuel told her the issue needed to be addressed without making commitments on a time frame. "President-elect Obama has made clear a campaign commitment to address this issue in his first year, and we know he takes that very seriously," Murguia said on a conference call organized by the National Immigration Forum, a group that advocates policies more welcoming toward immigrants. "And we plan to hold him accountable." On issues like immigration and climate change, Obama may focus on narrow moves first. He wants money in the economic package to double alternative fuels in the next three years, but his promise to enact a market-based limit on carbon called cap and trade does not appear on a fast track. "I'm not sure this year because I don't know if we'll be ready," the House speaker, Nancy Pelosi, told reporters last week.
The president-elect does not appear ready to scrap Nafta, nor does he seem in a rush to push through a hotly disputed plan making it easier for workers to organize unions. But Bill Samuel, legislative director of the AFL-CIO labor federation, said union leaders were focused on the economic package, which would provide hundreds of billions of dollars for job creation, much of it in road, bridge and other infrastructure construction that would benefit his members. If it takes longer to get some of the union's other priorities, Samuel said, so be it. "You can't do everything in the same week."
Small business woes have big impact on economy
It may be the final days of business for the Scandia Bake Shop. After almost 60 years of serving treats like julekake and Oslo rye bread, the Minneapolis store is worried it may have to shut its doors within the week, felled by shrinking sales, rising flour prices and a downright dismal holiday season. "They come out in droves and you make most of your money between Thanksgiving and Christmas," said 60-year-old owner Gary Arvidson, who took over the business in 1993. "And then this year I was really counting on that and the economy went into the dumper." Times are tough for small business owners, those whom politicians tout as the backbone of America. As the recession marches on, it's those businesses -- which employ about half of the country's private-sector workers -- that are particularly vulnerable to the squeeze.
To cope, small business owners -- from neighborhood plumbers to graphic design firms -- are paying employee salaries before their own, trying to renegotiate leases and pleading for customers on neighborhood blogs. But despite their best efforts, the customers aren't there. "It's all feeding on itself," said Raymond Keating, chief economist at the Small Business Survival Committee, an advocacy group based in Oakton, Va. "People are scared. They're not quite sure what to do." Not every small business is facing impending doom. But the economic quicksand brought on by the longest recession in a quarter century is getting worse as the nation's unemployment rate reaches a 16-year-high and banks become more careful about lending money. That's consuming even local favorites like Heinemann's restaurant chain in Milwaukee, Olsson's Books & Records in Washington, D.C., and The Music Mill, a popular performance space in Indianapolis.
Small businesses -- defined by the government as having 500 or fewer workers -- are a key portion of the country's commerce food chain. They account for more than 99 percent of all employer firms, according to federal statistics, pay nearly 45 percent of the country's private payroll and produce almost a third of the nation's export value. That means when they hurt, everyone feels the pain. Closures affect communities, where friends are co-workers and customers, and the cost-cutting creates a hard-to-stop cycle. Charitable donations wilt. Storefronts sit empty. Cities and towns get less tax revenue, and have to cut their budgets. And people wind up spending even less as those who are unemployed -- or those who worry they will be -- trim their own budgets at the expense of other businesses, large and small.
While falling sales and the credit crunch have made headlines, the small business owners left standing are facing problems as varied as the businesses they run. Manufacturing is slowing. Layoffs are looming. Financing is hard, if not impossible, to come by. Vendors are being skittish about extending credit for inventory. Rents are rising. And profits are falling -- or vanishing altogether as sales slip. Ajay Ekesa, 29, worries that his Kahawa Coffee House in Chicago may not last through the spring. He's spreading flyers around the neighborhood, opening his shop's space for community meetings and writing letters to a popular local Web site, asking them to publicize his plight.
"Right now I'm trying to do everything I can do," he said, adding that he's using his own money to pay the coffee shop's bills and the salaries of his two employees. "With every hour that I'm staying open, I'm not making money. I'm losing money, which doesn't make much sense." That's why Bonnie Mihalic closed her eponymous costume and bric-a-brac store on New Year's Eve, after sales fell by 50 percent during the all-important Halloween season. When she shut down the Ventura, Calif. shop, she laid off her seven employees and said goodbye to loyal customers she had come to know during 30 years in business. "They're like my children. Or my grandchildren," the 76-year-old said. "I'm heartbroken."
Now she's emptying her 10,000-square foot store and moving things to a warehouse. If she doesn't get rid of her stock, including hundreds of wigs, tiki torches, and leftover holiday decorations by the end of the month, she'll owe another $15,000 in rent. It's not just communities that feel the pain. Small businesses that are pinching their pennies also thwart corporate America. Just ask Wal-Mart Stores Inc., which blamed a pullback in spending by more cautious small business customers shopping at its Sam's Club stores for lower-than-expected December sales figures on Thursday. The surprise shortfall stunned investors in the world's largest retailer, which had been weathering the recession by catering to bargain shoppers.
The scrimping is spurring Office Depot Inc. -- which gets about 80 percent of its business from corporate customers, most of whom operate small and home-based businesses -- to change some of its merchandise, said Chief Executive and Chairman Steve Odland. The office supply chain is bumping up the number of sheets in some reams of paper and repackaging items such as pens into smaller -- and cheaper -- packages. "They say 'I just can't afford to buy a bulk pack of this,'" Odland said. Officials said fewer customers were buying more expensive items like desks and file cabinets or computers. "I do what I've got to do to keep the business running and the employees paid," said 36-year-old Parrish Walker, who owns Walker's Oak and More Furniture store in Fort Oglethorpe, Ga. "It's really having to think about every purchase and decision instead of buying willy-nilly."
Being deliberate about expenses is one way he's coping with the fact that sales are down more than 10 percent at the northwest Georgia store his father opened 15 years ago. He's also scaling back on inventory, making sure the schedules of his four employees are as efficient as possible and forgoing his own paycheck to make sure his workers get theirs. More than 110 people lost their jobs this month when the Heinemann's restaurant chain, a Milwaukee institution for 86 years, shut the three restaurants that remained of what was once a 10-location chain. "Their clientele was aging, and as they were aging and dying they weren't able to replace all those people with new people because younger people want chains they can recognize," said Jerry Kerkman, a lawyer for the company.
Customer Dennis Sell, 58, of Milwaukee, was a regular for more than a decade, ordering oatmeal pancakes and eggs, toast and sausage at Heinemann's on weekends before settling in for hours with a newspaper. He ate his last meal there on Saturday. "I'm hoping it's a dream and I'll somehow wake up and hopefully none of this really happened," he said. Carol Tomer wants to prevent Scandia and the bakery's 10 employees from enduring a similar fate. Tomer, the lead pastor at Pilgrim Lutheran Church in St. Paul, started what she called some "krumkake activism" -- named after the buttery Norwegian wafer cookies -- to spread word of the impending closure to the Twin Cities' large Scandinavian community.
So far, about 1,000 people have signed a petition to keep Scandia open, and business appears to be steady thanks to the community campaign, said Arvidson, the owner. After originally thinking he would shut his doors Saturday, he spent Friday stocking up on eggs, flour and shortening and said he planned to keep selling pastries until someone padlocks his door. Even so, he knows he'll have to downsize, since he can't afford the rising rent and was unable to refinance his home to help pay the bakery's bills because rising risk from the worsening economy has brought on a general reluctance to lend. Arvidson said he's heartened by the extra customers and community support and said business has been triple what the store normally sees in the slow weeks of January. Still, he's uneasy. "It's weird because you feel kind of like buzzards picking at the carcass," he said.
Interest rates and the economy: Does anyone in charge have a clue what to do?
I have yet to read a satisfactory explanation of the cut in interest rates this week. It is no consolation that the Bank, by cutting just 50 basis points rather than 100, has allegedly signalled that this will be the last. The pointlessness of what can best be described as Thursday's diversionary tactic was already a bridge too far. If you want to encourage banks to lend, then why give them less incentive by cutting their rate of return?
What is the point of an interest rate cut that many lenders choose not to pass on, because they risk going out of business if they earn so little for their money? But then, more than six weeks later, I still cannot fathom the point of the cut in VAT from 17.5 per cent to 15 per cent. I have yet to hear a retailer say that it (as opposed to huge sales discounts) has made any difference. Again, we are told that it may have an effect next autumn, just before VAT is due to go back up. I am not sure we can wait until then when, at this rate, even the charity shops won't be able to afford to take up all the empty spaces in the high street. As I expect the next few weeks to demonstrate, the horrors we are experiencing will soon be felt around Europe.
