Whites Bog at Brown Mills, New Jersey. Ten-year-old Rose Biodo. Working three summers. Minds baby and carries cranberries, two pecks at a time. Fourth week of school and the people here expect to remain two weeks more.
Ilargi: US state governors have finally stepped up to the plate -or more accurately, the trough- . They say they need $1 trillion. Obviously, they need much more, but they save that for round 2. Obama's alleged reaction is that the US can't keep printing money. I think he has no idea how right he is. I think that because his economic team is belching forth some pretty crazy stunts. If Obama knows the limit to the printing press, his people certainly do not.
But then again, look at who those people are. They have been born and bred with the idea that there's no problem with using the poor man's money to keep the rich man's world alive. They have all this money and all this power and they still will fail. Talk about a bunch of losers. Well, most of them. There are a few who are delighted at what's happening. A lot of things are up for grabs. And that's what makes their world spin: things. Not people. Talking about printing presses, the printed media come clamoring for a few hundred billion. Get in line! Yes, it goes all the way around the corner.
As my ever-wise partner-in-crime Stoneleigh explained, once again, in yesterday’s comments to How to cut a shrinking pie:
”There are practical limits to monetization imposed by the bond market. Excessive 'printing' (debt monetization) would be rewarded by double digit interest rates at would be the equivalent of hitting the 'emergency stop' button on the economy. This would initiate a gargantuan wave of defaults, which would be highly deflationary. While we still operate under the international debt financing model, the bond market limits the freedom of action of the debt junkies. We are not facing hyperinflation, at least not until the deflationary impulse is spent. As deflation and depression are mutually reinforcing it will probably be a long time until we need to worry about getting into hard assets.
Deflation is already underway, as losses dwarf the monetization of debt. The pace of loss realization is set to pick up significantly this year as well, and 2010 will be worse still. Liquidity injections fall into a giant black hole of credit destruction. They do nothing to increase liquidity in the economy as the velocity of money plummets and cash hoarding becomes the norm. While this may ease a little during rallies, or sideways consolidations such as we are currently experiencing, it will always worsen to an even greater extent once the market decline resumes.
Losses in the tens, if not hundreds, of trillions of dollars have already occurred - in frozen asset markets where the 'assets' would already be worth pennies on the dollar at most, if they could find a buyer at all. We have yet to see them exposed by a true panic, but that is coming. When we finally see a firesale of distressed assets, the scale of the losses will be revealed.
US manufacturing orders are at a 60-year low. 60 YEARS!! 1949! Manufacturing worldwide is scraping bottoms, and trying to get break them. Shipping is at lows so deep they’re hard to recognize. Today's headline award goes to the Wall Street Journal's: "Treasury to Ford: Drop Dead". See, Ford said they didn't want bail-out funds. And now Paulson allows GM, on which he has a tight grip, to provide 0% loans to buyers. Bye, Ford......
In Britain, there are people who now get 0% on their bank deposits. Might as well buy a Chevy, right? Well, no, because debt is going to be both the hammer and the anvil soon, and you children's heads will be in between. Look, if you take care of a modern car, they can easily last 15 years. European and Asian carmakers and other industries are going to smash that Buy America rhetoric right down the slammer, and the US can't survive on its own, not the way it functions today.
I see predictions of 13 million cars sold in the US in 2009, and I just smile. The number will be way below 10 million. There's not enough braindead people with money left who are not scared sh8tless when they see their bills coming in. Not at a million lay-offs per month. Not at another 20% decrease in average home value.
There is no way back to the way we were. And the longer we delay facing up to that simple little fact, the worse off we will be. All of us. Including Obama.
Ilargi: Update 2.15 PM EST: Stoneleigh again from yesterday's thread, answering to comments (in Italics below). Let's get this thing as clear as we can:
Stoneleigh: They are trying desperately to inflate and it isn't working. It isn't a choice open to them under current circumstances. Much of the world is heading at full speed into the liquidity trap, as the Japanese did after 1989.
The initial effect of debt monetization is to lower interest rates. The Fed buys up bonds, increasing demand for bonds and lowering their yield. Interest rates go down.
Interest rates have fallen primarily as a result of a flight to safety. The Fed follows the market in setting rates (lagging behind 3 month T-bills). The liquidity trap occurs as nominal interest rates hit approximately zero, but the collapse of credit means that the effectively money supply is shrinking - negative inflation. Where inflation is negative, the real interest rate will be high even if the nominal rate is zero.
After a lag, inflationary expectations might set in, and people might require high interest rates to hold cash, so market rates might rise -- but that process takes time, nothing like hitting an emergency stop button.
Eventually I am expecting an abrupt dislocation in the bond market that will send interest rates into the double digits, but not now. At the moment I am expecting a retreat from high prices and low yields in long bonds, but I think this is temporary and that the previous trend has further to go thereafter. The flight to safety is not over, and therefore neither is the rally in the US dollar (following a pullback).
We have just witnessed a period in which soaring asset prices coexisted with low interest rates. Stocks, real estate, commodities all doubling and more in short time periods, and people did not perceive it as inflation.
Ilargi: Sorry to butt in, but "people did not perceive it as inflation." is not exactly smart, is it now? Home prices double, but that's not inflation, it's value appreciation. Yeah, sure.... Back to Stoneleigh:
It was a credit expansion rather than a currency inflation. Globalization allowed many prices to fall thanks to off-shoring and international wage arbitrage - the process of taking comparative advantage to its logical conclusion. The credit that was expending at unprecedented rates became huge speculative flows of hot money and went into propping up asset prices. The sloshing around of these momentum-chasing funds has led to bubble after bubble, notably the recent one in commodities. As such funds ebb, once the greatest sucker has been fleeced, they ruin successive sectors. We are in the process of watching that unfold in commodities right now.
Double-digit mortgage rates did not hit like in the late 1970s. Don't know how they did it, those wizards at the Fed, but they did, and they certainly think they can do it again.
They can't do it again. By way of analogy, they're trying to cure a hangover by giving the patient another drink, but eventually the patient will die of alcohol poisoning. It isn't possible to get out of debt by eternally creating more of it. credit expansions are self-limiting for that reason.
A Fed determined to fight deflation needs to erase those losses you talk about. They know that....You seem to think this is impossible -- not just that the Fed is too chaste to do what is required -- but impossible.
You can[..] fight deflation, but you can't win. Deflation is simply too large a force. Imagine Ben Bernanke standing on the Gulf coast and ordering a cat 5 hurricane not to come ashore. That's the kind of completely unequal struggle we're talking about.
Is there no Zimbabwe?
Zimbabwe comes much later, once the international debt financing model is broken and debt-junkie countries are on their own. Over a couple of decades we'll probably see the worst of both worlds.
Credit Default Swamp
Could the political campaign to blame the financial panic on unregulated derivatives be losing momentum? Let's hope so, because this might save us from making new mistakes in the name of fixing the wrong problems. We now know that the predicted disaster for credit default swaps (CDS) following the Lehman Brothers bankruptcy never happened. The government also still hasn't explained how AIG's use of CDS to go long on housing would have destroyed the planet. And now the New York Federal Reserve's effort to regulate the CDS market is mired in a turf war.
The Securities and Exchange Commission and the Commodity Futures Trading Commission have backed rival efforts in New York and Chicago. But it is the New York Fed proposal that may pose the most immediate threat to taxpayers, because it is designed to include firms on at least one end of 90% of CDS contracts. After announcing its intention to begin by the end of 2008, the New York branch of the central bank is still awaiting approval from the Fed's Board of Governors to launch a central clearinghouse for CDS trades. Credit default swaps are essentially insurance against an organization defaulting on its debt, and they provide a real-time gauge of credit risk. This has proven particularly valuable because the Fed's method of judging risk -- relying on the ratings agencies S&P, Moody's and Fitch -- has been disastrous for investors.
Under pressure from the New York Fed, nine large CDS dealers -- giants like Goldman Sachs -- agreed to construct a central counterparty, which would backstop and monitor CDS trades. Called The Clearing Corp., it failed to catch on in the marketplace. So the big dealers recently gave an ownership stake to IntercontinentalExchange (ICE). In return, ICE agreed to make this government-created but privately owned institution work. ICE has given the venture, now called ICE Trust, operational street cred, but the Fed-imposed architecture should still cause taxpayer concern. That's because it takes the widely dispersed risk in the CDS marketplace and attempts to centralize it in one institution. If not structured correctly, it may reward the participating firms with the weakest balance sheets. For this reason, some of the dealers who have resisted a central counterparty because it threatens their profits may now embrace it as a way to socialize their risks. What's more, if it allows these big Wall Street dealers to build an electronic trading platform on top of the central clearinghouse, the big banks could prevent pesky Internet start-ups from threatening their market share.
Here's how the New York Fed's central counterparty would change the market: Right now, CDS trades are conducted over-the-counter as private contracts between two parties. They are reported to the Trade Information Warehouse, so the market has some transparency, but nobody is on the hook besides the two parties to the agreement. This provides an incentive for each party to make an informed judgment on whether the counterparty can be relied upon to pay debts. The buyer of credit protection -- who is paying annual premiums for the right to be compensated if a company defaults on its bonds -- has every reason to study the balance sheet of the seller of a CDS contract.
In the New York Fed's judgment, the recent panic showed there wasn't enough transparency in CDS trades. This claim would have more credibility if the Fed would come clean about AIG. But in any case, the Fed's solution is to force CDS contracts into its central counterparty. There is a virtue here: A particular bank cannot throw out its collateral standards to please one large favored client, because the same standards apply to all participants. The nine large dealers plus perhaps four or five more participating firms would each contribute roughly $100 million to the central counterparty, and they'd have to cough up more money if failures burn through this cash reserve.
However, this system also introduces new risks, because all participants become liable for the potential failure of the weakest members. How does one appropriately judge the credit risk of a participant? ICE Trust and the Fed haven't released details. Sources tell us that participants will need to have a net worth of at least $1 billion, and, more ominously, that the Fed wants a high rating from a major credit-ratings agency as a crucial test of financial health. If regulators learn nothing else from the housing debacle, they should recognize that their system of anointing certain firms to judge credit risk is structurally flawed and immensely expensive for investors.
