J. Reynolds, performing acrobatic and balancing acts above 9th Street N.W., Washington DC
Ilargi: There are days when it's hard to figure out what the biggest story in the economy is, the main trend. Like today: is it Wall Street’s sick sense of entitlement, which led to Merrill Lynch CEO John Thain being kicked out the door, or is it the growing unrest around the planet, which today culminated in the demise of the Iceland government? Or is it maybe Obama saying his $825 billion stimulus is on track, while HuffingtonPost reports it's been rejected? Or the ongoing downfall of Britain, which today -surprise!- admits to being in a recession, while even the word depression doesn't cover its situation anymore?
And then, while logging some wood in the rare breaks I allow myself during these long days, I realized it’s all part of the same story.
John Thain redecorated his office to the tune of $1.2 million, 2/3 of which went to the guy who now reinvents the White House, while Merrill’s employees were being handed pink slips. Thain is an obvious idiot. But he is of course by no means alone. And the sick sense of entitlement is not restricted to Wall Street either. It’s the norm in circles of bankers and politicians across the planet. Which is the reason the Icelandic prime minister was forced out today after days, even weeks, of increasingly violent protests. It will also be the reason for many more governments to tumble this year and next, and more after that.
Still, that's the easy part in this. The harder one will come to unfold because of the sense of entitlement that exists all across our societies, that is to say our own ideas about what we are entitled to. It’s not just the bankers who, in Meredith Whitney's words, try to keep their Malibu Barbie Houses. Most of those homes belong to people who are not bankers. And there's many Barbie homes outside of Malibu. The majority among us live in Barbie houses. We just don't call them that. If we look back, say 100 years, and see the size of homes, and the average living space per capita, we find that while the population of our societies has exploded in the last century, so too has the sense of entitlement we feel concerning the amount of space we want, and think we deserve. "Vastly" more people, who all want vastly more space. We can all figure out the trendline there.
We are also confident in telling ourselves we have a right to a nice and warm and fast car, and instantly available world-class health-care, and the best possible education for our children-so they can in time buy their own Barbie homes-, and supermarkets full of products flown, shipped and trucked in from exotic places all around the globe. So we're not really that different from John Thain, are we? He merely has an even higher entitlement pattern than most of us do, not a structurally different one.
I've been critical of Obama's choices for his economic team, and I won't take back one word of that. However, the fiercest criticism should go to his message of getting America back on the track of economic growth. That notion, which is nothing but a fallacy, deserves more scrutiny than any other one. Our economies are shrinking, not growing, and they will continue on down that path for a very long time. Perpetual growth is over, and if you look closely, it has been for at least 30 years. Education, health care and many other fields have become more expensive and less affordable during that time. Who needed day-care in the 1960’s? Who could not afford to go to a doctor? Today, both parents need to work full-time -or more- just to pay the monthly bills. It wasn't like that in the 1960's. Not at all. So were our parents so much less happy than we are? Not at all.
The fallacy of perpetual growth has led us into a sense of entitlement that is based on complete blindness and utterly wrong assumptions. If we are not awake enough to leave that behind, we will be the reason for fighting in the streets, in our own Barbie neighborhoods. If we want to prevent that from happening, we need to take not one, but 826 steps back. But the president of Hope and Belief talks about resuming the economy of growth. That is not possible. People need a reality check. They need to adjust to living on less personal, corporeal, space. If you think or hope that the PM of Iceland is the last one to be thrown out by the wayside, you need to start thinking instead of believing.
NOTE: TIME magazine published its list of the Best 25 Financial Blogs. Of course, The Automatic Earth is nowhere to be found. And that is just fine by me. We have added about 30% more regular readers since Jan 1, and would be comfortably, make that very comfortably, in the Top Ten of Gongol's list of Finance Blogs if we'd open our stats to the public.
Look, Stoneleigh and I have been right about so many things so much of the time, our record speaks for itself. Thank you all who have recognized that. We don't write to try and maximize profits for the investor community, we're here to try and prevent damage for those who don't belong to that community. They are the people who belong here. A financial blog used to be about enhancing profits. Today, it's about minimizing losses. That is a crucial difference, something for which there still is far too little attention. We're here for the bottom part of the population, not for the richest part. We want you to be alright, we're not pre-occupied with making you wealthy. There's plenty places for that if that's your thing.
The credit crisis is not an opportunity, it's a threat. And that is why what we provide is badly needed. I don't care what TIME Magazine thinks, or Gongol, or anybody. It's very clear to me why I do what I do. Not to make you money, but to save it for you. We've been doing great so far. 5 days ahead of our first anniversary, it's grown so much bigger than we ever would have thought, even though we knew all along what was coming. We have saved our combined readership many millions of dollars. That's why we're here. Please remember to donate part of that to The Automatic Earth, so we can continue doing what we do. We're in this together.
Obama Says New $825 Billion Stimulus Plan Is 'on Target'
President Obama said today that efforts to pass a massive new economic stimulus package by mid-February are "on target," despite Republican lawmakers' objections to some elements of the plan. Speaking before a meeting at the White House with a bipartisan group of nine congressional leaders, Obama said he recognizes that "there are still some differences around the table and between the administration and the members of Congress about particular details" of the plan. The proposed $825 billion package is designed to create 3 million to 4 million new jobs, he said. "But what I think unifies this group is recognition that we are experiencing an unprecedented, perhaps, economic crisis that has to be dealt with, and dealt with rapidly," Obama said. He thanked the House and Senate for "moving forward very diligently" on passing what he called a "recovery and renewal plan," adding, "I know that it is a heavy lift."
Obama noted that he has instituted a new daily economic intelligence briefing at the White House. "Frankly, the news has not been good," he said, with each day bringing a greater focus on job losses and "instabilities in the financial system." However, he said, "it appears we are on target" to get the package through Congress by the Presidents' Day weekend. Presidents' Day falls on Feb. 16. Obama told the group: "The recovery package that we're passing is only going to be one leg in at least a three-legged stool." He said it has to be "part and parcel of a reform package" aimed at ensuring transparency and accountability in the way taxpayer dollars are managed as part of the stimulus effort.
Flanking Obama as he spoke were House Speaker Nancy Pelosi (D-Calif.) and Senate Majority Leader Harry M. Reid (D-Nev.). It was Obama's first such meeting with the congressional leadership since he took office Tuesday. Pelosi has said she intends to bring the package to a vote in the House by Jan. 28. But Republicans are seeking deeper tax cuts than the proposal contains and questioning whether $550 billion in new federal spending for roads, bridges and other projects can stimulate the economy quickly enough. Some conservative Democrats are joining Republicans in complaining that the package is too big and some of the spending plans too wasteful.
Addressing reporters outside the White House after the meeting, Republican lawmakers said they made their reservations clear to Obama. "There's unanimity that our economy needs help, and there's also a desire to move a package that would help rescue our economy," said House Minority Leader John A. Boehner (R-Ohio). "We expressed our concerns about some of the spending that's being proposed in the House bill and the fact that it doesn't spend out very quickly." He said there were also "concerns . . . about the size of the package." The GOP proposes "fast-acting tax relief" in the form of bigger tax cuts, Boehner said. "At the end of the day, the government can't solve this problem," he said. "The American people have to solve it. And the way they can solve it is if we allow them to keep more of the money that they earn."
Asked about the views of some economists that the package may be too small, Boehner rejected the idea but indicated that the administration could request more spending in the future if that turned out to be the case. "I think at this point we believe that spending nearly a trillion dollars is really more than we ought to be putting on the backs of our kids and their kids," Boehner said. "We're borrowing this money from our kids." Other Republican lawmakers attending the meeting included Sen. Mitch McConnell (R-Ky.), the Senate minority leader. Pelosi said after the meeting that she was confident a bill could be ready for Obama's signature before the Presidents' Day recess. "If not, there will be no recess," she warned. She said Obama listened carefully to the Republican lawmakers' suggestions.
Reid told reporters, "There wasn't a single person [in the meeting] who felt we couldn't work our way out of the problems that we have." He added: "The president was leading us to be united, not divided. He listened to all of the suggestions, whether from us or the Republicans." Asked if he worried that Republicans would block the legislation, Reid answered, "No." Underscoring the nation's bleak economic situation was more bad news on the jobs and housing fronts. The Commerce Department reported yesterday that the number of new housing starts has dropped to its lowest level since the department began keeping data in 1959.
Initial claims for jobless benefits, meanwhile, jumped 62,000 to 589,000 for the week ended Jan. 17, matching the highest level since the recession of the early 1980s. Unemployment stands at 7.2 percent, but many economists expect it to continue to rise by at least another point. At the same time, analysts and economists are predicting more staggering bank losses of $1 trillion or more, a prospect that could overwhelm the federal $700 billion financial rescue plan known as Troubled Assets Relief Program. The dismal economic news raised fears that the nation's recession, which began in late 2007, would continue through much of this year.
House Rejects Obama's Request For Rest Of TARP
The House expressed its bipartisan anger over a massive financial bailout package Thursday as the Obama administration undertook to assure lawmakers that it would spend the remaining money prudently and with greater oversight than the Bush administration. In a symbolic vote, the House voted to reject President Barack Obama's request for the unspent $350 billion in a bailout fund for the financial sector. The 270-155 tally was a moot point because the Senate had refused to block the release of the money last week. That effectively made it available to the new administration. The vote let Obama know that in seeking to shore up a shaky financial sector, he, like Bush before him, is operating on shaky political ground, even as the weakened banking industry continues to roil the stock markets.
Eager to signal a change, the Obama administration promised to force bankers to report their lending activity on a quarterly basis and to meet tougher executive pay requirements. From the podium of the White House briefing room and in written responses to senators, Obama officials pledged to ensure that the money is used to extend credit to small businesses and consumers. "Those principles include ensuring that executive compensation is limited so that the American taxpayer can feel confident that any money that's used as a part of a financial stability package doesn't go to line the pockets of a CEO," White House spokesman Robert Gibbs said.
Timothy Geithner, whose nomination to be treasury secretary cleared the Senate Finance Committee on Thursday, told the committee in written response to questions that "oversight and transparency requirements in the original proposal were inadequate." He said banks would have to provide "detailed and timely information on their lending patterns broken down by category."
In addition, a new special inspector general assigned to oversee the funds said Thursday that he will ask all institutions that have already received money from the Troubled Asset Relief Program to account for their use of the money and to detail any steps they have taken to meet existing executive pay caps. "If the American taxpayer is to be expected to fund this extraordinary effort to stabilize the financial system, it is not unreasonable that the public and its representatives in Congress have some understanding as to how those funds have been used by the recipients," the inspector general, Neil Barofsky, wrote to Sen. Charles Grassley. Thursday's vote illustrated how the House, where members face election every two years, is much more sensitive to public opinion than the Senate, with its six-year terms of office.
Ninety-nine Democrats joined 171 Republicans in voting to reject the money in a vote that put conservatives and liberals on the same prevailing side. Republicans had grudgingly voted for the $700 billion Troubled Asset Relief Program last fall and were still smarting over Bush administration decisions to use some of the money to help the auto industry and to give money to banks with few conditions. Democrats, freed by the Senate from the pressure to support Obama, fled from the program as well. "My goodness, I can't stand here as a member of Congress and vote to release the second half of this money without knowing what happened to the first half of it," said House Minority Leader John Boehner, R-Ohio.
Democratic opponents of the fund described the bailout as a misplaced priority. "There's a massive transfer of wealth going on, taking money out of the pockets of the American people and putting it into these banks," said Rep. Dennis Kucinich, D-Ohio. "This has to stop. We have to stop." The vote came a day after the House voted 260-166 to set greater reporting requirements on banks that receive bailout funds. House Financial Services Chairman Barney Frank, D-Mass., who supported releasing the funds, conceded Thursday's vote was moot. "Why are we still voting on it?" he asked. "Because there is a degree of anger in the American public at what they think is a very unfair system that gives benefits unduly and disproportionately to some of those who caused the problem, while denying health care and unemployment compensation and a decent higher education for working-class people."
Meredith Whitney on BofA, Merrill Lynch, John Thain being booted, new Citi chairman ”not good news” and the Malibu Barbie house
Wall Street’s Sick Psychology of Entitlement
The news that Merrill Lynch paid out $15 billion in bonuses is sure to ignite new questions about the wisdom of bailing out Wall Street. Merrill Lynch took $10 billion from the TARP, allegedly to fill holes in its balance sheet. But instead of using that to repair its financial health, it simply put the money into the pockets of its employees. There is no way to defend this disgusting payout. But that won’t stop Bank of America, which now owns Merrill, from defending the bonuses. And across Wall Street there are lots of people who actually believe that Merrill did the right thing. How can so many smart people be so dumb?
Easily. There is a sick psychology of entitlement on Wall Street that was created during the bubble years. Many simply cannot believe that they do not deserve huge pay packages. Their brains have not caught up with the idea that they are working in broken institutions that would be unable to pay to keep the lights on if not for the fact that Washington has given them billions of taxpayer dollars. Of course, smart people are very good at rationalizing their fantasies, especially when the fantasy serves to make them money. There are three rationales they’ll offer when pressed on this. Each one is easily skewered.
This is the most sophisticated argument for huge bonuses. In Germany, this actually happened. As it turns out, executives would rather risk their firm collapsing due to lack of capital than give up their big paydays. But there's an easy solution to this: throw the bastards out. The boards of every single financial company that turned down bailout bucks with a bonus limit could demand a full accounting of why a bank's executives think it is healthy enough to forego a bailout. And if they aren't satisfied they should just fire the management.
- "We made money. It was just one part of the firm that lost it all. So we deserve to be paid." Sorry, buddy. That’s not the way capitalism works. Ask the guy who just lost his job installing seat belts in GM cars. He was really good at that but since no one is buying those cars, he’s out of a job. Being really good at what you do doesn’t matter if your firm is broke—and your firm is broke. It’s now on taxpayer supported life-support.
- "We didn’t use taxpayer money to pay the bonuses." This is the most ridiculous idea ever. Money is fungible. If you use billions to pay bonuses and then need to ask the government for money to stay alive, you are using taxpayer money to fill in the hole you dug by paying the bonuses.
- "We’ll lose all the greatest people if we don’t pay them." Oh really? Where will they go? Who, exactly, is going to hire them? Also: so what? That’s how capitalism works. Failing firms that cannot afford to pay for talent lose that talent to successful firms. That’s an important part of market discipline.
- "If we don't pay bonuses when firms take the TARP, they won't take it."
Look. We’re not hysterical opponents of paying big bonuses. Actually, I'm on the record as defending huge bonuses from a couple of years ago. If your firm makes money, it can decide how to reward its employees. If it loses money, it can still decide to pay bonuses if it still has cash on hand. But when you pay yourself a bonus with taxpayer money you are simply taking money from someone who earned it and giving it to someone who didn't. If the government hadn’t supplied the means for redistributing that money, you’d just be a mugger.
It was only a few months ago that we were being told that Merrill Lynch, among others, desperately needed billions of dollars to survive, that without injections of new capital the financial system would come crashing down around us. If any of this was true, it should have been impossible for Merrill to pay out $15 billion in bonuses. Even the sharpest critics of the bailout never imagined that it would be used to make wealthy idiots even wealthier. All of this is a reminder of why it is very, very dangerous to allow the government to rescue firms instead of allowing the market to decide who should survive. Perhaps instead of a bailout, we should have confined the TARP to overseeing the orderly disolution of failed financial institutions.
Expect the World Economy to Suffer Through 2009
By IAN BREMMER and NOURIEL ROUBINI
Political risk is a bigger factor than ever.
Some optimistic experts are now saying that though this will be a turbulent year for global markets, the worst of the financial crisis is now behind us. Would it were so. We believe that 2009 will be tougher than many anticipate. We enter the new year grappling with the most serious global economic and financial crisis since the Great Depression. The U.S. economy is, at best, halfway through a recession that began in December 2007 and will prove the longest and most severe of the postwar period. Credit losses of close to $3 trillion are leaving the U.S. banking and financial system insolvent. And the credit crunch will persist as households, financial firms and corporations with high debt ratios and solvency problems undergo a sharp deleveraging process.
Worse, all of the world's advanced economies are in recession. Many emerging markets, including China, face the threat of a hard landing. Some fear that these conditions will produce a dangerous spike in inflation, but the greater risk is for a kind of global "stag-deflation": a toxic combination of economic stagnation, recession and falling prices. We're likely to see vulnerable European markets (Hungary, Romania and Bulgaria), key Latin American markets (Argentina, Venezuela, Ecuador and Mexico), Asian countries (Pakistan, Indonesia and South Korea), and countries like Russia, Ukraine and the Baltic states facing severe financial pressure.
Policy remedies will have limited effect as insolvency problems constrain the effectiveness of monetary stimulus, and the risk of rising interest rates (following the issuance of a wave of public debt) erodes the growth effects of fiscal stimulus packages. Only when insolvent banks are shut down, others are cleaned up, and the debt level of insolvent households is reduced will conditions ease. Between now and then, we can expect further downside risks to equity markets and other risky assets, given the likelihood that markets will continue to be jolted by worse-than-expected financial news.
The U.S. twin fiscal and current-account deficits will rise over the next two years as the country runs trillion dollar-plus fiscal deficits. We're all aware that foreign actors have financed most of this debt over the past several years. During the 1980s, the U.S. also faced the burdens of twin deficits, but relied on financing from key strategic partners like Japan and Germany. This time, the situation is more worrisome because today's financing comes not from U.S. allies, but from strategic rivals like Russia, China and a number of relatively unstable petrostates. This leaves the U.S. perilously dependent on the kindness of strangers.
There's some good news in this interdependence. The mutually assured economic destruction that this relationship implies ensures that China can't simply pull the plug on all this financing without suffering a considerable amount of self-inflicted pain. Reducing its financing of Washington would, among other things, put significant upward pressure on the value of China's currency, sharply undermining its export sector and, therefore, the country's economic growth. But over time, the ability and willingness of China and others to finance U.S. deficits will diminish as they begin to run fiscal deficits of their own. They'll need to use their financial resources at home just as a tsunami of U.S. Treasury bond issuances peaks.
Politics will make matters worse, primarily because governments in both the rich and the developing worlds are intervening in their economies more broadly and deeply than at any time since the end of World War II. Policy makers around the world are hard at work crafting stimulus packages filled with subsidies and protections they hope will breathe new life into their domestic economies, and preparing to rewrite the rules and regulations that govern global markets.
Why is this dangerous? At the G-20 summit a few weeks ago, world leaders pledged to address the crisis by coordinating their economic policy responses. That's not going to happen, because politicians design stimulus packages with political motives -- to satisfy the needs of their constituents -- not to address imbalances in the global economy. This is as true in Washington as in Beijing. That's why politics will drive the global economy more directly (and less efficiently) in 2009 than at any point in decades. Its politics that is creating the biggest risk for markets this year.
This is part of a worrisome long- term trend. In China and Russia, where histories of command economics predispose governments toward what we've come to call state capitalism, the phenomenon is especially obvious. National oil companies, other state-owned enterprises, and sovereign wealth funds have brought politicians and political bureaucrats into economic decision-making on a scale we haven't seen in a very long time.
Now the U.S. has gotten in on the game. New York, once the financial capital of the world, is no longer even the financial capital of the U.S. That honor falls on Washington, where lawmakers are now injecting populist politics into economics decisions. Companies and sectors that should be left to drown are being floated lifeboats. This drama is also playing out across Europe and Asia. As engines of economic growth, Shanghai is losing ground to Beijing, Mumbai to Delhi, and Dubai to Abu Dhabi.
Global markets will also face the more traditional forms of political risk in 2009. Militancy in an increasingly unstable and financially fragile Pakistan will continue to spill across borders into Afghanistan and India. National elections in Israel and Iran risk bringing the international conflict over Iran's nuclear program to a boil, injecting new volatility into oil markets. The impact of the financial crisis on Russia's economy could produce significant levels of unrest across the country. And Iraq may face renewed civil violence, as recently dormant militia groups compete to fill the vacuum left by departing U.S. troops. The world's first global recession is just getting started.
Roubini, Edwards Predict Slump in S&P 500 on China
Stocks will retreat around the world because of shrinking demand from China as growth in the third- biggest economy slows, said Nouriel Roubini, the New York University professor who predicted last year’s financial crisis. Global equities will fall 20 percent from current levels as China, which contributed 19.5 percent to total growth in 2007, contends with its slowest expansion in seven years, he said. Wall Street strategists predict the Standard & Poor’s 500 Index will rise 29 percent this year from the closing level yesterday.
Roubini, an economics professor at NYU’s Stern School of Business, said China already is in a "recession" despite government data showing a 6.8 percent fourth-quarter growth rate, as power output drops and manufacturing shrinks. "Demand is falling in China, they’re over-invested in capacity and there’s a global supply glut," Roubini, 50, said in a telephone interview. "It has very, very important implications." Roubini’s view is shared by Societe Generale SA global strategist Albert Edwards, who was correct in forecasting in March 2007 that a U.S. contraction would spur a bear market in equities. Edwards says the China slowdown will reduce earnings at industrial, energy and raw-materials companies, worsening a selloff in emerging and developed-market stocks that may send the S&P 500 down 40 percent to 500.