Our position, which is now relatively bad, may soon start to look relatively good. That, too, should be no consolation. It will not betoken that our economic strategists have got something right; it will show, simply, that our commercial rivals are at last having as much grief as we are. It has been said that many economists backed this week's rate cut, as if that is supposed to reassure us. The death of Sir Alan Walters reminds us of his almost lone opposition to the 364 economists who wrote to the press in 1981 saying that the monetarism practised by the Thatcher government – especially the avoidance of debt and the desire to balance the budget – was wrong.
Within six or seven years, Britain was experiencing unprecedented prosperity and the country had been transformed. We then had a similar crew of economists telling us how essential entry to the European monetary system was. I think we can all agree that a period of silence from such people would be most welcome. In fact, even Mr Darling, the Chancellor, admitted this week that he really didn't have a clue what to do to put our economy back on the straight and narrow. Can we be surprised? He may have held various financial posts in government and in opposition, but usually in the shadow of Gordon Brown, and before that he was a leftie Edinburgh lawyer. I am not sure he can even read a balance sheet. I certainly wouldn't put money on many of his Cabinet colleagues being able to do so.
Look down the list and try to gauge their hands-on business experience – try to gauge any real understanding about how wealth is created – and you pretty much draw a blank. If you ran a public limited company, would you ask Hazel Blears to join the board? Would you want Jacqui Smith chairing your remuneration committee? Would you be happy for Lord Rumba of Rio to sign off your accounts, or little Miliband to mastermind your product development? Quite. To make matters worse, the Treasury has been politicised since 1997, so officials say what they think their masters want to hear, rather than what they should hear.
The unthinkable is never thought. Economists with an alternative view are ignored and marginalised. And of course, the Opposition hasn't a clue either, or the time to have one between skiing holidays. Only one thing will give us an economic revival. It is, and I apologise for being boring, the transfer of money from the client state to the productive and private sector of the economy. This means spending cuts and tax cuts. Everything else is simply propaganda.
Reform plan raises fears of Bank secrecy
The Bank of England will be able to print extra money without having legally to declare it under new plans which will heighten fears that the Government will secretly pump extra cash into the economy. The Government is set to throw out the 165-year old law that obliges the Bank to publish a weekly account of its balance sheet a move that will allow it theoretically to embark covertly on so-called quantitative easing. The Banking Bill, which is currently passing through Parliament, abolishes a key section of the law laid down by Robert Peel's Government in 1844 which originally granted the Bank the sole right to print UK money.
The ostensible reason for the reform, which means the Bank will not have to print details of its own accounts and the amount of notes and coins flowing through the UK economy, is to allow the Bank more power to overhaul troubled financial institutions in the future, under its Special Resolution Authority. However, some have warned that it means: "there is nothing to stop an unreported and unmonitored flooding of the money market by the undisciplined use of the printing presses." It comes after the Bank's Monetary Policy Committee cut interest rates by half a percentage point, leaving them at the lowest level since the bank's foundation in 1694. With the Bank rate now at 1.5pc, most economists suspect the Government and Bank will soon be forced to start quantitative easing directly increasing the quantity of money in the economy in a drastic attempt to prevent a recession of unprecedented depth.
Although the amount of easing is likely to be limited, news of this increased secrecy will spark comparisons with Weimar Germany and Zimbabwe, where uncontrolled use of the central banks' printing presses ultimately caused hyperinflation. The Bank said it will still publish details of its balance sheet, but, significantly, the data the main indicator of the extent of quantitative easing will not be presented until more than a month has elapsed. For instance, under the new terms of the law, if the Bank were to have embarked on a policy of quantitative easing last month, the figures on this would not be published until the end of this month. The reforms, which are likely to be implemented later this year, will make the Bank of England by far the most secretive major central in the world, experts said.
In the US, where the Federal Reserve has already cut rates to close to zero and started quantitative easing, the main way to track its purchases of securities and the expansion of its balance sheet is through precisely these same weekly accounts. "Quite why the Bank has to keep its operations so shrouded in secrecy is a mystery to me," said Simon Ward, economist at New Star. "This [reform] will make it much more difficult to track what the Bank is doing." Among the details which will no longer be published are those revealing the extent to which London's banks are using the Bank's deposit facilities a yardstick of pressure in the financial system.
Debating the issue in the House of Lords recently, Lord James of Blackheath, a Conservative peer, said: "Remove [this] control and there is nothing to stop an unreported and unmonitored flooding of the money market by the undisciplined use of the printing presses. "If we went down that path we would be following a road which starts in Weimar, goes on through Harare and must not end in Westminster and London. That is the great fear that the abolition of that section will bring about but the Bill abolishes it."
Treasury told to relax capital rules
The Treasury is considering overhauling international banking regulations after being warned by some of the country's most senior bankers that they are restricting the amount of money they can make available for new lending. The Chancellor, Alistair Darling, has acknowledged that the Basel-II set of rules for banks' capital ratios may need to be changed, amid suspicions that the set of accounting rules lie at the very heart of the credit crisis. In a letter sent to Mr Darling just before Christmas on behalf of major British banks, Stephen Green, the executive chairman of HSBC, urged the Treasury to consider whether the framework, which affects the way banks draw up their balance sheets, was impairing Government efforts to kick-start lending to British businesses.
The letter was also signed by the bosses of banks including Abbey and Barclays. The news comes with the Treasury and Bank of England poised to introduce a broad set of new measures aimed at tackling the economic crisis as soon as this week. It is putting the finishing touches to a new system of guarantees designed to encourage lending to small businesses - particularly manufacturers and exporters, through beefed-up guarantee schemes. The Bank is also set to announce the extension of the Special Liquidity Scheme, which expires at the end of this month. It is likely to expand the kind of loans accepted as collateral to securities issued in 2008 - a major departure from its previous policies.
However, the Treasury's recognition of the problems posed by the Basel rules represents a clear acknowledgement that the current system of financial regulations is due for a major shake-up. The rules are at the centre of the debate because while the Treasury is urging banks to maintain lending to businesses at the peaks achieved during the boom-times of recent years, Basel-II requires additional capital to be held against existing loans. The Treasury is now investigating ways to ease this pressure facing banks, amid concerns that the requirements are pro-cyclical - in other words intensifying the crisis.
"Basel is something that banks have raised with us," said a spokesman. "Although it took a long time to be implemented there are some issues around the way it may be operating. "There may be some things which we need to try to change - together with the Financial Services Authority. This is something we are pursuing, but obviously it is an issue where you need international agreement."
From Big Bang to whimper: welcome to the new City
It was a grand enough occasion to prompt Boris Johnson to blow-dry his famously unkempt blond mop. Dressed in black tie, on Thursday night the London mayor for the first time addressed City fathers in the imposing splendour of the Mansion House banqueting hall opposite the Bank of England. The assembled elders, financiers and London councillors sat patiently through Johnson's stream-of-consciousness blather, all the while waiting to hear whether the eccentric Tory had words of comfort to the denizens of the Square Mile in the midst of the most profound financial shock seen for 80 years. Eventually, he got there. "I know there are people who believe what is happening will deliver an irredeemable knock. I have to say those fears are overdone," he boomed defiantly to 350 high-powered London figures, who growled approvingly. "We may feel justifiable rage against bankers. But we have to stand up for the sector."
And the work started in earnest last week when Treasury ministers, regulators and Square Mile grandees returned to their desks en masse after the Christmas break for what will be a pivotal year. The grim and sobering challenge is to rehabilitate the City after a devastating 15 months. Rehabilitation means working out a way to get banks to lend to businesses and consumers. It means reforming banking structures as well as constructing a completely new regulatory and supervisory regime to take in how much money banks have to hold in reserve, appropriate lending levels, new transparency protocols and the controversial issue of executive remuneration. Whether it is possible is another matter. "Everybody in financial services needs to put their best foot forward in 2009 because I think we are talking about potentially reshaping financial markets and its participants - and this clearly has implications for many years to come," argues the influential Robert Talbut, chief investment officer at Royal London Asset Management.
