Hamburger stand in Alpine, Texas
Ilargi: I’ll be quiet today, and leave the talking to Neil Young and Dan W. (at AshesAshes ). The only thing I have to add is that it looks like we could have a pretty tough week in our economies, and perhaps even our societies (don't forget that the death of credit is throwing us full-face-first into a global political crisis). The best way to put it comes from England today:
"... the government is too small to help, [and] in trying to bail out the banks, is in danger of chucking not just good money after bad, but the entire economy after the banks."There are other voices which claim that the British banks' assets are almost at par with their liabilities, but as long as those assets are not valued fairly, either by the government or by the markets, that argument doesn't fly. Britain in the next few weeks will walk on a very fine, a chillingly steep, and a terribly sharp, edge. There are tons of reasons that say why the UK is different from Iceland. But how safe, then, is the present government, if it fails to calm its economy and banking system? The UK's biggest banks, like the ones on Wall Street, are insolvent, and would have been liquidated already if trillions of dollars hadn't been thrown at them. How much more will be thrown? And what will the result be? What further losses are in the offing. They refuse to let us know, our governments and Lords of Finance, while they are spending our money on propping up their own lifestyles. As Neil Young says:
"There's a bailout coming but it's not for youHow much longer can the hiding last? Iceland lost its government. Who's next? Is it reasonable to presume that the next one will involve more than some paint and a few stones being thrown?
It's for all those creeps hiding what they do".
Neil Young - Fork In The Road
Got a pot belly,
It's not too big
Gets in my way
When I'm driving my rig
Driving this country
In a big old rig
Things I've seen
Mean a lot
Friend has a pickup
Drives his kid to school
Then he takes his wife
To beauty school
Now she's doin' nails
Gonna get a job
Got a good teacher
There's a fork in the road ahead
I don't know which way I'm gonna turn
There's a fork in the road ahead
About this year
We salute the troops
They're all still there
In a fucking war
It's no good
Whose idea was that?
I've got hope
But you can't eat hope
I'm not done
Not giving up
Not cashing in
There's a bailout coming but it's not for me
It's for all those creeps watching tickers on TV
There's a bailout coming but it's not for me
I'm a big rock star
My sales have tanked
But I still got you
Sounds like shit
Keep on bloggin'
'Til the power goes out
Your battery's dead
Twist and shout
On the radio
Those were the days
Bring 'em back
There's a bailout coming but it's not for you
It's for all those creeps hiding what they do
There's a bailout coming but it's not for you
Bailout coming but it's not for you
Got my flat screen
Got it repo'd now
They picked it up
Left a hole in the wall
Missed the Raiders game
There's a bailout coming but it's not for you
There's a bailout coming but it's not for you
It's for all those creeps hiding what they do
First and foremost: If one clicks on the links on the right column of my blog and reads the words of Ilargi, Stoneleigh, Denninger, CR, Mish, Yves etc., one has taken a giant step forward in one's understanding of our current plight. These are brilliant women and men, and yours truly is edified by their erudition daily.
As a little kid I was always fascinated by apparent contradictions, paradoxes and illusions. I marveled in the revelation that the only way to free oneself from a “Chinese Finger Trap” was to push one's fingers forward, toward each other, instead of pulling them apart---which of course was utterly counter-intuitive, and which also was why the trap was really so ingenious, because as people pulled harder and harder and the trap squeezed tighter and tighter and the anxiety grew and grew, finding the actual solution became a virtual impossibility. I so-enjoyed, as a stoned young schoolboy, holding a pencil loosely between my thumb and index finger and shaking my arm up and down and making the pencil look like it was wobbling and bending. I still don’t totally get how that works, and I haven’t smoked pot in decades!
Now, as an adult, my appreciation for contradictions, paradoxes and illusions has become even more profound, for I have come to believe that our ability as a species to accept truths that seem contradictory and/or paradoxical---and subsequently to choose consciously not to fight against these seeming contradictions but instead to accept them and hence use our acceptance as a route of escape from our own intransigence---may in fact save us from our ourselves.
OK, so back to the economy.
The paradox of riptides: The paradox of riptides is pretty obvious. Struggle to overcome the riptide by fighting against it and swimming directly into it and you die. Swim perpendicular to the tide, thus eventually freeing yourself from the rip current, and then with relative ease return to shore.
Our political and financial leaders believe that they can fight against the economic rip tide in which we find ourselves. They believe that our survival is predicated on the earnestness and intensity of our struggle against the current “tide”. Our leaders also think that we can return to the same shore from which we were unceremoniously dragged out to sea by the financial rip tides that we are currently experiencing. They think that a return to the beach means a return to 5% per annum growth and low single-digit unemployment and thousands of new 10,000 square foot homes and thousands of new brands of cereal on the shelves of our super-markets and 75 inch HD TVs in every home. In this way, Obama and Summers and Rubin and Frank and Dodd and Pelosi and all of the actors in Washington and New York are not only swimming against the rip currents, they are trying to swim back to a beach that simply no longer exists. That beach, the one built with trillions in debt and no capital production, is gone. It is a mirage destroyed by the mathematical realities of a world in which debt and gambling replaced production and savings, thus eroding the system to the point of complete extinction.
Remember, surviving a rip current means accepting the fact that a paradigm shift is inevitable. One cannot survive the perils of a rip current by swimming back to the same spot on the shore from which one was rent. One must swim parallel to the shore, only returning to solid ground once the rip current has relented. And so, playing out the metaphor even further, when the swimmer---the survivor---returns to the beach, it is not the same beach from which he first departed. It is a different place on the shore. Survival is predicated upon accepting the fact that a return to the same shore is simply impossible; that a new shore must be explored, and that this new shore must be accepted not for how it can be manipulated and exploited, but for what is has to offer.
In the current economic crisis, our survival intact means accepting the mathematical reality that we cannot return to the same point on the beach from whence we came. We must accept the following THREE realities in order to make it through this catastrophe at least somewhat whole:
Growth is deadThe days of 5%, even 3% GDP growth are over. In a country that produces virtually nothing, and in a country in which 72% of GDP is a measure of debt-based consumption, growth is a misnomer, a fallacy, an illusion created by those in power to perpetuate a system that makes them rich whilst simultaneously robbing the rest of us of our futures. Any attempt to “return” to the days of growth is but a lie---it is fighting against the realities of the current: sure suicide. And the choice of a few to fight against this reality eventually leads the rest of us into the waters against our will. Many of us are willing to accept smaller lifestyles, smaller homes, less in the way of uniquely American extravagances. But many are not. And of course the majority of those who are not willing to accept such new realities are the ones on Capitol Hill and on Wall Street, and they’re killing us. They are going to fight for their mansions and HD TVs and their lattes at Starbucks and their 8-cylinder sedans and their central air-conditioning , and when they eventually drown---which is mathematically inevitable---they’re going to take us down with them.
Banking is dead. Banks have been exposed to the world as usurious middlemen who play absolutely no productive role in society. In a smaller world, communities will develop their own “banking” solutions to help facilitate commercial interactions without levying useless, criminal interest rates upon participants in the system. Attempts to revive and save the global banking system will be met with violent revolution.
Money as debt is dead This is the biggie. In the same vain as #2, the system of “money as debt”, the system that has brought us to the point of societal collapse, is also dead in the water. And yet everything we hear from the powers that be is that our economic recovery is entirely based upon our ability to not only get the system of credit and lending and debt flowing again, but to find ways to expand this system so that “growth” can occur. Of course this is the penultimate delusion, as lending and debt and credit have absolutely nothing to do with growth; in fact, the current system of “money as debt” is productive of collapse rather than growth in that it is a total fallacy; growth based upon consumption of goods and services whilst simultaneously all capital is summarily destroyed.
A system based upon lending and credit and debt implies several apparent realities: (a) That the economy experiences growth, and the subsequent creation of “wealth”, based predominantly upon charging interest on the monies created and lent out, (b) that the system functions when those receiving said loans are both willing and able to service both the principle and interest of those loans, and (c) that the system perpetuates “successfully” when the exponential growth of debt can be serviced through the production of concomitant amounts of fungible capital. But as has been demonstrated on several previous occasions, the aforementioned characteristics that drive a “money-as-debt” society are fatally contradictory. Maintaining serviceable debt in an economy in which REAL growth is a fallacy is a mathematical impossibility. It is, as the metaphor demonstrates, suicidal.
How do we get our leaders to accept reality? And if our leaders continue on such a suicidal course, when does it become our legal and justifiable responsibility to remove them from their positions of power? How do we compel our leaders to recognize the changing currents, and to join us in finding peace and relative prosperity on new and pristine shores rather then fight the suicidal battle against the forces of nature?
I am beginning to believe that political action on a mass scale may be the only route to change. Our leaders’ delusions know no ideological boundaries. Democrat and Republican alike believe that economic recovery means loosening of, and a return to, a credit-based economy, a return to 5% GDP growth despite the fallacy of such a belief, and saving a banking system whose usurious and fraudulent actions have led us to this point. These are all beliefs that demonstrate the utter denial of the rip currents in which we find ourselves caught today. It may very well take mass political action, on a scale not witnessed since the European revolutions of the mid-19th century, to either change the hearts and minds of our leaders---or to replace them altogether.
China fears riots will spread as boom goes sour
They surged into the grimy streets around the factory: first scores, then hundreds, then more than a thousand, as word spread and tension loaded the stale, grey air. The boldest overturned a police van and smashed up motorcycles, then tore through the building destroying computers and equipment. The mood was exhilarated, angry and frightened. "It happened so quickly ... There were maybe 500 involved and another 1,000 watching them. People were yelling: 'It's good to smash'," said a witness.
But the riot late last year at the Kai Da factory in Dongguan, amid the grim industrial sprawl of the Pearl River Delta, was not an isolated incident. It was one of tens of thousands of protests, many erupting from the same mixture of economic grievances, resentment of police and swirling rumour. The numbers have been climbing steadily for years. But as the Chinese New Year dawns and the global economic crisis deepens, the government fears that mass unrest could challenge its control of the country, threatening a communist regime that has embraced capitalism with spectacular results.
Today should be the highlight of the year for migrant workers in the country's southern manufacturing hub, but the hundreds of millions who have travelled home for their annual family reunion have little to celebrate. This is the year of the ox in the Chinese zodiac; a symbol of hard work and tenacity. But no one feels bullish as exports plummet and factories shut their doors. Officials announced this week that growth fell to 6.8% in the last quarter of 2008. Enviable as that sounds to countries in recession, it follows five years of double-digit growth and rising expectations. Just as crucially, experts believe that China needs 8% growth to provide enough jobs for new entrants to the labour force. But economists predict that the rate could fall as low as 5% this year.
It is figures like these that prompted the state-run magazine Outlook to issue a remarkably stark warning of the dangers posed by rising unemployment. "Without doubt, now we're entering a peak period for mass incidents ... In 2009, Chinese society may face even more conflicts and clashes that will test even more the governing abilities of the party and government at all levels," said a senior Xinhua agency reporter, Huang Huo. "The key is going to be what happens in a week or two. How many people are going to come back? And are there going to be jobs for them?" asked Geoffrey Crothall of China Labour Bulletin, a Hong Kong-based organisation defending mainland workers' rights. "The most likely thing is that it will get heated after the new year. The government pulls out all the stops beforehand to make sure people have enough money to put in the red envelopes [traditional gifts] when they go home. It puts a false gloss on the real situation."
The unrest at Kai Da began as a dispute over redundancy pay, when the company refused to renew the contracts of several workers. It led to a scuffle in which workers claim, but police deny, that laid-off staff were beaten. "How could the workers not fight back? What else could they do to defend themselves?" asked an employee rhetorically. That spirit has pervaded a spate of recent disturbances in Dongguan: protests outside government offices by unpaid workers; clashes with police as plants shut down. "Mass incidents", as officials describe them, have been on the rise for years. According to the Ministry of Public Security, there were 10,000 across China in 1994. By 2005, that had risen to 87,000. Experts believe the numbers have increased again, not least because the government has stopped publicising them.
Even in the boom years, China felt growing pains. Its frenetic development has created pollution, social dislocation, corruption and rocketing inequality. But it's the sharp decline in industry that is really hurting now. Pressures in the export-led Pearl Delta began to build in late 2007, as the appreciating yuan and growing production costs took their toll. Recession in the west was the final blow: exports actually fell in November, for the first time in seven years. According to officials, more than 15,500 businesses in Guangdong province shut in the first 10 months of 2008. More than half of those went under in October. Many more are teetering. Thousands packed workers home without pay months ahead of the holiday.
Officially, the urban unemployment rate has hit 4.2%. But that does not include migrant workers, who are not registered in the cities. The Chinese Academy of Social Sciences puts the real level at 9.4%, and expects it to rise. "The impact of the downturn has been huge," said Wu Qinfei who sells rich red-and-gold New Year decorations in Dongguan, just around the corner from the Kai Da factory. The banners bear wishes for wealth and happiness, but few expect the next 12 months to bring prosperity. "I've got maybe 60% of the business I had." Trade was even worse at Old Chan's stall, where workers buy showily packaged oranges as gifts. "Before, we could sell 70 boxes a day at this time - now it's 20," he said. "We could charge them 27 yuan, but that's gone down to 15 or 16."
Chan's fortunes mimic those of Guangdong. When he first arrived two decades ago, the Kai Da plant was still under construction. "It was on the other side of a stream, and on this bank, there were no buildings, just fields of banana trees," he recalled. "In the 1990s, things suddenly became better as the factory brought more people. But this year's business is really, really the worst." An hour's drive away, in the provincial capital, Guangzhou, Mrs Cui's eyes filled with tears as she contemplated thenew year. She and her husband were queuing for a train home to Shandong. "The family didn't have any money, so we came here to earn some selling flowers. We borrowed money from the bank and have lost about 30,000 yuan," she said.
Down the queue, Wei Xian is 40 years her junior; his punkish hairstyle and the two spikes through his left ear hinted at his newfound urban tastes. But he, too, was not coming back in the new year. "I hope I can have a life in a big city like Guangzhou, but being a migrant worker is too hard right now," he said. "We were dealing in scrap and the prices plummeted, so they cut my salary by a fifth. My family have a farm and maybe I can run a small business there." The government is happy to see them go. Liu Shanying, an analyst at the Institute of Political Science in the Chinese Academy of Social Sciences (Cass), says the unemployed are less likely to revolt at home. "People tend to behave themselves in such environments. When they work in other cities, where most other people are strangers, they may not care about what others think so much," he said.
Rural officials are trying to create work, investing in construction projects and running training courses on skills such as rabbit farming. But the villages do not look too appealing to most of those who have left. The urban-rural income gap is at a record high, with city residents earning more than three times as much as those in the countryside. Without the money sent home by migrant workers, the discrepancy would be far starker. Many migrants have settled their families in cities; others are landless, having leased their plots to friends or family. Younger workers have no experience of farming, and less interest. And even as workers leave the Pearl Delta, others are arriving. "I worked here a few years ago and wanted to go home, but it's hard to find work in Guizhou and hard to find a wife, so I came back," said Lan Chengguo. His first factory closed soon after he joined; the second paid just 200 yuan a month. But now he had found a third job and said he planned to stay.
Like Lan, many analysts are optimistic. Guangdong has been badly hit, but some laid-off workers have found jobs elsewhere. A recovery is predicted in China in the second half of this year. And, if consumer confidence holds up, the rot may not spread. "Large-scale unrest that threatens general social stability and overall investor confidence is unlikely," UBS economist Wang Tao wrote in a recent note. She pointed to the effects of the Asian financial crisis and the restructuring of state owned industries in the late 1990s. Some 35 million urban workers were laid off between 1997 and 2002, yet no major unrest resulted. This time, the government has more resources and has made it clear it will spend them. At one end of the scale is its four trillion yuan stimulus package; at the other, cash payments for laid-off workers in Dongguan.
But Victor Shih, assistant professor of political science at Northwestern University in Chicago, sees the potential for "explosive" change. He argues that unemployment could easily reach 50 million; that migrant workers are younger and more volatile than those laid off in the 1990s; and that news spreads faster thanks to mobile phones and the internet. The massive expansion in higher education has also led to millions of unemployed graduates - the most dangerous ingredient, in official eyes, given the student protests of 1989. At the least he expects a spike in localised riots resulting in the mobilisation of armed police all over the country. And "if a systematic trigger occurs and instability spreads to a sizable city, we will see the large scale mobilisation of both paramilitary armed police and army units, and possibly substantial bloodshed," he added in a recent article. Yet he, too, concludes that a change in regime remains highly unlikely.
China's leaders know better than anyone that their claim to authority rests on their ability to provide a good living. They are also particularly aware of this year's sensitive anniversaries, including the 20th of the Tiananmen protests and the 60th of the People's Republic itself. So far there is little sign of workers blaming the government for their woes. Most cite the global downturn; many have gripes with employers or local officials. Few seem to connect it to Beijing, let alone suggest that new leadership would improve matters. Nor are there signs of unhappiness and dissent becoming organised. Last November, a taxi strike in Chongqing prompted stoppages by drivers across the country, including Guangzhou. But it was copycat, not co-ordinated, action.
Similarly, there are few signs of workers and the middle classes forging links. Last month, 300 intellectuals launched Charter 08, which calls for multi-party elections and freedom of expression. Despite the detention of one of its authors and the censors' best attempts to scrub it from the internet, it has gathered more than 7,000 signatures. But so far it has had little impact outside the intellectual elite. The authorities have also become far more sophisticated in tackling unrest. Recently, the minister of public security warned officials that their chief task was to prevent mass incidents from getting out of control. "Absolutely avoid inappropriate use of police, poor definition of their role and mishandling that exacerbates conflict, and absolutely avoid incidents of bloodshed, injury and death," Meng Jian urged.
The message appears to have registered at every level: "Even when people turned over the cars and smashed property - police did nothing to stop them," marvelled one witness to the Kai Da riot. "But there were plain-clothed policemen taking pictures who came and detained some afterwards." Last year's riot in Weng'an in Guizhou province - which saw 30,000 take to the streets and the torching of government buildings over rumours of a murder cover-up - is instructive. It concluded not just with arrests, but with three apologies from the provincial leader to the city's residents. Local officials had been "rude and rough-handed" in dealing with former disputes, he said. Shortly afterwards, four senior officials were fired.
Even so, many China watchers predict a rocky year ahead. Groups such as China Labour Bulletin say the downturn threatens to derail the progress made by workers in recent years, with officials turning a blind eye to violations of labour laws. "The only way the government can prevent greater social conflict is by giving more power to the workers, not less," its director, Han Dongfang, wrote this week. "If workers have the right to negotiate as equals with the boss, the chances of disputes turning violent will be greatly reduced. If, on the other hand, the government ignores workers' rights and gives the boss free rein, the consequences will be very serious."
The government's distrust of rival organisations and civil society has left few channels for expressing frustrations: the risk is that they build to volcanic levels. Optimists hope that the downturn may prompt the country's leaders to address its underlying problems: restructuring industry, improving the social safety net, tackling inequality and protecting migrant workers. That sounds naive to some, given the challenges facing the country. But Liu Shanying said the outlook for 2009 was better than it appeared. "According to traditional culture, people tend to see the extreme of adversity as the beginning of prosperity," he said. "Chinese people are stronger and more optimistic when we fight against disasters or misfortune."
US economy in free fall in fourth quarter
The U.S. economy contracted violently in the fourth quarter, with gross domestic product falling at its fastest pace in more than 25 years, economists said ahead of what promises to be a grim week of economic news. "Real economic activity fell off a cliff during the fourth quarter, producing a sharp drop in employment, output and spending," wrote economists at Wachovia. And the worst part is that it's not over. Economists expect another huge decline in the first quarter, with a smaller contraction in the second quarter. GDP is expected to have fallen at a 5.5% annualized rate in the final three months of last year, according to the median forecast of economists surveyed by MarketWatch. That would be the biggest decline since the 6.4% drop in early 1982 and one of the worst quarters in the post-World War II era. The government will release its first estimate of fourth-quarter GDP on Friday, the culmination of a very busy week on the economic calendar. See Economic Calendar. Other major releases will include durable-goods orders for December, home sales for December, and consumer confidence surveys for January.
In addition, economists will be watching the weekly jobless claims data for more clues about the health of the labor market. We could see first-time claims breach the 600,000 mark for the first time since the early 1980s. None of the news in the coming week is expected to be positive. Almost everything that could have gone wrong did after the credit crisis worsened in September. More than 1.5 million jobs were destroyed in the quarter. Consumer spending fell again. Businesses put investment plans on hold. Home builders threw in the towel. Export markets dried up. The only bright spot was the collapse in prices for oil and other commodities, a sudden reversal caused directly by the global slump. This has boosted consumers' spending power, but has also slammed corporate profits. "The weakness was very widespread, with every type of final expenditure falling," wrote economist Michael Feroli of J.P. Morgan, who expects final sales to fall 5.9% annualized, which would be the third worst quarter since 1949.
According to Feroli's estimates, consumer spending likely declined at a 3.6% annual pace, about the same as the 3.8% drop in the third quarter. Business investment probably declined at a 20% pace, while residential investment plunged at a 30% pace, the worst yet in this episode. He expects nonresidential construction to fall 2%, the first decline in about three years, with bigger drops to come. And net exports are expected to fall, a big turnaround from earlier in the year when exports kept the economy above water. The only positive contributors to GDP are expected to be government spending and inventories. Government spending is expected to surge in the coming quarters given the huge fiscal stimulus being promised by the Obama administration and Congress. On the other hand, inventories are expected to be a drag on growth going forward. Companies have kept their inventories lean, but not lean enough. "Given the rate at which sales are falling, that means that the inventory-to-sales ratio is rising sharply, and production will have to fall further in the first quarter to work off the excess supplies," wrote Brian Bethune and Nigel Gault, economists for IHS Global Insight.
