Fortune teller at state fair in Donaldsonville, Louisiana
Ilargi: If today is any guide, my prediction yesterday that we might be in for a rough week looks spot on. Major corporations announced a minimum of 60.000 job losses. In one morning. The fact that this leads to stock exchanges doing happy dances, with London up close to 4%, and Amsterdam 6%, makes me lose what little faith I might have had left in our societies. As long as one man's misery is another man's profit in such a direct cause and effect line, there cannot be much of a future left.
What galls me in an equal fashion is reading about Citigroup buying a new $50 million corporate jet with its $50 billion taxpayer bail-out money. Or the ex-CEO of Deutsche Post, a semi-government institution as far as I can tell, getting a suspended sentence and a $1 million fine for sludging over $1 billion away from the German people. No jail, and an 0.1% fine. Justice, here we come. Or John Thain, who offers to pay back the $1.2 million he spent on his office while firing his employees. I think John Thain should by now be incapable of paying such amounts, period. Merrill Lynch paid out billions of dollars in bonuses when it was already clear they were going down and being bought up by Bank of America, with, there's the term once again, taxpayers' money. Confiscate it.
How about Richard Fuld, who led Lehman Brothers into a black hole that has left pain behind around the globe, and who turns out to have sold his $13 million Florida estate to his wife for $10. Leave him with only $10, about the daily pay in a state penitentiary. I don't necessarily want to see anyone behind bars, that's not my thing. But I AM very worried about the fact that if your societies don't deal with cases such as these in a way that is perceived by citizens as fair, the erosion of confidence and trust in that fairness will continue. Which will lead to pitchforks. When you have governments led by politicians who are too close to the financial fire, that will not happen: they will not push for what they see as one of their own to be punished the same way others would be. And that inevitably leads to a very dangerous and volatile situation. In Britain, there was a report yesterday that some of the happy few hoi-polloi in the House of Lords were willing to be paid by special interests to change laws. But they are not in prison yet, far as I know. UK bank auditors have filed false reports on the health of their clients. They still drive BMW's. And we can't go on like this.
Over the past few days, reports coming out of the UK have been alarming, and banks have lost 60-70% of their value. There may be a Barclay’s letter today that causes its stock to rise 70%, but the banking system is teetering. One more bad report could mean the end of that system, and the UK government. It will happen anyway; there's not enough money in the British economy to save the banks. Germany's banks are not in a much better state. While the system is very different, in that it's much less consolidated and concentrated, domino's can still start an unstoppable fall.
In the face of this, governments all over are preparing more, bigger, and more daring rescues and bail-outs. The most desperate and perilous one to date comes from my country of birth, The Netherlands. ING is a bank involved in the worst take-over failure in history, that of Dutch bank ABN-AMRO, the one that has also forced RBS in England and BNP Paribas to their respective knees. A few months ago, the Dutch government gave ING $13.5 billion. Today, they come with the classic double or nothing gamble. The Minister of Finance told parliament that the chance of making a profit on the deal is 70%. He should be fired for that remark alone, that's just a blatant lie. The deal is this: Holland's taxpayers are now responsible for 80% of ING's existing package of US mortgage-backed securities (MBS), which somehow got estimated to have about a $40 billion value (?!). ING doesn't have to give up anything, except for a change of CEO. No nationalization, no equity, nothing. The poor people of Holland (who got a lot poorer today) will pay ING 90 cents on the dollar for the MBS portfolio.
Some expert analyst firm, Keefe, Bruyette & Woods, says the paper is worth "only" 65 cents on the dollar, meaning there's some 40% in overpayment. But even then, still, really? 65 cents? Could you give me 25 recent examples in which substantial amounts of US MBS has traded at 65%? Please do, experts. Because I don't think, and this is based on experience, that the whole shebang is worth more than pennies on the dollar. And that would mean that the Dutch government just gave away about $35 billion of its citizens' money, without getting anything in return, to an utterly bankrupt institution. Sure, the finance monster (minister?!) claims to have looked at the books very thoroughly. Then again, that's what he said last time. And the time before that. Look, all these politicians have at one point or another admitted that they just don't know if their schemes will work, that they're entering unchartered territory. But those admissions always come way before they've committed to anything, or only after the fact, after another perverse amount of funds has been dished out.
Here’s that famous graph again that details the future of the Alt-A and Option-ARM US mortgages that we are talking about in the case of ING. It’s about two years old, but that's fine in this case (though I'd like an update). It's fine because it looks forward a number of years. As you can see, the worst part of subprime resets was "softened" by recent FED interest cuts, even though foreclosures still grew like kudzu. We are now in a lull, and soon the major part of the resets, the Alt-A and ARM part will start. In an economy in which credit is gone, in which unemployment rises fast, in which industrial production scrapes rusty gutters, in which consumer spending won't recover in a long time, if ever, in which people's money is being taken from them to provide life-support to fatally ill institutions, and in which individual debt levels rise significantly every single day.
No, minister Bos, there will never be any profits on the MBS portfolio at ING. As I said, you should be kicked out for even suggesting it. ING is a lost cause. They have, like all other major banks, tons more in toxic debt in their vaults. For a small country like The Netherlands, 20.000 lay-offs in one day is a lot. And so is $40 billion. A government cabinet should not be a casino. But that's what you have made it, like so many of your peers around the world. If you want to know your future, look at Iceland. You're just another gambler leaning on a vague belief system, and willing to risk the futures of your voters on another double or nothing, with no Plan B in sight.
Your voters never gave you permission to place ordinary bets with their money. So what's up with that? Why do you do it regardless? You say you have looked at the books. So let's see them. It's our money not yours. Open the books. You, like all your peers, will eventually be forced to do so anyway. To put this into perspective: Holland's population is some 5% of the US. So a $40 billion rescue plan equals a $800 billion US bail-out. That's about what Obama has in mind for his big and doomed rescue plan for the entire US economy. Holland spends it on just one already bankrupt bank! Las Vegas real estate may be plummeting, but its philosophies still rule the planet. And I, for one, am very sorry to see my dainty little country by the sea be swallowed up by a double or nothing bet. And then have it presented, in parliament of all places, as a profit opportunity. That sort of thing makes me lose my hope for all of us, everywhere.
Warning: Megabanks Could Fail Despite Federal Aid
by Martin Weiss
The time has come to issue one my sternest warnings to date: Bank of America and Citigroup could fail despite the most radical government rescues of all time. Right now, after recent close calls with instant death, these two megabanks are on life support, receiving massive transfusions of government capital. But they’re still hemorrhaging, and no one in Washington has found a cure. Already, they have received capital injections of $90 billion ($45 billion each). Already, this bailout is larger than the total combined capital of PNC Bank, Suntrust Bank and State Street Bank — all among America’s ten largest. Yet, ironically, that $90 billion is still a drop in the ocean compared to their massive exposure to risky assets. The shocking facts revealed in the banks’ own balance sheets and in the OCC’s Quarterly Report demonstrate the enormity of problem:
- Fact #1. Too big to save. Bank of America Corp. and Citigroup, Inc. have combined assets of $3.9 trillion, or 43 times the size of the Treasury bailout funds they’ve received to date.
- Fact #2. Bigger losses ahead. Even before any further declines in the economy, an unusually large portion of their assets are already in grave jeopardy — commercial real estate loans going sour, credit cards loans tanking, auto loans sinking, and residential mortgages turning to dust. Now, as the economy continues to tumble, avoiding much larger losses will be almost impossible.
- Fact #3. Big derivatives players. Bank of America and Citigroup are the nation’s second and third largest high-rollers in the derivatives market, with a combined total of $78 trillion in these bets outstanding. That’s over ten times the derivatives that Lehman Brothers had on its books when it failed last year.
- Fact #4. They’ve bet far too much on each other’s failure.
Bank of America and Citigroup are also the second and third largest participants in the most dangerous derivatives of all — credit default swaps. These are the big bets that financial institutions make on the failure of other major companies. But participants in this market are like shipwrecked sailors in a sinking lifeboat betting fortunes on who will live and who will survive: If a company bets too heavily on failures and too many companies actually fail, who’s going to make good on those bets?
And unfortunately, betting on each other’s demise in huge amounts is exactly what the nation’s megabanks have done. At their latest reckoning, Bank of America and Citigroup held credit default swaps with notional values of $2.5 trillion and $3.3 trillion, respectively. Total between the two: An astounding $5.8 trillion! This number is not directly comparable to capital. But just to give you a sense of the magnitude of the problem, Bank of America and Citigroup’s combined credit default swaps are more than sixty times larger than the $90 billion they’ve received so far in capital infusions from the Treasury Department.
- Fact #5. JPMorgan Chase is not far behind.Right now, Washington and Wall Street are still counting on at least JPMorgan Chase to pick up the pieces after major failures and shotgun mergers. But according to the OCC, among the three megabanks, JPMorgan Chase is actually the most heavily leveraged, with over 400% of its capital already exposed to the risk of default by trading partners. Bank of America’s and Citigroup’s exposure (177.6% and 259.5%, respectively) is also wild, but JPMorgan Chase’s exposure is obviously far greater.
- Fact #6. JPMorgan Chase’s derivatives could double the size of the banking crisis overnight. On the day that JPMorgan Chase needs to join the ailing Bank of America and Citigroup in Uncle Sam’s intensive care unit, the derivatives mess doubles immediately. Reason: The bank has $9.2 trillion in credit default swaps, almost twice as much as Bank of America and Citigroup combined.
- Fact #7. Stocks crashing. Shares in failed banks are worth zero, and that’s where Bank of America’s are headed. Citigroup’s are already close, making it almost impossible for the company to raise capital from investors.
In light of these facts, how can the government save America’s megabanks? Wall Street is hoping that the Obama administration will create a separate, government-run "bad bank" to take bad assets off their hands. And some pundits are even proposing that the U.S. government nationalize the big banks in trouble. But …
- Neither approach addresses the obvious reason our nation’s banks are in the ICU to begin with: Excess debts and risk-taking. In fact, these "solutions" would merely pile on more of the same. Meanwhile …
- Both approaches spread and transform the contagion from a Wall Street debt crisis into a Washington debt crisis, as the federal deficit explodes to as much as $2 trillion in fiscal 2009.
My Forecast: Washington Will Ultimately Lose This Epic Battle! No matter what the government does, it cannot patch back together the busted market for mortgages, derivatives and especially credit default swaps. It cannot stop a pandemic of loan losses among large AND small banks as the economy sinks and traditional bank lending goes bad. It cannot stop the contagion of falling confidence, fear and panic. It cannot outlaw gravity or stop investors from selling. Nor can it turn back the clock and reverse years of financial sins. So don’t count on Uncle Sam to save your bank, your business, or the economy. Keep up to 90% of your money in cash. Avoid bank deposits as much as possible, using mostly short-term Treasury bills or equivalent.
ING cuts 7,000 jobs for saving $1.4 billion
The biggest Dutch banking and insurance services company ING announced to cut up to 7,000 jobs in an effort to help save $1.4 billion. ING has replaced Chief Executive Officer Michel Tilmant after reporting a second consecutive quarterly loss. ING, which in October took 10 billion euros, or about $13 billion, from the Dutch government to bolster its capital, said it expected to post a 2008 full year net loss of about 1 billion euros. ING, one of the world’s top 20 banks by market capitalisation and with 85 million clients, will also use a Dutch state guarantee for its loans portfolio. The bank said the Dutch government would cover 80% of its 27.7bn euros residential mortgage-backed securities.
Dutch applauded over 'realistic' ING scheme
As the Treasury struggled with the vexed question of how many hundreds of billions its bailout of the banking system would cost the taxpayer, the Dutch government today won applause for what was seen as an innovative deal to rescue the stricken ING bank. The British Government's bailout is structured as an insurance scheme whereby the bank will shoulder a fixed percentage of its losses with the taxpayer stepping in to insure the rest. Treasury mandarins have been working night and day to thrash out how much of the losses should be borne by the taxpayer and how much by the banks. A US version of the scheme is insisting its banks pay the first 8%, but leaks last week suggested the British Government was looking at a level of about 2% - meaning that a far bigger burden would be shouldered by the taxpayer.
The Dutch have come up with a far more generous scheme, requiring very little from ING in return for its cash. While it may be 'politically incorrect', analysts said it reflected a realistic view of the fact that banks needed to be helped, not hindered with punitive charges and a threat of nationalisation that has destroyed share prices and weakened their balance sheets. In its deal, the Dutch state takes on the risks of 80% of ING's €27.7bn (£26bn) portfolio of risky mortgages - technically called Alt-A mortgages - allowing it 80% of the profits or losses the products make over time. Conscious of the need to keep ING strong enough to get its lending capabilities back to more normal levels, the Dutch have gone out of their way to avoid punitive charges or demand ING shares as payment - the creeping nationalisation being witnessed in the UK.
They are even valuing the Alt-A securities they are taking at well above the odds - paying about 90% of their value when the current market price would be more like 65%. ING will pay the government a fee for the help, but that will be offset by a management charge paid by the Dutch government to ING. 'The Dutch have done what the UK needs to do,' said Jon Kirk, banking analyst at researcher Redburn.
Dutch treat for ING ups ante for other governments
There are rescue packages and there are rescue packages. The Dutch government's second plan for ING has been a lot more favorably received than the second U.K. rescue for the Royal Bank of Scotland . There's little wonder why. Holland has taken on 80% of ING's 27.7 billion euro portfolio of Alt-A mortgages. That, in itself, is not unique. The Swiss government is protecting a UBS portfolio of toxic securities. Uncle Sam is backing a whole panoply of Citigroup and Bank of America debt. What is new is the price being paid. If Holland absorbs the assets, it will pay ING 90 cents on the dollar (and make no mistake, these are dollars, not euros -- it's a purely U.S. portfolio.)
But, according to a research note from Keefe, Bruyette & Woods, the securities are trading at 65 cents on the dollar. Not bad going for mortgages on some Florida swamp. Sure, there are strings attached, notably that CEO Michel Tilmant clean out his desk and, perhaps, collection of rugs. Nonetheless, it's a very generous package in total, and Holland isn't even asking for ING equity in return. Governments have dithered in whether to use the carrot or stick when dealing with loss-swamped banks. Most have tried both. To the credit of governments, the worldwide financial system has not completely collapsed. But judging by the continued lack of lending around the globe, their methods haven't really worked either. The Dutch have gone clearly the carrot direction. It's certainly not fair to taxpayers - but it may be the more intelligent route.
Stocks Surge on Lay Off Announcements
Stocks surged during early trading today despite weak earnings and big layoff announcements from corporations weakened by the recession. The Dow Jones industrial average was up 1.37 percent or110.9 points, while the Standard & Poor's 500 index was up 2 percent, or 16.9 points. The tech-heavy Nasdaq was up 2 percent or 30.4 points. Caterpillar, the maker of mining and construction equipment, said its fourth-quarter profit fell 32 percent and that it would lay off 20,000 workers. "We were whipsawed in the fourth quarter as key industries were hit by a rapidly deteriorating global economy and plunging commodity prices," Jim Owens, Caterpillar's chairman, said in a statement. The company, pointing to continued economic weakness, lowered its revenue and profit expectations for the year. Its stock tumbled 10 percent.
Sprint Nextel gained about 2 percent after announcing it would lay off 8,000 workers. Home Depot announced plans to eliminate 7,000 positions, or 2 percent of its workforce, and close its EXPO Design Centers. It's stock was up 5 percent. Dutch Bank ING Group is planning to eliminate 7,000 jobs. The market appears to be cheered by Pfizer's deal to acquire Wyeth for $68 billion. That deal is expected to include the elimination of 8,000 positions, but is an indication that acquisitions are still possible during the economic downturn. In economic news, existing home sales rose 6.5 percent to a seasonally adjusted annual rate of 4.74 million units in December, according to data from the National Association of Realtors. It is down 3.5 percent from December 2007. The median existing-home prices fell 15.3 percent to $175,400 in December, compared with December 2007.
Despite the unexpected uptick last month, sales in 2008 were still dismal. Sales fell 13.1 percent to 4.9 million. That is the lowest level of sales since 1997. The median prices for the year was $198,600, down 9.3 percent from 2007. "It appears some buyers are taking advantage of much lower home prices," Lawrence Yun, NAR chief economist, said in a statement. "The higher monthly sales gain and falling inventory are steps in the right direction, but the market is still far from normal balanced conditions. Buyers will continue to have an edge over sellers for the foreseeable future." Crude oil prices fell 2 percent to $45 a barrel.
Gloom deepens as 60,000 jobs go
The scale of the global economic downturn was thrown into stark relief on Monday as companies across Europe and the US announced plans to shed a total of more than 60,000 jobs. Heading the list on Monday was Caterpillar, the world’s largest maker of construction equipment and heavy-duty engines, which is cutting 20,000 jobs as the company – often seen as a bellwether for the overall US economy – struggles to cope with the downturn. Drugmaker Pfizer, which on Monday announced a $68bn acquisition of rival Wyeth, said it planned to cut 15 per cent of the combined company’s workforce, or 19,000 people. Among other US companies, Sprint Nextel, the nation’s number three mobile phone operator, said it would cut 8,000 jobs, or 14 per cent of its workforce, while DIY retailer Home Depot is shedding 7,000 posts and freezing salaries as it battles against a consumer slowdown in the US.
US President Barack Obama said on Monday that job cuts in US industry showed the urgent need for his economic stimulus programme. “We cannot afford distractions, we cannot afford delays, in getting legislation to boost the economy through Congress,” he said. The grim news from the US came after Dutch bank ING said it would axe 7,000 staff from its global payroll of about 130,000 and compatriot Philips, the electronics group, announced the loss of 6,000 jobs as it accelerated its restructuring plans. Corus, Britain’s largest steelmaker which is owned by India’s Tata Group, announced cuts of 3,500 jobs from its global workforce of 41,000, with more than 2,000 jobs to go in the UK where it employs 20,000.
The job cuts come as industry across the world slashes production. Figures released earlier this month showed the US economy lost more than half a million jobs in December for the second month running, taking the total of jobs lost in 2008 to 2.6m – the worst year for job losses since 1945. The jobless rate, which hit a low of 4.4 per cent before the credit crisis, has jumped to 7.2 per cent, its highest in 16 years. Germany, the UK, France and Spain have all reported sharp falls in industrial output, with some year-on-year falls running into double digits. The UK said last week that unemployment soared to almost 2m in the closing months of last year, with business leaders and economists warning that the “darkest days for jobs” were still to come.