"There's clearly a reasonable view that financial markets failed, and regulators need to ensure their proposed reforms are going to be in tune with the times and are also constructive to help rebuild confidence." At stake is not just the future of the hedge fund, credit derivative, private equity and investment banking industries in London, but the entire bedrock of the UK economy. The explosion in financial services that was unleashed after the deregulatory "Big Bang" in 1986 saw London overtake New York to become the money capital of the world. A staggering £2.15 trillion of capital flowed into the UK in 2007 - some £295bn more than the US (see map). What were considered to be the smartest minds around the world flocked to the city where stratospheric fortunes were made in double-quick time. They don't seem so clever now.
That said, the "gilded City" ensured restaurants, theatres, art galleries and designers all became indispensable props in the triumphant march of Mammon. All told, financial services contributed £165bn to the UK economy. Nearly half of that came from the City of London and Canary Wharf. But in January 2009, the Square Mile is a paranoid, shell-shocked place. Tens of thousands of jobs have gone; in total, more than 80,000 are expected to be clearing their desks. Even the most experienced grandees have no clue about the shape of things to come. "Nobody can count on their job," says an equity trader at Nomura in Canary Wharf. "Everybody knows good people out of work. There are stories of bosses having to fire whole teams, then [being] kept behind [after work] to be fired themselves."
Senior figures in the City believe more big-name institutions, hedge funds and property companies will go to the wall. There is major concern over banks' exposure to credit card debt, which has still to fully unwind. Some authoritative insiders suggest up to 80% of hedge funds will be wiped out this year. One senior hedge fund manager working at a profitable business says her fund is successful but may be forced under by banks desperate to redeem cash to shore up their own shattered balance sheets. From its peak of 500,000 in June 2007, Corporation of London boss Stuart Fraser estimates that around 17% of the financial workforce (about 85,000) will be axed, though he accepts the shake-out could be worse. Financial services' contribution to UK GDP is set to fall from 13% to 11% - equivalent to a loss of £25bn.
That loss could increase: new financial centres are moving in as London's reputation takes a battering. Singapore is aggressively marketing itself as a wealth management hub. Dubai is pouring billions into plans to become a finance centre. Dublin and Luxembourg have become bases for fund administration. Paris is working on plans to tempt private equity firms with low tax rates. The government's City minister, Paul Myners, plays down the threat. "Other centres have emerged where they develop specific excellence: reinsurance in Bermuda; funds administration in Luxembourg or Dublin. It's quite difficult to contemplate any other centres in the next couple of decades becoming large and all-embracing in their range of activity. There are some threats that may not be sustainable: tax incentives may not be sustainable, but they can give temporary advantage."
From his Treasury office, Myners, himself a former City grandee, makes clear what the Square Mile has to fear most: "The biggest threat is failure to keep our image. This is about innovation and also a failure to maintain confidence in our institutions and our structural frameworks. A year ago, one could say regulation could be an area where you chose to be competitive... I think we are in an environment now where people will seek evidence of strong and effective regulation as a precondition to wanting to do business. There's going to be more evidence of capital. We are in a mindset where safety and probity are highly valued." Even the outriders of light-touch regulation accept the new reality. When financial grandee Lord Levene was Lord Mayor in the late 90s, Michael Cassidy was chairman of the City's policy and resource committee. Effectively, they were president and prime minister of the Square Mile. Together they travelled the world promoting London as the place to do business. Now Cassidy says: "I was an arch-exponent of light-touch regulation. But I'm happy to concede the world has changed. A lot of the more exotic products will disappear."
Big Bang changed the City from a sleepy British backwater to an international playground for mega banks, aggressive hedge funds, highly leveraged private equity players and sellers of arcane debt instruments. But the financial sluice gates have now been firmly closed: the big US banks have either been wiped out or humbled, while private equity and hedge funds are on the ropes. After surviving two world wars as well as countless downturns, there seems little doubt London's financial centre will reinvent itself. Businesses such as shipping, foreign exchange and commodities, where it has long had an edge, remain sources of strength and financiers are looking to new potential growth areas such as green technology and Sharia-compliant banking for Muslim customers. The talk in the City is of swapping Porsches for Peugeots and returning to "plain vanilla" banking. And respected figures suggest that to get credit markets working the government needs to create a "good bank/bad bank" model in which toxic assets can be separated.
Jon Moulton, the managing partner of private equity firm Alchemy, who repeatedly warned about the perils of a debt-fuelled boom years before the storm broke, says new models are desperately needed: "The only way London can return to anywhere near its former glory is by being radical in setting up new structures. Tinkering and sticking-plasters will not do it. We need trustworthy banks. That means simple, manageable and regulatable banks." While government and regulators will take centre stage in 2009, shareholders will also come under scrutiny. Myners believes that, as the owners of banks and other businesses, shareholders have to be far more rigorous, stamping down on excessive executive pay and quizzing company bosses over strategy.
"If shareholders want a strong voice they will need to have the ability to hold management to account," says Talbut. "I think there's a sense that we have not done a good job preventing the excesses and we are going to have to become better to provide that oversight - being more demanding, prepared to say 'no', being intrusive and ensuring we are appropriate guardians of people's money." By October, new Financial Services Authority rules designed to ensure that banks have enough cash to withstand economic shocks should be in place. One of the reasons credit markets are still sealed up despite the injection of hundreds of billions of pounds in taxpayers' cash and guarantees is because banks are hoarding money in the expectation that they will need more reserves to comply with new regulations. "At the moment, I would characterise the state of mind of a number of our bankers as remaining in the shallow end of the pool, clinging onto the rail," says Myners. "They need to become more comfortable in getting to the deeper end." Whichever way you look at it, in 2009 it's sink or swim for the City.
Hurting on the High Street
Store closures, layoffs, and bankruptcies among British retailers underscore the seriousness of the economic downturn. If 2008 was the year financial services melted down in Britain, 2009 is shaping up as retail's moment to implode. The once-booming retail sector—known in Britain as the High Street—is reeling as weak consumer confidence, tight credit, and rising unemployment throttle sales and profits. The list of victims is eye-popping. Upscale clothing and food seller Marks & Spencer (MKS.L) said Jan. 8 that its fourth-quarter sales fell 7.1%, and announced plans to close 27 outlets and lay off 1,230 workers. Woolworths, which failed to find a white knight last year as it wobbled toward insolvency, closed the last of its 807 British outlets on Jan. 6, putting 27,000 employees out of work. And music emporium Zavvi, originally owned by Richard Branson, has called in the administrators and closed 22 of its 114 outlets as management struggles to sell the business.
All told, says insolvency and restructuring consultancy Begbies Traynor (BEG.L), nearly 2,000 retailers already are in bankruptcy proceedings in Britain. The carnage is likely to get worse. By yearend, predicts credit researcher Experian (EXPN.L), some 135,000 storefronts—1 in 7 across Britain—may be vacant. And up to 135,000 retail workers could lose their jobs by the end of 2009, says the London-based Center for Economics & Business Research. "There definitely are tough times ahead," says Jonathan De Mello, director of Experian's retail consultancy. The implications for the broader economy are worrisome. Consumer spending accounts for 65% of British gross domestic product, and retail is the third-largest source of employment behind business services and health care. A High Street slowdown thus translates quickly into sharply lower economic performance, declining tax revenues, and higher spending on jobless benefits. Economists figure Britain's GDP contracted 1.2% in the fourth quarter of 2008, after falling 0.6% in the previous quarter. Brokerage Morgan Stanley (MS) now predicts Britain's overall GDP will shrink 1.1% in 2009.
Even before the most recent spurt of retail layoffs, Britain's unemployment rate already had jumped almost one percentage point annually, to 6%, as of October, according to the Office for National Statistics. The last time joblessness was that high was in the first half of 1999. Now, with retailing expected to remain in the doldrums until 2010 at the earliest, Morgan Stanley figures unemployment could hit 7.4% this year. Other, more pessimistic estimates range up to 9%. So far, government efforts to help the retail sector haven't made much difference. To spur spending, the government trimmed Britain's value-added tax (VAT) before Christmas as part of an overall stimulus package. Most analysts say the modest cut was too little, too late. Likewise, the Jan. 8 decision by the Bank of England to chop interest rates to a record low of 1.5% may not do much to ease credit or kick-start consumer spending. Prime Minister Gordon Brown is now rumored to be mulling a new round of tax cuts to goose the economy.
