Calvin Coolidge could have danced all night
Ilargi: Yesterday's post, The Shortest President, got me a lot of flack. And that is not a surprise, nor is it unwelcome. By all means, let's talk. Part of it may have been that we have a lot of new visitors these days, who don't yet know what we do or why we choose to do it the way we do. I suggest you all read a bunch of the primers you can find in the right hand side column. And then there are many people who feel that Obama's party was a good reason to focus on something else than economic trouble, if even just for one day. I hope you understand that I don't see that as my role, and that I also think the problems are too large and too imminent to act for even one day as if they don't exist. Plus, I think that the day when everyone focused on Obama is a very good time to explain the issues I have with his approach of the economy. Finally, I have the nagging feeling that many people still don't fully grasp the depth of the downfall, both so far and ahead of us.
I didn't say Obama would be the president with the shortest term in history, only that if he doesn't act now, there's a risk he might be. And by that I don't mean to bring up the risk of physical aggression against him, I abhor it and don't think he deserves that at all. I’m talking political crisis. The fact remains, though, that he is now responsible, and that his choices and appointments for his finance team are highly dubious, and that's putting it very mildly. Tim Geithner today in his conformation hearing had nothing to say about toxic debt than that it is "very hard to value". And from what I can tell, no-one pushed him to clarify his, or Obama's position. And that is just plain dangerous territory.
The reason why lies in what we see happening in Britain since the start of this week. There has been a major turning point in the attitude of the markets with regards to government bail-outs. While in the past 18 months we've seen a pattern of ever growing bail-out amounts evoking ever shorter feel-good rallies, we've now come to the point where larger amounts of public rescue money have started to invoke increasing levels of fear amongst investors. And that means that yet another instrument has vanished from government toolboxes. The only realistic remaining tool in the US and UK is now complete nationalization of all banks, of the entire financial system. The reason it has come to this is precisely the reason why I am so adamantly poised against it: the losses on the casino bathroom paper inside the financials’ vaults are simply way too high to dump them into the laps of ordinary citizens. The discussion is not whether buying it all is the proper political instrument, it's whether the nation can even afford such action. It cannot.
The Royal Bank of Scotland last year was handed a £32 billion bailout by the British. Since then, its capitalization has gone from £75 to £4.5 billion, and it lost at the very least £28 billion. And these are the companies our governments keep insisting are so essential to our welfare that we need to cover all their losses, or else the skies will fall. I don’t want to go into the fallacy of such rhetoric right now, but I do want to point out that the UK government either has no clue what the total losses are, or they are not telling the very people whose money is being used to cover them.
And that has to stop. There is only one way to go from here, and if we pick the wrong fork in our road forward, we will make matters much worse still. We need to know and face the true and total extent of the losses in our economies that have not been revealed as yet. While that will murder many if not most of our banks and pension funds, it will also end the distrust and suspense that hangs over our economies, and down the line over our lives. It's the only way to restore confidence, and if we don't choose that way within the next few weeks, we will come to regret that for a very long time. The fact that Wall Street banks were the largest sponsors of yesterday's party spells a whole lot of trouble in that regard.
That is an expression of a deep lack of ethics. It's also an expression of the depth of the power that Wall Street exerts in Washington. Geithner was as vague about the way toxic assets will be handled once he's settled in at the finance department as he's been clear about what will indeed be done. Hundreds of billions more will be hosed into the banking system, while the managers responsible for leading their firms into the gutter remain in their seats, and still nobody will have any ides how much more will be left behind in losses inside financial institutions. Which in turn guarantees that there will be more, and then some more, calls for public money to be used to hide the dirty smell.
The trillions spent so far have done nothing to stabilize the system, they have only served to delay the wreckage from being unearthed before Christmas. Today, just a few weeks later, the picture of the system has deteriorated markedly. There is simply no time for a honeymoon. People look around their hometowns and tell themselves everything still looks mostly the same.
Think of this as the moment when the ants start scurrying around, while you are still enjoying the scenery. And then the earth starts shaking.
Ilargi: Please excuse me for a being a little late. I don't know who did the video below, the song is way older than the pictures in it.
There is no time- Lou Reed
This is no time for Celebration
this is no time for Shaking Hands
This is no time for Backslapping
this is no time for Marching Bands
This is no time for Optimism
this is no time for Endless Thought
This is no time for my country Right or Wrong
remember what that brought
There is no time
This is no time for Congratulations
this is no time to Turn Your Back
This is no time for Circumlocution
this is no time for Learned Speech
This is no time to Count Your Blessings
this is no time for Private Gain
This is the time to Put Up or Shut Up
it won't come back this way again
There is no time
This is no time to Swallow Anger
this is no time to Ignore Hate
This is no time to be Acting Frivolous
because the time is getting late
This is no time for Private Vendettas
this is no time to not know who you are
Self knowledge is a dangerous thing
the freedom of who you are
This is no time to Ignore Warnings
this is no time to Clear the Plate
Let's not be sorry after the fact
and let the past become out fate
There is no time
This is no time to turn away and drink
or smoke some vials of crack
This is a time to gather force
and take dead aim and Attack
This is no time for Celebration
this is no time for Saluting Flags
This is no time for Inner Searchings
the future is at hand
This is no time for Phony Rhetoric
this is no time for Political Speech
This is a time for Action
because the future's Within Reach
This is the time this is the time
This is the time
because there is no time
Seven reasons for healthy skepticism
Even in a city of cynics, the Inauguration of a new president — and the infusion of new ideas, new personalities and new energy that comes with it — summons feelings of reverence. Barack Obama, especially, is the object of inaugural good feelings. He has assembled an impressive White House and Cabinet team. The country is clearly in his corner. With the economy gasping, and two wars dragging on sullenly, even many Republicans who ordinarily might enjoy seeing Obama fail now root for him to succeed. The stakes are simply too great. Amid all these high hopes, it may seem needlessly sour to point out why expectations must be kept in check. But it is also realistic. Here are seven reasons to be skeptical of Obama’s chances — and the Washington establishment he now leads:
1. The genius fallacy
There is no disputing Obama has built a Cabinet of sharp and experienced public officials. His staff, especially on national security and economic matters, is often praised as brilliant — and that’s by Republicans. But recent history teaches us to be wary of the larger-than-life Washington figures supposedly striding across history’s stage. Consider the economy. Everyone seems to agree Larry Summers and Timothy Geithner are smart, vastly qualified to manage and repair the economy. Everyone was saying the exact same things about the two economic geniuses of the 1990s: Robert Rubin and Alan Greenspan. Now Rubin has been reduced to making excuses for his involvement in high-risk investments and for helping oversee the demise of Citigroup, which lost $10 billion in the past three months alone. The onetime oracular Greenspan has admitted to Congress that his once-revered economic philosophy had "a flaw," and many blame him for turning a blind eye to the housing bubble.
As it happens, the Obama economic team is full of Rubin protégés, including Geithner and Summers. Geithner had to recently admit he failed to pay taxes on a big chunk of income — as part of his confirmation process to run tax policy and the Internal Revenue Service. As president of the New York Fed, he was integrally involved in the decision not to rescue Lehman Bros., which many see, in retrospect, as a grievous error. The reception of the Obama economic team recalls the reception of President George W. Bush’s foreign policy team eight years ago. Many Democrats applauded the experience of Vice President Dick Cheney, Defense Secretary Donald Rumsfeld and Secretary of State Colin Powell. As Bush named his national security team in 2000, The New York Times editorialized: "Putting superstar players on the court does not always guarantee harmony or success." In retrospect, that was an understatement, indeed.
2. The herd instinct
The most bipartisan tradition in Washington is to laud bipartisanship, even while lamenting that there is not enough of it. But the instinct for bipartisanship overlooks an inconvenient fact: Some of Washington’s biggest blunders occur when the government moves to do big things with big support. Bush won the much-regretted Iraq war resolution of October 2002 with strong Democratic backing. The current economic crisis produces similar pressure to get on board the train — never mind for sure where it’s going. It is easy to sympathize with the temptation. Top officials on Obama’s team told us in recent days that things are much worse than most people appreciate. The Obama staff and top lawmakers are getting stern warnings that the banking system in particular is extremely fragile and could collapse. So they are moving with amazing speed to pump money into the economy.
First up is the stimulus package that could top $900 billion. It is a mind-numbing number rarely contemplated in U.S. history — and yet it might not work. There are no guarantees people will spend money the government doles out or that it will be enough to offset miserable economic performance elsewhere. The history isn’t encouraging. Rewind just a few months back. Republicans and Democrats alike said the best of many bad options was to approve $700 billion to prop up banks, mainly to thaw the credit freeze and juice the economy. Half the money is gone now. Many banks took the cash and sat on it. Some used it increase lending. But much of it was wasted or unaccounted for. Now Washington wants to spend the rest of it. And a top Hill aide told Politico’s David Rogers that Democrats will probably need to request even more.
3. We are broke.
The past several months have produced a rare convergence. Something that politicians of both parties find pleasurable — spending money — has overlapped with what economists and policy experts of all ideological stripes said is urgently necessary. As "Saturday Night Live’s" Church Lady used to say, "How convenient." One month from now, Democrats will likely have passed the massive stimulus bill and Obama will have signed it into law. The new Treasury Department will be well on its way to spending the second $350 billion chunk of the $700 billion bank bailout fund. After this rush of activity, the ability to spend during the balance of Obama’s first term — never mind if there is a second — will be sharply constrained.
Instead, the new administration and lawmakers on Capitol Hill will awaken to another first: the prospect of the national deficit approaching $2 trillion. For most, these numbers are simply too big to ponder. But ponder this: This country has never reckoned with deficits like these. Wait, it gets worse. Remember those entitlement programs the elderly and poor need more than ever: Social Security and Medicare? In budget terms, they are more troubled than ever. Social Security’s surpluses "begin to decline in 2011 and then turn into rapidly growing deficits as the baby boom generation retires," according to one recent report. "Medicare’s financial status," the report said, "is even worse." Basically, the government needs more money than ever at a time when people are losing jobs, income and confidence.
4. Words, words, words.
Bill Clinton and George W. Bush, though starkly different men, both viewed the presidency as pre-eminently a decision-making job. Clinton often waved away speech drafts bloated with lofty language by saying: "Words, words, words." Obama seems to have a different view of the presidency. He thinks that the right decisions can be reached by putting reasonable and enlightened people together and reaching a consensus. He believes his job as president is to educate and inspire, largely matters of style. He knows he is good with words. He knows he has great style. So that’s why he projects exceptional confidence in his ability to do the job. We don’t know yet how justified Obama is in his self-confidence — or how naive. But he is almost certain to face many tests, probably imminently, in which the test will be Obama’s ability to act quickly and shrewdly — and not merely describe his actions smoothly or impress people with nuance. And an unlike a governor — who must decide what’s in a budget and what gets cut, or whether a person to be executed at midnight should be spared — Obama has not made many decisions for which the consequences affect more than himself.
5. He rarely challenges the home team.
Obama frequently talks of the need to transcend partisanship. And he invokes his support for charter schools — a not-terribly-controversial idea — as evidence that he is willing to challenge Democratic special interest groups. In fact, there are few examples of him making decisions during the campaign or the transition that offended his own party’s constituencies, or using rhetoric that challenged his own supporters to rethink assumptions or yield on a favored cause. Has Obama ever delivered a "Sister Souljah speech"? Ever stood up to organized labor in the way that Clinton did in passing North American Free Trade Agreement? This is not a good sign. By Obama’s lights, the national interest usually coincides with his personal interest. Back to you, Church Lady.
6. Everyone is winging it.
No matter how much confidence Obama or other politicians project, the reality is the current economic crisis has totally scrambled the intellectual assumptions of almost every policymaker. People who used to bemoan deficits want to spend like crazy. Improvisation is the only proper response. But the chances that improvisation will take the country to exactly the right destination — without some serious wrong turns along the way — seem very slight.
7. The watchdogs are dozing.
The big media companies that once invested in serious accountability journalism are shells of their former selves. The Tribune Co. — in other words, the Los Angeles Times and the Chicago Tribune — has slashed its Washington staff by more than half. Newspaper chains such as Cox are fleeing D.C. altogether. The end result: There are few reporters in this country doing the kind of investigative reporting that hold government officials’ feet to the fire. Think back eight years to the pre-Iraq war reporting and consider the words of Scott McClellan in his otherwise humdrum book. "The collapse of the administration’s rationales for war, which became apparent months after our invasion, should never have come as such a surprise," McClellan wrote. "In this case, the ‘liberal media’ didn’t live up to its reputation. If it had, the country would have been better served." Rigorous reporting is even more important when you have one-party rule in Washington. Democrats, like Republicans, are simply less likely to scrutinize a president of their own. The end result here: Don’t expect the Democratic Congress to investigate the Obama administration or hold a bunch of tough oversight hearings. That means the only real check on Obama is the same one it’s always been — the voters.
The slide in sterling has turned "disorderly". We can argue over whether or not the first phase of devaluation acted as a shock-absorber for a badly mismanaged economy, providing a cushion against debt deflation and the housing crash. But the latest dive has a very malign feel. For the first time since this crisis began eighteen months ago, I am seriously worried that British government is losing control.
The currency has fallen five cents today to $1.39 against the dollar. It is now perched precariously on a two-decade support line -- the levels tested in 2001 and 1992. If it breaks that line, traders may send it crashing down towards dollar parity. The danger is blindingly obvious. The $4.4 trillion of foreign liabilities accumulated by UK banks are twice the size of the British economy. UK foreign reserves are virtually nothing at $60.6bn. (on this, more later in a piece I'm writing today) If the Government is forced to nationalise RBS and perhaps Barclays with their vast exposure in dollars, euros, and yen, it risks being submerged.
It is one thing for a sovereign state to let its national debt jump in a crisis -- or a war -- perhaps even to 100pc of GDP. It is another to take on foreign debts on such a scale with no reserves. Yes, the banks have foreign assets as well to match the debts. But how much are these assets really worth? This is the moment when the "rubber hits the road" -- to borrow from American argot -- the moment when the reckless debt experiment of our economic and political leaders comes back to haunt.
We cannot even do what Iceland did to save its skin. Reykjavik refused to honour the foreign debts of its buccaneering banks. It let them default, parking the losses in Resolution Committees. Small islands can do that. Iceland has fish instead, and lots of metals. Britain cannot follow suit. The debts are too big. If London takes such disastrous action it will set off global panic and lead to an asset death spiral, drawing the entire world into deep depression.
What have our leaders wrought? The reckless conduct of City, the fiscal incontinence of Gordon Brown (3pc deficit at the top of the cycle), and the pitiful regulation of the UK housing boom have all combined to bring the country to the brink of disaster. England has not defaulted since the Middle Ages. There is a real risk it may do so now. And no -- just so there is no misunderstanding -- it would not have been any better if Britain had joined the euro ten years ago.
The bubble would have been just as bad, or worse, as Ireland and Spain can attest. We have our disaster. They have their disaster. When the dust has settled in five years we can make a proper judgement on the sterling-EMU issue. Not now. The Baby Boomers have had their moment in power. The most spoilt generation in history has handled affairs with its characteristic hedonism. The results are coming in. The blithering idiots.
For US Banks, The Glass Is 1% Full
The raging debate about the largest American banks is whether their stock market values should be zero. Economist Nouriel Roubini, the most highly paid pessimist in the world, recently said that U.S. banks are "insolvent" and credit crisis write-downs will total $3.6 trillion. That is a great deal more than has been taken as losses by financial firms to date. Americans can also look at the choices made by the U.K. to salvage its credit system. Large banks there are being effectively bought out by the government as the U.K. attempts to put a firewall around huge losses from toxic assets. The Royal Bank of Scotland (RBS) is already 70% owned by the government and management's kilts have been repossessed.
The case that the equity value of firms including Citigroup and Bank of America has dropped to nothing is compelling. Once the government said it would back losses of over $300 billion from the Citi balance sheet, it was a tacit way of saying that Citi was no longer independent. Its market cap is now down to $15 billion, and at $2.80 its stock is a day-trader's dream. Not only are the Citigroup shareholders likely to be out of luck, especially if the Fed, Treasury, and FDIC have to step in again, but most of the preferred shareholders and debt holders will be wiped out in the flood as well.
Bank of America's purchase of Merrill Lynch could be the ruin of this bank. The bad assets of the brokerage firm were apparently both huge and well-hidden by management, the brokerage firm's board, or the auditors. The most charitable view of the people in charge at Merrill is that they were boobs. Anything beyond that starts to point a finger in the direction of liability and shareholder suits. If the federal government does have to make another large series of investments in this industry, companies like Citi will end up like AIG, Fannie Mae, and Freddie Mac, vassals who toil in the fields guided by the whims of Congressional committees and the financial arms of the administration.
U.S. banks do have one last and very large asset: their names. Marketers used to call this brand equity. It was a nonsensical way of saying that having a company's name on hundreds of buildings and sports stadiums made customers more comfortable being customers. Decades of advertising did that for Citi and B of A. The credit crisis has not entirely ruined those reputations. Citi retail customers in Italy probably don't worry about the hundred dollars they have in the big bank. It is simply very difficult to see how the "body of the brand" can be exhumed. Who would like to own the Citigroup name? It could probably be auctioned off to a lot of healthy local banks. It might even find a buyer in Asia or the Middle East, until, that is, their banks start to fail, too.
Roubini warns US banking system effectively insolvent
Losses in the US financial system may reach $3.6 trillion (£2.6 trillion) before the credit crisis is over, suggesting the country's banks are "effectively insolvent", according to the man who predicted the current economic meltdown. Professor Nouriel Roubini said half of the estimated losses would come from banks and broker-dealers, placing further pressures on an already heavily-laden system. "It means the US banking system is effectively insolvent because it starts with a capital of $1,400bn. This is a systemic banking crisis," he said.
To date, global losses and write-downs as a result of the crisis, which was triggered by the collapse of the US sub-prime mortgage sector, total about $1 trillion.
The New York University professor's comments were in part responsible for pushing banking shares lower on Tuesday. Citigroup fell 11pc and Bank of America lost 15pc. Banks were also impacted by news of heavy losses at institutional money manager State Street's commercial paper and investment arm, sending its' shares down as much as 50pc, its worst one-day slump in 24 years.
Speaking in Dubai, Professor Roubini said: "The problems of Citi, Bank of America and others suggest the system is bankrupt. In Europe, it's the same thing."
His warning comes just a day after the UK's second phase in its own banking bail-out, and after Bank of America, Merrill Lynch and Citi last week reported almost $26bn of fourth-quarter losses. "We have got a crippled financial sector, not only in the US but across the globe," said Keith Wirtz, chief investment officer of Fifth Third Asset Management.
Obama has no quick fix for banks
Even before they have settled into their new jobs, President Barack Obama's economic team faces an acute crisis in the U.S. banking system that has no easy answers and that they are not yet prepared to address. The president's advisers watched most banking shares fall sharply Tuesday, reinforcing what Obama officials have known for weeks: that their most urgent financial problem is an immense new wave of losses at banks and other lending institutions that threatens to further cripple their ability to resume normal lending. But when Timothy Geithner, the president's nominee to be the Treasury secretary, appears before the Senate Finance Committee on Wednesday for his confirmation hearing, he is not expected to have a detailed plan ready. While Obama's top advisers view the black hole in bank balance sheets as one of their most pressing problems, they cautioned that they would not be pressured into announcing a plan before they had carefully thought through all the options. Instead, they are scrutinizing an array of solutions, each of which has pitfalls and poses its own risks and dangers.