Caterpillar to slash work force by 20,000
Caterpillar, seeing sales for its bulldozers and other heavy equipment sinking in a worldwide economic mire, said Monday that its business was “whipsawed” during the fourth quarter and that it would eliminate 20,000 jobs in the face of a “very tough” 2009. The Peoria, Ill.-based company said the job reductions would affect every line of business and every geographical area where it has operations. Specifics were not available on how the job cuts might affect Caterpillar’s facilities in Clayton and Sanford. A Caterpillar spokesman did not immediately return a phone call seeking comment. Caterpillar announced the staff reductions as part of its fourth quarter earnings report, released Monday morning. The company said that while its revenue and profit for full-year 2008 were strong, its business ran head first into the worldwide recession in the fourth quarter.
"Through the first three quarters we experienced booming demand from key global industries, notably mining and energy,” said Jim Owens, Caterpillar’s chairman and CEO. “Then we were whipsawed in the fourth quarter as key industries were hit by a rapidly deteriorating global economy and plunging commodity prices. In anticipation of lower demand we encouraged dealers to align inventory with declining volume, and they responded with significant order cancellations, particularly in December." Caterpillar expects conditions to worsen in 2009, Owens said. The company is shedding the 20,000 jobs because it sees the need to lower costs in anticipation of a 25 percent reduction in sales this year. The company expects to have made most of the cuts by the end of the first quarter.
"These are very uncertain times, and it's imperative that we focus Team Caterpillar on dramatically reducing production schedules and costs in light of poor economic conditions throughout the world," Owens said. "While it's painful for our employees and suppliers, it's absolutely necessary given economic circumstances.” Caterpillar reported a fourth quarter profit of $661 million, down from net income of $975 million in the fourth quarter of 2007. Revenue rose by 6.4 percent, to $12.92 billion. Caterpillar said its earnings were hurt by higher operating costs for its Machinery and Engines business and by significantly lower profit from its Financial Products division. Those factors more than offset a $409 million one-time gain on a tax adjustment.”
"Fourth-quarter profit was disappointing, particularly in light of record fourth-quarter sales and revenues and a significant favorable tax adjustment," Owens said.
Caterpillar already has announced measures to deal with the slowing economy. The company said in October that its plants in Sanford and Clayton would experience work stoppages around the holidays. Then the company said Dec. 18 that some employees at those facilities would face temporary layoffs .
On Dec. 22, Caterpillar announced pay cuts of up to 50 percent for its executives and smaller reductions for other levels of management. The company also said it was offering buyouts to selected management-level employees.
Sprint job cuts to total 8,000
Sprint Nextel Corp. will cut a total of about 8,000 jobs by March 31, the company said Monday. The plan is to reduce internal and external labor costs by about $1.2 billion on an annual basis, Sprint Nextel said in a press release. The cuts will affect all levels of the company and various geographic locations, said telecommunications company, which currently employs about 60,000 people. "Labor reductions are always the most difficult action to take, but many companies are finding it necessary in this environment," said Sprint CEO Dan Hesse.
Sprint, the third-largest wireless provider in the country, repaid $2 billion in debt in the second half of 2008. The Overland Park, Kan.-based company has struggled against its more healthy rivals,AT&T and Verizon Communications. The job reduction total includes about 850 positions that the company said it expected would be eliminated under a voluntary separation plan started in late 2008. Severance and related costs associated with the reduction could result in a charge of more than $300 million in the first quarter of 2009, the release said. Sprint said the company is also suspending its 401(k) match for the year, extending a freeze on salary increases and suspending its tuition reimbursement program. The company will release its fourth-quarter 2008 financial results on Feb. 19, earlier than previously announced. Shares of Sprint rose 1 cent to $2.47.
Home Depot cutting 7,000 jobs
Home Depot, the No. 1 home improvement retailer, announced Monday that it is shuttering its high-end EXPO business and shrinking its support staff, with both moves resulting in a reduction 7,000 jobs. Home Depot said the staff cuts impact 2% of its total workforce. The company said the the latest job cuts will not impact any customer service positions in its Home Depot stores. "Exiting our EXPO business is a difficult decision, particularly given the hard work and dedication of our associates in that business and the support of our loyal customers," Home Depot CEO said in a statement. "At the same time, it is a necessary decision that will strengthen our core Home Depot business."
The company said in a statement that its EXPO business has not performed well financially and is not expected to anytime soon. "Even during the recent housing boom, it was not a strong business. It has weakened significantly as the demand for big ticket design and decor projects has declined in the current economic environment. Continuing this business would divert focus and resources from the company's core [Home Depot] stores," the statement said. Over the next two months, the closure of 34 EXPO Design Center stores, five YardBIRDS stores, two Design Center stores and a bath remodeling business known as HD Bath will impact 5,000 jobs, the company said. Additionally, the retailer said it will reduce support staff, impacting about 2,000 employees, and will result in a 10% reduction in the company's officer ranks.
Home Depot also announced a salary freeze for all of its officers although the retailer would continue to offer merit increases to non-officer level staff, earned bonuses an the company's existing 401 (k) matching contribution for all employees, including officers. The company reiterated its previously announced full-year sales and profit guidance. Home Depot expects fiscal 2008 sales and earnings per share from continuing operations to decline by 8% and 24% respectively, excluding charge associated with the latest job cuts and store closings Analysts expect Home Depot to post full-year profit of $1.73 a share on sales of $71.5 billion, according to Thomson Reuters. For 2009, Home Depot said it expects continued weakness in sales. The retailer said it will cut capital expenditure to approximately $1 billion and will open 12 stores. Home Depot will report its full-year results next month.
Philips to cut 6,000 more jobs after huge Q4 loss
Europe's largest consumer electronics group, Royal Philips Electronics NV (Amsterdam, the Netherlands) is to reduce its workforce by 6,000 worldwide this year after reporting its first quarterly loss for almost six years. It also halted an ongoing shares buy-back program. The company suffered a net loss of €186 million for 2008 after a fourth quarter loss of €1.47 billion, partly because of a write-down in the value of its Lumileds diode light unit, as well as downgrading the value of its remaining stakes in NXP Semiconductors and LG Display Co. In 2007, the company reported a net profit of €4.16 billion.
Sales for the year were €26.4 billon, down 1.5 percent, but fourth-quarter sales fell 8.9 percent to €7.62 billion. Gerard Kleisterlee, the president and chief executive, said that the fourth-quarter losses reflected "the unprecedented speed and ferocity with which the economy softened in 2008". He added that, in response to a sharp reduction in demand, especially in its consumer lifestyle and lighting businesses, management was giving "absolute priority to cash flow, where necessary at the expense of operating profits". Kleisterlee announced that in addition to the 3,000 job reductions made in the fourth quarter, a further 6,000 would be cut during the current year, adding this would cost about €400 million. The €232 million impairment charge against the goodwill of Lumileds came because of softening of demand for LEDs in segments ranging from the automotive, display and mobile phone market
Tata’s Corus to Cut 3,500 Jobs in U.K., Netherlands
Corus, Europe’s second-largest steelmaker, will cut 3,500 jobs as it reduces production following a collapse in demand from builders and carmakers. The company will slash 2,500 jobs in the U.K. and a further 1,000 jobs in the rest of Europe, or 8 percent of its workforce, after demand in the region fell 40 percent from a peak last year, Chief Executive Officer Philippe Varin said today. "The current measures match with the current level of demand," Varin said on a conference call, adding that three U.K. blast furnaces will remain idled through the second quarter. Corus said in October it would cut production by 20 percent, joining producers including Luxembourg-based ArcelorMittal, the world’s biggest steelmaker, and Thyssenkrupp AG, Germany’s largest, in curbing output as the world tips into recession. The reductions by Corus will boost annual operating profit by more than 200 million pounds ($275.5 million), the London-based unit of India’s Tata Steel Ltd. said today in an e-mailed statement.
Corus will sell a majority stake in Teesside Cast Products, mothball its Llanwern hot strip mill in Wales and close a defined benefit pension scheme to new members. It is seeking to cut costs by 20 percent in areas such as IT, finance and human resources. The company yesterday said orders for steel are down by a third. Worker representatives in the U.K. and Netherlands expressed concern about the cuts. The U.K.’s Community labor union was seeking "urgent" talks with Corus and aiming to "minimize" job losses, General Secretary Michael Leahy said in an e-mailed statement today. The Central Works Council for Corus’s Netherlands unit said it didn’t approve of compulsory job cuts.
Corus said it was talking to the U.K. government in hope of gaining funding to retrain workers who lose their jobs. The company said Dec. 31 it was eligible for financial support from the Dutch government to cut working hours at its IJmuiden plant. Corus, which makes steel for construction, cars, packaging and engineering, employs about 42,000 people in countries including the U.K. and the Netherlands. The company, formed in 1999 through the merger of British Steel Plc and Koninklijke Hoogovens NV, was bought in 2007 by Tata for 6.8 billion pounds. The price of European hot-rolled coil steel, a benchmark product used in cars and construction, has dropped 47 percent to $430 a metric ton since reaching a record in June, according to data compiled by Metal Bulletin.
GM to cut 2,000 jobs at Michigan, Ohio plants
General Motors Corp. is cutting a shift of production at both the Lansing-Delta Township and Lordstown, Ohio, assembly plants, resulting in 2,000 job cuts, the company announced this morning. In addition, the automaker plans to reduce its production of vehicles this year by adding various weeks of shutdowns at other company plants, Sherrie Childers Arb, a GM spokeswoman, said. She said 800 hourly and salaried jobs will be lost at the Lordstown facility and 1,200 at the Lansing-Delta plant.
"We need to rightsize our production with our sales and inventory. We need to do that. We’re going to take the appropriate actions that need to be taken," Ed Peper, GM North America vice president of Chevrolet, said following a meeting with GM dealers at the National Automobile Dealers Association convention Sunday in New Orleans. Asked about the production cuts Sunday, GM North America President Troy Clarke said the decision was "a function of the fact that the market is down."
Bankers' Fear of Unemployment
Despite all the pain in the financial sector, bank executives' biggest fear has yet to materialize. Now, it is rearing its ugly head. Bankers' worst nightmare is the unemployment rate climbing toward 10%, a level at which credit losses could balloon unpredictably because of high defaults among people with previously strong credit histories. Right now, bank balance sheets don't appear in a position to deal with unemployment moving sharply higher from its current 7.2% rate. Building up bad-loan reserves to deal with a 9% to 10% rate could produce enormous losses and pulverize capital when banks are trying to preserve the thin cushions they have. And fear of rising unemployment could deter lending when the government wants banks to expand credit. True, the Obama administration's stimulus plan could reduce unemployment expectations. But right now, banks are hoisting their joblessness forecasts.
Last week, consumer lender Capital One Financial increased its unemployment forecast to 8.7% by the end of 2009, from its previous expectation of 7% by midyear. And Capital One added that it is building more-severe unemployment scenarios into lending decisions. Also last week, Kelly King, chief executive of regional bank BB&T, said unemployment of 8% to 8.5% is "kind of manageable," but 9% to 10% would "have a dramatic impact on our scenarios." Why the trepidation of going above 9%? Take a regular credit-card book. Past data show that a percentage-point increase in unemployment leads to roughly a percentage-point rise in the charge-off rate, the amount of defaulted loans written off at a loss. But as unemployment exceeds 9%, bankers think charge-offs will start to increase by more than the increase in unemployment. The reason? A high rate could cause an unprecedented wave of defaults among prime borrowers, who tend to have bigger loan balances.
As unemployment gets worse, investors shouldn't rely on some bank executives to paint a clear picture about credit losses. "The situation is so extreme and beyond what we've seen in past cycles that management teams are becoming reluctant to predict the relationship between unemployment and credit losses," said Kevin Fitzsimmons, analyst at Sandler O'Neill & Partners. Investors can stay one step ahead by identifying banks that are exposed to regions and products that unemployment could hit hardest. Particular caution should be shown toward banks focused on California, where unemployment already is 8.4% and rose to 11% in the early-1980s' recession. Investors should quiz Golden State-based Wells Fargo about the relationship between job losses and credit when it reports earnings Wednesday.
The credit boom created an explosion of new-fangled, high-balance loans to prime borrowers that could get hit badly as unemployment rises. Last week, Capital One mentioned that its closed-end loans were going bad quickly, even though they were made to what the bank calls "superprime" borrowers. After halving in 2008, bank stocks already are down more than a third this year. Until the unemployment angst goes away, don't expect a strong recovery.
Economic Crisis Fuels Unrest in Eastern Europe
On a frigid evening this month, more than 10,000 people gathered outside a 13th-century cathedral in this Baltic capital to protest the government's handling of Latvia's economic crisis and demand early elections. The demonstration was one of the largest here since the mass rallies against Soviet rule in the late 1980s, and a sign of both the public's frustration and its faith in the political system. But at the end of the night, as the crowd dispersed, the protest turned into a riot. Hundreds of angry young people, many drunk and recently unemployed, rampaged through the historic Old Town, smashing shop windows, throwing rocks and eggs at police, even prying cobblestones from the streets to lob at the Parliament building.
Similar outbursts of civil unrest have occurred in recent weeks across the periphery of Europe, where the global financial crisis has buffeted smaller countries with fewer resources to defend their economies. Especially in Eastern Europe, the turmoil reflects surging political discontent and threatens to topple shaky governments that have been the focus of popular resentment over corruption for years. Europeans have compared the unrest to events of the 1960s and even the 1930s, when the Great Depression fueled political upheaval across the continent and gave rise to isolationism and fascism. But no ideology has tapped into public anger and challenged the basic dominance of free-market economics and democratic politics in these countries. Instead, protesters appear united primarily by dashed economic hopes and hostility against the ruling authorities.
"The politicians never think about the country, about the ordinary people," said Nikolai Tikhomirov, 23, an electronics salesman who participated in the Jan. 13 protest in Riga. "They only think of themselves." Days after the riot, a demonstration by 7,000 protesters in neighboring Lithuania turned violent, leading police to respond with rubber bullets. Fifteen people were injured. Smaller protests and clashes have erupted in Bulgaria, the Czech Republic and Hungary, following weeks of street violence in Greece last month. On Thursday, police in Iceland used tear gas for the first time in half a century to disperse a crowd of 2,000 protesting outside Parliament in Reykjavik. The next day, Prime Minister Geir Haarde agreed to call early elections and said he would step down.
Dominique Strauss-Kahn, head of the International Monetary Fund, said the financial crisis could cause further turmoil "almost everywhere," listing Latvia, Hungary, Belarus and Ukraine as among the most vulnerable nations. "It may worsen in the coming months," he told the BBC. "The situation is really, really serious." There is particular concern about the relatively young and sometimes dysfunctional democracies that emerged after the fall of communism in Eastern Europe, where societies that endured severe hardship in the 1990s in the hope that capitalism and integration with the West would bring prosperity now face further pain. "The political systems in all these countries are fragile," said Jonathan Eyal, director of international security studies at the Royal United Services Institute, a research group in London. "There's a long history of unfulfilled promises and frustration with the political elites going back to the Communist era."
Eyal warned of a revival of ethnic conflict in the region, where most countries have large minority populations, adding that tensions could rise after workers who have lost jobs in Western Europe return home. But he noted that extreme nationalist movements have won only limited support in Eastern Europe in recent years. "People here instinctively know the idea of a strongman who imposes order doesn't work," he said, arguing that the region's history with Communist rule, its integration with the European Union and its anxiety about Russia's intentions make a turn toward authoritarianism unlikely. "They have seen the past, and a return to previous populist schemes isn't very persuasive. At the end of the day, they know there's no alternative to the market economy." That assessment rings true in Latvia, where the government's approval ratings have fallen as low as 10 percent -- the worst in the European Union, and lower than at any other time in the nation's post-Soviet history -- but where people scoff when asked if they want to abandon markets and political freedoms.
"If some politician said, 'Let's leave the E.U., give up democracy and free markets,' you can be sure that nobody would vote for him," said Aigars Freimanis, director of Latvia's largest polling firm. The memory of Soviet occupation makes it difficult even for mildly left-wing parties to win elections, he said. But Freimanis said public anger could bring significant political change, noting that the crisis has renewed debate on constitutional reforms, including measures to give citizens the right to dismiss Parliament and to vote for individual lawmakers instead of only political parties. "We want more democracy, not less," said Renata Kalivod, 28, a social worker who attended the protest in Riga. She said that her father, who recently lost his job, had given up on elections but that she still believed it was possible for the public to have an impact. "If I gave up, I would leave the country like other young people. But I'm still here," she said.
After enjoying double-digit growth rates that were among the highest in the E.U., Latvia is now struggling to defend its currency and survive a sharp slowdown. The economy is forecast to shrink by 5 percent this year, after a 2 percent drop last year. Unemployment has doubled in the last six months to 8 percent, with the rate three times as high among young people. Forced to accept a $10.5 billion bailout from the IMF, the European Union and other sources -- including neighboring Estonia, a fact some considered humiliating -- the government has embarked on an austerity program involving 25 percent budget cuts, 15 percent wage reductions for civil servants and large-scale layoffs. Aigars Stokenbergs, an opposition leader in Parliament who quit the ruling coalition and helped organize this month's protest, said the public was as upset about corruption as economic mismanagement. The same conservative parties have dominated the government for years, he said, and many believe they serve a handful of billionaires who struck it rich in the privatization schemes of the 1990s.
"People don't want this government anymore. They don't trust it," he said, criticizing Parliament for firing the nation's anti-corruption chief in June and adopting the IMF reforms in a single day without consulting unions, businesses or other groups. But Andris Berzins, a leader in the ruling coalition and former prime minister, said the public's anger is misplaced because the country's problems are rooted in decisions by previous administrations to expand spending instead of building up reserves. "The government needs to take some very serious economic reforms, but it hasn't been able to build public support for them," he said. Public anger intensified in December when the finance minister, Atis Slakteris, badly fumbled an interview on Bloomberg Television. Asked what had caused Latvia's economic crisis, he replied, "Nothing special." The words were soon emblazoned on T-shirts and shop windows as parodies proliferated on the Internet.
The riots, which left about 25 people injured and resulted in 106 arrests, have unnerved people in part because Latvia has practically no history of such violence. Some are worried the crisis will exacerbate tensions between ethnic Latvians and the nation's Russian-speaking minorities, who make up more than a third of the population. President Valdis Zatlers has responded by distancing himself from the ruling coalition that elected him and essentially siding with the opposition, threatening to dismiss Parliament if it fails by March 31 to pass a set of reforms and take other specific actions to build public trust. Early elections would be held if it passed, followed by talks to form a new government. The entire process could take more than eight months, and some say such a prolonged period of political uncertainty would hinder Latvia's efforts to repair its economy, resulting in further unrest.