Until stimulus sets in, retailers are left scrambling to save themselves. Over the Christmas holidays, some offered discounts of up to 90% to woo shoppers. That brought short-term relief for a few: Upmarket department store Selfridges, for instance, recorded the most profitable hour in its 100-year history on Dec. 26 as customers snatched up luxury brands like Louis Vuitton (LVMH.PA) and Burberry (BRBY.L) for knocked-down prices. But slashing prices cuts both ways. "All the discounting has done is squeezed margins," says Tarlok Teji, head of British retail at consultancy Deloitte. He reckons that sales promotions will help keep like-for-like sales broadly flat over the first half of this year, but cautions that discounting will hit profits. Margins will likely fall 30% to 40% in 2009, and demand for big-budget items such as flat-screen televisions and home furnishings will remain weak even despite price cuts. "More retailers will enter administration in February and March," Teji says. "Companies will have to batten down the hatches until the economy starts to recover."
Cloud over new homes in the sun as Spanish banks renege on guarantees
A large number of Britons buying off-plan homes from bankrupt Spanish developers say they are tens or even hundreds of thousands of pounds out of pocket, because banks in Spain are refusing to honour guarantees. Bank guarantees, or Aval Bancario, from developers have been compulsory by law on off-plan purchases in Spain for the past 40 years. They mean that if a developer fails to build on time, or goes into administration and does not build at all, buyers should get most or all of their money returned. Until recently they worked well. As the holiday home market boomed, few developers went bust and buyers would accept minor delays. If a buyer did claim a refund, developers and banks gladly obliged knowing that rising values and strong demand would see any subsequent unsold home snapped up.
But now Spain's property market is in free-fall. At least 15 developers building holiday homes on the Costas filed for bankruptcy last year. Thousands of homes remain part-built and buyers are calling in bank guarantees. But many are discovering they were given faulty documents by developers, or have guarantees with conditions that make them worthless. One major developer in administration, Martinsa-Fadesa, has been accused by the newspaper El Pais of not issuing bank guarantees at all. "Until recently some developers would regard it as an insult to be asked for them by foreign buyers and just wouldn't issue them. In other cases guarantees exist but may be out of date or worded in a way that make banks feel they need not honour them," says Peter Ebders of the International Law Partnership, a British legal firm.
More ominously, Ebders says even some guarantees that are in order are not being honoured because banks do not want to pay out large sums in the current dire financial situation. Ruth Genda, from Wymondham in Leicestershire, fell foul of a worthless bank guarantee on an apartment in Marbella on the Costa del Sol. The retired educationalist put down a £75,000 deposit in 2003. But construction was delayed and then the flat was declared an "illegal build" for lacking formal planing permission. Genda took Banco Popular Hipotecaria (BPH) to court, which declared her guarantee valid. But BPH appealed and the original result was overturned. A further legal review found in the bank's favour.
Genda says the lack of appropriate building consent makes the flat impossible to occupy: "We're not prepared or able to buy an illegal property. It can't be mortgaged and it can't be sold because of its status. Our coffers are drained by legal fees and other costs, and we're likely to lose our deposit." Genda has launched an online petition - gopetition.com/petitions/spanishbankguarantees.html - but is realistic about the slim chances of success. "The guarantees have been given under false pretences, and no one in authority we've approached - MPs, MEPs, ministers, ombudsmen and so on - have been able to help." More than 100 people claiming to have valid guarantees have signed Genda's petition.
"The problem is widespread. Lots of Britons are caught up. It's scandalous," says Barcelona-based Mark Stucklin, editor of the website Spanish Property Insight. The Bank of Spain says it has told banks to honour valid guarantees but has no power to enforce the instruction. Lawyer Mark Wilkins of Marbella-based The Rights Group says any prospective buyer, or one in mid-purchase, should instruct a lawyer to check the eligibility of his bank guarantee - even if the developer appears not to be in financial difficultie
Staying out of the euro has spared Britain a Spanish-style catastrophe
Half-built flats and soaring unemployment show that the boom has turned to gloom on the Costa del Sol. And it's a fate that could easily have befallen Britain. For a place that's called the Sunshine Coast, Spain's Costa del Sol was unusually wet and cold last week. Friday and Saturday were particularly miserable in Marbella, as the rain lashed across the main promenade, forcing restaurants to bring in tables and pull down shutters. It was as though the weather gods had decided to reflect the country's economic outlook – which is becoming darker by the day. What many in Spain had regarded (foolishly) as an eternal summer of expansion, driven by a breakneck construction boom, has turned into a winter of plunging property prices, failing businesses and an epidemic of redundancies.
Spain's traditional new year greeting is próspero año nuevo. But even in this part of Andalucia, a favourite playground of wealthy sunseekers and golf fanatics, it is hard to find locals who are expecting prosperity in 2009. For a growing number of workers and small-business owners, anything better than a sharp decline in income will be greeted as a triumph. Like the toros bravos that die in the corrida, Spain's bull market began with impressive vigour but ended up being dragged off through the dirt. Unemployment hit three million yesterday, about 13 per cent of the workforce (double the rate in the UK), the worst it has been for 12 years. Nearly one million of those without jobs have lost them during the past 12 months. The speed of descent, from fiesta into crisis, has shocked the country's political class and commentariat. Inflation has dropped from 5.3 per cent to 1.5 per cent since the summer. According to the newspaper El Pais: "This situation was impensable [unthinkable] in July".
As historians begin to assess damage from the credit crunch, Spain will surely be singled out as a classic study for what can go wrong inside a monetary union when the policy requirements of its members become hopelessly misaligned. It is simply not possible to pursue the best interests of every participant when some nations are running trade and fiscal surpluses while others clock up huge deficits. Ten years after it was launched, the euro is propelling Spain towards disaster. In giving up control of domestic interest rates to the European Central Bank, Madrid handed over a vital instrument of macroeconomic management. It is learning to regret that. For the early part of this millennium, that loss of power seemed not to matter: Spain's outrageous (and in some cases illegal) construction frenzy hid a multitude of sins. At the peak, about 800,000 homes were being built annually on the basis that demand from foreign buyers was limitless.
That dream has vanished, along with the over-supply of cheap money that funded it. Drive down the E-15, the main motorway link between Malaga and Gibraltar, and you will see block after block of half-built apartments, connected neither to essential utilities nor to financial reality. They stand as temples to a religion that ceased to exist when the bubble popped. The Spanish economy is weak; it needs lower interest rates and a softer currency. Such a prospect, however, doesn't suit Germany, the eurozone's dominant force, so Madrid has to sit and suffer while its people cry for help. Discomfort is palpable in tourist centres where the purchasing power of British visitors and second-home owners has played a pivotal role in boosting local enterprise. Germans and Swedes have been important, also, but it is on the British that the leisure sector in southern Spain has depended most.
A quick scan of the exchange-rate charts explains why. In the summer of 2000, about 18 months after it was launched, the euro was out of fashion on the world's currency markets. At that time, £1 bought €1.75, making British travellers feel especially wealthy when holidaying in Spain. Today, however, as the British economy sinks into recession, prompting the Bank of England to slash interest rates to 1.5 per cent (the lowest level in the central bank's 315-year history), it is sterling that looks like a six-stone weakling. Many in the queue at Gatwick airport's Travelex desk last weekend were shocked to discover that the pound had fallen to below parity against the euro. For them, Spain has become an expensive experience. Old jokes about Costa Notta Lotta are no longer relevant, much less funny. I was treated by a friend to a round of golf at Rio Real, a middle-ranking course, that is by no means among the priciest. He was charged £172 for two (no buggy). Dinner for three in a modest pizza joint came to £75. One must assume that hoteliers from Morecambe to Margate are cheering wildly.
Competing currencies invariably fluctuate on a daily basis, but not all in the City are expecting a swift recovery of sterling against the euro (even though it has picked up in the past few days). HSBC believes: "In the UK… a weaker currency seems desirable to policy makers… in our eyes all roads lead to a stronger euro." If that analysis proves correct, parts of Spain will face devastation, and social policies that seemed generous during the go-go years will quickly become unaffordable. For example, in some instances the state pays 70 per cent of salary for up to two years when a worker is made unemployed. How will that be funded if, as some are predicting, Spain's jobless total reaches four million in 2010? Adding to Madrid's woes is the extraordinary influx of five million immigrants, who boosted the population by about 15 per cent between 1998 and last year. It was always assumed that in tough times many would return home. But for penniless fruit pickers from Africa, life in Spain, even in the harshest economic climate, is often better than what they left behind. The number of foreigners claiming dole payments has doubled and there are mounting tensions as native job-seekers slip down the food chain.