"People should be thinking really hard about this rather than sticking their heads in the sand," said Edwards, a London- based strategist and member of the top-ranked global investment strategy team in Thomson Extel’s surveys the past three years. "We’re just pointing out when the emperor doesn’t have any clothes on." The consensus among eight strategists surveyed by Bloomberg this week is for the index to end the year at 1,066. The S&P 500 fell 1.5 percent yesterday to 827.50, and futures on the index dropped 2.2 percent as of 4:32 a.m. in New York. Data at China’s National Bureau of Statistics is gathered in a "scientific and realistic method," Ma Jiantang, the agency’s director, said at a briefing in Beijing yesterday in response to a question about the accuracy of government figures. Zhang Yingxiang, a spokeswoman for the statistics bureau, declined further comment when contacted by phone today.
China’s economy grew 9 percent for all of 2008 after a 13 percent expansion in the previous year, the fastest in the world. China’s CSI 300 Index fell 0.6 percent at the close in Shanghai, the biggest drop in eight days. Commodity producers led declines after Aluminum Corp. of China Ltd. and Yunnan Copper Industry Co. reported lower profit. Economists at JPMorgan Chase & Co., Citigroup Inc., the World Bank and the International Monetary Fund all predict China will grow at least 7 percent this year, while investors Jim Rogers and Mark Mobius are buying Chinese shares on expectations the government will bolster economic growth with interest-rate cuts and fiscal stimulus. The IMF said China’s contribution to global growth increased to 19.5 percent in 2007 from 17.2 percent in the previous year.
China, which has $1.9 trillion set aside in the world’s largest reserves, plans to spend at least 4 trillion yuan on bridges, housing and tax breaks to boost the economy. Chinese President Hu Jintao has pledged further measures to maintain stable growth in the face of "serious challenges and difficulties." Rogers, who predicted the start of the commodities rally in 1999, recommends investors buy China’s agriculture, water treatment, power generation and infrastructure stocks because the companies won’t be hurt by the nation’s slowing economy. "China could be in recession, I have no idea and it’s not relevant to me because I’m using my judgment as to what will happen six months from now," said Rogers, who authored books on investing including "A Bull in China: Investing Profitably in the World’s Greatest Market." "There is a lot happening in China and there will be those that will hold up well."
China’s economy will grow 6.3 percent this quarter from a year earlier, according to the median estimate of nine economists surveyed by Bloomberg after yesterday’s GDP report. China’s electricity output declined 7.8 percent in November from a year earlier and fell 3 percent in October, the first declines since February 2002, according to China Economic Information Net data compiled by Bloomberg. Manufacturing shrank for a third month as the deepening global recession cut demand for the nation’s toys, clothes and electronics. Edwards said rising unemployment among factory workers will fuel social unrest, threatening the Communist Party’s survival and increasing the risk authorities will devalue the yuan to boost exports.
The yuan appreciated about 19 percent against the dollar between 2005 and July 2008 as China redressed what U.S. officials saw as an unfair price advantage for exports. The yuan has since stabilized at about 6.85 per dollar. Timothy Geithner, President Barack Obama’s nominee for Treasury secretary, said yesterday that China is "manipulating" its currency. The yuan fell the most in a month today as the nation’s banks refuted the new U.S. administration’s accusation. "If you amble your way through the analysis, you realize if push comes to shove they will devalue" the yuan, Edwards said. That may spur lawmakers in the U.S. and China to increase trade barriers, he said.
Roubini’s Gloom Gets Traction in Panicky Tokyo
The champagne must be flowing at Toyota Motor Corp. headquarters. It just ended General Motors Corp.’s 77-year reign as the world’s largest automaker. Toyota also is looking ahead and going full circle in terms of management: It just named the grandson of the company’s founder as president. The celebrations and nostalgia will be short-lived, and not just because Toyota is forecasting its first operating loss in 71 years. It’s on the frontline of an economic plunge that might push Japan into another "Lost Decade." That’s a strong statement, and one that’s worth exploring in Japan and beyond.
Economic data coming out of Tokyo have been atrocious. Exports, for example, plummeted 35 percent in December from a year earlier. That was the sharpest decline since 1980 (there are no comparable data before then). Exports were the main driver of the recovery that now has died a very sudden death. With nothing self-reinforcing about Japan’s expansion, Asia’s biggest economy seemed to go from 120 kilometers (75 miles) per hour to zero in all of a week. Now it’s going in reverse, and picking up speed. Global demand for cars and electronics is drying up fast. Toyota, Sony Corp. and Honda Motor Co. are shedding thousands of workers and closing production lines as profits and sales dwindle. It’s just the beginning as the U.S. and Europe sink.
The global crisis blindsided most Japanese executives and politicians. Much of the chatter in 2008 was about how Japan’s cash-rich banks would play a white-knight role for a Wall Street in turmoil. Mitsubishi UFJ Financial Group Inc.’s $9 billion investment in Morgan Stanley was seen as the first of many such deals. As 2009 unfolds, the folly of that view will come into sharper focus. Yes, Japan’s government has the resources and borrowing potential to forestall a meltdown. The roughly $15 trillion of household savings is a comforting counterpoint to press reports of rising Japanese poverty and homelessness.
Yet Japan will have the same problem as China this year. Both economies can hold their ground when others are booming. With the U.S and Europe in deepening recessions, all that’s left is domestic stimulus. That goes for Asia, too. Singapore may contract a record 5 percent this year. In South Korea, industrial production fell by the most on record in November. Officials in Indonesia, Malaysia, the Philippines, Taiwan and Thailand are struggling to boost slowing economic growth. No serious economist thinks Japan is going to crash. Yet the odds of another 1990s-like period of negligible growth and deflation are increasing as economies such as the U.S. risk a similar fate.
Minimal household savings, sliding home prices and dwindling retirement accounts leave Americans with one option: thrift. The specter of Americans consuming less is prompting a rapid reassessment of Japan’s prospects. "We’d better get ready for a three-year recession," says Hiroshi Yoshikawa, head of the government committee that charts economic cycles. The decline "will be very severe, not only in terms of duration but also depth." Richard Jerram, chief economist at Macquarie Securities Ltd. in Tokyo, headlined a Jan. 20 report: "Panic on Jobs." Yesterday’s was called "Unprecedented Contraction," arguing that the speed of declines in exports and production "is more than twice as fast as anything on record."
Such trends are engendering the kind of gloom envisioned by market seers such as Nouriel Roubini. The views of the chairman of Roubini Global Economics LLC in New York are worth considering. That goes both for what he’s saying now -- that Japan is in for a severe recession -- and more than decade ago. In November 1996, Roubini delivered a speech in Tokyo titled "Japan’s Economic Crisis." What is striking when reading Roubini’s remarks then is how, with a few changes here and there, many of them are just as relevant in January 2009. "The different social culture and history of Japan suggest that Japan will not and should not follow the brutal ‘Wild-West’ American model of restructuring and reform," Roubini said. "However, there is need in Japan for major structural reforms and economic deregulation in order to foster entrepreneurship, risk-taking, innovation and long-run growth."
Roubini added that "delaying these reforms will not help because short-run reduction of the pain might lead to more serious problems in the long-run." Prescient words. Because Japan did delay much-needed economic changes, it’s now in a very bad way. The Bank of Japan has already failed to boost growth by cutting interest rates to zero. Japan has already tried, and failed, to create a thriving domestic economy with massive public spending. The BOJ and the government will pull out all the stops to keep a recession from becoming a depression. Wealthy Japan is far better positioned to stay out of the abyss than peers in Asia. Yet Japan won’t be making the changes needed to prepare for a rapidly aging population and or help it to thrive in a region in which its standard of living is too high to compete. Unless officials in Tokyo act fast and furiously, Japan risks another lost decade. Or something even worse.
The World Won't Buy Unlimited U.S. Debt
By PETER SCHIFF
Barack Obama has spoken often of sacrifice. And as recently as a week ago, he said that to stave off the deepening recession Americans should be prepared to face "trillion dollar deficits for years to come." But apart from a stirring call for volunteerism in his inaugural address, the only specific sacrifices the president has outlined thus far include lower taxes, millions of federally funded jobs, expanded corporate bailouts, and direct stimulus checks to consumers. Could this be described as sacrificial?
What he might have said was that the nations funding the majority of America's public debt -- most notably the Chinese, Japanese and the Saudis -- need to be prepared to sacrifice. They have to fund America's annual trillion-dollar deficits for the foreseeable future. These creditor nations, who already own trillions of dollars of U.S. government debt, are the only entities capable of underwriting the spending that Mr. Obama envisions and that U.S. citizens demand. These nations, in other words, must never use the money to buy other assets or fund domestic spending initiatives for their own people. When the old Treasury bills mature, they can do nothing with the money except buy new ones. To do otherwise would implode the market for U.S. Treasurys (sending U.S. interest rates much higher) and start a run on the dollar. (If foreign central banks become net sellers of Treasurys, the demand for dollars needed to buy them would plummet.)
In sum, our creditors must give up all hope of accessing the principal, and may be compensated only by the paltry 2%-3% yield our bonds currently deliver. As absurd as this may appear on the surface, it seems inconceivable to President Obama, or any respected economist for that matter, that our creditors may decline to sign on. Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo. But just because the game has lasted thus far does not mean that they will continue playing it indefinitely. Thanks to projected huge deficits, the U.S. government is severely raising the stakes. At the same time, the global economic contraction will make larger Treasury purchases by foreign central banks both economically and politically more difficult.
The root problem is not that America may have difficulty borrowing enough from abroad to maintain our GDP, but that our economy was too large in the first place. America's GDP is composed of more than 70% consumer spending. For many years, much of that spending has been a function of voracious consumer borrowing through home equity extractions (averaging more than $850 billion annually in 2005 and 2006, according to the Federal Reserve) and rapid expansion of credit card and other consumer debt. Now that credit is scarce, it is inevitable that GDP will fall. Neither the left nor the right of the American political spectrum has shown any willingness to tolerate such a contraction. Recently, for example, Nobel Prize-winning economist Paul Krugman estimated that a 6.8% contraction in GDP will result in $2.1 trillion in "lost output," which the government should redeem through fiscal stimulation. In his view, the $775 billion announced in Mr. Obama's plan is two-thirds too small.
Although Mr. Krugman may not get all that he wishes, it is clear that Mr. Obama's opening bid will likely move north considerably before any legislation is passed. It is also clear from the political chatter that the policies most favored will be those that encourage rapid consumer spending, not lasting or sustainable economic change. So when the effects of this stimulus dissipate, the same unbalanced economy will remain -- only now with a far higher debt load. If any other country were to face these conditions, unpalatable measures such as severe government austerity or currency devaluation would be the only options. But with our currency's reserve status, we have much more attractive alternatives. We are planning to spend as much as we like, for as long as we like, and we will let the rest of the world pick up the tab.
Currently, U.S. citizens comprise less than 5% of world population, but account for more than 25% of global GDP. Given our debts and weakening economy, this disproportionate advantage should narrow. Yet the U.S. is asking much poorer foreign nations to maintain the status quo, and incredibly, they are complying. At least for now. You can't blame the Obama administration for choosing to go down this path. If these other nations are giving, it becomes very easy to take. However, given his supposedly post-ideological pragmatic gifts, one would hope that Mr. Obama can see that, just like all other bubbles in world history, the U.S. debt bubble will end badly. Taking on more debt to maintain spending is neither sacrificial nor beneficial.
Pressure Grows for More Rescue Funds
The White House's economic team is under pressure from Congress to finalize its financial rescue plan within a week amid a growing realization among lawmakers that they will have to find extra money to fund the new administration's program. The team is hammering out a three-pronged approach that focuses on stemming foreclosures, revamping the government's bailout program and purchasing toxic assets weighing down bank balance sheets and pressuring stock prices. White House spokesman Robert Gibbs said Thursday the plan will be completed "shortly."
The scale of the effort is almost certain to be larger than the $350 billion secured last week through the Troubled Asset Relief Program. Lawmakers say that means they need a proposal from the White House within days so they can appropriate more money. Congress could do that by either attaching the funds to the economic-stimulus plan already totaling $825 billion, or by approving legislation that expands TARP and includes new restrictions on banks that receive money. Kent Conrad (D., N.D.), chairman of the Senate Budget Committee, has told senior aides to President Barack Obama that $350 billion won't be enough.
Some members of Congress said they were worried the White House isn't moving fast enough. "I didn't feel I got the sense of immediacy, the sense of urgency that these questions warrant," said Senate Finance Committee member Ron Wyden (D., Ore.), who has pressed the administration to force financial institutions to disclose the toxic assets on their balance sheets. "I'm just going to ride this every day." The White House on Thursday sought to project that sense of urgency. Mr. Gibbs said the president began what will be daily economic briefings from National Economic Council director Lawrence Summers and other senior staff, along the lines of the president's traditional daily intelligence briefing. Work on the next phase of the Wall Street rescue is happening "as we speak," Mr. Gibbs said.
"The president will make a decision as soon as the financial team gives him those recommendations," he added. "He believes, obviously, that we have to act expeditiously to get this economy moving again." Timothy Geithner, Mr. Obama's nominee for Treasury secretary, told Congress Wednesday that the administration has no "current plans" to request more money, but might seek additional resources if financial conditions worsen. Mr. Geithner received the approval of the Senate Finance Committee by an 18 to 5 vote, paving the way for a full Senate vote in coming days. "We have to be prepared to act flexibly and with speed if conditions worsen appreciably, to devote more resources if that is necessary to secure our objectives," Mr. Geithner wrote in response to questions from lawmakers considering his nomination.
The administration has said it plans to devote between $50 billion and $100 billion in a "sweeping" effort to help homeowners. It also is considering a potentially expensive plan to remove the toxic assets clogging bank's balance sheets, including possibly by having the government purchase those assets. Some economists estimate that could cost trillions of dollars. One reason former Treasury Secretary Henry Paulson abandoned his plan to buy the assets was because of the high cost. "It's an incredibly difficult thing to do and to get right," Mr. Geithner told lawmakers at his confirmation hearing. "And getting it right will be central to the basic credibility of the program."
If the government pays too low a price, banks may have to take deeper write-downs than they have already, exacerbating their financial woes. But if the prices are too high, then banks are benefiting at taxpayer expense. Mr. Geithner said there are several ways to deal with the asset prices, including looking at how the market is pricing the assets, using a third-party to evaluate their value or getting a financial institution's supervisors to assess what the assets are worth. "All of them have risks. All of them are imperfect. They all have limitations," Mr. Geithner said.
The right and wrong way to bail out the banks
By GEORGE SOROS
According to reports in Washington, the Obama administration may be close to devoting as much as $100bn of the second tranche of the troubled asset relief programme funds to creating an "aggregator bank" that would remove toxic securities from the balance sheets of banks. The plan would be to leverage this amount up 10-fold, using the Federal Reserve’s balance sheet, so that the banking system could be relieved of up to $1,000bn (€770bn, £726bn) worth of bad assets.
Although the details have not yet been decided, this approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson, the former US Treasury secretary. The proposal suffers from the same shortcomings: the toxic securities are, by definition, hard to value. The introduction of a significant buyer will result, not in price discovery, but in price distortion.
Moreover, the securities are not homogeneous, which means that even an auction process would leave the aggregator bank with inferior assets through adverse selection. Even with artificially inflated prices, most banks could not afford to mark their remaining portfolios to market so they would have to be given some additional relief. The most likely solution is to "ring-fence" their portfolios, with the Federal Reserve absorbing losses that extend beyond certain limits. These measures – if enacted – would provide artificial life support for the banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. The banks would need fat margins and steep yield curves for a long time to rebuild their equity.
In my view, an equity injection scheme based on realistic valuations, followed by a cut in minimum capital requirements for banks, would be much more effective in restarting the economy. The downside is that it would require significantly more than $1,000bn of new capital. It would involve a good bank/bad bank solution, where appropriate. That would heavily dilute existing shareholders and risk putting the majority of bank equity into government hands. The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.
The latter course would avoid recognising and coming to terms with the painful economic realities, but it would put the banking system into the same quandary that proved the undoing of the government sponsored enterprises (GSEs) – Fannie Mae and Freddie Mac. The public interest would dictate that the banks should resume lending on attractive terms. However, this lending would have to be enforced by government diktat because the self-interest of the banks would lead them to focus on preserving and rebuilding their own equity. Political realities are pushing the Obama administration towards the latter course. It cannot go to Congress and ask for the authorisation to spend an additional $1,000bn on recapitalising the banks because Mr Paulson has poisoned the well in the way he demanded and then spent the money for Tarp. Even the second tranche of Tarp – the remaining $350bn – could only be pried loose by a congressional manoeuvre. That is what is leading the Obama administration to contemplate reserving up to $100bn of that tranche for the "aggregator bank" solution.
The stock market is pressing for an early decision by putting pressure on financial stocks. But the new team should avoid repeating the mistakes of the previous one and announcing a programme before it has been thoroughly thought out. The choice between the two courses is momentous; once made, it will become irreversible. It should be based on a careful evaluation of the alternatives. President Barack Obama can fulfil his promise of a bold new approach only by establishing a discontinuity with the previous team. Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way.
The Next Bank Bailout
With financial stocks sliding as fears grow that more major banks may fail, it’s easy to overlook the problems at the Federal Home Loan Banks, a group of 12 regional institutions that play a crucial role in providing banks around the country with money for mortgage lending. But that would be a mistake. The banks served as a lender of last resort as the credit crunch tightened, propping up other banks that now have gone under. The crisis now facing them exemplifies the regulatory and other weaknesses in the financial system that have led to the worsening banking crisis, analysts say - sloppy accounting, a lack of transparency, lax oversight, and the trend toward "scheming" a way out of the credit crunch. Wall Street is nervous because it can’t determine the true extent of problems at the banks. And, once again, taxpayers may end up picking up the tab.
"They’ve got a real problem on their hands," said James Bianco, president of Bianco Research in Chicago, a leading analyst and market commentator, in reference to the Federal Home Loan Bank system. "And it’s helping to drag down larger banks as well." The difficulties of the once-obscure government-backed but privately-run banks came into the spotlight earlier this month, when Moody’s released a report saying that in a worst-case scenario, eight of the 12 banks could run low on cash because they own billions of dollars of toxic mortgage securities that are now worthless. The banks are a major source of low-cost lending to 8,000 institutions ranging from small community banks to commercial banks to credit unions.
Federal Home Loan banks in both Seattle and Pittsburgh in particular warned recently that their capital is running low. Moody’s concluded the government may have to step in with funding to keep the banks going. Michael Youngblood, founder of Five Bridges Capital, an asset management company in Bethesda, Md., described the banks as "a victim of circumstance that has affected financial institutions doing mortgage lending in the United States." And Bert Ely, an industry analyst in Alexandria, Va. said the banks’ problems also are tied to accounting rules that make their losses seem more severe than they are. "Their investments have backfired on them," Ely said. "But I think they’re going to be all right. If they go under, we’ve got even worse problems in the economy than we thought."
But on Wall Street, that’s exactly what already-jittery investors fear. Some think the Atlanta FHLB could be taken over by the Federal Reserve, that the San Francisco bank could be merged with other banks, and that the New York bank has lost a significant amount of money, Bianco said. He doesn’t buy the argument that accounting problems are to blame: "That’s the same thing they used to say about Fannie Mae and Freddie Mac," he said. The government took control of the two mortgage giants in September, after the agencies suffered losses from risky mortgage-basked securities. The Federal Home Loan Banks have been plagued for years by "sloppy" accounting, Bianco said, and investors are wary of assurances that the worst-case scenario described by Moody’s is unlikely. "They could be sitting on big losses," Bianco said. "We don’t know how many bad loans they have, and their accounting is so bad investors don’t have any confidence in their numbers."
The banks’ regulator until recently was the Federal Housing Finance Board, created in the wake of the savings and loan scandal of the late 1980s. Asking why the banks were permitted to operate for years with poor accounting practices, Bianco said, is "like asking why the SEC never cracked down on Bernie Madoff," who ran a Ponzi scheme for years that ultimately cost investors $50 billion. The same regulators of the savings and loans that collapsed were hired on with the Federal Housing Finance Board, which meant real reform never happened. "When you fail in Washington," Bianco said, "you get a promotion." In July, the government merged the Federal Housing Finance Board into the Federal Housing Finance Agency, which now also oversees Fannie and Freddie and has expanded regulatory powers.
The problems of the Depression-era banks stem from the sharp expansion of their role in the credit crisis, beginning in 2007. The government used the banks as a "defacto discount window" to prop up the financial system, as other sources of credit began to dry up, Bianco said. Banks that eventually failed or were sold, from Countrywide to Washington Mutual to Citigroup, quickly borrowed a record $163 billion from the Federal Home Loan Banks to stay afloat. "The government was using the Federal Home Loan Banks as a way to bail out the banking system early on," he said.