Governments across Eastern Europe face similar uncertainty, and analysts said the timing of electoral cycles could determine which ones fall. Newly elected governments in Lithuania and Romania might survive, for example, while the Bulgarian government faces elections this summer and is in trouble. Anders Aslund, a senior fellow at the Peterson Institute for International Economics in Washington, said it makes sense in Latvia to hold new elections because the current Parliament is "utterly discredited" and can do little for the economy in any case. "You can't have a government that has no support," he said. "It's useless." Analysts said the E.U. serves as a bulwark against radical politics in the region, but they warned of a backlash if the developed nations that dominate policymaking ignored the problems of the smaller ones. In Latvia, politicians and business leaders complain about E.U. agricultural subsidies that benefit farmers in Western Europe and trade barriers in the service sector. But they have praised the E.U.'s swift response to the country's economic crisis so far. Pavel Nazarov, 21, a physics student who participated in the rally, said he welcomed E.U. intervention for another reason. "They can keep an eye on our corrupt politicians," he said, "even when we can't."
Bernanke Risks 'Very Unstable' Market as He Weighs Buying Bonds
Federal Reserve Chairman Ben S. Bernanke and his colleagues may try once again to cure the aftermath of a bubble in one kind of asset by overheating the market for another. Fed policy makers meeting tomorrow and the day after are exploring the purchase of longer-dated Treasury securities in an effort to push up their price and bring down their yield. Behind the potential move: a desire to reduce long-term borrowing costs at a time when the Fed can’t lower short-term interest rates any further because they are effectively at zero. The risk is that central bankers will end up distorting the Treasury market, triggering wild swings in prices -- and long-term interest rates -- as investors react to what they say and do. "It sets forth a speculative dynamic that is very unstable," says William Poole, former president of the Federal Reserve Bank of St. Louis and now a senior fellow at the Cato Institute in Washington.
The Treasury market has "some bubble characteristics," Bill Gross, the manager of Newport Beach, California-based Pacific Investment Management Co.’s $132 billion Total Return Fund, said in December on Bloomberg Television. He echoed that sentiment last week. "I will say, and I have said for the past three months, the governments are very overvalued," Gross said in a Jan. 20 interview. Treasuries last year returned 14 percent, according to Merrill Lynch & Co.’s Treasury Master Index, their best performance since 1995. Recent history shows the economic danger of inflating asset prices. After a stock-market bubble burst in 2000, the Fed slashed interest rates to as low as 1 percent and in the process helped inflate the housing market. The collapse of that bubble is what eventually helped drive the U.S. into the current recession, the worst in a generation. Faced with the danger of a deflationary decline in output, prices and wages, the Fed is considering steps to revive the moribund economy.
On the table besides bond purchases: firming up a pledge to keep short-term interest rates low for an extended period and adopting some type of inflation target to underscore the Fed’s determination to avoid deflation. The central bank has been buying long-term Treasury debt off and on for years as part of its day-to-day management of reserves in the banking system. Yet it has always gone out of its way to avoid influencing prices. What it’s discussing now, says former Fed Governor Laurence Meyer, is deliberately trying to push long rates below where they otherwise might be. Bernanke raised this possibility in a speech on Dec. 1. While he didn’t specify what maturities the Fed might buy, in the past he has suggested that purchases might include securities with three- to six-year terms. Investors immediately took notice, with the yield on the 10-year note falling to 2.73 percent from 2.92 percent the day before. Yields fell further on Dec. 16, dropping to 2.26 percent from 2.51 percent the previous day, after the central bank’s policy-making Federal Open Market Committee said it was studying the issue.
"Every time they mention it, the market reacts," says Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut.
Yields have since risen, with the 10-year note ending last week at 2.62 percent. Behind the reversal: expectations of massive fresh supplies of Treasuries as the government is forced to finance an $825 billion economic-stimulus package and a possible new bank-bailout plan. This week alone, the Treasury is scheduled to auction $135 billion worth of securities. David Rosenberg, chief North American economist for Merrill Lynch in New York, says the jump in yields may prompt the Fed to go ahead with Treasury purchases. This isn’t the first time Bernanke and the Fed have discussed buying longer-dated securities and ended up roiling the market. Bernanke touted the idea as a tool to fight deflation in speeches in November 2002 and May 2003. Egged on by his comments -- and later remarks by then-Fed Chairman Alan Greenspan that the central bank needed to build a "firewall" against deflation -- many investors became convinced the central bank was poised to buy bonds. The yield on the 10-year Treasury note fell to 3.11 percent in June 2003 from 3.81 percent at the start of the year. Traders quickly reversed course as it became clear the Fed had no such intentions, sending the 10-year Treasury yield soaring to 4.6 percent just three months later, on Sept. 2.
Poole, who was then at the St. Louis Fed, was critical at the time of what he called the central bank’s "miscommunication." He now sees the Fed making the same mistake with its latest suggestions that it might buy longer- dated securities. "If they do it, it’s going to be disruptive to the market," says Poole, who is a contributor to Bloomberg News. "If they don’t do it, it will impair the Fed’s credibility and erode the confidence the market has in the statements that the Fed makes." Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers, says the Fed should, and probably will, go ahead with purchases as a way to lower borrowing costs. "The story is stop talking and start buying," he says. Still, he notes that not everyone at the Fed is enthusiastic about the idea. One concern: Foreign central banks and sovereign-wealth funds, which are big holders of Treasuries, might cool to buying many more if they believe prices are artificially high.
That may undermine the dollar. "There’s no guarantee that international investors would switch to other dollar- denominated debt if flushed from the Treasury market," says Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, says foreign investors might also get spooked if they conclude that the Fed is monetizing the government’s debt -- in effect, printing money -- by buying Treasuries. Bernanke himself, in his 2003 speech, said monetization of the debt risked faster inflation -- something bond investors, foreign or domestic, wouldn’t like. Some economists argue the Fed would help the economy more if it bought other types of debt. Even after their recent rise, 10-year Treasury yields are still well below the 4.02 percent level at the start of last year. Yields on investment-grade corporate bonds, in contrast, stood at 8.24 percent on Jan. 22, the latest date for which information is available, compared with 6.45 percent at the start of 2008, according to data compiled by the Fed.
Hawks at the Fed wouldn’t welcome such purchases. They are already uneasy that some of the central bank’s programs are effectively allocating credit to one part of the economy rather than others. Case in point: the Fed’s ongoing program to buy $500 billion of mortgage-backed securities, which Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, has called "credit policy" rather than monetary policy. J. Alfred Broaddus Jr., who was Richmond Fed president from 1993 to 2004, says the lesson from the early part of the decade isn’t that the Fed went too far in easing policy to avoid deflation -- it’s that policy makers should have tightened more quickly afterwards and not allowed themselves to be boxed in by their pledge to keep interest rates low for a considerable period. In the current context, that means buying bonds "is something worth looking at," he says. Still, the Fed "needs to be careful and be ready to reverse course, especially given all the money that it’s pumped into the system."
Geithner Debt Sales to Benefit From Paulson Failures
Former Treasury Secretary Henry Paulson’s inability to restore confidence in the financial system is creating unprecedented demand for U.S. debt as his successor prepares to sell the most bonds in history. Timothy Geithner, who may be confirmed as head of the Treasury today, will have the benefit of near record-low yields as he presides over auctions of as much as $150 billion of notes and bonds the next three weeks. Goldman Sachs Group Inc., one of the 17 primary dealers that are required to bid at the auctions, said last week the U.S. will likely borrow a record $2.5 trillion this fiscal year ending Sept. 30, almost triple the $892 billion in notes and bonds sold in fiscal 2008. "There is just such a huge demand from the flight to quality and the flight to liquidity," that the U.S. will have little difficulty selling the debt, said Joseph Shatz, a senior government bond strategist in New York at Merrill Lynch & Co., another primary dealer. "You have a lot of forces keeping Treasury yields low."
While Paulson won approval last year to spend $700 billion to stabilize the financial system, bank losses and failures are increasing, sending investors to Treasuries and driving up credit costs for everyone but the government. Four-week Treasury bill rates fell to 0.01 percent last week, while 30-year fixed- rate mortgages averaged 5.12 percent, 2.49 percentage points above 10-year U.S. notes. The difference averaged 1.79 percentage points since the start of the decade. Citigroup Inc. and Bank of America Corp. sought additional funds after receiving infusions in October. The Standard & Poor’s 500 Index, which fell the most since 1937 last year, is down 7.89 percent this month. Yields plunged in the past year as losses and writedowns at the biggest financial companies rose above $1 trillion. Two-year note yields ended last week at 0.81 percent, compared with the average of 3.49 percent this decade, while 10-year rates are 2.62 percent, versus the average of 4.56 percent.
The plunge is helping Geithner, the 47-year-old head of the Federal Reserve Bank of New York since November 2003, because government interest costs are falling even as the amount of debt rises. Interest paid by the Treasury in the last three months fell $18.3 billion as debt rose to $10.6 trillion in December from $9.23 trillion a year earlier, government figures show. President Barack Obama, 47, and Geithner are counting on demand for Treasuries to finance a $1 trillion budget deficit inherited from the administration of George W. Bush and Paulson, who was chairman of Goldman Sachs before becoming Treasury Secretary in July 2006. As the economy worsened last year, Paulson, 62, won approval for the $700 billion Troubled Asset Relief Program that’s injecting capital into financial firms. The $8.5 trillion of initiatives by the Treasury and Fed, including the TARP funds, to prop up financial markets have done little to bring down borrowing costs for consumers and companies.
Even though the Fed cut its target rate for overnight loans between banks to as little as zero in December, from 4.25 percent a year earlier, companies are paying more to sell debt. It costs U.S. companies on average 9.5 percent to borrow in the bond market, up from 6.45 percent a year ago, representing about an extra $30 million a year in interest on every $1 billion of securities, according to Merrill Lynch & Co. index data. Banks charge each other about 1.07 percentage points more than what it costs the government to borrow for three months, up from an average of 0.32 percentage point before the credit markets seized up in the second half of 2007. Regulators closed 25 banks last year, the most since 1993, and shut three this year. New York-based Citigroup and Bank of America in Charlotte, North Carolina, are down more than 50 percent in New York Stock Exchange trading this year after the second- and third-largest U.S. banks sought more funding through TARP. Financial companies shrank to less than 10 percent of the S&P 500 last week, the least since the savings and loan crisis of the early 1990s, and down from the peak of 22.43 percent on Oct. 3, 2006, according to data compiled by Bloomberg. "When somebody wants to judge the Treasury Secretary you look at the broad stock indexes and the financial stocks," said Michael Cheah, who manages $2 billion in bonds at AIG SunAmerica Asset Management in Jersey City, New Jersey.
U.S. financial losses may reach $3.6 trillion, suggesting the banking system is "effectively insolvent," New York University Professor Nouriel Roubini, who in January 2007 predicted the economy was headed for a "hard landing," told a conference in Dubai on Jan. 20. Obama will have to use as much as $1 trillion of public funds to bolster the capitalization of the industry, he estimates. The government may say this week that gross domestic product contracted 5.5 percent last quarter, the most since it shrank 6.4 percent in the first three months of 1982, according to the median estimate of 66 economist surveyed by Bloomberg. Redmond, Washington-based Microsoft Corp. said last week it will cut as many 5,000 jobs, the first companywide firings in its 34- year history, because sales and profit will probably drop. "We’re turning up the volume on bad data," said Maxwell Bublitz, who oversees $3.5 billion in bonds as chief strategist at San Francisco-based SCM Advisors LLC. He said 10-year yields may drop below 2 percent, after ending last week at 2.62 percent. "As we approach 2.75 on the 10-year I kind of want to buy it."
To help pay for the bailouts and Obama’s proposed $825 million fiscal stimulus plan, the government will raise $78 billion this week selling debt with maturities ranging from 2 to 20 years. Wrightson, a Jersey City, New Jersey-based research firm specializing in government finance, forecasts the U.S. will auction $69 billion in 3-, 10-, and 30-year securities the week of Feb. 9 as part of the Treasury’s quarterly refunding. Treasury yields climbed last week from the record lows set in December as Obama revealed details of his economic stimulus plan and the government said the budget deficit soared to a record $485.2 billion in the first three months of the fiscal year that started Oct. 1. Thirty-year bond yields surged 44 basis points, or 0.44 percentage point, to 3.32 percent last week, the biggest increase since April 1987. Yields dropped to 2.51 percent on Dec. 18, the lowest since the Treasury began regular sales of so- called long bonds in 1977. They were 4.5 percent a year earlier. The yield was little changed as of 2:07 p.m. today in Tokyo.
Geithner helped push yields higher last week by saying during his Senate confirmation hearings that the Obama administration believes China is "manipulating" its currency. Paulson preferred diplomacy over confrontation with China to resolve disputes and, in semiannual reports, refrained from labeling the country a "manipulator." The remarks on China’s exchange-rate policy may mean a tougher line with the biggest foreign investor in government debt. China owned $681.9 billion of U.S. securities as of November, Treasury data show. "There’s concern on the China front," said Kevin Flanagan, a Purchase, New York-based fixed-income strategist for Morgan Stanley’s individual-investor clients. "Do they fire back and stop buying Treasuries, especially given the huge amount of supply we’re going to need to underwrite over the next few years?"
Higher government yields would jeopardize Fed efforts to lower consumer borrowing costs. Fed policy makers meeting tomorrow and the next day are exploring the purchase of longer- maturity Treasuries to push down yields and lower mortgage rates. While Fed Chairman Ben S. Bernanke and his colleagues risk distorting the Treasury market, the focus on driving borrowing costs lower makes U.S. debt attractive, according to Cheah of AIG SunAmerica. "Is this a buying opportunity for the Treasury bond market?" said Cheah. "I would say yes. Why? Because the Federal Reserve should be very concerned now with rising yields."
Existing home sales rise but prices see record drop
The pace of sales of existing homes in the U.S. rose 6.5 percent in December, but the median home price dropped by a record 15.3 percent compared to the same period the year earlier, a National Association of Realtors report showed on Monday. Existing home sales increased to a 4.74 million unit annual rate from a downwardly revised 4.45 million units in November. For the whole of 2008, existing home sales fell 13.1 percent to 4.91 million units, the lowest since 1997. The median national home price fell 15.3 percent from the year earlier to $175,400, the largest decline since the NAR started keeping records and probably the largest since the Great Depression, Lawrence Yun, NAR chief economist told reporters. Analysts polled by Reuters had expected existing home sales to set a 4.40 million unit pace in December. The inventory of existing homes for sale fell 11.7 percent to 3.68 million units from 4.16 million in November, translating into 9.3 months of supply.
Nationalization Gets a New, Serious Look
Only five days into the Obama presidency, members of the new administration and Democratic leaders in Congress are already dancing around one of the most politically delicate questions about the financial bailout: Is the president prepared to nationalize a huge swath of the nation’s banking system? Privately, most members of the Obama economic team concede that the rapid deterioration of the country’s biggest banks, notably Bank of America and Citigroup, is bound to require far larger investments of taxpayer money, atop the more than $300 billion of taxpayer money already poured into those two financial institutions and hundreds of others.
But if hundreds of billions of dollars of new investment is needed to shore up those banks, and perhaps their competitors, what do taxpayers get in return? And how do the risks escalate as government’s role expands from a few bailouts to control over a vast portion of the financial sector of the world’s largest economy? The Obama administration is making only glancing references to those questions. In an interview Sunday on "This Week" on ABC, the House speaker, Nancy Pelosi, alluded to internal debate when she was asked whether nationalization, or partial nationalization, of the largest banks was a good idea.
"Well, whatever you want to call it," said Ms. Pelosi, Democrat of California. "If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization. "I’m not talking about total ownership," she quickly cautioned — stopping herself by posing a question: "Would we have ever thought we would see the day when we’d be using that terminology? ‘Nationalization of the banks?’ "
So far, President Obama’s top aides have steered clear of the word entirely, and they are still actively discussing other alternatives, including creating a "bad bank" that would nationalize the worst nonperforming loans by taking them off the hands of financial institutions without actually taking ownership of the banks. Others talk of de facto nationalization, in which the government owns a sizeable chunk of the banks but not a majority, with all that connotes. That has already happened; taxpayers are now the biggest shareholders in Bank of America, with about 6 percent of the stock, and in Citigroup, with 7.8 percent. But the government’s influence is far larger than those numbers suggest, because it has guaranteed to absorb the losses of some of the two banks’ most toxic assets, a figure that could run into the hundreds of billions of dollars. Many believe this form of hybrid ownership — part government, part private, with the responsibilities of ownership unclear — will not prove workable.
"The case for full nationalization is far stronger now than it was a few months ago," said Adam S. Posen, the deputy director of the Peterson Institute for International Economics. "If you don’t own the majority, you don’t get to fire the management, to wipe out the shareholders, to declare that you are just going to take the losses and start over. It’s the mistake the Japanese made in the ’90s." "I would guess that sometime in the next few weeks, President Obama and Tim Geithner," he said, referring to the nominee for Treasury secretary, "will have to come out and say, ‘It’s much worse than we thought,’ and just bite the bullet." So far the Obama administration has signaled that it is trying to avoid that day, and members of its economic team — among them Mr. Geithner and the president’s top economic adviser, Lawrence H. Summers — made the case during the Asian financial crisis in the 1990s that governments make lousy bank managers. Indeed, the risks of nationalization they warned about then apply equally to the United States now.
The first is that nationalization can prove contagious. If the Obama administration took over Bank of America and Citigroup, two of the largest banks in the United States, private investors could decide to flee from the likes of JPMorgan Chase and Wells Fargo, or other major banks, fearing they could be next. Moreover, Mr. Obama’s advisers say they are acutely aware that if the government is perceived as running the banks, the administration would come under enormous political pressure to halt foreclosures or lend money to ailing projects in cities or states with powerful constituencies, which could imperil the effort to steer the banks away from the cliff. "The nightmare scenarios are endless," one of the administration’s senior officials said. The argument in favor of nationalization, even a brief nationalization of a few months or years, is straightforward: It might be the only way to pull America’s largest financial institutions out of the downward spiral that makes it enormously difficult to raise the capital they need to keep operating.
Right now, many banks are reluctant to write off their bad debts, and absorb huge losses, unless they can first raise enough capital to cushion the blow. But they cannot attract that capital without first purging their balance sheets of the toxic assets. Japan’s experience proved the dangers of that downward swirl; the economy stagnated, new lending ground to a halt and the country’s diplomatic clout shrank with its balance sheets. Nationalization could pull the banks out of that dive, at least temporarily, as the government injected capital, hired new managers and ordered a restart to lending. But some Republicans who bit their tongues when President George W. Bush ordered huge interventions in the market would charge that Mr. Obama was steering America toward socialism. Nationalization, said Charles Geisst, a financial historian at Manhattan College "is just not a term in the American vocabulary." "We think of it," he continued, "as something foreigners do to us, not something we do."