Marbella is not used to life on a budget. Shopkeepers, newspaper vendors and bar staff seem baffled by the downturn in their fortunes. On Sunday, my family and I had dinner in a seafront bodega and were the only customers all night. "What has happened to los Ingleses?" asked the waiter. The answer is that the United Kingdom never joined the euro. As a result, our government and monetary authorities are free to adopt policies that suit our needs. In today's circumstances, that means the freedom to live with a devaluing currency. This hurts those of us who can still afford to visit Spain, and is unfortunate for British pensioners living abroad, but is a small price to pay for the revival of our domestic industries. Had Britain been locked into Europe's single currency, at an exchange rate far higher than today's, there is good reason to believe that we, too, would be suffering double-digit unemployment. You won't read this very often under my byline, but Gordon Brown played a blinder in keeping us out.
Morgan Stanley May Pay Citigroup $3 Billion in Merger
Morgan Stanley may pay Citigroup Inc. as much as $3 billion for control of a venture that would combine their brokerage units and overtake Bank of America Corp. as the largest financial adviser to individuals, a person with knowledge of the discussions said. Morgan Stanley, led by Chief Executive Officer John Mack, may get 51 percent of the new company and an option to acquire the rest over three to five years, according to the person, declining to be identified because the deal isn’t complete and the talks are confidential. The transaction may be announced as soon as tomorrow, the person said.
Citigroup, which reported $20 billion of losses in the past four quarters, would get cash for its Smith Barney brokerage, while Morgan Stanley would get recurring fee revenue and more potential banking customers. The joint venture would employ about 22,000 advisers, compared with the approximately 20,000 at Bank of America after its purchase of Merrill Lynch & Co. Morgan Stanley Co-President James Gorman, 50, may oversee the company, tentatively named Morgan Stanley Smith Barney, the person said. "There’s been a lot of pressure for Citi to monetize some of their more valuable assets and Smith Barney is certainly one," said Michael Nix, a money manager at Greenwood Capital Associates LLC in Greenwood, South Carolina. "There’s also been a lot of pressure for Morgan Stanley to look at how they can better lever their business units."
The worst financial crisis since the 1930s has recast rivals in the financial industry as merger partners and transformed the U.S. government into one of the biggest investors in Wall Street firms, including Morgan Stanley and Citigroup. As Lehman Brothers Holdings Inc. sank into bankruptcy in September, crippled by the frozen credit markets, Merrill, then the biggest U.S. brokerage, agreed to be taken over by Charlotte, North Carolina-based Bank of America. Morgan Stanley converted from a securities firm to a bank holding company and Citigroup, led by Chief Executive Officer Vikram Pandit, took $45 billion of U.S. bailout money. Under the deal being negotiated now, Morgan Stanley and Citigroup would contribute their brokerage units to the joint venture, two people with knowledge of the talks said. Morgan Stanley would also pay Citigroup $2 billion to $3 billion, or 20 percent of the total value of Smith Barney, to gain majority control, one of the people said. The venture may be led by Morgan Stanley managers and a board with a majority of Morgan Stanley appointees, the person said.
The news came as Citigroup announced that former U.S. Treasury Secretary Robert Rubin, who joined the company in 1999 and has opposed calls to break it up, plans to quit the board. Directors have also discussed replacing Win Bischoff, Citigroup’s chairman, the Wall Street Journal reported today, citing unidentified people familiar with the talks. The U.S. government’s taxpayer-funded cash injections into the nation’s biggest banks may cause regulators to pressure some firms to break up or restrict activities that could threaten the financial system’s stability, analysts say. Morgan Stanley, the second-biggest U.S. securities firm before converting to a bank in September, would draw on its existing cash to pay for the brokerage merger and wouldn’t raise new money for the deal, a person familiar with the matter said.
Morgan Stanley received $10 billion from the U.S. Treasury last year. The firm, which lost 70 percent of its market value in 2008, has been trying to attract retail deposits from brokerage customers to help reduce its reliance on debt markets for funding. Citigroup, which is expected to post a fifth consecutive quarterly loss when it reports fourth-quarter results later this month, has received $45 billion from the U.S. Treasury and $306 billion of government guarantees for troubled mortgages and toxic assets. The bank suffered a 77 percent decline in its stock price last year. Citigroup was formed in 1998 by the $37.4 billion merger of Travelers Group Inc., led by Sanford "Sandy" Weill, and Citicorp, led by John Reed. Travelers, which owned brokerage Smith Barney Holdings Inc., had a year earlier paid about $9 billion for Salomon Inc., the parent of Salomon Brothers Inc., to form Salomon Smith Barney Inc. Some analysts and investors have called for the company to be broken up, saying that Citigroup is too large to manage.
"Morgan Stanley has been much more efficiently run because it really wasn’t a combination of so many different things," said Richard Lipstein, a managing director at Boyden Executive Search in New York, which specializes in financial services. "Smith Barney was having difficulty getting their arms around the cost cutting on the broker side." Pandit, who has been Citigroup’s CEO for more than a year, told employees on a conference call in November that he didn’t plan to dismantle the company and didn’t want to sell Smith Barney. He and Chief Financial Officer Gary Crittenden instead said they wanted to sell businesses that weren’t crucial to the bank’s main operations. In July the company agreed to sell its German retail bank, Citibank Privatkunden AG & Co., for $6.6 billion, and last month it sold a processing business in India with about 12,000 employees for $512 million. In a memo this week, Crittenden said the firm had sold 21 businesses over the past year and that divestitures would "again be critical in 2009."
Pandit, 51, in September replaced Sallie Krawcheck, the head of the wealth-management division, which includes Smith Barney. Taking her place was Michael Corbat, a 25-year veteran of the bank. At Morgan Stanley, Ellyn McColgan was named president of the wealth management business in December 2007, reporting to Gorman. Smith Barney has 14,133 financial advisers in about 600 offices in the U.S., according to Citigroup’s Web site. It had about 9 million U.S. client accounts as of Nov. 3, oversaw $1.32 trillion of client assets, and generated $7.94 billion in revenue during the first nine months of 2008. Morgan Stanley gained its retail brokerage in the company’s 1997 combination with Dean Witter, Discover & Co. The business had 8,426 financial advisers at the end of November, $546 billion in total client assets, and generated $6.3 billion in revenue during 2008 when the gain from an asset sale was excluded, according to a company report last month.
Up to 10,000 jobs to go in Citi-Morgan Stanley brokerage deal
Thousands of jobs are under threat from a deal that will see troubled Wall Street investment banks Citigroup and Morgan Stanley merge their retail brokerage and asset management businesses. The move will lead to huge cost savings and substantial job losses, mostly in America, but with some positions at risk in London and Asia. Negotiations come as Citigroup continues to struggle to raise enough capital to keep the giant banking group running, and follows the resignation of Robert Rubin, special adviser to the board and a former US treasury secretary.
Citigroup's problems - it has received a $45bn government bail-out - are thought to have made things awkward for Rubin, who has received $115m in pay since 1999, excluding stock options. A Morgan source said that very few, if any brokers will lose their jobs as the enlarged operation will need as many salesmen as possible to take on the recently merged operations of Merrill Lynch and Bank of America, which between them employ 16,000. But the Morgan source added that significant cost savings will be made by axing thousands of jobs from back office functions such as information technology.
The new combine could reduce the total number of ancillary staff by about a third, which may result in between 7,000 to 10,000 redundancies. David Wyss, chief economist at Standard & Poor's said the deal was a sign of desperate conditions. "All you are seeing on Wall Street is one distress deal after another. Citigroup is effectively selling off parts [of itself] to raise cash."
State lawmakers face painful spending decisions
Lawmakers return to the Georgia statehouse Monday for a legislative session that promises to be governed by a simple theme. Borrowing a line from Bill Clinton’s 1992 presidential campaign, "It’s the economy, stupid." Or more precisely, it’s the economy and the record-setting hole it has created in the state budget. From the ceremonial opening gavel in the House and Senate through the hectic 40th and final day, the economic meltdown and its impact on the state budget will cast a shadow over most everything lawmakers try to do. With a shortfall of about $2 billion this year and possibly worse news facing them in fiscal 2010, legislators are under unprecedented pressure to approve skimpy budgets that maintain needed services and help the economy rebound.