Obama officials are almost certain to intertwine help to the banks with Obama's goal of providing up to $100 billion for reducing home foreclosures. The two goals are not necessarily in conflict. Subsidizing loan modifications so that people can keep their homes could relieve banks of the steep losses associated with foreclosures and also prevent further erosions in bank asset values by putting a floor under home prices. "Mortgages are still the underlying problem, and I really think we need to address that problem head-on," said Christopher Mayer, vice dean at the Columbia University School of Business, in New York. "The foreclosure stuff is just trying not to have even bigger losses in mortgages than we have so far." Administration officials said they were determined not to repeat the mistakes of former President George W. Bush's Treasury secretary, Henry Paulson Jr., who sold Congress on an elaborate strategy for shoring up banks and then shifted to an entirely different approach before he even got started.
Industry analysts said the Obama administration's challenge would be to help banks get rid of severely devalued mortgage assets on their balance sheets — from nonperforming subprime mortgages to pools of mortgages and derivatives — without wasting taxpayer money or rewarding banks for bad practices. If policy makers were even remotely honest, analysts said, they would force banks to take huge write-downs and insist on a high price in return for taking bailout money. For practical purposes, that could mean nationalization or partial nationalization for many banks. One main difference between the options under consideration is how transparent the government would be about the ultimate costs to taxpayers and whether banks would be required to reveal the true magnitude of their likely losses. The ultimate taxpayer cost could be very high. A new analysis from the Congressional Budget Office suggests that the taxpayer costs are highest when the government's asset purchases involve opaque transactions that are difficult to understand.
When Paulson first pleaded with Congress to approve the $700 billion bailout program, known officially as the Troubled Asset Relief Program, he argued that the government might eventually recoup its entire investment because it would be able to resell its holdings when financial markets recovered. But the Congressional Budget Office, analyzing the program's $247 billion in bailout payments through December, estimated that taxpayers would end up absorbing $64 billion or 26 percent of that bill. The nonpartisan congressional agency estimated that taxpayers had already lost 53 percent of the government's $40 billion investment in American International Group, the giant insurance company that had been insuring tens of billions of dollars in junk mortgage-backed securities against default. As part of the rescue, the government helped AIG buy back billions in mortgage securities that it had insured.
As the Obama economic team pondered a new approach, one alternative, though an unlikely one, would be to revive Paulson's original idea of buying troubled assets through an auction process. The potential virtue of auctions is that they could get closer to establishing a true market value for the assets. But the drawback is that many of the securities are so arcane and complex that they are unlikely to generate the volume of bidding needed to establish a real market price. A second approach, which Paulson had already used in a second round of bailouts for Citigroup and Bank of America, is to "ring-fence" the bad assets by providing federal guarantees against losses, and separating the assets from the rest of a bank's balance sheet. The virtue of that approach is that it costs relatively little money up front, because the government is essentially providing insurance coverage.
The danger is that the potential cost to taxpayers of government guarantees can be even less transparent than other approaches. As a result, the final costs to taxpayers could be huge. Indeed, the guarantees would put the government in the same business that led to immense losses from mortgage-backed securities: credit-default swaps. In its recent report, the Congressional Budget Office estimated the $20 billion that the Treasury spent in November to guarantee $306 billion of toxic assets by Citigroup will cost taxpayers $5 billion — a 26 percent subsidy. William Seidman, a former chairman of the Federal Deposit Insurance Corp. who was closely involved with the bailout of savings-and-loan institutions in the 1990s, said the government should simply take control of the banks it tries to rescue. "When we did things like this, we took the banks over," Seidman. "This is a huge, undeserved gift to the present shareholders."
One big difference between today and the 1990s is that the government back then was seizing entire failed institutions. On paper, at least, the banks in trouble today are still viable. That leaves the third and increasingly talked-about approach — have the government buy up the toxic assets and put them into a government-financed "bad bank" or an "aggregator bank." The immediate virtue of the bad bank is that the remaining "good bank" would have a clean balance sheet, unburdened by the uncertainty of future losses from bad loans and securities. Richard Berner, chief economist at Morgan Stanley, described the "bad bank" strategy as the "least bad" of available options. The main advantage, Berner said, was that the government would have to decide how much it was willing to pay for the toxic assets. In turn, that would make it easier for the public to figure out whether the government was overpaying. Banks may not want that kind of openness, because accurately valuing the toxic assets could force many to book big losses, admit their insolvency and shut down.
Geithner Says Obama Economic Plan Will Come in Weeks
U.S. Treasury Secretary-nominee Timothy Geithner told Congress President Barack Obama plans within the next few weeks to propose a "comprehensive plan" for responding to the economic and financial crises. The plan will address the credit crunch and the collapse of the housing market, as well as global economic conditions that require a coordinated international response, Geithner told a Senate Finance Committee hearing on his nomination today. Obama "will come before the Congress in the next few weeks and lay out to the American people a comprehensive plan to help stabilize the core of the financial system so that banks, which are so critical to our economy, are able to provide the credit necessary to get recovery going again."
In addition to dealing with the housing crisis, the president’s plan will seek to "directly address the constraints" that are making it harder for small businesses, students, auto buyers and local governments to get access to credit, Geithner said. The Treasury nominee also urged Congress to pass a robust stimulus plan to revive the economy and pledged to overhaul the government’s $700 billion bailout program. "The ultimate costs of this crisis will be greater if we do not act with sufficient strength now," Geithner said in testimony at today’s hearing. "In a crisis of this magnitude, the most prudent course is the most forceful course." Geithner, president of the Federal Reserve Bank of New York, was also grilled by senators about his late payment of almost $50,000 in taxes. He said his tax errors were "careless" and unintentional, and apologized to the committee for the toll they have taken on his confirmation process. "I should have been more careful. I take full responsibility for them," Geithner said.
Geithner, 47, is still likely to win confirmation as Obama’s economic policy chief, lawmakers’ public remarks indicate. Senate Finance Committee Chairman Max Baucus, a Montana Democrat, endorsed Geithner’s candidacy as have several of the panel’s Republican members. Baucus has scheduled a committee vote on the nomination for tomorrow. Baucus said Geithner’s tax travails were "disappointing mistakes" that shouldn’t derail the nomination. "After discussing them with Mr. Geithner, I believe them to be innocent mistakes," Baucus said. "I know a man of Mr. Geithner’s talent will be meticulous on these points in the future." Senator Charles Grassley of Iowa, the senior Republican on the Finance Committee, said he remains concerned about Geithner’s "troubled tax history."
Geithner said in his opening statement that, if confirmed, he would refocus the Treasury’s $700 billion Troubled Asset Relief Program to help small businesses and families that are losing their homes and jobs. That would be an expansion of a program that former Treasury Secretary Henry Paulson devoted mostly to buying stakes in banks. "We have to fundamentally reform this program to ensure that there is enough credit available to support recovery," he said. "We will do this with tough conditions to protect the taxpayer," he said. It became clear last year that the government needed authority to make capital injections, provide insurance guarantees or make asset purchases to address the toxic assets on banks’ balance sheets and have the capacity to deal with "catastrophic" failures of nonbanks, he said.
Asked how the Obama plan for TARP will deal with the toxic assets, Geithner said it’s "incredibly difficult" to value the investments. Most experts think it’s best to use a mix of market prices, analysis by regulators and third-party estimates, he said. He didn’t specify how the Obama administration intends to use remaining TARP funds, which amount to about $350 billion. Still, he left little doubt about the urgency of the situation. Geithner said the financial system needs to recover from a "catastrophic loss of trust and confidence." Asked about providing further assistance to the auto industry, which the Bush administration financed out of TARP funds, Geithner said any government support should require "a comprehensive restructuring" of the carmakers. "That is going to require very, very substantial changes by all stakeholders in these companies," he said.
"If our policy response is tentative and incrementalist, if we do not demonstrate by our actions a clear and consistent commitment to do what is necessary to solve the problem, then we risk greater damage to living standards, to the economy’s productive potential, and to the fabric of our financial system," he said. Turning to international exchange-rate policies, Geithner said that confidence in the dollar is "critical" to the U.S. economy. He didn’t make any specific reference to support for the "strong dollar" policy held by Treasury secretaries since the mid-1990s. Geithner did say that other nations should avoid manipulating their currencies. "It’s very important for the United States and for the global economy that our major trading partners operate with a flexible exchange-rate system," he said in response to a question. Geithner also called for "comprehensive" regulatory changes to help ensure that an economic crisis of this magnitude -- the worst since the Great Depression -- doesn’t happen again.
"We need to move quickly to build a stronger, more resilient system now, with much greater protections for consumers and investors, with much stronger tools to prevent and respond to future crises," he said. Geithner also said the financial system needs regulation to function properly. "I believe that markets are central to innovation and to growth, but that markets alone cannot solve all problems," he said. "Well-designed financial regulations with strong enforcement are absolutely critical to protecting the integrity of our economy." The Treasury secretary designate warned lawmakers that solving the financial crisis will "take time" and "require action on a scale that we have not seen in generations." Former Fed Chairman Paul Volcker, speaking on Geithner’s behalf at the start of the hearing, said there’s "no end in sight" to the recession and the U.S. is facing "the mother of all financial crises."
The Ultimate Game Changer: Why 2009 Will Be Worse Than 2008 (Part 2)
I don’t want to belabor the point but wanted to stress the fact that credit, saving spending and investment will be changed for a generation. People will be forced to save more to buy stuff they could previously buy with little or no money down and low interest. Frugality will be a way of life, not just in the consumer sector, but also in the business and government sector. And the government (federal that is) can not create enough jobs to mitigate the economic pain in any meaningful way because the private sector is likely to cut another 6 million jobs this year and state and local governments will cut more than the federal level is apt to create.
I can’t see how and when consumers and businesses will be willing AND ABLE to spend more. Generation X & Y have pulled forward a lifetime of sales. Many hundreds of billions of dollars worth of stuff bought on credit in the last few years would have been bought in the period ahead if folks had to save for it. Instead, consumers and businesses alike have to retrench in order to pay overwhelming debt service burdens. And one man’s spending is another man’s revenue; and so it goes, the multiplier effect in reverse. These dynamics don’t change overnight. And to the extent that you buy into the bull crap (pun intended) spoon fed to you by CNBC pundits employed by fees on your assets your net worth and quality of life will suffer for it. Understand that the Abby Joseph Cohens of the world will never implore you to take your money out of the Goldman Sachs of the world because it means they get paid less or fired altogether. It’s not good business as they say; but if you ask me its bad business.
Strategists putting a 1100 and 1200 targets on the S&P500 as 2009 started were flat out irresponsible at minimum and probably disingenuous as well. I say that because not only are they clueless about what the earnings on the S&P500 might have been if the constituents remained the same; but many names are being changed to protect the guilty as they say, so what does it mean to the market that the new constituents earn whatever. If I recall correctly, they mentioned $53-$55 in EPS this year (which interestingly was at the low end of the street) and $60 next, but many of the top market caps have been replaced with companies with better balance sheets and earnings. Who in their right mind would take a skewed sample and put a high teen multiple on it and say that’s what they honestly expect. I’ll tell you who – its people with a vested interest in you not allocating capital away from equities. But that’s exactly what you ought to do.
Another reason why I doubt equities can snap back a lot anytime soon is because I can’t recall a time when equities have gotten pummeled to the extent they have and other assets are as attractive as they are. Investors that lost 50-60% in what was supposed to nimble "HEDGE" Funds (which didn’t hedge well) are going to be done with them in many cases and shift money back into the mutual funds (which have much less leverage) which never lost that kind of money for them. They will also buy debt securities, corporate bonds, munis, converts and real estate among other things. Sure there’s a lot of money that will come out of treasuries but it's not going into equities to the extent that it has historically. And that money on the sidelines is not all going back into the market either. Much of it will go to redemptions and other asset classes – I doubt many will underweight cash as much as they had in the past, regardless of what yields are.
As the market rallied a couple of weeks ago, I was shocked to see how many were sucked into the idea that the worst was over. Well educated money managers bought into the company line. Many remain in a state of disbelief and think it can’t get much worse now. They think "I can’t sell now, it’s too late". Wrong again, uncertainty has never been greater, our financial system is melting down and the meltdown is creating massive collateral damage. Otherwise good companies are seeing credit issues impair their operations; which are already under duress on the demand side. As corporate profits slide and the outlook for growth deteriorates so too will equity valuations. Earnings and Multiples will remain under pressure and equities will decline – if you don’t reallocate out of a long only overweight equities portfolio, the market will do it for you.
So the decline is apt to be more protracted than most think and the downside will be such that the comps can’t be easy enough. Retailers are a good example of this – things got bad with retailers almost 2 years ago, they’ve been up against what should have been easy comps but still comping the high teens NEGATIVE for many. Sure, we may be approaching a point where it's hard to get MUCH worse (much being the key) but I think the disconnect here is that everyone is assuming that things bounce back as they did in past cycles when consumer balance sheets weren’t decimated and banks were healthy and lending. Generation X & Y have pulled forward a lifetime of sales (which would have gone to sales in the period ahead and would have been more money with interest instead of deficits and unmanageable debt service burdens. One consumer’s/business’ spending is another consumer’s/business’ revenue and the multiplier effect you heard about in econ 101 (when the butcher buys baked goods and the baker then buy candles etc.) works in reverse. That’s how a mild recession turns into a really bad one – the butcher and the baker cut back the spending and employment and the candlestick maker goes out of business.
My point in all of this is not to be doom and gloom for doom and gloom sake – I’m not trying to be Marc Faber or Jim Rogers talking my book on Bloomberg or CNBC. I’m saying all this to impress upon you how important it is to worry more about containing the risk in your portfolio than missing out on a rally that has a very low chance of happening in the first place. That Goldman Sach’s S&P500 target is now almost 45% away and the hurt is palpable. It’s not too late to reduce exposure to equities and increase exposure to cash, and high quality/much less risky debt. That doesn’t mean you shouldn’t hold equities at all, it means to hold less. Avoid the temptation to bottom-fish banks, brokers, cyclicals, industrials, transports, materials, techs and other relatively high beta, economically sensitive sectors and instead focus on well managed, well financed less cyclical names likely to survive this hell of a cycle. I think names like DE and NUE are still good shorts. And am likely to put FSLR on short as well. I’ll be back to you soon with more names both short and long. But first I’ll tell you why I think TARP is a joke and I’ll suggest what I think is a much better way to stabilize the financial system in a much more cost effective way.
Can the UK government stop the UK banking system going down the snyrting without risking a sovereign debt crisis?
From Reykjavik ...
Late last night I returned from a four-day visit to Iceland with Professor Anne Sibert, co-author of a report anticipating the collapse of the Icelandic banking system and joint carer for our cats and children. Iceland’s largest three banks with border-crossing activities collapsed last fall, as did its currency. The three banks are in administration and new state-owned banks with a purely domestic focus have been set up. Strict capital controls make external borrowing all but impossible and discourage foreign investment. The country now has an IMF program. Strangely enough, the programme does not impose any fiscal pain until 2010. This year the fiscal automatic stabilisers are allowed to work freely, although no further discretionary expansionary fiscal measures are being proposed. Starting in 2010, under the programme, discretionary fiscal tightening of more than 8 per cent of GDP is envisaged between now and 2013. That number could be higher if the external indebtedness of the state turns out to be higher than the 110 per cent of annual GDP estimate of the IMF. The true state of the gross and net external indebtedness, including contingent off-balance sheet exposure, of the Icelandic state is a mystery even now. In addition to sovereign debt and sovereign-guaranteed debt, there are credit lines and possibly other contingent external liabilities whose take-up has to be estimated/guessed to get an accurate view of the state’s external obligations.
It is possible that the IMF figures include an offset against the sovereign’s external liabilities in the form of an estimate of the recovery value of some of the external assets of the sovereign (e.g. its share in the assets of the UK subsidiaries of Kaupthing and Landsbanki). Assigning any positive value to these assets is an act of faith. In any case, it would be helpful to have the hard external liabilities and the soft external assets reported separately. Iceland’s government had to let the country’s three main banks go into administration because it did not have the fiscal capacity to bail out financial institutions with balance sheets amounting to 600-700 per cent of annual GDP. Any attempt to commit further government resources to the rescue of the banking system would have precipitated a sovereign default.With each day that passes, estimates of the recovery value of the assets of the three ‘bad banks’ melts away like snow in April. The decision not to guarantee the liabilities or the assets of the banks (other than retail deposits, including retail deposits with foreign branches for amounts up to €20,000) was the only wise thing the Icelandic authorities have done in this whole sorry mess. It isn’t even clear that the Icelandic authorities came up with this sensible idea themselves. More likely the IMF opened their eyes. The creditors of the banks, which include Commerzbank and Bayerische Landesbank will have to explain to their own shareholders and taxpayers why they now in effect own large chunks of three defunct Icelandic banks.
… to London
Returning to London from Reykjavik last night was like coming home from home. Allowing for the differences in the scale of the Icelandic economy and the British economy (the UK population is more than 200 times larger than Iceland’s Coventry-sized population), there are disturbing economic parallels. The excesses in Iceland during the past decade were greater than in the UK, but not qualitatively different. In both countries, the regulation of banks was laughably lax. The UK’s much-touted light-touch regulation turned out to be soft-touch regulation. Relaxation of regulatory norms was consciously used by the British government as an instrument for attracting financial business to London, mainly from New York City. Fiscal policy in both countries became strongly pro-cyclical during the boom years preceding the financial crisis. Households were permitted, indeed encouraged, to accumulate excessive debt - around 170 per cent of household disposable income in the UK, over 210 percent in Iceland. Both countries permitted the real exchange rate of their currencies to become materially over-valued, more so in Iceland than in the UK, but still to a worrying extent even in the UK. The same version of the ‘Dutch disease’ - the crowding out of the non-financial internationally exposed sectors (exporting and import-competing) by the excessive growth of the financial sector and the construction industry - occurred in both countries, again to a greater extent in Iceland than in the UK, but to an highly undesirable extent even in the UK. Iceland’s gross and net external indebtedness are much greater than that of the UK, and its current account deficits during the years just prior to the crisis were much larger than those of the UK. But the UK too built up very large stocks of gross foreign assets and liabilities and ran persistent current account deficits.
Both countries pay the price for the hubris of policymakers who believed that they had engineered the end of boom and bust and replaced it with perpetual boom. The risks associated with asset market and credit booms and bubbles were dismissed ("how can you be sure it is a bubble? Do you know better than the market etc."). In neither country have the responsible parties (the prime minister, the minister of finance, the governor of the central bank and the head of banking regulation and supervision) admitted any personal responsibility for the disaster. Instead we are told tales of a once-in-a-lifetime calamity, coming at us from abroad, that ruined a perfectly sensible and sustainable set of domestic policies, regulations, rules and arrangements. As if! Both countries allowed the unbridled growth of banks that became too large to fail. In the case of Iceland, the banks also became too large to rescue. In the UK, the jury is still out on the ‘too large to rescue’ issue, but I have serious and growing concerns. Incrementally, the British authorities have guaranteed or insured ever-growing shares of the balance sheets of the UK banks. And these balance sheets are massive. RBS, at the end of June 2008 had a balance sheet of just under two trillion pounds. The pro forma figure was £1,730bn, the statutory figure £1,948 (don’t ask). For reference, UK GDP is around £1,500 bn. Equity was £67 bn pro forma and £ 104bn statutory, respectively, giving leverage ratios of 25.8 (pro forma) and 18.7 (statutory), respectively.