It is also something foreigners do to themselves: the British have recently taken a majority stake in the Royal Bank of Scotland. Some of Mr. Obama’s advisers have asked who the government would get to run the banks. Many of the most experienced executives are tainted by the decisions they made during the age of excess. And how would the government attract the best talent if it demanded that they take minimal pay — a political reality in the current environment? Another option is for the government to buy the banks’ most toxic assets either through a giant fund, or, more likely, a federally supported bad bank designed to buy up troubled investments. But in that case, taxpayers might well be the losers: They would have all of the banks’ worst assets and none of their performing loans. And unless a deal is worked out to take a larger share of the banks whose bad loans are shuffled off to the government, the taxpayers would not have the chance to benefit by selling the shares back to private investors.
Moreover, cleaning up the banks’ bad assets, without extracting a heavy price for the bank managers, shareholders and their lenders, is exactly what Mr. Summers and Mr. Geithner warned against during the Asian financial crisis. "We told the Asians that they had to be willing to let banks and companies fail," said Jeffrey Garten, a professor at the Yale School of Management and a top official in the Clinton administration. "We warned that there was great moral hazard if governments just bailed them out." "And now," he said, "we are doing the polar opposite of our advice."
Bad news: we're back to 1931. Good news: it's not 1933 yet
Barack Obama inherits an economy already contracting at an annual rate of 6pc, much like the mid-Depression year of 1931 (-6.4pc), writes Ambrose Evans-Pritchard. This may beat Germany (-7pc) Japan (-12pc) and Korea (-22pc) over the fourth quarter. But that merely underlines the dangers ahead as the collapse of global trade chokes the mini-boom in US exports, setting off another stage of the crisis. The US is losing 500,000 jobs a month. Brazil lost 650,000 in December. Beijing says 10m Chinese have lost their jobs since the crunch began. Japan's exports fell 35pc last month, year-on-year. The central bank is printing money furiously, buying bonds to prevent a relapse into deflation. So yes, it is like early 1931. Citigroup and Bank of America have more or less disintegrated. JP Morgan's health is failing fast. General Motors and Chrysler survive only on life-support from the US taxpayer. But it is not yet like 1933. That second leg down was the result of "liquidation" policies by a Dickensian leadership blind to the dangers of debt deflation. By then the Gold Standard had degenerated into an instrument of torture. It forced the Fed to raise rates from 1.5pc to 3.5pc in October 1931 to stem gold loss, with predictable results for shattered banks.
It is worth glancing at the front page of New York Times on Monday March 6, 1933 to see what the world looked like three days after Franklin Roosevelt moved into the White House. The newspaper splashed with the story that FDR had closed the US banking system – invoking the Trading with Enemies Act – and ordered the confiscation of private gold. From left to right, the headlines read: "Hitler Bloc Wins A Reich Majority, Rules Prussia"; "Japanese Push On In Fierce Fighting, China Closes Wall, Nanking Admits Defeat"; "City Scrip To Replace Currency"; "President Takes Steps Under Sweeping Law of War Time"; "Prison For Gold Hoarders". President Obama faces a happier world. The liberal economic order is still in tact, if fraying at the edges. Capital and ships move freely. North America and Europe talk the same political language. China has so far proved a dependable pillar of the international system. But then the world seemed benign enough in early 1931. It is the second phase of depression that does terrible things. Roosevelt took over a country where the economic machinery had completely broken down. The New York Stock Exchange and the Chicago Board of Trade had closed. Thirty-two states had shut their banks. Texas had restricted withdrawals to $10 a day. Few states could borrow on the bond markets. Illinois and much of the South had stopped paying teachers. Schools closed for months.
An army of 25,000 famished war veterans squatting in view of Congress had been charged by troopers of the 3rd US cavalry with naked sabres – led by a Major George Patton. Armed farmers threatening revolution had laid siege to a string or Prairie cities. A mob had stormed the Nebraska Capitol. Minnesota's governor was recruiting Communists only for the state militia. Lawyers attempting to enforce foreclosures were shot. More than 100,000 New Yorkers applied to go to the Soviet Union when Moscow advertised for 6,000 skilled workers. We forget how close America came to open revolt. Eleanor Roosevelt feared the country was beyond saving. Her husband kept the faith. He channelled the anger against Wall Street, diffusing it. "The practices of the unscrupulous money-changers stand indicted in the court of public opinion," he began his presidency. The Fed was an ideological deadweight. Bowing to pressure from Congress it began to purchase bonds in mid-1932 to boost the money supply, but then recoiled, before retreating into pitiful self-justification. A third of the rescue funds in Hoover's Reconstruction Finance Corporation had been embezzled.
Today there has been no such failure of US institutional imagination, even if, as George Soros argues, the Treasury's policies have been "haphazard and capricious". The twin blasts of fiscal and monetary stimulus have been massive. In short order the Fed has slashed rates to zero. It is now conjuring money out of thin air on an industrial scale, buying $600bn of mortgage bonds to force down the cost of home loans, and propping up the commercial paper market to avoid mass corporate default. Ben Bernanke, a Depression junkie, is proceeding with a messianic sense of certainty. The wash of money should ensure that the next 18 months will not mimic the cascade of disasters from late 1931 to early 1933. It buys time. But it does not solve the deeper problem, which is that a West addicted to Ponzi credit has put off the day of reckoning with ever more extreme monetary policy with each downturn, stealing prosperity from the future. It will be an extremely delicate task to right the ship again. Central banks will have to extricate themselves from their venture into the bond markets without setting off a bond debacle in 2010 or 2011. Governments will have to map out of a path of Puritan discipline for year after year. This will be Barack Obama's grim test of statesmanship.
US may ditch twice-yearly talks with China
Strained relations between the US and China are likely to increase in the coming months as a number of senior officials in President Barack Obama's administration are believed to be keen to axe bi-annual economic meetings between the two superpowers. The meetings – known as the US-China Strategic Economic Dialogue (SED) – are unlikely to continue in their current form under the Obama administration, which is understood to favour more proactive and honest communication, rather than what it perceives to be twice-yearly "talking shops".
In their place, President Obama's team, including US Treasury Secretary-designate Tim Geithner, are thought to prefer more proactive, less staged dialogue which will lead to actual agreements on economic policies. One criticism of the meetings, the most recent of which was in Beijing in December, was that though bold in aspirations, they achieved little. Mr Geithner, however, who served as under-secretary of the Treasury for international affairs in the Clinton administration, is more than aware of the need to keep talking to China. He learned Chinese as a student, and has lived in the country, as well as nearby Japan and Thailand.
Although last Thursday he made comments regarding the Chinese currency, the yuan – which he said the country's government was manipulating in order to boost exports – Mr Geithner is not so foolish as to risk rocking the boat with the Hu government, given he needs it to keep buying US securities in order to fund its recovery. The Chinese for their part, first "noted" Mr Geithner's comments, but later refuted them. The Chinese government owned $682bn (£494bn) of US government debt at the end of November, overtaking the Japan as the biggest foreign owner of the bonds late last year. A US Treasury spokesman did not comment.
When all else fails, blame China
by Willem Buiter
Timothy Geithner, the nominee for US Treasury Secretary, has risked damaging the global economy even before his confirmation by the full Senate. In a written answer to questions from US senators, Geithner said: “President Obama - backed by the conclusions of a broad range of economists - believes that China is manipulating its currency”. In the US, the words “currency manipulation” are fighting words. If the US administration were to formally name China as a currency manipulator, a range of trade sanctions could be imposed by the US government.
The threat to world trade comes from the Omnibus Trade and Competitiveness Act of 1988. The section dealing with the exchange rate, bilateral current account balances and the overall current account balance is a monument to economic illiteracy.
Under the Omnibus Trade and Competitiveness Act of 1988, "The Secretary of the Treasury shall analyze on an annual basis the exchange rate policies of foreign countries, in consultation with the International Monetary Fund, and consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade."
“If the Secretary considers that such manipulation is occurring with respect to countries that (1) have material global current account surpluses; and (2) have significant bilateral trade surpluses with the United States, the Secretary of the Treasury shall take action to initiate negotiations with such foreign countries on an expedited basis, in the International Monetary Fund or bilaterally, for the purpose of ensuring that such countries regularly and promptly adjust the rate of exchange between their currencies and the United States dollar to permit effective balance of payments adjustments and to eliminate the unfair advantage.”
Should the US Treasury officially determine China to be a currency manipulator, the US Administration can unleash a range of remedies, including antidumping measures, countervailing duties, and safeguards. Although the World Trade Organization permits certain retaliatory responses from importing nations which can prove that they suffered material injury due to unfair trade practices, much of what the US Congress and some members of the Obama administration have in mind is likely to be in clear violation of the United States’ WTO obligations. It would certainly provoke a response from China. The bilateral trade war that is likely to result could easily spread to the EU, Japan and emerging markets outside China.
Overall and bilateral current account imbalances and nominal and real, bilateral and effective exchange rates
The overall current account deficit of the US is the excess of US domestic investment over US national saving. The overall current account surplus of China is the excess of China’s national saving over China’s domestic investment. Bilateral trade balances are of no economic interest, unless there are only two countries in the world. Note that the first quote from the Omnibus Trade and Competitiveness Act of 1988 slides seamlessly from overall current account imbalances to bilateral trade imbalances, ignoring the transfer payments and foreign investment income items that are included in the current account but not in the trade balance. Trade balances and current account balances (bilateral or aggregate) can and do move in opposite directions.
There is no reason in economic theory or empirical fact why there should be any reliable correlation, between nominal exchange rates (bilateral or trade-weighted (effective) ) and the bilateral or aggregage trade balance, let alone a clear causal connection from any nominal exchange rate to the trade balance. Certain kinds of shocks and policy actions may produce an empirical association (not a causal relation) between a depreciation of the effective (trade-weighted) real exchange rate and an increase in the aggregate trade surplus. This is the case, for instance, for most aggregate demand shocks, e.g those produced by contractionary Keynesian fiscal policies. But supply shocks may produce the opposite correlation, that is, a depreciation of the effective real exchange rate and a reduction in the aggregate trade balance surplus.
In any case, as Chart 1 below shows, there has been a steady appreciation of the real effective exchange rate of the Yuan since the beginning of 2005. JP Morgan’s broad real effective exchange rate index for the Yuan shows a 27 percent real appreciation since December 2004. The from a macroeconomic perspective uninteresting nominal bilateral US$-Yuan exchange rate appreciated 21 percent over the same period.
Every fixed or managed nominal exchange rate is, by definition, ‘manipulated’. But only the most bone-headed of ultra-Keynesians believes that a country can influence its effective real exchange rate in a lasting manner by managing/manipulating its effective nominal exchange rate, let alone some bilateral nominal exchange rate. China is now enough of a market economy that its domestic prices and costs (in Yuan) are no longer controlled by the Chinese authorities. Instead they are driven by the same kind of monetary and other macroeconomic forces that drive US dollar prices and costs in the USA.
China still controls its capital account to a significant extent. Judging from the havoc created by wide-open capital accounts in other emerging markets, the Chinese decision to liberalise its capital account gradually and slowly is a wise one. Most gross external investment by Chinese residents is done by the state. With capital inflows (mainly in the form of FDI) policy controlled, the large current account surplus of China has meant a massive increase in the external assets of the state. The state has, unwisely, allocated most of the task of managing its foreign assets to the central bank, which has been a terrible foreign investor. By choosing to invest well over a trillion US dollar’s worth of foreign assets in US Treasury bills, the Chines central bank has produced horrible real returns for the Chinese government and the Chinese people, and made a large capital gift to the US government and the US people. The returns on Chinese foreign investment through its sovereign wealth fund have not been any better of course. Like the Japanese before them, great manufacturers and exporters often turn out to be terrible portfolio investors, even when their own FDI investments abroad have done well.
The accumulation of China’s external assets in the accounts of the Chinese central banks shows up statistically as an increase in official foreign exchange reserves. The Chinese authorities have been unable to sterilise this massive increase in reserves and China has seen rates of domestic cost and price inflation that have at times been uncomfortably high. This is the normal way in which management/manipulation of the nominal exchange rate fails to prevent the changes in the real exchange rate warranted by fundamentals. China is enough of a market economy that it cannot manipulate its real effective exchange rate.
There are indeed global macroeconomic imbalances. The US saves too little or invests too much (I would argue the former) and has an unsustainable current account deficit. China saves too much or invests too little (I would argue the former) and has an unsustainable current account surplus. China is taking policy measures that will reduce its external surplus, mainly through expansionary fiscal policy measures aimed at boosting public sector investment (infrastructure) and at reducing private and corporate saving.
The US is proposing policy measures that will increase its external deficit. The $825bn fiscal stimulus over two years proposed by the Obama administration will increase the US current account deficit. It will also strengthen the real effective exchange rate of the US dollar, unless there is a loss of faith in the ability of the US sovereign to service its debt in the future through higher taxes or lower public spending. In that case the nominal exchange rate could decline sharply, taking the real exchange rate with it in the short run, as market participants dump the US dollar and US dollar-denominated securities because they fear either a monetisation of public debt and deficits or a sovereign default.
So China is undertaking actions to remedy its own external imbalances and global imbalances. The US is proposing measures to increase its external imbalances and aggravate global imbalances. Instead of saving more, the US government is desperately trying to get the already over-leveraged US consumer to save less. And just in case the US consumer balks at the fiscal carrots dangled in front of him, the already fiscally challenged US government is proposing to reduce its own saving and increase its own investment.
The last thing the US economy needs is a large fiscal stimulus, or indeed any fiscal stimulus at all. A good argument can even be made for a US fiscal tightening. Expansionary monetary policy is the only instrument available to the authorities that will both boost the US economy and correct its external imbalance. With the Federal Funds target rate as close to zero as makes no difference, only aggressive quantitative easing and qualitative easing (what Bernanke calls credit easing) are available and the magnitude and timing of their impact is uncertain. That’s tough, but that’s the way it is. The belief- the faith almost - that there has to be a painless way out of the US economic dilemma is naive and will be disproven by economic record of the coming years. The notion that currency manipulation by China is a material contributor to America’s external trade deficit is either a dangerous form of self-delusion, or an even more dangerous form of pandering to xenophobic Congressional opinion, or both.
One reason I still nurture the hope that the current global recession will not become a second Great Depression, is that there has been no significant recourse to trade restrictions by countries trying to export their domestic demand deficiencies to their neighbours. There has been increased use of anti-dumping measures - the first recourse of the modern protectionist, beggar-thy-neighbour scoundrel - but less than might have been expected given the prevailing spineless political leadership around the globe. As unemployment and excess capacity increase, and corporate bankruptcies multiply, the calls for protection against ‘unfair’ foreign competition will multiply. Any excuse - environmental, social, labour standards, phyto-sanitary, national security - will be used to allow domestic industry and labour to find shelter from the storm. Old-style protectionists like Sarkozy find new converts such as Merkel, to push protectionist measures, including state aid for non-systemically important industries like automobile manufacturing.
So while the protectionist genie is not yet out of the bottle, it is kicking and pushing against the cork, trying to escape. The verbal sabre rattling by US Treasury Secretary Geithner is a threat to the open global trading system. More stupidities along the same lines could bring us the global trade conflict that we have been fortunate to avoid thus far.
American exporters in last-ditch attempt to stop Obama raising the trade barriers
A coalition of leading American exporters, including Boeing, Caterpillar and General Electric, is trying to stop a "Buy America" clause being included in President Obama’s $825 billion stimulus package. The American Steel First Act would ensure that only US-made steel was used in $64 billion of federally funded infrastructure projects. The money, earmarked for roads, bridges and waterways, is aimed at kickstarting the economy, but the initiative by steelmakers, which secured support last week in the House of Representatives Appropriations Committee, is opposed by American exporters, who fear retaliation by foreign governments.
Their concern is given credence by the European Commission and by Eurofer, the association of European steelmakers, which said that it would urge the European Union to challenge the "Buy America" clause at the World Trade Organisation. Gordon Moffat, director-general of Eurofer, said that the clause was a clear case of protectionism. He said: "It looks like they are trying to shut out imports. If we have the means to attack that under WTO rules, we would urge the Commission to do so." A spokesman for the European Commission said that America was a signatory to the Government Procurement Agreement, a WTO treaty aimed at ensuring fair access to state investment programmes. He said: "We would be entitled to retaliate and would certainly do so if they withdraw from [the treaty]." Mounting evidence that governments are taking steps to shut out imports and protect domestic jobs is arousing concern at the Geneva-based trade organisation.
Pascal Lamy, the WTO director-general, will today publish a report on protectionism, highlighting a profusion of recent initiatives taken by governments, including tariffs, subsidies and a 39 per cent increase in antidumping cases between WTO members. The global recession has led to a slowdown in international trade, exacerbated by the banking crisis. Last month, the World Bank warned that trade volumes would contract in 2009 for the first time since 1982. Efforts by governments to prop up the flagging automotive sectors have been hedged by undertakings to protect domestic jobs. Last week François Fillon, the French Prime Minister, promised up to €6 billion (£5.6 billion) in aid to Renault and PSA, the owner of Peugeot-Citroën, provided that they gave a commitment to French suppliers and French employment. "There is no question of the State helping a manufacturer which would purely and simply decide to close one or more plants in France," Mr Fillon said.
In a letter to Nancy Pelosi, the Speaker of the House of Representatives, trade bodies such as the US Chamber of Commerce, the National Foreign Trade Council and the Aero-space Industries’ Association wrote last week: "If the United States further restricts access to our market [that is overseas consumers], these other countries will certainly follow our lead, shutting US exporters and their workers out of hundreds of billions of dollars of new business, while propping up their own national champions, to the detriment of the United States." The letter continued: "One issue we urge you to bear in mind as you prepare this legislation is the vitally important role that international markets play in sustaining US jobs and the role they will play in economic recovery. Without sales abroad and access to inputs, many US workers would be out of a job."
Gordon Brown is like an arsonist posing as a firefighter
The Prime Minister's latest wheeze to tackle the financial crisis has only made things worse, says Norman Lamont. Gordon Brown, at the time of the Government's October bank bail-out, confidently told Newsnight: "You have got to get a restructuring right. I think people would take exception to a situation when there was a partial proposal and then we had to come back with another partial proposal, and then another…. What we have done is a far more comprehensive programme than ever people were asking for." Last week the Prime Minister announced "the next steps" in his rescue of the banks. He was wearing the same tie as in October, and this wasn't "the next steps", just another rushed emergency. Changing explanations, initiatives without detail, ad-hoc bail-outs, even the never-to-be-omitted sound bites about the "global nature" of the crisis, only increase the sense that the Government no longer knows what it is doing. Last week's announcements coincided with RBS's disastrous results and bank shares fell sharply. But the most dramatic fall was that of the pound, which dropped to a 24-year low against the dollar, over 20 per cent in 12 months.