What they do will affect millions of Georgians. The state helps pay to educate nearly 2 million students and provides health care to 1.5 million Georgians. More than 200,000 Georgians get all or part of their paychecks from the state. Decisions that lawmakers make will also affect what homeowners and business owners pay in property taxes. If they cut back on money sent to schools, for instance, local boards may raise property taxes to make up the difference. "This is the one thing we have to do, and we have to do it right," House Appropriations Chairman Ben Harbin (R-Evans) said. Some legislative leaders say they’d like lawmakers to come to Atlanta, pass midyear and fiscal 2010 budgets and quickly leave town. They point out that many of the 236 legislators have their own shaky businesses to run back home.
But if history is a guide, such talk is optimistic. Addressing the shortfall will take time. And legislators probably will try to come up with bills to help struggling industries, such as home building. Finally, lawmakers want to see what kind of stimulus package President-elect Barack Obama and Congress approve. That could have a major impact in how deep state officials have to cut into their budget. Gov. Sonny Perdue will recommend a budget to legislators on Wednesday. His staffers said the governor won’t talk about his budget-cutting proposal until then. Sen. Jack Hill (R-Reidsville), who chairs the budget committee, joked last week that he "prepared for the session by having a colonoscopy." Alan Essig, executive director of the Georgia Budget and Policy Institute, an Atlanta-based research group, said it will be hard for lawmakers to concentrate on anything besides the $2 billion in spending cuts they’ll have to make. "It’s going to suck the air out of just about anything else they are doing."
Most states are in the same situation as Georgia. In December states reported a collective shortfall of about $70 billion this fiscal year. Some states may use loans to pay bills. They are laying off employees, talking about cutting the number of school days and proposing tax increases to make ends meet. None of this is entirely new for Perdue and veteran lawmakers. Perdue took office in 2003 after a recession wrecked state finances. He persuaded lawmakers to raise cigarette taxes, but for the most part, the state survived using financial reserves and making steep budget cuts. This time, the reserves are a bit fatter, but the shortfall is much bigger. And the fiscal crisis may just be beginning. Typically, gains in state revenue collections lag behind economic activity. So even if the economy picks up in the second half of 2009 or early 2010, state finances could be troubled into fiscal 2011.
"It’s going to be a tough couple of years to get through here because revenues are going to be lousy and demands on spending are going to be going up," David Wyss, chief economist at Standard & Poor’s, told lawmakers at a conference in Atlanta last month. In Georgia, Hill said, while tax collections are down — off 2.7 percent through December — they haven’t been all that bad compared to other economic indicators. But Hill, who runs a grocery in South Georgia, added, "You just look around you, and you know the worst is yet to come." During last year’s session, a $21 billion budget was approved for fiscal 2009, which runs through June 30. After the fiscal year began, Perdue ordered spending cuts, killed pay raises for state employees and asked agencies to slash spending 6 percent, which has since been raised to 8 percent.
Perdue and lawmakers hope to avoid major cuts in public schools or health care programs for the poor and disabled. The problem is that kindergarten through 12th-grade education and public health care are the most expensive things in the budget. So other areas, such as public colleges, may be cut 10 percent to 15 percent to make up the difference. Hundreds, if not thousands, of jobs could be lost in the process. Tom Lewis, a longtime Capitol lobbyist who now serves as special assistant for government relations at Georgia State University, said cutbacks of up to 15 percent would be "devastating" for the downtown Atlanta campus. "If you get into cuts over 10 percent, you’ve going to have to get into furloughs, layoffs, cutting down on the hours at libraries and labs and cutting the number of class sections," said Lewis, whose school has 27,000 students and employs 3,000 people.
Michael Light, spokesman for the state’s technical college system, said officials have already laid off about 80 people and merged schools to save money. If more cutbacks are required, layoffs in administrative staff would be likely. "The one thing we’re not going to do is affect the students," he said, although he added that tuition increases may be discussed if much bigger cuts are mandated for fiscal 2010. Light said system officials have talked about the possibility of more dramatic cutbacks than the 8 percent mandated by Perdue. "We have to be prepared for worse." Chris Clark, who will be taking over as Department of Natural Resources commissioner this year, said his agency has gotten by in part by not filling vacant positions. State parks have remained open. Clark said he couldn’t say much until Perdue releases his budget proposal. But if deeper cuts are required, he said, "We are looking at all our options out there."
One of the most politically tricky decisions legislators will have to make is on the state’s property tax relief grants, which save average homeowners $200 to $300 a year and cost the state about $428 million. Perdue and House Speaker Glenn Richardson (R-Hiram) both said the grants have not helped hold down property taxes, as intended. Richardson and Lt. Gov. Casey Cagle, the Senate’s president, have committed to funding the grants this fiscal year. After that, the fate of the grants is unclear. If the grants aren’t approved for fiscal 2010, county officials have said homeowners will get a $200 to $300 property tax increase because they will lose money that funds the program. Lawmakers could choose to make up at least some of the shortfall with tax or fee increases. However, the leaders of both chambers have said they oppose any tax increases. Cagle, who is expected to run for governor in 2010, has been particularly vocal on the issue.
Even without new taxes, Perdue and lawmakers hope to stimulate one part of the economy: construction. Perdue said last month he will recommend an "economic stimulus package" that will include borrowed money for schools, roads and other construction projects. Perdue said borrowing money for construction projects will create jobs and provide communities with needed infrastructure. Lawmakers said Perdue has said the package will be in the range of $1.2 billion. They will be considering it while Congress is debating a larger but similar national construction package from the Obama administration. Other than the stimulus borrowing, legislative leaders say the state spending plans for the next two years will be lean. Like a lot of Republicans, Cagle sees the recession as a chance to pare the budget down to the "core functions" of government. "It’s going to be a painful session," he said. "Every line item in that budget has a constituency group and all of them view their program as a higher priority than the other programs. But government should not be all things for all people. Government should only do what the citizenry cannot do for itself."
Gazprom Prepares to Resume Gas Supply After EU Accord
OAO Gazprom said it’s ready to resume supplies of natural gas to Europe from Russia once an EU-brokered accord on monitoring transit via Ukraine is enacted, potentially ending days of disruption amid freezing temperatures. Russia’s state-run gas exporter will restart shipments "when the observers are in place," Sergei Kupriyanov, Gazprom’s spokesman, said by text message today. Czech Prime Minister Mirek Topolanek, acting for the European Union, secured a three-way agreement enabling monitors to check flows into Ukraine’s pipelines from Russia. Gazprom, supplier of a quarter of Europe’s gas, halted transit on Jan. 7, accusing Ukraine of siphoning fuel after it cut supplies to Russia’s neighbor amid a price and debt dispute. Ukraine denied the charge.
"If all "goes well", the monitors may be in place today, Topolanek told reporters in Prague today. The EU, Russia and Ukraine agreed to provide as many as 25 observers each to the mission "Ukraine is going to have to put its cards on the table," Ronald Smith, chief strategist with Moscow-based Alfa Bank, said today. "It will be apparent who is telling the truth. With the monitors it will be very clear what’s going on. On the pricing side there’s no reason for Ukraine not to pay market-based prices for its gas." Once gas starts to flow in Ukraine, it may take about 36 hours for it to reach EU states, where in some the situation is "serious," Topolanek said. The Czech Republic has called an energy council meeting for all EU members tomorrow in Brussels, Industry Minister Martin Riman said.
E.ON AG expects full deliveries of gas three days after the fuel enters Ukraine, Kai Krischnak, spokesman for the German utility’s Essen-based E.ON Ruhrgas AG gas division said today. E.ON has "no information" on when Gazprom plans to resume shipments, he said. Poland is yet to receive any news on when supplies may flow via Ukraine, Joanna Zakrzewsk, a spokeswoman for Polskie Gornictwo Naftowe i Gazownictwo SA, said today. The shutdown renewed calls in the 27-nation EU to develop nuclear power and alternative sources of energy. Fuel supplies are dwindling as temperatures as low as minus 15 degrees Celsius (5 degrees Fahrenheit) in the Balkans spur energy demand. "Ukraine signed the protocol so that Ukraine is not a barrier for Russia to resume gas deliveries to the European Union," Timoshenko told reporters after the accord’s signing during the night.