With a 25 per cent leverage ratio, a 4 per cent decline in the value of your assets wipes out your equity. What were they thinking? The fact that Deutsche Bank used to have a leverage ratio of 40 and is now proud to have brought it down to just below 34 is really not a good excuse. Lloyds-TSB Group (now part of the Lloyds Banking Group) reported a balance sheet as of June 30, 2008 of £ 368bn and shareholders equity of £11bn, giving a leverage ratio of just over 33. Of course, for all these banks, the risk-adjusted assets to capital ratios are much lower, but because the risk-weightings depend both on private information of the banks (including internal models) and on the rating agencies, they are, in my view, worth nothing - they are the answer from the banks to the question "how much capital do you want to hold?". That the answer is "not very much, really", should not come as a surprise. For the same date, HBOS, the other half of the new Lloyds Banking Group, reported assets of £681bn and equity of £21bn, giving a leverage ratio of just over 32; Barclays reported total assets of £1,366bn and shareholders equity of £33bn giving a leverage ratio of 41, and HSBC (including subsidiaries) reported assets of £2,547 bn and equity of £134 bn for a leverage ratio of 19. The total balance sheets of these banks amount to around 440 per cent of annual UK GDP. The government seems to be well on its way towards guaranteeing most if not all of it. No one outside the banks (and perhaps even no-one inside them) has a good sense of the true value of what they hold on and off their books.
There is a strong possibility that the UK banks are still hiding toxic or dodgy assets on and off their balance sheets, or are still valuing them at substantially more than their fair value. They are aided and abetted in this by the relaxation of fair value (mark-to-market) principles condoned by the International Accounting Standards Boards, when it permitted the reclassification of certain investments between the three categories of
The new IASB rules are an invitation to management to hide capital losses or to delay their translation into the profit and loss account by strategic reclassification of the assets in question. It is truly scandalous that the IASB approved this ex-post reclassification of investments. In the name of preventing a collapse of the UK banking system, we are witnessing the socialisation - at first gradual, but now quite rapid - of all balance sheet risk of the UK banks by the UK government. This is risky and, in my view, unwise. The manner in which it is done also seems designed to maximise moral hazard. The good news is that it is unnecessary for restoring and maintaining the flow of new credit in the the British economy.
- ‘assets held for trading’ (which are valued at market prices and have these valuations reflected through the profit and loss account),
- assets ‘available for sale’ (which are valued at market prices have these valuations reflected only in the balance sheet, not through the profit and loss account) and
- ‘assets held for investment’ (which need not be valued at market prices).
The state is stretching and testing its current and future fiscal resources both by guaranteeing or insuring ever-growing amounts of new and existing bank funding and bank assets, and through its assumption of private credit risk through such facilities as the £200bn Special Liquidity Scheme (SLS), which swaps Treasury bills against securities backed by mortgages and other loans originated before 2008. The new £50bn Asset Purchase Facility, through which the Bank of England will engage in qualitative easing (increasing the proportion of private and possibly illiquid securities in its portfolio) through outright purchases of private securities rather than by accepting them as collateral in repos and at the discount window, also raises sovereign credit risk, even though the Bank of England is required to purchase only "high-quality" assets. ABS backed by US subprime mortgages were considered high quality once. In view of this progressive socialisation of the balance sheet risk of the UK banks, it is not surprising that there has been some convergence between the CDS rates of the UK sovereign and of the UK banks whose balance sheets are guaranteed or insured to an ever-growing extent by the UK sovereign. I expect this convergence to continue, with the CDS rates of the banks falling and that of the UK sovereign rising. A similar pattern of converging sovereign and banking sector credit risk premia can be observed in other countries. As the banks become more secure, the government becomes less secure.
The UK may not be the first EU member state to face a sovereign debt crisis. According to the rating agencies, the CDS rates and the 10-year sovereign spread over Bunds, the leading candidates for a sovereign solvency crisis are Greece, Spain, Portugal, Italy and Ireland. Some of these countries are in fiscal trouble not because of their sovereign’s exposure to the banking sector but for other reasons, such as a long-standing inability to reduce a very high public debt to GDP ratio, coupled with the prospect of large cyclical deficits as the economy goes into a deep recession. Greece and Italy fall into that category. Among the countries where the sovereign is highly exposed to the banking sector, Ireland may well be the next country where the ‘too large to rescue’ theory may be tested, although countries like the Netherlands, Belgium, Luxembourg, the UK and, outside the EU, Switzerland, are also potential candidates for the ‘too big to rescue’ (without external support) club. Ireland’s outstanding sovereign debt is low as a share of GDP (around 25 per cent) , but the exposure of the sovereign to its overgrown banking system is massive: the Irish state guaranteed the entire liability side of the banks’ balance sheets, except for the equity. Irish 10-year sovereign debt spreads over Bunds stood at 198 basis points on January 16. We may get a test of Eurozone or even of EU fiscal solidarity before this crisis is over, as argued by Wolfgang Munchau. I believe that this crisis will certainly deepen EU-wide fiscal cooperation between national governments. It may even provide the spur for the creation of an embryonic proper supranational EU fiscal authority with independent revenue raising and borrowing powers.
But even if the UK is not the next European country to face a sovereign debt challenge, there is a non-negligible risk that before too long, the growing exposure of the British sovereign to the banking system (and especially to the foreign currency funding risk faced by the UK banking system), together with the 9 and 10 per cent of GDP general government fiscal deficits expected for the next couple of years, may prompt a loss of confidence by the global financial community in the British banks, currency and sovereign. We may well witness the UK authorities going cap-in-hand to the IMF, the EU, the ECB and the fiscally super-solvent EU member states (if there are any left), prompted by a triple crisis (banking, sterling and sovereign debt), to request a bail out. I hope and trust that the UK authorities are in regular contact with the IMF, the US administration, Brussels, Frankfurt and the leading EU member countries to prepare for a possible internationally coordinated bail-out operation for the British banking system and sovereign. My belief that the UK government should take over all UK high street banks (on a temporary basis) is based on the simplification this would provide as regards the governance of these institutions under extreme circumstances, when private ownership and governance have clearly failed, and on its positive effect on incentives for future bank behaviour (’moral hazard). When the public interest and the interests of the existing private shareholders and the incumbent managers and boards of directors diverge as manifestly as they do in this crisis, the sensible thing to do is to buy out the existing shareholders (as cheaply as possible). That way the failed and failing management and boards can be restructured (fired without golden parachutes) and the new owner can insist on and enforce an open, verifiable valuation of toxic and dodgy assets, on and off the balance sheet of the bank.
The non-state shareholders of the UK high street banks ought no longer to be a factor in the discussion of what to do. As of yesterday, their market capitalisations were (according to today’s Financial Times) as follows: Lloyds Banking Group £10.6bn, Barclays £7.4bn, RBS £4.6bn and HSBC £60.8bn. And these valuations reflect the implicit subsidies granted the banks through their access to such state-owned and state-run facilities as the Special Liquidity Scheme, the government’s guarantee of new bank borrowing, deposit guarantees, and the mitfull of new insurance/guarantee schemes announced yesterday. The second major rescue package for UK banks in three months includes very large (and in at least one case potentially uncapped) packages of guarantees and insurance offered to the banks by the state on terms that are not clear. This is very much in the US tradition, promoted by the US Treasury, the Fed and the FDIC, of maximising moral hazard for a given amount of immediate crisis fire-fighting. In the incoming Obama administration, both Treasury secretary Tim Geithner and NEC chair Larry Summers have had many years of experience, in the US and all over the globe, throwing good money after bad in pointless bail-out packages. The trio of Ben Bernanke, Geithner and Summers are likely to produce a veritable moral hazard monsoon. The second instalment of the UK bank rescue package provides unnecessary, undesirable and costly comfort for existing management and boards, for existing private shareholders and for existing creditors and bond holders of the banks. It is unnecessary because the same quantum of crisis-fighting solace can be provided with much smaller effects on the banks’ future incentives for excessive risk taking, by taking the banks into full public ownership and restricting government guarantees to new credit flows.
So here is my proposal:
- Take into complete state ownership all UK high street banks. This has to be mandatory, even for the banks that still like to think of themselves as solvent.
- Fire the existing top management and boards, without golden or even leaden parachutes, except those hired/appointed since September 2007.
- Don’t issue any more guarantees on or insurance for existing assets - regardless of whether they are toxic, dodgy or merely doubtful. Issue guarantees/insurance only on new lending, new securities issues etc. A simple rule: guarantee the new flows, not the old stocks. This will reduce the exposure of the government to credit risk without affecting the incentives for new lending.
- Transfer all toxic assets and dodgy assets from the balance sheets of the now state-owned banks (or from wherever they may have been parked by these banks) to a new ‘bad bank’. If possible, pay nothing for these toxic and dodgy assets. Since the state owns both the high-street banks (I won’t call them ‘good’ banks) and the bad bank, the valuation does not matter. If the gratis transfer of the toxic or dodgy assets to the bad bank would violate laws, regulations or market norms, let an independent party organise open, competitive auctions for these assets - auctions in which the bad bank, funded by the government, would be one of the bidders. Whatever price is realised in these auctions is paid by the new bad bank to the old banks. Capitalize the bad bank with the minimum amount of capital required to meet regulatory norms. Fund the rest of the assets through a loan from the state to the bad bank or through a bond issued by the bad bank and bought by the state. As regards the bad bank, that’s effectively it. With toxic and dodgy securities on the asset side of its balance sheet and with the state owning all the equity and as the only creditor, the assets can either be sold off, if a market develops again, or held to maturity, earning whatever cash flows they may yield.
- As a special case of (4), take the high street banks into full public ownership and treat these existing banks in their entirety as bad banks. Close the existing banks for all new business. Transfer the deposits of the high street banks (now the bad banks) to new (state-owned) ‘good’ banks (or perhaps rather, not yet bad banks). Replace the deposits on the books of the bad banks with loans from the state to the bad banks or with bond issues by the bad banks purchased by the state. Let the new banks (New Lloyds, New RBS, New Barclays and New HSBC) acquire, in a competitive bidding process also open to other market participants, any of the assets of the old banks. Run the new banks as competing publicly owned, profit maximising banks until they can be privatised again, when a sensible regulatory regime for banks is in place and the market for bank shares recovers. Don’t guarantee or insure any items on the balance sheet of the old banks. Use guarantees/insurance exclusively for new lending and new investments by the new banks. Gradually run down the old banks as their assets mature, as under (4).
The miracle of limited liability applies also when the state is the owner. As long as the state-owned bad banks (which could be merged into a single super bad bank) don’t obtain sovereign guarantees for their obligations, the financial exposure of the sovereign is limited to its equity stake and the existing guarantees and insurance it has provided in the past. It is key that there be no further injections of funds by the state into the bad banks until there are no longer any private creditors. If a bad bank becomes balance-sheet insolvent or liquidity insolvent and it still has private creditors (as it would, in general, under the model of item (5)), the bad bank should be put into administration and its debt to parties other than the British state should be converted into equity. That equity would be then be purchased by the UK state. With the bad bank now not just 100 per cent state-owned but also without private creditors of any kind, the assets can be managed as the state sees fit - one hopes in such as way as to maximise the present discounted value of their held-to-maturity cash flows.
The balance sheets of the British banks are too large and the quality of the assets they hold too uncertain/dodgy, for the British government to be able to continue its current policy of extending its guarantees to ever-growing shares of the banks’ liabilities and assets, without this impairing the solvency of the sovereign. Britain risks becoming a victim of the new inconsistent quartet: (1) a small open economy with (2) a large internationally exposed banking sector, (3) a currency that is not a serious global reserve currency and (4) limited fiscal capacity. It risks a triple crisis and a threefold run: on its banks, on its currency and on its sovereign debt. Limiting the exposure of the sovereign to what is fiscally sustainable may imply giving up on saving (all of) the banks. If my proposal for institutionally and legally separating existing stocks of assets and liabilities from new flows of credit and lending is acted upon, the flow of new lending and the supply of new credit need not require the survival of all (or indeed any) banks hitherto deemed systemically important. I look forward to the time when I will be blogging on the best way of privatising the banks again, under new regulatory and governance regimes.
Banking rout raises new fears on Wall Street
The Obama administration on Tuesday came under immediate pressure to rescue the battered financial sector as bank stocks plunged amid growing fears over their capital needs. The S&P Financials index lost 16.7 per cent, leading a 5.3 per cent retreat in the overall stock market. Among leading banks, Citigroup fell 20 per cent to $2.80, its lowest level since the 1998 merger that created the company; Wells Fargo lost 24 per cent; and Bank of America plunged 29 per cent. State Street, a custody bank that had been seen as relatively unaffected by the financial crisis, fell nearly 60 per cent after it reported higher-than-expected unrealised losses on investments and a 71 per cent fall in fourth-quarter profits. Mounting writedowns and provisions have put the banks at the mercy of government policy at a time when the policy framework is both uncertain and shifting in a more aggressive direction.
Some investors fear the clean-up process - probably involving an "aggregator bank" to take on toxic assets - could be prove highly intrusive. Future injections of public capital are likely to come with tough restrictions on dividends and lending mandates. The government could decide to take common stock rather than prefered stock, diluting existing equityholders. "Investors are deeply concerned that the US government might follow the lead of the UK and come in with a rescue package that hurts shareholders by wiping out companies’ shares," one senior banker said. Banking shares in the UK continued to slide on Wednesday after the government’s decision to pump billions of dollars into Royal Bank of Scotland. The move – which came after RBS reported the biggest loss in UK corporate history – reawakened talk that the US government might come to Citi’s rescue for the third time in three months. In the currency markets, sterling was hit hard by fears over the health of the UK banking system, touching a record low on Tuesday against the Japanese yen of Y125.25, and a seven-year low against the dollar of $1.386.
Mortgage-Securities Defaults Rise
Commercial mortgage-backed securities loan delinquencies increased again in December to 0.88% amid defaults on larger loans, according to an index compiled by Fitch Ratings. The ratings firm said the December increase was largely due to two loans with outstanding principal balances greater than $100 million, after a November reading of 0.64% that included two defaults of more than $70 million. The commercial real-estate market has held up better than the housing market, but began to struggle late last year.
Fitch reiterated that it expects large-loan delinquencies to keep driving the index up this year. "What began as weakness in the performance of smaller properties located in tertiary markets now includes larger collateral in secondary and primary markets," Managing Director and U.S. CMBS group head Susan Merrick said.
One of the two big December delinquencies was a $104 million note backed by a portfolio of two hotel properties in Tucson, Ariz., and Hilton Head, S.C. The other was a $125.2 million loan secured by a shopping center in Corona, Calif.
Retail and hotel properties continue to struggle amid the credit crunch and global recession. Fitch has said hotels will likely weaken further as consumers cut back on leisure trips and companies scale back on business trips. The strengthening dollar also is expected to decrease foreign tourism, which had been supporting U.S. hotels. Fitch continues to expect "the accelerated pace of defaults" seen in the fourth quarter will continue into this year, bringing the index to about 2% at year's end.
If the state can't save us, we need a licence to print our own money
In Russell Hoban's novel Riddley Walker, the descendants of nuclear holocaust survivors seek amid the rubble the key to recovering their lost civilisation. They end up believing that the answer is to re-invent the atom bomb. I was reminded of this when I read the government's new plans to save us from the credit crunch. It intends - at gobsmacking public expense - to persuade the banks to start lending again, at levels similar to those of 2007. Isn't this what caused the problem in the first place? Are insane levels of lending really the solution to a crisis caused by insane levels of lending?
Yes, I know that without money there's no business, and without business there are no jobs. I also know that most of the money in circulation is issued, through fractional reserve banking, in the form of debt. This means that you can't solve one problem (a lack of money) without causing another (a mountain of debt). There must be a better way than this. This isn't my subject and I am venturing way beyond my pay grade. But I want to introduce you to another way of negotiating a credit crunch, which requires no moral hazard, no hair of the dog and no public spending. I'm relying, in explaining it, on the former currency trader and central banker Bernard Lietaer.
In his book The Future of Money, Lietaer points out - as the government did yesterday - that in situations like ours everything grinds to a halt for want of money. But he also explains that there is no reason why this money should take the form of sterling or be issued by the banks. Money consists only of "an agreement within a community to use something as a medium of exchange". The medium of exchange could be anything, as long as everyone who uses it trusts that everyone else will recognise its value. During the Great Depression, businesses in the United States issued rabbit tails, seashells and wooden discs as currency, as well as all manner of papers and metal tokens. In 1971, Jaime Lerner, the mayor of Curitiba in Brazil, kick-started the economy of the city and solved two major social problems by issuing currency in the form of bus tokens. People earned them by picking and sorting litter: thus cleaning the streets and acquiring the means to commute to work. Schemes like this helped Curitiba become one of the most prosperous cities in Brazil.
But the projects that have proved most effective were those inspired by the German economist Silvio Gessell, who became finance minister in Gustav Landauer's doomed Bavarian republic. He proposed that communities seeking to rescue themselves from economic collapse should issue their own currency. To discourage people from hoarding it, they should impose a fee (called demurrage), which has the same effect as negative interest. The back of each banknote would contain 12 boxes. For the note to remain valid, the owner had to buy a stamp every month and stick it in one of the boxes. It would be withdrawn from circulation after a year. Money of this kind is called stamp scrip: a privately issued currency that becomes less valuable the longer you hold on to it.
One of the first places to experiment with this scheme was the small German town of Schwanenkirchen. In 1923, hyperinflation had caused a credit crunch of a different kind. A Dr Hebecker, owner of a coalmine in Schwanenkirchen, told his workers that if they wouldn't accept the coal-backed stamp scrip he had invented - the Wara - he would have to close the mine. He promised to exchange it, in the first instance, for food. The scheme immediately took off. It saved both the mine and the town. It was soon adopted by 2,000 corporations across Germany. But in 1931, under pressure from the central bank, the ministry of finance closed the project down, with catastrophic consequences for the communities that had come to depend on it. Lietaer points out that the only remaining option for the German economy was ruthless centralised economic planning. Would Hitler have come to power if the Wara and similar schemes had been allowed to survive?
The Austrian town of Wörgl also tried out Gessell's idea, in 1932. Like most communities in Europe at the time, it suffered from mass unemployment and a shortage of money for public works. Instead of spending the town's meagre funds on new works, the mayor put them on deposit as a guarantee for the stamp scrip he issued. By paying workers in the new currency, he paved the streets, restored the water system and built a bridge, new houses and a ski jump. Because they would soon lose their value, Wörgl's own schillings circulated much faster than the official money, with the result that each unit of currency generated 12 to 14 times more employment. Scores of other towns sought to copy the scheme, at which point - in 1933 - the central bank stamped it out. Wörgl's workers were thrown out of work again.