The silver lining is that sterling's fall will eventually boost exports in spite of very depressed overseas markets. But a collapse of this magnitude sends a warning signal. Gordon Brown has told us before that "a weak currency means a weak economy caused by a weak government". What has spooked the markets is the fear the banking crisis is metamorphosing into one about Britain's solvency. In standing behind banks, the Government, with its already massively overstretched finances, is effectively guaranteeing institutions whose liabilities, particularly in foreign currency, dwarf Britain's GDP or annual tax revenues. Spain, which has considerably lower debts, has had its triple-A status downgraded and there is concern about the finances of Ireland, Greece and Italy. David Cameron was hardly exaggerating when he warned of the dangers of Britain being forced to run to the IMF. Some misguided businessmen have even been calling for the nationalisation of the banks in the vain hope that this will bring an end to uncertainty. But the more bank shares fell, the nearer nationalisation seemed, and it was this very fear that drove shares and sterling ever lower.
The Sunday Telegraph's admirable economics columnist, Liam Halligan, has for months been hammering the point that what is most needed is transparency and an end to uncertainty about the scale of toxic debt in banks' balance sheets. Recapitalisation, though necessary, has not removed the uncertainty. For this reason banks are reluctant to lend to each other, let alone businesses. The Prime Minister has expressed his frustration about this failure to get all the bad news into the open. His remarks hardly inspired confidence. After all, if he doesn't know, who does? The original idea for solving the banking crisis by the US Treasury was a Troubled Asset Relief Programme (TARP), which would mean the taxpayer buying all the banks' toxic debt. This plan never came into existence, partly because of problems about the price at which the bad debts would be purchased. The British Government rejected both the TARP or the idea of a "bad bank" – a specially created vehicle into which all the toxic assets would be put. Yet, whatever their disadvantages, these solutions would have ended the uncertainty about bad assets.
Unfortunately, the wheeze that the Government announced last week only increases uncertainty. Mr Brown's latest idea is an insurance scheme, whereby the banks pay the Government a premium and, in exchange, the Government guarantees the value of loans above a certain level and picks up any losses. The Government hadn't worked out the details. And importantly, the scheme does not create certainty that the toxic loans have finally been removed and that it is now safe for the banks to deal with each other. Until the problem of disclosure is solved, the crisis will continue. Mr Brown expressed his anger about how UK banks had lent in the past. Part of the losses, he pointed out, were on foreign loans and acquisitions, and US sub-prime mortgages. But it wasn't America that caused the problem at Bradford and Bingley or HBOS, it was the UK housing market – and it was the Financial Services Authority, under arrangements designed by Brown, which was responsible for supervising RBS when it got involved in its misjudged overseas ventures. There will also be no end to the banking crisis until housing stabilises both here and in the US, as residential property is so widely used as security by banks. Of course, that market must find its own level. But because the banks are insisting on larger down-payments, there is a danger of house prices overshooting on the downside. It may be too early but, at some point, help for first-time buyers might be needed.
Last week it was officially confirmed, though it seemed like old news, that Britain was in recession. The figures leave the Chancellor's forecasts in tatters. The EU is predicting the UK will have a deeper recession than the European average. The longer this crisis lasts the more ridiculous seems the Prime Minister's oft-repeated boasts about "the longest period of expansion since records began" or the longest growth "since the eighteenth century". Now we can see this illusion was built on a mountain of debt by individuals and banks. We were heading for trouble, even if there had been no US sub-prime crisis. The Prime Minister now looks like an arsonist, posing as a firefighter. We are not going to return quickly to the world of "Goldilocks" – low inflation and fast growth. But the Goldilocks story was always a myth. Indeed, many fairy tales are sanitised versions, specially prepared for children, of old folk stories. In the nursery version, Goldilocks is chased away by the bears. In the original story, the bears ate Goldilocks. For far too long, we have been told stories meant for children and not faced up to the realities of our own situation.
Just how big is Britain's toxic debt?
An army of accountants is combing through the books, trying to establish just how much the toxic assets of the bailed-out banks are actually worth. At stake, says the Government, is the future of Britain's economy. Before he was unceremoniously fired as chief executive of Royal Bank of Scotland, Sir Fred Goodwin often said that he had turned the 280-year-old institution into "a sausage machine". RBS, like other banks, was buying and selling pre-packaged parcels of debt, which started out as mortgages and loans but were put through a corporate mincer and wrapped into packages containing small pieces of hundreds, if not thousands, of loans. Rather like sausages, no one could be entirely sure what was in them – but as long as they paid a decent rate of interest and the bonuses kept flowing, no one cared. As we all now know, those parcels had been bulked up with sub-prime loans, which became effectively worthless "toxic assets" when the US housing market crashed. Confirmation yesterday that the bankers' avarice has officially plunged Britain into recession added to the growing bewilderment as to exactly why we are on the hook for almost £1 trillion in bail-outs and guarantees.
No one even knows exactly how many of these toxic assets British banks are holding, and how much more it might cost the taxpayer to get out of this unholy mess – which is why an army of accountants is about to begin the daunting, if not downright impossible, task of tracking down and putting a value on all the debts of all the banks in which the taxpayer has taken a stake. In effect, to borrow Sir Fred's analogy, the Government-appointed debt hunters will be carrying out the accounting equivalent of dissecting all of those sausages and turning the constituent parts back into pigs. It will be a laborious, thankless task which is likely to take at least six months. But according to the Government, nothing less than the future of Britain's economy depends on it. The reason all the rescue packages have failed is that no one has yet calculated the full extent of these toxic assets – and nothing spooks the City so much as uncertainty. Lord Myners, the minister organising the hunt, says his sleuths will have to deal with "well over a billion items of individual data for each bank". The desperate need for some hard and fast facts was underlined on Monday, when the value of banking shares collapsed, despite the announcement of a raft of new measures. Gordon Brown is said to have been taken aback by the City's panicked reaction to RBS's announcement of a £28 billion loss, the largest in British corporate history.
Experts say the losses reveal the markets' fear of more bad news to come. Despite the Government pledging £954 billion so far – or £31,800 per taxpayer – some analysts believe another £200 billion in insurance may be needed to protect the banks fully against future losses. But no one is willing to predict that it won't be more, just as no one can be sure that our children, or even our grandchildren, won't still be paying off the debts the nation is accruing, as this economic black hole swallows a seemingly limitless amount of our money. In other words, until the number-crunching is done, there is no prospect of an end to the crisis. "The problem is that we don't really know just where these bad assets are, and the banks are not going to 'fess up," explains Peter Spencer, professor of economics at York University. "As things stand, it is a near-bottomless pit, and no one knows how smelly the stuff at the bottom is." The Prime Minister is pinning his hopes on the Asset Protection Scheme, announced this week, which will assess the exact extent of the toxic assets (currently estimated at £200-350 billion). The theory goes that once the banks know the worst-case scenario, and are insured against it by the taxpayer, they will be able to start lending again.
But the Government-appointed investigators, drawn mainly from Goldman Sachs, Credit Suisse and Deutsche Bank, will be entering uncharted waters when they set up shop in the offices of banks such as RBS. Few people on the planet understand the complexities of such opaque instruments as collateralised debt obligations (the technical term for those minced-up sausages of debt, of which £2 trillion were traded in 2006, £188 billion of it in the UK). In some cases they were dreamed up by real-life rocket scientists, poached by Wall Street from Nasa's labs in California. Until as recently as 2000, British banks lent only as much money as they held on deposit. But the availability of cheap financing on the money markets enabled banks such as Northern Rock to lend up to seven times the amount in their coffers. Rather than holding on to people's mortgages, the banks packaged them up with other loans and sold them on to investors, who could repackage and sell them on again and again. Unpicking these bundles of debt may involve tracking down and valuing the assets on which they are based – such as houses or commercial properties, or even part-shares of them. Nor will the vastly complex, and vastly expensive, hunt be confined to Britain. To pick just one example, RBS acquired 26 other companies during Sir Fred's eight-year reign, leaving it with £250 billion of foreign loans in the more than 50 countries where it has offices. These include Vietnam, Columbia, Uzbekistan and Pakistan, where RBS is the second-largest foreign bank – there are even seven branches in Kazakhstan, all of which are now 70 per cent owned by the British taxpayer.
Many of those loans will be sound, but the investigators must sniff out those that are not. "It will be a very intensive job and we will need to get professional support," one Treasury source says. "It's complicated, but if you didn't have these complicated problems, there wouldn't be a crisis in the first place." But how could the banks lose control to such an extent? "Greed is part of the answer," says Vince Cable, the Liberal Democrat Treasury spokesman. "We have had a bonus culture in which profits were the only motivating factor, and bankers were getting enormous bonuses on the back of very highly leveraged deals. It's also the case that even some of the bosses didn't understand the things they were trading in, because they had become so complicated. The banking regulators knew this and should have put a stop to it, but they didn't." It wasn't just the executives who failed to understand what was going on – the Prime Minister and his team were equally clueless. Treasury officials who began going through the books of RBS when the Government took a majority share last year were horrified at the way the bank had been run, as it borrowed more and more money to fund more ambitious deals, such its share of the £49 billion takeover of Dutch bank ABN-Amro in 2007.
The previously lionised Sir Fred has now been labelled "the world's worst banker", with growing calls for him to be stripped of his knighthood. Although the Financial Services Authority insists that there is no evidence he broke any rules, many investors who have lost money believe he was less than candid about the state of the bank's finances and recklessly overstretched himself in the battle for ABN-Amro. In America, RBS's subsidiaries are already the subject of two separate investigations. The Securities and Exchange Commission and New York's attorney general are both looking into the exposure of RBS-owned companies to the sub-prime mortgage crisis. Although he has said he is "angry" with Sir Fred, Mr Brown refused to be drawn this week on what action, if any, should be taken against his former friend, who was a valued adviser during his time as Chancellor. Nor has anyone at the Treasury offered an estimate of how much it will cost to work out the value of the toxic assets.
Yet many of the country's leading economists believe that there is an alternative to the scheme: to nationalise the entire banking system to restore confidence, and take control of lending once and for all. George Magnus, chief economic adviser to UBS Investment Bank, and the man credited with being the first to predict the current global recession, says: "There is a danger that a few months down the line further measures will be needed to shore up the banks. It would be cleaner, neater and cheaper just to call a spade a spade and take them into public ownership. "That would enable the Government to set up a 'bad bank' that could take on these toxic assets and hold on to them for 50 years if necessary, until their value rose and the taxpayer saw a return. "In the meantime, once the crisis is over, they could refloat the banks, as they did in Sweden in 1992. I just don't understand the hang-up the Government has with nationalisation." Professor Tim Congdon, a former adviser to the Treasury, agrees. "The idea of having these civil servants poring over the banks' books is barmy. There are much simpler solutions, such as the Government borrowing from the banks to increase the amount of money in the system." One thing all sides are agreed on is the need for a return to old-fashioned banking, preferably without so much as a rocket scientist – or sausage machine – in sight.
Warning over quantitative easing in eurozone
Unconventional emergency measures to boost the eurozone economy could prove exceptionally hard for the European Central Bank to implement, a member of its governing council has warned, highlighting the institution’s nervousness about following such steps in the US and UK. A programme of "quantitative easing" – the creation of money to buy assets – would be "much more complicated in the eurozone context than some people might believe", Yves Mersch, Luxembourg’s central bank governor (pictured below), said in an interview with the Financial Times. He also warned: "If you become hyperactive, you contribute to the confusion." The US Federal Reserve and Bank of England have been markedly more aggressive in cutting policy interest rates closer to zero, preparing the way for deploying unconventional measures to revive growth prospects. The Fed has already embarked on such steps. ECB policymakers have already signalled their wariness about cutting the bank’s main policy rate much below the current 2 per cent.
Mr Mersch’s comments revealed uncertainty within the ECB also over how quantitative easing would work in a monetary union covering 16 countries, which still run their own fiscal policies. "I don’t know whether what appears to be easy would actually be easy. It could well be the most complicated way," he said. The eurozone has plunged into one of the worst recessions in continental Europe since the second world war, with purchasing managers’ indices on Friday suggesting output was continuing to contract rapidly, although at a slightly slower pace than late in 2008. The European Commission last week forecast that eurozone gross domestic product could contract by 1.9 per cent this year. But the ECB has played down the threat of eurozone deflation. A first "quantitative easing" step, Mr Mersch suggested, would be to buy government bonds. "But the bonds of which country would you buy?" The issues had become more complex recently, he argued, because of the recent massive widening of spreads on some eurozone bonds compared with German bonds amid fears that public spending is spiralling of control. "We don’t bail out in Europe," Mr Mersch said. However, the idea that a eurozone government might default or quit the monetary union was "the fancy of a eurosceptic in wonderland".
An alternative policy step could involve buying commercial paper. But Mr Mersch appeared sceptical. As a result of its massively expanded financial market liquidity-boosting operations, there was "already a fairly big amount of such paper within the central banks", he pointed out. Since October last year, the ECB has slashed its main policy rate by 225 basis points to the lowest level for three years. Mr Mersch signalled he would be unwilling to see it going much lower through fear of falling into a "liquidity trap", in which interest rate policy becomes ineffective. "That means the margin for manoeuvre is rapidly diminishing, especially after the latest cut." The ECB’s 22-strong governing council appears to include differing views, however. Late last year, Athanasios Orphanides, central bank governor of Cyprus, described as a "fallacy" the idea that monetary policy became ineffective when interest rates fell to zero. Mr Orphanides worked previously at the US Fed, where he wrote papers on the issue. Separately, Mr Mersch signalled unease about the idea the ECB should be given powers of financial supervision, as floated by Jean-Claude Trichet, its president. The proposal raised questions, Mr Mersch said, for instance about the geographical area the ECB could cover (the UK is not a eurozone member). But he went on: "One thing that I am deeply convinced of is that countries that have too closely emulated the British FSA [Financial Services Authority] model are not those that have fared best."
The Banca d’Italia and the re-nationalisation of cross-border banking
by Willem Buiter
There is growing financial protectionism. This is happening even within the Eurozone - in violation of the Treaty. For instance, the Italian central bank (Banca d’Italia) has just created a Collateralised Interbank Market, where the Banca d’Italia will serve as the universal counterparty, guaranteeing settlement in case of default. The arrangement is, however, only open to Italian banks (one per group). In the current turmoil, the Banca d’Italia may be able to get away with an arrangement that clearly violates the Eurosystem’s principle of "equal treatment of institutions across the euro area", but the ECB will want to get rid asp of anything that hints at balkanisation of the eurosystem and preferential treatment offered by NCBs to their national counterparties. The ECB asserts indeed that the general eligibility criteria for counterparties to national central banks "are uniform throughout the euro area".
This finanancial protectionism is to a large extent the unavoidable consequence of the rediscovery, during the current financial crisis, that although banks and other financial institutions have become global, regulation and the fiscal capacity to bail out banks and other tottering financial institutions have remained national. Consequently, we have seen two forms of re-nationalisation of banking and finance. The first form of nationalisation has been the taking into partial or complete public ownership of banks and other financial institutions deemed too systemically important (too big, to interconnected or too politically connected) to fail. This has happened virtually everywhere the financial crisis has struck - in the US, the UK, the Netherlands, Denmark and Belgium among them. More examples will follow.
The second form of re-nationalisation of banking and finance is the restriction of access to the fiscal and financial resources of the nation state just to those banks and other financial entities that have a significant presence in that nation state. The foreign subsidiaries of bank groups or bank holding companies registered and headquartered in the UK will not be able to count on the fiscal support or on other financial support of the British sovereign. These foreign subsidiaries will sink or swim on their own or take the begging bowl to the fiscal authority of their host country. The same will hold for the foreign subsidiaries of bank groups or bank holding companies registered in the US, Switzerland, the Netherlands, France, Germany or any other country with large cross-border banks headquartered in its jurisdiction.
Branches create a bit of a problem, since they tend to be the regulatory/supervisory responsibility of the home country authority. As a result there may be pressure on the home country authority from the parent bank (or from the host country government, as the case of the Icesave depositors in the UK illustrates) to make fiscal resources available to support the commitments entered into by the branches. As a result of the current crisis, I expect that cross-border bank branches will become a thing of the past, and that the only cross-border subsidiaries we will continue to see will be independently and fully capitalised entities, regulated and supervised by the host country regulator and with recourse to the resources of the host country central bank and fiscal authority on the same terms as ‘domestic’ banks in the host country, that is, host-country banks that are not wholly owned by some foreign bank.
The Eurozone is in a bit of a pickle here, because although it has a central bank with supposed uniform access to its resources for all Eurozone banks, regulation and supervision remain national and fiscal bail-outs (recapitalisation by the state, guarantees, insurance, loans or whatever provided by the sovereign) definitely remain national. When the central bank acts as market maker of last resort, as the Banca d’Italia is now doing in the Italian interbank market, it takes on significant credit risk which requires a fiscal back-up - the Italian Treasury. But that undermines the principle of equal treatment of banking institutions across the Eurozone, and makes a mockery of the claim that general eligibility criteria for counterparties to national central banks "are uniform throughout the euro area".
So there we are. If we are to avoid the balkanisation of the Eurosystem, and its degeneration into 16 national sub-systems, with different conditions of access to central bank resources, we will need some form of common European fiscal authority. One solution would be a supranational fiscal authority with its own tax and borrowing powers, accountable to the European Parliament (as the lower house) and the Council (as the upper house). It may be a while before we get there. A second solution would be a pan-Eurozone fund, fully pre-funded and containing, say, 2 or 3 trillion euro to begin with. This Eurofund could be managed by the European Commission, subject to parliamentary oversight and control by the European Parliament and the Council. The fund could be drawn upon to provide financial assistance to systemically important troubled banks in the Eurozone, according to guidelines agreed by the EC, the EP, the Council and the ECB. An interesting way to combine the creation of such a fund with beneficial financial innovation would be for the fund to raise its resources through the issuance of bonds that would be guaranteed jointly and severally by all Eurozone member states.
There are undoubted potential benefits from cross-bording banking. But these benefits can only be realised fully if all the countries involved in the cross-border banking arrangement have a common regulator and a common fiscal backup for these banks. I believe it requires a common currency as well. The Eurozone has one out of three. Not bad - and better than the UK, the US and Switzerland - but still no cigar. Unless we move towards a common regulator and a common fiscal back-up, the re-nationalisation of cross-border banking will continue, even within the Eurozone.