Gazprom is yet to receive "even a copy" of the document signed in Kiev, the company said in a statement today. Chief Executive Officer Alexei Miller said yesterday flows would resume once the gas producer received confirmation that Ukraine had signed the accord. Czech Prime Minister Topolanek, whose country holds the EU’s sixth-month rotating presidency, said today the agreement is being distributed. European monitors started arriving in the Ukrainian capital two days ago as they sought to defuse the dispute that has affected at least 20 countries. One group of observers arrived today in the eastern city of Luhansk near a compressor station and one is en route to a station in the town of Sudzha, Valentin Zemlyanskyi, a spokesman for state-run energy company NAK Naftogaz Ukrainy, said by phone today. Three other groups should be in their posts in the south and west of Ukraine by 6 p.m. tonight, he said.
Gazprom’s European customers receive 80 percent of supplies through pipelines that cross Ukraine. Gazprom halted transit flows on Jan. 7, cutting overall deliveries to Europe were cut by about 60 percent, after accusing Ukraine of diverting gas intended for other buyers for its own use, a charge denied by the country. Supplies from Russia to Ukraine itself were suspended Jan. 1 pending a new contract. Gazprom will first send minimum volumes needed, mainly to Balkan countries, and increase the amount quickly once it’s sure Ukraine isn’t siphoning any fuel, CEO Miller said yesterday. Bulgaria, Hungary and Slovakia were among eastern European countries that maintained curbs on gas use on Jan. 9. Most countries in western Europe have suffered less from the cutoff, tapping stockpiles and alternative supplies to meet demand. Temperatures were forecast to fall as low as minus 11 degrees Celsius in Zagreb and minus 15 degrees Celsius in Sofia this weekend, according to AccuWeather.com.
Oleh Dubina, the head of Ukraine’s state-run energy company NAK Naftogaz Ukrainy, returned to Kiev yesterday from Moscow after three days of talks on his country’s dispute with Russia on the price Russian wants to charge for 2009 gas deliveries to Ukraine. "Russia offered us $450 per 1,000 cubic meters, a rate which doesn’t correspond to a European price, and a rate which we cannot accept," Dubina said in a statement posted on the government’s Web site. There are no plans for Dubina to return to Moscow and Naftogaz said "further talks should be conducted by top politicians." Gazprom’s prices to European customers under long-term contracts typically lag behind prices for crude and oil products by about six to nine months. Crude has fallen by more than 70 percent since reaching a record in July. Ukraine paid Russia $179.50 per 1,000 cubic meters for gas last year under a separate arrangement. Gazprom offered a price of $250 for this year, and Prime Minister Yulia Timoshenko and Ukrainian President Viktor Yushchenko said on Jan. 1 that $201 per 1,000 cubic meters would be fair.
Ukraine and Georgia, both former Soviet republics, have strained relations with Russia in their efforts to join the EU and the North Atlantic Treaty Organization. The gas dispute has come as Timoshenko and Yushchenko are facing a financial crisis that has forced them to seek a $16.4 billion International Monetary Fund bailout. In 2006, Russia turned off all gas exports to Ukraine for three days, causing volumes to fall in the EU, and also cut shipments by 50 percent last March during a debt spat. The Slovak government yesterday approved the restart of a nuclear reactor, in the face of opposition from the European Union, to meet the country’s energy needs as the halt in Russian gas supplies continued. Prime Minister Robert Fico told reporters the move would be for a "necessary" period until the gas market stabilizes. The reactor in Jaslovske Bohunice was closed Dec. 31 as part of the conditions imposed on Slovakia when it joined the EU. The Polish government will also decide next week on building nuclear power plants in Poland, Tomasz Misiak, a member of Poland’s ruling party Citizens’ Platform and chairman of Senate’s economy committee, said on Jan. 9.
'Bailout' Stocks Trading Down, Index Says
The stocks of companies that have received government bailout money are down 5% this week, according to a new Nasdaq OMX index that launched on Monday. The Government Relief Index, launched Monday to track companies that have received greater than $1 billion from the government through the Troubled Assets Relief Program, or TARP, began with a calculation value of 1,000.00 on Jan. 5. The index, listed under the symbol "QGRI," recently was trading down 0.2% at 943.71 on Thursday. "This index allows taxpayers and other investors to measure the performance of U.S. companies that are participating in the government's financial relief plan," Nasdaq Executive Vice President John Jacobs said in a statement. "We believe the Nasdaq OMX Government Relief Index will be useful in helping investors evaluate the government's investments and the impact of the relief plan on the economy during this period of historical significance."
TARP, pushed by Treasury and approved by Congress in October after Lehman Brothers filed for bankruptcy and AIG came close to the same fate, was originally intended to purchase toxic assets that have hamstrung many bank balance sheets. Treasury soon changed course, however, opting instead to decide $250 billion of the $700 billion program to invest directly in bank preferred equity stakes. Big banks including Citigroup, Bank of America, Wells Fargo, JPMorgan Chase, Goldman Sachs and Morgan Stanley were among the government's first and largest infusions. Citi went back to the government well in late November, when Treasury agreed to give the financial titan a second capital injection. Citi has received some $45 billion from the Treasury so far, as well as a guarantee of $306 billion in risky assets.
In late December, the government also agreed to provide $17.4 billion of funding for two struggling U.S. automakers, General Motors and Chrysler. As of Dec. 31, Treasury said it has invested $177.5 billion of the TARP funds in return for preferred equity stakes in banks. That figure does not include the aid to the automakers. So far, 24 companies -- General Motors is the only nonfinancial entity -- are included in the index. A Nasdaq spokesman says there is no limit to the number of index components and more companies will be added as the government programs evolve. The index is calculated in real-time across the combined exchanges and is disseminated in dollars. Nasdaq plans to establish other government relief indexes in the coming weeks, the exchange says.
College grads avoid brunt of layoffs
For one group of workers, the recession hasn't hit quite so hard. Their unemployment rate was nearly half the overall workforce in December. When they do lose jobs, they tend to find work more quickly than others. Their wages are higher, and they typically have enough savings to survive between jobs. Yes, it still pays to get a college degree. Despite recent high-profile layoffs of bankers, accountants and other highly educated workers, college graduates are faring much better than the labor force as a whole. For December, their unemployment rate was 3.7 percent, compared with 7.2 percent for everyone regardless of academic pedigree.
The reason is simple: A degree usually leads to higher-paying, more stable jobs. And if that job goes away, a highly educated worker can always take a step down the career ladder. Or, they may not have to. "We've made a big committement where we're still recruiting on campus," said Jennifer Allyn, managing director in office of diversity at PricewaterhouseCoopers. "We hired 3,000 people last year and we plan to do the same this year. It's not like it's going into a deep freeze." College grads "have a privileged position in the labor market," said Lawrence Mishel, president of the Economic Policy Institute in Washington. That's not to say they haven't been hurt by the recession. The December jobless rate is just shy of the record for college grads -- 3.9 percent hit in January 1983.
Tom and Shelley Ziech both have master's degrees and impressive resumes. They both lost their jobs last year. The Milwaukee couple makes ends meet by drawing on unemployment insurance, severance packages and personal savings. So far, they have avoided spending retirement investments. Tom Ziech said he's confident the couple will be back at work soon. "I have felt fairly optimistic, but I don't know why. I don't really have anything to back that up," he said with a laugh. "But I feel optimistic I'm going to find something." The spread between college graduates and overall unemployment has persisted through every recession since at least the 1970s. The 3.9 percent unemployment record in 1983 for college grads compared with an overall jobless rate of 10.4 percent. Though the Labor Department lacks comparable figures for college graduates before 1992, other department data suggest the jobless rate for graduates peaked around 3.9 percent in 1983.
The spread is there in good times, too. Since 1992, the jobless rate for college graduates has hovered near 2 percent. It's risen as high as 3.4 percent in 1992 and as low as 1.5 percent during the dot-com boom in 2000. By contrast, the jobless rate for high school dropouts rose as high as 12.2 percent in 1992. The lowest it ever got was 5.8 percent in 1999, and it climbed to 10.9 percent last month. College grads also earn more. When workers graduate high school, their average wage jumps about 32 percent, from $11.38 to $15.01 an hour. If they attend college but don't get a degree, their wages rise about 13 percent. But if they graduate, their average hourly wage leaps 77 percent to $26.51 an hour. Getting an advanced degree boosts earnings 27 percent, to $33.57, according to a 2008 study from the Economic Policy Institute.