As Columbia's Charles Calomiris has explained on these pages, one reason the Basel II standards for bank capital failed is because they subcontracted risk assessments to the same ratings agencies that slapped AAA on dodgy mortgage paper. Unfortunately, the Fed stubbornly refuses to learn this lesson. With its various lending facilities, the Fed continues to demand collateral rated exclusively by S&P, Moody's or Fitch. A rival ratings agency reports that the Fed recently rejected a request from a clearing bank to consider a ratings firm other than the big three. No doubt ICE Trust has a strong incentive to monitor counterparty credit risk. Our concern is that the Fed's failed policy on credit ratings will increase risks even further if it is allowed to pollute the $30 trillion CDS market.
The credit raters have shown they are usually the last to know if a bank is in trouble, yet under a credit-rating seal of approval such a bank could maintain the illusion that all is well. If you have trouble conceiving of such a scenario, reflect on the history of Enron, Bear Stearns, Lehman, Citigroup, the mortgage market, collateralized-debt obligations, etc. Now try to imagine how long it will take the Fed to commit taxpayer dollars if this central counterparty fails. Any plan that seeks to minimize marketplace risks by concentrating them in one institution deserves skepticism. Relying on ratings from the big three to assess these risks would be an outrage.
Governors ask Uncle Sam for $1 trillion bail-out
Governors of five states urged the federal government to provide $1 trillion in aid to the country's 50 states to help pay for education, welfare and infrastructure, as states struggle with steep budget deficits amid a deepening recession. The governors of New York, New Jersey, Massachusetts, Ohio and Wisconsin - all Democrats - said the initiative for the two-year aid package was backed by other governors and follows a meeting in December where governors called on President-elect Barack Obama to help them maintain services in the face of slumping revenues.
Gov. David Paterson of New York said 43 states now have budget deficits totaling some $100 billion as tax revenues plunge. "It's clear that the federal government needs to step in and jump-start the economy," said Gov. Deval Patrick of Massachusetts. The latest package calls for $350 billion to create jobs by building or repairing roads, bridges and other public works; $250 billion to maintain education; and another $250 billion in "counter-cyclical" spending such as extending unemployment benefits and food stamps, which are typically a responsibility of the states. The remainder would be used to fund middle-class tax cuts, stimulate the embattled housing market and stem the tide of home foreclosures through a loan-modification program.
Gov. Jon Corzine of New Jersey said he hoped some of the $700 billion authorized by Congress in the Troubled Asset Relief Program would be available to help the housing market. The governors said during a conference call with reporters that the plan had been discussed with Congressional leaders and the incoming administration, which had indicated its willingness to help. "The Obama team has been very receptive in listening to us," said Gov. Jim Doyle of Wisconsin. He said "quite a number" of other governors back the initiative.
The Republican Governors Association, however, said the level of federal aid being sought would create a burden for the future. "The proposal by the Democratic governors goes beyond things like 'shovel-ready' infrastructure projects and is essentially a bailout of these states' general funds," Nick Ayers, executive director of the Republican Governors Association, said in a statement. "Now is the time to focus on finding cost-effective ways to provide essential services without burdening future generations with ever greater debt." Doyle of Wisconsin said the plan would allow states to maintain essential services at about the current level until 2010, when the national economy is expected to begin a recovery.
The proposal comes amid expectations that the Obama administration, which takes office on Jan. 20, will provide hundreds of billions of dollars in economic stimulus to boost the shrinking U.S. economy and halt the loss of jobs. Paterson of New York said his state's budget deficit has surged to $15.4 billion currently from $5 billion in April 2008, despite a 3.2% cut in the education budget. Corzine said the money called for represents about 3% to 3.5% of the economy, equivalent to the amount that the economy is expected to contract by over the next two quarters. In light of the $700 billion provided to bail out the financial industry, "It's not shockingly large," he said.
Cash-poor states eager for a piece of Obama plan
President-elect Barack Obama's plan to overhaul the nation's roads, bridges and transit systems has local officials clamoring for their share of those federal dollars despite concerns that creating millions of jobs won't deliver the intended jolt to the economy. "Borrowing money and cutting checks to fund infrastructure is not the best way to juice the economy," Republican Gov. Mark Sanford of South Carolina said in an interview. "And this notion that Washington, with a blink of a wand, can create 2.5 million jobs is strange in a market economy."
The deepening economic crisis has wreaked havoc on state budgets across the country. At least 40 states are running deficits, forcing governors to raise taxes and trim spending while postponing urgent repairs to roads, bridges, hospitals and ports. "California's fiscal house is burning down," state Treasurer Bill Lockyer declared recently after a state regulatory board halted financing for some 1,600 infrastructure projects because of the state's nearly $15 billion deficit. California's woes are far from unique. "Because of the downturn in revenues, we're all starting to delay construction projects that are clearly maintenance. That risks public safety," said Maryland Gov. Martin O'Malley in an interview.
The rescue plan, which Obama has called "the largest new investment in national infrastructure since the creation of the federal highway system in the 1950s," is part of a broader legislative package intended to create up to 3 million new jobs, provide tax relief to middle-class families and help governors cover the soaring costs of education and Medicaid, the public health program for the poor. It is estimated to cost as much as $1 trillion. Lest the plan seem too much a throwback to the public works projects of the Depression-era New Deal, Obama has added several 21st-century goals, such as expanding broadband into underserved areas and making public buildings more energy efficient. But the bulk of the plan is old-fashioned construction and repair, much of which would be done by union laborers.
To avoid waste and hasten an economic recovery, Obama wants to target projects deemed "shovel ready" — meaning the design and permitting has been completed and the projects would be ready to launch within 90 to 120 days of being funded. He also is insisting on a "use it or lose it" policy, warning states that they would lose the money if they didn't begin building promptly after receiving it. Obama, who summoned governors to a meeting in Philadelphia in December, has said he will hold local governments accountable for money spent. "If we're building a road, it better not be a road to nowhere," Obama said last month. "If we are building a bridge, it better be because an engineer identified a bridge that has a structural weakness and that has to be dealt with."
So far, the proposed restrictions haven't been much of a deterrent. States have already identified about $136 billion in shovel-ready projects, according to the advocacy organization Building America's Future. And interest groups are lining up with their own requests: A ski area in northern Minnesota wants $6 million for snowmaking and maintenance, while the Association of Zoos and Aquariums announced it too will ask for money. Most governors professed to be thrilled by the promise of federal help while acknowledging the responsibility attached to it. "We have to protect the integrity of this effort and invest in things that have value after dollars are expended," O'Malley said. "Let's face it, we're borrowing from our kids."
Polly Trottenberg, executive director of Building America's Future, argued for a balance between immediate need and long-term investment that could have a more transformative impact on the economy. "There's a pretty broad consensus on 'fix it first,' but we also want to capture projects that might take more than 120 days but could bring real long-term value," Trottenberg said, citing light rail and other infrastructure projects that take years to develop and build. While Obama's team wants to avoid the kind of special-interest feeding frenzy that has soured taxpayers in the past, many Republicans are doubtful it can be done.
"Taxpayers are in no mood to have a single dollar wasted, but it's not yet been explained how their tax dollars will be protected," Senate Republican leader Mitch McConnell of Kentucky said in a statement. On Monday, McConnell and House GOP leader John Boehner of Ohio said they would seek greater input on the proposal and more information on how the money would be spent. Democratic congressional leaders have been working with Obama's economic team on legislation to be voted on in January. Although he has argued that Obama's plan would plunge the country deeper into debt, Sanford declined to say that he would turn down federal help for South Carolina if the plan goes through. "We'll see where we are," Sanford said.
Obama urges parties to work together on economy
President-elect Barack Obama on Saturday said the struggling U.S. economy could face more challenges and urged lawmakers to act quickly on recovery proposals even as some Republicans expressed concerns about plans for a huge stimulus package. "As we mark the beginning of a new year, we also know that America faces great and growing challenges -- challenges that threaten our nation's economy and our dreams for the future," Obama said in his weekly radio and Internet address. "For too many families, this new year brings new unease and uncertainty as bills pile up, debts continue to mount and parents worry that their children won't have the same opportunities they had,"
Obama, who takes office on January 20, said he would meet next week in Washington with Democratic and Republican leaders to discuss his plan aimed at bolstering the U.S. economy and creating 3 million jobs. "However we got here, the problems we face today are not Democratic problems or Republican problems," he said. "These are America's problems and we must come together as Americans to meet them with the urgency this moment demands." Obama said economists agreed that if the United States does not act "swiftly and boldly, we could see a much deeper economic downturn that could lead to double-digit unemployment and the American dream slipping further and further out of reach."
He said the country needed an economic recovery and reinvestment plan to create jobs in the short-term and spur economic growth and competitiveness in the long term. Obama gave few details of the plan, which has yet to be released by his transition team but has been estimated to cost between $675 billion to $775 billion. He said its No. 1 priority was to create 3 million jobs -- more than 80 percent of them in the private sector. Obama said the recovery plan should include strategic investments that would serve as a "down payment" on America's long-term economic future. In addition, as part of the plan the government must demand strict accountability and oversight and also must ensure the deficit be reduced as the economy recovers.
Democrats, who have a majority in Congress, want the economic stimulus to include tax relief for the middle class and spending on schools, roads and other infrastructure. States, which increasingly are having difficulties paying health-care costs for the poor, also would get federal money. But Republicans on Capitol Hill have been warning that the economic recovery package should not spend too much on government-funded projects and should not be rushed through Congress without adequate review.
Republicans have said they would not rubber-stamp a huge spending plan. Democrats had hoped to deliver the plan to Obama when he takes office on January 20, or shortly thereafter. One element of the plan could be "buy American" language benefiting U.S. industry, an Obama aide said on Friday. Such a plan has been reportedly suggested by the steel industry as a way to help the country through the economic slowdown.
Manufacturing Reports Show Depth of Global Downturn
From Australia to Asia and Europe to the United States, the message on Wednesday in the latest economic reports was clear: manufacturing continued to slump amid the worst slowdown since the Great Depression. In the United States on Friday, a crucial measure of manufacturing activity fell to the lowest level in 28 years in December. The Institute for Supply Management, a trade group of purchasing executives, said its manufacturing index was 32.4 in December, down from 36.2 in November. "Manufacturing activity continued to decline at a rapid rate during the month of December," said Norbert J. Ore, chairman of the Institute for Supply Management Manufacturing Business Survey Committee. This index was at the lowest reading since June 1980, when it was 30.3 percent.