Every other time in the modern era that the U.S. economy has contracted more than 5% in a quarter, falling inventories have been a major reason, if not the single biggest factor. Usually, really bad recessions are worsened by the need for companies to get rid of all the stuff they made but nobody bought. Once the inventories are sold off, the economy can grow quickly again because idled workers are called back. But so far in this recession, the inventory cycle hasn't been a major factor, outside of the housing and auto sectors. That means that we can't look forward to a quick reacceleration as the inventory cycle turns. This recession is rooted in a severe credit squeeze and a fundamental readjustment in consumer demand, not in the typical inventory cycle. Most economists are cautiously optimistic about a modest recovery later this year. The turn in the inventory cycle is one reason, but a bigger cause for hope is the massive amount of work by the Federal Reserve and the government. "Despite the current and expected near-term weakness, we caution against simply extrapolating. While momentum is currently downward, policy action has been stepped up dramatically, with more measures likely," wrote Maury Harris and Jim O'Sullivan, economists for UBS, who were among the few economists who saw this coming.
The Federal Open Market Committee meets Tuesday and Wednesday to consider the impact of what they've done and what they'll try next. Interest-rates are as low as they can go, so the FOMC will put its full attention on the nontraditional measures it's employed to thaw out the credit markets. The conventional wisdom is that nothing has worked, but that's not really accurate. First off, governments in the developed world have made it clear that they won't allow the financial system to fail, which has lessened the fear of a systemic collapse. If what they've tried so far doesn't work, there are other things that can be done, including nationalization of the banks as a last resort. There are signs of improvement already, especially in the short-term funding markets, where the Fed has concentrated its efforts lately. Credit spreads between government debt and the London interbank offered rate, commercial paper and mortgages are falling, although they certainly aren't back to normal levels. Yes, the days are cold and dark, but spring will come. It always does.
British economy is on the brink
Arriving back at Heathrow Airport at 4am on Monday morning, after a couple of hours sleep on the flight back from Jerusalem, Gordon Brown was at his desk in 10 Downing Street an hour later. By 9am, bleary eyed, he was alongside his Chancellor Alastair Darling, announcing the Government's second multi-billion pound bank bail-out in just three months – a radical plan to save Britain's economy from the brink of disaster. A few hours later, in Braintree, Essex, Lisa Green, 27, was summoned into her manager's office at the delivery firm where she worked as a customer adviser to be told she was losing her £18,000-a-year job.
The company, Business Post, was merging several customer services branches and they could no longer keep her on. "It's just a nightmare scenario," she said. "So many of my friends and family have been hit by the credit crunch – even my parents are worried about their jobs." At 27, and with a six-month-old daughter to care for, she may eventually be forced to move back in with her parents if she can't find work. Around the same time she was being made redundant, chartered surveyor Nicholas Peel was attending yet another job interview. He has had seven since losing his job last October and sent off countless job applications, but at 62 has found himself competing against younger, cheaper candidates.
He had been hoping his £55,000 job would see him through to retirement; now, he and his wife Judith are living on £240 a month state benefits. First to go were visits to favourite restaurants near their home in Orpington, Kent; a Caribbean holiday, booked before he lost his job, is set to be cancelled. "My most recent position was with a firm of City surveyors. Unfortunately they lost a key client – a large insurance firm – and had to slim down and I was asked to go. "The market is flat and for the few vacancies out there I'm competing against a wider pool of applicants. No company will admit to being ageist of course, but I can see the disadvantage to them of employing me as I'm coming to the end of my career."
Theirs are all-too familiar stories in a week when unemployment hit 2.9 million – the highest since September 1997 – a house was repossessed somewhere in Britain every seven minutes; sterling plunged to a 23-year low against the dollar; and the economy shrunk by 1.5 per cent at the end of last year, confirming we are in the grip of the worst recession since 1980. The most humiliating verdict came from the outspoken US investor Jim Rogers. He said: "Sell any sterling you might have. It's finished. I hate to say it, but I would not put any money in the UK." For days there appeared to be a sense of "drift" in Whitehall, not helped by the absence of business secretary Lord Mandelson, away in India on official business.
Tory leader David Cameron made the running, claiming that by piling on the national debt Britain risked being forced to go to the International Monetary Fund to prop up its economy in a repeat of Labour's 1970s economic humiliation. When Gordon Brown appeared on Friday's Today programme, he was taunted with repeated cries of "Boom and bust" by interviewer Evan Davis. This was not how the Prime Minister envisaged the week turning out when, on Monday, he unveiled his plan to shore up the banks. But Royal Bank of Scotland, which also owns NatWest, stole the government's thunder by admitting it would make the biggest loss ever announced by a British company. The company's shares plummeted by nearly 70pc. On Tuesday the newly formed Lloyds Banking Group, owner of Halifax Bank of Scotland, lost a third of its value.
On Wednesday, all traces of optimism generated by the inauguration of President Barack Obama were gone. The vultures fell upon the UK's remaining giant, Barclays, forcing down its shares by 9pc. In just seven days, Barclays has lost almost two thirds of its value – a colossal £10bn. The panic was fuelled as deep divisions emerged between politicians and leading businessmen about the government's actions. All that could be agreed on, was that a banking crisis was rapidly developing into a national catastrophe. Crispin Odey, one of London's best known hedge fund managers, said: "The government is still in denial about where we are. The country is bankrupt and sterling is under huge pressure. "Consumers face an environment of higher prices, inflation and job losses all at once. I don't think we've yet got to the place where we can say, this is all horrible but at least we can see the way out. There is far further to go."
Is he right? Is Britain about to slip not just into recession but depression, as some economists are now warning? Despite a week of increasingly awful news, some experts believe the whole drama is exaggerated. Research by Goldman Sachs claimed that the cost of the bail-out to the state should not exceed 8 per cent of GDP – painful but not fatal. Some experts predict household disposable income to grow this year at 1.4 per cent, twice last year's level and almost 50 times faster than in 2007. The optimists point out that business has complained about the strength of the pound for years: its weakened state should encourage manufacturing and deter imports. With house prices down, the magical bottom step of the property ladder is much lower; lower oil and gas prices will also help consumers. They say last week's events must be seen in the context of the government's long-running rescue plan which is now entering its fifth month.
One Treasury insider said: "Nothing that has happened this week wasn't predicted in November. This is not a panic reaction. This was prepared months ago. We hoped not to get to this round but government was ready." The Prime Minister said: "We are fighting this recession with every weapon at our disposal." But one government source admitted: "Let's hope this round works because we're fast running out of options." Starting in mid-September 2008, every weekend for six weeks, the Prime Minister and Chancellor met the bosses of Britain's biggest banks, plus an elite team of the best financial brains in the country, to devise a rescue mission for the banking system. The trigger was the events of September 15, the most dramatic day of the crisis so far, when American financial giants imploded: Lehman Brothers filed for bankruptcy, Bank of America swallowed Merrill Lynch and AIG, the US insurance giant, had to be thrown a $20bn lifeline.
In Britain, the stock market plunged in horror, wiping $50bn off the value of the biggest companies, including half of HBOS's market value. The next day, HBOS was railroaded into a merger with Lloyds TSB. Gordon Brown's £500bn bank rescue package, unveiled on October 8th, was designed as a two-year salvage job with the last resort being part-nationalisation at the end of it, but days later he was forced into a more dramatic response: part-nationalisation of Britain's banking system, using £37bn of state funds, that resulted in the Government owning stakes in HBOS, Lloyds TSB and RBS. As New Labour enacted a breathtaking political manoeuvre old Labour would never have dared, few suggested recovery was imminent but the rescue was deemed to have bought time for a painstaking rebuilding of the financial system. Yet within weeks the Prime Minister was again holding secret crisis talks with bank bosses who warned him British banks were due to unveil appalling financial figures.
On Thursday 15th January Bank of America, the US giant that swallowed Merrill Lynch last year, reported a fourth-quarter loss of $2.39bn – its first loss since 1991 – and bank stock in Britain started to plunge. By Friday morning, Ireland had nationalised Anglo Irish bank, its third biggest lender. Treasury officials were yet again put on red alert but this time their task was even more daunting: much of what could be done had already been deployed. Left in the arsenal were the barely palatable last resorts of completely nationalising all the banks or creating a state-owned "bad bank'' to buy up tens of billions of pounds of "toxic'' assets from the high street banks. It was hoped that by removing the risky assets entirely, confidence in the banks would be restored. Then in turn, the banks would at last be able to lend money and oil the increasingly brittle economy. In the event, the government shied away from both options and instead on Monday announced a hybrid scheme to insure the banks' toxic debts.
The proposals included three core measures: a £50bn Bank of England fund, financed by the Treasury, aimed at buying up corporate assets; a decision to let Northern Rock maintain its loan book, to "support prudent lending to creditworthy customers"; and conversion of the preference shares in Royal Bank of Scotland into ordinary shares. New support measures were announced: an extension of the credit guarantee scheme introduced in October, which already covers £100bn in loans; an additional £50bn of guarantees, initially on new mortgage lending and eventually on other assets; and, finally, a plan for the Financial Services Authority to adjust capital requirements, to encourage lending in the downturn. The announcement was radical, rapid and far reaching. So why was it rejected so violently? To start with, the answer was uncertainty. The government said it would 'insure' bank losses but had to admit it had no idea of the scale or size of these losses.
Hugh Osmond, partner of Sun Capital said: "The market is alarmed because it can't see the detail or see how it will work – and it doesn't think the government can either." The implications were huge. First, the uncertainty made bank shares difficult to evaluate: were the risks smaller because of government backing or greater because of looming nationalisation? Investors, already badly burnt by financial stocks, dumped it, causing the widespread drop in bank shares. While there was a big question over whether the rescue would work, the more frightening quandary was could Britain afford it in the first place? The plummeting pound showed that many market players thought not. As one said: "Britain is like a vast indebted company. Who would want to lend to that? Of course Britain will always have options but the pound – like the nation's shares – will go down."
Another uncertainty is over the government's intentions. Last week the chancellor insisted: "We have a clear view that British banks are best managed and owned commercially and not by the government." But critics pointed out that, judging on the recent performance of bank chiefs, this assessment was demonstrably wrong. Others simply did not believe him. Some called for the government to get on and finish the job. Experts argue that the government cannot fix the problem because it has still not understood the scale of it. The balance sheets of many of the world's largest banks more than doubled within a few short years, mostly with a vast increase in debt. The Bank of England says the average ratio of debt to equity within British banks is more than 30 to 1. In other words, the bank balance sheets are roughly 440 per cent of Britain's GDP. As a result, the government is too small to help, [and] in trying to bail out the banks, is in danger of chucking not just good money after bad, but the entire economy after the banks.
'We are happily, and with decreasing morality, pledging our offspring to vast debts by chucking vast cheques at every problem that comes along,' said John Moulton, founder of private equity house Alchemy Partners. Worse, some argue that it isn't even necessary. Few would doubt the centrality of the banking system to Britain's economy. But the growth of the banks has been due to foreign expansion, not domestic. Stanley Fink, the new Tory treasurer and one of the City's most respected players said: "The government has been too simplistic about targeting Britain's help. "Three-quarters of the balance sheets of British banks is overseas lending so the government is handing out the scarce resources of taxpayers to ease the debts of people around the world. "The government should be helping global banks with British operations rather than British banks with global operations."
For restaurateur Renato Poloni, it is all immaterial now. Last week, he was forced to close La Scala, in Romford, Essex, declaring himself bankrupt. As customers dwindled, he borrowed £20,000 from HSBC, but they refused to increase his loan facility and he began to use his credit cards to pay his suppliers, running up debts of £40,000. With little income coming in, he was unable to keep up with the interest payments. "In the last five months my customers just disappeared," said Mr Poloni, 66, who worked as a waiter at the Savoy and other West End restaurants before realising his dream of owning his own restaurant 18 years ago. "The restaurant was my life. I can't bear not working, but I'm too old to start again."
Lord Mandelson: We are fucked!
As the Treasury last night finalised its second sweeping banking revival package in three months, Downing Street was preparing to go on the offensive, justifying the package not as a bail-out for the banks, but an attempt to protect companies and families trying to secure a mortgage. The £200bn insurance scheme is not for the culpable banks, but for their innocent customers, ministers will say. The tone towards the banks is becoming more aggressive. Gordon Brown and a phalanx of ministers will say they share the frustration of the public at the irresponsibility of past lending practices, the slowness with which they have revealed their debts and their stubborn refusal in the past few months to release credit.
The tactics, however, betray a nervousness in Labour circles that the public will simply not understand why there is a second tranche of help going to Britain’s bankers, who have already received billions of pounds of loans, guarantees and capital. There is also a worry that Brown’s inadvertent title as saviour of the world might be slipping. Opinion polls show government popularity falling in the new year. David Cameron may be internationally isolated in his opposition to a fiscal stimulus, but it does not seem to be hurting him. A YouGov poll in the Sunday Times showed Cameron’s Tories rising four points to take a 13-point lead. Privately, something close to desperation is starting to develop inside government. After watching the slide in bank shares on Friday, one cabinet minister did not altogether joke when he said: "The banks are fucked, we’re fucked, the country’s fucked."
Speaking at a Fabian Society gathering at the weekend, Lord Mandelson was typically and disarmingly frank. "I’m not going to say to you I think we’ve now at least reached a set of measures and actions that almost for sure are going to work." Referring to the banks, he said: "What they’ve got themselves into is so complex technically, so challenging that nobody responsible would say that this is all that needs to be done in order to put right what has gone wrong. "It’s going to take more time, it’s going to take more ingenuity." Despite the polls and the myriad concerns over the banks, many cabinet ministers hope the current crises will ultimately expose the Tories as intellectually bankrupt.
At the Fabian conference, Ed Miliband and James Purnell likened the last six months to the winter of discontent in 1979. An ideological watershed had been reached, they argued. "I think there is no question that 2008 will be seen as a similar historical moment," said Miliband. "This is a moment of profound crisis for the idea that, in economics, as far as possible we should leave markets to their own devices; the idea that government is the problem not the solution." Purnell, from a more New Labour position, said: "For the last 30 or so years, politics in Britain has been determined by the image of the winter of discontent. The idea of achieving a fairer society through state action was damaged. I think that unbalanced politics. I don’t think we will rebalance to the other side, where markets are entirely dismissed, but I think we can have a more balanced politics as a result."
Douglas Alexander, the international development secretary, added: "I think the real opportunity for the Labour party is to say that we did not just witness the demise of individual institutions, we ultimately witnessed the demise of an ideology that says that the only role for government is always to get out of the way and that the right response to a financial crisis is to nudge, privatise and deregulate." Yet, on the evidence so far, the public have not yet bought these somewhat abstract notions, and Cameron will not make the mistake of siding with bankers or opposing better regulation.
Last week Cameron met William Buiter, the economist who is a keen advocate of better regulation. Buiter, according to Cameron, told him "the last time we built up this much debt was when we were fighting … half of Europe. This time we’ve done it on our own. It’s quite a chilling thought. This is my worry is that it’s like the man in the casino has lost it all on red and you know … what’s to stop Gordon putting it all on red all over again?"
Brown, however, will do so today, and who knows if he will win.
Bank of England goes for broke with asset buying
The massive stash of sterling the Bank was forced to accumulate as hedge funds led by George Soros assaulted Britain's ill-advised peg against the deutsche mark laid in its vaults for five or six years, and was eventually sold off – when sterling was far stronger – generating a small profit for the Bank. It is a lesson worth remembering, for this week Mervyn King will lay out one of the biggest transformations in the Bank's history – one which will see the Bank turn, for a short period of time at least, into a fund manager. It is an epochal shift. For its entire history the Bank has been focused on two jobs: controlling monetary policy – largely through the tool of interest rates – and financial stability within the UK. However, in a matter of weeks, the Bank will add another weapon to its arsenal.
The Treasury sketched out the broad details last week, when it unveiled its second banking bail-out package. The full details will be contained in a letter to be sent to Alistair Darling this week. In short, the Bank will start buying up assets from financial investors in the latest bid to bring the financial system back under control. The assets will – at first – be limited to corporate bonds, commercial paper and some high-grade asset backed securities, and will be held by the Bank until it can sell them off again to the private sector. The objective is to reinject demand into markets and, should the value of the assets recover, generate a profit for the taxpayer. What the Governor's letter will outline this week is precisely how the Bank intends to do this.
The final decision about which types of assets to buy – about the scale of risk the Bank plans to take on and likewise about the potential maturity of the investment – will be taken not by fund managers but by the executive directors at the Bank, led by Mr King. They will seek advice from investment banks and consultants, but Mr King intends to do much of the work in-house. Questions will be asked as to whether the Bank has the resources or know-how to select the best investments and whether, as Bank insiders claim, that the corporate bond markets present excellent opportunities or, as others claim, that they have collapsed for good reason. Still more controversial, is the fact that Mr King's letter will not rule out investing in other types of assets – government bonds or even housing – in the future. Many economists suspect such an eventuality will be inevitable.
The Bank is to be given a £50bn sum by the Treasury for this Asset Purchase Facility, but it has one extra weapon. Under command from the Monetary Policy Committee, whose usual job is to decide on interest rates, the Bank will be able to buy those assets not by using that Treasury cash but simply by creating money. This is, in other words, the method by which it will employ quantitative easing. This move has been lauded by economists but it again presents some important questions - among them whether the Bank in general and the MPC in particular really has the expertise to select the appropriate investments to buy. Much depends on its canniness. Buy the right securities and it will ensure the Bank ends up both preventing a depression and generating some profit for taxpayers. Choose the wrong ones, and risk another Black Wednesday-style humiliation - but this time without the prospect of making the money back afterwards.
U.K. Takes a Turn for the Worst
The U.K. is in trouble. Today it was reported that the British economy contracted a much worst-than-expected 1.5% during the fourth quarter (not annualized!), the steepest economic decline since the dark days of 1980. Manufacturing activity sank a dismal 4.6%, while services contracted by 1%. Some forecasts now have the British economy this year suffering the most severe economic contraction since 1946. There’s now a strong case for using “depression” when describing this deepening financial and economic malaise. The pound today traded at the lowest level against the dollar since 1985. This currency has depreciated 30% against the dollar over the past 12 months. Against the yen, the pound has collapsed 42% during the past a year. There is little room left for conventional monetary policy. At 1.50%, the Bank of England’s (BofE) base lending rate is today at the lowest level since 1694.
Curiously, the British pound has declined 6.5% against the dollar so far this month, while the dollar index has gained about 6%. I say “curiously,” as I would argue that in key aspects of financial and economic structuring, the U.K. provides a microcosm of our own systemic vulnerabilities. In a recent Bloomberg interview, Jim Rogers stated “The pound sterling is going to be under pressure. The U.K hasn’t got much to sell the world anymore.” His comments to the Financial Times were even harsher: “I don’t think there is a sound U.K. bank now, at least, if there is one I don’t know about it… The City of London is finished, the financial centre of the world is moving east. All the money is in Asia. Why would it go back to the west? You don’t need London.” Following our direction, the U.K. over the past decade gutted their already shrunken manufacturing base as it shifted headlong into “services” and finance. While this finance and asset inflation-driven Bubble economy seemed to work miraculously during the boom, the post-Bubble reality is a severely impaired financial system and an economic structure incapable of sufficient real wealth creation.
I feel for British policymakers. Just five short quarters ago, overheated nominal GDP was expanding at about a 6% pace. And with inflation surging to the 5% level, the Bank of England pushed its base lending rate to 5.75% (summer of ’07). I’ll give the BofE Credit for trying to tighten financial conditions. It was, however, in vain, as Acute Global Monetary Disorder overwhelmed domestic policymaking. BofE tightening only widened interest-rate differentials, especially compared to near zero borrowing rates in Japan. Finance inundated the City of London in a finale of unwieldy speculative excess, setting the stage for a reversal of flows, de-leveraging and today’s collapse.
Yesterday, U.S. insurance company Aflac dropped 37% on concerns for its exposure to European “hybrid” securities - in particular preferred-type instruments issued by the large U.K. banks. According to research by Morgan Stanley (Nigel Dally), “When it comes to capital adequacy and investment portfolio strength, Aflac has historically been viewed as the gold standard across the industry.” Accordingly, the Street responded violently to the report highlighting the company’s potentially significant exposure to securities that have suffered huge losses in market value (Aflac rallied sharply today). According to the Morgan Stanley report, some of the hybrid securities issued by U.K. lenders Royal Bank of Scotland (RBS), HBOS, and Barclays are now trading at between 15 and 45 cents on the dollar.
Not long ago during the boom’s heyday, these types of securities were viewed as low risk instruments. They were, after all, issued by major – and at the time well-capitalized –banking institutions. In the worst-case scenario, these institutions (and their hybrid securities) were viewed as too big to fail. In reality, these banks were issuing a most dangerous class of securities - higher yielding (“money-like”) instruments appealing to even the more conservative investors. Today, the entire U.K. banking system is enveloped in a vicious downward spiral. Tens of billions of securities that only a short time ago were perceived as safe are being heavily discounted for the possibility the issuing institution will be “nationalized.”