The moves raised some questions at the time. Sen. Charles Schumer (D-N.Y.) wrote a letter in November 2007 to the Federal Housing Finance Board, complaining about $51.5 billion in loans from the Atlanta Federal Home Loan Bank to Countrywide. Schumer said he found the figures "alarming." Peter Wallison, an American Enterprise Institute scholar who studies the financial system, also expressed concern that the government was taking unnecessary risks in making the banks the lender of last resort. But not only did the lending continue - it grew even more. In February of last year, Barry Ritholtz of The Big Picture called the banks’ expanded role a covert bailout and an "ongoing and expensive venture into irresponsible lending and speculation - all at the taxpayer’s expense."
Youngblood, of Five Bridges, said the Federal Home Loan Banks had little choice. The Office of Thrift Supervision, Countrywide’s regulator, had declared the bank sound, giving the banks little criteria to turn down loans. Besides, the alternative might have been making the credit crunch even worse, he said. "It was a calculated risk," he explained. But Washington Mutual eventually collapsed, in the biggest bank failure in U.S. history. Countrywide, once the nation’s largest subprime lender, was bought by Bank of America in January, and its shares have fallen by 64 percent since then. Citigroup, awash in bad loans, said it lost $19 billion last year. Investors are worried about Wells Fargo since its acquisition of Wachovia and its toxic mortgage securities. Nouriel Roubini, the New York University business professor who predicted the credit crisis, this week called the U.S. banking system "essentially insolvent."
The Federal Home Loan Banks are chartered by the government but operate as a privately run cooperative. As they did with Fannie and Freddie, investors assume the federal government would bail the system out if it got in trouble. The banks receive top ratings from the ratings agencies and are able to borrow money more cheaply due to the implicit government backing. The banks’ problems illustrate how the government may have promised more than it can deliver in keeping failed or troubled institutions afloat, Bianco said. "Everybody thinks we can scheme our way out of this," Bianco said. "There’s no scheming our way out of it. There’s not enough credit to go around." With the real possibility of government guarantees being called on "all in one day," he said, "the whole system is coming apart."
Not everyone is as pessimistic as Bianco. Alex Pollock, a banking expert at the conservative think tank, American Enterprise Institute, said the doesn’t think the Federal Home Loan Banks are in peril of going under. "It doesn’t really look to me like an insolvency issue," Pollock said. Neither Youngblood nor Ely also thinks the banks will fail, but acknowledged they may need some financial help from the government. Regardless of whether they survive, the crisis has opened a window into longtime, overlooked weaknesses in Federal Home Loan Bank system and its oversight. Ely said the in the 1980s, the Federal Home Loans Banks were known as "flubs," for their poor risk controls. Bianco described them as "having had losses for years." Yet as the credit crisis intensified, the government chose to make them the lender of last resort to major banks overwhelmed with toxic mortgages. And that leaves taxpayers facing the possibility of yet another bailout.
Fed Likely to Keep Focus on Rates, Loans
Federal Reserve officials are likely next week to stick closely to their approach for handling the financial crisis -- near-zero interest rates and a focus on special lending programs -- despite internal rifts about some of their tactics. Some steps being considered -- such as setting an inflation target or buying Treasury securities -- are likely to stay on the back burner as Fed officials examine the efficacy of those ideas. An inflation target could help manage expectations for future inflation, while Treasury purchases could help bring longer-term interest rates down further, but officials want to study them more.
The efforts by some regional Fed bank presidents -- most notably Charles Plosser of the Philadelphia Fed -- to get the central bank to set numerical targets for how much money it pumps into the financial system also have gone nowhere so far. Those targets could act as a constraint on its rescue programs -- a prospect Fed Chairman Ben Bernanke wants to avoid. The Federal Open Market Committee, the Fed's policy-making arm, meets next Tuesday and Wednesday. The committee, which sets monetary policy, consists of members of the Federal Reserve Board in Washington and a rotation of five presidents from the 12 regional Fed banks. In normal times, the focus of FOMC meetings is the level of the Fed's benchmark interest rate, the federal-funds rate. At the FOMC's December meeting, the central bank said it would push the fed-funds rate to near zero. With policy makers unable to move the target lower to boost the weak economy, the focus of FOMC meetings has shifted to the wide range of new lending and asset-purchase programs the Fed has introduced.
Much of the coming meeting will be spent reviewing these programs, their effectiveness and challenges the Fed will face in running them and one day unwinding them. The programs -- ranging from efforts to buy commercial paper to offering emergency loans to banks and securities firms -- are the province of the Federal Reserve Board and the New York Fed. Some regional Fed bank presidents worry that these new programs are causing the central bank's balance sheet and some measures of the U.S.'s money supply to grow too quickly, which could eventually cause inflation. They are pushing for stricter guidelines on how fast the programs can grow. "I believe we must proceed with caution," Mr. Plosser, the Philadelphia Fed president, said in a speech earlier this month. "While the lending programs are designed to improve the flow of credit, they are currently injecting enormous amounts of liquidity into the system," said Mr. Plosser, who doesn't have a vote at the FOMC this year.
In another speech this month, Richmond Fed president Jeffrey Lacker, who does vote on the FOMC, warned that the Fed's market interventions could conflict with its independence. Mr. Bernanke, whose view carries the day, opposes efforts to set limits or targets for how much the Fed's balance sheet should grow, or how much cash it pumps into the economy. Such limits, he said in a speech last week, could force the Fed to be more restrained at a time when its intervention is most needed. "The usage of Federal Reserve credit is determined in large part by borrower needs and thus will tend to increase when market conditions worsen and decline when market conditions improve," Mr. Bernanke said. Setting targets for the balance sheet "could thus have the perverse effect of forcing the Fed to tighten the terms and availability of its lending at times when market conditions were worsening." In their statement following next week's meeting, Fed officials are likely to acknowledge the continued deterioration in the economy since officials last met, and the quick slowdown in inflation.
Several Fed officials have highlighted the potential benefits of an inflation target, which could help convince investors of two things: officials won't pump so much money into the economy that they will create inflation later, and they won't let the economy sink so low that deflation, a broad decline in prices, would set in. But officials aren't prepared to take such a step. Setting a target raises many questions, including: What is the appropriate inflation rate to target? And what is the appropriate measure of inflation? They are also examining closely the idea of buying Treasury securities, but this also appears to be on the back burner for now. Such a policy could help push long-term interest rates lower, but some Fed officials worry that investors could see it as an effort by the central bank to finance large government budget deficits, which could be inflationary. They are instead focused on other efforts to bring down other long-term rates, such as mortgages.
RIP: Credit as Money
by EUGENE LINDEN
The drumbeat over the Obama administration’s plans to fix the banking crisis has reached fever pitch. Over the past week, what appears to be a carefully choreographed series of leaks has raised expectations that the administration has something very big planned (my guess is that it would've been announced today, but for the delay in Timothy Geithner’s confirmation as Treasury Secretary). Various newspapers and blogs have speculated on the details, some of which would be truly dramatic. Examples include: An omnibus take-over of a raft of banks; a process that would include wiping out existing shareholders; converting debt to equity to avoid the new N-word (nationalization); the FDIC providing a backstop for deposits; and, to restore trust in bank balance sheets, the establishment of a new entity to buy, hold, and trade trillions of dollars in now-suspect bank assets.
Clearly something needs to be done, and just as clearly, the banks have gotten wind of the proposals and are trying to head off the scariest parts of the plan. (I interpret the trumpeted insider-share purchases by JPMorgan Chase’s Jamie Dimon and execs at Bank of America to be a message: "Hey, no need to nationalize us, we believe in our equity value!") Ignored by much of the commentary, however, has been a small but crucial change in the proposed composition of the much-discussed new entity to buy toxic bank assets. Moreover, if this entity comes to pass, it will serve as the grave for a widely shared -- but very dangerous -- artifact of the bubble years: the confusion of money as credit.
First, the new wrinkle in the "bad bank" concept. Last week on CNBC, Sheila Bair, the outgoing and incoming head of the FDIC, remarked on the possibility of setting up an entity funded by both public and private money to buy toxic assets. The involvement of private money is new, and the timing of this announcement begs many questions. In the CNBC interview, Bair said, "One approach we think might have some merit is what we call an "aggregator bank" where you would set up a facility capitalized through some portion of the TARP fund to acquire troubled assets…" So far so good. The basic idea has been floated many times over the past year. But then she remarked that the new structure would "also require those institutions selling assets into this facility to contribute some capital cushion themselves…"
The suggestion about lenders having a stake in the entity is both crucial and new - at least new to the Bush administration. (A number of observers, including me, suggested such an entity at the beginning of the crisis in Aug. 2007.) Forcing banks to have skin in the game alongside taxpayers makes it less likely that financial institutions will try to screw the taxpayers. Having the government involved also provides adult supervision in the setting of the ground rules. Why then, didn’t,the Bush administration put forth this key provision before the very end? Someone must have suggested it - after all, it’s little more than common sense. If it’s a good idea in the full teeth of the crisis, why wasn’t it a good idea at the outset? That it will be the Obama administration that launches this entity implies that the Bush administration was loathe to push for the self-policing aspects of having the banks provide capital.
And then, there’s the end-of-an-era aspect of plan. Whether it’s called a "bad bank" or "aggregator" or "RTC II," the new entity represents an explicit admission that no one else is willing to accept trillions of dollars in credit instruments that 2 years ago were treated as interchangeable with money. Thanks to the ingenuity of Wall Street’s rocket scientists, so-called structured credit products proliferated wildly during this decade, backed by mortgages and other obligations (or by other credit instruments that in turn, were backed by assets). With credit rating agencies blessing these products as AAA, these instruments were treated almost as money, and provided much of the liquidity that spurred the illusion of wealth creation during the bubble years.
Now, pension funds, hedge funds, endowments and financial institutions that confused money and credit have discovered -- in the most brutal fashion -- that the value of anything deemed to be money-good rests entirely on the willingness of someone else to accept it. With no one but the government willing to accept these assets, this former currency will be retired as scrap. RIP, money as credit. Unfortunately, the story does not end there. While officials cross their fingers that these disgraced credit instruments will remain quarantined, this nuclear waste could still leach into the financial system - particularly if the prices paid are above market (whatever that is!). The scale of this pollution is such that the sum total of government guarantees and obligations may impact the value the rest of the world puts on the US dollar, the linchpin of the global financial system. In the end then, money and credit do turn out to have some something in common: the value of either depends entirely on the trust of strangers.
U.S. Stance on the Yuan Gets Tougher
President Barack Obama's nominee for Treasury secretary accused China on Thursday of "manipulating" its currency, a sharp rhetorical break from the Bush administration's approach to Beijing's controversial exchange-rate policy. Timothy Geithner's use of the term signaled an escalation in the war of words -- if not necessarily of actions -- over Beijing's practice of keeping the yuan artificially weak against the dollar. Many U.S. manufacturers, unions and lawmakers charge that Beijing tinkers with its currency to give Chinese companies an edge over foreign competitors. Responding to questions from the Senate Finance Committee overseeing his confirmation hearings, Mr. Geithner stressed Mr. Obama's promise to "use aggressively all diplomatic avenues open to him to seek change in China's currency practices."
Should Mr. Geithner win Senate confirmation, as the committee recommended, his choice of language will likely draw attention to Treasury's next report on international currency practices, due in April. U.S. trade law requires the report to identify any country that manipulates its exchange rate for purposes of gaining an advantage in international trade. Such a designation would require the Treasury Department to open formal negotiations with Beijing over currency policy. Treasury officials frequently talk currency with their Chinese counterparts. The manipulator label would be a symbolic slap. While the Bush administration pressed Beijing to loosen its grip on the yuan, it consistently declined to brand China a currency manipulator. When he was in the Senate, Mr. Obama co-sponsored legislation to create new penalties "so countries like China cannot continue to get a free pass for undermining fair trade principles," in Mr. Geithner's words.
Mr. Geithner didn't say whether Mr. Obama would take a more punitive approach to China over its currency policy. He said the immediate priority is to persuade China to stimulate its domestic economy. "You don't want to be the bull in the China shop when it comes to currencies right now," said Frank Vargo, a vice president of the National Association of Manufacturers, which has long lobbied against China's yuan policy. "But...we all know the Chinese currency is deliberately undervalued." A spokesman for the Chinese Embassy in Washington couldn't be reached for comment on Thursday afternoon. President George W. Bush's Treasury secretary, Henry Paulson has cited the 21% appreciation of the yuan since July 2005 as evidence that China understands the need to liberalize the exchange-rate regime.
Timothy Geithner currency 'manipulation' accusation angers China
China has responded angrily to an accusation of currency "manipulation" by Timothy Geithner, the new US Treasury Secretary. Mr Geithner wrote three times to a senate finance committee that "President Obama, backed by the conclusions of a broad range of economists, believes that China is manipulating its currency." He added: "President Obama has pledged as President to use aggressively all the diplomatic avenues open to him to seek change in China's currency practises. While in the US Senate, he co-sponsored tough legislation to overhaul the US process for currency manipulation and authorising new measures so that countries like China cannot continue to get a free pass for undermining fair trade principles."
His comments, on only the second day of Mr Obama's presidency, sent a much stronger message to China than his predecessor, Hank Paulson, ever dared to. Mr Paulson often urged China to revalue its currency upwards but stopped short of using the word "manipulation" for fear of offending Beijing. The US has long-standing concerns that China has artificially depressed the value of the renminbi in order to boost exports. It believes the subsequent imbalance was detrimental to US business and may have helped trigger the financial crisis. China abandoned a fixed currency peg with the US dollar in 2005 for a managed float and since then the renminbi has appreciated by about 20pc against the greenback. Mr Geithner's comments had little effect on the exchange rate on Friday. In Shanghai, the dollar traded at 6.8401 yuan, compared to 6.8371 yuan on Thursday.
Mr Geithner stopped short of warning that the US Treasury would formally name China as a currency manipulator in its annual report. "The question is how and when to broach the subject in order to do more good than harm," he said. He also said the "most important" priority was to help China to boost its domestic demand, and said the US would urge China to embark on a further stimulus package, in addition to the £400bn it has already pledged. Nevertheless, Mr Geithner's words are sure to have angered the Chinese leadership, which issued a short message on Friday to say it had "noted" his remarks.
The timing of the comment was particularly provocative, since China has staunchly refrained from devaluing the renminbi since the financial crisis began, despite a wave of closures in its export sector and a fast-deflating economy. Nouriel Roubini has become the latest high-profile economist to remark that the Chinese economy is now on the verge of a full-blown recession. He said on Thursday that the latest GDP figures, which showed 6.8pc growth in the last quarter of 2008, were misleading since they did not show that growth had stalled to "zero" between the third and fourth quarters. "I was very disappointed and surprised at the remarks," said Hua Ercheng, chief economist at China Construction Bank. "We are concerned about rising trade protectionism in the US."
Party Line Central Banking
With Tim Geithner poised to become Treasury Secretary, his current post as president of the New York Federal Reserve Bank now opens. The bank's search committee has reportedly settled on Fed insider William Dudley as his replacement, which wouldn't help the Fed's reputation for independence, or the world's confidence in the dollar. By all accounts Mr. Dudley has done a fine technical job running the New York Fed's markets desk since January 2007. The presidency is a policy position, however, and during the current financial panic a crucial one. The New York Fed president is both vice chairman of the larger Federal Reserve's Open Market Committee and serves as the Fed's main liaison with the financial community. At the current moment especially, the New York Fed needs new blood -- someone markets will see as a bulwark against political meddling and a force for U.S. financial strength.
Mr. Dudley will be perceived, and fairly so, as a Geithner and White House loyalist. This isn't helpful at a time when the Fed is already widely seen as far too willing to bend to Treasury and Capitol Hill wishes. Mr. Dudley won't be a voice for restraint against the Fed's tendency to create new taxpayer guarantees and obligations. And he'd be no match for Larry Summers, the White House economic adviser who would like to replace Ben Bernanke when the Fed chairman's term expires in a year. The last thing Mr. Summers wants is competition. One of the Fed's most important tasks in coming months will be deciding when to remove the oceans of liquidity that it has been pushing into the economy to fight off a deeper recession. Remove it too late once the recovery begins, and the Fed will risk creating new asset bubbles or a run on the dollar. Yet as chief economist for many years at Goldman Sachs, Mr. Dudley consistently supported a weak dollar in the name of reducing the U.S. trade deficit.
This is a dangerous message to send at any time, but in particular as the new Administration embarks on an epic spending spree that will require from $2 trillion to $3 trillion in new U.S. borrowing over the next two years. The world's creditors aren't likely to lend as much, or as cheaply, if they think their dollar assets will be debased as a matter of U.S. policy. The head of the New York Fed search committee is Stephen Friedman, also of Goldman Sachs. We think that in focusing on Mr. Dudley the committee is bending more to the wishes of Mr. Geithner and the Obama Administration, rather than relying on an old Goldman school tie. But the Goldman political optics of the selection won't help either Mr. Dudley or the new Administration as they try to design the rules for a new financial regulatory system.
Financial circles are full of conspiracy theories that major Treasury and Fed decisions have been made to help Goldman -- for example, nationalizing AIG in order to rescue Goldman's counterparty trades with the insurer. We've seen no evidence to support these claims. But the perception alone is a market reality that hurts the credibility of U.S. officials as they try to lead the financial world. We believe Presidents deserve the policy advisers they want in most cases. But the Fed and the regional Fed banks in particular are supposed to be independent. Perhaps Mr. Dudley will surprise us and emerge as his own policy man, but on the evidence so far America's creditors are right to wonder what his selection means for the Fed's independence in the Obama era.
EU states monitor spread of civil unrest
EU member states are "intensively" monitoring the risk of spreading civil unrest in Europe, as riots over the economic crisis erupt in Iceland following street clashes in Latvia, Lithuania, Bulgaria and Greece. The worst street disturbances for 50 years struck Reykjavik on Thursday (22 January), as police streamed a hardcore of a few hundred anti-government protesters in the early morning with pepper spray and then tear gas after an earlier crowd of around 2,000 gathered outside the Althingi, the country's parliament, to demand the government resign.
The crowds surrounded the building while banging pots and pans and shooting off fireworks. The demonstrators also lobbed paving stones, rolls of toilet paper and shoes. It was the second day of protests after on Wednesday protesters jostled Minister Geir Haarde's limousine, pummelling it with cans of soft drinks and eggs. The regular demonstrations have strained the government coalition, with the ruling Independence Party on Thursday saying it "realises that there will be elections this year."
Iceland is not an EU member, but the protests could result in it being the first European country to see its government brought down by the economic crisis. "It's a democracy that has its problems like many other states as a result of the economic crisis," European Commission external relations spokeswoman Christiane Hohmann said. The events in Iceland come hot on the heels of anti-government clashes in Latvia, Lithuania and Bulgaria in recent days, where economic discontent mixed with local issues erupted in violence. Trade unions in Greece meanwhile warn that further strikes are still likely, after protracted street fighting by students and young workers in December that caused billions in damage.
Concern about the spreading unrest is high on the EU agenda, as governments find it increasingly more expensive to borrow money, putting pressure on social programmes. "There are concerns. The EU shares them. It is one of the major challenges for the Spring European Council," said a senior EU official, referring to the quarterly gathering of EU leaders. EU ambassadors in Brussels are discussing the issue and receiving "regular updates", according to another official, although he added that more intelligence on the situation is needed to see whether the riots are "part of a social trend" or manipulation by opposition elements.
Lithuania's interior minister visited Latvia to discuss public security problems related to the economic crisis even before the Vilnius and Riga riots last week. Lithuania is currently collecting "all available information about similar events in other member states" and sharing it with "concerned" countries Estonia, France, Germany and Latvia, a Lithuanian diplomat told the EUobserver. "Intensive share of information" is also taking place between the Baltic states and Poland, he added. Following the ructions in Vilnius, 11 further peaceful demonstrations were organised around the country by trade-unions. "Due to the declining economic [situation] and problems raised by it, a possibility of similar meetings still remains, but we hope that riots will not be repeated," he said.
In a Wednesday interview with the BBC, the head of the International Monetary Fund, Dominique Strauss-Kahn, predicted that the economic downturn will cause more unrest. "[It could happen] almost everywhere, in Europe certainly, and also in emerging countries," he said. "You've had some strikes that look like normal, usual strikes, but it may worsen in the coming months." Asked which countries were most at risk, Mr Strauss-Kahn mentioned Hungary, Ukraine, Latvia and Belarus. "It can be my own country [France], the UK, it can be eastern Europe," he said. "The situation is really, really serious," he added.
European leaders fear civil unrest over economic woes
Europe, Canada's second-largest trading partner and top global ally after the U.S., is getting pounded by a tidal wave of bad economic news that has prompted warnings of a frightening hike in civil unrest. Europe's top politicians are so rattled by the prospect of growing protests that they have arranged an emergency leaders' summit in March to deal with growing tensions, the Daily Telegraph reported Thursday. The latest spate of grim economic news here Thursday included a plunge in consumer spending in France, tumbling factory orders in the United Kingdom, predictions of an even deeper recession this year in Germany, and continued concern about the impact of billion-dollar bailouts of the continent's troubled banking system.