Similar projects took off at the same time in dozens of countries. Almost all of them were closed down (just one, Switzerland's WIR system, still exists) as the central banks panicked about losing their monopoly over the control of money. Roosevelt prohibited complementary currencies by executive decree, though they might have offered a faster, cheaper and more effective means of pulling the US out of the Depression than his New Deal. No one is suggesting that we replace official currencies with local scrip: this is a complementary system, not an alternative. Nor does Lietaer propose this as a solution to all economic ills. But even before you consider how it could be improved through modern information technology, several features of Gessell's system grab your attention.
We need not wait for the government or the central bank to save us: we can set this system up ourselves. It costs taxpayers nothing. It bypasses the greedy banks. It recharges local economies and gives local businesses an advantage over multinationals. It can be tailored to the needs of the community. It does not require - as Eddie George, the former governor of the Bank of England, insisted - that one part of the country be squeezed so that another can prosper. Perhaps most importantly, a demurrage system reverses the ecological problem of discount rates. If you have to pay to keep your money, the later you receive your income, the more valuable it will be.
So it makes economic sense, under this system, to invest long term. As resources in the ground are a better store of value than money in the bank, the system encourages their conservation. I make no claim to expertise. I'm not qualified to identify the flaws in this scheme, nor am I confident that I have made the best case for it. All I ask is that, if you haven't come across it before, you don't dismiss it before learning more. As we confront the failure of the government's first bailout and the astonishing costs of the second, isn't it time we considered the alternatives?
The Trouble with TARP
Financial stocks plunged Jan. 20 as investors worry about the strings attached to the U.S. Treasury's bailout of institutions like Bank of America. Just as the prospects for bank stocks can't seem to get any worse, they do. To the all-too-real problems of the financial crisis and recession, add another serious concern: A U.S. government bailout may prop up the financial system and save big banks from collapse, but it may prove disastrous for bank shareholders. A case in point is Bank of America, which led the stock market lower on Jan. 20 by plunging 29%. With shares of Citigroup, another troubled banking giant, dropping 20%, financial stocks were responsible for much of the stock market rout on Jan. 20.
The Dow Jones industrial average lost 332 points, or 4% of its value, while the broad Standard & Poor's 500-stock index, with a heavier concentration of financial stocks, lost 5.3%. Investors were clearly worried about mounting problems for banks, exemplified in recent earnings reports that show huge increases in problem loans and billions more in investment losses. New York University Professor Nouriel Roubini, who foresaw the credit crisis, heightened investors' panic when Bloomberg reported on Jan. 20 that he estimated credit losses for U.S. firms could hit $3.6 trillion. Thus, the U.S. banking system—with just $1.4 trillion in capital—is "effectively insolvent," Roubini said, according to Bloomberg. "The problems of Citi, Bank of America, and others suggest the system is bankrupt," he added.
The supposed cure for this is the federal government's $700 billion Troubled Assets Relief Program, or TARP, enacted late last year. However, a growing number of investors and analysts warn that the TARP program may come at a large cost to bank shareholders. Banks get TARP relief only by giving the federal government preferred shares. On Jan. 16, BofA issued the government another $20 billion in preferred stock that pays an 8% dividend. In exchange, the government agreed to limit future losses on $118 billion in BofA investments, including a large amount of the portfolio acquired through BofA's buyout of Merrill Lynch. "Increased support by the U.S. government provides protection on certain problem assets," notes Deutsche Bank analyst Mike Mayo, but "it also comes with more restrictions on [BofA] as a whole." There are three main concerns about the government's rising stake in banking firms like BofA, says Stifel Nicolaus (SF) analyst Christopher Mutascio.
First, there is the size of dividend payments due to the government each year, which leave little remaining for regular shareholders. On Jan. 16, BofA slashed its first-quarter dividend to just 1¢ per share. Meanwhile, Mutascio estimates the preferred dividend payment to the U.S. Treasury will be $4.8 billion per year. That's 73% of the total net income he expects from BofA in 2009. FBR Capital Markets (FBR) analyst Paul Miller estimates preferred dividends could shave 90¢ per share off BofA's annual earnings "for the next three years at least." Second, the TARP program's investments must eventually be paid back. At BofA, the government's equity stake is $49 billion. After the stock's disastrous drop on Jan. 20, the government's equity stake is almost twice the public market capitalization for the bank of $25.6 billion. To repay TARP money, Mutascio warns, banks may need to issue new public shares, which would greatly dilute current shareholders' stakes. Finally, there is the power that the TARP investment gives federal policymakers over bank operations.
With so much of BofA owned by the taxpayers, "we are concerned that common equity is no longer the dominant form of capital at Bank of America," FBR's Miller warned on Jan. 20. "It is reasonable to assume that political pressure will only mount on [BofA] to do things that may not be in the best interests of its common shareholders," Mutascio wrote on Jan. 20. The arrival of the Obama Administration only adds to the uncertainty. Standard & Poor's equity analyst Erik Oja raised his rating on shares of BancorpSouth (BXS) in part because the regional bank hasn't needed to take TARP funds. Banks don't know all the disadvantages of taking the TARP bailout, Oja says, because "the government does reserve the right to tweak some of the rules going forward." For example, analysts warn banks may be forced by the government to loan out money.
That may help the U.S. economy recover more quickly, but it could hurt bank balance sheets if they're forced to lend to people and businesses just as their finances are being hurt by a serious recession. In some cases, banks could be forced to eliminate dividends to common shareholders, Oja warns. While others could be forced to boost lending, even though it's difficult to find creditworthy borrowers in a recession. "Taking that money and putting it to work right now is tough," Oja says. According to a Keefe, Bruyette & Woods analysis, 262 firms have announced they've received TARP capital. Another 121 institutions say they won't seek bailout funds. Most of those refusing TARP money are smaller regional banks, including BancorpSouth, New York Community Bancorp, and Union Bankshares.
Many of those who took TARP money simply had no choice as credit losses mount. Those losses remain banks' biggest concern, because they are the reason banks must seek federal bailouts despite the strings attached and the disadvantages to shareholders. "Credit losses are the key to earnings for any financial company," Miller says. Losses in the housing market, commercial real estate, and other investments and loans are leaving banks dangerously short of capital, analysts warn. "We would avoid not only [BofA's] shares, but also shares of most financial institutions until the companies are better capitalized," Miller adds. Some analysts look at the cheap stock prices for major banks and see buying opportunities.
Raymond James analyst Anthony Polini rates Bank of America a "strong buy." The bank's "core" annual earnings power is something like $4 per share. "Although it may take three or four years to regain this level of earnings, longer-term investors should be well rewarded for their patience," Polini writes. One of those long-term investors is the U.S. taxpayer. The Congressional Budget Office on Jan. 16 estimated that, using one method of analysis, the U.S. Treasury's $247 billion in TARP investments made as of Dec. 31 have lost 25% of their value. Uncle Sam, like ordinary stockholders, can only watch, and wince.
Geithner Urges Quick Changes to Bailout Fund
President Barack Obama’s nominee for Treasury Secretary, Timothy F. Geithner, called for "fundamental reform" of the government’s $700 billion bailout plan Wednesday saying it favored big financial institutions over small businesses and struggling families. In testimony to the Senate Finance Committee, Mr. Geithner, who is the former head of the New York Federal Reserve, said changes in the Troubled Asset Relief Program, or TARP, were needed immediately. "Many people believe the program has allowed too much upside for financial institutions, while doing too little for small business owners, families who are struggling to keep their jobs and make ends meet, and innocent homeowners," Mr Geithner said. "We have to fundamentally reform this program to ensure that there is enough credit available to support recovery."
Although Mr. Geithner’s nomination is expected to be approved, he faces questions over his recent payment of $34,000 in back taxes for Social Security and Medicare that he failed to pay as a senior official of the International Monetary Fund from 2001 to 2003, including a small payment in 2004 after he left. The chairman of the Senate Finance Committee, Senator Max Baucus, a Montana Democrat, said in his opening remarks that Mr. Geithner’s tax problems were disappointing, but innocent. Congress has approved the second $350 billion tranche of the TARP program, but it has yet to be deployed. The first tranche, originally intended to buy up toxic mortgages and other assets from banks, has so far been used to large stake in financial institutions and bailout major United States automakers.
Mr. Geithner, who played crucial roles in the government bailout of the insurance giant American International Group and JPMorgan Chase’s purchase of Bear Stearns, urged swift action to get credit flowing again. "If our policy response is tentative and incrementalist, if we do not demonstrate by our actions a clear and consistent commitment to do what is necessary to solve the problem," he said, "then we risk greater damage to living standards, to the economy’s productive potential, and to the fabric of our financial system." Mr. Geithner said the $825 billion economic stimulus package that House leaders unveiled last week is a critical part of the solution, "but has to be accompanied by aggressive action to address the housing crisis and to get credit flowing again."
Why Obama must mend a sick world economy
Pity President Barack Obama. He won power partly because of the global economic crisis. He himself, most of his fellow citizens and much of the rest of the world agree that the US broke the world economy and now has the duty to fix it. Unhappily, this consensus is false. The crisis is a product of the global economy. It cannot be cured by the US alone. Happily, Mr Obama has the authority needed to lead the world towards a resolution: his hands are clean, and his lack of desire to exculpate his country is evident. It is also in the interest of his country and the world that the world economy be put on a sounder footing. Should this effort fail, I fear a resurgence of protectionism will be the outcome.
What then is the global failure? It is the malign interaction between some countries’ propensity towards chronic excess supply and other countries’ opposite propensity towards excess demand. This is the theme of my book Fixing Global Finance. But the biggest point about the world economy today is that the credit-fuelled household borrowing that supported the excess demand in deficit countries has come to a sudden stop. Unless this is reversed, excess supply of surplus countries must also collapse. This statement follows as a matter of logic: at world level, supply must equal demand. The question is only how the adjustment occurs.
Michael Pettis of Peking University laid out the argument in the Financial Times on December 14 2008. Professor Pettis sees the world as divided into two economic camps: in one are countries with elastic systems of consumer finance and high consumption; in the other are countries with high savings and investment. The US is the most important example of the former. China is the most significant example of the latter. Spain, the UK and Australia were mini versions of the US; Germany and Japan are mature versions of contemporary China. I have argued that the driving force behind these "imbalances" has been the policies of surplus countries and particularly of China, whose surpluses have grown particularly quickly. A managed exchange rate, huge accumulations of foreign currency reserves and sterilisation of their monetary consequences, tight fiscal discipline and high retained earnings of companies have generated national savings rates of well over 50 per cent of gross domestic product and current account surpluses of more than 10 per cent.
Household savings appear to generate less than a third of total savings. In turn, investment has poured into expanding supply, including of exports: the ratio of China’s exports to GDP rose from 20 per cent of GDP at the beginning of 2002 to 37 per cent in 2007 (see chart). The view that the excesses of deficit countries were partly a response to the behaviour of surplus countries is shared by a number of policymakers, including Hank Paulson, outgoing US Treasury secretary. Zhang Jianhua of the People’s Bank of China is reported to have declared that "this view is extremely ridiculous and irresponsible and it’s ‘gangster logic’ ". In this perspective, the pattern of global deficits and surpluses was solely caused by western policymakers, particularly the Federal Reserve’s lax monetary policies and unregulated expansion of credit.
Yet, whoever was most responsible, one point is certain: huge asset price bubbles made possible the excess supply of some countries, particularly China. Since the Asian financial crisis of 1997-98, the developed world – and the US in particular – have experienced, successively, the largest stock market bubble and the biggest credit-fuelled housing bubble in their histories. This era is over. We will struggle with its aftermath for years. So what happens now? The implosion of demand from the private sectors of financially enfeebled deficit countries can end in one of two ways, via offsetting increases in demand or via brutal contractions in supply.
If it is going to be through contractions in supply, the surplus countries are particularly at risk, since they depend on the willingness of deficit countries to keep markets open. That was the lesson learnt by the US in the 1930s. Surplus countries enjoy condemning their customers for their profligacy. But when the spending stops, the former are badly hurt. If they try to subsidise their excess supply, in response to falling demand, retaliation seems certain. Obviously, expansion of demand is much the better solution. The question, though, is where and how? At present much of the expansion is expected to come from the US federal budget. Leave aside the question whether this will work. Even the US cannot run fiscal deficits of 10 per cent of GDP indefinitely. Much of the necessary expansion in global demand must come from surplus countries.
Managing this adjustment is far and away the biggest challenge for the group of 20 advanced and emerging economies, which will meet in London in early April. Mr Obama must take the lead. He can – and should – say he expects these adjustments to be made, but understands they will take time. He can also sustain exceptional fiscal and monetary measures in the short term, if his country’s main trading partners make the necessary medium-term adjustments in their spending. China, in particular, needs to create a consumption-led economy. That is in the interests of China. It is also in the interests of the world. Yet this is not all the US should propose. If the world economy is to be less dependent on destructive bubbles, more of the world’s surplus capital needs to flow into investment in emerging economies. The problem, however, is that such flows have also always led to crises. This is why emerging economies set themselves to accumulate vast foreign currency reserves in this decade. It is essential, therefore, to make the world economy much more supportive of net borrowing by emerging economies.
What will be needed for this is far bigger and more effective insurance against systemic risks than the International Monetary Fund now provides. A crucial step is a restructuring of the IMF’s governance, to make it more responsive to the needs of responsible borrowers. One of the ideas Mr Obama should propose is the establishment of a high-level committee to recommend a radical restructuring of global institutions, with a view to lowering risks of the emerging market crises that preceded the era of advanced country bubbles. Let us be clear about what is at stake. It is essential to clean up the huge current mess. But it is also evident that an open world economy will be unsustainable if it remains dependent on bubbles. Collapse of globalisation is now no small risk. Mr Obama is present at the re-creation of the global economic system. It is a challenge he has to take up.
Amid Revelry, Recession's Shadow Looms
Dan Kidd put his life savings into the Pex Pocket Crimper. Now he is hoping that President Barack Obama will help keep that investment from driving him into bankruptcy. The 60-year-old mechanical engineer from Limington, Me., spent three years and $100,000 -- some of it borrowed from friends -- developing the new plumber's tool. He even managed to get it placed in big home-improvement stores. "Now, because of the economy, it's on the edge," Mr. Kidd said Tuesday, standing at the base of the Washington Monument waiting for Mr. Obama to take the oath of office. "I've got all of my eggs in one basket." Looming over the joyous crowds on the National Mall on Tuesday was the shadow of recession. Even as they celebrated the inauguration of Mr. Obama as the 44th president of the U.S., many were preoccupied by the prospect of vanishing jobs and vanishing savings. Since the recession started in December 2007, the U.S. economy has shed 2.6 million jobs. It is expected to lose two million more before year's end.
Mr. Kidd and five friends piled into his van to drive to Washington for the inauguration. The van broke down about 20 minutes from home. So they rented another van and forged ahead. It cost Mr. Kidd about $100 to make the trip, money he could ill-afford but considered well-spent. "I'm very encouraged with this new guy taking office," Mr. Kidd said. Not far away, 32-year-old Brian Murphy, who teaches economic history at City University of New York, pondered the cutbacks his department is facing. "They stopped buying toner for the printers" for a few weeks in December, he said. "Make your last copies before it runs out." The current financial chaos reminds him of the Panic of 1907, when a failed attempt to corner the market on stock in a copper company led to a run on banks and trusts. Public confidence in financial institutions evaporated. Such financial crises, he said, typically take a decade to resolve.
Mr. Murphy thinks his own job is secure for now. His students aren't so lucky. Many study finance; a year ago they planned on a career in investment banking. Now many of the major investment banks have disappeared. "It's such a lousy year to graduate," Mr. Murphy said. "It's a great time to teach economic history." His friend Rachel Shiffrin, 28, who works for a nonprofit group that specializes in Medicare issues, said that her organization has already lost some government funding and laid off more than 10% of its staff. "I was one of the most recent hires," Ms. Shiffrin said. "I'm cuttable." Nearby, Tokumbo Shobowale, 38, chief operating officer of the New York City Economic Development Corp., said his agency, like others in the municipal government, is seeing 10% budget cuts, thanks in large part to the revenue lost because of Wall Street's collapse. But he hopes that Mr. Obama's $800 billion-plus tax-cut and spending package will clear Congress quickly and direct new infrastructure spending the city's way.
"The investment in the stimulus package should be proportional to the population of the city," he said hopefully. In front of him stood Steve Wickmark, 57, commissioner of social services for Chautauqua County, N.Y. Since mid-October, he has seen Medicaid and food-stamp applications jump more than 10% a month. "It's a reflection of a lot of people out of work and having a really difficult time," he said. To make ends meet, the county will have to shift funds out of prevention programs -- drug treatment, home-care for elders and the like -- "that help before people become desperate," he said. Candace Hunstad, a 29-year-old primary-school teacher in Fairfax County, Va., said the economic outlook is "all doom and gloom." The school system has announced there will be no raises and no cost-of-living adjustment this year, she said. A year ago she would have replaced her 1995 Honda Accord, which has 240,000 miles on the odometer.
Now she lives with the water that seeps in through the rotting floorboards and the car alarm that sounds off at random intervals. When money is tight, she poaches from her parents' refrigerator. She is worried that she will also lose the $700 government subsidy she gets to attend a graduate program that could help her move up to school principal someday. "That will mean more debt for us," Ms. Hunstad said. "It's not something we planned for," added her husband, 38-year-old Quentin Hunstad, a communications manager for an aerospace company. The couple bought a $350,000 house in Herndon, Va., last summer. They felt lucky to get a mortgage at all, with credit being tight as it is. But they figure the house has already lost value. "We're juggling a lot of chainsaws," Ms. Hunstad said.
U.S. January home builder sentiment sinks to new low
U.S. home builder sentiment sank to a new low in January as concerns about the faltering economy and reluctant home buyers hurt confidence in the market for newly built single-family homes, an industry group said on Wednesday. The National Association of Home Builders said its preliminary NAHB/Wells Fargo Housing Market Index was 8 in January, down from 9 in December. That is the lowest level on record since the gauge was launched in January 1985. Readings below 50 indicate more builders view market conditions as poor than favorable. The January index was below expectations of 9, based on a Reuters survey of economists.
Eric Belsky, executive director at Harvard University's Joint Center for Housing Studies, said home builders are not only struggling under sinking demand and a credit crisis, but are facing a flood of homes in foreclosure. "They have been responding to slack conditions by reducing production dramatically, but demand continues to fall and until that comes back, the drop in production is not enough to make the market turn around," he said. Interest rates on mortgages have fallen sharply recently, a key development that could help turn around the hard-hit housing sector, but not enough to improve demand at this point.
"Even though we have lower mortgage rates, people are staying sidelined out of fear over further home price drops, anxiety about the economy, their income and their job," Belsky said. The U.S. housing market is suffering the worst downturn since the Great Depression as a huge supply of unsold homes, tighter lending standards and record foreclosures push down home prices. "Clearly, conditions in the nation's housing market aren't getting any better, and they aren't going to get any better until the federal government takes substantial action to encourage qualified buyers to get back in the market," NAHB Chairman Sandy Dunn, a home builder from Point Pleasant, West Virginia, said in a statement.