On Wednesday, troubled Royal Bank of Scotland promised to lend $8.7bn in exchange for various lines of government support. The market took the news as a huge leap toward nationalization and governmental control over the U.K. banking sector. Even RBS’s CEO was quoted as saying, “We’ll be one the first guinea pigs.” The markets now view that U.K. policymakers will have few available options other than borrowing hundreds of billions to recapitalize their banks and support the securities markets. Ten-year government “gilt” yields spiked 29 basis points higher this week to 3.68%, with a 2-wk gain of 55 bps. On Tuesday, Britain reported a $20.5bn (14.9bn pounds) fiscal deficit for the month of December. Spending was up 6%, while tax receipts were down 5.5%. The European Commission is now forecasting the U.K. deficit to surpass 8% of GDP this year. After trading at about 20 bps this past June, the cost of U.K. Credit default swap protection has spiked to 147 bps (traded as high as 165bps Wednesday).
The U.K. gilt market seemed to lead global bond rates higher this week. As the scope of global financial sector capital shortfalls and forthcoming economic stimulus become clearer, bond market nervousness grows. U.S. 10-year yields ended the week 31 bps higher at 2.59%, about 110 bps below comparable gilts. There should be little doubt that our new Administration will move quickly and decisively to try to bolster the financial sector and stabilize the real economy. I fully expect our Post-Bubble Financial and Economic Predicament to parallel that of Britain. At some point, our problems will likely be of much greater scope due to, among other things, our system’s larger size. So far, the U.K. has suffered a more acute crisis due to its inability to stabilize its troubled financial sector. For one, it is suffering through a more destabilizing outflow of speculative finance (unwind of carry trades). Also, the U.K. financial structure has traditionally been less government-influenced – leaving it today more vulnerable to a crisis of confidence. Outside of government debt instruments, confidence has faltered for large cross-sections of U.K.’s financial claims (“moneyness” has been lost).
Our system has to this point proved relatively more stable due primarily, I believe, to the instrumental role played by government and quasi-government institutions such as the FHA, Fannie, Freddie and the Federal Home Loan Banks. The market’s perception of “moneyness” is retained for multi-Trillions of U.S. claims – a dynamic that bolsters the view that the U.S. dollar retains its “reserve currency” and safe-haven status. And as long as this confidence holds, faith in the government’s capacity for system “reflation” endures. But it all has the look of a fragile confidence game, and I fully expect the invaluable attribute of “moneyness” to be tested at some point. There is absolutely no doubt that a massive inflation of U.S. financial claims is in the offing. One would suspect it is only a matter of when market perceptions of “moneyness” adjust. This week’s jump in gilt yields could portend a troubling new phase in the U.K. financial crisis. It could also be a harbinger of a more general crisis of confidence for global currencies and debt markets. The long-bond suffered its worst week since 1987 (according to Bloomberg). Gold was up $43 today and $56 for the week.
Here comes terrible
The week ahead: Investors gear up for a deluge of weak earnings and the biggest plunge in GDP in 26 years.
Investors this week will face the largest batch of company report cards yet, in what is quickly shaping up to be the worst quarter for corporate profits in a decade. The earnings avalanche will test the market's mettle. Last week, the Dow fought back after falling below the 8,000 point psychological benchmark for four days in a row. Analysts say if the Dow can hang on to this level in the weeks ahead, that's a good indication that a bottom has been set. The biggest week for earnings brings reports from 137 S&P 500 companies and 12 Dow components. Standouts include Caterpillar, American Express, McDonald's, Yahoo, Wells Fargo and Exxon Mobil. Only 10% of the 85 S&P 500 companies that have reported so far have topped forecasts. Another 60% have met estimates and another 30% have missed, according to Thomson Reuters. "We're in the process of absorbing just how bad the fourth quarter was," said Bernard McGinn, CEO of McGinn Investment Management. "We had a feeling things were terrible, now we're getting proof of it. The question is 'where do we go now?"
This week also brings the latest Fed policy meeting - although it's likely to be less influential than usual since the central bankers are expected to keep interest rates unchanged near zero, said Kenny Landgraf, principal and founder at Kenjol Capital Management. Investors will also digest reports on housing, consumer confidence and leading economic indicators early in the week. The end of the week brings the fourth-quarter gross domestic product (GDP) report. It's expected to have fallen by an annual rate of 5.2%, it biggest plunge in 26 years. "Everyone is bracing for the GDP number to be pretty terrible, but the bigger surprise could come with the housing numbers, which are also expected to be awful," he said. Landgraf said that investors are also looking for more concrete news to come from the Obama administration this week regarding the use of the remaining $350 billion of the TARP money and negotiations on the $825 billion stimulus package.
With 15% of the S&P 500 having already reported results, fourth-quarter profits are expected to have fallen 28.1% from a year ago, according to the latest figures from tracker Thomson Reuters. Typically, the final number is lower than where it stands at this point in the quarter. But even if the final number is no worse than where it stands now, the fourth quarter will still rank as the biggest decline for S&P 500 profits in the 10 years Thomson has been tracking results. Worse-than-expected reports from big financial companies such as Citigroup and Bank of America have weighed heavily on the results so far. "It's not how many companies are missing," said John Butters, Thomson Reuters' senior research analyst. "It's the size of the companies missing and the magnitude of the losses." Financials are currently expected to lose $12.5 billion this year as opposed to their profits of $5 billion a year ago. But financials aren't alone, with 7 of 10 S&P economic sectors due to post declines. However, not all of the news has been bad. Last week Google, Apple and IBM reported earnings that were better than expected.
On the docket
Monday: December existing home sales are expected to have fallen to a 4.40 million unit annual rate from a 4.49 million unit rate in November.
The December index of leading economic indicators (LEI) is expected to have fallen 0.3% after falling 0.4% in November.
Tuesday: The January consumer confidence index from the Conference Board is expected to hold steady at an all-time low of 38.0, unchanged from December.
Also due Tuesday is the S&P/CaseShiller home index for November, expected to show steep declines.
Wednesday: The Federal Reserve concludes its two-day policy meeting with an announcement on interest rates due at around 2:15 p.m. ET. No change is expected in the fed funds rate: The central bank lowered interest rates to nearly zero in December and hinted it would keep them there for some time. As always, the statement accompanying the decision will be critical, as it offers the Fed's assessment of the economy, now in its second year of a recession. (Full story) Also on Wednesday, the World Economic Forum kicks off in Davos, Switzerland. It runs through Sunday.
Thursday: The December durable goods orders report is due before the start of trade. Orders are expected to have dropped 1.8% after dropping 1.5% in November.
December new home sales are due after the start of trading. Sales are expected to have fallen to a 400,000 annual unit rate from a 407,000 annual unit rate in November.
Friday: Fourth-quarter gross domestic product (GDP) is expected to have fallen by an annual rate of 5.2%, after falling by an annual rate of 0.5% in the third quarter. That would be the biggest quarterly decline in roughly 26 years. The January Chicago PMI, a regional read on manufacturing, is expected to have fallen to 34.2 from 35.1 in December. The University of Michigan releases its revised January consumer sentiment index, which is expected to hold steady at 61.9.
Earnings to watch
Monday: Before the start of trade, heavy-equipment maker Caterpillar, a Dow component, is expected to report earnings of $1.31 per share versus $1.50 a year ago, according to a consensus of analysts surveyed by Thomson Reuters. Fellow Dow component McDonald's is expected to report earnings of 83 cents per share versus 73 cents a year ago. After the market close, Dow component American Express is expected to report earnings of 22 cents per share versus 71 cents a year ago. Also after the close, biotech Amgen is expected to report a profit of $1.07 per share versus $1 a year ago.
Tuesday: Dow component DuPont is set to report results before the start of trading. The chemical maker is expected to have lost 24 cents per share, after having earned 57 cents per share a year ago. Verizon Communications, also a Dow component, is expected to report earnings of 62 cents per share, the same as it did a year ago. After the market close, Yahoo is expected to report earnings of 13 cents per share versus 15 cents a year ago.
Wednesday: AT&T reports results before the start of trade. The Dow component is expected to report earnings of 65 cents per share versus 71 cents a year ago.
Also in the morning, Wells Fargo is expected to report earnings of 33 cents per share, versus 41 cents a year ago. Wells Fargo is perceived as having held up better than a number of other banks.
Thursday: 3M, due to report results before the start of trade, is expected to have earned 93 cents per share versus $1.19 a year ago. The Dow component is often seen as a proxy for the economy because of the breadth of its businesses. After the market close, Amazon.com is expected to report earnings of 39 cents per share versus 48 cents a year ago.
Friday: A pair of oil companies report results before the start of trade. Chevron is expected to have earned $1.81 per share versus $2.32 a year ago. Exxon Mobil , a Dow component, is expected to report earnings of $1.47 per share versus $2.16 a year ago. Also before the open, Dow component Honeywell is expected to have earned 97 cents per share, versus 91 cents a share a year ago. Procter & Gamble is expected to have earned $1.58 per share versus 98 cents a year ago.
Six Errors on the Path to the Financial Crisis
What's a nice economy like ours doing in a place like this? As the country descends into what is likely to be its worst postwar recession, Americans are distressed, bewildered and asking serious questions: Didn’t we learn how to avoid such catastrophes decades ago? Has American-style capitalism failed us so badly that it needs a radical overhaul? The answers, I believe, are yes and no. Our capitalist system did not condemn us to this fate. Instead, it was largely a series of avoidable — yes, avoidable — human errors. Recognizing and understanding these errors will help us fix the system so that it doesn’t malfunction so badly again. And we can do so without ending capitalism as we know it. My list of errors has six whoppers, in chronologically order. I omit mistakes that became clear only in hindsight, limiting myself to those where prominent voices advocated a different course at the time. Had these six choices been different, I believe the inevitable bursting of the housing bubble would have caused far less harm.
WILD DERIVATIVES In 1998, when Brooksley E. Born, then chairwoman of the Commodity Futures Trading Commission, sought to extend its regulatory reach into the derivatives world, top officials of the Treasury Department, the Federal Reserve and the Securities and Exchange Commission squelched the idea. While her specific plan may not have been ideal, does anyone doubt that the financial turmoil would have been less severe if derivatives trading had acquired a zookeeper a decade ago?
SKY-HIGH LEVERAGE The second error came in 2004, when the S.E.C. let securities firms raise their leverage sharply. Before then, leverage of 12 to 1 was typical; afterward, it shot up to more like 33 to 1. What were the S.E.C. and the heads of the firms thinking? Remember, under 33-to-1 leverage, a mere 3 percent decline in asset values wipes out a company. Had leverage stayed at 12 to 1, these firms wouldn’t have grown as big or been as fragile.
A SUBPRIME SURGE The next error came in stages, from 2004 to 2007, as subprime lending grew from a small corner of the mortgage market into a large, dangerous one. Lending standards fell disgracefully, and dubious transactions became common. Why wasn’t this insanity stopped? There are two answers, and each holds a lesson. One is that bank regulators were asleep at the switch. Entranced by laissez faire-y tales, they ignored warnings from those like Edward M. Gramlich, then a Fed governor, who saw the problem brewing years before the fall. The other answer is that many of the worst subprime mortgages originated outside the banking system, beyond the reach of any federal regulator. That regulatory hole needs to be plugged.
FIDDLING ON FORECLOSURES The government’s continuing failure to do anything large and serious to limit foreclosures is tragic. The broad contours of the foreclosure tsunami were clear more than a year ago — and people like Representative Barney Frank, Democrat of Massachusetts, and Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, were sounding alarms. Yet the Treasury and Congress fiddled while homes burned. Why? Free-market ideology, denial and an unwillingness to commit taxpayer funds all played roles. Sadly, the problem should now be much smaller than it is.
LETTING LEHMAN GO The next whopper came in September, when Lehman Brothers, unlike Bear Stearns before it, was allowed to fail. Perhaps it was a case of misjudgment by officials who deemed Lehman neither too big nor too entangled — with other financial institutions — to fail. Or perhaps they wanted to make an offering to the moral-hazard gods. Regardless, everything fell apart after Lehman. People in the market often say they can make money under any set of rules, as long as they know what they are. Coming just six months after Bear’s rescue, the Lehman decision tossed the presumed rule book out the window. If Bear was too big to fail, how could Lehman, at twice its size, not be? If Bear was too entangled to fail, why was Lehman not? After Lehman went over the cliff, no financial institution seemed safe. So lending froze, and the economy sank like a stone. It was a colossal error, and many people said so at the time.
TARP’S DETOUR The final major error is mismanagement of the Troubled Asset Relief Program, the $700 billion bailout fund. As I wrote here last month, decisions of Henry M. Paulson Jr., the former Treasury secretary, about using the TARP’s first $350 billion were an inconsistent mess. Instead of pursuing the TARP’s intended purposes, he used most of the funds to inject capital into banks — which he did poorly. To illustrate what might have been, consider Fed programs to buy commercial paper and mortgage-backed securities. These facilities do roughly what TARP was supposed to do: buy troubled assets. And they have breathed some life into those moribund markets. The lesson for the new Treasury secretary is clear: use TARP money to buy troubled assets and to mitigate foreclosures.
Six fateful decisions — all made the wrong way. Imagine what the world would be like now if the housing bubble burst but those six things were different: if derivatives were traded on organized exchanges, if leverage were far lower, if subprime lending were smaller and done responsibly, if strong actions to limit foreclosures were taken right away, if Lehman were not allowed to fail, and if the TARP funds were used as directed. All of this was possible. And if history had gone that way, I believe that the financial world and the economy would look far less grim than they do today. For this litany of errors, many people in authority owe millions of Americans an apology. Richard A. Clarke, former national security adviser, set a good example when he told the commission investigating the 9/11 attacks that he wanted victims’ families “to know why we failed and what I think we need to do to ensure that nothing like that ever happens again.” I’m waiting for similar words from our financial leaders, both public and private.
Crisis talks on the slopes
A renewed slide in stock and oil prices and fresh upheaval in currencies and bonds will set a bleak backdrop for the world's business and political leaders gathering in the Swiss resort of Davos this week. More than 40 heads of state and government, about 35 finance ministers and central bankers and other corporate leaders attending the World Economic Forum will try to forge a consensus on how to fix the worst financial crisis in 80 years. The annual event is the largest gathering of key policymakers outside the Group of seven or G20. However, U.S. President Barack Obama and his pick for treasury secretary -- yet to be confirmed -- are missing from the participants list.
This leaves political leaders from Britain, Germany, Japan, Russia and China to tackle a crisis that originally broke out in the United States nearly 1-1/2 year ago. "The banking system is still in intensive care, the economic background is of collapsing demand and economic activity is shelving away in a very abrupt fashion," said Philip Saunders, head of investment strategy at Investec. "There is an unprecedented need for international cooperation because we have a global problem... If Davos highlights that and encourages international corporation that would be a constructive outcome." After a brief respite in December, world stocks are on the skids again as fresh signs of troubles emerge in banks.
The benchmark MSCI world equity index is already down more than 10 percent since the start of the year after slumping 44 percent last year -- its worst performance in 20 years. The euro, dollar and sterling are all falling sharply against the low-yielding yen and investors are rushing to safer government bonds, driving yields of many to record lows. However, concerns that governments will have to borrow more to finance their economic support packages and worries over fiscal balance have driven the cost of insuring sovereign debt against default to record highs. The five-year credit default swap (CDS) for Britain hit record highs around 150 basis points last week, while those for the United States, Germany and many other European countries are also at all-time peaks.
As a result, according to CDS prices, debt issued by sovereign lenders is now considered riskier than that of financial firms -- suggesting risk has been transferred from the private to the public sector. The spread between the 10-year sovereign CDS basket and the iTraxx senior financials index -- 25 major banks, insurers and reinsurers in Europe -- has fallen to -22 basis points from around +120 bps in September, according to data from Morgan Stanley. With a wide range of markets on the decline, picking what to invest in is no longer a beauty contest -- asset managers are left with making the best of a bad bunch. This is especially true in the foreign exchange market, where currencies are feeling the impact of a race to zero interest rates among central banks and deteriorating fiscal balances as global growth slows.
Recent moves have been dramatic. The dollar fell as low as 87.11 yen
last week, its lowest since July 1995. Sterling had fallen as low as $1.3502 , its weakest since September 1985. Japan and the United States already have interest rates near zero while central banks in Britain and Canada are set to cut interest rates to 0.5 percent this year. "One way to navigate in this tricky environment could be to try to identify those currencies best suited to withstand both an anticipated sharp decline in global demand and lack of credit," Swedish bank SEB said in a note to clients. "Based on persistent tight credit markets, we still expect a premium for holding currencies less dependent on foreign financing. However, the deteriorating outlook for global growth may ensure that this group becomes even smaller."
In addition to the yen, SEB said the dollar could outperform others, even with Washington's huge budget deficit, as more countries follow the United States in boosting fiscal spending, making relative comparisons less problematic for the U.S. currency. In Britain, aggressive rate cuts and the formal arrival of a recession are knocking sterling lower, with the British currency losing more than 8.5 percent against the dollar last week. Wary of trade competition via currency depreciation, France complained about a sterling's fall. The issue could also be raised at a meeting of Group of seven finance chiefs, taking place just a fortnight after the economic forum. "(The forum) at the ski slopes of Davos should prove a warm-up exercise for sterling chatter, FX speculation and verbal and intervention, leading to the Feb 14 G7 meeting in Rome," said Ashraf Laidi, chief market strategist at CMC Markets.
IMF to cut global growth forecast further
The International Monetary Fund (IMF) will cut its 2009 global growth forecast again, this time to between 1 percent and 1.5 percent, as economic conditions deteriorate further, an IMF official said on Sunday. The IMF's most recent forecast, made in November, was for growth of 2.2 percent. Since then, economic indicators have deteriorated to their worst levels in decades, with many of the world's biggest industrial economies in recession. "It will be revised to 1 to 1.5 percent in 2009, which is huge," Axel Bertuch-Samuels, deputy director of the IMF's monetary and capital markets department, told Reuters on the sidelines of a conference in the United Arab Emirates. "Global economic prospects have deteriorated in recent months, consumer and business confidence have dropped to levels that we have not seen in decades, and activity too has dropped sharply," he said.
The 2009 year will be enormously challenging for the world's economy, Bertuch-Samuels said. Economists are bracing for the worst downturn since World War Two as most of Europe follows the U.S. into a recession triggered by the financial crisis that has battered markets and virtually paralysed lending. Governments have announced bank rescue and stimulus packages worth hundreds of billions of dollars, and G7 central banks have cut benchmark interest rates ever closer to zero, but that has still not been enough to turn the tide. In November, the IMF had cut projections for world growth in 2009 by 0.8 percentage points to 2.2 percent from an October forecast.
An official release of updated IMF economic forecasts is expected on Wednesday, he said, and even forecasts for emerging markets such as China and India will see downward revisions. The IMF, for example, sees economic growth in the energy exporting Gulf Arab states cooling to 5.1 percent in 2009 compared with around 7 percent in 2008, and that could be cut again, said Saade Chami, an IMF coordinator in Lebanon, at the conference in Abu Dhabi. In October, the IMF had forecast economic growth for the Gulf Arab region of 6.6 percent in 2009, up from 7.1 percent in 2008.
What banks are doing with TARP funds
Eleven Bay Area banks have taken capital from the U.S. government under the Troubled Asset Relief Program. Where is this money going? I wish I could say. The local bankers I spoke with who took TARP funds say they will use it as the Treasury intended, to increase lending. But few could point to specific loans they had made with TARP money or say whether their overall lending had increased since they took it. One reason is that most banks have received the money in the past 30 to 60 days. "It does take some time to process applications, market to new customers and ultimately lend the money. It doesn't happen overnight," says Walt Kaczmarek, chief executive of Heritage Commerce Corp. in San Jose., which took $40 million from TARP.
And if a bank wants to leverage its capital - or lend more than a dollar for every dollar in new capital - it generally has to gather additional deposits, which can be loaned out. Attracting deposits takes time and can be harder for banks in competitive markets. "Even if you get the deposits, you have to find people with the wherewithal and the mental state to borrow money," says Dan Myers, chief executive of Bridge Bank in San Jose, which took $24 million. In a recession, that's no slam dunk. "It is harder to find qualified buyers with the economy being the way it is," says Kaczmarek, whose banking subsidiary, Heritage Bank of Commerce, deals mainly with business. Kaczmarek says there are plenty of companies that would like to refinance their mortgages, but their properties are now worth less and they are not willing to take a smaller loan.
Russell Colombo, president and chief executive at Bank of Marin, which accepted $28 million in TARP money, agrees. "It's not like every bank has a huge lineup of customers wanting to borrow money. You have to underwrite them properly," he says. Bank of Marin, which serves consumers and businesses in San Francisco, Marin and Sonoma counties, has been holding public meetings to explain "the purposes of the TARP money, why we took it and what we are doing with it," Colombo says. One notion he wants to dispel is that taking TARP money means you're troubled.
When Congress approved $700 billion for TARP, it was supposed to buy troubled mortgage securities from banks. But the bill's language was broad, and former Treasury Secretary Henry Paulson decided in October he would use $250 billion to buy preferred stock in banks to bolster their capital. In late October, Paulson forced the nation's nine largest banks to accept a total of $125 billion, regardless of their health. San Francisco's Wells Fargo got $25 billion in that first round. Citigroup and Bank of America later came back for billions more. Paulson allocated another $125 billion to buy stakes in the nation's remaining 8,000-plus banks. To get these funds, banks were supposed to be financially strong, but Treasury never disclosed how it would determine a bank's health.