Iceland's government topples amid financial mess
Iceland's coalition government collapsed Monday, leaving the island nation in political turmoil amid a financial crisis that has pummeled its economy and required an international bailout to keep the country afloat. Prime Minister Geir Haarde said he was unwilling to meet demands from his coalition partners in the Social Democratic Alliance Party, which insisted upon the post of prime minister in order to keep the coalition intact. Haarde, who has been prime minister since 2006, said he would officially inform the country's president later Monday that the government had collapsed. Foreign Minister Ingibjorg Gisladottir, who heads the Social Democrats, is expected to start talks immediately with opposition parties in an attempt to form a new government. That government would sit until new elections are held, likely in May.
Haarde had previously said he wouldn't lead his Independence Party into new elections, because he has cancer. He told reporters on Monday that he had proposed Education Minister Thorgerdur Katrin Gunnarsdottir, of Haarde's own party, be appointed Iceland's new prime minister — but Gisladottir rejected that offer. "It was an unreasonable demand for the smaller party to demand the premiership over the larger party," Haarde said. Iceland has been mired in crisis since the collapse of the country's banks under the weight of debts amassed during years of rapid expansion. Inflation and unemployment have soared, and the krona currency has plummeted.
Haarde's government has nationalized banks and negotiated about $10 billion in loans from the IMF and individual countries. In addition, Iceland faces a bill likely to run to billions of dollars to repay thousands of Europeans who held accounts with subsidiaries of collapsed Icelandic banks. The country's commerce minister, Bjorgvin Sigurdsson, quit on Sunday citing the pressures of the economic collapse. Sigurdsson, a member of Gisladottir's party, said Icelanders had lost trust in their political leadership. Thousands have joined noisy daily protests in the last week over soaring unemployment and rising prices.
The day the banks were just three hours from collapse
Narrow escape: The Bank of England was forced to contact RBS's creditors abroad to persuade them not to withdraw their funds
Britain was just three hours away from going bust last year after a secret run on the banks, one of Gordon Brown's Ministers has revealed. City Minister Paul Myners disclosed that on Friday, October 10, the country was 'very close' to a complete banking collapse after 'major depositors' attempted to withdraw their money en masse. The Mail on Sunday has been told that the Treasury was preparing for the banks to shut their doors to all customers, terminate electronic transfers and even block hole-in-the-wall cash withdrawals. Only frantic behind-the-scenes efforts averted financial meltdown. If the moves had failed, Mr Brown would have been forced to announce that the Government was nationalising the entire financial system and guaranteeing all deposits.
But 60-year-old Lord Myners was accused last night of being 'completely irresponsible' for admitting the scale of the crisis while the recession was still deepening and major institutions such as Barclays remain under intense pressure. The build-up to 'Black Friday' started on Monday, October 6, when the FTSE 100 dropped by nearly eight per cent as bad news on the economy started to multiply. The following day, Chancellor Alistair Darling began all-night talks ahead of an announcement on the Wednesday that billions of pounds of taxpayers' money would be used to pour liquidity into the system. But shares continued to plummet, turning into a rout on the Friday when the FTSE crashed by ten per cent within minutes of opening.
Both Royal Bank of Scotland and HBOS were nearing complete collapse - but Lord Myners, who built up his fortune during a long career in the City, said the problems ran far wider. 'There were two or three hours when things felt very bad, nervous and fragile,' he said. 'Major depositors were trying to withdraw - and willing to pay penalties for early withdrawal - from a number of large banks.' The threat to the system was so severe that the Bank of England was forced to contact RBS's creditors in New York and Tokyo to persuade them not to withdraw their funds, but it is not known which other banks faced a run on their reserves. 'We faced the very real problem of how banks could stop depositors from withdrawing their money,' a Treasury source said yesterday.
'The banks themselves were selling their shareholdings, accelerating the stock-market falls, and preparing to shut up shop. Mortgages would have been sold on and savers would have been spooked, to put it mildly. It would have been chaos.' After a weekend of crisis talks, which concluded at dawn on the Monday, it was announced that Lloyds TSB was taking over HBOS, supported by £17billion of taxpayers' money, and RBS would receive an injection of £20billion - prompting the resignation of RBS's infamous chief executive, Sir Fred 'the shred' Goodwin. Share prices at last started a small rally.
Ruth Lea, economic adviser to the Arbuthnot Banking Group, said last night that it was 'highly irresponsible' for Lord Myners to reveal the scale of the problems because it could serve to further wreck already fragile levels of confidence. 'We are not out of the woods yet,' she said. 'I fear for Barclays, after the fall in its share price, and Lloyds has been damaged by the HBOS takeover.' She added: 'If it was panning out in that way, then the Government would have had no choice but to step in and nationalise the entire financial system.'
Angela Knight, chief executive of the British Bankers Association, said: 'The issues related only to HBOS and RBS. To imply that all the banks would have gone under is wrong. It is complicated.' Lord Myners also said that bank executives had been 'grossly over-rewarded' during the 'golden days' of big bonuses. 'They are people who have no sense of the broader society around them,' he said. 'There is quite a lot of annoyance and much of that is justified.'
'German Banks Are on the Edge of the Abyss'
The German government is desperately trying to find a way to save the country's ailing banking sector. Can a so-called "bad bank" solve the problem by taking over toxic assets? German commentators aren't convinced, but they are certain that something needs to be done. Several government rescue packages later, the troubled German banking sector is still showing no sign of recovering from the financial crisis. The discussion over what to do with the hundreds of billions of euros worth of toxic securities the banks still have on their balance sheets has received fresh impetus in Germany after it became clear that the Special Fund for Financial Market Stabilization -- known as Soffin after its German acronym -- is not succeeding in its intended aim of helping out troubled banks and jump-starting financial markets. Günther Merl, the head of the agency that manages Soffin, announced Wednesday that he was resigning -- the second person to quit the agency's steering committee within the last three months. Insiders say that Merl was frustrated at having his authority usurped by government and Finance Ministry officials. Now the talk is of setting up a so-called "bad bank" to take over banks' toxic securities -- an approach backed by a number of leading German bankers.
Sweden was able to successfully use this model in the early 1990s to combat its own credit crunch. The state even made money when distressed assets were later sold. According to a report in the Friday edition of the Süddeutsche Zeitung, the German government is considering setting up individual bad banks for each financial institution, instead of establishing a single bad bank for the whole sector. These bad banks could then be helped out by Soffin without the respective financial institution being absolved of its responsibilities, the paper wrote. German media reported Thursday that Chancellor Angela Merkel's government -- a coalition of conservative Christian Democrats and center-left Social Democrats -- was considering ways of assisting banks without being saddled with the toxic assets themselves. Finance policy experts from both coalition parties on Thursday categorically ruled out setting up a national bad bank. One regional lender appears to have already chosen the bad bank approach. On Friday, troubled German state-backed bank WestLB confirmed reports that it was considering spinning off its risky debt -- with a value of around €80 billion -- into a new bank. The remaining "healthy" bank would then be a more attractive target for a takeover or merger, observers said. Commentators writing in Germany's newspapers Friday agreed that urgent action was necessary but were divided over the merits of the bad bank model.
The center-right Frankfurter Allgemeine Zeitung writes:
"The (German government's) rescue operations have so far not brought the desired results. The banks have been plugging up their worst holes with billions of euros of taxpayers' money, but their losses have been growing even faster. Meanwhile complaints from companies about increasingly restrictive lending practices are growing louder. Obviously the banks can not be helped just with money alone. The accounting principles and supervisory rules for banks also need to be examined. A vicious circle has begun: Forced sales of securities are pushing down prices, which leads to new rounds of write-offs, causing institutions' capital to shrink -- which in turn makes further sell-offs necessary. The government needs to break through this crisis. Then it will also no longer need to take over the bad risks of the all-too-careless banks."
The financial daily Handelsblatt writes:
"It is not easy to say this loudly and clearly: The German banks are on the edge of the abyss. This is the painful truth, and nothing but the truth. … All of them have been hit (by the financial crisis). We urgently need a 'bad bank' in which a large part of the toxic securities and loans which are still on the banks' balance sheets can be deposited. It doesn't matter whether each type of bank gets its own bad bank, or whether there is only one bad bank for all. The crucial thing is that the state is behind it. … If all other major industrialized countries are taking over their investment banks' toxic securities in one way or another, then Germany cannot simply stand by and watch. Otherwise, its own banks will fall far behind."
The Financial Times Deutschland writes:
"Soffin's facility for buying toxic securities from banks simply doesn't work. Not one single bank has reached an agreement with Soffin to do this, and there are no signs that this will happen in the future either. According to a ruling by the European Commission, the banks will have to take these risks back again after three years. Hence there is no real cleaning-up of the balance sheet and no such cleaning-up would be recognized by auditors. It is absolutely incomprehensible why Berlin accepted this EU condition. German politicians would be well advised to approach the European Commission again and to demand that this passage is corrected. Only in this way can Soffin fulfill its intended function as a 'bad bank'. If this doesn't happen, then the instrument will remain useless. And nobody needs that."
The conservative Die Welt writes:
"Taken as a whole, (Germany's) financial institutions have dead weight to the tune of hundreds -- or even thousands -- of billions on their balance sheets. This problem can not be solved simply by sitting it out -- action needs to be taken now so that the economic crisis is not exacerbated. In this respect, the government should follow two principles that are in no way contradictory: applying market principles on the one hand, and minimizing costs on the other. These principles rule out the setting up of a bad bank as the central repository for the toxic assets. Instead, each institution should set up its own repository. If the government then needs to get involved, it is important that it create mechanisms so that taxpayers should at least be able to benefit from a subsequent upturn. Otherwise, the foundation is laid for the state to suffer a concrete financial crisis of its own as a result of the banking crisis."
BNP Paribas sees Q4 loss of €1.4 billion
French bank BNP Paribas SA said Monday it expects a €1.4 billion net loss in the fourth quarter and said it plans to tap another €2.55 billion ($3.26 billion) cash injection from the French state, doubling the aid it received in December. BNP Paribas said the loss -- while less than that of some major banks during the global financial crunch -- resulted from "exceptionally violent" market swings that led to writedowns on assets and a loss at its investment banking unit. For the full year, BNP Paribas said it expects a net profit of around €3 billion thanks to the "good performance" of retail banking and asset management. Shares of BNP Paribas soared 11.4 percent to €23.82 in early afternoon Paris trading Monday.
David Williams, an analyst at Fox-Pitt Cochran Caronia who rates the shares as "outperform", said some investors read the announcement as a sign that BNP Paribas doesn't plan to issue new ordinary shares anytime soon. "The key concern for BNP Paribas was on the capital side," he said by phone from London, adding that the market interpreted the loss as a "one-off" during the fourth quarter. And BNP Paribas' stock "was very heavily punished last week. All things considered, it looks a little bit like a relief rally," Williams added. BNP Paribas said in a statement its corporate and investment banking unit is expected to book a pretax loss of around €2 billion due to the higher cost of risk on capital markets. It also wrote down €400 million in the quarter after the sharp drop in stock markets. The bank also said its board of directors plans to convene shareholders to vote on a proposal to issue euro5.1 billion worth of preference shares to the French state -- part of a two-tranche bailout package it set up to ease the credit crisis.
The €5.1 billion amounts to twice the financial support BNP Paribas received in the first phase of the state aid plan announced in December. It said last week it was considering asking for the extra €2.55 billion in new aid, but that it was not considering issuing new ordinary shares to receive it. BNP will publish its full annual results on Feb. 19. "In this period of strong market turbulence, I think it was very important, out of concern for transparency, to tell the market what the results were" for the fourth quarter and the year, CEO Baudouin Prot said on BFM radio, explaining the early forecast of 2008 results. Prot defended BNP's handling of the crisis and said the bank had "a very good performance for the year as a whole. In a year that was difficult for all banks, with euro3 billion in profits for the group, we will be among the top 10 banks worldwide by earnings," Prot said. Among other French banks that tapped the first round of aid, Credit Agricole received euro3 billion, Societe Generale SA received €1.7 billion and Credit Mutuel received €1.2 billion. Caisse d'Epargne received euro1.1 billion and Banque Populaire received just under €1 billion.
Japan Caught in the Pop of Its Manufacturing, Export Bubble
Japan has largely escaped the housing bubble and huge credit losses that are weighing on the U.S. and Europe. Then why is Japan's economy shrinking faster? Economists and corporate executives are realizing that the nation suffers from the bursting of another type of bubble -- one in manufacturing. Between 2002 and 2007, Japan's manufacturing sector boomed, driven by soaring demand for Japanese automobiles and electronic gadgets by consumers globally, including Americans feeling flush amid rising home prices. Fueling the gains was a weak yen that kept Japanese products competitive and propelled yen-based revenue and earnings for companies such as Toyota Motor and Sony to lofty highs. Many in Japan were relieved to see their economy growing at a healthy pace again thanks to strong exports, after a slump for more than a decade. But many didn't realize just how vulnerable the economy was becoming to consumers abroad, despite decades of hectoring from the U.S. and Europe that Japan needed to rely less on exports and more on domestic demand.
The foreign advice was hard to implement. That's because workers' pay was kept low amid competition from low-cost nations like China, making it tougher for them to spend. During the six years starting in 2002, Japan's annual exports jumped by 74%. Corporate capital spending, led by exporters, rose 31%, according to data compiled by Ryutaro Kono, a BNP Paribas economist in Tokyo. In contrast, annual domestic household spending grew a mere 6.6% during that period, as Japan's effort to diversify its economy away from exports stalled in the absence of bold steps by the government, laden with a huge deficit and political gridlock. Now that American consumers have stopped splurging, the Japanese economy is deteriorating at an alarming rate. In December, exports plummeted a record 35% from a year earlier. Machine-tool orders, a prime indicator for capital spending by manufacturers, fell 58% during the October-December quarter from a year earlier.
Overall, Japan's economy, the second largest in the world, probably contracted at an annual rate of more than 10% during the latest quarter, economists say. That would follow an annualized 1.8% decline in the third quarter. It also is a much steeper decline than is likely in the U.S. -- where economists estimate about a 5% annualized decline for the fourth quarter -- and other major economies. The pain is felt widely. At Maki Takasugi's sushi restaurant in Meguro, an affluent residential neighborhood in Tokyo, customer traffic has been slow since October, when sales suddenly fell about 30% from a year earlier. "Even people whose businesses are doing quite well now feel splurging on sushi is too much of a luxury," says the 45-year-old, who runs the restaurant with her husband, the chef. To spur sales, the Takasugis are offering free beer to customers this month.
Other economies that depend heavily on exports also are suffering, particularly in Asia. Singapore has warned that its economy may contract between 2% and 5% this year after shrinking an annualized 12.5% during the fourth quarter. South Korea's economy last quarter shrank 5.6% from the July-September period, or an annualized rate of 20.8%, according to J.P. Morgan, the sharpest contraction since the Asian financial crisis a decade ago. Europe's largest manufacturing nation, Germany, has also been hit. Sales of car makers such as BMW and Daimler dwindled in the U.S., and machinery sales to emerging markets faltered. Total exports in November were down 9.1% from a year earlier, and 10.7% lower than in October. New orders from abroad were down 27% in November, which bodes ill for German output in the months to come, even though many firms expect some stabilization in mid- to late-2009. In Japan, manufacturers are saddled with too many workers and excess capacity as production begins to fall. To cut costs, companies have let go tens of thousands of factory workers on temporary contracts, and they are cutting hours for remaining workers.
Sony said Thursday that it would report its first annual net loss in 14 years for the fiscal year through March 31, due to falling LCD-television prices and a rising yen. Sony, which sells 80% of its electronics products overseas but has half of its 57 factories in Japan, plans to cut 16,000 jobs from its electronics divisions world-wide and close a Japanese plant for its flagship product, televisions. With auto exports falling by nearly half in December from a year ago, the situation is just as bleak in the car industry. Even as it snared the title of the world's largest auto maker recently, Toyota is expecting its first operating loss in 70 years during the fiscal year ending in March as sales fall in the U.S., Europe and previously red-hot emerging markets. The auto giant has eliminated thousands of temporary jobs and plans to close its domestic factories for 11 days during February and March.
Also hurting exporters is the reversal of the yen's value against major currencies, including the dollar and the euro. The dollar, which had traded above 120 yen during peaks in 2007, is now below 89 yen. The shift reflects, in part, interest-rate cuts by the Federal Reserve to the near-zero levels close to Japan's. That boosted the appeal of the yen. With exporters struggling, the outlook is darkening for the entire Japanese economy. The unemployment rate, which has stayed relatively stable despite losses of temporary jobs, is likely to start climbing in a few months while consumer spending is cooling. The Bank of Japan Thursday forecast the economy would shrink 2% during the next fiscal year, which starts in April, after contracting 1.8% during the current fiscal year. If realized, it would be the first time the economy declines for two consecutive years since World War II. Only three months ago, it projected growth of 0.1% for next fiscal year. "Here is our main scenario," Bank of Japan Gov. Masaaki Shirakawa said at a news conference. "The economy is deteriorating sharply and it will continue to deteriorate in the foreseeable future."
'Scrapping Bonus' Injects Life into German Car Sales
A new measure to pay owners of old cars €2,500 to junk their wrecks and buy something new has proven popular in Germany. In fact the idea is so popular that money for the program may be running short -- even before the measure has passed. It's almost a sport in Germany these days to criticize Berlin for its erratic attempts to confront the worsening economic effects of the ongoing financial crisis. Chancellor Angela Merkel isn't doing enough, her critics say. The country's two stimulus programs amount to a random collection of spending plans, say some observers, not a strategic approach to the economic storm. But one aspect of the second stimulus package, which has not yet been passed into law, looks like a rousing success. The package foresees granting €2,500 ($3,250) to people who elect to junk their current automobile, provided it's at least nine years old, and buy a new (or slightly used) car. Interest has been intense. As many as 1.2 million people may advantage of the offer should it become law, according to the market research institute Puls. The government office that will oversee the plan -- the Federal Office of Economics and Export Control (BAFA) -- has been overwhelmed by requests for information. Some 270,000 people called the agency's hotline on Monday; on Tuesday the number was 150,000.
Interest has been so great, in fact, that the €1.5 billion set aside for the so-called "scrapping bonus" may now be too limited. The budget could pay for the scrapping of 600,000 cars -- meaning that car owners who wait too long may miss out on the bonus. The aim of the program is to boost sagging automobile sales in Germany. A number of factories, including Ford and Audi on Friday, have announced that they are slowing production due to slow demand. Car sales in Germany in 2008 hit a 17 year low, primarily because of a miserable fourth quarter. That trend may turn around because of the scrapping bonus. According to the industry association ZDK, car dealerships in the country have reported a sharp uptick in the number of potential buyers in recent weeks. The Süddeutsche Zeitung reported on Friday that some dealerships have seen new car sales increase by a factor of 10 since Merkel's government agreed to the measure in mid-January. The measure would cover car sales from Jan. 14 to Dec. 31 this year.