The gauge of current single-family homes sales fell to 6 from 8. The index of sales expected in the next six months, however, increased to 17 from 16. The prospective-buyer traffic measure also climbed, rising to 8 from 7, the group said. Home builders have curbed new construction as they have been working through inventories of unsold homes by slashing prices at the expense of profits to pay off debt and keep afloat. "Builder views continue to track with historically low consumer confidence measures," NAHB Chief Economist David Crowe said in a statement.
"The fact that there has been microscopic movement in the historically low HMI and its component indexes over the last three months provides further evidence of the need for government action to rejuvenate housing demand," he said.
Fundamentalist View: 'There will be only two London-listed banks left by the end of 2009'
Two years ago, the suggestion that nationalisation could happen in the United Kingdom would have been laughable. But the government is now the largest, or only, shareholder in Lloyds/HBOS, RBS and Northern Rock and it seems highly likely that HSBC and Standard Chartered will be the only UK-quoted bank shares by the end of 2009. Even in these tough markets, however, it is worthwhile to continue to think about the need for long-term, inflation-beating investments to fund or supplement retirement. UK equities can do this over the long term because gross domestic product (GDP) – a measure of economic output – growth will return and plenty of companies are in decent shape to benefit from this. In one or two years' time inflation could well raise its head again as emerging markets recover from their cyclical slowdown and capital injections start feeding through.
Governments by that time also need to start paying down some of their mountains of accumulated debt, and inflation would help to erode this over time. Cash, government bonds and corporate bonds are unable to beat inflation over the long term. We undoubtedly have a difficult period ahead for the UK economy with its structural bias towards financial services and household consumption. Both of these, we believe, are likely to deliver weak to no growth over the next few years as the deleveraging process continues and regulation intensifies. As a result the outlook for the UK equity market as a whole remains tough. Good stock selection will continue to be crucial. Those areas that have benefited from the credit boom continue to be best avoided. We continue to avoid equity exposure to UK domestic banks despite the significant falls in their share prices. We are moving to a new world where thrift will, and should be, pre-eminent.
Banks do not want to lend, and will not do so unless government compels them to. We believe 2009 banking bad debts will deteriorate at a rate that will still surprise negative market observers. Many defaulting assets classes have not been tested in past recessions as they simply were not around on a meaningful scale, for example credit cards, innovative mortgages and private equity debt. These could well destroy all the bank capital that was raised in 2008. As a result, UK domestic banks remain short of equity capital with the UK government the only source of new capital. The trend towards nationalisation will continue, consistent with government objectives to force banks to lend more. As a result we think the outlook for UK bank stocks remains bleak.
Government priority is to support the banking system, not bank shareholders. But there are some very attractive dividend yields to be had in the UK. In fact, an investor can get 3.2 times more dividend yield on the FTSE All Share than on Bank of England base rates. According to Barclays Capital data going back to 1899, this is the highest the stock market dividend yield has ever been, even beating the last "highest ever" level (3.1 times) at the start of the World War II. There are still plenty of uncertainties around but, if we can make sure the dividend yields we get on our stocks or funds come through, then it may be that investors are starting to get paid to take on some additional risks.
We believe investors can find relative safety in dividends in those UK equities that offer comparatively safe defensive earnings – that is, shares with a lower risk of downgrades – exposure to globally diversified markets (to benefit from a translation back into the weak pound); a strong balance sheet (so expensive borrowing can be avoided), head room in the percentage of earnings that has been paid out as dividends (so this has room to rise in tougher times) and a firm dividend growth commitment at board level. Many of the UK's mega cap companies – that is, very large companies with a big stock market capitalisation – tick most or all of these boxes. We favour companies like BP, Shell, GlaxoSmithKline, AstraZeneca, Vodafone, and British American Tobacco, but also many of the utilities. We believe BP and Shell will be able to meet their dividend commitments for a number of years – even at these levels of oil prices.
In fact, Shell has at least maintained its dividend going all the way back to the World War II. At its last results, Vodafone's CEO explicitly stated that the company sees increasing its dividends as the primary reward to its shareholders. We believe Vodafone's dividend will grow by at least 3pc going forward from an already attractive dividend yield of nearly 6pc. When it comes to picking funds offering income, we believe investors should analyse if these funds have grown their income consistently, even in prior periods of dividend cuts, such as 2001 and 2002. We also believe investment houses with their own analysts should offer greater confidence in avoiding companies which cut their dividends. Typically, in uncertain times like these, sell-side analysts tend to be late or wrong in their earnings and dividend forecasts.
UK cannot take Iceland's soft option
The British government faces an excruciating choice. It cannot let Royal Bank of Scotland and its fellow mega-banks go to the wall. Yet it risks being swamped by the massive foreign debts of these lenders if it takes on their dollar, euro and yen exposure by opting for full nationalisation. Britain has foreign reserves of under $61bn dollars (£43.7bn), less than Malaysia or Thailand. The foreign liabilities of the UK banks are $4.4 trillion – or twice annual GDP – according to the Bank of England. The mismatch is perilous. It is why sterling has crashed 10 cents from $1.49 to $1.39 against the dollar in two days. The markets have given their verdict on Gordon Brown's latest effort to "save the world". Credit default swaps (CDS) measuring risk on British debt have reached an all-time high of 125, just below Portugal.
The yield spread on 10-year Gilts over German Bunds has doubled to 53 since last week. Standard & Poor's has quashed rumours that it will soon strip Britain of its AAA credit rating – an indignity averted even after the International Monetary Fund bail-out in 1976. But there was a sting yesterday as it responded to the Treasury plan for the banks. "Market confidence in the sector has eroded to such a degree that it is not clear whether these measures by themselves will bring about a material improvement," the IMF said. "As a result, full nationalisation of some banks remains a possibility in our view." Spain was relegated from AAA to AA+ on Monday, and Spain's public debt is a much lower share of GDP. "If Spain can get downgraded, then the risks for the UK are self-evident," said Graham Turner, of GFC Economics. "The increase in the UK gross public debt burden – 11.8 percentage points in just one year – is troubling. The market rightly fears the long-term fiscal costs of a collapsing banking system. Rising Gilt yields are the main impact of the botched move from the UK Treasury."
Mr Turner said the British Government had taken far too long to resort to quantitative easing – printing money – and had wasted months with fiscal frippery as debt deflation throttled the banks. The parallels with Iceland are disturbing. The country was ruined by the antics of its three big banks. They built up foreign liabilities equal to 900pc of GDP. Operating as hedge funds, they borrowed in dollars, euros and pounds to speculate. However, the state lacked the foreign reserves to match this leverage. But Iceland at least had the luxury of letting banks default – shifting losses on to the rest of the world. It refused to honour foreign debts. "They drew a line," said Jerry Rawclifffe, who tracks Iceland for Fitch Ratings. "They created new banks, parking the old losses in resolution committees. It is not easy for other governments to walk away. They have a duty of care."
Indeed, if Britain walked away from UK banks' $4.4 trillion of foreign liabilities – worth eight times Lehman Brothers – it would destroy the credibility of the City and take the whole world into deeper depression. "The UK cannot go down that route because it would set off an asset price death spiral," said Marc Ostwald, a bond expert at Monument Securities. "The Western banking system is already on life support. That would turn it off altogether." So whatever the temptations, and whatever the feelings of righteousness over the follies of the RBS leadership in its debt-driven campaign of Napoleonic expansion, the Treasury is wedded to the banks and all their sins. Chancellor Alistair Darling cannot copy Iceland. S&P's lead UK analyst, Trevor Cullinan, said the Government faces a "severe test" and will be judged by its actions, but he doubts whether matters will reach such a dangerous pass.
"The challenges to UK banks are significant amid a correction in property prices and a contraction of GDP. Nevertheless, the situation is very different from Iceland. The UK benefits from sterling, which is a major global funding currency. UK access to external funding is far more secure. In a worst-case scenario we estimate the cost of recapitalising the UK banking system to be in the region of £83bn (5.7pc of GDP)," he said. The Government can take out derivatives contracts on currency markets to hedge the foreign debt risk. Perhaps it already has. The banks have $4.4 trillion foreign assets to offset their liabilities, of course. But what is their real value in this climate? Britain is not alone in its current distress, although the fall in sterling speaks for itself. The sovereign debt of Russia, Ukraine, Greece, Italy, Belgium, Austria, The Netherlands, Ireland, Australia, New Zealand and Korea is all being tested by the markets. The core of countries deemed safe is shrinking by the day to a half dozen. Sadly, Britain is no longer one of them.
European emerging markets suffer most
After a dire 2008, the new year has brought little relief for these emerging economies as their equity and currency markets have been the laggards, underperforming developing markets in other parts of the world. With every kind of economic data deteriorating across the globe in what has been described as the most synchronised recession since the 1930s, no market is safe from the general malaise. But in eastern and central Europe the pain has been greater as investors continue to head for the exits amid growing fears that one of their faltering economies could default. Stock markets in Russia, Poland, the Czech Republic and Hungary have fallen by 15 per cent on average since the start of the year, while their currencies have tumbled about 12 per cent against the dollar. The Turkish stock market has fallen about 12 per cent. In Asia and Latin America, by contrast, stocks and currencies have by and large held their own. Chinese stocks have outperformed, rising by around 9 per cent since January 1, while the Brazilian Real is only a touch down against the dollar.
Nigel Rendell, senior emerging markets strategist at RBC Capital Markets, says: "It is a very nasty world at the moment. There are few, if any, markets that investors like in this environment. But eastern and central Europe are suffering the most." This is because the region took on vast amounts of debt before the financial crisis blew up in August 2007, leading to unsustainably high current account deficits and ballooning foreign debt payments. Such were the difficulties in Hungary and Ukraine that they had to be rescued by the International Monetary Fund. In a risk temperature gauge tracking the biggest emerging market economies published by RBC Capital Markets this week, the top 10 economies most likely to default all came from eastern and central Europe, with the exception of Iceland. The risk calculations were based on current account deficits, the amount of debt held by banks and companies in the particular countries and their capital adequacy ratios. Deutsche Bank research this week also showed the combined current account deficits and debt of eastern and central European countries is around 18 per cent of gross domestic product compared with only 8 per cent in Asia and Latin America. Countries with the highest ratios of external debt include the Baltic republics of Estonia, Latvia and Lithuania, according to Deutsche.
But it is the bigger economies that worry analysts most because a default could have serious repercussions for their neighbours. Many of these economies have to repay billions of dollars of their debt this year, which is putting yet more pressure on them because of the continuing difficulty in accessing the credit markets. Russia, which has seen the rouble fall about 12 per cent against the dollar and about 5 per cent against the euro this year, has to renew about $500bn, according to ING Financial Markets. Ukraine and Hungary have debts to roll over of about $30bn and $15bn this year respectively. RBC Capital Markets last week said the emerging world of the 16 biggest economies was now in recession, after seeing a combined contraction in the fourth quarter of last year and forecasts of a further contraction this quarter. Fears of further sovereign defaults have also risen with some analysts warning that Ukraine, with its high level of short-term debt and one of its banks running out of cash at the end of last year, could default, in spite of the IMF help. So far, only tiny Seychelles and Ecuador have defaulted on their sovereign debt since the credit crisis started in August 2007. Even Iceland managed to avoid a sovereign debt default, in spite of a collapse in its banking system, as international agencies came to the rescue.
Arend Kapteyn, chief economist of the Europe, Middle East and Africa region at Deutsche bank, says: "Global trade is collapsing, confidence is plummeting and the credit and industrial production data have been horrible. Trying to call the bottom here is a bit like trying to catch a falling knife. Price volatility in equities and currencies is being exacerbated by market illiquidity, which itself is a good indication of the stress and uncertainty still in the system." There are some rays of hope in the Latin American and Asian markets, although pessimism surrounds the Middle East because of the low oil price, while Africa remains a bit of an enigma with political uncertainty in many countries. It is China, the biggest emerging market, where hopes mainly rest. It has started rebounding after suffering heavy losses in 2008. Consensus forecasts for growth in 2009 are around 8 per cent as it is expected to benefit from a massive stimulus package. Brazil, with its solid public finances, is also seen as a good bet by some investors. Its stock market is up on the year so far, in spite of continuing worries over commodities. However, the weakness of the US economy remains the biggest drag on any chance of recovery in the emerging markets, with the so-called decoupling theory completely debunked. "Decoupling is just a distant memory," says Mr Rendell. "Even China with exports making up 35 per cent of its GDP, which mainly go to the US and Europe, is reliant on the US consumer."
In U.K., Currency Tumbles on Fear That Bailout Will Fall Short
The U.K.'s latest bank-rescue effort initially backfired Tuesday, helping drive its currency to historic lows while aggravating fears about the stability of the country's banks and the fate of the government's finances. Rather than reassure markets, the giant new bailout plan announced Monday by Prime Minister Gordon Brown underscored the depth of the crisis faced in one of the world's largest financial centers. The pound slid nearly 5% Tuesday to an all-time low against the yen, according to Morgan Stanley, and to a seven-year low against the dollar. Bank shares fell steeply on fears that the government will be forced to nationalize banks, after it already injected £37 billion ($53.48 billion) into its three largest. Lloyds Banking Group led the way down among bank stocks Tuesday, dropping 31%. Throughout Europe, meanwhile, prices of government bonds fell -- reflecting growing concerns that a number of governments will be dragged further into costly efforts to prop up their banking systems. European Union finance ministers warned that governments are running out of room to spend to boost their economies because of rising public debt -- even as Germany, the region's largest economy, said its gross domestic output would shrink 2% this year.
Investors are increasingly on guard against the prospect of rating downgrades on government debt after ratings company Standard & Poor's downgraded Spain and Greece in the past week. S&P has affirmed the current ratings of the U.K., Germany and Italy, and Trevor Cullinan, sovereign ratings analyst at Standard & Poor's in London, says Britain's credit rating could withstand spending a total of £83 billion on direct capital injections into its banks -- including the £37 billion already injected. But investors are fretting the mounting cost of U.K. bailouts could eventually lead to a downgrade. Mr. Brown on Monday announced new measures to rescue banks and revive lending, including an insurance plan to limit banks' losses on bad investments and government guarantees on bonds backed by mortgage and other consumer loans. Mr. Brown has said the new measures, with others announced last year potentially costing more than £500 billion, will help stimulate an economy that government data due out Friday will likely show has entered a deep recession after a 15-year boom.
Investors worry that Britain could end up fully nationalizing more of its banks, adding more pressure on its balance sheet. Shares of Royal Bank of Scotland Group sank a further 11% on Tuesday, after falling 67% Monday on a warning that its 2008 losses could reach £28 billion; investors now fear that RBS, already majority-owned by the government, could be fully taken over. Barclays PLC fell 17% on similar fears. "People are beginning to understand what's actually happening to the [U.K.] government's finances, and the amount of debt we're taking on," said Russell Silberston, head of global interest rates at investment firm Investec Asset Management in London. Analysts at Bank of America's Merrill Lynch said in a Tuesday report that the government could end up insuring £115 billion in troubled assets at RBS, Barclays and Lloyds. British taxpayers could end up bearing losses of £26.8 billion, compared to £6.8 billion for the banks, the report said. Treasury officials did not respond Tuesday to requests for comment on the plan.
Bank of England Governor Mervyn King said Tuesday the government's measures were designed not to "protect the banks as such" but "to protect the economy from the banks." He suggested that the central bank may increase the broad money supply to support growth -- a prospect that has added further downward pressure on the pound. He said the bank is considering what he called "unconventional, unconventional" measures such as intervening directly in credit markets. Investor reaction to the new bailout efforts has been much harsher than it was when the U.K. government announced its original rescue plan on Oct. 8. Then, bank shares were mixed and the pound fell a bit more than 2% against the dollar in the two days following the announcement. The pound has fallen more than 5% against the dollar since Monday morning.
Some foreign investors, many of whom already have aggressively sold off U.K. assets, believe that Britain's economy is set to be one of the biggest casualties of the credit crunch, and that falling interest rates will send the pound down further. "The U.K. economy is in a worse shape than the U.S. and most other European economies," said Robert Levitt, a principal of Levitt Capital Management LLP in Boca Raton, Fla., who last year dumped all of his U.K. holdings, including both equities and government debt. "The U.K. has had all the vices of the U.S. -- high debt, property prices, an overvalued currency -- but they have been even greater in Britain." For more than a decade, the U.K. has reaped benefits of its role as a hub for the world's capital, building London into a major financial center and allowing foreign companies to take over its firms with no political obstructions. As the country boomed in 2006, some $2.4 trillion flowed in and out of the U.K., only $400 billion less than the U.S.
But according to Bank of New York Mellon Corp., net outflows of foreign investment from U.K. fixed-income instruments in October and November 2008 alone wiped out about three-quarters of the net purchases in the nearly four years previous. Renewed outflows in the last few days have contributed to the sharp fall in the pound, according to the bank's analyst Simon Derrick. Foreigners are buying fewer British companies, which had propped up the pound. In the past two years nearly half of U.K. acquisitions have been from overseas, compared with 20% in the U.S. But in 2008 foreign companies spent 28% less than in 2007 buying U.K. companies, according to data provider Dealogic. Concerns over the cost of bailing out banks also has prompted investors to dump U.K. government bonds. Jittery investors also pushed up the cost of insuring such debt in the derivatives market Tuesday, though the cost fell later in the day. The U.K.'s debt as a percentage of GDP is likely to leap from 44.2% in November to around 70% in 2012, according to Neville Hill, an economist at Credit Suisse Group in London.
Spain Facing 'Exceptional' Hardship
Rising youth unemployment, soaring public spending, and now a downgrade by S&P: Spain is facing its toughest challenges in decades. Spain is heading toward "something exceptional" as youth unemployment and public spending soar during a historic recession, with a top ratings agency downgrading Madrid's ability to pay back debt. US agency Standard & Poor's (S&P) reduced Spain's "AAA" credit rating to "AA+" on Monday (19 January), making it the first country to lose the company's highest classification since Japan in 2001. The move comes amid fears over Spain's public finances as it attempts to spend its way out of recession, with the S&P downgrade set to make matters worse by increasing the cost of public borrowing. "Current economic and financial market conditions have highlighted structural weaknesses in the Spanish economy," the agency said in a statement.
Madrid has launched a fiscal stimulus programme worth €90 billion in a bid to relieve the economic downturn. It has also guaranteed €100 billion in new bank debt atop the purchase of €50 billion in bank assets to relax the credit crunch. Spain last week forecast its economy will contract 1.6 percent this year before a slight pick up in 2010, with unemployment to climb from 13.4 to 15.9 percent. The figures augur the worst recession in 50 years. But European Commission estimates are even more pessimistic, saying unemployment will hit 16.1 percent this year and almost 19 percent in 2010. As unemployment soars, government tax revenues will shrink while spending on social support will increase, with Spain's public deficit to reach 6.2 percent of GDP this year, Brussels forecasts. Youth unemployment is a particular worry in the country, the member state with the highest rates of young jobless, already on 29.4 percent. Spanish youth describe themselves as "mileuristas" – the Spanish for the low figure of €1,000 they earn every month – echoing militant Greek youth which calls itself "the €600 generation."