Politicians are warily eyeing the public mood that led earlier this week to riot police being forced to rescue Iceland Prime Minister Geir Haarde, whose limousine was pelted by eggs and drink cans hurled by protesters. Iceland's government will almost certainly fall in coming days, London School of Economics professor Robert Wade told Canwest News Service Thursday. "The situation is very tense and very unstable," said Wade, who has just returned from a visit to Iceland where he spoke to about 1,000 people about the crisis.
Thousands of protesters have participated in sometimes-violent street demonstrations in Bulgaria, Hungary, Latvia, Lithuania and Greece in recent weeks. French President Nicolas Sarkozy has warned that Europe could face the kind of demonstrations that paralyzed several capitals in the spring of 1968. But one analyst said Thursday that the comparison could be an understatement. "I think fears have moved beyond chic academic protests a la May 1968 in Paris," said Fredrik Erixon of the Brussels-based European Centre for International Political Economy. A more apt comparison for Iceland and some of the Baltic countries could be the French Revolution of 1789, he warned.
PM of Iceland steps down, elections to take place in May
The Icelandic Prime Minister Geir H. Haarde, in a press conference held at noon today, announced he will be stepping down as the leader of the Independence Party due to his grave health condition. He has been diagnosed with a malignant cancer of the oesophagus. He also announced that he is, in cooperation with the Social Democrats who are in coalition with the Independence party, recommending national elections to take place on the 9th May this year.
As IceNews has reported, heavy and growing protests have been taking place in Reykjavik and all across the country and pressure has been mounting on the government to take action towards re-election. The diagnosis of the Prime Minister comes as a shock to the nation, especially in light of the fact that the Foreign Minister, Ingibjorg Solrun Gisladottir, the leader of the Social Democrats, has been undergoing treatment of a benign brain tumor since last autumn.
Iceland hunts the euro
For a small country, Iceland has room for lots of contradictions. Some can be seen in the harbour of Reykjavik, the trim capital. On one side of the Aegisgardur pier lie whale-watching boats that take foreign tourists to commune with whales, dolphins and puffins. But just across the pier are four large ships, with mysterious gantries and winches above their decks: whalers, their harpoon guns in storage as the government ponders allowing a commercial hunt. Iceland’s stance on whaling is ambiguous: it opted out of an international moratorium, but the most recent big hunt was in 2006. Some fishing bosses support catching whales: there are plenty of them, they say, and they eat fish. Activists say whales are intelligent, scoffs Kristjan Loftsson, boss of the whaling fleet. His family has been hunting fin whales in the same spot since 1948, "and they still come there to eat".
If whales went farther offshore, they would not be caught, he adds, as their large carcasses might rot on the journey back. Ambivalence about whales mirrors larger tensions. Iceland—three times as big as Belgium, but with only 300,000 inhabitants—has full access to the European Union’s single market through the European Economic Area (EEA). Its citizens can live and work across the EU, and it is assiduous about implementing directives from Brussels. But most of its leaders have always been hostile to full EU membership: they prize their sovereignty (Iceland became independent from Denmark only in 1944) and fear foreign control of their fish.
EEA membership has been good for Iceland, which pays relatively little into EU funds, and runs its own farm and fish policies (it also escapes EU laws banning whaling). Yet the EU debate has been revived by the collapse of Iceland’s economy after its debt-fuelled boom. Above all, the Icelandic krona is barely traded now: banks cannot borrow abroad, and capital controls block investment flows. A large majority of Icelandic voters want a new currency. Given trading patterns, the euro makes most sense.
What happens next revolves around a congress next week of the ruling Independence Party, a broad centre-right coalition hostile to EU membership. The prime minister, Geir Haarde, remains a Eurosceptic. But he also knows that the Icelandic krona is "finished", says an observer. Hardliners have called for unilateral adoption of the euro (or maybe the dollar, Swiss franc or Norwegian krone). But Mr Haarde has been told by EU bosses that unilateral action without the boring necessity of joining the EU first would wreck relations with Brussels. And an open letter, signed by 32 Icelandic economists, gave warning that it would not even provide Iceland with what it needs: international credibility as a normal developed state. Mr Haarde agrees, say officials.
Which leaves him pondering EU membership after all—and trying to preserve party unity. Mr Haarde is "not a decisive man", and will try to keep his options open at the congress. Talk of a referendum on opening EU talks briefly tempted him. He may now prefer a committee to review options (with strong caveats over fish) and discussions with his coalition partners, the pro-EU Social Democrats. The Social Democrats say they will quit the coalition if an EU membership application is not lodged by March. But they have as much to fear from a snap election as Mr Haarde (a tide of protests suggest the big winner might be the Left-Green Movement, which denounces the EU as too capitalist). In short, the government may end up stalling for time.
Unfortunately, Iceland does not have time. The European commissioner for enlargement, Olli Rehn, is a strong ally. A Finn, Mr Rehn says that Iceland "would complement the EU, both philosophically and economically". Its strict fish-management policies have been praised by the fisheries commissioner, Joe Borg (who is from Malta, a small island that has no selfish interests in cod). But there will be a new European Commission in the autumn. To catch both Mr Borg and Mr Rehn in their current jobs, an application must go in by April at the latest. The commission could rush through a formal positive opinion in six months (Iceland already applies two-thirds of EU laws). Iceland could then become a formal candidate in late 2009, when Sweden (another ally) holds the rotating EU presidency, and a full EU member by 2011. Membership of the single currency would take a bit longer, but pro-EU politicians say the simple act of applying and working towards euro convergence would reassure the markets.
As time passes, Iceland’s chances may shrink. Sweden will be followed in the presidency by Spain, a country with a prodigious appetite for others’ fish. Then comes federalist Belgium, which may feel Europe has enough sceptical Atlantic islands already. Icelanders fear the EU wants to grab some of their fish through the common fisheries policy. Such fears are "exaggerated, but not wholly unjustified", admits one Eurocrat. If Iceland wants the euro, it may have to "move a bit" on fish. (Greenland and the Faroes, nearby Danish dependencies, control their own fish, but neither is an EU member.) Exemption from the fisheries policy is a non-starter, not least because future applicants might seek the same. But Iceland may win transitional arrangements, perhaps along the lines of national subsidies permitted for far-northern Finnish and Swedish farms.
Will such a fudge do it? Icelanders are fond of national myths of splendid isolation, says Arni Pall, a Social Democratic member of parliament. But they are also deeply pragmatic. Just consider whale hunting, he suggests. Icelanders grew up thinking of whaling as normal, but whaling offends public opinion abroad and harms lucrative fish exports, so it is now stalled. Iceland will be bullied, in subtle and unpleasant ways, if it applies to join the EU from its present position of weakness. Yet it may never have a better chance of a good deal. That sounds like a contradiction, but Iceland is good at managing those.
The heat is on
While Barack Obama was being sworn in to office on Capitol Hill yesterday, the people of Iceland were starting the first revolution in the history of the republic. The word "revolution" might sound a bit of an overstatement, but given the calm temperament that usually prevails in Icelandic politics, the unfolding events represent, at the very least, a revolution in political activism.
Four months after the collapse of Iceland's entire financial system, no one has accepted any responsibility. Our currency has lost more than half its value, rampant inflation has already eaten up most people's savings, property values have dropped by more than a third and unemployment is reaching levels never seen before in the life of our young republic. The fault is clearly shared between the business elite and the government, which failed to regulate the newly privatised financial sector, allowing a few incompetent and egotistical business tycoons to gamble with the nation's fortune. And yet neither the government nor the bankers – who, by the way, seem to have disappeared into the cold thin air – see anything wrong with their own behaviour.
The governor of the central bank blames the risk-seeking bankers, the bankers blame the government and the prime minister attributes the whole crisis to the international credit crunch. This lack of any sense of responsibility has angered the Icelandic public to the extent that they have turned to the streets in greater numbers than ever before. It started in October with peaceful demonstrations. Then the frustration grew, first with the lack of any sense of responsibility, then with the lack of any effective action to ease the economic pain most people feel – and finally with the sense that all the political elite were incompetent.
Initially the government tried to dismiss the protesters as frustrated wannabe politicians and disillusioned youngsters who did not understand the complexity of the situation. But when our grandmothers put down their knitting gear, strapped their boots on and took to the streets shouting for new elections we all saw that the disgust was almost universal. Yesterday parliament resumed for the first time after Christmas. Without much organisation or central planning the public surrounded the parliament building and put forward a clear demand for early election. Ignoring them, the ministers and parliamentarians tried to sit out the protest, hiding inside the old building in downtown Reykjavik.
This time it didn't work. The protests grew and ordinary people kept warm by burning torches in front of the building. They were going nowhere. Well into this dark night in Iceland's history, parliament remained under siege, and the vigil resumed this morning. It is the first time in Icelandic history that a young anarchist can well expect to meet his grandmother in the crowd demonstrating against the government and drumming with her kitchen knife on pots and pans. The government is surely hanging by a thin thread and might fall at any moment. The Icelandic public fear that their country has virtually been stolen by the globetrotting business elite that spent more time rubbing shoulders with international high society than giving back to the society that enabled them to enjoy this privileged lifestyle. Now ordinary Icelanders are determined to take their country back.
Iceland protests grow, premier vows to stay on
Angry protesters stepped up calls for a new Icelandic government on Wednesday and the country's prime minister said he had the support of his coalition partner. Iceland Prime Minister Geir Haarde, speaking after his limousine had been pelted with eggs and cans by a crowd of demonstrators, said the government was "fully functional". The government is coming under fierce pressure from Icelanders who are frustrated by the handling of a financial crisis that has wreaked havoc with the island's economy. Opposition politicians and demonstrators have called for Haarde and other senior officials to resign.
"The government is still fully functional and the coalition parties are going to continue their cooperation as confirmed to me today by Ingibjorg Gisladottir," he told journalists after meeting with lawmakers from his Independence Party. Foreign Minister Gisladottir is head of the Social Democratic Alliance, which forms a coalition government with the Independence Party. Asked if there were plans for new general elections to be called during the spring, Haarde said: "The Independence Party is always ready for an election."
Protests against the government and the central bank have become regular fixtures in the once-tranquil capital since the currency fell sharply and the financial system collapsed in October due to billions of dollars of foreign debt incurred by banks. Footage on the Web site of Icelandic television channel RUV showed protesters surrounding Haarde's black limousine outside the government building in the centre of the capital Reykjavik. Protesters first banged on the car with cans and then threw eggs at it before a bodyguard and police pushed them away. The vehicle managed to drive away after riot police arrived.
"He was, I shouldn't say attacked, but there were some demonstrators who came quite close to him and they didn't look all that peaceful," said Haarde's press secretary, Kristjan Kristjansson. "This happened in a parking place behind his office, he got into his car, and the police arrived and secured his car, and paved a way through the crowd for him to leave." Chief police inspector Johann Thorisson said demonstrators had thrown eggs and snowballs at the prime minister's car, but that he had not been physically attacked.
The protest left the government building splattered with eggs and paint. The demonstrators then moved off to parliament, where on Tuesday protesters clashed with police, who used pepper spray and batons to drive them back. By evening about 3,000 protesters had gathered to face riot police surrounding the Althing, hurling fire crackers at the building and chanting "disqualified government". One demonstrator scaled the face of the parliament building, reaching a balcony from which he hung a sign reading "Treason due to recklessness is still treason".
Reykjavik police chief Geir Jon Thorisson said no arrests had been made at the demonstrations. "We are trying to give people the means to protest peacefully and we will avoid using force, as long as possible," Thorisson said. The volcanic island's economy is expected to suffer a huge contraction this year while unemployment, once close to zero, is set to soar. "People feel that it is incredible that after such a policy disaster that we faced last year, there has been no resignation, no minister, no one has resigned or responded, or taken responsibility for what happened," said Gunnar Helgi Kristinsson, political scientist at the University of Iceland.
Kristinsson said there was a substantial likelihood that the government would not survive the coming two weeks. "I think it is more likely than not. It could happen today, next week or the weekend at the end of the month, especially since the Independence Party convention will be held next weekend," he said. Haarde's Independence Party is due to begin a national congress of its members on Jan. 29 to discuss issues which include revisiting the party's long-standing opposition to Iceland seeking membership in the European Union.
UK government prevented from taking Barclays stake by deal with Abu Dhabi
A clause inserted during the Abu Dhabi Royal Family’s investment in Barclays last October has made it practically impossible for the Government to take a meaningful stake in the bank, The Times has learnt. News of the clause is likely to reignite controversy over the way that Barclays raised the money — dubbed at the time by Vince Cable, Liberal Democrat Treasury spokesman, as "a scandal of mammoth proportions". Barclays shares fell another 9 per cent yesterday, having collapsed by 35 per cent at one point, amid speculation that it is poised to raise more capital — either in the market or from the Government.
But the small print in the deal, in which Barclays raised £7.3 billion from Abu Dhabi and Qatar, means that if the bank raises fresh capital before the end of June, the Middle Eastern investors would receive a greater number of shares for their original investment without paying more. If Barclays were to raise fresh capital at last night’s closing price, for example, it would automatically hand almost 50 per cent of the bank to the Middle Eastern investors. The only way to get around the anti-dilution clause, should Barclays need more money before the end of June, would be if new capital was raised at more than the 153p-a-share at which paper issued to Abu Dhabi and Qatar is due to convert into Barclays stock.
This would mean that if the Government wanted to take a meaningful stake in the bank, it would have to do so by paying more than 153p for Barclays shares — which were trading at just 66.1p yesterday. The Treasury would face accusations of wasting taxpayers’ money were it to do this. The clause was inserted at the request of Amanda Staveley, chief executive of PCP Capital, the private equity firm, who advised the Middle Eastern investors on taking the stake. It is understood that she insisted on the clause because she was concerned that instability in the markets in coming months could potentially force Barclays to raise more capital.
The Times has seen a letter from Ms Staveley to Sheikh Mansour bin Zayed Al Nahyan, the owner of Manchester City Football Club and the Abu Dhabi royal who led the deal, explaining the benefits of the clause. Part of it says: "If Barclays does have to issue new shares at a price which is, for example, half our agreed price, then you will automatically get twice as many ordinary shares for the money you have already invested. If this provision comes into effect you could, subject to the size of any new investment, potentially end up owning significantly more of Barclays Bank at no extra cost." Ms Staveley last night declined to comment but sources at Barclays confirmed the clause exists.
Meanwhile, Barclays was yesterday pressing on with contingency plans to bring forward its annual results amid growing investor unease over its financial strength. Although it is due to publish its figures on February 17, it is trying to speed up the process to pacify increasingly nervous investors. Traders fear that the bank’s £1.4 trillion balance sheet could contain more hidden problems and that the worsening global economy will add to the red ink. The lifting of the ban on short-selling — making down bets — on bank shares last Thursday has added to investor fears, though there is little evidence of widespread "shorting" of bank shares. MPs on the Treasury Select Committee yesterday wrote to the Financial Services Authority asking it not to hesitate in re-introducing the ban if it found shortsellers were undermining stability of the banking sector.
Eurozone companies slash jobs as recession bites
The eurozone’s plunge into deep recession is leading companies to slash jobs at an ever faster rate even though the speed of the downturn has eased, a closely-watched survey has shown. Purchasing managers’ indices for the 16-country region rose slightly in January, but remained consistent with a pace of economic contraction not seen since the launch of the euro more than a decade ago. Eurozone businesses, meanwhile, cut employment for a seventh consecutive month – and at the steepest rate since the survey began in 1998. Germany – the eurozone’s largest economy – continued to perform particularly badly, hit by the slump in global demand for its exports. The indices showed the eurozone downturn reached maximum intensity at the end of last year but that the recession was far from over, with its effect now spreading more broadly into the labour market.
"The near-term outlook for the Eurozone remains very bleak. Not only was the fourth quarter a disaster, the first quarter of this year does not look a lot better," said Carsten Brzeski, European economist at ING in Brussels. Chris Williamson, chief economist at Markit, which produces the survey, said this month’s readings were consistent with eurozone gross domestic product contracting by 0.7 per cent a quarter. "Job losses continued to mount as firms scaled back capacity at a pace never seen before," he added. Earlier this week, the European Commission forecast eurozone gross domestic product would contract by 1.9 per cent this year, with German GDP plunging by 2.3 per cent – which would be the country’s worst performance by far since the second world war. With the eurozone economic outlook continuing to decline, the European Central Bank is under pressure to cut interest rates further.
But Jean-Claude Trichet, ECB president, made clear last week that it had already factored-in a further deterioration when announcing its latest cut of 50 basis points, and that no reduction was likely at its February meeting. Since early October, the ECB has slashed its main policy rate by 225 basis points to 2 per cent. The "composite" eurozone purchasing managers’ index, covering manufacturing and services, rose from the record low of 38.2 in December to 38.5 in January. Manufacturers continued to report a much faster rate of decline than services. In Germany, the composite index hit a new low of 38, down from 39.5 in December. The indices are regarded as offering a good, up-to-date guide to trends in economic activity. A figure below 50 indicates a contraction in output.
What's really wrong with Sterling?
How bad is this fall in the pound? In a word: hideous. Measured against a basket of other currencies – the best way in this globalised era to test a currency's strength – the pound has fallen in the past year by around a quarter. This is more than any previous devaluation in the past century – greater even than in 1931, when, under Ramsay MacDonald, the UK was forced to abandon the gold standard and saw the pound plummet by more than 24 per cent against the dollar. Greater than after Black Wednesday and the abandonment of the Exchange Rate Mechanism; worse than in 1967, when Harold Wilson was forced to make an extraordinary televised statement to the nation claiming that the "pound in your pocket" would not be worth any less after his devaluation.
As anyone who has been overseas recently will know, it has fallen from over $2 against the dollar to under $1.40. This week it touched the lowest level since the Plaza Accord of 1985 – in which year the pound very nearly went to parity against the US currency. Against the euro, the pound has slid from €1.35 to just above €1 in the past year. In practice this means that anyone travelling to the Continent will find it tough to get anything more than a euro for every pound they want exchanged, after the bureau de change has taken its cut and commission. For Gordon Brown, who mocked the Conservatives in 1992, it is acutely embarrassing. Back then, he said: "A weak currency arises from a weak economy which in turn is the result of a weak Government." This time he is staying conspicuously quiet about the whole thing.
But why is sterling sliding?
In large part because it reflects Britain's economic prospects. The UK is facing a nasty recession – one that is likely to be as bad as any experienced by the Western world. House prices are falling at the fastest rate since the 1930s, unemployment is on the rise and will soon climb beyond two million, consumer spending is sliding. In such circumstances, investors are naturally likely to withdraw their money from the UK. On the one hand, they will sell sterling shares and investments since they are likely to fall in value as a result of the recession. On the other, those who invest their cash in the UK will pull it out of the country, since the Bank of England is cutting interest rates as a response to the slump. Any money in sterling in a UK bank account is earning very little interest, so overseas investors calculate they might as well take it elsewhere.
How worried ought we to be?
If the above was all that was happening, not unduly. In a world of floating exchange rates, the falling pound is not merely a symptom of the disease (the recession) but its cure. All else being equal, a weak pound should boost the exports of British companies, since it makes their products cheaper than those of their overseas rivals. Machinery produced in the north of England is fast becoming cheaper than that produced in eastern Europe. And this goes not just for visible trade – actual physical goods – but for invisible trades such as legal or financial services. So, although Britain's manufacturing sector has shrunk significantly since the 1980s and 1990s, the comparative value of UK products should nevertheless help boost the economy. The same goes for tourism, which has already picked up significantly as foreigners come to the UK to pick up bargains.
London's days as Europe's most expensive city are well behind it. The problem, however, is that all else is not equal at the moment: the appetite abroad for exports of any type has dried up in a way never before experienced. From Europe to the Americas to Asia, trade has almost entirely seized up as the recession has turned global. And let's not mention financial and legal services – the appetite for which has evaporated. In the 1990s and the 2000s, successive governments decided to focus the UK's economy on financial services. A decision was taken to put almost all our economic eggs in one basket. Unfortunately, that basket has come crashing to the ground.
So is this now a full-blown sterling crisis?
Until recently, it wasn't a crisis. There are, broadly speaking, two types of devaluation – one benign, the other far less so. The good one is much as described above – a competitive devaluation in the pound which, over time, provides a cure. After the pound fell in 1992, it ushered in years of recovery and then prosperity for the economy. The bad version is a full-scale crisis – a run on the pound. It is a vote of no-confidence in a country's economic policies, and occurs when investors start pulling their cash out of the UK not because of a temporary period of recession but because they are worried about the direction the economy is taking (over years and decades rather than months). In the months up until this week it was possible to argue that this represented a competitive devaluation, and would be a boon for exporters. All of that changed on Monday. Following Gordon Brown and Alistair Darling's announcement of a second bail-out package for struggling banks, the pound suffered what can be described as a minor run. Investors took fright that the UK was drawing closer to insolvency, and as a response sold off their stocks of government debt. It is difficult to overstate the significance of this. Britain's power and prosperity since the earliest days of the Union have been founded on its reputation for being a good risk. Whereas other countries, such as Argentina and Russia, have occasionally defaulted on their debts, Britain's government has always been among the best borrowers in the world. For the first time in decades this is being questioned. The rumour around the market this week was that Standard & Poor's, a ratings agency which tells traders what has and does not have the stamp of approval, was set to downgrade Britain's government sovereign debt. The agency has since denied this, but the UK fulfils many of the criteria for such a humiliating decision.