To date, Treasury has bought $193 billion in preferred stock from more than 200 banks, including the original nine. These shares pay a 5 percent annual dividend the first five years and 9 percent thereafter. The banks can buy the stock back from Treasury after three years. "It provided very inexpensive capital," Colombo says. Participating banks can't increase their dividends without Treasury's approval and must agree to certain limits on executive compensation. Few other strings were attached. Although Treasury wants banks to make loans with TARP money, it didn't put any demands on its use. Banks say that's exactly how they will use the funds, if they can find the right borrowers. "I am convinced that our bank and many, many others are lending more than we would have if we hadn't taken the TARP money, says Ken Wilcox, chief executive of SVB Financial, which operates Silicon Valley Bank in Palo Alto.
Wilcox says his bank, which caters to startup and publicly held technology companies, was able to raise several billion in new deposits since it took $235 million in TARP funds in early December. "We have enough loan demand from qualified borrowers that we are definitely making use of" the TARP money, Wilcox says. But, he adds, "We are in a unique industry." Early stage tech companies have not been hit as hard by the economy as other sectors. Other banks might have more trouble finding borrowers. "Lending into a recession is a very challenging proposition," says Bill Schrader, president of Exchange Bank in Santa Rosa, which took $43 million in TARP funds in mid-December. Around that same time, it loaned $14.7 million to a redevelopment agency in Santa Rosa to support below-market housing. Although the bank had been talking to the agency beforehand, getting the TARP money made it more confident about going ahead.
Schrader insists his bank won't make riskier loans because it has TARP money, but without it, he might have been less willing to risk his capital on good loans during a recession. Pacific Coast Bankers' Bank, which lends exclusively to community banks, got $12 million from TARP on Dec. 23. Since then, "We have purchased some securities (from banks) that are in turn backed by single-family mortgages," Brown says. "In this marketplace, we would not have been as eager to do it" without TARP funds. Although it's getting off to a slow start, Brown says TARP "is definitely going to do some good." For banks, "the hardest thing in the world to get is capital," he says. The second-hardest is qualified borrowers. The third is deposits.
"The fact that banks are structured so they can leverage capital up is the fastest way I know of to get lending and consumers and businesses back on their feet," Brown says. The two largest Bay Area banks taking TARP funds answered my questions about their use of it via e-mailed statements. Wells Fargo said it will use the funds "to make more loans to creditworthy customers and to find solutions for our mortgage customers late on their payments or facing foreclosure so they can stay in their homes." UCBH Holdings, parent of United Commercial Bank, said it "intends to focus on single-family and multi-family residential loans. ... It will also focus on trade finance activity, as its Greater China platform provides opportunity for commercial borrowers who do business in China." For a list of banks taking TARP money, see links.sfgate.com/ZFYM.
Pelosi signals willingness to add to TARP funds
U.S. House Speaker Nancy Pelosi said on Sunday the federal government may need to pump more taxpayer funds into the faltering banking system and that taxpayers should receive equity as compensation. Pelosi told ABC's "This Week" program that "some increased investment" might be needed beyond the $700 billion approved last year under the Troubled Asset Relief Program, or TARP, to stabilize the nation's banks and get them to resume making loans. Congress would require more oversight of any further bank bailout, the California Democrat said. "Change has to happen in terms of what is done, what the transparency of it is, what the accountability of it is. Only then would we be able to pass any additional funding," Pelosi said.
President Barack Obama's pick for treasury secretary, Timothy Geithner, said last week the Treasury had no current plans to request more bailout money beyond the $700 billion already authorized, but that the situation was "dynamic." "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," he wrote last week in reply to written questions during his confirmation hearing. Billions of dollars in auto and credit card debt held by banks are expected to default in 2009, after the billions in mortgage-backed debt that initiated the financial crisis. The first $350 billion in TARP funds has been committed and lawmakers agreed last week to release the second half.
Pelosi said the government should take an equity stake in banks that receive funds so taxpayers could share in any upside as banks return to health. "If we are strengthening (the banks), then the American people should get some of the upside of that strengthening," she said. "Some people call that nationalization. I'm not talking about total ownership." The government has obtained preferred shares for the capital it pumped into ailing institutions as part of the first half of the TARP program. Geithner said on Wednesday the Obama administration in coming weeks would unveil a multi-pronged effort to stabilize the housing market, strengthen core banks and support consumer credit to help foster economic recovery.
One idea calls for the establishment of a "bad bank" that would take distressed assets off banks' balance sheets to free them up to resume lending. Geithner won Senate Finance Committee backing on Thursday, and the chamber's majority leader said he expected the full Senate to confirm him. Pelosi said any new phase of a bank bailout would be done openly. "Whatever we have to do will have to be clearly explained to Congress and to the American people as to what the purpose of the money is, why it is urgent, and then accountability for it as it is distributed."
Obama's team turn to EU bank for inspiration
President Barack Obama's administration is looking to establish a $60bn (£43.5bn) infrastructure bank based on the European Investment Bank (EIB), which is bailing out small UK businesses hit by the financial crisis. The President's transition team has met at least one City figure close to the EIB to discuss how to set up a bank dedicated to rebuilding America's creaking transportation infrastructure. It is estimated that the backlog of road repairs is close to $5 trillion. A spokesman for the Federal Highway Administration said on Friday: "There are no plans currently in place, as the US Secretary of Transportation was only sworn in yesterday. [But] I can tell you that state infrastructure banks are being considered."
These banks would have lent states cash for roads projects, but instead the new transport team, led by former congressman Ray LaHood, have been impressed by the EIB model. Rather than just act as a middleman directing money from central government, the EIB can raise funds from the capital markets through a mix of commercial paper and bonds. In 2007, the EIB borrowed €55bn. Also, the EIB lends to specific projects rather than to individual EU states. This, said one EU source, has intrigued the Obama team, which originally planned to lend money to states rather than to specific transport schemes. If the US bank follows the EIB's lead, it could look at infrastructure projects beyond roads, such as housing and hospitals. Bridges are also likely to be highlighted, as more than a quarter across the US are in a state of serious disrepair.
The source added: "Obama's new government is talking about a $50bn-to-60bn infrastructure bank. The EIB is going to lend more than that this year, so the US is now looking at how the bank operates." The Chancellor, Alistair Darling, announced in November that the EIB, as well as providing £300m to the programme to rebuild every secondary school in the UK, had pledged £4bn to small UK businesses by 2011. Ailing infrastructure is one of the big problems facing Mr Obama. According to a survey by KPMG, 75 per cent of US executives claim that their companies will face an operating cost rise as a result of poor infrastructure. The report cites communications giant AT&T, which moved its headquarters from San Antonio to Dallas for better air travel links. More than half those surveyed in North America were concerned that local workforces lacked the training to improve local infrastructure.
Last month, California governor Arnold Schwarzenegger argued in Newsweek: "Our infrastructure is more than just a quality-of-life issue. It is an economic issue.... We are a dinosaur economy trying to compete in a space-age global environment." More than 300 directors – 47 per cent chief executives – from 21 countries were surveyed by KPMG last November and December. Roads were in the top two areas of infrastructure in most urgent need of investment in every region of the world. Energy generation, schools and hospitals were all widespread concerns, though water infrastructure was considered particularly poor in India and China.
Obama Economic Adviser Predicts Relief Within Weeks of Stimulus Passage
Measures to save law enforcement and teaching jobs will help cities see changes rapidly while withholding changes on paychecks could come "within weeks" of passage of an economic stimulus plan now being considered by Congress, one of President Obama's top advisers said Sunday. National Economic Council director Lawrence Summers said despite the fact the U.S. economy's problems took months or years to create -- and it may take just as long to solve them -- immediate stimulus could come with hundreds of billions of dollars in government spending and tax cuts.
Congress is working on an $825 billion package -- the largest that would ever be enacted by the U.S. Legislature. Obama is scheduled to meet with Republicans this week to go over details of the plan. He met with a bipartisan, bicameral group of lawmakers at the White House on Friday. But Arizona Sen. John McCain told "FOX News Sunday" that as far as he can tell, not one Republican proposal has been incorporated into the stimulus. "Maybe there has been. I just may have missed it, but clearly we need to have serious negotiations. We all recognize that the economy is in deep and serious trouble," McCain said, noting that as it stands now he would not support the package. McCain agreed that the best way for the package to work is if it creates jobs, but said, "We are losing sight of what the stimulus is all about and that is job creation, if it doesn't create jobs than it's just another spending project."
Summers said that spending money to respond to the extra financial burdens of people is a good investment, and fiscal discipline will be necessary once the economy recovers, but spending is vital now to save an economy that shed 2 million jobs last year. New York Democratic Sen. Chuck Schumer told "FOX News Sunday" that the president and congressional Democrats "are trying to work very closely with the Republicans" to create a good package. He said tax cuts account for about a third of the stimulus package. "A third of the package is tax cuts. That's generally the way the Republicans prefer to jump-start the economy. We prefer -- we think that tax cuts are probably not the most efficient way to do it, but in effort to compromise, there is a significant chunk of tax cuts in there," he said. Schumer said Senator Majority Leader Harry Reid will allow Republicans to offer amendments to the package during debate "as long as they're relevant." House Speaker Nancy Pelosi said any changes offered by Republicans would have to be measured by how many jobs they will create.
Pelosi described the economy as "dark, darker, darkest almost," and said economists believe new spending will create more jobs than would tax cuts. Republicans are seeking tax help for small businesses and some home buyers and for lowering some income tax rates. Tennessee GOP Rep. Marsha Blackburn told FOX News that Americans know that they can't spend their way to recovery. "This is a bridge to bankruptcy," Blackburn said of the current package. While tax cuts are included in the package, including income tax cuts for individuals who don't pay income tax but pay payroll taxes, Summers asserted that the tax cuts passed during the Bush administration in 2001 and 2002 "are not going to be with us for long." Whether that means repeal, or letting them expire at the end of 2010, House Minority Leader John Boehner said he didn't think Democrats "will be bold enough" to repeal tax cuts this year. Summers and Boehner appeared on NBC's "Meet the Press." Pelosi appeared on ABC's "This Week."
£40,000 loss for every British taxpayer
Every taxpayer in the country has lost almost £40,000 since the onset of the credit crunch, as plunging house prices and the savage sell-off in stock markets have obliterated £1.2 trillion of Britain's national wealth. The combined impact of the property downturn and the slide in share prices has wiped out the equivalent of a full year's economic output, according to research by analyst Dharval Joshi at City bank RAB Capital, £38,700 for every one of Britain's 31 million taxpayers. "We're only halfway through; there's more destruction to come before we stabilise," said Joshi, predicting that as much as £2 trillion could be knocked off the value of assets.
Even by the end of 2008, just six months into what many analysts believe will be a prolonged recession, he calculates that £700bn has been lost in the housing market since the downturn began, plus £500bn from Britons' pension pots and share portfolios. With public anger at senior bankers, regulators and politicians growing as the scale of the damage becomes clear, Gordon Brown will use a speech tomorrow to demand tighter international regulation of banks. He will argue that the crisis was exacerbated because no regulators, no ministers and startlingly few banking executives knew what assets had been sold to whom.
The prime minister will try to build a consensus around curbs on irresponsible banking practices later this week at the World Economic Forum in Davos, the annual gathering of tycoons and politicians. The Commons Treasury select committee will also seek to hold the industry to account over short-selling bank shares when it cross-examines five leading hedge fund managers on Tuesday. The Conservatives seized on Joshi's research yesterday to accuse the government of failing to protect consumers. Philip Hammond, shadow chief secretary, said: "Gordon Brown said he'd ended boom and bust, but he's presided over the biggest asset bubble in living memory and now we are all paying the price. Confidence in Brown's economic management has evaporated at home and the relentless decline of the pound shows that the rest of the world thinks the same."
Sterling declined sharply on the foreign exchanges last week, amid fears that the government's insurance scheme to protect banks against losses on 'toxic' assets - details of which are still being finalised this weekend - could expose the taxpayer to billions of pounds of additional liabilities. Official figures revealed on Friday that the economy contracted by 1.5% in the final three months of 2008, underlining the severity of the downturn. Lord Myners, the City minister, said the economy was undergoing a "correction". "We know that there were elements of a bubble, not just in credit markets and share prices, but also in things like art and jewellery. There's a correction back towards an equilibrium. That's why we're taking the action that we are to support those who are most exposed."
But Liberal Democrat treasury spokesman Vince Cable said the government should have warned the public earlier that the housing market in particular was in the grip of an out-of-control boom. "They failed in their responsibility by failing to recognise the seriousness of the problem. We were rushing towards the edge of the cliff." Rapid declines in wealth alarm economists, because consumers tend to respond by cutting spending, exacerbating recession. Danny Gabay of City consultancy Fathom said consumers had previously boosted their spending power by borrowing against their houses, but by the last quarter of 2008 mortgage borrowers were actually paying down equity, with a potentially devastating impact on spending.
"If you bought your house for £100,000 and some bloke in a pinstripe suit tells you it's worth £200,000, then you feel like you're being conservative if you only borrow an extra £25,000," said Gabay, who is concerned that the knock-on impact of the housing crash on families' spending habits has only just begun. Joshi said Britain's housing boom and resulting bust meant the economy was likely to take longer to recover than America's, where consumers have more of their savings tied up in shares, which tend to see recovery faster.
British MPs probe bank auditors
The government was under pressure last night to investigate the role of auditors in the collapse of British banks, after a Sunday Times investigation into fees paid to the “big four” accountancy firms. The four banks that are expected to sign up to the government’s controversial toxic-asset-protection scheme have paid almost £650m in fees to their auditors since 2000. Royal Bank of Scotland, HBOS, Lloyds TSB and Barclays have paid their auditors almost as much for “other services” as they have for their official role in checking the books. The findings resurrected cross-party calls for a probe into the relationships between auditors and their clients.
Questions are due to be tabled on the issue this week in both houses of parliament. Representatives of the leading audit firms – Deloitte, Ernst & Young, KPMG and Price Waterhouse Coopers – are due to appear before the Treasury committee this week to answer questions on the crisis engulfing the banks. John McFall, the Labour chairman of the committee, said: “What is the role of auditors? Is it to examine the books and provide a company’s board, and the public, an accurate view of the health of that company? Or is it to provide other services that are more profitable than the auditing undertaken for that company?” Conservative Michael Fallon, deputy chairman of the committee, said: “We need to examine who was supervising what, and the role of audit is clearly a part of that.” In the palm of the banks?
Labour lords change laws for cash
Labour peers are prepared to accept fees of up to £120,000 a year to amend laws in the House of Lords on behalf of business clients, a Sunday Times investigation has found. Four peers — including two former ministers — offered to help undercover reporters posing as lobbyists obtain an amendment in return for cash. Two of the peers were secretly recorded telling the reporters they had previously secured changes to bills going through parliament to help their clients. Lord Truscott, the former energy minister, said he had helped to ensure the Energy Bill was favourable to a client selling “smart” electricity meters. Lord Taylor of Blackburn claimed he had changed the law to help his client Experian, the credit check company. Taylor told the reporters: “I will work within the rules, but the rules are meant to be bent sometimes.”
The other peers who agreed to assist our reporters for a fee were Lord Moonie, a former defence minister, and Lord Snape, a former Labour whip. The disclosure that peers are “for hire” to help change legislation confirms persistent rumours in Westminster that lobbyists are targeting the Lords rather than the Commons, where MPs are under greater scrutiny. Brendan Keith, the registrar of Lords’ interests, said on Friday that taking a fee to help amend bills was a breach of the “no paid advocacy” rules which prevent peers from promoting the cause of a paid client in parliament. “The rules say that a member of the House must never accept any financial inducement as an incentive or reward for exerting parliamentary influence,” he said. Baroness Royall of Blaisdon, leader of the House of Lords, issued a statement yesterday saying: “I am deeply concerned about these allegations. I have spoken to the members who are the subject of them and I shall be pursuing these matters with the utmost vigour."
Norman Baker, the Liberal Democrat MP, said he would take up the issue with the Lords authorities. “Legislators in the Commons and the Lords are there to pass legislation on behalf of the country, not to change the law in return for financial favours,” he said. The Sunday Times began its investigation last year after Taylor had been forced to apologise for asking a question in the House on behalf of a paying client without declaring an interest. His friend Jack Straw, the justice minister, was reprimanded last week over an undeclared donation which had been arranged by the peer. Our reporters posed as lobbyists acting for a foreign client who was setting up a chain of shops in the UK and wanted to secure an exemption from the Business Rates Supplements Bill. We selected 10 Lords who already had a number of paid consultancies. The three Conservative peers did not return our calls and a Liberal Democrat and an Ulster Unionist both declined to help after meeting the undercover reporters.
However, four of the five Labour peers were willing to help to amend the bill in return for retainers. Some were more forthright than others. Taylor, a former BAE consultant, said he would not table the amendment himself but offered to conduct a “behind the scenes” campaign to persuade ministers and officials. After agreeing a one-year retainer for £120,000, he said he would discuss the amendment with Yvette Cooper, chief secretary to the Treasury, and talk to officials drafting the bill. Truscott, his Labour colleague, was also keen to help “behind the scenes” — for a fee of up to £72,000: “I can work with you . . . identifying people and following it . . . meeting people, talking to people to facilitate the amendment and making sure the thing is granted.” He said he would identify and talk to people who could be persuaded to change the legislation. He offered to contact MPs, peers, civil servants and John Healey, the minister in charge of the legislation. Moonie offered to help for a fee of £30,000 a year and Snape indicated that he would charge £24,000. By contrast Lord Rogan, the Ulster Unionist peer, said: “If your direct proposal is as stark as for me . . . to help to put down an amendment, that’s a non-runner. A, it’s not right and B, my personal integrity wouldn’t let me do it.”
Is it too late for Britain's banks to make an honest living?
What will the United Kingdom's banking sector look like in a year's time? "Post offices," quips one banking executive. "They will be all that is left." It is not such an absurd prediction. Despite the government announcing a second rescue package, designed to insulate the leading banks from losses on their bad lending - which some estimate could cost as much as £500bn - and a further cash injection into Royal Bank of Scotland, bank shares continued to plunge. In just a week, more than £20bn was wiped off the value of RBS, Barclays and Lloyds Banking Group, leaving the trio valued at just £17bn put together - or less than the £20.5bn the three raised between them last summer.
For a while, calls to go the whole hog and nationalise the banks intensified - a point of view summed up by John Greenwood, chief economist at fund manager Invesco Perpetual: "By not removing all the toxic assets of the banks in one fell swoop, for example by injecting them into a 'bad bank', the government is leaving itself open to the risk that the economy and the banks' operating results will deteriorate further, requiring open-ended intervention in the future. "This means that if the other components of the government's plan for economic recovery - such as its fiscal spending plans, or any quantitative easing by the Bank of England - do not work, then the authorities will gradually be drawn into larger and larger commitments to the banking system. Full-scale nationalisation of several large banks would probably be the ultimate outcome. If this is the case, why not do it immediately?"
For the moment, the government seems set against such a move, insisting that banks are better run by commercial, private-sector managers - although anyone looking at the scale of losses incurred so far, never mind what is still to come, might question that confidence. The trouble is that, nationalised or not, investors across the globe are uncertain of Britain's ability to rescue its banks - a worry that is sending sterling falling almost as rapidly as bank shares. The government is refusing to estimate how much its insurance package - under which it will underwrite future credit losses in exchange for a premium, probably paid in bank shares - will cost, but the numbers could be frightening.
Simon Ward, chief economist at New Star, points out that in October, the Bank of England estimated that British banks could lose £130bn over the next five years, and that was before the economy really started to turn nasty. Last week's trading update from RBS warned that the worsening economic climate meant bad debts of between £6.5bn and £7bn, with another £8bn in write-offs against the value of toxic assets - far worse than the City had been expecting. And, in a bleak statement, chief executive Stephen Hester warned: "More asset deterioration and significant credit losses seem certain." Barclays chief executive John Varley insists it is not in such a parlous position - indeed, it says it made a profit of £5.3bn last year. Yet no one is willing to bet that it will be one of the survivors. Its shares more than halved last week alone, and now change hands at less than a tenth of their value last month.
That is despite the fact the bank has been stressing the differences between RBS's investment banking business and its own, Barclays Capital. RBS's capital-markets loan book, at £600bn, is twice as big as that of BarCap's, while its commercial property loan book is also much larger. The panic selling of Barclays shares also overlooks the fact that the temporary relaxation of capital requirements by the Financial Services Authority, announced at the start of last week in a bid to help the banks weather the financial storm, is equivalent to an extra £25bn of retained profits, or £20bn in new capital - and possibly as much as £100bn across the banking sector as a whole.
Lord Turner, in his first significant speech since he took over as chairman of the FSA, gave a clear indication that, when this mess is finally cleared up, the banking industry that emerges from the rubble will look very different. "Not all innovation is equally useful," he said. "If by some terrible accident the world lost the knowledge required to manufacture one of our major drugs or vaccines, human welfare would be seriously harmed. If the instructions for creating a 'CDO-squared' [a credit derivative manufactured out of other derivatives] have now been mislaid, we will, I think, get along quite well without. "And in the years running up to 2007, too much of the developed world's intellectual talent was devoted to ever more complex financial innovations, whose maximum possible benefit was at best marginal, and which in their complexity and opacity created large financial stability risks."