"This report indicates that the U.S. economy was on even weaker footing than commonly believed as 2008 came to a close," said Joshua Shapiro, chief United States economist at MFR. "Moreover, the signal from the export orders index is that the rest of the world is right there with us. Hardly a signal for economic recovery anytime soon." In addition, Mr. Ore said, "new orders have contracted for 13 consecutive months, and are at the lowest level on record going back to January 1948." The new orders index was 22.7 percent in December, 5.2 percentage points lower than the 27.9 percent registered in November. No industry sector surveyed reported growth in December; the jobs sector was particularly grim. The employment index was 29.9 percent in December, a decrease of 4.3 percentage points from November. That was the lowest reading since November 1982.
In Europe, a closely watched index of purchasing managers showed manufacturing hit a low in December, falling to 33.9 from 35.6. Any reading above 50 signals growth, while a reading below 50 indicates contraction in manufacturing. Similarly grim readings in Australia, China and India highlighted how the Asia-Pacific region has become caught up in the global turmoil. In China, the purchasing managers’ index by the brokerage firm CLSA showed the manufacturing sector had contracted for a fifth consecutive month. The survey showed the steepest decline in its history. With five back-to-back purchasing index readings signaling contraction, "the manufacturing sector, which accounts for 43 percent of the Chinese economy, is close to technical recession," said Eric Fishwick, head of economic research at CLSA in Hong Kong, in a note with the release.
The data added to the flood of statistical evidence from across the Asia-Pacific region showing that activity was slowing faster than previously thought as demand withers in the United States and Europe. Australia’s manufacturing index showed a seventh month of contraction, and a similar survey in India showed activity down for a second month in December. In South Korea, December data showed exports plummeted 17.4 percent from a year ago. President Lee Myung-bak of South Korea pledged on Friday that the government would go into emergency mode to pull the country out of its economic crisis.
And in Singapore, the economy shrank 12.5 percent in the last quarter of 2008 from the previous period, causing the trade and industry ministry to lower its growth forecast for 2009. The ministry now expects Singapore’s economy to shrink up to 2 percent, with only 1 percent growth at best. Previously, it had expected up to 2 percent growth. The worsening data, combined with a stream of company profit warnings, production cuts and layoffs, raises the pressure on policy makers to step up their efforts to bolster their economies. India on Friday cut its main interest rate by a full percentage point, to 5.5 percent, and took a series of steps to bring more money into the country. It also raised the limit on overseas investments in corporate bonds to $15 billion, from $6 billion, and will contribute 200 billion rupees ($4 billion), to increase the capital of state-run banks.
Countries across the region were widely expected to make more interest rate cuts in coming weeks. "China’s economic outlook for 2009 will be best characterized as ‘getting worse before getting better,’ laying the foundation for a firmer recovery in 2010," said Qing Wang, chief economist for Greater China at Morgan Stanley in Hong Kong. Mr. Wang expected growth to continue to slow in the first six months, before stimulus measures could take effect. "The authorities have already made delivering economic growth a top policy priority by adopting a campaign-style policy execution approach," he said. Mr. Wang expects interest rates to be cut aggressively by an additional 1.35 percentage points this year. The country’s important one-year lending rate is 5.31 percent. He added that a $586 billion stimulus package announced in November "is unlikely to be the first and only stimulus package for the entire year."
The package includes substantial infrastructure spending, which will begin to lead to increased activity once weather allows construction to begin in the spring. "The stimulus package provides a short-term buffer for the economy, and other policy measures such as health care and land reforms will be a long-term growth driver. This should help the stock market at least to stabilize in 2009," said Yi Tang, general manager at Edmond de Rothschild Asset Management in Hong Kong. "We are seeing some encouraging signs that institutional investors are starting to consider putting money back into equities in China and the rest of Asia, hopefully in the next month or two," he said. "But it will take longer for retail investors — who are worried about their job prospects and the wider economy — to go back into the market."
U.S. Manufacturing Shrinks, Orders at 60-Year Low
The decline in U.S. manufacturing deepened in December as demand for such products as cars, appliances and furniture reached the lowest level since at least 1948, signaling further cutbacks in factory jobs and production this year. The Institute for Supply Management’s factory index fell to 32.4, below economists’ forecasts and the lowest level since 1980, from 36.2 the prior month. Readings less than 50 signal contraction. The group’s new-orders measure reached the lowest level on record and prices slid the most since 1949.
“Every component suggests that the weakness is going to carry over into 2009,” Mark Vitner, a senior economist at Wachovia Corp. in Charlotte, North Carolina, said in a Bloomberg Television interview. “There’s just not a whole lot of new business coming in,” and companies will have a “painful adjustment” as consumers shun spending. Today’s figures underscore that, with private demand collapsing, manufacturers’ best hope for new business this year may be President-elect Barack Obama’s plans for an unprecedented stimulus package. Obama has pledged an investment program in roads, schools and the U.S. energy network akin to the 1950s-era interstate highway construction boom.
Stocks climbed to a two-month high on the first day of trading in 2009, following the market’s worst annual drop since the Great Depression, as General Motors Corp. got its first cash infusion from the government and rising oil prices lifted energy shares. The Standard & Poor’s 500 Index rose 3.2 percent to close at 931.8. Benchmark 10-year Treasury yields rose to 2.39 percent at 4:41 p.m. in New York from 2.22 percent late Dec. 31. The report also showed the impact of recessions abroad: the Tempe, Arizona-based ISM’s measure of exports fell to the lowest level since that series began in 1988.
Separate figures today showed business at European factories contracted in December by the most on record. Manufacturing declined in China for a fifth month in December, for an eighth month in the U.K., for a seventh month in Australia and at the fastest pace in at least 14 years in Sweden. The figures “confirm a sharp contraction in global investment, output and trade activity, consistent with the deepest global recession since at least the early 1980s,” said Lena Komileva, head of market economics in London at Tullet Prebon Plc. The ISM’s gauge, which covers about 12 percent of the economy, was projected to drop to 35.4, according to the median estimate of 57 economists surveyed by Bloomberg News. Forecasts ranged from 34 to 40 and the measure averaged 51.1 in 2007.
Clogged credit markets, the collapse in housing and mounting job losses have hurt demand for everything from furniture and appliances to automobiles, driving General Motors Corp. and Chrysler LLC to the brink of bankruptcy. The ISM’s employment index decreased to 29.9 from 34.2 in November. The gauge of prices paid fell to 18, reflecting the drop in commodity costs. Economists had projected that the measure, which averaged 65 in 2007, would drop to 20. Automakers have been among the hardest hit as November sales plunged to the lowest level in a quarter century, according to industry figures. President George W. Bush announced Dec. 19 that General Motors and Chrysler will get $13.4 billion in initial government loans to keep operating while they restructure operations to return to profitability.
The carmakers last month expanded their traditional holiday shutdowns to clear out unwanted stock. Chrysler idled all 30 of its assembly plants on Dec. 17 for at least a month, while GM announced output cuts Dec. 12 that affected 20 plants. The closings will extend into this month. Ford Motor Co. said 9 of 15 North American factories would shut for the first week in January. The U.S. Treasury this week issued broad guidelines for aid to the auto industry, opening the door to using taxpayer money to finance a wider array of companies, such as GM’s bankrupt former parts unit Delphi Corp.
The factory slump has spread well beyond autos as demand from abroad also weakens. Ingersoll-Rand Co., the maker of Thermo King and Hussmann refrigeration equipment, said last month that profit will fall short of fourth-quarter and full- year estimates after demand declined “sharply” in North America and Western Europe. “Probably the U.S. and developed world are in recession,” General Electric Co. Chief Executive Officer Jeffrey Immelt said in his annual outlook address on Dec. 16. “The environment is still the toughest, for people of my generation, that we’ve ever seen.” U.S. exports dropped in October for a third straight month, leading to an unexpected widening in the trade gap, figures from the Commerce Department last month showed. The drop indicated the economy was sinking even faster than previously estimated.
Auto industry girds for chilling December sales report
The good news for the auto industry in December came when General Motors and Chrysler got their federal bailout. The bad news is coming Monday, when automakers are expected to report another month of staggering sales declines. Many analysts are predicting the industry to report that U.S. sales in December dropped about 40 percent, bringing an official close to what has been one of the industry's most trying years and providing little hope for much improvement in 2009. "I'm off the same 40 percent that everyone else is," said David Kelleher, owner of two Chrysler dealerships in the Philadelphia area. "I've had to downsize quickly to get in front of this. We're hanging in there." The auto Web site Edmunds.com is predicting December sales of 852,000 light vehicles in the U.S., down 38 percent.
Deutsche Bank auto analyst Rod Lache predicted a sales drop of 41 percent to a seasonally adjusted annual rate of 9.5 million. That figure reflects what sales would be if they remained at that month's pace all year, with adjustments for seasonal fluctuations. "All the negative factors that were with us the last three months will still have an impact on sales in December as well," said Jesse Toprak, executive director of industry analysis for Edmunds. U.S. auto sales fell 37 percent to 746,789 in November, their lowest level in more than 26 years, as skittish consumers avoided big purchases, unemployment and home foreclosures rose, and tight credit markets made it difficult for some willing buyers to obtain loans. Edmunds expects sales for the full year will total just over 13 million, down 18 percent from 2007 and the lowest level since 1992, according to Ward's AutoInfoBank. Sales peaked at 17.4 million in 2000.
As the battered industry staggers into 2009, analysts caution that the sales slump is likely to persist. "Perhaps by the second half of (2009) there can be a case for an improved economy, or at least an economy that's getting back on its feet," said George Pipas, Ford Motor Co.'s top sales analyst. J.D. Power & Associates is forecasting sales this year of 11.4 million units. Chrysler in its presentation to Congress last month said it expects industrywide sales of 11.1 million in 2009, while GM said it will become profitable again once annual sales return to between 12.5 million and 13 million. A major source of trouble in 2008, particularly for the Detroit Three, was consumers' newfound aversion toward pickups and sport utility vehicles. These high profit-margin vehicles have been the bread and butter for GM, Ford and Chrysler, and Asian automakers like Toyota Motor Corp. and Nissan Motor Co. boosted their own truck and SUV production in recent years. But if December is anything like the rest of the year, 2008 will be the first year that passenger cars outsold trucks and SUVs since 2000, Pipas said.
"There was a presumption on the part of the auto manufacturers -- and it wasn't just a Big Three thing -- that trucks would never look back once they outsold cars in 2001," Pipas said. But the summer's run-up in gas prices and a political and consumer climate that has shifted drastically against big gas guzzlers changed all that this year, he said. "There's no rebound in the SUV market," he said. "The idea that people are going back to sport utility vehicles is just that -- it's an idea." In Philadelphia, Kelleher blames the tight credit markets for half of his dealerships' recent sales decline, while the other half he pins on the troubled economy. "I have customers that I should be able to get loans for that, in a lot of cases, are repeat customers who we've worked hard for," he said. "They got a loan two years ago at one level and now I can't match that."