Does it really matter if Britain's creditworthiness comes under question?
Yes – immensely. Britain has a large current account deficit – of about £7.7 billion. This means we, as a nation, spend more money than we generate each year. This is no problem while we can borrow the difference, but that £7.7 billion chunk has to come from overseas investors. Should they stop lending to the UK, Britons would face a sudden, painful jolt and their living standards would fall even faster and more painfully than they are at the moment. The Government would have to seek assistance from the International Monetary Fund which would, most likely, dole out a baleful dose of economic medicine – higher interest rates, lower government spending and immediate austerity. Although, in the long run, Britain does need to borrow less and save more, such an adjustment should ideally take place over years, not weeks.
Isn't this all really the fault of the bankers as well as the Government?
Indeed it is. Now that the majority of the banking system is effectively nationalised (and the Government has promised to insure the nastiest debts of the remaining private banks) the taxpayer is effectively standing behind another massive liability. The banking system has about $4.4 trillion of foreign debts, and most analysts predict that around £200 billion of these could default. What scared investors this week was the sudden realisation that the Government, rather than the banks, will have to pay the bill. The UK, unlike Iceland, does not have the luxury of being able to default on those foreign debts (remember the fracas when Britons faced losing their savings in Icelandic banks?) Were the UK to do the same as Iceland, the size of Britain's liabilities are such that it would trigger an international panic and financial meltdown worse than when Lehman Brothers collapsed last year.
This all sounds unremittingly gloomy. Is there any solution?
Mainly to hope that the economic medicine served up by the Bank of England and its fellow central banks does the trick. As long as house prices are falling and unemployment is rising, the liabilities of the Government will swell and the pound will remain weak. But when, eventually, the economic backdrop improves, so should the financial outlook, and, eventually, the pound. However, there is little hope of returning to the heady days of a near-80p euro and a $2 pound. The pound was significantly stronger than it ought to have been over the previous decade. It is probably undervalued now, and if all goes well it should bounce back in the coming years. However, everything now depends on trust: that trust will return to the beleaguered financial system; that investors will start to trust the Government again and that Britons trust that there will be life after the recession.
UK recession now officially the worst since 1980
Britain has tumbled into its worst recession since the 1980 when the country was grappling with high unemployment in the Thatcher era. Official confirmation came with figures from the Office for National Statistics showing the economy shrank by 1.5pc in the final three months of 2008. That was the sharpest three-month contraction since gross domestic product fell by 1.8pc in the second quarter of 1980. It follows a 0.6pc fall in the third quarter of 2008, which brought an abrupt end to 64 consecutive quarters of growth in the UK. The cumulative fall in GDP of 2.1pc in the second half of last year is also the biggest six-month drop since the first half of 1980. Economists had predicted a fourth quarter fall of 1.2pc, and reacted with dismay at the speed of the economic deterioration revealed today.
"Today’s figures are the final nail in the coffin for Prime Minister Gordon Brown’s claim to have ‘ended boom and bust’; the United Kingdom economy is most definitely bust at the moment,"said Charles Davis at the Centre for Economics and Business Research said. "It is not just the fact that the UK has officially entered recession that will cause concern; it is the size of the contraction. This supports our view that the economy is set for the steepest contraction in the post war era in 2009, with a fall in the region of 3pc year-on-year" he said. The manufacturing sector, which accounts for 14pc of the economy, was hit particularly hard in the fourth quarter by a 4.6pc decline in output. The services sector, which contributes three-quarters of GDP, shrank by 1pc.
However, what separates this recession from previous downturns is the way in which it has infiltrated almost all sectors, hurting businesses and consumers alike. It began with a credit crisis in the US banking sector, took a firm hold on the UK housing and construction sectors, and has since led to the collapse of a string of well-known retailers and the highest level of unemployment since September 1997 at almost 2m. The Government has twice bailed out the country's battered banks and the Bank of England has slashed interest rates as they together try to pull the economy back from the brink. The hope had been that the recent weakness of sterling would help make Britain's exports more competitive. However, the downturns in Britain's key export markets - the US and Europe - has meant the boost has been negligible so far.
The pound was trading at around $1.35 after the GDP numbers were published, a 23-year low. Stephen Gifford, chief economist at Grant Thornton, said: "Today's figures have confirmed what we have known for months that the UK is now officially in recession. Yet the sheer fall in GDP is staggering. Financial meltdown has probably been averted but the economy has now entered a recession which is sure to be as bad as the early 80s. "UK output is likely to fall by more than 2pc in 2009 with the first signs of recovery early next year as interest rates fall close to zero to stimulate the economy and to counter deflation. But the real worry is unemployment, with the number of jobless set to rise to more than 3m by the end of 2010, it will certainly be a worrying and depressing year for many UK households."
UK recession 'may last two years'
That is the estimate of Nouriel Roubini, professor of economics at New York University, and one of the few people to predict the credit crunch. The problems facing the UK economy are "pretty severe" and "will take quite a while to resolve", he told the BBC's Today programme. Yet he said things were manageable, and the UK could afford the banks bail-out. Mr Roubini's comments came before official data confirmed that the UK is now in recession after two consecutive quarters of falling economic output.
The government spent more than £37bn last autumn in a rescue deal for Royal Bank of Scotland, Lloyds TSB and HBOS. And earlier this week it announced a new government insurance scheme for the whole banking sector, that may also prove expensive for taxpayers. "The public debt of the UK relative to its GDP is relatively small even if the final deal of bailing out the banks is significant and large," said Mr Roubini. He added that it was wrong to compare the UK with Iceland, which due to its small population size, was struggling to pay for its own banking rescue plans.
Mr Roubini said that the UK was more like the US, and therefore able to afford the final bill for rescuing the banking sector. Turning his attention to the recent falls in the value of the pound, Mr Roubini said some decline was inevitable, as sterling had previously been overvalued. "The pound might be falling slowly, slowly over time, but the risk of total crash is still limited," he said. "The problem should be manageable with the right policies... and [in the meantime] the weak pound is a good way of stimulating exports."
We'll have to go begging to the IMF, says UK opposition
Britain risks bankruptcy and a humiliating bailout by the International Monetary Fund (IMF) because of Gordon Brown's borrowing, David Cameron said yesterday. With official confirmation that the economy has entered recession expected today, the Tory leader delivered his strongest warning yet: "If we continue on Labour's path of fiscal irresponsibility, at some point – and it could be very soon – the money will simply run out." His speech to the Demos think-tank in London raised the spectre of the 1976 bailout, when James Callaghan's Labour government was forced to make deep public spending cuts in return for a £2.3bn loan from the IMF.
His remarks are bound to provoke Labour accusations that he is running the country down. Mr Cameron insisted he was not predicting a date by which the Government would "end up back at the IMF". But he added: "What I am saying is that we are running the risk of those things happening and those are risks that no government should responsibly run." The Tory leader added: "We are borrowing, according to the Government's current estimates, 8 per cent of our GDP in the next financial year. That is the same percentage that Denis Healey [the then chancellor] was borrowing when he went to the IMF in 1976." In his speech on "progressive conservatism," Mr Cameron suggested that an incoming Tory government would not adopt Thatcher-style spending cuts which could "give rise to anger, hurt and social division," but would address the economic problems "in a way that brings the country together, not drives it apart".
As in 1976, investors' concerns are putting sterling under severe selling pressure. So far the depreciation of the pound – down to 23-year lows against the dollar and the subject of discussions within the G7 – has failed to bring in more export orders. UK car production has slumped 47 per cent on last year, it was revealed yesterday. The human costs of the downturn are being laid bare. Repossessions almost doubled in the third quarter of last year, according to the Financial Services Authority. A total of 13,161 properties were reclaimed by banks and building societies during the three months to the end of September – 92 per cent more than during the same period of 2007, with arrears also escalating. An increasing number of families are turning to their local authorities to house them, with the number on council waiting lists now 1.77 million – up 100,000 on last year.
"With the banks overstretching their credit facilities, it could mean that in the coming months that councils will have to help pick up the pieces," the Local Government Association's housing spokesman, Paul Bettison, said. Shelter's chief executive Adam Sampson added: "The rescue schemes announced by the Government recently will help just a fraction of those in trouble. Since Labour took power 12 years ago, the council house waiting list has risen from 1 million to almost 1.8 million, showing this Government has failed to build anywhere near the number of social homes Britain desperately needs."
Matters are unlikely to improve while business confidence remains low. The CBI's latest industrial trends survey shows confidence at its lowest ebb since 1980. Some 16 years of continuous growth shuddered to a halt in the second quarter of 2008, the economy shrank by 0.6 per cent between July and September, and the decline is expected to have accelerated to between 1 and 1.5 per cent in the closing months of 2008. The economy is expected to stumble further during 2009 – by as much as 2.8 per cent, according to the European Commission forecast on Monday. The Governor of the Bank of England, Mervyn King, declared earlier this week that the world economy had "fallen off a cliff" in recent months, a verdict few seem ready to dispute.
Alistair Darling: bear with us, we need more time to beat recession
The Chancellor today admitted that the recession was deeper the Government had expected, but urged consumers and businesses to give his policies time to work. Official figures out today confirmed that Britain is in the grip of its sharpest recession for three decades, sending sterling tumbling to a 23-year low against the dollar. The economy suffered a brutal 1.5 per cent drop in Gross Domestic Product (GDP) during the past three months from October to December, shrinking at its fastest quarterly pace since 1980. Alistair Darling, who forecast that the economy would be growing again by this summer, said that the fall in GDP was "sharper than many people believed" attributing the downturn to a drop in industrial production and a fall in overseas demand for British made goods.
The Chancellor attempted to assuage concerns over the growing level of public debt as the Government launches a series of measures to stave off the worst of the downturn. He said: "We will need to make sure that we can live within our means in the medium term and start to raise money as we come into the recovery. "There were two parts to what I proposed last year: supporting the economy but also, critically, making sure that we can pay for it." Mr Darling said: "The tax reductions I announced last autumn, bringing forward construction projects; they are all important if we are going to take action that will help us get through the recovery."
Today's 1.5 per cent fall in GDP follows a 0.6 per cent fall in the previous three months, meaning that the widely accepted definition of recession as two consecutive quarters of falling output has finally been met. This puts Britain officially in recession for the first time since the early 1990s episode that is seared into the memory of millions of homebuyers, workers and business people. Sterling slumped to a new 23-year low today, with the pound falling to $1.355, down more than 12 cents since the end of last week. There was widespread pain in all sectors of the British economy except agriculture, which managed to eke out a 0.1 per cent expansion in the final three months of the year. But manufacturing output plunged by 4.6 per cent, while the services sector, which accounts for nearly three quarters of the economy, shrank by 1.5 per cent.
The construction sector also contracted by 1.1 per cent, as housebuilders struggled amid a sharp downturn in homebuying. For millions more younger people, this will be their first encounter with recession — and the scale of decline already recorded in the economy means that it is likely to be a painful one. Today’s bleak figures will fuel fears that the new recession will be not only deep but long, amid a growing chorus of warnings from City economists that Britain now faces its most vicious downturn since the Second World War. A rising number of City experts, who have scrambled to downgrade forecasts of the outlook, now expect the economy to shrink by more than 2 per cent during this year, with the worst forecasts foreseeing a slump by as much as 2.7 per cent or more.
Unemployment is expected to soar, after already registering increases of more than 161,000 in the past two months alone. The latest stark projections from the City, in a poll by Reuters this week, saw the jobless total tipped to rise to as much as 3 million by early next year. The housing slump is also expected to deepen, while for those that keep their jobs a stark new era of pay cuts and freezes lies ahead. This morning’s figures showed that the vicious downturn in Britain, fuelled by the lending drought inflicted by banks, is being driven by a combination of crumbling manufacturing output, rapid declines in investment by businesses, and faltering consumer spending as households dig in for a protracted period of economic woe.
The mounting toll from the downturn has been underlined in recent weeks by a spate of collapses from household name businesses in the high street, and beyond, including Woolworths and Zavvi, the entertainment stores group. Even the traditional frenzy of Christmas shopping did little to boost retail trade last month. Company chiefs and economists alike fear that the economy is being sucked into a vicious downward spiral, as the bank lending drought and faltering consumer demand undercut consumer spending, leading business to succumb to plunging sales and closures, driving up unemployment, and further undermining consumer confidence and spending. However, many experts still believe that the combination of the Bank of England’s unprecedented interest rate cuts, the Government’s tax and spending measures, and moves to restore bank lending to more normal levels will eventually put a floor under the decline in the economy and lead to recovery.
Gordon Brown admits he failed to see economic crisis
Gordon Brown has admitted that he failed to see the looming economic crisis and warned that Britain will not emerge from recession this year unless there is emergency action in the Far East, America and Europe as well. He said that despite warning about the possibility of some breakdown in the markets it was impossible to predict over the past 10 years that they would seize up totally. The Prime Minister refused to admit that Britain was living through "a bust" and repeatedly failed to say that in fact he had not abolished "boom and bust" - an achievement he often claimed while he was Chancellor. Mr Brown said that previously the whole of economic policy had been focussed on "how to control inflation".
The Government had recognised there had been a danger of "institutional failure in the banking system" and acted to bolster national regulation, he insisted. But he added that the global financial crisis was "completely new territory". He told the BBC: "What we did not see, nobody saw, was the possibility of markets failure." He comments came on the day Britain will officially enter a recession with growth figures released by the Office of National Statistics. Mr Brown attacked both the opposition and speculators who have advised investing in Britain. David Cameron warned on Thursday that Mr Brown could be forced to go to the International Monetary Fund for a cash bail out. Mr Brown said: "If you think we are going to build our policy around the comments of a few speculators who want to make money out of Britain then you are very, very wrong indeed. "The decisions we take about the future of the economy are based on what is right for Britain."
On the Tory leader's comments he added: "I think this is ridiculous behaviour on behalf of opposition parties. The situation in Britain is this: that we have low public debt, we have low inflation, wages are under control." Repeatedly he was asked to admit whether he claims to have abolished "boom and bust" were now laughable. But he said that the unique circumstances of the financial crisis made this situation completely different to any other recession, because it was not driven by high inflation and wages. He refused to say how long Britain could be in recession. But he said "common action" was now central to the recovery and that President Obama was about to announce his own economic measures. He said: "Every country is facing these problems and I believe we are doing it with a great deal more determination than a lot of people are giving the credit for."
The case for and against nationalising the banks
"Shoot the bankers, nationalise the banks", reads one headline. "Time to quit mucking around and make with the nationalisations", reads another. No, not headlines from some obscure hard-left publication – the respective pieces were penned in the Financial Times and the Economist, no less. Bank nationalisation is much on the agenda across the globe, with an increasing army of supporters saying governments have now no choice but to bite the bullet and seize control of failing institutions. Should they? Or is nationalisation a step too far?
The Swedish example: the blueprint for successful handling of a financial crisis is provided by Sweden’s centre-right government in the early 1990s. It forced banks to write down their bad loans and then injected equity, nationalising the country’s two biggest banks. The banks were detoxified and later re-privatised, with taxpayers getting back much of the money they had contributed. Bailouts and partial nationalisations don’t work, according to influential economics professor and FT blogger William Buiter. Partial state ownership and the threat of future state control incentivises banks to stop lending. Banks look to pay back government money "as soon as possible" to "get the government out of its hair", causing them to "hoard liquidity".
This helps them avoid outright nationalisation but cripples the economy. German economics professor Hans-Werner Sinn agrees, saying that government proposals to cap corporate salaries mean most banks would prefer to cut back on business lending and stumble along, zombie-like, rather than accept government interference. AIB CEO Eugene Sheehy, who said in October that "we’d rather die than raise equity", comes to mind. The alternative to the "unfortunate halfway house" prevailing at the moment, Buiter says, is temporary nationalisation. There’s no point trying to nurse banks back to health – it’s a case of "dead men walking". Nouriel Roubini estimates that US financials will ultimately suffer credit losses of $3.6 trillion. The US banking system, with capital of $1.4 trillion, is "effectively insolvent". Roubini’s estimate is high, although losses in excess of $2 trillion are commonplace today.
In Britain, RBS analysts Ian Smillie and Cormac Leech describe British banks as "technically insolvent" on the basis that they are suffering from a £36 billion shortfall and are facing an additional £143 billion in writedowns. Author and professor Frank Partnoy says that banks have been insolvent for more than a year, surviving on a diet of misplaced government support and investor denial. Current policies are "the financial equivalent of putting tubes into dying patients". Opting for more sweetheart deals means throwing good money after bad. In November, the US government injected an amount into Citigroup than exceeded its entire market capitalisation. It also guaranteed the firm’s toxic assets to the tune of $306 billion. Despite that, it ended up with a mere 7.8 per cent equity stake while management was left in place.
Recently, Bank of America received $20 billion of government money on top of the $25 billion it received months earlier. It was also given guarantees of $118 billion on potential losses. It’s not just a waste of money, it’s a case of "moral hazard" – heads you win, tails I lose. Taxpayers are taking all of the risk but none of the reward. Hedge fund manager Whitney Tilson says that current US plans will lead to "the greatest heist in history". Poor decision making is rewarded if shareholders and debt holders are not wiped out. Markets are saying that nationalisation is inevitable anyway, as this week’s collapse in Irish and British bank share prices show. Banks cannot receive the monies they need from the private sector, as AIB and Bank of Ireland are finding out. Governments have been behind the curve throughout the crisis – they must grasp the nettle and listen to what the markets are telling them.
"Creeping nationalisation", as it’s been called, has already set in. Better be done with it sooner rather than later. Ideological hang-ups mean too many see nationalisation as a last resort. In truth, the financial sector has been kept on life support though massive government intervention for over a year now. Recognising that fact through nationalisation and preparing the sector for eventual re-privatisation is a victory for pragmatism, not ideology.
The Swedish example is simplistic. It nationalised just two banks whereas more than 300 US institutions received TARP money, many of them healthy and solvent. Nationalising en masse is wrong. Also, the Swedish example was local in nature whereas today’s problem is global. Were Britain to nationalise RBS (or others) and follow the Swedish example of writing down assets to nuclear levels, the knock-on effect on other global financial players would be catastrophic. Governments are not the best people to run banks. A couple of years of crisis in the financial sector does not negate the long-held idea that the private sector manages resources more efficiently. Former RBS chief executive Sir George Matheson said the government should instead guarantee the bank’s deposits and "let it trade out of difficulties".
Fear of nationalisation has driven financial shares below their true value. For example, AIB is currently valued at around €500 million, even though its has stakes in US bank MT and Poland’s Bank Zachodni WBK valued at €800 million and €1.1 billion respectively. Falling share prices are being used to justify nationalisation, even though the fear of nationalisation has caused the falling share prices. Shareholders have the right to hold on for eventual recovery. Recent UK measures should help enormously. Besides the £250 billion credit guarantee scheme, regulatory changes mean that banks are being given additional latitude in terms of their capital ratios, with regulators accepting core equity of 4 per cent and Tier 1 capital of 6-7 per cent.
The RBS analysts who said banks were "technically insolvent" added that this is not unusual "at this stage in the economic cycle", which is why the regulators have given banks breathing space. As Goodbody’s Eamonn Hughes said, similar regulatory moves in Ireland would make nationalisation fears "overstated". The cost would be enormous. Despite share price falls, buying up the banks would not be cheap (JP Morgan alone is worth almost $85 billion). Also, the risk of individual states defaulting on their debt is hugely increased by increasing their exposure to the banking system via nationalisation. The odds of a British debt default hit record levels after it took a 70 per cent stake in RBS. The UK is at risk of losing its AAA credit rating and markets estimate that it stands a one-in-10 chance of debt default in the next five years – something that hasn’t happened since the Middle Ages.
The cost of insuring Ireland’s debt against default also hit record highs in the wake of the Anglo nationalisation, soaring by over 100 basis points to 297bps in little over a week. That’s over twice the cost of insuring Tesco’s debt and more than five times that of Germany’s. What’s wrong with the "creeping" nationalisation approach? "The good thing about creeping, as opposed to sprinting, is that it’s easier to stop and reverse course if obstacles are in the way," as Financial Times city editor Andrew Hill put it. The notion that nationalised banks could be quickly returned to private ownership is facile. Such a process would inevitably be drawn out, during which time all the disadvantages of public ownership would become obvious. George Matheson said nationalisation would bring "pressure" to do things "according to government practice rather than commercial banking practice".