That is a pretty damning obituary for a securitisation market which, according to the Bank of England, was worth more than $600 trillion at the end of 2007. The FSA will produce its blueprint for the future of regulation in April, but Turner's speech gave plenty of hints about what it might contain. Regulators were too focused on the risks of individual banks and not enough on how their inter-relationships were increasing financial instability. In future, they will need to make more judgments about the risks inherent in banks' business models. Far more capital needs to be held in support of banks' activities - and they need to put aside larger amounts in the boom years to cushion against the bad.
The banks themselves are already working as fast as economic conditions will permit to shape themselves for the future. Hester will give an outline of his bank's strategic review when it announces its 2008 results on 26 February. But already it is clear that riskier activities - such as lending £1.5bn to Russian oligarchs, trading in complex financial instruments and bankrolling large property projects - will be ditched in favour of increasing mortgage lending, offering pricing pledges to small businesses and - most likely - retaining the Direct Line and Churchill insurance businesses that Hester's predecessor Sir Fred Goodwin was planning to sell.
RBS points out that it has a comparatively small share of the mortgage market and has been able to increase that, even during the downturn. It is unlikely to be alone in its intentions: virtually every other international bank is pulling back to old-fashioned core lending and savings business - assuming, of course, that they have managed to survive the costs of pursuing the alternative, high-risk and highly toxic, securitised lending. HSBC is aggressively expanding its mortgage loan book in the UK while working out how to rid itself of Household, its sub-prime lending business in the United States. Lloyds Banking Group's chief executive Eric Daniels has made it clear that he plans to ditch the high-risk property and private equity lending book acquired with his acquisition of the HBOS banking group as quickly as is possible in such a dismal climate, in favour of back-to-basics banking. Only Barclays continues to insist that its investment banking arm can grow and prosper, although it, too, is scaling back on the higher-risk areas.
In the US, Citigroup has all but ended its quest to be a global universal bank, while Goldman Sachs - the purest of investment banks - has opted for deposit-taking status. And Bank of America is growing increasingly agitated by the losses and bonus culture it is uncovering at Merrill Lynch, the investment bank it rescued earlier this year. The retail banking sector became even more crowded last week when the mutually-owned Co-operative bank merged with the Britannia building society to create what it describes as "a unique ethical alternative to shareholder- and government-owned banks". While it will still be a relatively small player, it should find it easier to attract depositors who have been horrified by the excesses of the publicly quoted institutions.
Hester thinks there should still be enough banking business to go round, even when lending volumes get back to normal. Foreign banks - such as those from Iceland and Ireland - and non-banking groups like America's GE Capital, were responsible for as much as 40% of British lending; and, bank bosses insist, it is their departure, rather than British banks' shutting up shop, that has caused the slump in the availability of loan finance here. "I think there should still be good business growth," he says. "Obviously, the world is huge and complex and will still have the need for complex financial products, albeit less than there were before, and there will be greater capital scarcity. So even if volumes are lower, the number of players will be fewer and smaller in size, so banks should be able to make a good living. Not as racy a living as for the last decade, but that is no bad thing."
Simply getting to a position where banks can make a living is presenting a big challenge to regulators, bosses and the government. Gavin Oldham, chief executive of the Share Centre, thinks one solution would be to temporarily suspend the shares of the leading banks to allow them to work through their problems. He has written to financial services minister Paul Myners to point out that, as the FSA acknowledges, "a very substantial part of bank over-indebtedness lies in the complex web of claims between financial institutions: in other words, not in lending to business or for mortgages. If these claims could be netted off, there would be a massive reduction in the scale of bank losses." He believes that suspending trading would give them breathing space to unravel these problems. At their current levels, he adds, bank shares are "little more than an option against nationalisation, and do not provide the basis for any further injection of private sector capital to resolve future needs".
The Share Centre's own customers, however, continue to snap up bank shares as they tumble, betting that even a small improvement in sentiment could lead to a big profit should the prices rise sharply. The stock market is taking a very gloomy stance: Bruno Paulson, banking analyst at Bernstein Research, calculates that, based on their capital position, the market price of RBS shares suggests investors consider it has just a 19% chance of survival: at Barclays and Lloyds, the probabilities are 43% and 38% respectively, he says; but that was before the most savage falls of last week. Six months ago, few investors would have bet that Royal Bank of Scotland would be announcing a loss of close to £30bn - stealing the record for biggest loss by a British company from Vodafone - or that it would end up being 70% owned by the government. That just shows that anything is possible.
Rescue remedies: the bail-outs
September 2007: The Treasury agrees an emergency loan to tide over Northern Rock - but queues form outside branches, with savers well aware that only the first £35,000 of their deposits are guaranteed by the government.
17 February 2008: After months of wrangling about Northern Rock's future, Alistair Darling announces that it will be nationalised as a "temporary" measure.
21 April 2008: The Bank of England announces a "special liquidity scheme", which will allow banks to swap hard-to-sell loans for more liquid government bonds. Initially worth "at least" £50bn, it is later extended to more than £100bn.
29 September 2008: The government announces that it will nationalise Bradford and Bingley, taking on liability for £50bn of loans, and selling the deposits to Spanish bank Santander.
13 October 2008: Realising that piecemeal efforts to help particular banks are not enough, Gordon Brown announces a £37bn "recapitalisation" plan, plus a scheme worth up to £250bn to underwrite interbank lending for participating institutions.
19 January 2009: Darling announces another bail-out scheme, including an uncosted "insurance" scheme to protect banks from losses on toxic loans, and £50bn for the Bank to buy up corporate loans.
Britain is not Iceland. Is EU the next Japan?
What went wrong? The past few days should have been positive for the economy and the banking system but we were plunged into a mini-crisis. I think I know. It is easy for pundits and opposition politicians to criticise but this is difficult stuff. Governments love precedent but there was not one here for, first, a rescue of the banking system and then measures to get damaged banks lending again. So there is bound to be trial and error, though the package announced last week was not just thrown together. I was talking to Alistair Darling many weeks ago about changing Northern Rock’s role from drain on the mortgage market to net lender. Guarantees for new mortgage-backed securities had been in the offing since Sir James Crosby recommended them in November. Other elements of the package, including Bank of England purchases of corporate bonds, commercial paper and syndicated loans, came straight out of the Federal Reserve textbook.
The problem was that the government allowed speculation to build about a “bad bank” to take on banks’ toxic assets, when the work had not been done on it. When the chancellor announced he would instead insure the banks against some losses on these toxic assets, but that it was impossible to say how big they would be, the vultures began to circle. Even that would not have raised the alarm if not for Royal Bank of Scotland’s announcement of losses of £7 billion to £8 billion for 2008, plus up to £20 billion of goodwill write-downs on its ABN-Amro acquisition. Whose daft idea was it to spoil the banking package with such dire news, which set the tone for a bad week for bank shares and the pound? I present as evidence Gordon Brown’s interview last weekend when he said banks should disclose their losses, but the government insists that RBS itself felt obliged to issue its profit warning. That said, reaction in recent days verged on the hysterical. We have not seen the last of government efforts in this field, and may see full nationalisation of some banks, plus a “bad bank”. But the measures were helpful, including the Financial Service Authority’s relaxation of its capital rules.
People get things wrong. One scare story is that UK banks have foreign-currency liabilities equivalent to three times gross domestic product. If the government was liable for these, we could be in trouble. But this refers to all banks in London, whether owned by EU countries, America or Japan. These foreign-currency liabilities are £4.6 trillion, which is indeed about three times our GDP. But they also have foreign-currency assets of £4.7 trillion. British banks account for less than a third of these liabilities, just under £1.5 trillion, with foreign-currency assets of more than £1.5 trillion. Compared with Switzer-land, where such liabilities are 2? times GDP, or Iceland’s seven, the UK’s liabilities – roughly equal to GDP – look comfortable. There are others ways in which the “Reykjavik-on-Thames” suggestion is ridiculous. I am told there was never a possibility ratings agencies would downgrade the AAA rating of Britain’s sovereign debt and, sure enough, Moody’s reaffirmed it, saying the UK was not even an outlier among AAA economies. But the rumour was reported.
Ben Broadbent of Goldman Sachs has taken the government’s “toxic” assets programme, made aggressive assumptions, and concluded the maximum liability for taxpayers could be £120 billion, 8% of GDP, spread over several years. It is a lot, but a far cry from suggestions of many hundreds of billions, and should be partly offset by profits on other elements of the rescue. Broadbent concludes that, with UK government debt low by international standards, there was no case for a downgrade. What should we make of the views of Jim Rogers? The “investment guru” said: “I would urge you to sell any sterling you might have. It’s finished. I hate to say it, but I would not put any money in the UK.” Rogers has probably taken enough punishment but, apart from the fact that it is nonsense – the world’s fourth-largest reserve currency isn’t finished – and puzzlement that anybody gives him publicity, I found it mildly reassuring. He said much the same about the dollar in April, since when its average value has risen 12%.
Last June he said: “The bull market for oil has many years to go before it peters out.” We know what happened next. He was speaking from Singapore, where he has moved to see the Asian miracle at first hand, and where the economy is officially expected to shrink 5% this year. The same goes for Crispin Odey, the hedge-fund manager, who said the UK was “bankrupt”. Odey, who makes money from short-selling, appears to have been put on Earth to give hedge funds a bad name. Some hedge funds and trading arms of investment banks, having wrought havoc elsewhere, now see profit in currency volatility. There is also an element of cannibalism at work, heavy selling of bank shares being often provoked by bearish research notes issued by other banks. For some, the more mayhem the better. But it is important to inject balance and this is not political. Wishing ill on the economy, banks or currency to hasten Brown’s departure is strange. Long after he has gone, we would still be suffering.
Currencies rise and fall. Sterling’s problems are partly related to the curtailment of international banking flows into the City and to the view among some that Britain will suffer a much worse recession than other big economies after Friday’s figures showed a 1.5% drop in GDP in the fourth quarter. But Germany and America look at the very least similarly afflicted. Some experts such as Neil Mackinnon, chief economist at the ECU Group, also think sterling is a proxy for global financial risk. When risk aversion rises in markets, sterling gets clobbered. These things pass. The pound was once a petrocurrency. Episodes of sterling weakness are followed by periods when it rises too much. After the 1976 IMF crisis, it rose from $1.65 to above $2.40. Between 1996 and 1998 sterling climbed 25%. Exporters hope that at least some of today’s depreciation holds.
If there was a currency I would be worried about at the moment, however, it would be the euro. Three of its members, Greece, Portugal and Spain, have had their credit ratings downgraded and Ireland is on “negative watch”. The European Central Bank, having started well in the crisis, is now dragging its feet and seems in a similar state of denial to the Bank of Japan in the early 1990s, before the “lost decade”. European finance ministers last week rejected proposals to coordinate banking bailouts. Again, this looks like foot-drag-ging. Britain is not Iceland. But Europe, if it is not careful, could be the next Japan.
PS: I have had requests for an update on my skip index, an informal indicator based on the number of builders’ skips in my street. It held up until Christmas, based on “can’t move, will improve” demand, but now stands at zero. No green shoots there. But something odd is happening. Recessions are grim but you expect compensations such as quiet roads, empty trains and helpful shop assistants. This may be a London thing, but to me roads are busier and on train and Tube journeys I get closer to fellow passengers than is comfortable. As for shops, maybe the retail trade is too miserable, though it is common to find that, when you are ready to buy, the item is not in stock. Finally, unfinished business from last week when I presented a calculation showing a 2% interest rate with zero inflation was better for savers than 5% with 3% inflation, because of tax. Plenty of pensioners point out that this may apply to young whippersnappers wanting to increase the real value of capital but not to most pensioners, drawing down savings and wanting maximum cash income from it. An interesting debate.
RBS to purge directors in big shake-up
Royal Bank of Scotland is preparing a boardroom clearout to purge the company of directors linked with the reign of Sir Fred Goodwin, its former chief executive. BP chairman Peter Sutherland along with former civil servants Sir Steve Robson and Jim Currie are all thought to be preparing to step down. Bob Scott, the senior independent director, and Colin Buchan, who has been on the board since 2002, are also expected to go but they may delay their exit until replacement candidates are found. A final decision on the timing of these departures will be made when Sir Philip Hampton takes over as chairman. The company has already drawn up a list of names from which it will pick three nonexecutives. The government, which owns 70% of the bank, has made it clear it wants to see change at the head of the company. Stephen Hester, who replaced Goodwin as chief executive, has already identified the senior staff who will have to leave and those who will be promoted.
The clearout comes as The Sunday Times can reveal RBS is preparing to place £50 billion to £100 billion of loans into the government’s new bank-insurance scheme. The bank’s advisers are locked in negotiations with the Treasury over the terms of the deal, designed to protect RBS from significant further losses and allow it to restart lending to British companies. The move comes as Hester puts the finishing touches to a radical restructuring. As many as 30,000 jobs, out of 170,000, could go in the next three to five years as he scales back the bank’s network. A total of 10,000 jobs have already been lost. Hester intends to take risk out of the bank’s balance sheet, sell noncore operations and shut down businesses that sold problematic products that almost broke the bank. This is concentrated in the wholesale-banking division which was formerly headed by Johnny Cameron.
The plan will be unveiled to the bank’s board in two weeks’ time at an all-day meeting. RBS will maintain a global network of commercial-banking operations, but it will pull out of a number of countries around the world – thought to include Pakistan, the Czech Republic, Slovakia, Romania and Uzbekistan. In Asia it is likely to focus on creating a hub. RBS, which has more than £2 trillion of assets, is being used as a guinea pig for the government’s loss insurance rescue scheme. A deal is expected to be hammered out with RBS in the next four weeks so that Treasury officials can open negotiations with Lloyds Banking Group and Barclays on joining the scheme. Although the final terms are yet to be decided, the government is likely to insist that RBS takes the first 10% of any further losses. RBS is looking to put good as well as bad assets into the scheme. The Financial Services Authority has also allowed banks to run their tier-one capital ratios down to 6% as they absorb losses in the recession. The move helps RBS and Barclays which can use a further £20 billion of retained capital before having to ask shareholders for more cash.
The Bank's professor who got his sums right
When David “Danny ” Blanchflower was appointed to the Bank of England’s monetary policy committee (MPC) nearly three years ago, there was surprise. Though renowned as a labour market economist, like Steve Nickell, the man he replaced, he had left Britain for America in the late 1980s. A professor of economics at the Ivy League Dartmouth College in New Hampshire, he emerged during the debate over UK university funding and the row over Laura Spence, the state school pupil who was refused a place at Oxford. But newspaper speculation about who might replace Nickell did not feature Blanchflower, and younger Bank staff had to be told why the 56-year-old was universally known as “Danny” - after the Spurs footballer of the 1950s and 1960s. But Blanchflower has made his reputation on the MPC by being consistently more worried than his colleagues about the downside risks facing the economy.
While they were fretting about inflation, and the embarrassment of the governor, Mervyn King, having to write public letters to explain why it was overshooting the target, he was concerned about the recession danger. In the 31 MPC meetings he has attended, he has voted 16 times to cut Bank rate and only once to raise it. It was a lonely furrow to plough. Speaking by videolink from snowbound New Hampshire, where he spends half of each month, he recalled that his consistent view was that where America led, Britain would follow, with housing market woes followed by recession. “To use a baseball analogy, you have to call balls and strikes as you see them,” he said. “It is very important to be your own person. The strength of the committee is its diversity, not its narrowness. It was very hard being in a minority for such a long time.”
He regrets the fact he could not persuade the rest of the MPC to cut rates more aggressively earlier and that the Bank got “behind the curve”. Had interest rates come down sooner, Britain, he says, would be in a better position now. “If you look back to what I was saying in January 2008, a year ago, it was that we needed to cut interest rates to avoid a recession.” That does not mean he is an unthinking “dove”. The Bank should have acted earlier to head off the housing boom, he said. “It certainly appears that the housing market was a bubble and that rates should have been raised earlier than we did, and cut much sooner when the housing market turned. “But let’s put those differences aside. We have to get rates down, do what we have to do. Doing too much too early is better than doing too little too late. But obviously when you get rates down to zero you have to be prepared, once the economy recovers, to raise them again.”
Blanchflower repeats that there is further to go on interest rates, taking them down to American levels. “Obviously we have cut a lot but we are still a long way from 25 basis points [0.25%] as in the US,” he said. “I don’t think the interest-rate weapon is defunct; we still have an inflation target; we are obviously approaching zero rates. Would you prefer to have 5% interest rates now, or where they are? But we’ve had to play catchup and that’s not what I would have liked.” Even zero rates are unlikely to be enough, however. He welcomes signs that “quantitative easing” - artificially boosting the money supply - will soon be part of the Bank’s armoury. “This is new territory,” said Blanchflower. “There’s obviously literature on it . . . but many of the models we looked at didn’t allow for the possibility of financial meltdowns. And there’s no room in the models for quantitative easing. So this is a very tough time. The devil will be in the detail but, as I understand it, the MPC will make the decisions on quantitative easing.”
In the job market, Blanchflower worries about the rise in unemployment, particularly among the young. He dates the recession's start to April last year when the labour market turned decisively downwards, and warns that even normal recessions have resulted in unemployment rising for three to four years. “We’re at 1.92m now. It would be hard to think we would not get to 3m, perhaps in a year’s time. If you take the experience of previous recessions, 3m might be optimistic. “When unemployment rises, it rises more among the young. The most worrying number in the latest statistics was that of the 131,000 rise in unemployment, 55,000 was among 18-24-year-olds. “Then there’s the worry about the Class of 2009 and the people who will be entering the labour market in June. This is a big problem. Unemployment when people are young really matters. There are 600,000 18-24s unemployed now, 14.5% already. That’s my concern.”
The recession’s roots in the financial crisis make its path difficult to predict. The Bank will publish a new forecast next month but Blanchflower says the uncertainties are huge. “Economics missed this. One of the things I’m struck by is how silent economics has been through this because it does not fit well with the models. “This is the biggest financial crisis, accompanied by an oil shock, we’ve seen in our lifetime. This doesn’t mean we’ll have a Great Depression - we’ve thrown, or are throwing, everything at it. “It is very hard to forecast with traditional means. Surveys, including our agents’ reports, appear to forecast pretty well for about three quarters ahead. I don’t know where we are going to be after Q3 2009, but I don’t see any recovery before then. Q1, Q2 and Q3 will certainly be negative.” Despite this, and despite a reputation for being the gloomiest member of the MPC, he insists he is optimistic about the medium term.
He also dismisses suggestions that Britain is faring worse than the euro-zone, fears that have helped drive down sterling recently. “I don’t think people quite realise that what has been going on in the UK exactly maps what has been happening in the euro area,” he said. “People have been more down-beat on the UK relative to the euro area than they should be. We’re on the case now. My view is that people have been too bearish, too pessimistic.” Though concerned that inflation will fall too far, pushing the country into deflation, he also thinks the drop will be a mechanism of recovery, even alongside slower pay growth. “As inflation falls that means real wages improve. Economies do recover when positive real wage growth starts to kick in.” We saw that at Christmas to an extent - people started to respond to lower prices.”
Despite his worries about unemployment in the coming months, Blanchflower argues that Britain’s flexible labour market will be a big advantage. “Migration has made the labour market more flexible, so the effects of that should be that the shake-out of the labour market should be earlier . . . it’ll be a big shock in the next few months - but perhaps unemployment won’t go as high as in the past because wages will take some of the strain. “I’m not all doom and gloom. We are throwing everything we can at this - that’s what we learnt from the Great Depression. Economies will bounce back . . . We want to see the housing market stabilising, consumer confidence returning and firms more optimistic about their ability to invest.” The Bank has its role in this. “If people are fearful about what’s coming, they are going to hunker down, so it is part of our job to restore confidence, to return things to normal,” he said. “Economies turn around, economies recover, and this economy will. The priority right now is to get us out of a difficult situation.”
There are good things about recessions, however, he says, even despite the gloom. “It is what I call the purging effect of recession. These are difficult times but there are huge opportunities for some - huge business opportunities.” Perhaps most encouragingly, for one who believes Britain takes its lead from America, he detects signs of hope there. “The sense I have is of renewed optimism. Part of it is that oil and gas prices have come down but there is also a feeling that the turn has come. I know there are difficulties in the banking sector and in the markets but people feel . . . there will be an Obama effect. And if we have a turnround in America, that will feed over to Britain.” If Blanchflower is right, Britain will still be in recession when his three-year MPC tenure ends on May 31. But, with luck, there might be a few green shoots on show.
According to a survey of analysts by Ideaglobal.com, the financial research company, analysts expect the Bank of England to cut interest rates from 1.5% to 1% when the MPC meets on February 4-5. In America, the Federal Reserve will meet this week and is likely to give more details of its strategy of “credit easing” – boosting the flow of credit by buying bonds and other debt from the private sector. The UK Treasury will also give further details of its plan to allow the Bank to engage in a similar exercise. Alistair Darling, the chancellor, will set out the terms in a letter to Mervyn King, the Bank’s governor. After figures on Friday showing Britain’s gross domestic product dropped by 1.5% in the fourth quarter of 2008, attention will switch to America’s fourth-quarter GDP data, which are set to show an annualised fall of about 5%, roughly equivalent to a 1.2% fall if calculated the British way.
UK needs real economic solutions – not political stunts
The Tory front bench now boasts someone who's not only widely known and popular with the public, but with real experience in office – having run the Treasury and Home Office, as well as the departments of Health and Education. With opinion polls giving David Cameron a double-digit lead, a return to Tory government is now in the offing. As Clarke returned, even the party's gun-slinging Eurosceptics held fire. The Cameroons are being lauded for some canny positioning. But I can't help feeling political parlour games are a thin response to the economic problems we face.