Automakers have been working aggressively to steer credit toward consumers. A consortium of 3,700 credit unions launched a partnership with Chrysler LLC and General Motors Corp. last month pledging $22 billion for low-cost auto loans. GM's troubled financial arm, GMAC Financial Services LLC, got a $5 billion cash injection from the Treasury Department earlier this week. GM said the money allowed it to launch a low-interest financing program for dozens of its vehicles. "It alleviates one of the main consumer concerns, which is accessing credit," Mark LaNeve, a GM vice president, said of the deal on a conference call earlier this week.
Ford sees sharp drop in U.S. sales
Ford Motor Co expects industry-wide December U.S. auto sales to drop by some 35 percent from a year earlier with no sign of a turnaround in the first quarter of this year. Ford, the No. 2 U.S. automaker, expects that full-year sales of light vehicles in the world's largest market will drop to near 13.2 million for 2008, down from near 16.2 million in 2007, Ford's chief sales analyst George Pipas said on Friday. The only other time the U.S. auto industry has seen a similar 3-million unit plunge in sales over the course of a single year was during 1974 in the wake of the first oil shock, Pipas told reporters.
Major automakers are set to release December and full-year 2008 sales data on Monday. Analysts have said they see December light-vehicle sales slipping below the 10.2 million unit sales rate recorded a month earlier. Annualized auto sales rates have declined on a quarter-to-quarter basis throughout 2008. The sales rate fell from 15.6 million vehicles in the first quarter to an estimated 10.6 million in the fourth quarter. Those figures include medium and heavy-duty truck sales of about 300,000 units on an annual basis.
"The sales rates have declined like a lead balloon, really," Pipas said. "I think when December comes in every segment will be down. Not one segment will be up versus a year ago." "We're not looking for the first quarter to be much different from what we saw in the fourth quarter," Pipas said. The sharpest sales declines in 2008 came in full-size SUVs, a gas-guzzling category that U.S. consumers abandoned during the spring and summer spike in oil prices. On a full-year basis, Pipas said, 2008 is on track to become the first year since 2000 that passenger cars have outsold light trucks in the United States. The light trucks category includes: pickups, SUVs and minivans.
Manufacturers have responded to the slump in truck sales with aggressive discounts in recent months, including cash rebates and low-rate financing. Pipas said data tracked by Ford showed the average incentive on a full-size pickup truck was between $7,000 and $8,000 in December and near $7,000 for a full-size SUV. By contrast, the average discount on a compact car was just $1,300 and near $2,000 for a mid-size car, he said. With manufacturers scrambling to clear year-end inventory, average sales incentives across all vehicle segments were up about $900 in December from a year earlier, Pipas said.
Pipas said Ford expects that its own 2008 market share will end up just over 14 percent, down by about half a percentage point from a 14.6 percent share a year earlier. In order to regain market share, Ford recognizes that it needs to have a more competitive line-up of small vehicles on the market reflecting the increasing importance of that segment, Pipas said. Unlike its Detroit-based rivals General Motors Corp and Chrysler LLC, Ford has not sought an emergency loan from the U.S. government. The No. 2 U.S. automaker, which borrowed more than $23 billion in 2006, has attempted to use its better financial position and recent quality gains to distinguish itself from its battered competitors in the eyes of car shoppers.
GM and Chrysler were given a $17.4 billion bailout from the Bush administration. Ford has sought a $9 billion credit line from the government if the ongoing recession runs deeper and longer than it expects. But Pipas said Ford's sales planners expected to see industry-wide U.S. auto sales declines of between 20 percent and 30 percent in monthly sales reports in the first quarter. Second-quarter sales results are also expected to show double-digit percentage declines, he said. Ford does not expect U.S. auto sales to begin to stabilize until the second half of 2009 based on the view that the U.S. economy will begin to improve late this year, Pipas said.
Treasury to Ford: Drop Dead
When the Bush Treasury decided to bail out Detroit, GM and Chrysler quickly said yes to the taxpayer cash, but Ford Motor Co. said it didn't need the money and declined. Ford's reward for this show of self-reliance? Treasury is now helping GM again by giving it a credit pricing advantage against Ford in the marketplace.
That's one little-noted result of Treasury's action earlier this week to rescue GMAC, the GM credit arm that, as it happens, is 51% owned by the Cerberus private-equity shop that also owns Chrysler. With $5 billion in taxpayer cash in its pocket, GMAC quickly decided to offer 0% financing on several of its models. "I think it would be fair to say that without this change . . . we would not be able to do this today," explained GM Vice President Mark LaNeve in a conference call with reporters this week.
GM said it will offer 0% financing for up to 60 months on the 2008 Chevrolet TrailBlazer, GMC Envoy and Saab 9-7X sport utility vehicles through GMAC. The Saab 9-3 and 9-5 sedans also qualify for 0% financing. The car maker is also offering financing between 0.9% and 5.9% on more than three dozen other 2008 and 2009 models, including many trucks and SUVs. The deal runs through January 5, and no doubt GM is hoping for a booming sales weekend. The messy little policy issue is that these GM products compete with those sold by Ford, Toyota, Honda and numerous other car makers that won't benefit from GMAC's cash infusion. And with the cost of financing often crucial to buyer decisions, the feds have now put the muscle of the state behind one company's products.
Ford in particular must wonder what it did to deserve this slap. CEO Alan Mulally joined the GM and Chrysler chiefs in testifying for the bailout even while insisting his company didn't want the funds. And once the bailout was announced, Mr. Mulally said that "All of us at Ford appreciate the prudent step the Administration has taken to address the near-term liquidity issues of GM and Chrysler." So much for gratitude.
Ford -- and for that matter Honda and Nissan and most others -- makes cars with American workers. President Bush justified the auto bailout in the name of saving jobs, but apparently GM's jobs are more valuable than others. And with the taxpayers now having a stake in GM and Chrysler success, the Washington temptation will be to take other steps to help the two companies gain market share at the expense of their private competitors. Never mind that Ford is still struggling and Toyota recently posted its first full-year loss in 70 years.
This is always what happens when politicians decide to muck around in private industry. Even when made with the best intentions, their policy decisions have unintended consequences that help some companies at the expense of others. Meanwhile, your neighbor who buys a GM SUV this weekend with 0% financing should thank you when he pulls into the driveway. He did it with your money.
Chrysler gets 'initial' $4 billion bailout loan
Chrysler LLC said Friday it has received a $4 billion "initial" loan from the federal government to "help bridge the current financial crisis." The closely held automobile maker said in a statement that negotiations with the U.S. Treasury Department were completed Friday, resulting in a loan that "will allow the company to continue an orderly restructuring." "We recognize the magnitude of the effort by the Treasury Department to complete the multiple financial arrangements and appreciate their confidence in Chrysler," Chrysler Chief Executive Bob Nardelli said in a statement.
Chrysler and General Motors Corp. had both appealed to the government for a bailout after seeing their sales plummet amid the economic downturn and rising fuel prices. The government approved $17.4 billion in loans for domestic automakers last month, in order to help them stave off bankruptcy. See related story on the automotive bailout package. Last month, the government provided a $6 billion cash infusion for GM and its GMAC lending unit, in a move intended to spur new financing opportunities for prospective car buyers. See related story on GM's government cash infusion.
As a result of that funding, GMAC swiftly lowered its credit requirements for retail consumers. Chrysler's Nardelli, who alongside the CEOs of GM and Ford had traveled to Capitol Hill late last year to appeal to lawmakers for aid for their troubled industry, said Friday that the $4 billion loan will help Chrysler "build the fuel-efficient, high-quality cars and trucks people want to buy."
US Treasury assumes free rein on finance, auto rescues
The US Treasury Department has given itself free rein in deciding the rescues of companies in the finance and auto sectors, according to two Treasury statements published this week. The Treasury on Friday released guidelines for its Targeted Investment Program (TIP), part of emergency legislation enacted in early October to ease a credit crunch from the worst global financial meltdown since the Great Depression. In the statement, the Treasury outlined the principles of the program under which it rescued ailing banking giant Citigroup on November 23.
Under TIP, the Treasury said it would determine the eligibility of participants and the allocation of resources "on a case-by-case basis." "Treasury may invest in any financial instrument, including debt, equity, or warrants, that the secretary of the Treasury determines to be a troubled asset, after consultation with the chairman of the board of governors of the Federal Reserve System and notice to Congress," the department said.
Among the criteria in determining a financial firm's eligibility is "whether the institution is sufficiently important to the nation's financial and economic system that a loss of confidence in the firm's financial position could potentially cause major disruptions to credit markets ... or lead to similar losses of confidence or financial market stability that could materially weaken overall economic performance." Wednesday, the Treasury Department posted on its website a description of its Automotive Industry Financing Program, justifying after the fact its decision to lend a combined 13.4 billion dollars in TARP funds to embattled automakers General Motors and Chrysler to stave off their imminent collapse.
"The objective of this program is to prevent a significant disruption of the American automotive industry that poses a systemic risk to financial market stability and will have a negative effect on the real economy of the United States," it said. Similar to its approach to the finance industry, the Treasury said it would determine eligibility of participants in the program on a case-by-case basis. The Treasury announced on December 19 a massive rescue of cash-strapped GM and Chrysler, facing a threat of imminent bankruptcy that could create economic chaos and throw millions out of work across the country.
Treasury to mull Citi-style rescues
The Treasury Department opened the door Friday to using a Citigroup-style rescue package to help other troubled financial institutions.The financial lifeline thrown to Citigroup Inc. in late November involved backing billions in risky assets and providing the banking giant with a fresh capital infusion. Treasury said participation by other companies in such a program would be weighed on a case-by-case basis. Treasury said it would consider, among other things, whether the "destabilization" of a financial institution could threaten the viability of creditors and others. It also would weigh the extent to which the institution faced a loss of confidence because of the troubled assets it held.
The information was contained in guidelines for the initiative, dubbed the Targeted Investment Program, unveiled on Friday. Separately, a new program that provides government backing for a financial institution's potential losses from risky assets will be used sparingly, the department said. Congress required that the insurance program be created as part of the $700 billion financial bailout package enacted in October. "This program will be applied with extreme discretion in order to improve market confidence in the systemically significant institution and in financial markets broadly," the department said. "It is not anticipated that the program will be made widely available."