In particular, politicised lending. "The focus isn’t going to be on the needs of banks," said Obama economic adviser Larry Summers. "It’s going to be on the needs of the economy for credit," a point also hammered home by Gordon Brown. The last thing massively indebted societies need, however, is a return to the easy credit that triggered this crisis. Government demands to increase mortgage lending, even though property values remain at historically elevated levels, are as misguided.
Canada’s Currency Depreciates on Concern Global Slump to Deepen
Canada’s dollar weakened against its U.S. counterpart as concern that a worldwide economic recession may deepen crimped commodity-linked currencies. "There are views of a more prolonged recession and lower global growth, and I don’t think that’s going to be particularly positive for commodity currencies," said Chris Turner, London- based head of foreign-exchange strategy at ING Groep NV. "Any sort of recovery in commodity currencies will be quite shallow and quite short-lived."
The Canadian dollar weakened 0.6 percent to C$1.2624 per U.S. dollar, trading close to a seven-week low, at 12:11 p.m. in Toronto, from C$1.2551 yesterday. One Canadian dollar buys 79.21 U.S. cents. Canada’s currency, dubbed the loonie, extended declines after a government report showed Canadian retail sales fell 2.4 percent in November, the most since January 1998 and more than the 2 percent median forecast of 14 economists surveyed by Bloomberg News.
"Consumers are discouraged," said Andrew Gretzinger, a senior economist and portfolio manager at MFC Global Investment Management in Toronto, a subsidiary of Manulife Financial Corp. "The Canadian economy continues to weaken, and it’s a foregone conclusion that the U.S. economy is in pretty bad shape. It doesn’t argue well for the Canadian dollar." ING’s Turner recommends buying the U.S. dollar against emerging-market and commodity-based currencies, predicting the Canadian dollar will slide to C$1.30 in as little as two weeks. Canada’s central bank cut its economic growth forecast for the first quarter, saying output will shrink at a 4.8 percent annualized pace, after predicting in October it would be unchanged.
Global economic growth may be weak through 2009 and recovery may not start until next year, Dominique Strauss-Kahn, the head of the International Monetary Fund, said yesterday. He repeated that the IMF later this month will cut its 2.2 percent growth forecast for the global economy this year. "The U.S. dollar remains well-supported against the Canadian dollar," Jacqui Douglas, a currency strategist at TD Securities in Toronto, wrote today in a note to clients. She cited "disappointing economic data and an increasingly pessimistic assessment of the economy from the Bank of Canada."
Crude oil declined 5.8 percent to $41.01 a barrel on the New York Mercantile Exchange. Crude generates about a tenth of Canada’s export revenue and is the largest component of the Bank of Canada’s Commodity Price Index, accounting for 21 percent. The Reuters/Jefferies CRB Index of 19 raw materials dropped 1.5 percent. Commodities generate about half of Canada’s export revenue. The yield on the two-year government bond rose one basis point, or 0.01 percentage point, to 1.08 percent. The price of the 2.75 percent security due in December 2010 fell 3 cents to C$103.04.
Eastern European workers go home
The number of Eastern Europeans working in Denmark has fallen dramatically in recent months. Over the past 12 months, the number of Eastern European workers in Denmark has dropped by some 4,000, with employers tending to lay off the cheaper Eastern Europeans rather than their more expensive Danish counterparts, according to Berlingske Tidence. Although Eastern Europeans tend to work for lower wages than their Danish construction colleagues, they also appear to be at the top of the list when layoffs have to be chosen as a result of the current recession.
According to figures from the Labour Market Board, the number of Eastern Europeans with an active working permit in Denmark has fallen from 12,784 to 8,814 – despite the fact that it has become much easier for companies to import foreign workers. "The drop in working permits for workers from the new EU countries is much higher than the rise in unemployment. When it became possible for Eastern Europeans to work in the old EU countries, there were all sorts of forecasts that suggested that employers would keep the so-called ‘cheap foreign labour’ and lay off the expensive Danes when unemployment began to bite. But we can see that that certainly has not happened," says Labour Market Board Head of Department Erik Holck Hansen.
Iraq forced to cut spending as oil price falls
Iraq's government will have dramatically less money to spend this year than expected because of plunging oil prices — a dire economic situation that's already forced the country to slash rebuilding plans by 40 percent, The Associated Press has learned. As the U.S. seeks a timetable for withdrawal, cutbacks on spending and jobs could trigger heightened violence. U.S. commanders have repeatedly warned that without speedy economic development and reconstruction, the sharp improvements in security since the U.S. troop surge of 2007 could be at risk in a country where about 38 percent of the work force is estimated to have no job or just part-time employment. But rebuilding requires money. And with oil prices plummeting, the government has been forced to cut planned spending — by one-third overall and 40 percent for rebuilding, Iraqi officials told the AP — and to consider even deeper reductions.
It's an ironic turnaround from just months ago when U.S. lawmakers complained that Iraq was swimming in cash from high oil revenues and should do more to help itself, rather than spend U.S. taxpayer money to rebuild. Iraq is almost entirely dependent on oil money. More than 90 percent of the government's revenues come from oil sales. The government says it earned about $60 billion from oil sales in 2008 but hasn't said publicly how much it expects to take in this year. Iraq's government has in the past often used money to create jobs and projects as a way to keep different political groups happy, such as the money it threw into Baghdad's Sadr City district last summer to ease Shiite tensions there. That will become harder now that revenue expectations have fallen sharply. The government has already been forced to scale back its 2009 budget twice. The budget now is set for $53.7 billion, down from the original planned $79 billion and from an interim cut to $68.6 billion, according to the Finance Ministry.
The reductions have cut the money earmarked for reconstruction projects from $21 billion in the original budget to $12.54 billion in the latest revision, a member of parliament's budget committee, Alaa Saadoun, told the AP. That figure had not previously been disclosed. Officials warn that more cuts may be necessary if oil prices continue to fall. On Thursday, Iraq's finance minister urged Iraqis to save money and prepare for "hard days to come" but pledged that government salaries would not fall at least this year. The most recent Iraqi budget was based on an assumption that oil prices would average $50 a barrel this year. This week, oil prices fell below $34 a barrel but recovered to about $44 Thursday. That is down from the high, just last summer, of $147 a barrel. The sharp, fast decline in oil prices "has serious implications for the Iraqi economy," deputy Prime Minister Barham Saleh said recently.
Iraqi officials told the AP recently that some reconstruction projects may have to be delayed though they would provide no details. They insist no project will be canceled long term. Instead, the Iraqis are gambling that oil prices will recover and the country's oil production will increase in coming years so they can eventually finish all planned projects. Iraq could fairly quickly bring in big revenues again if oil prices bounce back, but that may be wishful thinking in the short term because the global economic crisis has reduced demand for oil and could last a significant amount of time. Iraq also has a cushion of about $32 billion in unspent development money from recent years, according to the Central Bank. That could help ride out the price collapse if oil prices remain low. The country currently produces about 2.4 million barrels of oil per day, and the Oil Ministry hopes to boost exports from 1.8 million to 2 million barrels per day this year to generate more revenue. But that may be too optimistic, according to World Bank experts, because Iraq's oil industry is too dilapidated to quickly ramp up production.
"The question will be what happens if oil stays depressed going into 2010 and even beyond," U.S. Ambassador Ryan Crocker said Thursday. "This country is and will remain for some time really hydrocarbon-dependent." Because of that, Finance Minister Bayan Jabr and other officials have warned that Iraq may need to take further austerity measures this year, unless oil prices recover. For now, the prospect of even a slowdown in reconstruction money holds dire security implications. It is not clear if the United States would change its still-evolving plans to draw down American troops if violence in Iraq worsened. President Barack Obama said in his inaugural address that the U.S. would begin leaving Iraq to its people. Key key danger areas include the shell-pocked streets of Mosul, where Sunni militants are still holding out; Anbar province, where Sunni tribes turned against al-Qaida; and the southern city of Basra, where U.S.-backed Iraqi forces broke the grip of Shiite militias last spring.
In those areas and more, U.S. commanders have warned that security improvements are fragile, and badly need economic development and rebuilding money to boost them. In Mosul, Iraq's third-largest city of nearly 2 million people, police Gen. Khalid Soltan said last month that "half of the terrorists" in the city could be defeated "if we defeat unemployment," now estimated at more than 60 percent. That's no small task in a city filled with abandoned and bullet-riddled shops, rutted streets, bomb-shattered buildings and heaps of uncollected garbage from past fighting. Overall, Iraq still needs significant rebuilding. The U.N. estimates that more than half the country's 27 million people lack access to one or more essential services such as clean water, electricity and health care.
When oil prices were high, the Iraqi government was the target of complaints by members of Congress that the country was relying on U.S. money rather than spending its own surplus. Last summer, the U.S. Government Accountability Office — Congress' watchdog arm _estimated that soaring oil prices and the laggard pace of Iraqi government spending could leave Iraq with a cumulative budget surplus as high as $79 billion by the end of 2008. That estimate was disputed by both the Iraqi government and U.S. officials here at the time. But U.S. officials have long complained that Iraq's Shiite-led government has been slow to commit enough money for reconstruction, especially in areas dominated by the Sunni minority. Now that spending is likely to slow even more.
Santander applauded 'impeccable' Madoff weeks before scandal
Spanish banking giant Santander reportedly praised Bernard Madoff for his "impeccable" timing just weeks before the disgraced financier was accused of the biggest fraud in corporate history. According to the Financial Times, Optimal, Santander's fund-management arm, told its institutional investors in a report last autumn that Madoff had an ability "to find great entry and exit points to benefit investors". US regulators now believe, though, that Madoff may never have made a single trade. He is accused of running a massive pyramid scheme, using cash from new investors to fund payments to earlier clients.
Clients of Santander are thought to be some of the biggest victims of Madoff's alleged $50bn (£37bn) fraud. With lawyers on both sides of the Atlantic already considering legal action, the bank faces the prospect of being sued by investors who have lost money. A Santander spokesman declined to comment this morning, other than to state that the bank is not involved in any legal action over Madoff. While Santander faces losses of just €17m (£16m), its clients face total losses of €2.3bn. Spain's top anti-corruption investigator has already launched an investigation into how such a large exposure could have been built up without triggering Santander's risk controls, and Spanish legal firm Cremades & Calvo-Sotelo has teamed up with America's Labaton Sucharow to represent victims.
Labaton Sucharow has cited Optimal as one of the "feeder funds" who channelled funds into Madoff Securities in return for what it calls "lucrative commissions". "Labaton Sucharow is investigating whether these feeder funds conducted adequate due diligence before investing in Madoff in light of the multiple red flags that are now know to have been evident, including the absence of a serious or reputable auditor, the absence of an outside clearing agent, and the overly consistent returns," it said last month. Many other financial institutions have also reported being exposed to Madoff Securities, including Man Group – which is considering legal action of its own.
Reports from Spain have shown that many small investors were also encouraged to put their savings into Madoff Securities via Optimal, including a retired school teacher who put half her savings in the fund, and a street vendor who invested more than $400,000 in lottery winnings in the fund. And in Philadelphia, a widow who thought she had more than $7m invested with Madoff has now taken up cleaning work. Bernard Madoff himself is still on bail in New York, and wore a bullet-proof vest on his last court appearance.
Bank of America axes Thain, Cuomo investigates Merrill bonuses
John Thain was ousted from Bank of America on Thursday, just three weeks after closing the sale of Merrill Lynch to BofA, plunging the company into crisis and raising new questions about the government’s efforts to save the banking industry. Mr Thain, a former Goldman Sachs president who earned the nickname “Mr Fix-it” while chief executive of the New York Stock Exchange, had taken charge of Merrill only 13 months earlier to rescue the bank after it suffered massive losses under his predecessor, Stan O’Neal. Hailed as a financial wizard when he sold Merrill to BofA in September, Mr Thain suffered a spectacular fall from grace after Merrill disclosed operating losses of $41.2bn (£29.7bn) for 2008 and BofA turned to the federal government for an additional $20bn to help it close the deal.
Andrew Cuomo, New York attorney-general, on Thursday launched an investigation into Merrill’s decision to pay billions of dollars in bonuses days before the closing of its sale to BofA, as Wall Street buzzed with talk of the money Mr Thain spent redecorating his Merrill office. Ken Lewis, BofA chief –the target of shareholder lawsuits questioning his decision to pay a premium for Merrill – flew to New York on Thursday for a face-to-face showdown with Mr Thain. One insider said there was “mutual agreement” Mr Thain could no longer be effective. Brian Moynihan, BofA general counsel, will replace Mr Thain as head of investment banking and wealth management.
The dismissal may have come as a surprise to Mr Thain, who on Wednesday bought 84,600 shares of BofA stock at $5.71 per share, according to SEC filings, bringing his total to about 764,000 shares. Since BofA’s purchase of Merrill was announced on September 15, its shares have fallen about 80 per cent. Mr Thain could not be reached for comment. Merrill said last week it lost $15bn in the fourth quarter. BofA said Mr Lewis learnt the magnitude of the losses after shareholders approved the deal in December, and subsequently sought additional aid. He secured $20bn in federal money, on top of $25bn allocated to BofA and Merrill in October.
As recently as last week, Mr Lewis said “we are happy that John Thain has assumed a major role” at BofA. But evidence of the rift between the men spilled into the open on Wednesday when the FT reported that Merrill had accelerated its bonus payment plan for 2008, doling out as much as $4bn on December 29. A BofA statement confirming the payments singled out Mr Thain by name, saying he had decided to pay the bonuses a month early. Mr Cuomo will “examine closely disturbing reports of what appeared to be large, secret last-minute bonuses”, a person familiar with the investigation said.
Former Merrill star Thain ousted at Bank of America
John Thain, the Merrill Lynch boss who orchestrated its fire sale to Bank of America at the height of last autumn's financial panic, has been ousted from the company after a vicious run-in with BoA's chief executive, Ken Lewis. Insiders said Mr Lewis had lost confidence in the 53-year-old Mr Thain, amid rising unrest among Merrill's senior staff and after new allegations that Mr Thain spent $1.2m (£865,000) to redecorate his office even as Merrill's losses were skyrocketing. The two men have been at loggerheads since last month, when unexpected losses on Merrill Lynch's trading desks came to light and threatened to unravel the takeover. A furious Mr Lewis initially considered backing out of the $50bn deal, but the US government agreed to provide $20bn in new capital and $118bn of guarantees to ease the strain of absorbing Merrill's battered balance sheet.
At a dramatic 11.30am showdown, a meeting lasting barely a few minutes, Mr Thain resigned as head of the Bank of America wealth management division which has absorbed Merrill. The rancour at the top of the company has been a major talking point on Wall Street for days, and damaging leaks from inside Merrill continued yesterday morning, when details of Mr Thain's expensive office redesign emerged on the news website The Daily Beast. He signed off on the purchase of an $87,000 rug for his personal conference room, a 19th-century credenza costing $48,000 and a "parchment waste can" worth $1,400, among numerous luxury items. The work totalled $1.2m, including an $800,000 fee for the celebrity designer Michael Smith, who is currently redesigning the White House for the Obama family for just $100,000.
The office makeover came a few months after Mr Thain moved to Merrill from the New York Stock Exchange, where he was chief executive until November 2007, and the revelations yesterday represent another blow to his reputation. Last month, it emerged that he had asked for a $10m bonus, even after the company posted billions of dollars in writedowns on toxic mortgages and prepared to lay off thousands of staff. He withdrew his request after it was leaked to the press. Mr Thain was fêted as a hero in September for engineering the sale to Bank of America on the same weekend that Lehman Brothers went bust. Wall Street players believed that Merrill Lynch could not have survived the financial panic that ensued.
Mr Lewis paid in BoA shares, so the original $50bn price tag had shrivelled to $24.1bn by the time the deal closed on 1 January, but many investors now believe that the deal was ill-advised while the value of Merrill Lynch's assets remained so uncertain. In a New York lawsuit, the shareholder Steven Sklar accused BoA of failing to tell its shareholders about the record $15.3bn quarterly loss towards which Merrill was headed when investors gathered to vote on the deal on 5 December. Mr Lewis is understood to feel that he never got a satisfactory explanation for the spiralling losses at Merrill as they emerged in December, undermining his relationship with Mr Thain. Mr Lewis was also furious over Mr Thain's decision to head off on a Colorado skiing holiday during that period. People close to the Merrill boss have briefed that he didn't trust BoA insiders not to leak financially sensitive information, and that he was working and contactable in Colorado.
Unrest within Merrill Lynch also helped to undermine Mr Thain's position. In recent weeks, his deputy, Greg Fleming, quit, along with wealth management chief Robert McCann, amid speculation of differences with Mr Thain. Mr Lewis has turned the north Carolina-based Bank of America into the biggest retail bank in the US, but he has been repeatedly embarrassed by his company's ventures in investment banking. In 2007, he said he had already "had all the fun I can stand in investment banking" after big losses on mortgage derivatives. Last week, BoA posted a $1.79bn loss for the last three months of 2008 – its first quarterly loss since 1991 – and slashed its dividend to 1 cent.
Merrill’s Thain Paid $1.2 Million to Redecorate Office
John Thain, the former Merrill Lynch & Co. chief executive officer ousted yesterday, spent $1.2 million redecorating his downtown Manhattan office last year as the company was firing employees, a person familiar with the project said. Thain hired Los Angeles-based decorator Michael Smith, chosen by President Barack Obama and his wife Michelle to redecorate the White House, CNBC reported. Thain paid Smith $837,000 and his purchases included $87,000 for area rugs, $25,000 for a pedestal table and $68,000 for a 19th century credenza, CNBC said.
Thain, 53, oversaw the sale of Merrill Lynch to Bank of America Corp. last month, and took over the bank’s wealth management and corporate and investment banking divisions. Merrill’s $15.4 billion fourth-quarter loss forced Bank of America to seek additional aid from the U.S. government, which last week agreed to provide $20 billion in capital and $118 billion in asset guarantees. "Spending company money on a lavish re-do at a time when Merrill’s finances were rocky sends the wrong message," said Amy Borrus, deputy director of the Council of Institutional Investors. "Thain was compensated well enough to foot the bill himself if he wanted such an upscale redecoration."
"It is pretty surprising that John Thain would need to spend that much on a power office in this economy," said Sheila Bridges, a New York interior designer who decorated former President Bill Clinton’s Harlem office. "I do hope the designer’s fees were also included in that price tag." The antiques Thain reportedly purchased will probably hold their value over time, said Clinton Howell, a New York dealer in English furniture. "Michael Smith is a very smart guy and he buys very good things," said Howell. "It’s very likely that what he bought was worth the money if Merrill Lynch wants to get their money back."
Smith’s firm didn’t return a phone call for comment. Merrill spokeswoman Selena Morris declined to comment. Margaret Tutwiler, who was Thain’s spokeswoman at Merrill, said he wasn’t available to comment. In light of Merrill’s $56 billion in losses from subprime loans and the credit crisis, $1.2 million spent on antiques hardly seems worth getting outraged over, Howell said. "What John Thain did with his office is a little like noting that somebody failed to turn on his blinker before driving into a train," said Howell. Designer Dennis Rolland, who has done homes and offices for financiers including Peter Peterson, the co-founder of Blackstone Capital Partners LP, said it’s unwise to furnish an office with antiques.
"I would seldom encourage someone in an office to use antique furniture, it’s too fragile," said Rolland. Wall Street executives may no longer be able to spend lavishly on perks, said James Post, professor of corporate governance and business ethics at Boston University School of Management. "That’s symbolic of a pattern that has developed on Wall Street over this past decade of more and more extravagant, more and more lavish, more and more one-upmanship in all of these visible symbols," said Post. "This may be the last vestige of a culture that we’re not going to see for many years to come."
California jobless rate jumps to 9.3 percent
California's unemployment rate jumped to 9.3 percent in December from 8.4 percent in November and 5.9 percent a year earlier due to sweeping job cuts across most industries as recession tightened its grip on the most populous U.S. state, state officials said on Friday. California's December jobless rate was significantly higher than the month's national average of 7.2 percent and underscored steep job losses at the end of the year.
California has for some time been contending with one of the worst housing markets in the nation, with some areas posting some of the nation's highest foreclosure rates, and its effects have spilled over into the state's broader economy. State officials reported a loss of 78,200 nonfarm payroll jobs in December from November and a fall of 257,400 from December 2007, marking a 1.7 percent decline in California's nonfarm payrolls. Ten of 11 industry categories shed jobs between the two months, led by trade, transportation and utilities. Eight of the categories cut payrolls from a year earlier, led by construction.
Nationalize Like Real Capitalists
It will come to no surprise of readers of this blog that I favor nationalization of failed, systemically important banks. But James Surowiecki and Floyd Norris have a point. We absolutely should not nationalize as a means of persuading banks to issue credit more freely. If the government (idiotically) wants looser lending than banks are willing to provide, it oughtn’t take their money and lend it. The government can lend its own damned money (well, our own damned money) if it thinks that profitable loans are not being made, or that for the good of the economy unprofitable loans must be made. The reason to nationalize a bank is because the bank has failed and its former owners have no legitimate claim to its assets. The government has been forced to offer support with public money, thereby purchasing the corpse fair and square. We take the bank into public ownership because taxpayers who have been conscripted to accept extraordinary losses are entitled to whatever gains follow the reorganization they finance.