The UK has now officially entered recession. Preliminary GDP data shows the economy shrank 1.5pc during the last quarter of 2008. Along with the 0.6pc fall in the previous three months, that amounts to "two successive quarters of negative growth" – the "r-word" definition. This is the first UK recession since 1991, but October to December saw the worst quarterly downturn since 1980. As the credit crunch has tightened, starving millions of essentially sound firms of working capital, the impact of those toxic sub-prime loans has spread right across our economy. The UK's manufacturing sector – often written off, but still world-class in places – contracted an eye-watering 4.6pc in the last quarter. Even our much-vaunted services sector shrunk 1pc – not least given the job cull in the City.
Gordon Brown's out-of-control public spending has already put the pound under pressure. But these ghastly GDP figures sent sterling tumbling to a 23-year dollar-terms low. In not much more than a year, our currency has lost more than a third of its value against both the greenback and the euro. Sterling is also at a 37-year low against the yen. On a trade-weighted basis, the pound has shed 27pc since the middle of 2007. That's almost precisely what happened in the early 1930s, when the UK was forced off the gold standard – marking the end of our time as a truly global power. Throughout this crisis, the Tories have clearly identified the problems. While he's taken some stick for doing so, Cameron is right to highlight we could face a run on the pound. The UK's current debt to GDP ratio is 54pc. Add in the cost of taking-on the losses of some – or even all – of the UK's main clearing banks and, along with other bail-out costs, that ratio could easily double.
Even before that happens, the Government needs to issue three times more gilts in each of the next four years than it did during 2007. Under those circumstances, a "gilts strike", and an outright sterling collapse, is a very real danger. After all, Britain is one of many slump-ridden, ailing Western nations trying to sell vast numbers of Treasury bills on global markets. Across the Middle East and Asia, foreign creditors – not least the Chinese – are sick of losing money on Western government debt. Such investors sold a record $24bn (£17.7bn) of US T-bills in November – and December data will surely be worse. Western governments have long relied on Eastern nations to finance profligate spending. That reliance is about to be tested, possibly to destruction. So, again, Cameron is correct to say Britain "runs the risk", not to say ignominy, of a bail-out from the International Monetary Fund.
But such criticisms are only "on" if they're backed up with clear, concise, explanations of the Tories' proposed solutions. HM Opposition is good at political point-scoring, but what would they actually do? The Cameroons put themselves forward as our next government, yet how would they tackle the biggest economic crisis in a generation, and the fact savings are at an all-time low? All we know is they (sort of) opposed Brown's ill-judged VAT-cut and they'd deal with an impending fiscal meltdown of historic – biblical – proportions by "cutting government waste". Warming to the themes floated in this column, the Tories are now finally starting to accept the banking system needs to purged and the sub-prime losses "fessed-up".
But, again, the shadow cabinet takes the easy option, criticising the Government for "failing to come clean" about the true cost to taxpayers of bailing-out our banks. That's a valid issue, but how about the Tories showing some real courage? Cameron should bite the bullet and publicly slate the all-powerful banks themselves for continuing to systematically hide their losses – a reality that means the crucial inter-bank market remains frozen, blocking credit lines to firms and households and holding the rest of the economy to ransom. Mr Cameron, red cheeks and cigar smoke aren't enough. The UK is crying out for real economic solutions – not just political stunts.
Ukraine needs hard decisions to satisfy IMF
Ukraine must take tough budget decisions if it is to have a good chance of continuing its programme of support from the International Monetary Fund, President Viktor Yushchenko's top economic aide said on Friday. An IMF team is in Kiev to review progress before disbursing the next part of a $16.4 billion loan, and economic aide Oleksander Shlapak said it had queries on a range of issues including the budget deficit and how Ukraine was going to finance its energy imports after the latest gas row with Russia. The head of the delegation, Ceyla Pazarbasioglu, met Yushchenko on Friday at the beginning of its mission, due to last at least two weeks.
The IMF had set a number of monetary and fiscal conditions to be met quarterly, including a balanced 2009 budget and a looser currency policy. Parliament, however, passed a budget with a deficit of 3 percent of gross domestic product. The economy, forecast to shrink by up to 5 percent this year, faces higher gas prices agreed this week with Russia after a three-week stand-off. "The mission has many questions and these questions concern the budget deficit and also gas problems which have arisen," Shlapak told a news conference. "They are also demanding an answer as to how we will balance our finances and energy sources. "I assess the possibility of continuing (the programme) as quite high only if Ukraine, as it did late last year, shows its readiness to take difficult decisions on the budget and for companies and for our people... not through words but through its decisions."
The head of Fitch Ratings for emerging Europe signalled on Thursday that it would likely again cut Ukraine's credit rating -- governing how much it costs Kiev to borrow -- if the IMF said the country was off-track on its commitments. Yushchenko and Prime Minister Yulia Tymoshenko assured the IMF on Dec. 30 that they were willing to amend the budget. But the two former allies have been at loggerheads for months now and their rowing has delayed policy making. The president told IMF delegation head Pazarbasioglu on Friday that the anticipated economic contraction posed serious problems for meeting budget targets. "As the IMF mission is an assessment, it is very important for Ukraine to implement what is set down in the memorandum," he said in comments posted on the presidential Web site. "We are talking about achieving a plan of macro-economic stability. There are many difficulties in both specific sectors and in the overall budgetary process."Yushchenko said he wanted to hear the IMF's proposals on forecasts set down in the budget. "There are huge difficulties at the moment with the budget," he said. "Many of them lie within the context of political decisions which must be taken by the prime minister and parliament, questions requiring political will."
Iceland's senior minister resigns as government becomes first global political casualty of the credit crunch
Iceland's Minister of Commerce Bjorgvin Sigurdsson has resigned, two days after the prime minister announced his own departure due to pressures from the island nation's economic collapse. Mr Sigurdsson, a member of Iceland's junior Social Democrat coalition party, made the announcment at a news conference this morning. 'I have decided to do this to take responsibility,' he said. Prime Minister Geir Haarde shocked the country on Friday when he said he would not seek re-election and called for a general election on May 9.
The government of Iceland became the first in the world to be effectively brought down by the credit crunch. It came after several nights of rioting over the financial crisis. A poll would not normally be held until 2011. Mr Haarde also revealed that he had been diagnosed with a malignant tumour of the oesophagus and would not seek re-election. 'I have decided not to seek re-election as leader of the Independence Party at its upcoming national congress,' he told a news conference. The global financial crisis hit Iceland, which has a population 320,000, in October, triggering a collapse in its currency and financial system under the weight of billions of dollars of foreign debts incurred by its banks.
The economy is set to shrink 10 percent this year and unemployment is surging. Critics wanted Mr Haarde, the central bank governor and other senior officials to resign. Some senior figures in his party have also said they favour an early election, but Mr Haarde had up to now vowed to defy plunging popularity and stay on. Protests had been held weekly since the crisis broke last year, but since Tuesday have been held every night. On Thursday, police used teargas on demonstrators for the first time since protests against the North Atlantic island's entry into the NATO alliance in 1949. Special forces had to rescue Mr Haarde from his car after he was surrounded by an furious mob hurling eggs and cans outside the government offices, in Reykjavik.
The seething crowd spattered the building with paint and yoghurt, yelling and banging pans, hurling fireworks and flares at the windows and even lighting a fire in front of the main doors. 'There were a couple of hundred (protesters) when they had to use the gas,' police spokesman Gunnar Sigurdsson said. 'It went on for two hours or so. There were no arrests. Some injuries, but not serious.' Latvia, Bulgaria and other European countries hit hard by the global economic meltdown have also seen unrest.
Mister Softee is Only Worth 136 Dow Points
Off and on over the years I have written about the distortions that the Dow Jones Industrials creates by using a price-based index rather than a market cap index. As an example, if Microsoft with a market cap of $153 billion went to a price of zero, all the Dow would lose would be 136 points, or less than 2%. If IBM with a market cap of $120 billion went to zero, the Dow would lose over 700 points! But it gets worse. David Kotok forwarded this note to me from our mutual friend Jim Bianco (www.biancoresearch.com), which Jim graciously allowed me to reproduce for your edification (prices quoted below are from a few days ago):
"Comment - The Dow Jones Industrial Average (DJIA) is a price-weighted index. The divisor for the DJIA is 7.964782. That means that every $1 a DJIA stock loses, the index loses 7.96 points, regardless of the company's market capitalization. "Dow Jones, the keeper of the DJIA, has an unwritten rule that any DJIA stock that gets below $10 gets tossed out. As of last night's close (January 20), The DJIA had the following stocks less than $10 ...
Citi (C) = $2.80
GM (GM) = $3.50
B of A (BAC) = $5.10
Alcoa (AA) = $8.35
"If all four of these stocks went to zero on today's open, the DJIA would lose only 157.3 points. "The financials in the DJIA are ...
Citi (C) = $2.80
B of A (BAC) = $5.10
Amex (AXP) = 15.60
JP Morgan (JPM) = $18.09
"If every financial stock in the DJIA went to zero on today's open, it would only lose 331.25 points, less than it lost yesterday (332.13 points). "If you want to add GE into the financial sector, a debatable proposition, then: GE (GE) = $12.93 "If the four financial stocks above and GE opened at zero today, the DJIA would only lose 434.24 points. "The reason the DJIA is outperforming on the downside is the index committee is not doing it job and replacing sub-$10 stocks, and the financials are so beaten up that they cannot push the index much lower. "So what is driving the index? The highest-priced stocks:
IBM (IBM) = $81.98
Exxon (XOM) = $76.29
Chevron (CHV) = $68.31
P&G (PG) = $57.34
McDonalds (MCD) = $57.07
J&J (JNJ) = $56.75
3M (MMM) = $53.92
Wal-Mart (WMT) = $50.56
"For instance, if all the sub-$10 stocks listed above, all the financials listed above, and GE opened at zero, the DJIA loses 528.63 points. To repeat if C, BAC, GM, AA, JPM, AXP and GE all open at zero, the DJIA loses 528.63 points. "If IBM opens at zero, it loses 652.95 points [IBM has risen since then – JM]. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE, and Alcoa combined. "The DJIA is not normal as the index committee is not doing their job during this crisis, possibly because to the political fallout of kicking out a Citi or GM. As a result, this index is now severely distorted as it has a tiny weighting in financials and autos." You could add Microsoft to the list Jim created and not be over where IBM is today in terms of the DJIA index. Let's look at it another way. A 10% positive move for IBM would move the Dow up by over 60 points. A 10% move by Citigroup would increase the Dow by less than 3 points. Having stocks with low prices clearly prevents the Dow from declining as much as other market-cap-weighted indexes like the S&P 500.
But there are other problems with using the Dow. Since 1871, real stock prices (after inflation) have grown at 2.48% while the economy grew at 3.45%. There is almost 1% of "slippage" between the growth of stocks and the economy. Bears could paint a bleaker picture by pointing out that much of the growth was from an increase in valuations. By that I mean, P/E ratios increased substantially. Investors were paying more for a dollar's worth of earnings. The market was valued at an average P/E of 12 (or 20 times dividends) for periods prior to the last bull market. The current valuation levels are still over 20, even after a nasty bear market. Almost 1% of the growth of the stock market over the past 130 years has been due to the recent bubble in prices.
Wait a minute, what about the studies which show the S&P 500 grew at almost 10% a year? Part of the answer is that these indexes include dividends, which averaged almost 5%. You also have inflation, which accounts for a great portion. And part of the answer is that the indexes do not reflect the actual results of the companies. If you measured the Dow or S&P by the companies that were in them in 1950, as an example, the growth would not have been as much. That is not to say the Dow should be fixed. They make the changes to reflect the broad economy, which is what the Dow and other indexes are supposed to do. That is what makes index investing so attractive in bull markets, and why it is so hard for a mutual fund to beat an index. They keep adding fast-growing companies and getting rid of the dogs. As valuations increase, the funds become self-fulfilling prophecies. But they can have the opposite effect in a bear market, as we now experience.
For instance, IBM and Coke were added to the Dow in 1932. Coke was dropped for National Steel three years later, and IBM was booted for United Aircraft in 1939. IBM was once again put in the Dow in 1979. Coke returned in 1987. National Steel has long since departed, as has Nash-Kelvinator, Studebaker (I learned to drive in a Studebaker), Woolworth's, and American Beet Sugar. Let's hear it for progress. Clearly, buying the component stocks of the Dow and holding them for long periods would not have produced the same returns as the managed index. In fact, the returns would have been rather dismal. I would invite readers to think about the implications of this for one moment. While today we might smirk at Nash-Kelvinator or Studebaker or American Beet Sugar, or any of the scores of firms that have been added and dropped from the Dow over the last 125 years, at one time they were considered worthy of inclusion in the most prestigious roll call of companies.
Proponents of buy and hold use indexes to support their claims of its effectiveness. Indexes, however, are not instruments of a strict buy and hold philosophy. They clearly buy and trade. For every GE – which was added to the Dow in 1896 and then dropped in 1898 for US Rubber, and added again in 1899, dropped in 1901, and added yet again in 1907 – there are scores of other firms which were once a part of the mighty Dow and have now faded into oblivion. None of the other companies from 1900 are names which are familiar to me, except as historical curiosities.
Fifteen of the Dow companies have been added since 1990. There are only six stocks still in the Dow that were there in 1940. IBM was dropped in 1939 and was not added back in until 1979. Many of the stocks that have been dropped have gone to zero. If I remember correctly, some 60% of the stocks in the S&P 500 have been replaced in a little over 30 years. In fact, many of the large market cap companies now in the index did not exist 30 years ago. So, when you buy stocks "for the long run" you are buying stocks selected by a committee (the Dow) or because their market caps increased to a size where they were included (market-cap-weighted indexes). In a very real sense, the S&P 500 is a self-selective growth-stock index.
As an aside, Dow Jones & Co. has no plans to change the companies in its industrial average after four fell below $10 a share, said John Prestbo, executive director of indexes at the Wall Street Journal parent. "Do I think the Dow is in need of adjustment? No, not at this moment," Prestbo said. "Those stocks have been in the Dow for a while, most of them, and I think changing horses right now would be the very distortion that some people complain about." (Bloomberg) Prestbo has a tough job. As Jim notes, can you imagine the political fallout if the dropped Citigroup or GM right now?
TARP 3 and 4 Are on the Way
There are a lot of complaints about the use of the first $350 billion in TARP money. How could (now) former Merrill Lynch Chief John Thain have been so tone deaf as to spend $1.2 million on decorating his office with the company clearly in financial trouble? And some of it apparently after the government was kicking in money? Large bonuses for select managers at the last minute before the merger and subsequent major losses? The list could go on and on. The Obama administration has plans to keep such abuses from happening. I wish them luck, because the next round of $350 billion is just a down payment. (By the way, we should remember the TARP money is intended to be a loan and not a subsidy. Taxpayers should at least have the chance to come out whole. We will see.)
Professor Nouriel Roubini and his team at RGE Monitor (www.rgemonitor.com) have been noting in speeches in various venues around the world that they estimate that losses from the financial world could be as high as $3.6 trillion. That is composed of $1.6 trillion in loan losses and another $2 trillion in mark-to-market losses of securitized assets. "U.S. banks and broker dealers are estimated to incur about half of these losses, or $1.8 trillion ($1-1.1 trillion loan losses and $600-700bn in securities writedowns) as 40% of securitizations are assumed to be held abroad. The $1.8 trillion figure compares to banks and broker dealers capital of $1.4 trillion as of Q3 of 2008, leaving the banking system borderline insolvent even if writedowns on securitizations are excluded."
Roubini argues that banks will need an additional $1-1.4 trillion dollars in private- and public-sector investments. Then he and colleague Elisa Parisi-Capone lay out in detail how they come up with their numbers. They argue: "Thus, even the release of TARP 2 (another $350 billion) and its use to recapitalize banks only would not be sufficient to restore the capital of banks and broker dealers to internationally accepted capital ratios. A TARP 3 and 4 of up to $1.05 trillion (assuming generously that all of TARP 2 goes to banks and broker dealers) may be needed to restore capital ratios to adequate levels."
Even with all the government money added to the banking system, net capitalization of US financial institutions may fall to as low as $30 billion, from around $1.4 trillion before the credit crisis. Let's think about what that means. This same exercise in principal works for England and other European countries. England may be down $2 trillion pounds, which is relatively much larger than the US losses. Senators at the Banking Committee hearings which looked into the appointment of Tim Geithner as Treasury Secretary (and kudos to the five who voted against approving him) were outraged at the problem of giving banks all that TARP money and other Fed commitments, and now they were not lending that money and indeed it looks like they want more! I know this will shock some of my foreign readers, but most of the Senators on the banking committee don't really understand the banking system.
Here's the problem. The banks are lending. If you look at bank lending numbers, there is growth. The banks, per se, are not the real problem with the lack of lending. The real problem is that we vaporized an entire Shadow Banking System that bought securitized debt in a wide variety of forms: autos, homes, student loans, credit cards, etc. That industry exists no more. Banks over the last ten years became originators of loans, and not actual lenders. They would make the loans and then package them up for other institutions to buy. A pension fund in Norway (or wherever) would look at the rating from Moody's, see AAA, and buy it. Or banks would create off-balance-sheet vehicles (SIVs) to buy their debt and leverage it up, and book some nice profits. In any event, the debt did not end up on the banks' balance sheets for very long.
That process was responsible for the majority of debt that was extended over the last decade. Now that process is broken, and it will not be fixed this year or next year or the year after that. We are going to have to come up with new ways of credit creation and debt processing. You can't go to Goldman and tell them to start making auto loans. They simply don't have the people to do that. Now, they used to be able to take auto loans from other actual originators and package them and sell them, but they did not make the loans. And the buyers for much of that securitized auto loan paper are gone. And they are not coming back any time soon without greater transparency and real capital guarantees and higher returns. A Moody's (or any rating agency) rating is not worth the paper, as far as the markets are concerned.
In essence, we are asking the banking system, with greatly reduced capital, to do the heavy lifting that all the buyers of securitized debt did a few years ago. And if Roubini is remotely right, they simply do not have the capital to do it. Further, the banks are in a bind. The regulators, properly so, are making sure that banks have adequate capitalization and are marking assets to real market prices. But they simply have less capital to make loans, even with TARP. And the loans that many banks have made are showing higher losses than normal. Maine fishing buddy and bank maven Chris Whalen of Institutional Risk Analytics thinks that loan charge-offs will be twice the 1990 level, or around $800 billion, not far off from Roubini's number. That will force banks to loan less money and raise capital. Not exactly what the Senators want. And it will force banks to tighten lending standards. Look at this chart from Binit Patel, Senior Global Economist for Goldman Sachs. It tells the story of a banking industry in crisis:
Notice that the standards for commercial real estate are the highest of all lending standards? And why wouldn't they be, as the banks watch the deals they have done lose value? Think what a Senate hearing in 2010 would be like if they lowered lending standards and their balance sheets got worse. Senators would be asking how they could put taxpayer money (FDIC) at risk by making risky loans that had now gone bad. And where were the regulators? (It would be helpful if Senator Schumer in particular stopped grandstanding and actually thought before he made some of the statements he does. People assume he knows something because he represents New York and the large money center banks, and accept his pronouncements at face value.)
Bottom line? It is going to take a lot more TARP and private money to capitalize the banks. A whole lot more. And that is before any of the other stimulus. And all that next $1 trillion does is get the banks back to where they were two years ago. Further, it does not give them the capital they need to make up for the loss of the Shadow Banking System. It is going to take some time to build what I call the new private credit system. We are going to get what Federal Deposit Insurance Corp. chairman Sheila Bair calls an "aggregator bank," which will buy bad loans from banks. In an interview with the Wall Street Journal, she commented: "The idea here is that the aggregator bank would buy the assets at fair value. Some are concerned that you'd have to mark the assets down to purchase them, but I think it could help provide some rational pricing, actually, for the market in some of these assets, because we don't have really any rational pricing right now for some of these asset categories.
"The idea would be to set up a facility, it could be structured as a bank, to capitalize it with some portion of the TARP funds. Financial institutions that wanted to sell assets into the bank could also perhaps take part of their payment as an equity interest in the aggregator bank to provide an additional cushion. If you sold $1 of assets into the bank, you would get 80 cents in cash and you would get 20 cents in an equity interest in the bank. So that would be an additional cushion against loss. "With a combination of private equity contributions plus TARP capital, I think you could leverage that into some fairly significant volume to purchase assets."
This is an idea that she calls "... beyond hypothetical. I think all of the agencies are committed to coming up with a program for troubled asset relief. We're vetting the various different structures, the pros and cons of those. I think we would all like to have something in place in the not too distant future. I'm hoping the decision making on it would be fairly quick. It has been discussed for some time. So I think we are nearing the point to make a decision. But it's complicated. We want to make sure we get it right." (Interestingly, Prieur du Plessis, my South African partner, writes me at midnight tonite as I am writing this letter: "... have tried registering the domain www.aggregatorbank.com last night, but no luck as somebody has already done this. The price? $100,000.")