The department said it is exploring using the program to address guarantee provisions that were part of the Citigroup rescue package. The program provides guarantees for troubled assets held by a financial institution that would otherwise risk a loss of market confidence. Treasury said it would determine eligibility for the program on a case-by-case basis. In accordance with the law, any assets to be guaranteed must have been originated before March, 14, 2008.
Insurance program would be used sparingly
The Bush administration says a new program that provides government backing for a financial institution's potential losses from risky assets will be used sparingly. Guidelines for the insurance program, required by Congress as part of the $700 billion financial bailout package enacted in October, were unveiled by the Treasury Department on Friday. "This program will be applied with extreme discretion in order to improve market confidence in the systemically significant institution and in financial markets broadly," the department says. "It is not anticipated that the program will be made widely available." The department says it is exploring using the program to address guarantee provisions that were part of a Citigroup Inc. rescue announced in November. Under those provisions, the government is guaranteeing hundreds of billions of dollars of risky assets held by Citigroup.
GMAC Pays Up For Its Tarp
GMAC's recent entry into the U.S. Treasury's Troubled Asset Relief Program beneficiary club underscores the ad hoc nature of the program as each cash injection is made on what seem to be unequal terms. GMAC , the troubled lending wing of General Motors, said Friday it will pay 8.0% interest on 5 million preferred shares it will issue to the U.S. government in exchange for a $5.0 billion capital injection the firm desperately needs to avoid bankruptcy. This follows the Federal Reserve's Christmas Eve announcement that GMAC would be allowed to become a bank holding company, and therefore be eligible for TARP funds, even though the lender refused to disclose its capital position.
GMAC will be paying more interest than most of the banks considered "healthy" enough to participate in the Treasury’s voluntary TARP Capital Purchase Program. The TARP elect pay just 5.0% interest for the first five years on their preferred stock with the quarterly payment jumping to 9.0% thereafter. They also agreed to give the U.S. central bank warrants to buy stock worth up to 15.0% of their government investment with stock prices based on a 20-trading day trailing average. The relatively low introductory interest rate is intended to ease capital troubles for recipients as they try to muddle through the credit crunch.
Meanwhile, beleaguered Citigroup is paying the same 8.0% rate as GMAC on its $20.0 billion emergency TARP injection. which was a supplement to its initial $25.0 billion TARP borrowings, which were at the more common 5.0%/9.0% split rate. The relatively tougher terms might relate to the billions in souring real estate bets that Uncle Sam agreed to sit on. Under the terms of its newest deal, Citigroup agreed to absorb up to $29.0 billion in losses on its $306.0 billion portfolio of risky property-related assets with the government shouldering 90.0% of any further losses. In exchange for the guarantees, the megabank issued warrants to the U.S. Treasury and the Federal Deposit Insurance Corp. to buy up to 254.0 million in Citi shares at a strike price of $10.61. Citi was trading Friday afternoon at $7.09, up 38 cents, or 5.7%, on the day.
Meanwhile, American International Group , continues to beg for improved borrowing terms even as the interest and structure of its now $152.0 billion federal lifeline continues to soften. The insurer, which is 79.9% owned by U.S. taxpayers per its September bailout package, has to pay a hefty 10.0% interest rate on its $40.0 billion TARP injection, but was able to renegotiate and lower the interest on a separate bridge loan. The government was also allowed a warrant to buy shares equal to 2.0% of the outstanding shares of common stock on the date of investment at $2.50 per share. AIG, which traded in the $70s in the spring of 2007, went for $1.67 on Friday afternoon, up a dime, or 6.4%.
Commercial real estate in for tough 2009
The balance of power between landlords and tenants will shift dramatically in 2009. For landlords, this promises to be a year of intense competition, more bankrupt tenants, and tightfisted lenders. For renters, it looks like a time of abundant choices and tiny -- if any -- price increases. From apartments to shopping malls, office towers to dockyard industrial space, the commercial real estate market will be marked by rising vacancy rates and weak to no rent growth. And the choke hold on credit could push many property owners that need to refinance into foreclosure. Nearly 40 percent of real estate investors need to refinance part of their portfolios this year, according to more than 1,100 investors surveyed in October by Marcus & Millichap Real Estate Investment Services and National Real Estate Investor magazine. The investors also expect prices to decline 15 percent on average this year. "It's hard to be an optimist right now," said Dan Fasulo, managing director of research firm Real Capital Analytics. "We're at the point where there's another potential systemic failure that the industry is trying to avoid."
Real Capital identified more than 1,000 large commercial properties nationwide, representing $25.7 billion, that are already bank-owned or the landlord is in default. But there are another $80.9 billion, or more than 3,700, properties that could potentially fall into trouble this year, the firm estimates. Last month, a commercial real estate trade group appealed to the Bush administration for a slice of the $700 billion bailout of the financial services industry. The Treasury Department has yet to make a decision whether to include commercial property loans. If the government doesn't come to the rescue, industry experts expect lenders to step up in aiding troubled property owners by offering maturity extensions or other workouts. "Lenders don't want to run malls," said Victor Calanoog, research director at Reis Inc. The crunch isn't just affecting landlords that need to refinance. Acquisitions have all but disappeared following a bang-up 2007. Fasulo said just 50 large office properties traded hands nationwide in the month of November, the lowest level since the early 1990's when the industry was in a severe recession.
Falling real estate prices will only make it harder for landlords to refinance. Owners with less than 30 percent equity in a property will have to pay higher interest rates -- if they can get a loan at all. Failed retailers like Linens 'n Things and Mervyn's have left many shopping mall owners with dark storefronts. Retail vacancy rates are forecast to climb to 11 percent this year, says Hessam Nadji, managing director at Marcus & Millichap. He also expects rents will decline between 4 and 6 percent as property owners contend with more tenant bankruptcies, store closures and fewer retailer expansions. General Growth is the poster company of retail woes. Earlier in the decade, the company piled on debt to fund an aggressive acquisition program. Now, it's on the hook and desperately needs to refinance to shore up its books. Many of its properties are so far still healthy, Fasulo points out, but General Growth's chances of refinancing diminish as retail fundamentals soften.
Office properties won't escape the recession unscathed either. Nadji expects office vacancies to rise to almost 18 percent by the end of the year, up from an estimated 15 percent at the end of 2008. Some major financial centers, including Boston, New York, and Charlotte, N.C., will see much higher vacancies. Already, the Manhattan office market is reeling from the financial carnage. In the last three months of 2008, nearly 2.4 million square feet of so-called "shadow space" or sublease space, came onto the market, according to real estate services firm FirstService Williams. Half of that came from the financial services industry. Sublease space is often offered at below-market rents, which pressures other landlords to lower their rents. Nadji expects rental rates for office space to fall between 4 and 6 percent this year. Industrial properties should fare a tad better than retail, but the recession is taking its toll on the manufacturing sector. Last month, manufacturing activity shrunk to its lowest level in 28 years.
No industry -- from bakeries to cigarette-makers -- reported any gains in new orders, production, employment or prices. Nadji expects the industrial vacancy rate to fall to almost 13 percent and rents to decline between 3 and 4 percent. Compared to those ugly numbers, the apartment market looks quite attractive. The vacancy rate is expected to rise to roughly 8 percent by the end of the year and rents will be flat, Nadji said. In fact, the dismal housing market is helping apartment owners. Foreclosures are driving many homeowners back into rental apartments. At the same time, plenty of renters who could afford to buy a home are waiting for housing prices to stabilize. One sliver of hope for the industry is the lack of overbuilding during the last boom. High construction and labor costs kept a lid on rampant development, and, in many areas, homebuilders often outbid commercial developers for land. But the welfare of commercial real estate trails the rest of the economy, so landlords might not get any relief for another two years. "If the economy recovers late this year," said Robert Bach, chief economist at Grubb and Ellis Co. "Our industry will still have a ways to go before it will recover."
Desperate Retailers Try Frantic Discounts and Giveaways
At a dealership on the outskirts of Miami, people who agree to buy one Dodge Ram truck can get a second truck or car — free. In 415 supermarkets across the East, customers who bring in a prescription can walk out with free antibiotics. And one clothing chain, not to be outdone, has started offering three suits for the price of one. An era of desperation marketing is at hand, with stores and automobile dealerships adopting virtually any tactic that might grab the attention of frightened consumers.
After one of the worst holiday seasons in decades, businesses are doing whatever they can to clear their shelves and make way for spring merchandise. Sales of 50 percent off stopped capturing the attention of customers weeks ago, so stores are layering discounts on top of discounts, and trying to lure shoppers with promises of giveaways, bulk bargains and other gimmicks. "Retailers are trying everything in the book," said C. Britt Beemer, chairman of America’s Research Group, a consumer research firm. "You’re seeing things like, ‘Buy one, get two free.’ That’s just unheard of, and the item you’re buying isn’t even full price." He added, "When you’re advertising those sorts of price points, you’re just trading trash for cash. There’s no strategy. You’re just trying to get rid of it."
For stores, offers like free antibiotics, three-for-one sweaters and 90-percent-off Sony PlayStations are usually "loss leaders," a retailing term for sweet deals meant to drive traffic. The stores hope not only to clear out merchandise that is not moving, but also to draw in customers who will spend money on other items. With sales of clothing, electronics, luxury goods and more down by double digits in the dismal economy, these loss leaders are more important than ever, analysts said. Stores began discounting long before the holiday season and slashed prices even more as Christmas approached, but the sales alone were not enough to clear away winter inventory.
"Fear is very high right now," said Dan de Grandpre, editor of the Web site DealNews. "What you’re going to see is retailers do as much as they can to be as creative as possible. You’re going to see more of this aggressive and sometimes panicky discounting from apparel stores and electronics stores." At the Samsonite outlet in Castle Rock, Colo., two free pairs of boots come with the purchase of one pair; similarly, at the home furnishings store Domestications, three throw rugs go for the price of one. Toys "R" Us had three-for-one Crayola products, and there were three-for-one cashmere sweaters at Off Fifth, the Saks outlet chain, according to news reports.
"They had so many freebies," said Carrie Koors, who lives in Cincinnati and writes a blog about bargain-hunting. "It was really a great holiday season to shop and get stuff for next season." Of course, selling items at two- or three-for-the-price-of-one is effectively just a fat discount on each item. But Dan Ariely, a professor of behavioral economics at Duke University, says the word "free" can work psychological magic on reluctant consumers. "When you offer something for free it’s more exciting," said Mr. Ariely, the author of "Predictably Irrational." "We don’t think of it in the same way. We just get tempted, because we think of it as only having pluses and no negatives. Free is like a whole new category."