This year has already seen widespread student demonstrations across Spain over education reform but little in the way of economic protests. Local commentators and the government however worry this may change. Finance minister Pedro Solbes described Madrid's fears in a Sunday interview with daily newspaper El Pais. "We are living in a very unusual situation and different from everything that has happened," finance minister Pedro Solbes said in an interview with the El Pais daily this weekend. "We are heading towards something exceptional." Meanwhile, S&P warned that Ireland and Portugal are in danger of similar downgrades. Greece's rating was already knocked down from "A" to "A-" last week ahead of the Spanish move.
New Bank of England powers will start in weeks
The Bank of England will embark on unprecedented new measures to pump cash directly into the economy in "a matter of weeks", Mervyn King has pledged. In a speech in Nottingham tonight, the Bank's Governor said he and the Monetary Policy Committee would soon start buying up assets from private investors in their latest bid to prevent the economy sliding into a long-lasting depression. The move will mark the effective passing of traditional monetary policy in the UK. Mr King acknowledged that interest rates, which have already been reduced from 5.5pc to 1.5pc - were losing their power. He said: "With Bank Rate already at its lowest level in the Bank's history, it is sensible for the MPC to prepare for the possibility – and I stress that we are not there yet – that it may need to move beyond the conventional instrument of Bank Rate and consider a range of unconventional measures."
Many economists now expect the Bank to reduce interest rates to zero in the coming months, following in the footsteps of Japan in 2001 and the United States last month. However, many economists have urged the Bank not to wait before embarking on alternative measures. A number of mortgage lenders have refused to pass on interest rate cuts to their customers, limiting the effect of changes on the economy. Mr King's speech follows the Treasury's decision on Monday to set up a guarantee to cover illiquid assets - so-called toxic waste - in their accounts. The move has met with some disappointment in the markets. Mr King also pledged to set up a new instrument - alongside the Bank rate - to attempt to restrain the growth in debt in future economic cycles but he failed to elaborate on the plan. However, most attention will be focused on his description of how the Bank will conduct quantitative easing - whereby it pumps cash directly into the economy to boost growth and lending.
Such techniques have been used rarely in the past, but are now being employed by the Federal Reserve in the US and are already showing tentative signs of boosting the flow of money around the economy. Mr King said in the first instance the Bank would start buying up assets - including corporate bonds, credit instruments and asset-backed securities - using a £50bn fund set up by the Treasury. However, should the MPC determine that interest rate cuts will not have enough impact, it may pay for the assets by creating money, rather than via a Government-created fund. This would amount to increase the supply of money directly. However, Mr King's speech betrayed few signs that he intends to embark on full-scale quantitative easing such as this immediately. He said he was particularly focused on reducing the spreads on corporate bonds, which recently rose to the widest level since the 1970s, saying: "The Bank estimates that a significant element of this spread represents an illiquidity premium which could be reduced somewhat by increasing activity and liquidity in the market." He added: "It will be a matter of weeks not days before a programme of purchases can begin, but it will be weeks not months."
Stricken UK banks shunned by overseas lenders
Funding difficulties for UK companies are being made worse by a sharp reduction in lending to British banks by overseas institutions. Outstanding loans to UK banks by overseas institutions fell about 20 per cent in the four months to November alone, according to data from the Bank of England. This illustrates the extent of the government’s challenge to increase the flow of funds to companies. Alistair Darling, the chancellor, has warned that the drop in foreign lending has in part restricted the ability of UK banks to extend credit to British businesses. "We see a lot of foreign banks going home with their ball. That’s understandable for some of them that had been propped up in various ways," said John Grout, of the Association of Corporate Treasurers. The data show that the drop in lending has been particularly sharp from banks based in other EU member states. Market loans and holdings of certificates of deposit have roughly halved in that time, as have deposits at UK building societies, while European bank holdings of UK bank commercial paper are off by a third.
The inflow of deposits and loans to UK banks enabled a rapid expansion of their trading and lending activities in recent years. Now, as that flow is being reversed, it is reflected in tighter credit conditions. Meanwhile, economists note, the fourth quarter of 2008 is shaping up as one of the worst periods for borrowing by companies since 1965, Bank data show. In the months of October and November, the most recent period for which data are available, loans to private non-financial companies, which form the backbone of the UK economy, fell at an annualised rate of 2.0 per cent. Analysts at Citi noted that a lack of demand from credit worthy UK businesses might be as much behind the drop in lending as the reluctance of banks to make loans. "Although improving the supply of loans remains a priority, the uncomfortable truth is that private sector debt at 212 per cent of GDP is too high already," the analysts wrote.
Britian's government must stop the fears of bank nationalisation becoming self-fulfilling
The UK must clarify the details of its "bad bank" as soon as possible. The government's mega bail-out has gone down like a lead balloon in part because there are no details on this crucial element of the plan. That makes it impossible to value bank stocks. Investors have feared the worse, pummelling Royal Bank of Scotland, Lloyds and Barclays into a pulp. This is setting off a dangerous new downward spiral in which the confidence of banks - and the market's confidence in banks - risks being further undermined. The government must fill the information vacuum rapidly before more havoc is wreaked. Sticking to its current timetable - which doesn't envisage a further announcement until the last week of February - is barmy. Sunday night would be a better deadline. Investors seem resigned to nationalisation. That's certainly not the government's intention. Nor is it probably necessary - given that the state has just thrown a huge pile of goodies at the banks. But if the details are not filled in rapidly, nationalisation could become a self-fulfilling fear.
The best potential goodie is the new "asset protection scheme" - the bad bank by another name. It will put a floor under the value of the toxic assets on banks' balance sheets. But none of the details are clear. How many billions of assets will the state insure? How savagely will the banks have to write down their assets to participate? How big a "first loss" will each bank have to bear? What will the banks pay in return for this insurance? If all these numbers were out in the open, investors could do the maths. They could work out new "worst-case" pro forma capital ratios for the banks. They could then see whether the banks would still have more than the 4pc minimum level that the Financial Services Authority has reiterated. The government itself could then pump in more capital if there was still a shortfall. It's not clear why the authorities want until the end of February. Maybe they think it will improve their negotiating position vis-à-vis Barclays and Lloyds, both of which want to keep a distance from the state's embrace. But this is not a time for dawdling. It is a time to knock heads together.
UK unemployment climbs as record numbers made redundant
A record number of people are being made redundant in Britain as unemployment climbs towards two million, official figures show. The number of people losing their jobs surged to 225,000 in the three months to November, bringing the jobless total to 1.92 million, the highest for over a decade. The UK now has an unemployment rate of 6.1 per cent and the two million barrier is almost certain to be breached next month following a spate of job cuts since the start of the year. The number of job vacancies fell by 69,000 to 530,000, the lowest figure since records began in 2001. Manufacturing jobs continued to be lost, down by 86,000 to a record low of 2.82 million in the quarter to November compared with the previous year.
Most sectors showed falls in jobs, with the highest, 72,000, hitting finance and business services. Job losses continued today when electronics component firm TT electronics announced 700 cuts, including 100 in the UK. Employment Minister Tony McNulty said: "In these tough times, people need real help to find a job. That's exactly what this Government is offering and every day people are finding work. These figures show that whilst more people are claiming Jobseeker's Allowance, 231,000 have come off in the last month as people take advantage of the extra help on offer. The Government is doing all it can to ensure economic stability for businesses, homeowners and jobseekers. The measures that we have introduced over the recent months are designed to support the recovery of the economy and ensure that people have the best support to get back into employment.
Every person looking needs to know that there are jobs out there and we will give you the support you need to fill one of those half a million vacancies that are available right now. We will continue to ensure everyone who loses their job has access to the full range of support that Jobcentre Plus has available. Our message to job seekers is clear - we won't give up on you but you mustn't give up on looking for work." The number of people claiming jobseeker's allowance increased last month by 77,900 to 1.16 million, the worst figure since 2000. The monthly benefit claimant increase was the second highest since 1991, and the claimant count has now increased for 11 months in a row, according to the Office for National Statistics.
UK mortgage lending figures 'will decline further'
Mortgage lending will continue to decline for six months, banks and building societies have warned, as figures show mortgage lending dropped 30 per cent in 2008 to hit a six-year low. The amount borrowed by homeowners dropped to a total of £256.4 billion from £363.7 billion the previous year as the credit crisis intensified and the property market ground to a halt. Borrowers are finding it virtually impossible to find a mortgage unless they have a sizeable deposit and a spotless credit history. The Council of Mortgage Lenders, which published the data, said the figure is the lowest since 2002. The group, representing the majority of Britain's banks and building societies, warned that mortgage approval figures from the Bank of England indicate lending levels "will decline further in the coming months", with improvements in lending unlikely to be seen in completion levels until the second half of the year at the earliest. Mortgage lending continued its downward trend in December, with just £12.6 billion advanced during the month, the lowest monthly figure since April 2001 and 47.2 per cent lower than the same month a year earlier.
The CML welcomed the package of measures announced by the Government earlier this week to support the banking sector and boost lending, describing them as "essential". However, it called for the details of the schemes to be settled so that they could be used by as wide a range of people as possible, as soon as possible. Michael Coogan, director general of the CML, said: "Increasing the range of active lenders and funding capacity in the market overall is a vital next step. "Further measures targeted at the housing market are likely to be needed to supplement yesterday's welcome intervention to address liquidity and capital concerns." Experts said the irony is that estate agents are reporting an increasing number of enquiries - but this will not translate into completions unless banks are more willing to lend. In a rare bit of good news for home owners, the Association of National Estate Agents claimed average asking prices had increased from November to December with the value of a terrace property increasing from £149,589 to £151,406. It said the rise was an indicator that the fall in house prices in some areas is slowing, but it warned against seeing it as a sign that prices have bottomed out nationwide.
SocGen sees break-even in final quarter
Société Générale, France’s second biggest bank, sought to reassure markets by issuing a trading update on Wednesday, saying it expected to have broken even in the last three months of 2008 and to make €2bn ($2.6bn) in full-year net profit. Although the guidance was below analysts’ forecasts, it calmed fears of extraordinary fourth-quarter losses. The shares bucked a downward trend in the banking sector, rising by nearly 5 per cent in early afternoon Paris trading to €25.84. They have fallen by 30 per cent in the last two weeks as markets have hammered banking shares on fears that they may need more capital.SocGen also said it would take €1.7bn from a second tranche of €10.5bn in state aid for French banks, which the government announced late on Tuesday night. In December, the state provided €10.5bn in subordinated loans to BNP Paribas, SocGen, Crédit Agricole, Caisse d’Epargne, Banque Populaire and Crédit Mutuel.
This time, the banks can choose between taking subordinated debt or preference shares without voting rights. The preference shares will be more expensive — carrying a coupon rate double that of the debt — but will count towards core tier one capital, a measure of balance sheet strength that excludes debt-like instruments. The government has increased the number of conditions for the aid, which banks have until August 31 to take up. As before, the banks must boost annual lending by 3-4 per cent but in addition, bank bosses must forgo bonuses, limit dividend payments and pledge to finance €7bn of export contracts. The banks have fallen into line. On Tuesday, Daniel Bouton and Frédéric Oudéa, respectively SocGen’s chairman and chief executive, renounced their bonuses, as did Georges Pauget, chief executive of Crédit Agricole. This followed a similar decision last week by Michel Pébereau and Baudouin Prot, respectively chairman and chief executive of BNP Paribas, France’s biggest bank.
SocGen said the state funds would boost its Tier One ratio from "approximately" 8.5 per cent at the end of December to 9 per cent. It said the €2bn net profit expected for 2008 came mainly from its retail banking operation. The asset management division "continued to suffer from outflows and depreciations" while the investment bank would break even in the fourth quarter. This compares with a €3.4bn investment banking loss in the final quarter of 2007, after the rogue trading scandal a year ago in which Jerôme Kerviel placed allegedly unauthorised bets on futures markets. SocGen said trading losses in the investment bank in the final quarter of 2008 were limited by a risk reduction strategy put in place after the Kerviel scandal. BNP Paribas indicated in December that its investment banking arm had made a €1.6bn loss in the final quarter when it warned of a €710m pre-tax loss in the first 11 months of the year.
French bankers give up bonuses to secure €10.5bn from Sarkozy government
French President Nicolas Sarkozy agreed to provide a further €10.5bn ($9.8bn) in aid to the country’s biggest lenders in exchange for their top executives giving up bonuses. The agreement late on Tuesday to channel the extra capital came a day after British Prime Minister Gordon Brown announced his second rescue plan in three months, underscoring how an initial round of bailouts failed to restore credit. President Barack Obama is also considering new measures to fix the US banking system as a global economic slump deepens. Mr Sarkozy has been pressuring banks in recent days, saying repeatedly that they shouldn’t pay bonuses to management or dividends to shareholders.
Credit Agricole SA and smaller rival Societe Generale SA said on Tuesday they wouldn’t pay bonuses to their chairmen and chief executives. BNP Paribas SA, France’s biggest bank, made a similar announcement last week. "We ask banks that make a profit to finance the economy" and not reward shareholders, Finance Minister Christine Lagarde told reporters after the bankers met Sarkozy and top officials in Paris. The state wants banks to use 2008 earnings to boost shareholder equity, she said. The more profitable banks may still pay a dividend, she said. The new funds will be made available "shortly," a statement said. The finance ministry today said the aid will boost every bank’s Tier 1 ratio, a capital measure of financial strength, by 50 basis points. Societe Generale said on Wednesday it will receive €1.7bn from the state, boosting its Tier 1 capital ratio to "close to" 9pc from about 8.5pc. It also expects to report a 2008 profit of about €2bn. Societe Generale climbed 5.5pc to €26 at 9:17 a.m. in Paris trading, while BNP slipped 3.1pc to €22.96. Credit Agricole gained 2.5pc to €7.40. France has earmarked €360bn for its banks, most in the form of guarantees. In exchange, it has prodded them to increase lending, appointing an ombudsman to ensure they are. Last month, the government pumped €10.5bn into the six largest financial institutions.
Banks will have a choice to issue by August 31 either subordinated debt, the instrument used in the last aid package, or preferential shares without voting rights, the finance ministry said today. Preferential shares will be better remunerated for the government, with a rate up to twice as high as for debt, it said. "The financing of banks has improved since the extreme difficulties that characterized the September-October period," Sarkozy’s office said. "To accompany them, the state will shortly put at the banks’ disposal a new pool of shareholders’ equity to draw upon, depending on their requests." The other banks attending yesterday’s meeting were Credit Mutuel, Caisse d’Epargne, Banque Populaire and La Banque Postale, a unit of the state-owned mail service. Separately, the French banking federation said that the banks "are playing the game" and maintain their goal of increased lending even as the economy deteriorates. The European Union yesterday projected that the French economy will contract 1.8pc this year, cutting its earlier forecast for no growth, a forecast Lagarde called "painful." Officially, she still projects the economy will expand next year, although she said today she’s preparing new estimates. In an interview on RTL radio, Lagarde said the European Commission will today start reviewing the new aid. The decision should be quick, she said, because the Italian government has already used preferential shares to channel funds.
GM official says cash could run out by March 31
General Motors Corp. will run out of cash long before the end of the first quarter if it doesn't get the second installment of government loan money that was due Jan. 16, the company's chief operating officer said Tuesday night. Fritz Henderson told the Automotive News World Congress in Detroit that the company has said the money is critically needed to pay its bills, and it expects to get the second installment soon. He attributed the delay in receiving the second installment of $5.4 billion to the Treasury Department's workload and the change in administrations. "If we don't get our second installment of the funding we'll run out of cash, it's that's simple," he said. "We've been finalizing what we need to do. We anticipate receiving it. But it's critical that we receive it."
In December, the Treasury Department granted $13.4 billion in loans for GM and another $4 billion for Chrysler LLC to keep both automakers out of bankruptcy. GM got $4 billion in December and also is to receive another $4 billion on Feb. 17. Henderson also disagreed with United Auto Workers President Ron Gettelfinger who said on Monday that that a mid-February deadline for General Motors and Chrysler to complete their restructuring plans may be "almost unattainable" and that the automakers may have been set up to fail. Henderson said the Treasury Department wouldn't have worked as hard as it did to provide the loans to GM and its financial arm GMAC LLC if it was setting up failure, and he said he's confident GM can meet the Feb. 17 deadline to turn it a plan to show how it will be viable.
"It's a tight time frame. We're confident we can achieve all our milestones. Not everything has to be done by Feb. 17," he said. He also said January U.S. sales were looking a lot like December, which was among the worst months in the past quarter-century. And he told the group that GM will have four core brands in the future: Cadillac, Chevrolet, Buick and GMC. GM is reviewing the Saturn brand with its dealers, is studying Saab and Hummer for sale and will shrink Pontiac to a performance niche brand. Henderson also predicted that oil prices will rise rapidly once global economic activity recovers, justifying GM's electric car research spending.
Fiat Won't Be Chrysler's Savior
Chrysler needs cash and competitive new models now—neither of which Fiat can bring. Can two small and struggling carmakers join forces and make one strong company? Chrysler and Italy's Fiat Auto (FIA) are about to find out. Chrysler and Fiat signed a partnership agreement today that gives the Italian carmaker a 35% stake in Chrysler. Fiat will give Chrysler some small and midsize cars while Fiat gets access to the North American market. On paper, the deal makes sense. Fiat needs to reach beyond Europe and South America, where the company is strong.
While Chrysler gets about 95% of its sales in North America, the automaker is strong only in the minivan, SUV, and pickup markets, and it needs the technology to make smaller cars, which Fiat has. "A Chrysler/Fiat partnership is a great fit as it creates the potential for a powerful new global competitor," Bob Nardelli, chairman and chief executive officer of Chrysler, said in a statement. The deal offers "Chrysler a number of strategic benefits, including access to products that compliment our current portfolio; a distribution network outside North America; and cost savings in design, engineering, manufacturing, purchasing, and sales and marketing," Nardelli said in the statement.
But big questions remain about how the two companies will fund development of jointly built vehicles. In the agreement, Fiat made no commitment to give Chrysler cash now or in the future. Chrysler certainly has big cash problems. In January, Chrysler Chief Financial Officer Ronald Kolka told the media that the company had between $2 billion and $2.5 billion in cash, which is the bare minimum it needs to fund payroll, buy parts, and keep its plants going. That's down from more than $11 billion last summer. "From a technology perspective, Fiat will help Chrysler fill some gaping holes in its product line. Fiat is one of the best small-car makers in the world," says Michael Robinet, vice-president of auto consulting and research firm CSM Worldwide. "But with no cash infusion, it puts (Chrysler owner) Cerberus Capital Management on the hook to fund this."
Meanwhile, Chrysler also has $7 billion in debt. And that's before the $4 billion it just borrowed from the government. Chrysler hopes to get another $3 billion in loans from the Treasury Dept. through the Troubled Asset Relief Program (TARP) once it submits a turnaround plan to the government on Feb. 17. It will be tough to get cash assistance from Fiat. Fiat's industrials division, which includes the carmaker, had $2.9 billion in cash on Sept. 30, 2008, down from $7.4 billion a year ago. And it carries almost $4.4 billion in debt, which rose sharply last year from just $470 million at the start of 2008. In December, Standard & Poor's lowered the outlook on Fiat's debt rating from "stable" to "negative."