An aggregator bank (the so-called "bad bank") is going to happen. So, for what it's worth, let me make a few suggestions. Banks that are technically insolvent and which will need to put taxpayer money at risk should just be "put down." The shareholders and bond holders need to be wiped out before taxpayer money is spent. And the banks should be put back in strong private hands as soon as feasibly possible. We do NOT want government agencies subject to political manipulation making decisions about lending. But deals should be structured which give taxpayers a real chance to get their investments back. And please, no more deals that are not on the same terms that Warren Buffett or other private investors get. That was simply embarrassing for Paulson and team, or should have been. In closing, let me quote two paragraphs from Bridgewater Associates that I think sum up the problem in a rather brilliant and clear way, and which I wholeheartedly agree with:
"The root problem is that debts that were incurred to finance assets at high price levels remain in place at their original amounts even though the assets that they financed are now worth far less. Debt that was incurred to finance extrapolated high incomes remains in place at its original amount even though incomes are now much lower. And, debts that were incurred to finance loans remain in place at their original values even though the loans that were made cannot be repaid. Until the debts are brought in line with the assets and the income, there is no moving forward no matter how much liquidity is provided or how eloquent the speech. And, until this happens, the self-reinforcing nature of the debt squeeze will only reduce incomes and asset values further.
"There is no easy way out of a debt restructuring. Someone will have to bear the cost of prior bad decisions. The people who should bear the cost are those who made the bad decisions to make the loans or those who financed the people who made the loans. They intended to profit and would have profited if they were right. But they were wrong, so they should lose. The government needs to allow the losers to lose and focus their actions on minimizing the knock-on effects of their failure on people who didn't do anything wrong (to minimize systemic risk). They should then take action to minimize the future exposure of the innocent to the future dumb decisions of the small minority, because no amount of regulation will ever eliminate dumb decisions, so you have to plan for them (through much lower bank leverage limits to cushion losses, bank size limits and non-bank entities playing bank-like roles to improve diversification, safety nets to prevent losers from poisoning the whole system, etc.)." Hear, hear!
Bankers are idiots, sometimes. As a professional class, bankers are thought to be as immoral as Russian pimps and as incompetent as Renaissance electricians. Thanks to them, the banking system is in trouble. Thanks to the failure of the banking sector, the American and UK economies are in trouble. And thanks to the failure of the Anglo-American economy, the whole world is in trouble. Everyone is on the bankers’ case. In France, even Jerome Kerviel is criticizing his bosses at Societe Generale for not preventing him from taking “crazy risks.”
Meanwhile, in Britain, Sir Fred Goodwin, recently esteemed head of the Royal Bank of Scotland, is now said to be the “world’s worst banker,” according to the Times . Trevor Kavanagh, writing in the SUN , says he is “criminally incompetent.” His purchase of ABN Amro is said to be the “worst acquisition in history.” In the new world, meanwhile, ISI group figures that the top four US banks alone have $1.2 trillion in bad assets. The total market value of those four banks is only about half of that amount. The banks are ‘effectively insolvent,’ says Nouriel Roubini. So, the feds have taken them into their care, if not yet into their custody. But the bankers are ingrates. They borrow, but they don’t lend. They take but they don’t give. They party ’til the wee hours...and then, when the bill is served, they play dead.
The New York Times reports: “At the Palm Beach Ritz-Carlton last November, John C. Hope III, the chairman of Whitney National Bank in New Orleans, stood before a ballroom full of Wall Street analysts and explained how his bank intended to use its $300 million in federal bailout money. “Make more loans?” Are you kidding, Mr. Hope seemed to say: “We’re not going to change our business model or our credit policies to accommodate the needs of the public sector....” Bankers don’t make loans in the hopes of getting ‘good citizenship’ awards. They lend money when they think they can make a buck. The remarkable thing is that they’re so bad at it. They lent recklessly when there was little hope of getting their money back. Now, with the widest spreads in history – the difference between their cost of money and their return on it – it’s easier to rob a bank than get a loan from one. There are two explanations for this anomaly – both of them wrong.
The first is that bankers are wicked. A report in the Daily Express , for example, tells us that RBS “bosses spend 50k pounds on champagne banquet” celebrating Burns Night on Friday, before announcing a 45 billion pound loss on Monday morning. Over in the United States, the Wall Street Journal gave out word on Tuesday that much of the $140 million donated to fund the biggest inauguration in history came from banks that had received bailouts. But wait, say the bankers’ defenders; they’re not evil, they’re just incredibly stupid. Evil bankers might have sold sub-prime debt to widows and orphans, but they never would have kept it in their own accounts. At the end of 2007, for example, the aforementioned Sir Fred Goodwin had shares of RBS worth nearly 6 million pounds; now his pile will barely buy a mid-size apartment in a bad section of London.
We do not reject the ‘bankers are stupid’ hypothesis completely; we simply add an important nuance: they are not stupid permanently; they are – like the rest of us – only stupid episodically. Among the queerest financial stories of the last week was the proposal to create a ‘bad bank.’ It hardly seemed necessary. There were already dozens of them. The idea is to transfer all the sins of the bubble era to the ‘bad bank’ – funded with public money. Then, the bad bank will be crucified so that the rest of us can have life, and have it more abundantly. We first saw the idea floated in the pages of the New York Times last week. Now, it has made its way to the Financial Times in London, gaining favor as the measure of sin increases. The SUN says British taxpayers are on the hook for as much as 2 trillion pounds. In America, the bankers face $3.5 trillion in losses, says Mr. Roubini.
But if the ‘bad bank’ idea could work, why not create a super baaaddd bank? We could use it to get rid of all our mistakes. Writers could unload their bad novels. Businessmen could sweep their errors under its broad carpet. What the heck, let people get out of bad marriages without penalty; the super baaaddd bank could pay the alimony and divorce costs. The hitch with the bad bank idea is so obvious even a banker could spot it. If the cost of mistakes is reduced, people might make more of them.
Like the rest of us, bankers are neither good nor bad, but subject to influence. Unlike metallurgy or particle physics, banking does not have a rising learning curve. It’s not science. Instead, it’s more like love and gambling...with a circular learning pattern. They learn...and then they forget. They get carried away in the boom upswing; then they get whacked when it turns down. So let them have a good beating. It will give them of a lesson that will last a lifetime...and give the next generation a solid banking sector.
Far Away From Wall Street, a Herd Gets Gored
Some of the world's biggest banks and law firms are fighting over what's left of Lehman Brothers Holdings. And so are the owners of 1,000 goats. A Lehman-financed venture owes a company called Goats R Us about $53,000. The goats performed fire-prevention by munching shrubs and grass on a property the venture owns in Oakland, Calif. There's little hope now that the bill will be paid, and that makes Terri Oyarzun, the founder of Goats R Us, bleating mad. She says she has had to put off buying a new truck to transport the goats, and she can't hire new herders. "This is not how I operate my business," she says. Lehman's collapse and bankruptcy filing in September left an eclectic group of businesses and individuals clamoring for what they're owed. About $43 billion of Lehman's $639 billion in assets was from the firm's far-flung real-estate operations, which included housing projects, resorts, office buildings and other properties all over the world. Those hurt include hydrologists near San Francisco and chambermaids in Palm Springs.
Also left in the lurch were Chinese laborers who were flown into the Turks and Caicos Islands in the West Indies to help build a Ritz-Carlton resort. The workers stopped getting paychecks abruptly after the Chapter 11 bankruptcy filing. About 60 of them followed managers of the project around the property until they finally got paid. Many vendors didn't know that their fates were tied to the high-flying investment bank. "For Lehman Brothers, we are a speck, a drop," says Ms. Oyarzun. Lehman declined to comment for this story. The hills of East Oakland where the goats grazed couldn't have been further removed from the frenetic world of derivatives, swaps and forward contracts. The animals were hired by Lehman's partner, SunCal Cos., California's largest land developer, which planned a housing development on the 167-acre property. Twice a year, Goats R Us transported about 1,000 Angora and Spanish goats to the site and let them roam to nibble on coyote brush and other shrubs, which can pose wildfire dangers in the dry season.
The herders, who were recruited from ranches in Peru and Chile, slept in a travel trailer, eating their meals on the site and looking after the goats with the help of two border collies. The goats had worked at the property, called Oak Knoll, for the Navy, which operated a hospital on the site for decades. Lehman and SunCal bought the land at a government auction, conducted on the Internet, for $100 million in late 2005, near the height of the property boom. The venture envisioned about 900 homes, walking trails and public parks. Big land owners use goats for fire control because they are dependable and hard-working. They clear brush and poison oak, which two-legged landscapers try to avoid. The goats also are often preferable to herbicides, especially in residential areas, such as Oak Knoll. "They were doing a good job at vegetation management,'' says Al Auletta, who was overseeing the project for the Oakland Redevelopment Agency. "The goats were pretty effective at that."
For many years the goats were happy, Ms. Oyarzun says. The sprawling hospital campus was a favorite of the herd. Some goats liked to sun themselves on the porches of the empty Navy buildings. One goat preferred to sit by the former officers' club, near the tennis courts. His nickname is Admiral. Another prominent goat at the site was Cookie, who has the distinction of being one of the few animals that Ms. Oyarzun considers an honorary union worker. In the late 1990s, Local 70 of the International Brotherhood of Teamsters sent a lighthearted letter of protest to a college in Oakland that had hired the goats without first informing the union. After the parties settled their dispute, Cookie was outfitted with a Teamsters jacket. But the global financial meltdown finally caught up with the goats of Oak Knoll. Last spring, Ms. Oyarzun submitted a bill to SunCal for the goats' work at the property. She says she repeatedly dunned the developer but went unpaid.
What Ms. Oyarzun didn't know was that behind the scenes, Lehman had taken financial control of many of SunCal's huge development projects across California, including Oak Knoll, according to a lawsuit that SunCal filed against Lehman two weeks ago in federal court in Santa Ana, Calif. As concern on Wall Street mounted over Lehman's property holdings amid the housing bust, Lehman restructured its Suncal investments, which it valued at $2 billion. Lehman also promised to continue funding the projects, according to SunCal's lawsuit, which demands money for its creditors. "But Lehman's funding never materialized anywhere close to what was promised or needed," according to the lawsuit. As a result, Suncal says, it can't pay about 450 creditors, including Goats R Us. "SunCal was assured by Lehman that these people would be paid," says SunCal's lawyer, Skip Miller, of the Los Angeles firm Miller Barondess, LLP. Alvarez & Marsal, which is handling the restructuring of Lehman, has declined to comment, citing the ongoing litigation between Lehman and SunCal. Lehman has offered short-term financing to the projects, but a deal hasn't materialized.
The goats are caught in the fight between SunCal and Lehman. The Lehman estate wants to foreclose on SunCal's properties. SunCal wants to keep many of them afloat. Shortly before Christmas, and eight months without a payment, Ms. Oyarzun got fed up and called up demanding to talk to SunCal's owner. She finally got through to an executive who gave her the bad news: The SunCal unit, a limited liability company that hired Goats R Us, had filed for bankruptcy protection and couldn't pay her. She later learned that Lehman was being blamed for the project's problems. Ms. Oyarzun was stunned that an investment bank she had barely heard of could cause such damage to her business. Her unpaid bill nearly equals her annual alfalfa budget. "I don't create limited liability companies," she says. "I have one company that hires people to herd goats and take care of the dogs, and then I pay them."
Lehman and SunCal have taken off the gloves. SunCal has accused Lehman of fraud in its court papers and points out that it, too, has suffered. SunCal has closed four offices, laid off a number of employees, and put up one of its two jets for sale. People familiar with Lehman's position say that the lawsuit is a diversion and many of Suncal projects aren't viable. No matter how bad things get, though, Ms. Oyarzun says the goats will be cared for and will never be sold for meat. After they become too old to travel, they "retire" with medical care to the family ranch. Cookie, now the oldest goat in the herd at age 17, sleeps in a private garden shed. "We won't cut back on the animals' welfare," she says.
As the economy slumps, so does trash
There's an upside to the economy being down in the dumps: Less trash. Consumers are eating fewer meals away from home, reducing food waste -- the No. 1 space hog at landfills. Contractors are building fewer homes and tossing aside less drywall, lumber and other heavy debris. Pack rats who can't afford to move are postponing cleaning out their closets, landfill operators say. For a commentary on California's economic health, visit its landfills, where disposal rates are hitting record lows. Over the last six months, operators at Puente Hills Landfill, among the nation's largest, have noted a 30% decrease in tonnage from neighboring municipalities. The dump used to close at noon because it would reach its daily tonnage limit; now it stays open all day without hitting that mark.
San Francisco is disposing of less in landfills than it has in 30 years. In San Diego, disposal rates at the Miramar Landfill are on track to bring in the lowest total in 15 years. "There always have been three givens in life: death, taxes and garbage," said Evan Edgar, a civil engineer and a regulatory advocate for the California Refuse Recycling Council. "Since the 1970s, that's been a mantra in our industry. But what this recession has shown is that we will have death and taxes, but garbage is no longer recession-proof." Southern Californians confirm that concerns about layoffs and unstable gasoline prices are prompting them to buy little except necessities. And it shows in the makeup of their trash. "I spend less," said Sara Serrano, 46, an employee at Costco in Los Feliz. She said that the warehouse store now rarely sees the long lines that until last spring had been common during her 13 years there. "My trash can -- the recycle one -- I don't bring it out anymore. My other one only has one or two bags in it a week, where before it was three or more."
Glendale retiree Helga Santiago, 63, said she's taken to finding second uses for oversized packaging such as cereal boxes and for disposable glasses and plates before tossing them in the recycling bin. The former home-care aide to the elderly said she never strays from her list at the grocery store, sticking to staples such as oranges and rice. The reduction in trash has been a blessing for many municipalities statewide, because they had begun seeing steep declines in revenue from their recycling programs when commodity prices tanked last fall. Now, they are able to offset some of those losses by paying less in landfill fees called tipping fees. However, the trend has had the opposite effect in San Diego, where the Miramar Landfill is owned by the city. Officials there are grappling with whether to cut services or raise fees to make up in part for tipping fee losses.
Haulers ferried 66,000 tons of trash to the landfill in December, a 12% decline from the same period a year ago. Construction and demolition waste plunged 80%, from 36,000 tons in December 2007 to 7,000 tons last month. Frugal consumer buying habits like those practiced by Serrano and Santiago are reflected in the city of Los Angeles' waste stream. The city collected 6% less trash in the last three months, saving the Bureau of Sanitation $405,728 in tipping fees compared to what it paid for a similar period in 2007. This savings more than made up for a $254,000 drop in recycling revenue, said Enrique Zaldivar, the bureau's director. And that raises another consequence of the downturn: its effect on recycling. The slumping economy has driven down commodity prices for plastic, glass and especially paper in ways that have discouraged conservation advocates and dented city programs that depend on revenue from recycling. Los Angeles is less vulnerable to unpredictable swings in commodity prices -- which for some materials, such as cardboard, fell by as much as 90% in recent weeks -- because its contractor has agreed to pay, in most cases, a minimum of $25 per ton of recyclables, Zaldivar said.
Still, he worries that volatility in the market could cause some recycling companies to go under. In San Diego, the city expects that recycling revenues for the fiscal year starting July 1 will be half what they were two years ago, when it collected $6.2 million from selling used glass, plastic and cardboard. Declines in recycling revenues and tipping fees will require some tough choices for the city during this spring's budget negotiations, especially given that a 1919 law prohibits the city from assessing a trash fee on single-family homes, said Stephen Grealy, waste reduction program manager. "We're pretty close to the bone," he said. "We have been in a situation of not having a lot of funds for many years." The recession and falling commodity prices have also caused officials at Puente Hills Landfill to trim costs. The Los Angeles County Sanitation Districts, operator of the dump, recently reduced the days that contract workers sort recyclables at one of its material recovery centers from five days a week to one, said Habib Kharrat, supervising engineer in solid waste operations.
"Recoverables don't have value anymore for selling, so they won't cover the labor," he said. "What's happening now is that more of that material ends up at the landfill." With fewer contract workers sorting materials at Puente Hills, the districts decided to send some recyclable material to the dump -- about 16 tons of the 400 tons disposed of at the center each day. The landfill itself accepts about 9,000 tons of trash on a daily basis. Even though the trashed recyclables account for a fraction of overall garbage collection activity, conservation experts fear that the recession may set the state back in its efforts to reuse most of its waste. In 2008, California posted the nation's highest recycling rate, diverting 58% of its trash from landfills, according to the California Integrated Waste Management Board.
This rate is "definitely going to drop. We don't know how much," said Gary Petersen, Gov. Arnold Schwarzenegger's environmental appointee to the board. He added that officials hope to take advantage of the unstable commodities market by building more facilities to reuse trash in the state. Less trash at landfills can be attributed in part to a state law calling for 50% of trash to be diverted from dumps. But officials say that even taking the state's unusual recycling rates into account, the recent falloff in disposal rates is largely the result of less consumption. "There is definitely a drop in trash and that is probably due to a bit more to the recession than it is to recycling," said Edgar, the regulatory advocate. "People aren't producing as much garbage because they're not buying as much."
Auto Dealers Feel Strains Amid Declining Sales
About 1,000 General Motors Corp., Ford Motor Co. and Chrysler LLC auto dealers went out of business last year, a loss deeper than anticipated amid a crippling decline in auto sales. The rate of decline has been so swift and deep that GM and Chrysler have backed off once-aggressive efforts to strategically downsize their vast dealer networks, sized for a time when Detroit's Big Three commanded more than 75% of the U.S. market. While many dealers consolidated stores or voluntarily bowed out of the auto business, many left under duress. "You can't explain how depressing it is to drive past an abandoned dealership every day, how it leaves you with an empty feeling," Annette Sykora, chairwoman of the National Automobile Dealer Association said Saturday in a speech at the group's annual convention. "What is happening to the business I grew up in?"
NADA in December predicted about 900 dealerships -- including small numbers of foreign-based auto makers -- would go out of business in 2008. But Detroit's auto makers alone lost more than that, company executives said this weekend. About 300 Ford dealers closed last year, while 401 GM dealers and 287 Chrysler dealers went out of business. Consulting firm Grant Thornton estimates about 2,500 of the nation's 25,000 new vehicle dealerships will close in 2009. However, 5,000 would need to close to have a healthy level for this year's anticipated level of auto sales, the firm said this week. "Auto makers have had these plans to reduce dealers, but the cost of implementing those schemes is intensive," Paul Melville, a Grant Thornton expert on dealer restructuring, said. "Now market conditions are forcing dealers to consolidate."
The strain is evident as thousands of dealers and their spouses convene for a scaled down convention with fewer posh parties and more sessions coaching how to stay afloat in tough times. Adding to the pressure is uncertainty around plans by GM and Ford to eliminate or overhaul several brands, including Ford's Volvo lineup and GM's Hummer and Saab brands. GM also is in the midst of a strategic review of Saturn, whose fate could range from being shut down to getting sold to franchise owners. "There's a lot of anxiety, a lot of worry," GM sales Chief Mark LaNeve told reporters on Saturday. Eliminating dealers has been a key goal for Detroit's auto makers as they adjust to the reality of a smaller market share and contracting U.S. market. The auto companies believe profitable, healthy dealers attract customers and create a more appealing image. Yet domestic-brand retailers sell far dealers fewer cars and trucks on average than rivals selling nameplates made by foreign-based auto makers.
In recent years, auto makers have facilitated downsizing of their networks either by helping negotiate consolidations or pitching in money to facilitate deals. It's a balancing act for the companies, which fear losing the wrong dealers in the wrong markets could cost them valuable sales. Chrysler Vice President Jim Press said Chrysler doesn't have a target for the number of dealers that should close, but that a "Darwinian" process is occurring that will cull the number naturally. Of the 287 Chrysler dealers to go out of business last year, 92 left as part of Chrysler's strategy to get its Chrysler, Dodge and Jeep brand dealers under the same roof. The remaining 195 left for economic and other reasons. Press said the auto maker is being less aggressive for fear of losing market share. "We want to consolidate, but not at the risk of losing market share," he told reporters on Saturday.
GM also is less active in its dealers' affairs, in part because the cash-strapped auto maker doesn't have resources help dealers close or merge, GM's LaNeve said. The auto maker has said it plans to cull 750 of 6,450 stores from its dealer network as part of a viability plan presented to the government as part of the loan request. The reduction is not a condition of the deal. "It costs money to consolidate," Mr. LaNeve said. "And we've slowed down the activity while we figure out our brand and nameplate situation." Ford said the company's strategy is unchanged. Even more than closed dealerships, Ford worries drastic cost cutting at dealerships threatens the business, said Ken Czubay, Ford's vice president of U.S. sales and marketing. "We're dealing with dealer families that have been in business 100 years," he said. Dealers, who will meet on Sunday with top auto maker executives, appealed to auto makers and lawmakers to stay out of the fray. "When a manufacturer targets a specific number of dealers to cut, that disturbs me," Ms. Sykora, of the dealer association said. "What's the right number of dealers? The question is irrelevant. (Dealers) have the answers."
Bad Times Spur a Flight to Jobs Viewed as Safe
After years of struggling to get their wages up, the nation’s workers are trying to find jobs that will simply last, at least through the deep recession. Fearing layoffs, investment bankers at a Merrill Lynch or a Morgan Stanley are joining small Wall Street firms for less pay but with signed employment guarantees. Academics are migrating to community colleges, which are adding teachers as enrollment rises. And in Eastern Wisconsin, workers furloughed from a paper mill they fear will not reopen are training as truck drivers and welders. “Looking online and in newspapers and talking to my instructors, I’ve decided that trucking and welding stand out as jobs that are available and will continue to be available, and a lot of my friends agree,” said Dan Geneen, who has picked up a truck-driving certificate and is learning welding since he was let go by the paper mill last fall.