Still, Mishel predicted the unemployment rate for college graduates will reach a record 4 or 5 percent during 2009 and that educated workers "are going to experience the kind of pain that has been common for people with less education." The power of a degree also has been partly diluted by broader college attendance. Ten percent of workers had a college degree in 1973, 12.7 percent in 1979 and 21 percent in 2007, according to the Economic Policy Institute. "Back in the 70s and 80s, a much smaller percentage of the work force had a college degree," said Steven J. Davis, a scholar with the American Enterprise Institute think tank in Washington. "When your mother told you to get a college degree so you can get a secure job, well, that was a much more powerful track to the secure job."
College grads have more options when they're job hunting than people with less education. As a rule, it's easier to move down the work-force food chain than to move up, said Sylvia Allegretto, an economist at the University of California, Berkeley. Kris Kleindienst, co-owner of Left Bank Books in St. Louis, is used to seeing a few college graduates with a "book disorder" apply for clerk positions. But this year, she is interviewing trained engineers in their 50s who are out of work. "It's totally ridiculous that they would come here to work, on many levels, but they are applying," she said. "If you have to take a job that is beneath you, then this is a great environment."
Lennar Hit by Claims on Off-Balance Sheet Debt
Shares of Lennar Corp. plunged Friday after a high-profile investigator raised questions on a Web site about the home builder's off-balance-sheet debt and a large personal loan taken out by a top company executive. The allegations by Barry Minkow's Fraud Discovery Institute sent Lennar's shares tumbling 20%. They closed at $9.15 in 4 p.m. New York Stock Exchange composite trading, down $2.27. In a statement, Lennar called Mr. Minkow's allegations "false and inflammatory" and said he is acting on behalf of a "disgruntled litigant," who is suing Lennar. In a written report and Web video, Mr. Minkow criticized Lennar's practice of putting large amounts of debt in off-balance-sheet joint ventures, saying there is insufficient disclosure about them to investors. Lennar has about $4 billion in off-balance-sheet debt through 116 joint ventures and has typically given very few details about these arrangements.
The builder's chief financial officer, Bruce Gross, said in an interview, "we have full disclosure on our joint-venture debt. There is nothing concealed." Mr. Minkow is a convicted stock-fraud felon who was imprisoned for his role in masterminding the ZZZZ Best stock swindle in the 1980s. Since his release, Mr. Minkow has won kudos from the Federal Bureau of Investigation for uncovering frauds on the Internet, in the real-estate field and elsewhere. His recent effort to expose executives and directors who embellish their academic credentials has led to several resignations of high-level officials. Other campaigns against public companies have had mixed impact.
In some cases, Mr. Minkow has sought to profit from his investigations by betting on a decline in the target company's stock, through buying put options. In the case of Lennar, Mr. Minkow says he has no such option position, but instead is being paid a fee by an unnamed client. In his report, Mr. Minkow takes aim at a $5 million loan taken out by Lennar's chief operating officer, Jon Jaffe, in 2007. He claims that Mr. Jaffe obtained the loan from a California real-estate broker who has done business with a Lennar business partner and that the broker also has made a big profit on property adjacent to a Lennar development. Mr. Jaffe denied that Lennar had business dealings with the broker who extended the loan. Mr. Jaffe said he took out the loan to pay for renovations on his six-bedroom, ocean-front home in Laguna Beach, Calif., recently appraised for $18 million.
"My loans on my home had nothing to do with Lennar," Mr. Jaffe said. Mr. Minkow also accuses Lennar of perpetrating a "giant Ponzi scheme" in its land deal with the California Public Employees Retirement System that landed in bankruptcy court. He said Lennar moved other joint-venture assets into the venture, known as LandSource and depleted the venture of cash before it imploded amid the housing downturn. Mr. Gross denied that Lennar controlled other assets that were rolled into the LandSource venture. He said they were contributed by Lennar's partner in the deal, MW Housing Partners, a Calpers investment vehicle, as part of its overall $970 million investment.
Iran Moved Billions via U.S. Banks
Iranian banks illegally shifted billions of dollars through American financial institutions in recent years, and authorities suspect some of the money may have been used to finance Iran’s nuclear and missile programs. Details of the illicit transfers came to light on Friday when New York State and federal authorities announced that a large British bank had agreed to pay $350 million to settle accusations that it had helped the Iranian banks hide the transactions. The British bank, the Lloyds TSB Group, "stripped" information that would have identified the transfers in order to deceive American financial institutions, which are barred from doing business with Iranian banks, Robert M. Morgenthau, the Manhattan district attorney, said. Lloyds acknowledged its conduct and agreed to turn over detailed records of the transactions. "They went to great lengths to obliterate any identification," Mr. Morgenthau said.
The district attorney’s office was still investigating nine major banks that might be engaging in similar conduct, but prosecutors declined to name them. Mr. Morgenthau said, however, that money in one transaction was used to buy a large amount of tungsten, an ingredient for making long-range missiles. He said he suspected that other funds might have been used to finance Iran’s nuclear program. In the current case, investigators were unsure what the money was used for, said Daniel J. Castleman, the chief assistant district attorney. The stripping made it impossible to determine where the money was going, he said. "We don’t know of any money that has gone to any terrorist organizations, individuals or anything like that," he said.
Lloyds has agreed to examine all of the transactions it stripped to try to determine where the money was headed. In all, Lloyds hid the source of billions of dollars that passed through the United States, prosecutors said. Lloyds also hid transfers from banks in Sudan, which are also banned from doing business with American institutions. Half of the $350 million Lloyds has agreed to pay will go to the federal government and the rest to Mr. Morgenthau’s office, which will divide the money between the city and the state. Mr. Morgenthau said he hoped the money, the largest financial penalty his office has ever collected, would provide a boost to tight city and state budgets.
Although prosecutors did not identify specific individuals at Lloyds responsible for the fraud, Mr. Castleman said, "It was a systemic, wide-ranging scheme." The training manual given to employees of Lloyds even included a section on how to strip transactions, prosecutors said. Banks in several nations are banned from doing business with American institutions, but the United States is particularly concerned about Iran, which it says finances terrorists and runs an illicit nuclear weapons program. Iran denies those accusations. The investigation into Lloyds goes back to 2006. It was conducted jointly by Mr. Morgenthau’s office and the Justice Department, with the assistance of the Treasury and banking regulators.
According to a deferred prosecution agreement, Lloyds handled $300 million of Iranian transfers and $20 million of Sudanese transfers that ended at American banks. Mr. Morgenthau said billions of dollars of transactions went through American banks but ended outside the country. Several employees in Lloyds’ international payment processing unit in London removed from the bank’s central system orders from certain foreign banks, according to the agreement released Friday by Mr. Morgenthau’s office. Employees struck out identifying information about the originating banks on printed copies of the payment instructions, which someone then re-entered into the payments system. When American banks received the transfers, they seemed to have originated at Lloyds.
Worried that they might be violating American law, senior officials at Lloyds stopped the stripping operation for Iranian banks in 2004, but transfers from Sudan were stripped as recently as 2007. Under the agreement between Lloyds and Mr. Morgenthau, no employees, officers or the bank will be charged with a crime unless evidence emerges that the bank or its employees and officers knew that specific transfers were sent to or by terrorist groups or "proliferators of weapons of mass destruction." The agreement lasts for two years. In recent years, officials in the Treasury have stepped up a campaign to have foreign banks sever links with Iranian banks, which they accuse of providing support for groups like Hezbollah and Hamas, in addition to financing Iran’s own nuclear ambitions.
In November, the Treasury barred American financial institutions from handling certain money transfers for Iranian interests that had been previously allowed, closing what it described at the time as the "the last general entry point for Iranian banks." Certain exceptions are still allowed for humanitarian aid and remittances. In December, federal authorities moved to seize the assets of the Assa Corporation, which the Treasury says is a front for Bank Melli, Iran’s largest bank. Assa owns a stake in a Midtown Manhattan office tower. Mr. Morgenthau’s office had been investigating ties between the Iranian government and Assa and a related entity, the Alavi Foundation, since 2006. Mr. Morgenthau said evidence unearthed in that investigation led his office to inquire about money transfers made through Lloyds.