Similarly, Moody's on Jan. 15 placed Fiat rating "under review" for possible downgrade. That's why Fiat won't be a savior for the smallest of Detroit's Big Three. Chrysler will need cash to see the benefits of the alliance. Retooling its factories to make Chrysler versions of Fiat's cars could cost hundreds of millions per model. Even if Fiat exports some of its Alfa Romeo or Fiat brand cars to the U.S. for sale at Chrysler dealerships, it would take 18 months to get the cars in compliance with American emission and safety standards, Robinet says. Retooling a factory to make Chrysler versions of Fiat passenger cars could take three or four years. Says Robinet: "We're looking at 2011 at the earliest. And that's aggressive."
But there are some good fits. Chrysler has a Dodge Hornet subcompact coming late next year. The car will be jointly developed with Nissan. Aside from that, Chrysler has only a few small cars, and its family sedans—the midsize Dodge Avenger and Chrysler Sebring—have been also-rans. "They could rebadge the Fiat Bravo compact and Punto minicar," says Neil king, an analyst with IHS Global Insight in London. The announcement would not affect existing alliances that Chrysler has with Nissan and Volkswagen. For Fiat, the deal means the Italian carmaker can expand into North America. Right now, Fiat plays mostly in Europe and South America. The company already had its eye on selling Alfa Romeo cars in the U.S. The brand has some resonance in the U.S. but has not sold cars here in more than a decade. Fiat could also build its stylish 500 subcompact in Mexico and sell it in the U.S. as a rival to BMW's Mini brand. Says Robinet: "The prize for Fiat is distribution here."
Fiat once was one of the sickest car companies in the business. But CEO Sergio Marchionne restructured the company and got it back in the black in 2005. He also improved quality and pushed for better styling. In the first nine months of 2008, Fiat sales rose 9%, to $30.5 billion, and the company made $1.2 billion. But like all carmakers, weak economies forced sales into a freefall in the fourth quarter. The company has warned that its sales could be off 20% this year. Fiat has idled some factories for January and February. The deal will halt speculation that owner Cerberus will liquidate Chrysler by selling off core pieces of the business, such as the vaunted Jeep brand, or the minivan and Ram pickup lines.
It also has the blessing of Ron Gettelfinger, president of the United Auto Workers, who says he plans to work with Fiat and Chrysler to shape the company. But it also may not be the panacea for Chrysler. "I'm not sure this is an end to deals involving Chrysler," says David E. Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich. "Even after this, we could see Renault-Nissan, for example, come into it. We shouldn't jump to premature conclusions that this would be an end, it could just be a beginning of more to come." That will be especially true if Chrysler can't find a source for new cash.
A Penny For Citi Investors
Citigroup managed to alienate its investors even further Tuesday when it officially cut its dividend to a penny as it previously hinted it would. The banking company said Tuesday that it would cut its dividend to 1 cent from its previous dividend of 16 cents, which was half of its 32-cent payout in the previous quarter. The penny-per-share payout is all that is allowed under the federal government's $20.0 billion bailout of the financial firm outlined in November. The new dividend is payable on Feb. 27, to stockholders of record as of Feb. 2. In October, Citigroup received $25.0 billion from the Troubled Asset Relief Program and then wrangled itself another $20.0 billion from the Treasury in November. The U.S. Treasury and the Federal Deposit Insurance Corp. said in November that it will provide protection against the possibility of "unusually large losses" on an asset pool of approximately $306.0 billion of loans and securities backed by residential and commercial real estate in Citi's portfolio.
At the time of the capital infusions from the government, the bank agreed that it would not issue a dividend that was more than a penny for three years unless it obtains consent from the three federal agencies - the Treasury Department, the Federal Reserve and the FDIC. That is now being instituted. Shares of the ailing bank dropped 20.0%, or 70 cents, to $2.80, at the close of regular-day trading on Tuesday. Citigroup announced on Friday that it was splitting its business in two, after years of the financial supermarket model failing. Friday's announcement came as the New York-based financial company reported a fourth-quarter loss of $1.72 per share, well ahead the $1.31 per share loss predicted by Wall Street.
Pimco Quits GM Creditor Group After Reneging on GMAC
Pacific Investment Management Co., manager of the world’s biggest bond fund, resigned from an investor committee negotiating with General Motors Corp. to exchange debt for shares. The decision by Pimco comes about a month after it reneged on a Dec. 15 agreement to join bondholders in GMAC LLC’s $38 billion debt swap. The 10-member GM bondholder committee overlaps with the GMAC group, including San Mateo, California- based Franklin Resources Inc. and Fidelity Investments of Boston, said a person with knowledge of the situation who declined to be identified because the members haven’t been publicly announced.
"We’re just not good committee members," Bill Gross, Pimco’s co-chief investment officer, said in an interview yesterday from his Newport Beach, California-based office. "We have the interests of our clients more at heart than the interests of particular corporations or even the government, I guess, so it’s best that we simply look at the situation from afar as opposed to from inside." The withdrawal means Pimco may gain less information from other investors or have a smaller influence in talks with Detroit-based GM, which needs to cut two-thirds of its $27.5 billion in unsecured public debt. GM is negotiating with the committee of creditors as part of a government bailout of the biggest U.S. carmaker.
GM is attempting to reduce debt to avoid bankruptcy as the economy sinks deeper into a recession. The company has posted about $73 billion in losses since the end of 2004, the last time it recorded an annual profit. The company’s 77-year reign as the world’s largest automaker ended after it said today that 2008 sales fell more than 11 percent to 8.35 million vehicles. Toyota Motor Corp. recorded a 4 percent drop to 8.92 million. GM’s U.S. sales fell 23 percent last year, outpacing the 18 percent industrywide decline. Pimco pulled out of its agreement with a committee of GMAC bondholders to swap their debt for as little as 60 cents on the dollar. The exchange allowed Detroit-based GMAC, the main lender to GM dealers, to convert to a bank and obtain federal aid. GM sold a 51 percent stake in GMAC to a group led by New York-based private equity firm Cerberus Capital Management LP in 2006 for $7.4 billion.
The decision by Gross, 64, initially raised concern the swap would fail to meet government requirements that 75 percent of the bonds be tendered. Without Pimco’s participation, 59 percent of the bonds were exchanged. Pimco is a unit of Munich- based Allianz SE, Europe’s largest insurer. Pimco bet correctly that GMAC would get bailed out anyway because the government wouldn’t allow the lender or GM to collapse. The value of the firm’s holdings soared as much as 83 percent, to 80.5 cents on the dollar. Members of the GMAC committee "probably felt shortchanged and rightly so," Sean Egan, president of ratings company Egan- Jones Ratings Co., said in an interview from his Haverford, Pennsylvania, office. "There’s a variety of reasons why the other creditors would have cause for being upset with Pimco."
Gross said he "can understand" how other committee members would be upset. "All members of the GMAC deal basically agreed with each other that each member was able to, you know, go their own route in terms of decision making, so the fact that Pimco did I think would not have been an abrogation of the agreement," he said. Gross told the New York Times last month he wouldn’t tender because Cerberus was trying to bully creditors to reduce their claims by as much as half. Gross told the Times he wanted Cerberus to put more money into GMAC. Pimco owned more than $340 million of GMAC debt as of Sept. 30, according to regulatory filings and data compiled by Bloomberg. Such committees often negotiate with troubled borrowers to obtain the best terms in a restructuring for bondholders, who get repaid after banks and ahead of shareholders in a bankruptcy.
"The advantage of being on a committee is you can help guide the firm and have an active voice in the firm’s future," Egan said. The disadvantage is holders on the committee may have trading restrictions imposed if they gain access to insider information, he said. Pimco is among the biggest holders of GM bonds, behind Franklin, Capital Research & Management Co. and Fidelity, Bloomberg data show. Pimco owns more than $138 million of the debt, according to Bloomberg data based on regulatory filings in September. Its largest holding is 39 million euros ($50 million) of GM’s 1.5 billion euros of 8.375 percent bonds due in 2033, according to Bloomberg data.
Those bonds, part of a $13.5 billion sale of dollar-, pound-and euro-denominated debt in 2003, closed yesterday at 17.5 cents on the dollar to yield 47 percent, down from 73 cents on the dollar a year ago, according to Bloomberg data. GM’s bonds have gained 4.4 percent on average this month, compared with a return of 5.1 percent for high-yield, high-risk securities, according to Merrill Lynch & Co. index data. On Jan. 12, analysts at JPMorgan Securities Inc. cut their recommendation on GM’s bonds to "hold" from "buy." Bonds rated below BBB- at Standard & Poor’s and less than Baa3 at Moody’s Investors Service are considered high-yield, or junk. GM’s senior unsecured debt is rated C by Moody’s, the lowest grade, and CC by S&P. As recently as 2005, the company had investment-grade ratings.
Gross’s Total Return Fund, which outperformed 99 percent of its peers over five years, rose 4.8 percent in 2008, Bloomberg data show. Its peers, government and corporate funds, declined an average of 8 percent last year, according to Bloomberg. The government provided $6 billion in aid to GMAC. Cerberus and GM must divest most of their ownership under the accord. GM received $4 billion in government loans last month through the Troubled Asset Relief Program after saying it would run short of operating cash by the end of 2008. It’s due to get an additional $5.4 billion this month. With the release of the second $350 billion in TARP funds, approved by the Senate on Jan. 15, GM is scheduled to get $4 billion more in February. The automaker has to restructure its business and present a progress report to the Treasury Department by Feb. 17. The TARP program was originally designed to purchase bad mortgage assets, then later expanded to inject capital directly into troubled companies.
Ilargi: I think seeing Christoper Whalen express the same views as me is a good thing, even as he seems to underplay the potential consequences for CIti and others. His first paragraph is a riot.
To Stabilize Global Banks, First Tame Credit Default Swaps
"Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham's current shareholders - and it would also encourage excessive risk-taking in the future. Still, the possibility of such a gift is what's now supporting Gotham's stock price. A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks' debts to make them solvent; and sold the fixed-up banks to new owners."
Paul Krugman, "Wall Street Voodoo", The New York Times January 18, 2009
Congratulations to President Barack Hussein Obama on assuming the Presidency of the United States. We wish you and yours Godspeed.
A long-time colleague and IRA reader who works for a mostly nationalized UK bank tells the following tale. Upon arriving at Heathrow Airport several weeks ago, he was pulled out of the line by UK immigration authorities and told to sit in a windowless interview room. After waiting for quite a while, two plain clothes members of the UK immigration service came into the room, sat down and informed the banker that he had made a false statement on his customs declaration. "Sir, you are not a banker as you have claimed," said one of the immigration officers. "You are in fact an employee of Her Majesty's Government. In future, please ensure that you form is filled out correctly." And they were deadly serious.
Such is the level of public anger and outrage at the moves by the UK government to rescue the few, large players in that nation's banking sector. And there are similar political trends building in the US. Thus the need to fashion a prompt but effective response to the crisis, as none other than Nobel Laureate Paul Krugman outlines above. Simply buying and/or guaranteeing bank assets, without first passing these banks through a receivership, is pointless. First the market value of the assets and liabilities must be put back into balance, then and only then the banks may be recapitalized. In our latest report to our advisory clients, we discussed the likely magnitude of the losses to hit the US banking sector in 2009. We had been pondering this issue with respect to Citigroup, JPMorganChase and Bank of America for some while now, but the reports from FBR and, more recently, a draft paper from our friend Nouriel Roubini, forced us to focus on some hard numbers.
The bad news is that estimates that put aggregate charge-offs for all US banks over the next 12-18 months above $1 trillion are probably in the right neighborhood. The entire banking industry only has $1.5 trillion in capital, so new equity must obviously be provided by Washington and/or private investors. This is why the UK, US and other affected nations must soon abandon the bailout model championed by Fed Chairman Ben Bernanke and Treasury Secretary-designate Tim Geithner, and instead embrace the strategy of resolution and restructuring exemplified by Sheila Bair and her colleagues at the FDIC. The good news is that much of that loss is going to be concentrated among the largest banks, with C accounting for as much as a quarter of the total all by itself. When you see a 40% loss rate vs. total assets for a relatively simple institutions such as IndyMac, tell us why you would not start at that level with C? Impose a conservative 30% loss rate on C's $1.3 trillion in bank assets and you have wiped out the group's $150 billion in Tier One Risk Based Capital several times over. The common and preferred of C is toast, in our view. Restructuring is the only rational choice for C and for Washington. And maybe, just maybe, the C bond holders will see a modest recovery.
Our long-time estimate of 2x 1990 loss rates for peak charge-offs in 2009 implies that the industry will reach 4% defaults and relatively riskier players like C will be much higher. In 1990-91, Citibank NA peaked around 3.5% charge-offs vs. total loans and leases, almost causing the bank to fail. Some observers believe that had regulators resolved Citibank two decades ago, we would not be facing the same type of financial crisis today. So now the past is prologue. But even with all of this red ink in evidence and easily projected, the magnitude of current and prospective charge-offs does not fully explain the crazy, triple-digit volatility of the debt and equity of C and other banks, large and small. Even the events of the past year, including the failures of Lehman and Bear, do not fully explain why financial names are behaving so erratically, this even after the US government has effectively underwritten the banks' operations. No, the reason for the continued heebie-jeebies in bank equity and debt stems from the unfinished business in the market for credit default swaps or "CDS."
As readers of The IRA know full well, the Fed of New York and the Depository Trust & Clearing Corp have been working for years to address the bank office issues facing CDS, this all the while declaring that there is nothing basically wrong with the CDS market. Strange, then, that as part of the process of rationalizing CDS contracts, nearly half of the outstanding contracts have been torn up in the past year! This is because, dear friends, when it comes to CDS, clearing is the least of our problems. The tension with CDS regarding the money centers in particular and banks generally comes from several basic flaws in the ISDA model for these instruments, including the lack of a central counterparty and the issues that arise from this archaic, bilateral market structure. Most crucially, because the Fed still refuses to enforce any type of credit margin discipline over the CDS markets by raising collateral requirements to realistic levels, the short-selling pressure of C and other wounded money centers is magnified many times above the true pool of investors with hedging needs. Yesterday's trading in US bank names is a case in point.
Unlike a centralized exchange where an impartial counterparty holds the cash, the bilateral relationships in the CDS market lead to gross under-collateralization of CDS trades which are, in turn, governed by separate collateral security agreements. This leads to what one participant calls "a dirty float," where counterparties keep minimal collateral with one another and thus nobody is sure whether their contracts are money good. It is thus possible to run short positions against banks or other names and have virtually no collateral backing these trades, both for dealers and their customers. Why should the citizens of the industrial nations tolerate the existence of this unsafe and unsound market for another moment longer? By failing to enforce margin limits on CDS leverage while investing new capital in C, BAC and other large banks via the TARP, the Fed and Treasury are essentially trying to fill up a bucket with a hole in the bottom.
Providing new capital to wounded banks is pointless if you are going to allow the remaining street dealers to short bank stocks with impunity and virtually no collateral. To fix the systemic risk issues with the CDS market permanently and also provide a much need additional buttress to the bank rescue efforts by the Fed and Treasury, here is what we would suggest. First, the Fed and Treasury should prohibit the writing of new CDS on any financial institutions that is participating in the TARP. Instead, the Fed and Treasury should interpose themselves as counterparties for these names, writing CDS for any and all counterparties and capturing the revenue for the US Treasury. This change can be accomplished unilaterally, without notice or Congressional authority, pursuant to the safety and soundness provisions of 12CFR. After all, since the government is already effectively backing the liabilities of these insolvent firms, the taxpayer has first claim on any insurance premiums written against such public support. It is absurd for the government to allow private speculators to profit by trading against public-guaranteed liabilities of banks that participate in the TARP. Unfortunately, Chairman Bernanke and his colleagues at the Fed are still not willing (or able politically) to enforce prudential rules on the CDS casino.
Second, the Fed and Treasury, via legislation if necessary, should propose changes to the legal configuration of the CDS contract that will take it away from the OTC FX/interest rate model used by ISDA over the past decade or more. Regulators should require that CDS contracts be exchange traded, but with collateral and delivery requirements that mirror not the cash settlement world of OTC FX and interest rate OTC contacts, but instead based on the basic model of the exchange traded world of physical commodities, but priced based upon the risk measures used in the insurance industry. While it is entirely appropriate for exchange traded instruments like the S&P 500, Eurodollar futures, or OTC interest rate swap and currency contracts to settle in cash, allowing cash settlement in CDS has opened a Pandora's Box for bank managers and investors, who must manage both the market and credit risk of dealing in these contracts as de facto central counterparty, while at the same time being attacked by their clients who are shorting the bank's equity and debt! Remember, a speculator must only agree to pay for CDS based upon the short-term yields on the underlying bonds -- a price that does not even begin to approximate the true cost of funding a short put position in the underlying basis upon default.
When traders use CDS to build short positions on C, BAC and JPM as part of equity volatility trades and similar short-term strategies, they are increasing the cost of the TARP bailout to the taxpayer while at the same time adding to the overall instability of the financial system. As we've said before, if there were nothing wrong with the basic model for CDS, then there would be no need for the industry to have torn up $30 trillion in notional amount of contracts during the past year! The basic model for a CDS contract does not really fit the needs of investors or the real economy, who are in the most simplistic terms looking for a practical way to hedge an illiquid corporate bond. Unfortunately, most corporate bonds cannot be borrowed in the securities lending market, WHICH MEANS THAT THERE IS NO TRUE CASH BASIS FOR SINGLE NAME CDS. Faced with this issue, the happy squirrels at ISDA came up with cash settlement as a way to ensure the astronomical growth of CDS - never realizing that in so doing, they were also magnifying the overall level of risk in the global financial system many times over and above the actual "basis," represented by the bonds specified in each CDS contract.
CDS are a great tool for playing/managing volatility in time of low or no defaults. In the period 2002-2007, when the CDS market was growing many times faster than the underlying real economy and corporate default rates were virtually zero due to the plenitude of credit, using CDS to trade volatility produced huge paper profits to dealers. But now that all types of default rates are rising and credit spreads are widening, the cost to the system of a CDS contract -- which requires the seller to fund the par value of the underlying security, less recovery value -- is a dead weight around the neck of the global financial system. As we've noted before, CDS contacts are high-beta risk, that is, highly correlated with the broad financial markets. Unlike natural disasters and other low-beat risks, where the frequency of events is relatively low and uncorrelated to the financial markets, in CDS the high degree of market correlation ensures that most or all of a portfolio of single-name CDS contracts will deteriorate when economic conditions turn negative. There is no way to hedge such risk because it is entirely correlated to the broad market -- unless you happen to be a conservative P&C underwriter! The yield spread on a bond represents the current cost of renting money for a year, but it does not begin to describe the cost of refunding the entire security upon default!