Trucker and welder are hardly glamorous careers to most Americans. But there is a new allure developing around jobs likely to keep a person employed, at reasonable pay, through a prolonged downturn. Government employment once offered that promise, certainly in the Great Depression. But government hiring is less than robust now, at 181,000 additions over the last year, mostly at the state and local level. That is far from offsetting the 2.5 million jobs lost in the 13 months of recession. With his economic recovery package now before Congress, President Obama promises to generate thousands of steady jobs, some of them in government. Until those positions appear in abundance, however, the hunt for safe work is occurring mainly in the private sector — and the hunting is not easy. “The companies doing the least hiring right now are very often the companies that offer the safest jobs,” said Susan Houseman, a senior economist and labor expert at the Upjohn Institute, a research group in Michigan.
With employers shedding half a million jobs a month, some economists, like Nancy Folbre of the University of Massachusetts in Amherst, liken safe jobs to high ground amid the turbulent flood waters of lost employment. “There is a danger in using the term ‘safe jobs’ for this perch,” Ms. Folbre said. “That makes them sound like sinecures, and they are not.” Such is certainly the case on Wall Street. The flow to the smaller boutique firms often involves top people at big but shaky investment banks. Fearful they will be laid off, they move on before the ax falls, said Cheryl Solit, a partner at Solit Tessler & Company, a placement firm in Short Hills, N.J., that helps such executives make the switch to jobs with less initial compensation but more security, although in these hard times, not that much more. “The no-layoff clauses in the contracts they sign are usually for one or two years,” she said, “and usually in the form of guaranteed compensation. The new employer is not likely to lay you off when he has to pay you anyway.”
Community colleges are turning out to be a similar mecca as enrollment rises because of the recession. Laid-off workers are flocking to the schools to retrain for other occupations, and young people are enrolling in greater numbers to avoid the higher tuitions of a four-year college, said James Jacobs, president of Macomb Community College in Warren, Mich. At 41,000 students, Macomb’s enrollment is up 10 percent from last year, Mr. Jacobs said. With the recession driving enrollment, he is adding to his staff of 220 full-time teachers and 750 adjuncts. Most of the new hires are adjuncts, though the courses they teach there and at another community college often add up to full-time work. Since enrollment is rising, they are assured of work semester after semester, Mr. Jacobs said. The annual pay is $40,000 or less — usually less — and no benefits. Still, they are coming back. “If you spent six or seven years and hundreds of thousands of dollars getting a graduate degree and you end up doing this, that is not a happy thought,” Mr. Jacobs said. “But it is steady work.”
That is precisely what Mr. Geneen, the displaced paper mill worker, seeks from his course work at Fox Valley Technical College in Appleton, Wis., where he earned a truck driver’s certificate in December and is now learning to be a welder. He was laid off in September as an operator of a coating machine when the NewPage paper company in Kimberly, Wis., shut — a victim of plunging demand. Mr. Geneen, 47, had worked at the mill since high school. He says he is not even trying to match the $60,000, with overtime, he earned at NewPage. Steady work, even in a recession, is his current goal, which makes him reluctant to exercise his recall rights even if NewPage reopens. “I don’t want to have the same thing happen to me again five years from now, when I’m older,” he said. Taking advantage of a federal subsidy to train for what he considers a safer occupation, he completed a 10-week course to become a commercial truck driver. Even though truck shipments are off sharply and drivers’ employment has fallen, Mr. Geneen sees a need for truck drivers, in good times and bad. So do 34 others who were laid off at NewPage and took the same course.
“Two of my classmates just this week applied at a trucking company advertising for tractor-trailer drivers,” Mr. Geneen said. “They were hired on the spot and told to report for work on Feb. 1. They didn’t even meet with the personnel people.” Mr. Geneen says he plans to drive a truck, preferably within Wisconsin. But with his wife, Kathy, earning $40,000 a year as a certified public accountant and with enough severance from his mill job to help carry the family for a while, Mr. Geneen has enrolled in a yearlong course to qualify as a welder. It is another occupation chronically short of qualified people, even in a recession. At $40,000 a year or so, welders’ work would not match his old pay but would provide a backup plan for the future. “I want options that will hold up in a failing economy,” he said.
As the recession deepens, the only industry in the private sector adding jobs in significant numbers is health care, according to data from the Bureau of Labor Statistics, and it is doing so across the board, from physician to bed pan attendant. Government used to be a refuge, particularly postal work and public school teaching. But the post office has been shrinking its payroll for several years. Public school employment — mainly kindergarten through high school — rose through August to nearly 8.1 million jobs, but it has fallen each month since as declining tax revenue forces cutbacks. Those cutbacks rarely apply to math and science teachers, who are often in short supply. “Teaching math in a high school in an affluent suburb,” said Tom Geoghegan, a labor lawyer in Chicago and a Democratic candidate for Congress, “that is my idea of the ultimate safe job.”
Living on thin ice
On a cold Monday in December, one of Britain's most experienced polar explorers is sitting in an even colder room in Portsmouth, explaining his latest mission. The temperature has been turned down to a mere -20C, tropical by comparison to the almost inconceivable conditions he will have to endure during his next expedition to the Arctic. There, temperatures can drop as low as -90C; it is dark all day or the sun can blind people in minutes; the explorers will wake up, their eyelashes frozen together, in sleeping bags full of shards of ice; the ground beneath the trekkers' feet will be only inches of frozen water which can at any moment open into icy rivers which will kill almost instantly, and, apart from the odd grey seal, the only life they are likely to meet is a hungry polar bear.
Meeting Pen Hadow for the first time is something of a shock. He is the first man in history to have managed one of the ultimate feats of human endurance - to trek solo and unaided to the North Pole. But instead of the great strapping giant of a man you might expect, the 46-year-old is slightly built, and his hand, when he shakes mine hello, is almost the hand of a woman. As Hadow talks his breath frosts the air in front of his face, but he looks unperturbed while sitting still in this giant concrete freezer. Such small extremities, along with his brown eyes, olive skin and naturally low heart rate, make him ideally suited to a life of spending months at a time alone or responsible for teams of amateurs in one of the most inhospitable environments on earth.
Now, though, Hadow is about to embark on a very different expedition. In February he will leave northern Canada to trek more than 1,000km to the North Pole; what's different this time is that he is travelling with two fellow polar explorers, his friends Ann Daniels and Martin Hartley, and they will be dragging with them not just food and repair kits but 100kg sleds each, laden with equipment to take up to 12m readings of the depth and density of snow and ice beneath their feet. The readings that Hadow and his team are taking will feed into our understanding of the Arctic's relationship with climate change. Based on occasional submarine journeys and more recently satellite data, charts of the total area of Arctic sea ice have shown a gradual decline over the past 40 years. Then, in 2007, the line on the chart appeared to drop off a cliff, plunging below 5,000,000 sq km a full three decades ahead of forecasts. The dramatic events of two summers ago, when a Russian submarine rushed to plant a flag under the pole and Canadian and European governments tersely laid rival claims to sovereignty, led many scientists to warn that the Arctic sea ice could disappear entirely during the summer months much sooner than had been feared.
Most experts agree on the impact this will have on 5m Arctic inhabitants and the rest of the world - from the loss of the unique habitat that exists under the ice to rising global sea levels and possible changes to the ocean circulation and the weather patterns of the whole planet. Yet forecasts for when this will happen range from just four years to the end of the century. The reason is that very little is understood about the depth and density of the sea ice, and therefore the total volume of water frozen at the top of the world. This is what Hadow's Catlin Arctic Survey - appropriately sponsored by an insurance company - hopes to put right by providing the much-needed data about how much ice is left, and so help work out how much time we have to prepare for what is probably the most immediate, truly global threat of climate change. The survey is supported by the United Nations Environment Programme, the Prince of Wales and the conservation charity WWF. "If you want to understand climate, we should invest more in making observations of climate change, and as the Arctic ocean is the amplifier of global warming, we should concentrate on the Arctic region to understand how fast the warming is taking place," says Wieslaw Maslowski, a research associate professor in oceanography at the US Naval Postgraduate School and science adviser to the Catlin survey.
Hadow puts it more chivalrously: "I see the Arctic as a maiden newly discovered on the social scene, and we're melting away her petticoats, and there are some avaricious types peering underneath, and someone needs to defend her honour." Hadow's defining 75-day trek to the North Pole in 2003, alone and with no aeroplanes to resupply him, began with a spur-of-the-moment promise to his father on his deathbed, a promise which was to haunt him for 10 years through two earlier failed attempts and financial and health problems. So obsessed did he become that in his autobiography, Solo, Hadow wrote: "Above all other things, even the birth of my son, it seemed to be absolutely central to my being." The roots of that trip and Hadow's long love affair with the Arctic lie deeper, though. His parents Nigel and Anne hired a nanny named Enid Wigley who had looked after Scott of the Antarctic's son Peter, and her routine involved teaching the young Pen to endure the cold by leaving him outside. She also spent years telling him stories of Antarctic explorers.
Years later, drifting in an unhappy job with sports management group IMG, Hadow found a book in the library of the Royal Geographical Society which was to bring back those memories, lead him to both poles, and now set him on his mission to alert the world to the imminent threat to the Arctic. The book was the translated diaries of an obscure 19th-century German ornithologist called Bernhard Adolph Hantzsch who, after being shipwrecked, died trying to trek across the far north of Canada to find a ship home. Hadow was captivated and decided to finish the German's journey. "I remember walking back to the office, thinking: 'Of all the books I have, 90% of them are written by adventurers and explorers and scientists: Francis Chichester, Jacques Cousteau, Chris Bonington, Ranulph Fiennes, [Robin] Hanbury-Tenison,'" recalls Hadow. "It never occurred to me until that moment that I could ever lead a life approximate to those. In that moment I thought: 'I'm going to start this journey.'"
The official history records that, thanks to "Nanny" Wigley and Hantzsch, Hadow advertised for a companion, made his first journey, and was hooked. Reading between the lines of his biography, though, there appears to be another crucial factor in his career choice: an extraordinarily strong need to prove himself, from hanging upside-down from trees as a child to taking up competitive gardening and school sports. "There were lots of reasons why I did it [the solo trek] which were based around this vow I made, the main reason being that at the time it was regarded as the ultimate feat to be done," Hadow admits in conversation. If anything, the latest expedition comes even closer to fulfilling this need. After the solo feat, Hadow was researching his book, and while in bed one night read a report by the US Navy discussing design changes to its ships undertaken to cope with changing sea ice because of global warming. "I thought: 'Even I don't really know about this and I'm in the almost unique situation of having this relationship with the Arctic,'" he says. "I thought: 'I could be the amplifier or explainer; I might be the person to reach out to as wide an audience as possible, globally, to tell them what's going on.'
That's what explorers do, classically. They discover information and then have the potential to engage audiences." With a new reason to return to the Arctic, Hadow asked climate scientists how he could help. He discovered that measurements of sea ice began in the 1960s, but for three decades there were only annual submarine voyages, providing too little data to be sure what was happening more broadly. Since the 1990s, satellite maps have been used to calculate the height of snow and ice above the waterline, but experts have to make assumptions about the roughly five-sixths of mass underneath, and there is a "hole" in the data over the North Pole which is 1,600km across. The satellites show that in 2007 alone, the Arctic sea ice lost an area nearly the size of Alaska, reaching an all-time low of 4,130,000sq km on 16 September. Following this and another poor year in 2008, the US National Snow and Ice Data Centre now calculates the permanent sea ice - measured in September at its nadir - is receding by 11.7% a decade, or an average area the size of Scotland every year.
Little is known about thickness, nor about the density of different layers of snow and compacted ice. Submarine data suggests a 40% thinning between the 1960s and 1990s. Last year the journal Geophysical Research Letters published a paper by three experts at University College London which calculated that the ice in the winter of 2007/8 was thinner than the previous five-year average by 26cm, plus or minus 5cm. The margin of error reflects the lack of long-term and wide-ranging data. Last September, despite a cooler summer, the sea ice only recovered to its second-lowest recorded extent, possibly because there was more thin first-year ice than usual. And some scientists think the total volume last year was even lower than 2007, says Maslowski. Part of the wide range in estimates for when summer sea ice will disappear is due to uncertainty about how quickly the exposed darker sea will warm, triggering a cycle of more melting and warming. The models also differ in their varying assumptions about ice thickness. Maslowski, whose team has projected the most aggressive date - between 2010 and 2016, based on current trends - argues, for example, that too little is known about increasingly warmer water brought by ocean currents from the Pacific and Atlantic, and its contribution to melting sea ice.
A few scientists do venture to the far north, usually by boat or plane, to drill cores or take radar measurements, but in an area which in winter can cover up to 4% of the globe, there are only about a half a dozen such locations, says Seymour Laxon, one of UCL's experts. The problem is that few scientists have the inclination, physical endurance, time and money to do the training necessary to spend months in such harsh conditions, says Hadow, who has raised almost £3m and spent years planning the trip, including an extra delay after funding fell through for 2008. "What captivated me more than anything was that I could do this," says Hadow. "For once in my life I was in the right place at the right time." After the cold room, the explorers have more chilling work to do at the Institute of Naval Medicine in Portsmouth. As well as walking, the team expects to swim for up to 100 hours, dragging their specially designed sleds over "leads" of water which can open up between ice pans. While swimming they will wear bright-orange immersion suits, which they now put on, lowering themselves into the pool of icy water. Hadow says it's like being "shrink-wrapped". I tried it for myself and it was how I imagined it would feel to swim in mercury. The pool temperature is much warmer than the cold room, 4C, but because water conducts heat 26 times better than air, it "rips" the heat away from the explorers. The final test is to get back into the water in only their walking clothes to simulate what would happen if they fell through the ice. If they do, the water is likely to be even colder, probably below zero - salt water freezes at -1.8C.
Early polar explorations left a trail of graves - men killed by hypothermia, scurvy, gangrene and even poisoning after eating the livers of polar bears. Modern science has alerted those who have followed to many of these dangers, and provided remedies. But for all the advances in modern technology, many risks still remain, almost all of them bound up in the landscape over which the team will have to walk and swim. "Your brain is so used to visual information pouring in that when you go there the instant impression is: there isn't anything up here - it's all white," says Hadow. In the first few days, the brain "retunes", and as the other senses are dulled by the cold and the heavy layers of clothing, the eyes become more alert. "Some people talk about the Arctic as a monotonous wilderness of white, but if you open your eyes and look at the landscape, especially in spring, you realise that there are no whites whatsoever," says Hadow in Solo. "Everything is in shades and tones of pastel colours - cream, grey, blue, green, yellow, orange, pink - and only in the stark bright light at the height of the polar summer, when the sun is high in the sky, do you begin to see true whites among the other colours."
Nor is the Arctic a great flat glass to glide over. Before each trip, Hadow spends hours on Dartmoor pulling strings of tyres around tors, getting caught on and under rocks, untangling, pulling, shoving and scrabbling over cold wet granite to prepare for the huge pressure ridges he will have to clamber over: steep walls of frozen slippery ice rubble which test both his physical strength and patience. Even on the "flat" pans, the ice is "rough, cracked, pitted and pocked with holes, lumps, bumps, projections and cracks where your burden becomes wedged or threatens to topple over, spilling its load," he writes. Then there are the wind and currents, which constantly work on the great floating, constantly changing landscape, grinding ice together, pulling pans apart, sometimes so "rapid as to equal a ship running before the wind", to cite the evocative description of the ancient Norse writer of Kongespeilet. Not infrequently travellers have to make huge detours or backtrack over a ridge or rubble field because of an impassable lead; occasionally they wake to find they have drifted south of the point they began walking the previous day. And the sounds of all this movement are amplified by the otherwise silent emptiness. The landscape is so empty that in 2003 Hadow recorded that the only life he encountered were three seals, one snow bunting and the tracks of a single polar bear.
By day, the whooshing of skis and scratching of poles and the roar of wind past their ears dominate the explorers' world. At night, however, after the cooker is turned off, they lie with their heads on the ice and listen to it. "You wouldn't conceive such random movements could produce such metronomic sounds: you get this der-der-der-der-der-errrr, der-der-der-der-der-errrr. It's disconcerting because it tends to be the ice breaking up around your tent, often literally around you. This happens three or four times in an expedition," says Hadow. "You have to take a view: will this open up and will we be falling in in the morning, or will it be little hairline cracks rather than major fractures?" Sometimes the wind also beats against the tent like a drum. Today, the biggest threats Arctic explorers face are those things that happen quickly, before help can be summoned from a few hours' away, or possibly days if the weather is bad. There is the moment-to-moment threat of falling through the ice - a risk which rises with every year the ice recedes. There are the constant dangers of being crushed by sleds, a sudden serious illness, and always the fear of a polar bear attack. Then there's the nightly gamble with carbon monoxide poisoning from burning stoves inside tents.
And all the time, of course, there is the ever-present, grinding cold. In temperatures as low as -50C, with wind chill that can sink to -90C, cold remains a constant danger. Travellers cannot stop for more than 10 minutes to mend equipment or they start to freeze - mucus dries like gravel in the nose, contact lenses would freeze to eyeballs, unprotected parts of the body can be frostbitten before you have noticed, fillings in teeth expand and contract, sweat freezes under clothes, and as the temperature drops the human brain begins to slow, making people less responsive to problems - in extreme cases causing them to make the problem worse by acting in exactly the wrong way, such as undressing. The constant struggle over the ice, the stress and cold are compounded by exhaustion. To keep their sled weight down, the explorers calculate they can survive on a "deficit" of about 1,500-2,000 calories a day, but after two weeks their body starts to consume muscle to keep going. And, despite their exertions, sleep is often hard. "For the first month you're cold every night, shivering," says Hartley, "then you worry about polar bears sniffing around looking for a canapé in a sleeping bag."
To cope with such conditions, Hadow adopts an almost obsessive regime of walking, eating from his "nosebag" of chocolate and nut rations, and checking his condition and his kit regularly. In a team, some risks are mitigated by having other people to help. But this time they will carry much more weight because of the measuring work and Hartley's cameras and video equipment, and the trio has also taken advice from a psychologist about how to cope with personality problems that might arise. Despite all these reasons, getting to the North Pole is still "85% in your head", says Hadow. "Over the 70-odd days I was there last time [for the solo trip], I would only think there was less than half a day when all things were good." "It messes with your mind," he says in another conversation. "The Arctic is a dynamic surface, and there are all sorts of things that can go against you. It feels like you're against a mightier force, which is a disastrous way to reach your goal. It's like a white crucible. You put yourself or your team in and apply a Bunsen burner to the crucible, and all the fluff and juices are evaporated off and you're just left with the essence of those people."
For these reasons and the added difficulties of dragging extra weight, having additional tasks, raising many times the usual cost of a polar expedition, and - ironically - the worsening ice conditions, Hadow admits they cannot guarantee success. His own training has also been interrupted by one of the many viruses which gripped the UK this Christmas. "We cannot know whether we can do it," he admits. "But we're not just giving it a go - we're very locked on to going the distance, to 90 degrees [north]." All being well, on 24 or 25 February the Catlin survey team will leave the base at Resolute Bay in northern Canada, be flown up to 80°N 140°W, where the multi-year ice begins, and start walking northeast along the line of 140° longitude. There can be no maps of ephemeral sea ice, and Hadow believes that the route has not been taken for 40 years, since Sir Wally Herbert, after whose wife Hadow has named his sled.
As they travel across the ice pans, a radar specially designed for the conditions, weighing just 4kg, will take a measurement every 10cm. The team will also stop regularly to drill cores of snow and ice and take measurements of the ocean temperatures and currents below. As they travel, Hadow will dictate notes into a special voice recorder about the regularity and make-up of ridges and other features. And Hartley, a multi-award-winning photographer of difficult environments, will capture their progress and the landscape. The data will be fed back via satellites to the scientists every night, and they hope that early results will be available before a UN meeting at Copenhagen in Denmark in December, when the world's governments will be asked to agree an ambitious treaty to cut greenhouse gas emissions and so, it is hoped, reduce global warming and the resulting climate change. "Once they have a figure for how long the Arctic sea ice will be there for, they will have to act," says Hartley.
Scientists already believe that melting ice is responsible for average air temperatures warming twice as fast in the Arctic as in the rest of the planet. So far they believe the melting of the floating ice has an undetectable effect on global sea levels and the expansion of the warming water contributes less than 1% of the annual average rise. But if the ice melts further, or disappears, that cycle of melting and warming will add noticeably to sea levels, and there are emerging concerns that the warming water temperatures are speeding up the melting of the Greenland ice cap, which could add metres to sea levels. Less certainly, the influx of fresh and warmer water could start to alter the planetary circulation of ocean currents and winds which dictate weather patterns.
At the extreme, this could trigger one of the more catastrophic "tipping points" of climate change - the switching-off of the "thermohaline circulation" which brings warm water from the Tropics to the northern Atlantic and sends cooler Arctic waters south - events which were dramatised, if somewhat fancifully, in the film The Day After Tomorrow. In the impeccably bureaucratic language required to achieve consensus among hundreds of scientists and governments, the latest UN Intergovernmental Panel on Climate Change report described such an abrupt transition as a "low-confidence" event - that is, a 2 in 10 chance. At best, Maslowski does not believe the results will give them more than a decade beyond his 2013 projection before the end of all summer ice. What then? Is it not too late? "Even if it's too late to do anything about sea ice, what other wildernesses are we going to let go?" adds Hadow.