When a bank is nationalized, shareholder equity should be written to zero, and existing management should be handled as roughly as the law allows. If we have a bit of courage, we should impose haircuts or debt-to-equity conversions on unsecured creditors, but I don’t think we have that kind of courage. "Toxic" assets should be revalued at pennies-on-the-dollar market bids or else written to zero and hived into "bad banks". Once we have a conservative valuation of the assets and know exactly what is owed, we’ll know how much public money would be required to cobble a robustly funded bank from the wreckage. However, if we recapitalize "too big to fail" banks without restructuring them, we will quite deserve our next mugging. We had better cut these monsters into little, itty, bitty pieces. We should embed strict size and leverage limits into their itty, bitty charters, restrict their ability to recombine, and then hire management to run the little things on strictly commercial terms.
Hopefully we will change what it means for a bank to run on commercial terms — We should create a tax and regulatory structure that penalizes scale and leverage across the board. Better yet we should decouple the payment system from risk investment by reorganizing banking functions into "narrow banks" and credibly not-guaranteed investment vehicles. But whatever the banking industry comes to look like, nationalized banks should be recapitalized once, then managed to compete in it, and for no other purpose. Taxpayers should seek to extract maximum value from their eventual privatization. But should any of the reorganized banks seek a second helping of at the public trough, they should be ostentatiously permitted to fail. Rather than an implicit government guarantee, successors of nationalized banks should face a particularly itchy trigger finger.
Having nationalized "banks" make loans that prudent managers of a well-capitalized bank would not make is just a way of obscuring a subsidy and guaranteeing permanent quasipublic status by requiring on-going guarantees, bail-outs, and capital injections. Further, putting easy-lending public banks in competition with ordinary thrifts would resuscitate the destructive dynamic we have just put behind us, wherein bank managers must match the idiocy of their most foolish counterparts or watch their businesses wither. If we want to stimulate the economy, put idle resources to work, stoke animal spirits, whatever, we should do that with some combination of transfers, investment subsidies, inflation, and public works. But if we are dumb enough to force-feed credit into the economy, let’s not hide that behind a bunch of puppet banks. And let’s keep it very clear that we are not confiscating private firms in order to make them tools of the state. We nationalize reluctantly, when we have had no choice but to inject public money (or guarantee assets, which amounts to the same thing) in banks that otherwise would have failed. We nationalize because, in a capitalist economy, investors get to keep the profits they endow, even when the investors happen to be taxpayers.
What if Uncle Sam Takes Over Your Bank?
Could your bank turn into the Bank of the U.S.A.? The latest wave of banking problems has investors worried that the government will nationalize deeply wounded institutions, such as Bank of America Corp. and Citigroup Inc. Such a dramatic step could make it easier for some bank customers to get a loan. And customers with deposits will still be protected by federal insurance, just as they are today. Still, consumers could see more branch closings, more standardization across bank products and a deterioration in customer service. Common and preferred shareholders, meanwhile, will likely get wiped out in a bank nationalization. With all of the problems that banks are now facing, here is a primer on bank collapses and the impact of possible bank nationalization.
What does "bank nationalization" mean?
A nationalized bank is owned and run by the government. The shocks of the credit crisis last fall spurred lawmakers to seminationalize the banking sector; nearly 314 institutions have already signed over some of their shares and other securities to the Treasury in return for $350 billion in government TARP funds. The government could now go a step further by taking complete ownership of certain troubled banks.
Why nationalize banks?
It makes sense only if banks are in danger of failing. In Western countries, nationalization is largely used as an emergency method to prop up banks during tough times. It is typically used to lend to small and medium-sized businesses and restructure burdensome loans to consumers.
Has nationalization ever worked before?
It has a mixed record. Sweden took over its banks, restored them to health and privatized them again. France nationalized its banking sector, privatized it again by selling it into private hands and now may be in the process of another wave of nationalization. In the U.S., the government took over hundreds of institutions during the savings-and-loan crisis a couple of decades ago. It aggressively sold off bad assets, and the experiment is now regarded as a success.
What will happen to my account if my bank is nationalized?
There should be very little change to consumers' bank accounts and insurance-protection levels if their bank is nationalized. The Federal Deposit Insurance Corp., which insures deposits for up to $250,000, will continue to cover all FDIC-insured institutions, regardless of who the owner is. And even though an increasing number of banks are failing, the FDIC -- which is backed by the full faith and credit of the U.S. government -- can't run out of money because of its ability to borrow from the Treasury.
Will I be able to get a loan?
Nationalized banks are more likely to loosen the lending spigots. Banks would start making loans that they wouldn't otherwise make today, such as to borrowers with less-than-stellar credit. There would be more pressure to make loans to achieve social objectives. Homeowners at nationalized banks should also benefit since the government is likely to halt any foreclosure proceedings, says Greg McBride, senior financial analyst at Bankrate.com. "Uncle Sam is not going to want to put anybody out of their house," he says. Government-owned banks could offer basic credit cards with low rates that would appeal to less-creditworthy customers who regularly use cards to borrow. But such cards are less likely to come with costly rewards programs, such as those that earn frequent-flier miles, says Dave Kaytes, managing director at Novantas.
How will private-banking and brokerage-account customers be affected?
That depends on whether the government takes a short- or long-term view. If it intends to be a long-term owner, then it will probably sell off the brokerage, investment-banking and other auxiliary operations as nonessential to the core banking business. If, however, the government sees its step as a short-term fix to shore up the system temporarily, then it may hang on to such operations.
What other products and services might be affected?
If the government takes over a bank, management will be under even more pressure to cut costs. Expect more branch closings and poorer customer service. "Think of the bank as the DMV of the future, run by government employees who have little upward mobility," says Mr. Kaytes. "I think we can expect that over time, the nationalized banks will be less open to innovation and new product development, more conservative in their approaches, and more constrained in their actions and subject to tighter scrutiny," says Jim Eckenrode, banking and payments research executive at TowerGroup.
What are the disadvantages of bank nationalization?
In the U.S., the biggest problem for the government would be the sheer impracticality and expense of taking over all 8,000 banks -- or even the 314 institutions that described themselves as "banks" in order to receive government aid. The U.S. government would have, at most, the ability to take over only a handful of the most important institutions. As a result, nationalization would not solve the pressing problem of potential bank failures, particularly among small banks. Consumers who have deposits in such banks would still be dependent on the FDIC to return their money during a failure, and such a process could be lengthy and involve a lot of red tape.
End of an era: crunch blows $525bn hole in hedge funds
The scale of the crisis gripping the global hedge fund industry was illustrated today by figures showing that panicked investors withdrew $525bn (£380bn) in the second half of 2008 to avert huge losses on volatile global financial markets. Total capital invested in hedge funds shrank by more than a quarter, dropping from an all-time peak of $1.93tn mid-year to $1.4tn at the end of December. Hundreds of once high-flying firms ceased trading, with the global number of hedge funds dropping from 10,096 to 9,176 over the course of the year, according to Chicago-based Hedge Fund Research.
Years of dramatic growth in the once obscure alternative investment industry came to an abrupt halt as it became clear that sophisticated strategies were proving unsuccessful in shielding clients from heavy falls in the stockmarket. Kenneth Heinz, president of HFR, said an era of easy access to borrowing and low volatility in asset prices had come to an end. "What we're now seeing is a consolidation, which is a normal functioning of the economic system," he said. Worst hit were convertible arbitrage funds, which use complex mathematical techniques, often driven by computer models, to exploit anomalies in stock prices. These funds slumped by 34% during the year, compared with an 18% decline for the hedge fund industry overall.
The traditional "long-short" model fared little better. These hedge purchases of shares with short positions, and they lost 26% of their value. Funds specialising in distressed assets or companies undergoing restructuring found their high-risk approach to be wanting, with their value slumping by 25%. "Event-driven" funds, which typically capitalise on mergers and acquisitions, dropped in value by 21%. "There's no question this was a challenging year for these types of strategies," said Heinz. He pointed out, however, that hedge funds could still boast an annualised return since 1990 of 11.8% – more than four percentage points higher than typical Wall Street stocks.
A few funds have prospered in the crisis – including Paulson & Co, which made spectacular gains by putting money on a collapse in the US mortgage industry. The top 10% of hedge fund performers delivered an average gain of 40% on the year. But some of the biggest names in hedge funds are battening down the hatches. Citadel, which had more than 1,200 staff and $20bn under management last year, lost 53% of the value of its main fund in 2008, according to Dow Jones, and temporarily barred investors from withdrawing money. Citadel's founder, Ken Griffin, recently acknowledged that hedge funds had done little better than underlying markets in the credit crunch. "This is going to be a great disappointment to investors around the world," he said.
Firms Keep Lobbying as They Get TARP Cash
Troubled financial institutions and the Detroit auto makers continue to spend heavily on lobbying Congress while accepting billions of dollars in U.S. government money, reports to Congress suggest. General Motors Corp. spent $3.3 million on lobbying in the fourth quarter of 2008, a period that coincides with the government committing $13.4 billion to the ailing auto maker under the Treasury's Troubled Asset Relief Program. In all of 2008, GM spent $13.1 million on lobbying, down from $14.3 million in 2007. GM's reported lobbying expenses for 2008 were only slightly less than combined spending by Ford Motor Co. and Chrysler LLC. "Lobbying is the transparent and effective way that GM has its voice heard on critical policy issues...that companies should not be required to forfeit if they receive federal funding," said GM spokesman Greg A. Martin, who added that no funds lent from the Treasury would be used for lobbying.
Bank of America Corp., whose heavy losses prompted it to appeal to the government for a second bailout this month, spent $4.1 million on lobbying last year, nearly $1 million more than in 2007. The bank spent $820,000 on lobbying in the last quarter, about one-fifth less than in the third quarter. Bank of America is in line to receive a total of $45 billion from the government, including $20 billion committed by the Treasury this month. Merrill Lynch & Co., which was acquired by Bank of America Jan. 1 at the government's urging, spent $1.2 million on lobbying in each of the last two quarters, and $4.7 million for the year, $280,000 more than it spent in 2007. Merrill's losses last year were another reason why Bank of America appealed for a second injection of taxpayer money. "Our last year numbers reflect to some degree costs resulting from our merger with Countrywide," said Shirley Norton, a spokeswoman with Bank of America. "We are now reducing our lobbying expenses...consistent with bank-wide efforts to reduce expenses."
When the U.S. placed government-sponsored mortgage giants Fannie Mae and Freddie Mac into federal conservatorship in August, the two entities, once among the financial services industry's biggest lobbying spenders, were required to stop lobbying. In October, American International Group Inc., which is nearly 80% held by the government, said it would voluntarily stop federal lobbying after criticism from Congress. But Congress has placed no similar restraints on other recipients of taxpayer money, though some lawmakers favor that. "Clear restrictions must be imposed on firms receiving assistance," said Sen. Dianne Feinstein (D., Calif.). "These include tougher reporting requirements, lobbying prohibitions, and a ban on lavish and unnecessary expenditures," she said. Lobbying spending by GMAC LLC, GM's auto- and mortgage-lending arm, more than tripled to $4.6 million in 2008 from 2007. GMAC has received $6 billion in government money to help stave off a financial crisis. GMAC has suffered heavy losses in its mortgage unit, Residential Capital LLC, or Rescap. GMAC spent $1.5 million on lobbying in the fourth quarter, about $400,000 less than in the previous quarter. GMAC is 51% owned by private-equity firm Cerberus Capital Management LP, which also controls Chrysler.
Toni Simonetti, GMAC's vice president for global communications, said the firm spent more on lobbying last year because it was lobbying on more issues than before. "I think it's obvious that the increased spending on Washington-related activities was related to the environment and the restructuring that we are going through," she said. Chrysler spent $1.2 million on lobbying last quarter, and $1.9 million on lobbying in the third quarter. The White House committed $4 billion in loans to Chrysler in December. "There has been significant demand from legislators and government officials for education and information on Chrysler," said Mary Beth Halprin, a company spokeswoman. Ford spent $1.9 million on lobbying in each of the last two quarters. It spent $7.7 million on lobbying for all of 2008, about $600,000 more than in 2007. Ford's Washington spokesman Mike Moran said that although the company didn't take government money and says it doesn't need it now, it joined the other two domestic auto makers in pressing for a government rescue. "Should one of the other companies falter, that would have an impact on the entire auto industry," he said.
Congressional filings show that lobbying by American International Group, which the government took control of in September, continued in the fourth quarter, despite the government's holding 78.8% of the company. Congressional filings show that AIG spent $1.08 million in the fourth quarter. AIG's 2008 lobbying spending was $9.5 million, $1 million less than in 2007. AIG spokeswoman Christina Pretto said the company's fourth-quarter figures include spending on state-level lobbying and trade-association activity. AIG stopped federal lobbying after criticism by Congress in October, which was the reason for the 2008 decline in spending, she said. The company continues to lobby on insurance issues and legislation at the state level, but activities must be approved by the company's general counsel and chief regulatory and compliance officer, she said. In October, after the Wall Street Journal reported that AIG was lobbying states for more favorable interpretations of a law that would place new controls on mortgage originators, Sen. Feinstein and Republican Sen. Mel Martinez of Florida introduced legislation that would ban recipients of taxpayer money from lobbying. The two lawmakers are seeking sponsors for a House version of the bill.
SocGen rogue trader Jerome Kerviel 'hit the jackpot' on 7/7
It was a day of carnage that left 56 people dead and a dark shadow for ever cast over the history of London. But for Jérôme Kerviel, the French rogue trader, 7/7 was the jackpot. Mr Kerviel, whose wild bets on the stock market ended with record losses, celebrated as Britain’s worst terror attack helped him to register a €500,000 profit and to continue a winning streak that brought him "orgasmic pleasure". The trader made the confession as he told the newspaper Le Parisien how he had lost touch with reality in the pursuit of money-making at Société Générale, the bank that employed him. It is alleged that his rogue dealings resulted in record losses of almost €5 billion and plunged the 144-year-old French financial institution into crisis.
Mr Kerviel, who was questioned by magistrates yesterday, is under investigation on suspicion of breach of trust, fabricating documents and accessing computers illegally. He faces a maximum sentence of five years in prison if found guilty. The trader, 32, claimed that his colleagues and superiors had been aware of his actions, which brought him the nickname of le cash machine. He painted a damning picture of the bank’s trading room as earnings soared in the years before the financial crisis. "The best trading day in the history of Société Générale was September 11, 2001," he said. "At least, that’s what one of my managers told me. It seems that profits were colossal that day. "I had a similar experience during the London attacks in July 2005."
A few days earlier he had bet on a fall in the share price of Allianz, the German insurance giant, he told Le Parisien. Everyone was losing money when the 7/7 bombings sent the insurance sector into a downward spiral "except for me", he said. "Thanks to the positions I had, I earned €500,000 in a few minutes. It was the jackpot. I was jubilant." After the celebrations Mr Kerviel said he paused for thought. "I understood that I was having fun when people had just been hit by the bombs. I ran to the toilet and I was sick. But the moment of weakness did not last long. I went back into the trading room and I returned to work." Mr Kerviel also spoke of his financial triumphs in the months leading up to the discovery of his unauthorised trades in January last year.
"From August to December 2007, I win every day," he said. "That creates a sort of addiction. A good day for a normal trader is a profit of €30,000 to €40,000. For me, a €1 million day is rubbish. I take crazy risks. And I make astronomic profits which sometimes give me an orgasmic pleasure." He denounced his former colleagues as hypocrites for claiming that they had no idea of his deals after he ran up a profit of €1.4 billion in 2007. "I covered the losses of several of my colleagues," he said. Mr Kerviel sought to distance himself from his comments after their publication in Le Parisien, saying that they stemmed from a private conversation and were taken out of context. The newspaper said that he met its journalist six times for on-the-record interviews at the request of his lawyers.
Wage Cuts as Alternative to Devaluation in European Economies
Well it's pretty clear to me at least that there is now one, and only one, major and outstanding topic towering head and shoulders above all those other pressing and important problems those of us following the EU economies currently find lying in our macro-policy in-trays: the issue of wage cuts. Not since the 1930s has the possibility of such a generalised reduction in wages and living standards loomed out there before policymakers, and doubly so if we now hit - as I fear we may well for reasons to be explained at the end of this post - systematic price deflation in a number of core European economies.
The issue that has suddenly and even violently erupted onto the European macro horizon over the last week (as if we didn't already have sufficient problems to be getting on with) is, quite simply, how, if they either don't want to, or can't, devalue, do politicians successfully go about the business of persuading the people who, at the end of the day, vote them into office (or don't) to swallow a series of large and significant wage cuts? And this is no idle and abstract theoretical problem, since in the space of the last week alone the issue has raised its ugly head in at least four EU member states - Ireland, Greece, Latvia and Hungary.
In the case of the first two of these devaluation simply isn't an option, since there is no a local currency to devalue, while in the case of the latter two the presence of prior large scale foreign currency borrowing means that authorities are nervous about anything that smacks of devaluation (since the providing banks would take large losses following the inevitable defaults, and the cooperation of these providing banks is necessary in the future if the economies in question are ever to recover). This latter view (no devaluation) prevails even though many economists, (including myself), would argue that is a highly questionable one, since wage deflation on a sufficient scale will ultimately produce those very same defaults (with the added schadenfreude, as Paul Krugman points out, that even those who have borrowed in the domestic currency are also pushed into default).
War of the Sicilian Vespers Part II
Now, there is already quite a debate going the rounds on the merits or otherwise of devaluation in the Latvian case (see IMF Central European representative Christoph Rosenberg here or RGE Monitor analyst Mary Stokes here), but what I want to focus on in this post is the acute difficulty faced by any elected politician when it comes to enforcing wage cuts. This has to be one of the most important arguments in favour of devaluation, at least from the practical policy point of view. And this is also why, in my humble opinion, the IMF constantly ends up being the whipping boy, since the easiest way for any local politician to try to side step the responsibility for taking difficult decisions is to throw the country to the mercy of the "dreaded" fund (or at least, as seems to have happened in last weeks Irish case, threaten to do so), and then tell everyone that there simply is no alternative, as "they" will accept nothing less.
All this puts me in mind of the popular urban legend according to which mothers in Naples put the fear of god into their recalcitrant offspring by warning them that they'd better darn well behave since otherwise "the Catalans will come" (in reference to an infamous incident in the aftermath of the War of the Sicilian Vespers in which Catalan Commander Roger de Flor allegedly massacred 3000 Italian soldiers on his arrival in Constantinople - for default on a debt as it happens - simply because his mercenary troops had not been paid). Now mothers all over Europe are apparently telling their children "lock the front daw, Dominique Strauss Kahn is Coming".
The Irish Gaffe, Or Just Another Load Of Old Blarney?
First Up this week was Irish Prime Minister Brian Cowen, whose alleged threat to call in the IMF if the trade unions did not agree there an then to all overall 5% wage cut for public sector workers (a threat which was subsequently denied) made quite a few waves in the press and even got as far as producing an official denial on the part of the Fund.
Prime Minister Brian Cowen, while at an investment conference in Tokyo on Wednesday, was reported to have endorsed the view of an Irish union leader that the parlous state of Ireland's public finances could lead to the IMF ordering mass dismissals of public sector workers. Dan Murphy, the general secretary of the Public Service Executive Union, had previously told his branch members that the Fund could intervene if public spending was not curtailed, according to the Irish Times......As for public sector wages, the prime minister's comments may simply have been an attempt to scare unions into agreeing to public sector wage cuts. That ploy "may have backfired somewhat," for all the attention it has now received, remarked Rossa White, chief economist at Davy stockbrokers.
Around 20.0% of Ireland's 1.2 million-strong workforce get their salaries from the state. While that proportion is not unusual in Europe, wages are unusually high, as are their accompanying pension benefits. The Irish government is now working to scrap a 6.0% pay increase it announced last September--badly timed to have launched around the time of Lehman Brothers Holdings' collapse--and White believes another 10.0% cut is needed.
Lightening Trip To Hungary
Cowen was swiftly followed out of the starters box by IMF Managing Director Dominique Strauss-Kahn who must certainly have been the highest profile vistor to pass through the VIP lounge at Budapest Ferihegy's airport last week as he found himself having to take time out to fly-in and offer a spine-stiffener to a government who were giving every indication of backtracking on the 8% public sector wage cut they had agreed to as one of the conditions for the 20 billion euro IMF-lead rescue loan. Strauss-Kahn arrived amidst a notable weakening in the value of the forint, and all manner of speculation about whether or not the fund was set to withhold the second tranche of the loan.
At the heart of last week's visit were concerns about the size of Hungary's 2009 budget deficit, since while Hungary has been steadily reducing the size of the deficit as part of the austerity programme agreed to in the summer of 2006 and the deficit was down to around 3.3% of GDP last year, according to Finance Minister János Veres last Tuesday, it is not clear what impact the recession will have on the 2009 target number of 2.6%. And we still need to say "about" 3.3% for the 2008 deficit since we evidently don't have a final figure for Hungary's 2008 GDP on which to make a more precise calculation.