What a shame the folks at American International Group forgot the centuries of experience that the insurance industry has with managing different types of risk. The widening sinkhole around AIG provides a case in point of what happens when a low-beta and high-beta portfolio are mixed without adequate capital and, more important, an understanding of the full downside funding risk. Recall that in the traditional, low beta world of P&C insurance, the assumption is that most coverage will never result in claims. In a broad portfolio of single-name CDS during a recession, by comparison, the assumption must be just the opposite. As corporate defaults rise and recovery rates fall, the net funding required to perform on single name CDS must approach 100% of par. In such an event, the exercise of extant CDS contracts could theoretically consume all of the capital in the global banking system, several times over. How is this good public policy? Indeed, viewed from an actuarial perspective, the world of CDS makes no sense at all. In order for premiums to be high enough to make a high-beta portfolio of CDS contracts profitable in an economic sense, a new pricing methodology based upon true, medium-term default risk need be developed - but such a framework would be very expensive and might not be practical to implement.
So what is the solution? So us, the Fed and Treasury must immediately force the CDS market onto exchanges and go back to the pre-Delphi bankruptcy model to require physical delivery of the underlying bonds in order for purchasers of protection to collect their insurance payments. The Fed should also reinstate higher margin requirement for all securities and include CDS in a newly reformed margin regime. On single name CDS, the margin requirements for sellers of protection should approximate roughly 50% of the amount of the net exposure, roughly half the estimated recovery value less par. By imposing this Draconian requirement, the doubts as to funding of CDS and the related market fear, will disappear. Admittedly, these changes will have the effect of driving most or all of the speculative players out of the CDS market and make it a hedge-only market, but frankly there are many more liquid alternatives for traders, including exchange traded futures and options, to use to support volatility strategies, including short-sales of bank stocks. Allowing cash settlement CDS contracts to continue to exist and trade in their current form seems to be contrary to all of the efforts currently underway to stabilize the global financial system.
Unless and until Chairman Bernanke and the other regulator are willing to tame the CDS tiger, there will be no success in bringing stability to the US banking system or foreign banking markets. And the longer Bernanke & Co refuse to say an emphatic "no" to Goldman Sachs, JPMorganChase and the other CDS dealers, the financial crisis affecting global banking institutions will continue to worsen. Making this change may force GS and other dealers into mergers or liquidations, but such is the cost of reform. The US economy can live without the major Sell Side dealer firms, but we cannot survive without commercial banks, insurance companies and commercial companies, all of which are targets for the CDS Mafia and the unlimited leverage that they use as weapons against us all to generate speculative gains. We have the power to fix this aspect of the financial crisis immediately, but do our leaders have the courage and the vision to close down this reckless, speculative market before it destroys what remains of our economy?
Downturn Dooms Showcase Skyscrapers
They were certainly heady years. In cities like Shanghai, Moscow and Dubai, the urban landscape was re-invented at breakneck speed. Revolving construction cranes dominated skylines and economic growth was measured in the number of stories a building had. It was a high-stakes gamble involving money, steel, and glass. In the new urbanism, nothing could happen quickly enough, nor could anything be praised loudly enough. Numerous entities had their fingers in the pie of each major deal, from banks to investors to brokers. There were no limits to the business savvy and the flows of capital involved. Anything seemed possible. Every new building was supposed to a superlative, so that it could serve as visible proof of enormous economic power. Yearnings for pomp and prestige were transformed into architecture. Some designs were reminiscent of perfume bottles, others of rockets. But now the enormous real estate bubble of the sheikhs, oligarchs, and neo-capitalist financiers has burst. The international economic crisis has caught up with the nouveau-riche high flyers in the Middle East and Asia who, until recently, had gloatingly watched the collapse of the West, where one skyscraper project after the next has been abandoned. But now the brakes are also being put on one construction project after another in Dubai, Saudi Arabia, and Russia.
The globalized world is truly proving to be a single entity, one in which the collapse of the market affects everyone. There is suddenly a lack of credit or demand -- often both -- for the countless square meters of newly constructed office, retail, and residential space. And the construction moguls have been nervous for a long time. One of the centers of the new era was Dubai, a city on the Persian Gulf with no history, no special mineral resources, but with a seemingly unlimited future. Dubai was a promising real estate mirage which gradually became reality. Its mantra of "build it and they will come" worked for years. The masters of Dubai even created new luxury building sites by developing artificial islands in the shape of palm trees. Two groups of islands are already complete, but a planned third group is now likely to be put on hold. An event held in Dubai one Friday in December showed just how different things are looking in the Gulf city these days. The invitation revealed, as usual, only the most important details. Aiman Holding planned to unveil a project it called "The Twelfth," consisting of a high-rise residential building on one of the palm islands. The event was to be held at the five-star Raffles Hotel. Guests would apparently only be allowed entry if they presented a copy of their passport and checkbook.
Ordinarily, it would not have taken any more than that to fill a ballroom in Dubai with real estate investors. They came by the dozens whenever a new real estate developer appeared on the scene, and by the hundreds when an established vendor announced that it was accepting bids for a luxury residence, an office tower or a shopping mall. There were times when speculators in suits and ties would camp out in the lobby to be the first to place their orders. That might have still been the case in October, but not today. At 11:30 a.m., an hour and a half after the beginning of the event, 10 real estate agents are sitting alone at their tables. The model of the residential high-rise looks abandoned next to the opulent, untouched buffet. There was no deluge of customers. No one was interested in the penthouse pool, the four-story garage or the private beach with a view of the Dubai skyline. Developers are quietly removing one project after another from the market. Donald Trump's $600 million (438 million) Trump International Hotel and Tower on the Palm Jumeirah island has been "postponed." A 1,000-meter tower being planned by the partly state-owned real estate development company Nakheel is "under review." And the new Jumeirah Gardens neighborhood, with a planned total investment of $100 billion (73 billion), has also been "postponed."
The tallest building in the world is still under construction in this ambitious emirate. The Burj Dubai ("Dubai Tower") is a mixed-use tower which will be more than 800 meters (2,624 feet) tall when completed. But by the time of the dedication ceremony planned for next fall, will its roughly 200 stories still be needed? Won't the market in Dubai, famous for its insane profit margins, have imploded long before then? In some high-rise apartment buildings in Dubai, only a few apartments are occupied so far -- a fact that becomes particularly noticeable at night, when the lights are on in only a few windows. "Wait a while before buying real estate in Dubai," says a broker at his real estate booth in the "Mall of the Emirates," his voice lowered. Another bad sign is that The Brasserie restaurant in the Arabian Park Hotel began serving free lunches to Dubai's new unemployed in mid-December. Most of those who come are real estate brokers -- yesterday's resourceful gold-diggers dining in soup kitchens today. Similarly glum news is coming from the real estate markets in Qatar, Bahrain, Kuwait and even Saudi Arabia, the heavyweight on the Gulf. The King Abdullah Economic City, a new 170-square-kilometer (65-square-mile) commercial, residential and industrial city being built in Saudi Arabia 100 kilometers (62 miles) north of the city of Jeddah, is having trouble finding international investors, the development company Emaar conceded.
It is hard to believe that the region was experiencing a boom of Babylonian proportions until very recently. The value of projects under construction or in planning in the United Arab Emirates and Saudi Arabia alone amounts to well over $1 trillion (730 million). Until recently, the Saudis envisioned an unbelievably tall structure for the port city of Jeddah: a giant of a building stretching more than 1 kilometer (3,280 feet) into the sky. But now falling oil prices have taken their toll on the real estate industry, and it is now questionable whether the developer, Kingdom Holding, will ever build the giant tower. These are only the first signs of what could lie ahead: a long-term economic slump for high-flying construction projects in countries where officials recklessly relied on revenues from the sale of mineral resources, borrowing against their oil and natural gas reserves. As prices have come down, plans have been cancelled or put on hold. Those who can are trying to put on a brave face.
In Abu Dhabi, the young Stuttgart-based Lava architecture firm has been commissioned to build the Michael Schumacher World Champion Tower, a dynamically shaped structure which, at 250 meters (820 feet), is almost modest in its scale. The groundbreaking ceremony was scheduled for next month. But now, says Alexander Rieck, one of the directors at Lava, it has been postponed until March, April or possibly even later. He insists, however, that this is no cause for concern. "A few weeks ago, they were still saying that we should not delay the start of construction, because prices were going up from one month to the next," he says. "But now prices are falling, and any delay simply reduces the cost of the project." But is "delayed" just a euphemism for cancelled? No architect, investor or emirate is likely to willingly release news of cancelled skyscraper projects or abandoned construction sites. Nevertheless, Abu Dhabi, with its oil reserves, is still in a stronger position than Dubai.
Another example is Russia and its economic miracle. In Moscow's new Moscow City district -- Europe's biggest construction project -- a skyscraper called Rossiya ("Russia") was in the planning stages. When finished, it was intended to serve as a proud symbol of the country's resurrection and prominence. The architectural concept was straightforward: "Three skyscrapers in one." The world-renowned and award-winning British architect Lord Norman Foster designed the future landmark. At 612 meters (2,007 feet) and with 118 stories, Foster's slim tower was to be Europe's tallest building. Recently, however, the developer, Russian Land, announced laconically that it planned to "freeze" the construction of the ber-skyscraper because of the crisis. And Foster's fame is a currency that is suddenly worth nothing in this game. Instead of gazing at dizzyingly tall buildings, Muscovites now look at an ugly wasteland of a construction site. A few months ago, Shalva Chigirinsky, the head of Russian Land, pointed out that Moscow, as a "gigantic city with a colossal turnover of money and people," needs such mega-projects. But he has become reticent since the crisis reared its ugly head. Although Chigirinsky insists that construction of the skyscraper is only "temporarily" on hold, he doesn't know when it will be resumed.
Now Chigirinsky must also do without another prestige project from Foster's drawing board. Crystal Island, a glittering, 450-meter (1,476-foot) pyramid, was meant to beautify Moscow with 2.5 million square meters (27 million square feet) of luxury space. But then the developer lost his financial backing for the mega-project, a joint venture with the city government with a projected cost of $4 billion (2.9 billion). Moscow Mayor Yuri Luzhkov is now desperately seeking a new investor for Crystal Island -- so far unsuccessfully. The competition is still trying to look active. Mirax Construction, which earned a handsome $1.3 billion (950 million) in revenues in 2007, is building the Federation twin towers in the Moscow City development. They are designed to be 240 and 350 meters (787 and 1,148 feet) tall. Mirax CEO Sergei Polonsky has the biggest mouth of all of Moscow's construction magnates. Nevertheless, if he has no comment on the current situation, it is ostensibly for only one reason -- a building freeze is simply not an issue for him, he says. The Federation Tower, designed by Sergei Tchoban, a German of Russian descent, and the Hamburg native Peter Schweger, is scheduled to be dedicated in 2012. Nevertheless, Schweger, in faraway Hamburg, speaks candidly about the economic situation in Moscow: "It's a house of cards that is built on Western loans and which is now collapsing." Is the dream of a new, golden Russia already a thing of the past?
China, more than ever, is now clearly setting the pace. Twenty new large cities are founded in the People's Republic each year. The Dutch architect and urbanist Neville Mars speaks of a "Chinese speed" -- and of the fears this architectural megalomania has sparked in the rest of the world. But even China is increasingly feeling the effects of the financial crisis. Its exports have already dropped sharply, economic growth is declining and all forecasts for the enormous country point to a significant downturn. This also means bad news in the construction sector. In Macau, the southern Chinese gambling mecca, a developer from Las Vegas pulled out of a costly hotel construction project. In Beijing, the Hong Kong-based Swire Group cancelled a portion of its new shopping and restaurant center known as The Village. But given the large number of projects on the drawing board in China, some white elephants are bound to be cancelled before construction begins -- something that was already true in previous years.
Other prestige projects are still underway. For example, in late November, workers in the financial center of the Yangtze River metropolis of Shanghai began building one of the world's tallest buildings. The Shanghai Tower, which will stand 632 meters (2,073 feet) tall when complete, is projected to cost $2.2 billion (1.6 billion). Gensler, an American architecture firm, designed the helical tower, which will capture rainwater for its bathrooms and will generate electricity using wind turbines -- enough to power the building's exterior lighting, at least. There is little risk that the developers will run out of money for the tower, because all three companies are government-owned. The government will also find tenants for the building in the future -- by compulsion if necessary. "The three shareholders are the city's strongest government-owned businesses, with assets of hundreds of billions of yuan," says Gu Jianping, the president of the construction firm managing the project. "This guarantees that the project will progress favorably."
China's strategy for coping with the crisis is different from that of other countries. The Chinese are simply building in the face of the crisis -- no matter what the cost. In other words, in China a crisis manifests itself not in stasis, but rather in the government blindly taking action simply for the sake of doing something. Frankfurt urban planner and architect Albert Speer was one of the first Germans to be awarded major contracts in China. He too is under the impression "that the Chinese are even stepping on the gas and ratcheting up their speed to keep the domestic economy going." But for how long can the Chinese afford such a stimulus program? The rules in this speculative poker game have been invalidated worldwide, and no one knows how long it will last. The question of what is being built will probably be followed by the question of how buildings are built. In other words, the real estate crisis will shake up architects' careers. This is especially true of the luminaries in the industry, whose services have been snapped up for princely sums around the world in recent years. Their calling card was often the dramatic impact of their buildings, while they paid less attention to practical aspects like environmental compatibility and sustainability.
For those who still have the money, skyscrapers remain a means of showing off. "In many cases, developers still favor highly symbolic, even heroic architecture," says Frankfurt architect Jrgen Engel of the firm KSP Engel and Zimmermann. This, according to Engel, is an aesthetic that is not based on functional or economic principles. Nevertheless, he is convinced that a paradigm shift will invariably follow. "For many people, this crisis is a blow. In the future, everyone will think carefully about how they invest their money." Is the crisis an opportunity for architecture? The jury is still out. The fact that the rich, Western industrialized nations have at least begun looking at environmentally compatible construction suggests that there is a relationship between affluence and an environmental conscience. But this relationship does not apply in the suddenly prosperous East, where building has been and remains a matter of -- often eccentric -- taste, rather than sustainability. Everything emits an aura of waste, the costly chic of excessive scale.
Whether in Shanghai to Moscow, everything about a prestige construction project should be unique, nothing should resemble an ordinary tower block. The Trump hotel project in Dubai, which has been shelved for now, was touted as a sculptural attraction under the slogan: "Greater Height, More Drama, Unmistakable Presence." Size was no object: The skyscraper-cum-artwork is supposed to be centered around a giant open core. Many architects, including the stars in their midst, helped concoct this environmentally unfriendly symbolism in urban planning in the first place by designing skyscrapers in the shape of desert roses and walkie-talkies. In addition, there was great demand in some cities to play catch-up by building more or less prestigious residential and commercial buildings. Developers were in a hurry, and they were eager to keep investments low and profit margins high. No one was interested in the concept of sustainability that was being discussed in the West, at least. Sustainability is costly and time-consuming.
Western architects find fault with the low quality of many buildings in the luxury-obsessed Emirates, for example, especially the poor composition of the concrete used in their construction. As a result, many structures, including skyscrapers and prestige buildings, will essentially have to be torn down after a few years. And anyone who pays so little attention to getting the concrete right is unlikely to be concerned about energy-hungry air-conditioning systems and other environmental nasties. Does this mean that the crisis will at least awaken a green conscience, because environmentally responsible construction spells cost savings in the long term? Like Jrgen Engel, his Stuttgart colleague Alexander Rieck believes that a corresponding shift is taking place, and that the quality debate will begin after the "big market reassessment." According to Rieck, "the signs of the times are clear, and the environment is becoming increasingly important worldwide."
Perhaps the deceleration brought on by the financial crisis will trigger a change in attitudes. Perhaps the energy-saving factor will be the strongest selling point in the future, and perhaps a new aesthetic of environmentally friendly simplicity will develop as a result. Or maybe not. Such good intentions could be quickly forgotten by Russia developers and Arab sheikhs once the economy gets going again, and when, once again, money appears to be no object. Then the urbanization of the world will be resumed at a record pace. The architecture museum in Munich's Pinakothek der Moderne, a modern art museum, is currently exploring the phenomenon of the city in an exhibition. It has even proclaimed the current century to be the "Century of Cities." Since the beginning of the modern era, the curators write in the exhibition's catalog, the idea has existed that the world can be shaped by humanity, and that the rational intellect can design a rational environment. But it is human beings themselves who are far too irrational, as the chaos in the financial markets has demonstrated only too persuasively.
Ethics crisis in America? Church leaders say yes
From billion-dollar ponzi schemes to bad mortgages and pay-to-play dealings by public officials, some are asking: Is there a crisis of ethics in America? The swirl of corruption, fraud and greed stretching from Wall Street to Main Street has many U.S. church leaders saying the answer is a resounding yes -- America is facing not only an economic meltdown, but also a moral one. And they are rushing to bring flocks back into the fold. "Honesty is honesty. It doesn't matter if you are Christian, Jewish, Muslim, whatever. A lot of these debacles we're seeing can be traced and sourced back to a lack of good old ethics," said the Rev. Jerry Johnston, who this month launched a 12-part series of sermons on ethics at First Family Church in Overland Park, Kansas, which has about 5,000 members.
Johnston is one of a number of religious leaders and scholars who say the current spate of troubled times are an opportunity to lead more Americans into church pews and to prayer. "We're beginning to see this across the nation," said Ken Eldred, a California technology company entrepreneur who writes books about the role of religion in business. "There has been a crisis of ethics ... and I think sadly it is quite significant. People think business has nothing to do with faith, that honesty is not always the best policy. But when you take that away, people end up worse overall." The list of examples of dishonest dealings ranges from disgraced financier Bernard Madoff, who has been accused of fleecing investors out of $50 billion in what may be the largest Ponzi scheme ever, to Illinois Gov. Rod Blagojevich, accused of trying to sell the U.S. Senate seat formerly held by President Barack Obama, to the more than 400 people charged last summer in a $1 billion U.S. mortgage fraud investigation.
"Our economy is badly weakened, a consequence of greed and irresponsibility on the part of some, but also our collective failure to make hard choices and prepare the nation for a new age," Obama said at his inauguration as president on Tuesday. Greed and lack of accountability are blamed for the suffocating personal debt borne by millions of Americans and the toxic financial products that led to the decline of several U.S. banks and brokerages. David Gushee, a professor of Christian ethics at Mercer University in Atlanta, said the United States needs not just an economic recovery plan but also a "moral recovery plan."
"I think that this transition point is a good one in the life of our nation," said Gushee. "We need ... a renewal of the moral compass to do the right thing just because it's right, obeying not just legal laws but moral laws related to how people need to be treated."
Not everyone saw an ethical decline behind the nation's economic troubles. Gideon Rosen, professor of philosophy and chair of the Council of the Humanities at Princeton, said calling the economic crisis a moral failure was to be expected, but he did not think it was valid. "It is much simpler and extremely natural for human beings to try to find a moral story that makes sense of a bad outcome," Rosen said. "But this is an economic problem. Greed of a particularly egregious sort has played a causal role but that is not really the deepest feature of this crisis." Still, Charles Brock, founder of Church Growth International, which aids start-up ministries in the United States and abroad, said the economic meltdown that has led to massive U.S. job losses is fueling a return to church.
"Any time there is a crisis, economic or otherwise... people tend to search for peace and security," said Brock. "The greater the crisis, the greater the return to the church." Johnston said at his Overland Park church, he was specifically aiming outreach efforts at businessmen and women. "This is the ideal time to reach that demographic of people," said Johnston. "We will tell them it is time to change things."