And so the deals keep multiplying. The clothing company PacSun is offering a $10 discount coupon that allows customers to buy $9.99 T-shirts and slippers for only the cost of shipping. A Ford dealership in San Mateo, Calif., is offering a free scooter with the purchase of every 2009 Ford F-150. And shoppers at Jos. A. Bank can buy three suits for the price of one, while customers at Stop & Shop and Giant Food supermarkets can get free antibiotics to treat their winter ailments — with a doctor’s prescription, of course. "We’re going to take a leadership role in the industry, and we’re going to be different," said Faith Weiner, Stop & Shop’s director of public affairs.
In Davie, Fla., University Dodge dreamed up a "Buy 1 ... Get 2!" deal to attract the attention of potential customers and whittle excess inventory, which had spilled onto the lot next door. So far, the dealership has sold 40 vehicles under the promotion, which promises customers a free Dodge Ram, Dodge Caliber or PT Cruiser if they buy a 2008 Ram. "Most people think we’re crazy," said Ali Ahmed, the sales manager. "More than anything, it’s a way to catch the customer’s interest than to just offer a percentage or dollar amount off. They’ve heard that before."
The dealership has advertised its two-for-one car sale online and in newspapers, Mr. Ahmed said, and customers have been calling and showing
up to see whether the sale is a gag. But it is no joke from Mr. Ahmed’s point of view: an estimated 900 auto dealerships out of 20,770 nationwide went out of business in 2008, according to industry estimates, and Mr. Ahmed said he did not want to join the thousands likely to close this year.
"It’s a tough environment," he said. "Of the dealers around you now, you know some of them aren’t going to be on the map next year. If you can steal a little bit of market share now, you’re not going to be one of those."
Realtors Protest Increase in Fannie Mae Mortgage Fees
The National Association of Realtors said an increase in fees by Fannie Mae "imposes major new costs" on home buyers and people trying to refinance into more affordable mortgage loans. The trade group's protest -- made in a letter to the Federal Housing Finance Agency, the regulator of Fannie and its smaller rival, Freddie Mac -- underscores growing tensions between the role of these government-backed mortgage companies in propping up the housing market and their efforts to contain heavy losses from defaults.
In an update posted on one of its Web sites Monday, Fannie raised some of the fees it charges to lenders when it buys or guarantees certain types of mortgages. The fees generally are passed on to consumers. For instance, for a 30-year fixed-rate mortgage to buy a condominium, allowing for initial payments of interest only and with a 20% down payment, a borrower with a credit score of 690 will pay fees totaling 3.25% of the loan amount for mortgages Fannie purchases after April 1, up from 1.25%. (Under a system devised by Fair Isaac Corp., credit scores range from 300 to 850. The median is about 723.)
A Fannie spokesman said the higher fees are targeted at some of the highest-risk loans, such as those allowing deferment of principal payments and those allowing borrowers to draw cash when they refinance. He said Fannie and Freddie in October canceled plans for an increase in another fee that applies more generally to mortgages. A spokeswoman for the FHFA said the agency is reviewing the Realtors' letter.
Prepare for the sequel to the UK bank bail-out
One might have hoped for some good news on the first working day of the New Year. Instead what we received was a chilling reminder that the financial crisis and the credit crunch have a good way to run yet. In fact amid the raft of data published was one statistic which was particularly telling. It underlines the likelihood that the Government will most probably feel compelled to step in with another banking bail-out package before too long; it reveals that the credit crunch may now be more of a constraint on the economy than the common or garden recession. We have know for some time that the economy and the housing market have been weighed down by a collapse both in the supply of credit (the financial crisis) and a similar slide in the demand for borrowing (consumers’ fears of further house price falls).
Knowing this, it has been hard to argue that if there really was money available to borrow - in other words if the supply side of this problem was solved - people would actually go out and get it. However, the Bank of England’s Credit Conditions survey reveals that while the supply of credit continues to dwindle, with banks both cutting the amount they are handing out and increasing the stringency of the conditions attached to the money, demand for mortgages and credit card borrowing may be starting to recover. This makes sense. Although many people have overextended themselves in recent years, some have not and they want to snap up bargains - cheap houses or cars for instance. That they are being prevented from doing so by banks, which are still repairing their balance sheets and rationing credit, underlines that while the financial bail-out package of October ensured the banking system would not collapse it has failed in its bid to boost the availability of lending to households.
Given that the Government is unlikely to tolerate such an outcome (witness the public horror as Nationwide revealed it was sticking to the terms of its mortgage deals and not passing on further rate cuts to its tracker mortgage customers) there will almost certainly be another banking bail-out - this one likely to take Royal Bank of Scotland and HBOS/Lloyds TSB further into public ownership. There are other solutions: among them temporarily relaxing capital requirements and mark-to-market rules or exhuming the Paulson plan to buy up toxic debt, but none of these will make more cash available to households instantly. If that is the Government’s intention, it is fast becoming clear that it will have to do it itself. For better or, more likely, for worse, full-blown nationalisation of vast swathes of the banking system beckon.
UK credit squeeze set to intensify in 2009
The credit squeeze for families and businesses looks set to intensify into 2009 despite unprecedented measures to recapitalise the banking system and get lending flowing again, a survey showed Friday. The grim news came as a deluge of data suggested the economy was plunging deeper into recession. A survey from Halifax, the country's biggest mortgage lender, showed house prices fell a record annual 16.2 percent last month. Bank of England figures showed mortgage approvals slumped to a record low in November and a survey of purchasing managers showed manufacturing activity contracted in December for an eighth month running.
"There's no let-up in sight," said George Johns, an economist at Barclays Capital. The pound resumed its slide on the foreign exchanges and two-year gilt yields fell below 1 percent for the first time as traders bet the Bank of England will deliver another hefty rate cut next week. Interest rates have already been slashed to 2 percent, their lowest level since 1951. With the economy battered by the worst financial storm for 80 years, markets are pricing in another cut of at least half a percentage point next Thursday. "Today's weak data is likely to add to the list of reasons for the Monetary Policy Committee to cut aggressively next week," said Amit Kara, an economist at UBS.
Kara expects rates to be cut to just 1 percent next week and to 0.5 percent by March. Interest rates have never gone below 2 percent since the central bank was created in 1694. Evidence that banks are still reining in lending will be embarrassing for the government which has pumped billions of taxpayers' money into the country's major banks in return for pledges that lending would be maintained. Bank of England Governor Mervyn King has singled out bank lending as the single most pressing challenge facing policymakers and warned that banks may need further injections of money if financial conditions worsen.
The Bank's quarterly credit conditions survey showed lenders had reduced the availability of both secured and unsecured credit in the fourth quarter of last year and expected to cut back further in the next three months. A vicious downward spiral -- in which falling house prices make banks reluctant to lend, pushing prices down further -- may prove difficult to break. Halifax figures showed house prices fell by a record 16.2 percent year-on-year in the three months to December, taking them to their lowest level since August 2004.
House prices have already shed some 20 percent from their 2007 peak, falling even faster than in the last recession of the early 1990s. Moreover, the pace of house price falls show no sign of slowing. Mortgage approvals for house purchase -- a leading indicator of the market -- fell to just 27,000 in November, the lowest level since the series began in January 1999 and a third of its level a year ago. "There's no end in sight to the pain in the housing market," said Matthew Sharratt, an economist at Bank of America.
Signs that British bail-out is failing
Interest rates on short-term UK government bonds have dipped beneath 1pc for the first time amid a shower of evidence that Gordon Brown's banking bail-out package has failed to reignite lending. The two-year gilt yield dropped to 0.98pc, indicating that investors expect the Bank of England to slash rates even further, alongside other more drastic measures to bring the financial crisis to an end. The fall, which leaves the yield at the lowest level since records began 30 years ago, came after a Bank survey indicated that the credit crunch will intensify in the coming months as banks take further steps to ration the amount they lend to consumers and businesses alike. The Credit Conditions survey, an official barometer of banks' willingness to lend, reveals that UK financial institutions slashed their available mortgages and loans in the final quarter of last year, and intend to tighten availability even further in the current quarter.
The news coincided with Nationwide's announcement that it will not pass on further interest rate cuts to its tracker mortgage customers. It proves embarrassing for the Prime Minister and Chancellor Alistair Darling who had insisted that their bold plan to recapitalise Britain's banks would raise mortgage availability back to 2007 levels. The news makes it more likely that the Treasury will have to embark on further schemes to support lending, ranging from pumping extra capital into banks and fully nationalising certain banks to scrapping regulatory rules constraining banks' balance sheets. Another scheme under consideration involves the Government lending directly to businesses and households through its nationalised institutions. Robert Self of Credit Suisse said: "The data continues to indicate tightening credit availability, higher default rates and worse loss given default experience across both household and corporate lending ... We continue to believe that tight credit availability will further pressure asset prices leading in turn to higher impairment and pressure on capital ratios. For now we continue to remain cautious on the UK banks sector."
Economists have said the UK is trapped in a so-called negative feedback loop, with the economy slumping further as banks restrict mortgage and other loan availability in an effort to repair their balance sheets. This in turn causes further defaults, which causes more damage to their accounts, and worsening the vicious cycle. In a further sign of economic weakness, the growth rate of M4 cash lent to private non-financial corporations has dipped to the lowest level on record – an indication that the economy is set for a sharp contraction in the coming months, according to Simon Ward, economist at New Star. He said the Bank of England's survey shows that lenders reduced the availability of secured credit such as mortgages to households in the three months to mid-December 2008, adding: "A further decline was expected over the next three months."
The survey also revealed that demand for credit from both households and companies fell in the fourth quarter, while defaults and losses increased. Banks said that the inability to lend funds and the volatility in the money markets was the key factor behind their reluctance to lend. The Bank's Governor, Mervyn King, has signalled that the Government will have to attempt new extraordinary measures in order to kick-start lending, suggesting that lower interest rates alone would not be enough. Nevertheless, the Bank's Monetary Policy Committee is widely expected to cut borrowing costs to an all-time low of beneath 2pc next Thursday.