The scrapping bonus belongs to a €50 billion economic stimulus plan that Merkel's government hopes to see passed by German parliament in early February. The package calls for billions of euros to improve Germany's roads, rail network, schools and universities. The tax threshold was also raised slightly and employee health insurance contributions were lowered. The package comes on top of a much-criticized program passed last November. Originally, the plan to promote the junking of old cars was advertised as one that could not only improve car sales, but would also help the environment. Rules governing greenhouse gas emissions have strengthened in recent years, meaning that replacing older cars with newer ones, so goes the logic, would help the environment. Critics, though, say the environmental effects will be minimal at best -- and suggest that a bonus should be also given to those who decide to junk their car and switch to public transportation. It isn't clear yet how much the German economy might benefit from the junking-bonus incentive. According to a study by Puls, 7.9 percent of all those who own cars nine years old or older are considering taking advantage of the scrapping bonus. Of those, 17.2 percent have considered buying a Volkswagen. But the next three carmakers on the list -- Dacia, Ford and Fiat -- are all foreign brands.
After Receiving Rescue Funds, Citigroup Buys A $50 Million Luxury Jet
Fresh off receiving $50 billion in rescue funds from the Government, Citigroup (NYSE: C) decides to go ahead with the purchase of a $50 million luxury jet, the NY Post reported. Even though Citi is burning through a $45 billion taxpayer-funded rescue, Citi executives thought it was prudent to still purchase a new Dassault Falcon 7X, according to a NY Post source. The Dassault Falcon 7X seats up to 12 in a plush interior with leather seats, sofas and a customizable entertainment center. It can cruise 5,950 miles before refueling and has a top speed of 559 mph. There are just nine of these top-of-the-line models in the United States.
Citigroup decided to make this new purchase two years ago, when things were different, but the surprising thing is it is still going to take possession of the jet despite its current woes. The NY Post column, said it's not uncommon for large companies to pay a deposit on a new plane then cancel the order before delivery. Hmm. So will Citi changes its mind after this article makes its way around the media? Last week, President Obama did say he plans to crack down on companies who are in receipt of federal funds and spend their money wastefully.
Deutsche Post ex-CEO to Pay EU1 Million; Gets Suspended Sentence
Former Deutsche Post AG Chief Executive Officer Klaus Zumwinkel received a two-year suspended sentence and must pay a 1 million-euro ($1.29 million) penalty after a German court convicted him in a tax evasion scandal involving Liechtenstein. Zumwinkel, 65, "knowingly, meticulously, enduringly and, thus, criminally evaded taxes," Presiding Judge Wolfgang Mittrup today when delivering the verdict. Part of the 1 million-euro penalty must be paid to charities, the judge said. Zumwinkel confessed last week to charges that he avoided about 970,000 euros ($1.3 million) in taxes by depositing money in a foundation in Liechtenstein without declaring the proceeds as income. The case, which featured Zumwinkel’s arrest at his home broadcast live on television, is one of hundreds involving German residents’ use of Liechtenstein accounts to avoid taxes.
"It’s hard to understand why rich people do this," Mittrup said. "You cannot explain it alone with the wish to aggrandize assets." The sentence is the same as that sought by the prosecution. Zumwinkel’s defense attorney Hanns Feigen had asked the court to impose a "considerably" lower sentence. Zumwinkel opened a foundation in 1986 in Liechtenstein that earned him 346,173 euros to 472,710 euros a year and by the end of 2006 had 11.8 million euros. He didn’t declare the income. He had been charged with six counts of evading almost 1.2 million euros of taxes from 2001 to 2006. The court threw out the charges relating to 2001, saying a statute of limitations applied.
For $10, Fuld Sold Florida Mansion to His Wife
Housing prices are falling around the country, but this one sounds hard to believe: A seaside mansion on Jupiter Island in Florida, bought for more than $13 million five years ago, was just sold for $10. That’s right, 10 bucks. But in this case, the transaction is likely to raise eyebrows for reasons other than the price. The seller, according to county records, was Richard S. Fuld Jr., the former chairman and chief executive of Lehman Brothers. The buyer was his wife, Kathleen. The motivation is unclear, but Mr. Fuld has been under intense scrutiny since Lehman declared bankruptcy in September.
The longtime leader of the brokerage firm is at the center of a federal investigation into whether Lehman executives misled investors about the state of the company. And he was grilled by lawmakers at a Congressional hearing in October. Mr. Fuld said in sworn testimony before a Congressional panel last year that while he took full responsibility for the debacle, he believed that all his decisions "were both prudent and appropriate" given the information he had at the time.
The couple jointly bought the home in Hobe Sound, Fla., for $13.75 million in March 2004, and the sale to Mrs. Fuld on Nov. 10 was first reported by Cityfile.com. It is possible that he is now transferring properties because of his fears of investor lawsuits or a possible bankruptcy, lawyers in Florida said. "This is the oldest trick in the books" said Eric S. Ruff, a lawyer with Ruff & Cohen in Gainesville, Fla. "It’s common when you hear the feet of your creditors approaching to divest yourself." Mr. Fuld has been accused by some of doing too little too late to save the firm. However, he has said publicly that the blame should be shared by regulators and that he took steps to try to save — or sell — the investment bank.
Florida has particularly generous home protection laws that protect residents from losing their homes in the case of lawsuits or bankruptcy. But Mr. Fuld may not see much benefit by shifting the house to his wife’s name because the Fulds may not be able to prove residency there. Mr. Ruff, the lawyer in Florida, said that it might be difficult for him to claim residence in Florida, because he primarily lived and worked in the New York area. That could mute any bankruptcy benefit. And, Mr. Ruff said, the transfer to his wife could be deemed fraudulent conveyance if she did not pay enough for the house. That would make the house fair game for creditors who come after Mr. Fuld.
It is also unclear how much Mrs. Fuld paid for the house. It is standard for property deeds to contain a placeholder number. The $10 on the deed in Martin County could simply be a placeholder, and Mrs. Fuld might have paid more, lawyers said. The tax stamp on the deed says there were 70 cents of taxes, which would suggest that she may have paid as much as $100 for the house. "All that you can say is that he transferred it. We don’t know his motivation," said Jordan E. Bublick, a bankruptcy lawyer in Miami. "But he’s one of the rogue’s gallery. A lot of people when they’re in trouble say, ‘Oh, we’re going to put everything in my wife’s name.’ " Mr. Fuld has owned his house in Florida since 2004, according to records in Martin County, Fla. He also owns a sprawling property in Greenwich, Conn., the leafy suburb of New York. The Fulds could not be reached for comment at either residence.
Mr. Fuld received about $34.4 million in 2007, though much of that was in stock that later became worthless. Mr. Fuld left as chief executive at the end of 2008, with no bonus or severance payments, the firm has said. The Fulds have taken steps to cut back, like selling some of their multimillion-dollar art collection. Still, they are thought to be worth tens of millions. When Mrs. Fuld went shopping at Hermès over the holidays, she requested white bags — rather than the brand’s signature orange ones — to try to disguise her purchases. Mrs. Fuld is well known among art collectors in the New York area. When the Museum of Modern Art honored Mr. Fuld for their giving a few years earlier, he said in a speech, according to people who were there, "My wife loves art, and I love my wife."
Lynched at Merrill
Even at the end, after presiding over the worst performance in the 94-year history of Merrill Lynch, and as Bank of America pinned the blame for a bonus payment scandal squarely on his back, John Thain did not seem to know what was about to befall him. Last Wednesday, Mr Thain purchased 8,400 shares in BofA, which had just rescued his company, and was finalising plans to jet off to Davos, where he would hobnob with members of the global business elite. But on Thursday morning, it was Ken Lewis, BofA chief executive, who hopped on a jet for a short flight from Charlotte, North Carolina, to New York, where he confronted Mr Thain in his corner office and dismissed him. Just like that, in a meeting that was over in 15 minutes, the high-flying Wall Street career that Mr Thain had spent three decades constructing came to a crashing end.
Named chief executive of Merrill Lynch in November 2007, Mr Thain took over a legendary investment bank that, in common with the rest of Wall Street, had fallen on hard times since the credit crisis hit that August. His mission was clear. Based on his record both at the rival Goldman Sachs, where he had been president, and then as head of the New York Stock Exchange, his nickname "Mr Fix-it" made it appear likely he would excel at the job and perhaps earn a place in the pantheon of Wall Street titans who had secured the future of great institutions. His analytical mind, sharpened at MIT and Harvard Business School and proven through executive experience in finance, could grapple with many of the thorniest business challenges. But Mr Thain had been reared on a market that always rebounded from downdraughts. For 25 years, his one frame of reference was a world in which banks could keep lending, investing and growing. Yet when it began to become clear they could not, he seemed to have hit on the best possible solution: shelter under the wing of the largest US bank, with its broad operating base and bountiful retail deposits.
After taking on the clean-up job at Merrill, he was hardly alone in failing to fathom how bad 2008 would be. Bear Stearns collapsed in March from a lack of liquidity and was forced into a sale to JPMorgan Chase. But in the second quarter, the world appeared to return to normal. Subordinates including Greg Fleming, head of investment banking, encouraged him to sell the group’s toxic assets – subprime mortgage securities and the like – in April and May. But Mr Thain would not budge on the issue until late July, when the market for such assets had eroded even further. So if there is one signature achievement to his barely year-long tenure at Merrill Lynch, it was his decision to sell the group to BofA over the weekend of September 13-14, as Lehman Brothers was desperately seeking a government bail-out. By Monday September 15, Lehman had filed for bankruptcy protection and Mr Thain had inked a sale agreement at $29 per share, a 70 per cent premium over the price at which Merrill stock had been trading at the previous Friday. The deal valued the brokerage at $50bn.
What went wrong since then and why? Accounts by those who know Mr Thain point variously to blind spots in attuning himself to differences in corporate culture, to the mood outside downtown Manhattan and simply to people. For a start, though analytical power was his strong suit, at an institution such as Merrill Lynch people skills are paramount. "Merrill has a way of being very hard on outsiders coming in," says Thomas Caldwell of Caldwell Financial in Toronto. "It’s a unique culture. If you come in as an outsider, you’d better be paying attention, because it’s a tough game." Mr Caldwell, who worked at Merrill in the 1970s, came to know Mr Thain in 2004 when the ambitious Goldman Sachs executive took the stock exchange helm. At the time, the NYSE was reeling from a pay scandal involving Richard Grasso, his predecessor, as well as a Securities and Exchange Commission probe into the dealings of specialist brokers. Mr Caldwell, who owned more than 40 of the exchange’s 1,366 seats, watched Mr Thain guide the NYSE through its regulatory woes, transform it into a public company, modernise its trading platform and globalise by acquiring the Paris-based Euronext.
His disagreements with Mr Thain were many, but Mr Caldwell says he respected Mr Thain’s professionalism and his penchant for deliberating over problems before acting. He says he is saddened by what he calls a "character assassination" taking place in the aftermath of Mr Thain’s firing, highlighted by the disclosure last week that Mr Thain spent more than $1m to decorate his corner office at Merrill last year. But after 13 months during which Mr Thain evidently crossed, belittled or antagonised subordinates at Merrill and then at BofA, one more pertinent question might be whether there was anyone left in upper management who did not cheer his ousting last Thursday. Another is whether he was indeed, as portrayed, the visionary architect of September’s deal with BofA. According to several executives involved in the matter, Mr Thain had to be forced into those negotiations by Hank Paulson, then Treasury secretary and his old boss at Goldman.
Late on Saturday morning September 13, as Wall Street’s most prominent bankers met at the New York Federal Reserve to hatch a rescue plan for Lehman, Mr Thain says it dawned on him that Lehman would not be rescued, so he called BofA’s Mr Lewis to initiate talks. But several people present say Mr Paulson first took him aside and gave him a stern talking to. These witnesses, who represented different parties in the talks, add that it was only after Mr Thain returned from his one-on-one with Mr Paulson, looking somewhat shaken, that he placed the call to Mr Lewis. Asked about the conversation with Mr Paulson, Mr Thain characterises things differently. The Fed and Treasury "were initially focused on Lehman but grew concerned about us", he told the Financial Times last month. "They wanted to make sure I was being proactive [but] they didn’t tell me to call Ken Lewis." Compared with Richard Fuld of Lehman Brothers, who became the avatar of wrongheaded Wall Street leadership last year for failing to save his firm, Mr Thain emerged from the gruelling September weekend not only unscathed but with his reputation as a miracle-worker enhanced. In early October, he ended speculation about his future by accepting a position as head of global banking, securities and wealth management at BofA, reporting directly to Mr Lewis and positioning himself as a candidate to succeed the BofA boss.
But Mr Thain’s embrace of his role as Merrill’s saviour and his reluctance to spend time in Charlotte with his future colleagues generated simmering enmity within BofA. The tension boiled over on December 8, three days after Merrill shareholders had voted to approve the BofA acquisition, when Merrill’s board of directors met to sign off on the annual bonuses the investment bank was to pay. In the weeks leading up to that meeting, Mr Thain put together an argument for a bonus for himself of more than $35m, says someone with knowledge of the situation. Other princes of Wall Street, starting with the top executives at Goldman Sachs, had publicly forsworn their bonuses for 2008 because of poor market conditions and public uproar over the US government’s $700bn bail-out for the financial industry. But by comparing Merrill’s successful sale with the collapse of Lehman and Bear Stearns, Mr Thain concluded that he deserved a big payday, according to the executive familiar with the situation.
Mr Thain’s plan was exposed in the Wall Street Journal on the morning of the meeting. That afternoon, he told the board he did not want a bonus. But the board approved close to $4bn in incentive compensation to many others among the 58,000 Merrill employees. According to BofA, Merrill’s performance deteriorated that week, prompting Mr Lewis to approach the federal government on December 17 for an additional infusion of $20bn in order to complete the acquisition. Mr Thain appears to have been unaware of Mr Lewis’s reservations. Instead, a week before Christmas, as BofA’s auditors were poring over Merrill’s books, Mr Thain left for three weeks at his vacation home in Vail, Colorado. On December 29, Merrill paid the cash portion of its bonuses – 70 per cent of the $4bn set aside – to its employees. On January 2, the remainder was paid out in BofA stock. That came the day after BofA’s acquisition of Merrill Lynch closed. Mr Thain then launched a plan to reduce headcount in investment banking, capital markets and research by almost 40 per cent. But the brunt of redundancies would be visited on BofA employees.
On January 16, after Mr Lewis’ December plea for government help was revealed, BofA disclosed an attributable loss of $2.4bn for the fourth quarter. But that sum was dwarfed by Merrill’s pre-merger loss of $15.3bn. For the year, Merrill was $27bn in the red. Nonetheless, Mr Lewis told analysts he was "happy" that Mr Thain had decided to stay on. BofA’s share price continued to swoon and internal animosity towards Mr Thain raged. BofA employees grumbled that the acquisition of Merrill had devastated their 401(k) retirement accounts, which were padded with company stock, as well as ruining their bank, which was now a "ward of the state", and costing them jobs as the merger led to a big cull. Most galling to BofA staff was the $4bn paid to Merrill employees, just as the transaction closed, using money that appeared to come directly from US government funds.
After the revelation of those bonus payments in the FT last week, Andrew Cuomo, New York’s attorney-general, launched an investigation. Mr Lewis, toasted as "banker of the year" by American Banker the previous month, was now the target of criticism from shareholders and analysts. On Wednesday, BofA issued a statement to the FT laying responsibility for the December bonus flap squarely on Mr Thain. To executives schooled in the language of corporate pronouncements, usually contrived to avoid the assignment of any blame, BofA’s statement was a clear indication that the end was near. Executives at BofA headquarters in Charlotte knew Mr Thain’s days were numbered. At Merrill Lynch it was also apparent that his reign was nearing an end. But on the 32nd floor of Merrill’s headquarters, Mr Thain was among the last to see it coming.
How things went sour
• Nov 2007: John Thain becomes Merrill Lynch chief executive
• Sept 13-15 2008: Agrees deal to sell Merrill to Bank of America
• Dec 8: Merrill board approves $4bn in bonuses to employees
• Dec 17: BofA’s Ken Lewis asks federal government for $20bn infusion
• Dec 29: Merrill pays the cash portion of its bonuses; remainder paid out in BofA stock on Jan 2
• Jan 16: BofA discloses $2.4bn fourth-quarter loss – dwarfed by a pre-merger loss of $15.3bn by Merrill
• Jan 22: Merrill’s accelerated bonus payments revealed by the Financial Times. Lewis dismisses Thain
A cool, calculating analyst who ‘didn’t see the massive bubble’
John Thain rose to power – first at Goldman Sachs, then the New York Stock Exchange and, finally, Merrill Lynch – with a reputation as Wall Street’s ultimate technocrat, a cool operator who could quantify risks and avoid mistakes, writes Henny Sender. He joined Goldman after studying electrical engineering at MIT and earning a graduate degree at the Harvard Business School. Trim and athletic, with an unassuming midwestern mien, Mr Thain became known at Goldman for his steely intelligence, rising under Jon Corzine, then chief executive, to become chief financial officer before he was 40.
"He was calculating and logical," one member of Goldman’s management committee remembers. "He analysed everything." Mr Thain, now 53, also earned a reputation with some colleagues for ruthlessness. During a power struggle that developed as Goldman considered going public in the 1990s, Mr Thain turned against Mr Corzine, his mentor, to help Hank Paulson emerge as the firm’s top boss. When Mr Thain became chief executive of the NYSE in 2004, his icy demeanour became the stuff of New York legend. Traders, it was said, referred to him as "I, Robot". For Merrill, however, this all seemed like a good thing. A company so bathed in sentimentality that its executives called it "Mother Merrill", the bank turned to Mr Thain in late 2007, hoping that his brain power would help it survive the huge losses incurred under Stan O’Neal.