The days before Strauss-Kahn's visit were rife with speculation that Hungary might be forced to adopt new austerity measures in order to stay on track with its deficit target, with analysts estimating Hungary could be set to overshoot the target by something in the region of HUF 200 billion-HUF 250 billion, due to the recession being deeper than expected and a sudden drop in inflation. Lower than anticipated GDP growth is important since Hungary currently has an estimated 0.9% contraction pencilled-in for its fiscal calculations, while in reality the final outcome may be anywhere between minus three and minus five percent, depending on the view you take (in fact the EU Commission Hungary 2009 Forecast - out today has -1.9, but this is almost certainly too optimistic). Also the sudden drop in inflation is also taking everyone by surprise, since if prices are lower than expected then VAT returns etc will be down accordingly, too. Hungary's inflation stats will likely undershoot the current forecast, Veres emphasized, confirming analyst expectations for a significantly lower inflation path for Hungary (the current market consensus for annual inflation in December 2009 is 2.6%, but again personally I think this is way too high).
"Currency traders in London took a sentence out of context in last night's media reports (which included Portfolio.hu coverage) which said the International Monetary Fund might cancel October's credit agreement with Hungary. This was the main reason for extreme pressure on the forint this morning," a Budapest-based trader told Portfolio.hu. After this morning's statement by Finance Minister János Veres, who claimed it was “impossible" for Hungary not to meet fiscal targets (or else the government was ready to take further austerity measures), market players began to see that the panic was unsubstantiated. As a result, we have seen an intense correction towards midday, the trader argued.
Portfolio Hungary Report
So Hungary's 2009 budget is in trouble, and this is partly due to exaggerated inflation and growth forecasts, and partly due to some hefty government compensation for state employees who lost their “13th month" bonus at the end of 2008. Arguably it was this latter point which was the main reason for the IMF Managing Director's visit. Strauss-Kahn met with Prime Minister Ferenc Gyurcsány, Finance Minister János Veres and National Bank of Hungary Governor András Simor, President of opposition party Fidesz Viktor Orbán, and a number of MPs, according to the IMF press release.
Apart from putting a stop to any kind of "back door" compensation for wage cuts, the tangible outcome of the meeting was a battery of agreed measures intended to bring the budget deficit back into line with targets.
“In order to partially offset the loss of budget revenues, we do not want to rule out the possibility of tax hikes," Hungary's Finance Minister János Veres told a morning talk show on Hungarian TV channel ATV. Veres did not make direct reference to a VAT hike, but recent press leaks and comments from analysts suggest that this may well be in pipeline.
Naturally Strauss-Kahn explained at his post meeting press conference that the International Monetary Fund was generally satisfied with Hungary's efforts to meet the conditions for the IMF loan (he was, of course, hardly likely to say otherwise in public), and he even dangled out the possibility that the loan might be extended beyond 2010 if economic condititions made it necessary. We will return in the future to this point, since as I personally cannot see the present plan working as anticipated, I cannot help asking myself when it will be (if ever) that Hungary is able to be discharged and certfied as fit to stand on its own by the fund. Or are we about to see the creation of a new set of Fund Economic Protectorates, a possibility which I'm sure was never envisaged by the institution's founders.
How To Dangle Your Government On The End Of A Very Thin Thread Latvian Style
But things were obviously a lot hotter under the collar (despite the snow) in Riga round about the same time, since according to the Financial Times Latvia’s president threatened to call early elections last Wednesday after anti-government protests led to the Baltic country’s worst rioting since independence in 1991.
“It’s going to bring down the Parliament, and through that the government,” said Krisjanis Karins, a member of Parliament and former leader of the opposition New Era party. “It’s already happening, and the pace is such that nobody really understands.”
Such demonstrations - and similar ones in Bulgaria and Lituania (shown in photo) - raise doubts over whether Latvia’s government actually has enough political and social capital to implement the painful austerity plan agreed with the International Monetary Fund last month as an alternative to devaluation.
“Trust in the government and in government officials has collapsed catastrophically,” President Valdis Zatlers told a news conference. “The Saeima [parliament] and the cabinet of ministers have lost links with the voters.”
About 10,000 Latvians demonstrated in Riga’s Dome Square on Tuesday night in a rally called by opposition parties, trade unions and civic organisations. The demonstrators accused the government of corruption and of economic mismanagement and demanded that elections – not due until 2010 – be brought forward. The government now forecasts that the economy will contract 5 per cent this year and unemployment will soar to 10 per cent.
The Latvian government is well aware that strong adjustment will be needed to ensure success. In fact, most of the tough measures—including a nominal wage cut in the public sector of no less than 25 percent—was proposed by the Latvian government itself. This shows that the economy—including the labor market and the wage-setting mechanism—is very flexible, much more flexible than in most other countries, even outside Europe. The IMF is supporting the government's policy package through a $2.4 billion loan, with the EU, the World Bank, and a number of bilateral creditors providing additional financing.
Marek Belka, Current Head of IMF's European Department, quoted in IMF Helping Counter Crisis Fallout in Emerging Europe, IMF Survey Magazine.
What really seems to have angered people are the conditions attached to the €7.5bn stabilisation package agreed last month with the International Monetary Fund and the EU after the nationalisation of the country’s second largest bank shook confidence in the country’s fixed exchange rate. In particular Latvian citizens seem to have been upset by the stringency of the austerity package since in the letter of intent Latvia undertakes to limit budget spending to under 40% of GDP, and this in the context of a sharp contraction in GDP is not an easy thing to do- Clearly not of the envisaged measures are popular - cutting wages in the government sector by about 15%, freezing pensions as well as cutting back government spending on goods and services.
And in addition to the cut in provision an increase in VAT is also being contemplated. All this contrasts, however, with the measures envisaged for restructuring the banking sector, including recapitalization of banks, honoring liabilities via the deposit guarantee fund and ensuring the maintenance of confidence in the various liquidity instruments, all of these areas of spending where increases in spending will be permitted. Of course, once you decide to stay on the peg there is no avoiding this, but it is hard for ordinary people to understand that this is not simply favouring Nordic banks at the expensive of Latvia's pensioners and unemployed.
Its All Greek To Me
Greece, as ever, is steering a rather different course. In the Greek case it is not the IMF who is waving the big stick, but the credit rating agencies, in the shape of Standard & Poor's who last week cut its credit ratings on Greece's sovereign debt, already the lowest in the 16-nation euro zone, to A- with a stable outlook from A. Greece was only one of four euro zone countries who have been warned by S&P recently that they may have their ratings cut, and ideed Spain has only today had its rating cut too.
"The ongoing global financial and economic crisis has in our opinion exacerbated an underlying loss of competitiveness in the Greek economy," S&P credit analyst Marko Mrsnik said. "In our opinion, the ongoing slowdown in credit growth will likely lead to a deceleration in domestic demand, thus increasing the risk of a recession and a possibly protracted adjustment."
S&P said Greece was entering the downturn with a fiscal deficit of around 3.5 percent of GDP, after repeated government failures to bring expenditure under control and reduce high debt levels despite years of economic growth averaging four percent. Following the announcement, spreads in Greek 10-year government bonds over benchmark German Bunds widened by about 10 basis points to a session high of 246.9 basis points.
The extra interest Greece must pay to borrow money for 10 years as compared with Germany stands at 246 basis points, while for Ireland the figure hit 180 basis points, also a record, and spreads have widened too for Spain and Portugal.
click to enlarge
Wage moderation and enhancing wage flexibility are important challenges. The authorities will continue with the policy of containing increases in basic wages of government employees and are hoping for a favorable signaling effect on private sector wage settlements. However, in recent years, wage increases in the private sector have been relatively large and often exceeded productivity growth.
Greece: 2007 Article IV Consultation - IMF Staff Report On Greece
It should not surprise us then to learn that one of the key areas of controversy behind the recent Greek protests was a law which effectively ended the employees' right to collective wage contracts - a law which won approval in the Greek parliament last August. The government justified the move by saying that it wanted to clean-up debt-ridden state companies and overhaul protective employment laws in an attempt to attract more foreign investment. The now-dismisssed Greek Finance Minister Alogoskoufis recently told parliament the reform should be pushed ahead "for the sake of the Greek economy and society," since higher wages have added to state companies' debts, which ordinary Greeks had to cover with their taxes.
A much fuller review of the Greek problem can be found in my "Why We All Need To Keep A Watchful Eye On What Is Happening In Greece" post.
So What Are The Options?
IMF Survey Online: The IMF appears to be advocating fiscal restraint in all of its loan programs in Europe. Wouldn't these countries recover faster with fiscal stimulus packages?
Marek Belka: The answer is obvious: can a country finance its borrowing requirements or not? If only these countries could afford a larger budget deficit, fiscal stimulus would have been fine. But when a country is already in crisis, the main problem is usually to come up with enough liquidity. In these cases, fiscal restraint is necessary. Choices in a financial crisis are very constrained.
Well really there are no very easy solutions here, and anyone who suggests there are is kidding you. In all the countries we are talking about above (and a good few more) the citizens, and the corporates (and in some, but not all, cases the governments) are very highly leveraged (indebted in relation to their realistic future income expectations) and the debt accumulation process has pushed living standards to a level which is higher than sustainable. Just think of your own household. If you push all the available credit to its limit during the first half of a year, its clear you can't live on the same level in the second half unless you keep borrowing, but when the lenders not only won't allow you to do this, but even have the nerve to ask you to pay some of your borrowings back, well then your standard of living in the second half is bound to drop, and this, of course, is what is happening across all these countries.
There is an additional problem here, however, since all that "over-the-top" borrowing drove these countries forward above their normal "capacity" level, and that is also what all the above four economies have in common. This driving-forward beyond capacity is what is called "overheating", and this overheating is normally reflected in above average inflation, which is again what we have seen in these countries. The end product is that they have not only an indebtedness problem but also a competitiveness one, and that is what the IMF packages are intended to address.
Of course, the problem is if you get your salary cut it becomes harder to pay back the money you owe (loan defaults) and you can't spend as much on consumption (demand slump). And on top of this, as these first two lock-in, government revenue falls (less VAT) while expenditure rises (unemployment payments and bank bailouts), so we get fiscal deficit problems. So not only do you have banks lending less, households spending less, and companies investing less (as demand drops), we also have governments finally forced to cut back (at least in the more vulnerable economies), as the ratings agencies get to work. So you get a downward spiral of falling wages, and falling prices as GDP just comes down and down. And this process can become systematic (deflation) meaning that nominal GDP starts falling even faster than real GDP, making for a car that becomes increasingly "wobbly" and difficult to steer.
In this environment, there really is only one way to halt the spiral, and to jump start the economy, and that is to export, and to try and encourage export directed investment. But to get going with exports you need to recover competitiveness. You can achieve some of this restoration via productivity improvements, but not enough, and not quickly enough, especially if the distortion is large, and has been going on over a number of years (see the real exchange rate chart for Hungary above). So you can either do one of two things, devalue, or cut wages and prices. Neither is easy, but as we are now seeing the second is hardly universally popular either.
Dark flow: Proof of another universe?
For most of us the universe is unimaginably vast. But not for cosmologists. They feel decidedly hemmed in. No matter how big they build their telescopes, they can only see so far before hitting a wall. Approximately 45 billion light years away lies the cosmic horizon, the ultimate barrier because light beyond it not has not had time to reach us. So here we are, stuck inside our patch of universe, wondering what lies beyond and resigned to that fact we may never know. The best we can hope for, through some combination of luck and vigilance, is to spot a crack in the structure of things, a possible window to that hidden place beyond the edge of the universe. Now Sasha Kashlinsky believes he has stumbled upon such a window.
Kashlinsky, a senior staff scientist at NASA's Goddard Space Flight Center in Greenbelt, Maryland, has been studying how rebellious clusters of galaxies move against the backdrop of expanding space. He and colleagues have clocked galaxy clusters racing at up to 1000 kilometres per second - far faster than our best understanding of cosmology allows. Stranger still, every cluster seems to be rushing toward a small patch of sky between the constellations of Centaurus and Vela. Kashlinsky and his team claim that their observation represents the first clues to what lies beyond the cosmic horizon. Finding out could tell us how the universe looked immediately after the big bang or if our universe is one of many. Others aren't so sure. One rival interpretation is that it is nothing to do with alien universes but the result of a flaw in one of the cornerstones of cosmology, the idea that the universe should look the same in all directions. That is, if the observations withstand close scrutiny.
All the same colleagues are sitting up and taking notice. "This discovery adds to our pile of puzzles about cosmology," says Laura Mersini-Houghton of the University of North Carolina, Chapel Hill. Heaped in that pile is 95 per cent of the universe's contents, including the invisible dark matter that appears to hold the galaxies together, and the mysterious dark energy that is accelerating the universe's expansion. Accordingly, Kashlinsky named this new puzzle the "dark flow".
Kashlinsky measures how fast galaxy clusters up to 5 billion light years away are travelling by looking for signs of their motion in the cosmic microwave background, the heat left over from the big bang. Photons in the CMB generally stream uninterrupted through billions of light years of interstellar space, but when they pass through a galaxy cluster they encounter hot ionised gas in the spaces between the galaxies. Photons scattered by this gas show up as a tiny distortion in the temperature of the CMB, and if the cluster happens to be moving, the distortion will also register a Doppler shift. In any individual cluster, this shift is far too small to detect, which is why no one had ever bothered looking for it. However, Kashlinsky realised if he combined measurements from a large enough number of clusters, the signal would be amplified to a measurable level.
Kashlinsky and his team collected a catalogue of close to 800 clusters, using telescopes that captured the X-rays emitted by the ionised gas within them. They then looked at the CMB at those locations, using images snapped by NASA's WMAP satellite. What they found shocked them. Galaxy clusters are expected to wander randomly through their particular region of space, because matter is distributed in uneven clumps, creating local gravitational fields that tug on them. Over large scales, however, matter is assumed to be spread evenly, so on these scales the clusters should coast along with space as it expands. What's more, everything in the standard model of cosmology suggests that the universe should look pretty much the same in all directions.
So what is behind the dark flow? It can't be caused by dark matter, Kashlinsky says, because all the dark matter in the universe wouldn't produce enough gravity. It can't be dark energy, either, because dark energy is spread evenly throughout space. That, leaves only one possible explanation, he concludes: something lurking beyond the cosmic horizon is to blame. Before the findings were published in October in The Astrophysical Journal Letters (vol 686, p L49), Kashlinsky knew how heretical his idea would seem. "We sat on this for over a year checking everything," he says. "It's not what we expected or even wanted to find, so we were sceptical for a long time. But ultimately it's what's in the data."
No one knows exactly what might lurk over the horizon or indeed how large the cosmos is (see "Just how big is the universe?") But Kashlinsky suspects it is a remnant of the chaotic state that existed just a fraction of a second after the beginning of time, before a phenomenon known as inflation took hold. It is generally thought that our universe began as a tiny patch in some pre-existing space-time forming a bubble which then underwent a burst of exponential expansion. This period of inflation stretched and smoothed our universe, leaving an even distribution of matter and energy. Outside this bubble, far beyond our cosmic horizon, things might look very different. Without inflation's ironing skills, space-time could be highly irregular: smooth in one neighbourhood and with massive structures or giant black holes in another. "It could be as bizarre as one can imagine, or something rather dull," says Kashlinsky. Either way, he suggests that something outside our bubble is tugging on our galaxy clusters, causing the dark flow.
Other, more radical, explanations for dark flow have also been floated. It is possible - even likely, some say - that ours wasn't the only bubble to inflate out of primordial space-time. In this "eternal inflation" scenario, bubbles pop up all all over the place, each defining its own universe within a larger multiverse. Many cosmologists are happy to relegate those other universes to that dusty corner of theory where unobservable by-products are stored. Mersini-Houghton is not one of them. She argues that the dark flow is caused by other universes exerting a gravitational pull on galaxy clusters in our universe. She and her colleagues calculated how other universes, scattered at random around our bubble, would alter the gravity within it (www.arxiv.org/abs/0810.5388). "When we estimated how much force is exerted on the clusters in our universe, I was surprised that the number matched amazingly well with what Kashlinsky has observed," she says. "I firmly believe that this is the effect of something outside of our universe."
Others believe dark flow could be a sign that our bubble universe crashed into another bubble just after the big bang. In eternal inflation each bubble universe can pop into existence with its own unique set of particles and forces of nature, so collisions between bubbles can have dramatic consequences. If two universes with the same physics collide, they will generate a burst of energy, then merge. However, if two very different universes collide, a cosmic battle ensues. At the site of the crash, a wall of energy called a domain wall will form, holding the two incompatible worlds apart. The bubble with lower energy then expands, sending the domain wall sweeping through its rival, obliterating everything in its path.
If our universe underwent such a collision, any lingering evidence of the cosmic wreckage should appear in the part of the sky facing the impact site. The collision's impact should distort space, and that would in turn affect how light rays, including the CMB, travel through it and how large-scale structures, including galaxies and clusters, evolve. Looking out across the sky today, we would expect to see the universe exhibiting strange properties in the direction of the collision. The collision might have imprinted a special direction onto the CMB, says physicist Anthony Aguirre of the University of California, Santa Cruz. "As you move away from the special direction, the temperature [of the CMB] would change." Physicists are now combing the data looking for the hallmarks of such a shift. Whenever there are weird things happening on a large scale within the galaxy, the remnants of a collision are a candidate for explaining it, Aguirre says.
A completely different take on dark flow comes from Luciano Pietronero of La Sapienza University in Rome, Italy and Francesco Sylos Labini of the Enrico Fermi Center in Rome, Italy. They say the standard cosmological model is wrong, and that a different model might explain the motion of galaxy clusters that Kashlinsky found. "This is just another element pointing toward the fact that the standard picture of galaxy formation is not correctly describing what is going on in the real universe," Pietronero says.
Predictions of the motion of galaxy clusters based on the conventional model assume matter is evenly distributed throughout space on very large scales. Pietronero and Sylos Labini claim analysis of the distributions of galaxies and galaxy clusters throughout the sky shows that this is not true, and that at large scales matter is like a fractal. If that is the case, the gravitational field throughout the universe would also be irregular and could lead to the effects Kashlinsky observed. New results from the Sloan Digital Sky Survey, which has already mapped about a million galaxies, will help give Pietronero and Sylos Labini a more precise picture of the spread of matter, which they hope will confirm their ideas. "I think we will have interesting news very soon," says Sylos Labini.
A fractal universe would, however, raise big problems of its own. For one thing, a fractal distribution of matter is incompatible with cosmic inflation, so theorists would be left to figure out how it arose in the first place (New Scientist, 10 March 2007, p 30). Physicist Douglas Scott of the University of British Columbia in Vancouver, Canada, is also sceptical that dark flow is evidence of anything outside our observable universe. "There is no reason at all to expect it to come from structures beyond the horizon," he says. Scott notes that so far dark flow has only been observed out to distances that are only a few per cent of the total distance to the horizon. "If the effect is real," he says, "then the likely explanation would be some very large-scale structure, but still within the horizon." Such a structure, though, would still present a major challenge to cosmology's standard model.
The most important thing now is to confirm that dark flow is real and that it continues all the way out to the cosmic horizon. Two other teams have made measurements consistent with Kashlinsky's results, but only on scales less than 200 million light years - just a short step compared to the distance out to the horizon. To confirm their finding, Kashlinsky's team will be analysing more recent WMAP data and working with researchers at the University of Hawaii on data from an all-sky X-ray catalogue. The tiny Doppler effect that Kashlinsky uses to measure the clusters' velocities is only observable in bulk, which means the more galaxy clusters he can look at the better. "If confirmed, this will be an exciting way of probing the ultimate structure of the universe and perhaps even the multiverse," Kashlinsky says. "But you have to check and recheck."
"If this thing is confirmed and it is real, it will be incredibly important," says Aguirre, "on the same order of discovery as the realisation that those little smudges on the sky are other galaxies. The most important thing it would tell us is that the standard picture is broken in some way. And the most exciting thing it could tell us is that there are other universes." If it does, space and time will open up to reveal a reality that is so much bigger than we know. When that happens, those claustrophobia-stricken cosmologists will finally be able to breathe easy.Just how big is the universe?
It is 13.7 billion years since the big bang, so light now reaching us cannot have started its journey longer ago than that. Yet the most distant object we could conceivably see today lies further away than 13.7 billion light years. That's because throughout the life of the universe, space has been expanding. Taking this into account, cosmologists calculate that the edge of our observable universe is now approximately 45 billion light years away.
Beyond that, who knows? The inflation theory of cosmology predicts that the universe grew from a bubble. Just how big that bubble has now become depends on how long inflation lasted. If it continued for a very long time - in this context "very long" is still only a fraction of a second - then the edge of our universe might lie far beyond the 45-billion-light-year limit of our vision. That could also rule out the possibility of observing the influence of other universes on our own. As physicist Matthew Kleban of New York University puts it: "It's totally possible that we live in a multiverse and we'll never know because there's been so much inflation."