Savers facing accounts with no interest
Millions of savers are braced for zero per cent accounts within days as the Bank of England is poised to cut interest rates to the lowest level in its 315-year history. Experts have warned the return on savings could plumb new depths with the Bank expected to take unprecedented steps to regain control over the economy. They widely believe the Bank will reduce borrowing costs to below their 2 per cent level - and possibly all the way down to 1 per cent - in its first meeting of the year next week. More than 7 million people have saving accounts which already pay interest of 1 per cent or less. If a cut is passed on in full by banks, these accounts will dive towards negative territory for the first time on record. Many elderly people who rely on the income from savings have found themselves struggling in recent months as returns fall.
Just 18 months ago average interest rates on savings accounts were as high as 6 per cent. But consecutive cuts by the Bank's Monetary Policy Committee have led to banks slashing their savings rates, with the current average rate being just 2 per cent. The Daily Telegraph has launched a campaign aimed at giving pensioners a tax cut on the income earned from their savings and investments to help them during the recession. Mark Dampier, of asset managers Hargreaves Lansdown, said: "It is a dire times for savers, especially for elderly people who rely on their income. They have already seen a sharp drop in excess of 50 per cent and can anyone tell me of someone in the public or private who would put up with a 50 per cent pay cut?" A cut in interest rates raises the bizarre possibility that some savers may soon end up having to pay banks to keep money with them. Kevin Mountford, head of savings at Moneysupermarket.com, said: "A large number of savings accounts only pay 1 per cent and so a wave of savers will end up receiving no interest at all if rates are cut significantly again - and may, in theory, end up paying banks for having being prudent savers. All round it is bad news for savers."
Calls for a rate cut were strengthened by evidence that Gordon Brown's £300 billion banking bail-out has failed to make it easier for households to borrow money. The credit crunch is instead set to worsen in the months ahead and lenders intend to make it even more difficult for customers to borrow, according to a new report from the Bank. They intend to continue passing on only a fraction of the Bank's rate cuts and increasing the stringency of their loan conditions as they seek to repair their own balance sheets. New figures showed that house prices have fallen by a record 18.9 per cent in the last year. The average house is now worth what it was in August 2004, according to Halifax. Amid the deepening economic crisis, experts warned that while borrowing costs look certain to remain high, savings rates, which have already fallen fast, are set to dip to the lowest levels on record as soon as next week. Economist Howard Archer, of Global Insight said: "It seems a stone dead certainty that the Bank of England will deliver another hefty interest rate cut next Thursday." If they do, it will take interest rates to the lowest level since the Bank was founded in 1694. The forecasts come after Nationwide announced that it is reducing the interest rates across its savings and banking accounts by an average of 0.87 per cent following the Bank of England's decision to cut rates by one percentage points in December.
The cuts mean some of its savings accounts pay as little as 0.5 per cent gross, such as its e-savings plus account if customers make more than three withdrawals in a year. The building society is also refusing to pass on any further interest rate cuts to its customers with tracker mortgages. The Bank of England indicated that there would be further examples of this in the coming months. Its Credit Conditions survey underlined the growing realisation that the banking bail-out package unveiled by Gordon Brown in October has failed. Although the bail-out has ensured the survival of the major banks it has not fulfilled its other promise: to increase the availability of credit to families. It raises the prospect that the Government will be forced in the coming months to pump another multi-billion pound sum into the British banking sector - perhaps going as far as to wholly nationalise some of the biggest lenders. Analysts believe there may be no alternative if the Government truly intends to increase the availability of mortgages to British consumers.
David Cameron urged Gordon Brown to admit that his bank recapitalisation plan has failed and more needs to be done to get banks lending to businesses. The Conservative leader said: "Instead of Gordon Brown striding round the world lecturing everyone about the brilliance of his bank recapitalisation plan he has to recognise that it hasn't worked. "The banks are now traumatised and trying to rebuild their credit – the government needs to react to move banks out of that position – small businesses shouldn't be going bust and they are because the are not getting the money they need." He said it was vital that the Government brought in a national loan guarantee scheme. The Telegraph revealed last month that ministers are working on a scheme which will see the Government guarantee part of new loans that banks agree with businesses. A Treasury spokesman said: "The Government is continuing to closely monitor commitments made by banks, through (the) new lending panel, and will continue to take whatever action is necessary to ensure the availability of new lending. "Recent actions by many of the major banks to increase the availability of lending in 2009 are welcome but clearly we need to see more. "As the Chancellor has said, he is prepared to look at further measures to make it more likely that banks will lend, but banks have to understand that with billions of pounds of taxpayers' money invested, or being made available as a guarantee, the public and businesses are looking for something in return."
France to sell morality to the markets
France is to step up efforts to instil moral values in the global market economy by urging policymakers to consider fresh ways of combating financial short-termism. Nicolas Sarkozy, France’s president, and Tony Blair, the former UK prime minister, will jointly host a conference in Paris next week of political leaders and Nobel prize-winning economists to discuss ways of strengthening the ethical foundations of the capitalist system after the financial crisis. “There is no system of wealth creation without a system of values and this value system has been badly shaken,” said Eric Besson, the French minister for policy planning, who is organising the conference. “People are prepared to accept others getting high pay and enjoying different lifestyles, but only if they have the feeling that the system is fair and that the law is the same for everybody.”
Mr Besson criticised complex securitisation of debt, excessive financial leverage, short-selling and demands for unrealistic returns on investment, saying they pointed to a pervasive “failure to value the long term” across all sectors of the economy for the past 20 years. “Nobody wants to ban the stock market,” he said, even though it had become a “casino”. “But how can we return to certain fundamental values where the stock exchange is the place businesses come to for the long-term capital they need?” Mr Besson, a former Socialist party adviser who jumped ship to Mr Sarkozy’s centre-right government, acknowledged that it was more difficult to find the technical solutions than diagnose the problems. But he said this should not prevent a long overdue discussion by top policymakers, economists and intellectuals on how to restore a sense of responsibility to the global financial system.
“Those who want to defend the virtues of free market capitalism must at the same time demand a balance of rights and responsibilities from top executives. Setting an example matters.” An “intellectual opening- up” in the wake of the financial crisis, a new US administration and a second summit of G20 leading and emerging economies in April made it the right moment to discuss the values underpinning capitalism before moving on to specific regulatory issues. “I think the accession of Barack Obama is going to create an extraordinary window of opportunity,” he said. “From what I have heard, he talks the language of regulation.” But Mr Besson added there would be many people, for now keeping quiet, who would argue that the financial crisis was a “little car accident” caused by a few specific US problems and that it would soon be “back to business as usual”. Mr Sarkozy has long argued for the “moralisation” of capital, calling for a capitalism for entrepreneurs rather than speculators.
He was instrumental in bringing about the first summit of G20 in Washington in November but has so far come up with few detailed policy proposals of his own. Mr Besson dismissed suggestions that the conference was an attempt by Mr Sarkozy to hog the limelight and control the policymaking agenda ahead of the G20 summit with another international gathering in Paris. “The idea of regulation automatically sounds better to French ears whatever their political convictions,” Mr Besson said. But France’s instincts would be tempered by the need to keep on board other European capitals, particularly London and Berlin, he said.
Ilargi: I don't know yet what to think of this. The Ukraine has said they have a 2-month reserve. So they could just be putting pressure on Moscow. As long as they have gas, why worry, why not pay your bills at the last moment? They could also be trying to drag the EU into the conflict. Don't forget, the Ukraine got a big IMF loan, which means US influence has increased even more than before. Putin seems to have nothing else to gain than getting the US of his front porch. Don't, in any case, let's underestimate the explosive potential of the situation.
Ukraine warns EU serious gas shortages possible
A senior Ukrainian official says European consumers will see serious natural gas shortages in only two weeks if Moscow and Kiev don't solve their dispute over gas supplies. Bohdan Sokolovsky's statement raises the stakes in an escalating row between the two neighbors.
Russia cut off gas supplies to Ukraine on New Year's Day after the two countries failed to resolve payment issues or agree on a price contract for 2009. Most Russian gas bound for Europe travels through Ukraine. Sokolovsky said Saturday even though Ukraine will continue shipping Russian gas intended for Europe, disruptions in supplies will occur in the next 10 to 15 days if Ukraine's gas is not shipped along with it. He said the pipelines require a minimum amount of gas to avoid an automatic shutdown.
The Russian gas monopoly Gazprom on Saturday accused Ukraine of boycotting negotiations on a natural gas contract dispute that has led to supply reductions in several European countries. Russia and Ukraine also traded accusations over who was responsible for the drop in natural gas supplies to other European nations. Europe gets one-quarter of its natural gas from Russia, and 80 percent of that travels across Ukraine's pipelines. On Thursday, Gazprom cut off all gas supplies to Ukraine, saying Ukrainian officials had failed to pay a $2.1 billion bill. Ukraine's state gas company Naftogaz made an 11th-hour payment of $1.5 billion, but Gazprom says Ukraine still owes more than $600 million in fines. Ukraine disputes the fines.
The two nations are also at odds over the price Ukraine will pay for natural gas in 2009 — Gazprom has proposed a price jump from $179.50 to $418 per thousand cubic meters. At a news conference in Prague, Gazprom Deputy Chairman Alexander Medvedev accused Naftogaz representatives of not coming to Moscow for talks. He also said during the gas cutoff, Ukraine has been siphoning off natural gas from Russia's shipments to other countries and also from underground storage. "It's absolutely unacceptable situation," Medvedev told reporters. "We're not negotiating," he added. "There's nobody from Naftogaz to negotiate (with)." Naftogaz, however, denied that it was siphoning off gas intended for Europe. Spokesman Valentyn Zemlyansky said Saturday that on the contrary, Naftogaz was spending its own so-called technical gas to pump Russian gas to European consumers.
Medvedev spoke at the start of a tour that includes the Czech Republic, Germany, France and Britain to reassure European customers that Russia is a reliable energy partner. He said Gazprom has been using alternative routes that don't cross Ukraine but does not have enough capacity there to bring gas supplies to normal levels. As a result, countries including Romania, Hungary and Poland are suffering a reduction in supplies. "We try to do our utmost to compensate for what Ukraine is doing...but the capacity to compensate has its limit," Medvedev said.
Ukrainian President Viktor Yushchenko's energy adviser Bohdan Sokolovsky warned that the two countries had at most two weeks to reach an agreement before European countries would begin experiencing serious interruptions in gas supplies.