Mr Thain moved quickly at Merrill, raising capital in December 2007 from investors including Singapore’s Temasek Holdings and again in January 2008 from Japan’s Mizuho Financial, the sovereign wealth arms of Korea and Kuwait, the New Jersey state pension fund, the Olayan group of Saudi Arabia and TPG-Axon, the hedge fund affiliate of the large private equity firm. In July 2008, Merrill Lynch struck a deal to sell toxic assets with a face value of more than $30bn to Lone Star Funds, a distressed debt investor, receiving 22 cents on the dollar. Wall Street breathed a sigh of relief, hoping that Mr Thain was clearing the desks for a rebound. But it was not to be. Like so many others on Wall Street, Mr Thain proved unable to keep up with the speed of the collapse. In a December interview with the Financial Times, Mr Thain acknowledged that at the time he had taken over Merrill, "I didn’t see the massive bubble." The times changed too quickly even for the robot of Wall Street. One major Merrill shareholder mused: "John Thain of Goldman would have fired the John Thain of Merrill."
KBR bribery case could cost Halliburton nearly $560 million
Halliburton said today it has reached tentative settlements with government agencies pursuing bribery allegations against its former KBR subsidiary and would shell out nearly $560 million to close the issue once the agreement is complete. The proposed settlements with the Department of Justice and the Securities and Exchange Commission would conclude Federal Corrupt Practices Act investigations into whether a joint venture that included KBR made improper payments to win contracts. Halliburton disclosed in 2004 that the probes were taking place. Albert Jack Stanley, former chairman of KBR, pleaded guilty last year to taking part in a scheme to bribe Nigerian officials. Halliburton, with dual headquarters in Houston and Dubai, completed its separation in April 2007 from KBR, a government contractor and energy industry contruction firm.
As part of that spin-off agreement, Halliburton agreed to accept some responsibility if the FCPA investigations resulted in fines or settlement payments. Under the proposed agreement with the Department of Justice, Halliburton has agreed to pay $382 million on behalf of KBR over the next two years, and pay an additional $177 million in disengorgement to the SEC. KBR has agreed Halliburton’s indemnification obligations under the spin-off pact would be "fully satisfied" if the new agreement is approved, Halliburton said. The settlement has been approved by the SEC contingent upon the completion of a settlement with the Justice Department, Halliburton said. KBR declined to comment on Halliburton’s disclosure about the settlement. "Our position on this issue will be disclosed in KBR’s earnings release scheduled for Feb. 25," company spokeswoman Heather Browne said.
Word of the proposed settlement came on the same day Halliburton announced a 32 percent decline in fourth quarter earnings, a drop it attributed in part to a $303 million, or 34-cent per share, charge it took related to the proposed settlement. Net income dropped to $468 million, or 53 cents a share, from $690 million, or 75 cents, a year earlier, Halliburton said today in a statement. Revenue rose 17 percent to $4.91 billion. In a conference call with financial analysts this morning, Halliburton Chief Executive Dave Lesar declined to discuss the proposed government settlements but touted the company’s "excellent performance" in the quarter despite difficult market conditions. Excluding such items as the KBR settlement and a gain related to a patent case, fourth-quarter profit was about 84 cents a share, 11 cents higher than the average of 23 analyst estimates compiled by Bloomberg.
Protecting Your Portfolio from Inflation
Inflation isn't a top worry currently, but you still need to guard your retirement savings. Inflation-protected securities could be attractive now. Investors are being haunted by the threat of inflation, despite the fact that real inflation is nowhere to be seen. The effects of inflation on an investor's portfolio are so pernicious that they can't be ignored. Even in the low-inflation environment, market pros are keeping close attention on Treasury Inflation-Protected Securities (TIPS), bonds guaranteed by the federal government to keep up with rising prices. TIPS are out of favor in the market, as most economists will tell you that inflation is the least of our concerns right now. With the economy mired in recession, falling prices—or deflation—pose more of a threat. Gasoline prices are down 56% from last July, and consumers are still slashing spending, says Deutsche Bank (DB) economist Joseph LaVorgna. "The consumer pullback is clobbering inflation," he wrote Jan. 20.
Yet fears of an eventual return of inflation can't be dismissed. That's because governments are spending an unprecedented amount of money, while central banks are slashing interest rates, to spur economic growth. In effect, "We've thrown a lot of money into the system," says David Hinnenkamp, chief executive of KDV Wealth Management. Governments may even add to that inflation threat. To combat deflation or pay off debt, "A lot of governments will be tempted to start printing money," says Michele Gambera, chief economist at Ibbotson Associates, a subsidiary of Morningstar (MORN). "This may cause inflationary pressure worldwide." With so much extra money sloshing around, a strong recovery in the world economy could send inflation soaring again. That's why some experts are telling long-term investors to buy TIPS. Without protection, inflation can erode the buying power of investment portfolios. On paper, a conservative portfolio might tread water, staying at the same nominal value, but that's little comfort when the price of everything else—from housing to food and energy—is rising.
TIPS are relatively cheap, and may be necessary insurance for investors who can't risk a loss of buying power. "For the person who will retire in less than 10 years or who has already retired, it may make sense to allocate some to TIPS," Gambera says. There is some evidence the appeal of TIPS is returning slightly. Tony Crescenzi of Miller Tabak notes that 10-year TIPS were priced on Jan. 23 for the consumer price index to rise 0.72% over the next decade. That's a small increase, but its the highest since Nov. 17 and 15 times the almost negligible inflation expectations of three months ago. The problem, though, is that conditions in the next few years could make TIPS very unattractive to investors. The value of TIPS is indexed to U.S. government inflation data, so low inflation makes TIPS less attractive compared to other assets. Also, while aggressive government spending and rate cuts are likely to prevent full-blown deflation, negative government price data, if it occurs, would be bad news for TIPS holders, who would see their bond yields shrink in response.
Marilyn Cohen, president of Envision Capital Management and writer of the Tax Advantaged Investor newsletter, says the inflation threat is "way down the road." She doesn't expect inflation to return in either 2009 or 2010. She believes investors should avoid TIPS for now, preferring safe short-term corporate bonds until signs of inflation actually appear on the horizon. In other words, investors may be right to worry about inflation, but that doesn't mean it's time to dive in and buy TIPS or other inflation hedges right now. "The difficult part will be making a call on when that happens," Hinnenkamp says. Another inflation hedge traditionally favored by investors has been commodities like oil, gold, or other precious metals. But Gambera notes that in the past year these assets have had "very high volatility." Those wild swings make them less reliable for conservative investors. TIPS, because they are issued by the federal government, are more reassuring to investors trying to flee the market madness. The essential appeal of TIPS remains that they are a government-backed refuge of last resort. If Cohen and others are right, TIPS may not make money for some time. But they provide insurance to skittish investors during uncertain times like these.
A chill wind blows through Davos as global crisis bites
The downturn will make the World Economic Forum a sombre occasion for heads of state and business leaders. Forty one heads of state, 60 ministers, 10 ambassadors, 1,400 chairmen and chief executives and one global financial meltdown. Welcome to Davos 2009. Klaus Schwab, the founder of the World Economic Forum (WEF), has already said that this year's meeting, which starts on Wednesday, will be the most important in the WEF's 39-year history. As the 2,500 participants start to make their way to the Alpine resort this weekend, they can expect a more sombre, urgent, business-like meeting than in previous years. It won't be hard. In recent years Davos has become as famed for its parties as its programme of speakers. Last year, Arcelor's Lakshmi Mittal hired Jamie Cullum, the jazz musician, to play at the resort's Belvedere Hotel, while singer Annie Lennox flew in for a separate bash.
Stephen Roach, the chairman of Morgan Stanley Asia, has reportedly said that parties at Davos this year "will be few and far between". "We're at an unbelievably critical juncture in the global economy debate. This will not be a normal year at Davos," he said. Other regular attendees are less certain. "It's Davos. These people are rich. Of course there will be parties," said one. But whatever the party count, the event's tone will differ dramatically from previous years. Entitled 'Shaping the Post-Crisis World', this year's Forum will focus on how governments, countries, continents and businesses can stabilise and revive the global financial system. The chatter is expected to major on bail-outs, regulation, remuneration and protectionism. But not in a conceptual way. This is the first time that all the big stakeholders in the world's financial system – bank chiefs, prime ministers, corporate chairmen – will have a chance to meet on a grand scale since the bottom fell out of their world four months ago.
"There will be lots of discussions behind the scenes and lots of cross-checking: 'what are you seeing in your place?', 'what is working?" said Mark Spelman, head of global strategy at Accenture, who is about to attend his fifth Davos. "The mood is going to be somewhat sober," he said. Mr Spelman believes that there will be three main talking points: how liquidity can be re-introduced to the banking system, what should be done to mitigate unemployment, and what the slowdown means for efforts to create a low-carbon economy. Most big-hitters will be there. Russian Prime Minister Vladimir Putin will deliver the opening address. Prime Minister Gordon Brown and Chinese Premier Wen Jiabao will attend too. Stephen Green, chairman of HSBC and Sir Victor Blank, the chairman of Lloyds TSB, will be there, as will be economists such as Nouriel Roubini, the so-called "Dr Doom" economist who predicted the current slowdown. Facebook founder Mark Zuckerberg and Sir Win Bischoff, chairman of Citigroup, will also attend.
As ever, a smattering of celebrities will be braving the cold. Singer Peter Gabriel, and actors Jet Li and Amitabh Bachchan, the Bollywood superstar, will be there. And the Mayor of London Boris Johnson will fly the flag for the UK. But among the 2,500 attendees from 96 countries, there is one person whose presence would turn Davos from an high-level summit into a truly global event. President Obama was never set to attend but it has not stopped commentators from dreaming. In reality, a number of his key senior staff are expected to travel to Switzerland. Timothy Geithner, President Obama's Treasury Secretary, and Lawrence Summers, the director of the National Economic Council, were both on the WEF's "registered participants" list on Friday and are likely to be there. Despite the cold economic winds blowing through Davos, these men are likely to receive the warmest reception of the week.
Baboon’s Blood Offers Davos Leaders Shakespearian Market Magic
That old black magic has even the World Economic Forum in its spell. "Double, double, toil and trouble, fire burn and caldron bubble," says WEF delegate Richard Olivier, one of the 2,500 global business and political leaders starring at the forum’s 39th annual meeting this week in Davos, Switzerland. The son of Shakespearian actor Laurence Olivier isn’t conjuring up Wall Street’s Triple Witching Hour before its next scheduled appearance in March. He’s hosting a seminar titled "Leadership Lessons From Macbeth" for WEF delegates who include Russian Prime Minister Vladimir Putin, News Corp. Chief Executive Officer Rupert Murdoch and Chinese Premier Wen Jiabao. "Cool it with a baboon’s blood," the 47-year-old Olivier advises, reciting the witches’ recommendation to the troubled Thane of Cawdor in Shakespeare’s play. The WEF’s theme this season is "Shaping the Post-Crisis World." Yet Olivier reckons the kettle of fiscal crises currently heating up WEF delegates from JPMorgan Chase & Co. CEO James Dimon to American International Group Inc. Vice Chairman Jacob Frenkel makes the Davosian stage an ideal venue for the princes of Wall Street to delve into the magic of "Macbeth" and discuss how they persuaded people, including themselves, to believe in things that were not real.
When magic involves money, some call it economics, a sometimes illusory undertaking that 2008 showed to be big on vanishing acts. U.S. mutual funds declined by $2.4 trillion, according to the Investment Company Institute, losing a fifth of their value from a year earlier. Last year, the value of global stock markets shrank by almost half to around $30 trillion. A recent study by Morgan Stanley foretells of hedge- fund assets valued at some $1.8 trillion in early 2008 dematerializing into $900 billion by the end of this year. As for the prestidigitators of profit, more than 200,000 of them dissolved into thin air in 2008, including 52,000 layoffs at Citigroup Inc. Foremost among the sleight-of-hand experts is Bernard Madoff, shaman-in-chief of a New York-based investment securities firm federal prosecutors have charged with running a Ponzi scheme, charming clients out of some $50 billion. "The dark black magic of Macbeth has a particular resonance this year at Davos," says Olivier, artistic director of Olivier Mythodrama in London, a corporate-leadership- training outfit that has coached executives at Nokia Oyj and Royal Dutch Shell Plc. "It’s about ambition, about how people who have bloody, murderous or greedy thoughts attract bloody, murderous or greedy spirits."
Whenever hobgoblins get in on the act, Greg Frewin takes note. The 44-year-old Canadian from Niagara Falls is the International Grand Champion of Magic, a title awarded by his peers in the $250-million-a-year illusion industry to the professional sorcerer who wins first prize in the world’s top three magic competitions. Frewin, who manages his own $2 million theater and a staff of 50 assistants, has played the Tropicana and Caesar’s Palace in Las Vegas, and staged command performances for Toronto- Dominion Bank and the Canadian Imperial Bank of Commerce. Right now, he’s turning $100 bills into $1 bills. "This routine is so popular that they used it at Lehman Brothers," Frewin jokes. As he tells it, there’s no difference between him levitating a scantily clad showgirl on stage and a credit-rating company elevating a subprime security on Wall Street. "In both cases, the audience is led to believe they’re seeing the impossible become true" he says. "Illusionists call it misdirection."
Adam Smith described it as a mysterious force. "They are led by an invisible hand," the Scottish economist and theoretician of capitalism wrote in "An Inquiry Into the Nature and Causes of the Wealth of Nations" (1776), referring to the supernatural power that would compel the market to disavow demons like the credit-default swap in favor of promoting trustworthy Treasury bills. "Macbeth also allowed the darkness to overcome the light," Olivier says. To do so, the tragic Scottish hero, fatally possessed by ambition, summoned the invisible hand for help. "And with thy bloody and invisible hand cancel and tear to pieces that great bond which keeps me pale," Macbeth says. "Macbeth is asking evil spirits to cut the bond between his soul and his conscience, so that he can carry out his dark deeds," Olivier explains. "Smith was a professor of morality at the University of Glasgow and certainly aware that the invisible hand represented a link between the natural and the supernatural."
Likening rogue capitalists to necromancers already has gained acceptance in legal circles. Consider the U.S. vs. Marc Dreier, founder of the New York law firm Dreier LLP and now in jail on criminal charges that allege he swindled hedge funds and investors out of $380 million. Dreier hasn’t responded to the charges. "He is the Houdini of impersonation and false documents," Assistant U.S. Attorney Jonathan Streeter said when Dreier’s lawyers in December tried to spring him for a $10 million bail. The analogy holds for more tranquil money managers, too. Ian MacDonald in Bristol, England, says legerdemain is a powerful investment tool. "My wife Sue is clairvoyant, the best I’ve ever come across," MacDonald says. Sue is so good that the 69-year-old Scotsman named his investment partnership after a hallucination and employs the ancient highland incantation "every mickle makes a muckle" -- the ability to turn nothing into something -- as the motto for Mirage Asset Management LLP.
George Magnus, senior economic adviser at UBS AG, Switzerland’s biggest bank, says all the hocus-pocus will be a "hard concept" for the WEF to quantify. "But the invisible hand clearly came back and slapped the free market in the face, so we have a big audience ready to discuss it," says Magnus, whose own institution in October rematerialized with a $5.3 billion Swiss government bailout package and permission to transfer as much as $60 billion of toxic assets to a fund supported by the country’s central bank. Even Alan Greenspan found himself bewitched. "Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself especially, are in a state of shocked disbelief," the former U.S. Federal Reserve Board chairman, 82, said last October in Congressional testimony on the causes of the subprime crisis. "The invisible hand pushes people into doing crazy things," Magnus says. Gregory Berns says he can help with the exorcism. He holds the Distinguished Chair of Neuroeconomics at Emory University in Atlanta and he’s hosting a WEF seminar that explores the relationship between fiscal judgment and brain waves. "Most traditional economists believe this endeavor is a waste of time," the professor says.
Berns and his colleagues at the 120-member Society for Neuroeconomics nonetheless study human perception and how the brain represents the value of any asset. "Subprime was a collective illusion," the 44-year-old Berns explains. "The market said subprime investments weren’t all that risky. A neural adaptation, what magicians call a cognitive illusion, took place. People stopped valuing the asset based on their own perceptions and reasonable assumptions." Back in Niagara Falls, the loudspeaker atop Screamers House of Horrors blares "This jittery journey is not for the squeamish." Inside the theater across the road, Frewin is shoving fire-tipped spears into a box that contains a woman in a bikini. He removes the lances, opens the carton, and a Bengal tiger leaps out instead. "Money illusions actually create the most powerful magic," Frewin says. "Money always triggers an extremely personal and emotional response, but a magician or an investment banker must believe in the illusion or it won’t work." Frewin snaps his fingers and a $100 bill falls out. "That was their illusion," he says.
Financial Crisis Drives Down Price of Pollution
As the economic effects of the financial crisis deepen, it has become surprisingly cheap to pollute. Prices for carbon dioxide emissions permits have fallen below 12 euro per ton. Some companies are selling them to generate much needed cash. The ongoing financial crisis, as has become clear in recent weeks, is bad for both budgets and business. It is also, it turns out, bad for the environment. Prices for carbon dioxide emission certificates in Europe have fallen drastically in recent weeks as companies have slowed down production to keep pace with falling demand. In addition, some companies have begun selling their certificates as a way of generating much needed -- and otherwise difficult to obtain -- cash. The result has been an oversupply of emissions certificates that has driven the price down below €12 ($15.58) for every ton of CO2 emitted.
As recently as last summer the price was close to €30 ($38.94) per ton. Such a low price is concerning for two reasons. On the one hand, it removes the incentive for companies to make improvements aimed at cutting back their greenhouse gas emissions. The idea behind the European Union Emission Trading Scheme is to create a financial disincentive to pollute. Analysts say that a price per ton of emissions of at least €20 is necessary before it becomes cost effective for companies to install environmentally friendly technology. On the other hand, higher prices for CO2 emissions certificates mean a greater motivation for factories to switch from coal to natural gas for their energy needs. If pollution is cheap, there is less of a reason to convert to the cleaner-burning fuel. The EU ETS, as the European Union's CO2 permit system is known, is currently in its second trading period, the first having ended at the end of 2007. Factories are given emissions allowances for several years at a time for free -- the current period runs until 2012.
Should they emit more than their allotted permits allow, they are required to buy more permits on the open market. Should they pollute less, factories can sell their unneeded permits. The plan foresees a gradual elimination of free permit handouts toward a system in which all permits are auctioned off. Currently, though, the permit market -- with banks still reluctant to lend money -- has proven itself a way for some companies to generate some much needed liquidity. A recent survey conducted by the Financial Times Deutschland shows that a number of mid-sized companies in Germany are selling CO2 emissions permits to fill financial holes. Indeed, the FTD even describes the case of the paper factory Scheufelen in south-western Germany which managed to avoid a complete collapse by selling the majority of its pollution permits in December. The low price of the permits is likely to mean that companies will delay technological improvements and run older, less efficient factories longer. The result will be greater emissions than would have been the case were permit prices higher.
Ice Alert Over Warming Antarctica