In Prague, the Czech Republic, which holds the EU rotating presidency, urged both sides to solve quickly the dispute and called "for an immediate resumption of full deliveries of gas to the EU member states." It was not the first time Russia has cut Ukraine's natural gas supplies. In a 2006 dispute, Russia halted Ukraine's shipments, which temporarily affected supplies to Europe and led to accusations that Russia was an unreliable energy source. Many in the West viewed the 2006 cutoff as a Russian effort to punish Ukraine's political leaders for their pro-Western policies.
Sokolovsky accused Moscow of once again exerting political pressure on Ukraine and of seeking to drive Naftogaz into debt by refusing the raise the transit fee Russia pays to use Ukraine's pipelines. "It is obvious that his is political pressure on Ukraine," Sokolovsky said. "This is pure politics." Medvedev rejected the claim, saying the gas contract dispute was caught up in the political fight between Ukraine's prime minister and its president. Yushchenko and Prime Minister Yulia Tymoshenko are bitter political rivals.
EU gas supplies fall as Russia-Ukraine row deepens
European Union countries were on alert on Saturday for further disruption to their gas supplies after Russia cut off Ukraine in a row over pricing, and accused it of stealing gas bound for western markets. The EU's fear of disruption to its gas supply in the dead of winter became a reality late on Friday, when Romania's pipeline operator said supplies had fallen by 30-40 percent that day and Hungary and Poland also reported drops. But there was no immediate sign the problem had spread further. The Czech pipeline operator said there were no problems in a main pipeline to Germany, Europe's biggest economy.
The Russian state-controlled gas monopoly, Gazprom, halted supplies to Ukraine on New Year's Day, saying Ukraine had failed to pay its gas bill and talks on 2009 gas prices had broken down. The European Union, which gets a fifth of its gas from pipelines that cross Ukraine, said it would call a crisis meeting of envoys in Brussels on Monday and demanded that transit and supply contracts be honoured. "Energy relations between the EU and its neighbours should be based on reliability and predictability," the Czech presidency of the 27-nation bloc said in a statement on Friday.
The disruptions are likely to undermine Russia's attempts to present itself as a stable energy supplier and add to concern that Moscow is trying to bully its neighbours just five months after the war with Georgia. Ukrainian President Viktor Yushchenko has angered the Kremlin by trying to join the NATO military alliance. Russia and Ukraine have insisted they will honour their commitments but Gazprom said Ukraine was stealing gas destined for Europe, a charge Ukraine's state-run gas company denied. Europe, where temperatures fell below freezing overnight, has enough gas stockpiled to manage without Russian supplies for several days but could face difficulties should problems last for weeks, analysts said.
In an indication of how seriously Moscow and Kiev view the crisis, both sides had delegations touring European capitals to explain their positions. Martin Chalupsky, spokesman for pipeline operator RWE Transgas in the Czech Republic said: "We are without problems today." "The problems are on the south pipeline in Hungary and Romania and so on. The main pipeline through Slovakia, Czech Republic and Germany are now without problems." Russia's 2006 dispute with Ukraine prompted calls for the EU to reduce its reliance on Russian gas but Gazprom forecasts that the bloc will rely on Russia for as much as one-third of its gas by 2015, up from about a quarter now.
Alexei Miller, CEO of Gazprom, said on Thursday he wanted Ukraine to pay $418 (287 pounds) per 1,000 cubic metres (tcm) of gas, compared with the $179.50 Kiev paid in 2008. Talks between Gazprom and Ukraine's state-run gas company, Naftogaz, have not resumed since failing late on New Year's Eve and the two sides remain far apart. Ukraine says the most it can afford to pay is $235 but only if Gazprom pays it more for gas transit. Gazprom says it already has a gas transit deal to 2010 and does not need to rework it. Gazprom says Ukraine owes it $600 million in fines for the late payment of $1.5 billion in gas bills. Ukraine's Naftogaz says it paid the $1.5 billion to an intermediary and Gazprom said it hopes to get that payment on January 11.
"We are ready to enter negotiations day and night and we have delivered this message to our Ukrainian colleagues but they probably have other tasks than to solve this problem because they are not in Moscow," Gazprom Deputy CEO Alexander Medvedev told the BBC in English. Ukraine, facing a deep recession, says it can ill afford to pay higher prices for its gas. President Yushchenko and Prime Minister Yulia Tymoshenko, who are locked in a battle for influence, would likely be loath to explain to voters why gas bills have to be raised again. Ukrainians on the street in Kiev seemed to blame their own politicians for failing to get a deal with Russia. "This is just bandits sitting in the Kremlin arguing, deciding, talking to bandits sitting in Grushevska street," Oleg Karlichyk a plumber in his mid-30s going on his way to work, said referring to the seats of power in Moscow and Kiev.
Polish gas supply via Ukraine falls 11 percent
Russian gas deliveries to Poland through Ukraine fell further on Saturday, dropping by 5 million cubic metres a day, but deliveries through Belarus made up for the shortfall, the director of gas operator Gaz System said. Tadeusz Abramowicz told a news conference that Poland could import an additional 2 million cubic metres of gas a day through Belarus should the row between Russia and Ukraine cause furher declines in gas supply.
"The volume imported through Ukraine dropped by 11 percent, or 5 million cubic metres, we have increased imports through Belarus by that amount," Abramowicz said. "We are able to get 2 million cubic metres more from that direction." On Friday the operator reported a 6 percent drop in supplies through Ukraine. Gazprom halted supplies to Ukraine on New Year's Day, saying Ukraine had failed to pay its gas bill and talks on 2009 gas prices had broken down.
Three years after a similar dispute briefly disrupted supplies, European fears of gas flows dropping off in the dead of winter were once again becoming a reality. Poland is heavily dependent on Russian natural gas, importing nearly two-thirds of its 14 billion cubic metres a year consumption from that country. About 40 percent of that gas is shipped via Ukraine. The gas monopoly PGNiG said earlier that its storage tanks were 85 percent full, enough to supply Polish customers for weeks if supplies stopped altogether.
Russia oil output falls for first time in a decade
Russian oil production fell by around one percent in 2008, official data showed on Friday, the country's first annual decline in a decade after large increases in previous years and a sign of things to come. The decline is widely expected to continue because of ageing reserves and plunging oil prices, which combine with heavy taxation to leave producers with limited cash to invest in maintaining production and opening new fields.
The Energy Ministry data showed that December crude and gas condensate production fell 1.6 percent, month-on-month, to 9.66 million barrels per day (bpd), bringing the annual average output to 488.105 million tonnes or 9.78 million bpd. The annual figure is 0.9 percent lower, on a daily basis, than Russia's 2007 oil production, which stood at 491.481 million tonnes or 9.87 million bpd. Analysts expect oil output growth to recover only in the next decade after a number of new major deposits are launched in Eastern Siberia, which is rich in resources but lacks infrastructure. In 2007, output rose 2.3 percent from 2006, supported mainly by the Sakhalin-1 field on the Pacific island of the same name, developed by U.S. oil major Exxon Mobil.
The data also showed that Russian oil exports via pipeline monopoly Transneft fell by more than 5 percent to 4.19 million bpd (209.152 million tonnes) last year from 4.43 million bpd (220.597 million tonnes) in 2007. In December, Russian oil exports via Transneft rose by 17.8 percent to 4.36 million bpd (18.445 million tonnes) against 3.70 million bpd (15.142 million tonnes) in the previous month. Natural gas output by Gazprom, the world's largest gas producer and supplier of a quarter of Europe's gas needs, stood at 550.587 billion cubic metres (bcm) in 2008, compared with 549.597 bcm in 2007.
Slovaks embrace new economic cushion
Slovaks set aside fears over their slowing economy for a few hours on New Year’s eve as midnight fireworks and an all-night rock concert in Bratislava heralded the adoption of the euro. As Slovakia bid farewell to the koruna – becoming the 16th country to adopt the single European currency – their neighbours and former compatriots in the Czech Republic were taking over the six-month European presidency. But while the Czechs display no urgency to join the euro, Slovakia’s change of currency has provided a cushion against the turmoil of the global economic crisis. Earlier this year, the Czech koruna soared against the euro and the dollar, putting a squeeze on exporters. But since then, the currency has declined by 15 per cent against the euro and by 30 per cent against the dollar, as investors have fled emerging markets.
Meanwhile, the Slovak koruna has been fixed at 30.1260 against the euro since July. “Euro adoption is definitely a positive step,” said Ladislav Juza, from the Prague office of the consultancy PwC. “It will allow companies to stop focusing on the currency fluctuation only. The Czech Republic and Poland might gain a competitive advantage in the short term, provided local currencies decrease in strength, but, in the long term, euro adoption will bring much more positive effects.” The move has helped to bolster the economy. Slovakia’s central bank estimates that gross domestic product growth this year will come in at 4.7 per cent, compared with an expected 7.5 per cent for 2008, with the caveat that the risks are mostly on the downside. By contrast, the Czech economy is expected to grow at only 2.9 per cent in 2009. Slovakia’s convergence with the economies of the eurozone has created the starkest difference between the two countries since the 1993 “Velvet Divorce”, which peacefully broke up Czechoslovakia.
In Slovakia, the euro is seen as one of the most significant events since independence, and a confirmation of the country’s status as a mainstream European nation. When it split from the Czech Republic, Slovakia was much more agrarian and dependent on antiquated heavy industry and Soviet-era weapons manufacturing than the historically wealthier and more developed Czech lands. Politically, the country steered a pro-Moscow line under the authoritarian governments of Vladimir Meciar, and was left an increasingly isolated backwater, while its central European neighbours raced towards membership in Nato and the European Union. That changed in 1998, when Mr Meciar was replaced by Mikulas Dzurinda, who began some of the most far-reaching economic reforms in Europe. These turned Slovakia into a fast-growing magnet for foreign investment, and the country has become the highest per-capita car producer in the world. The contrast with the situation in the Czech Republic is stark.
Although both the government and the opposition say they are in favour of joining the euro, the centre-right government of Mirek Topolanek, the Czech prime minister, plans only to announce a possible entry date in November. The Czechs feel less of a rush to join than their Slovak cousins. They have long felt themselves to be an integral part of western Europe and regard their economic policy and currency as being at least as sound as that of the eurozone. The Czechs are likely to meet all the Maastricht criteria for joining the euro in 2009. However, in a recent speech at the London School of Economics, Mr Topolanek said this was “unfortunate” because it would require a decision from the government on accession. He added: “Czechs are thrifty and conservative and are not eager to accept the euro.” He said the Czechs were keen to see how the Slovak experience with the euro panned out before making a decision, explaining that the Slovaks would find themselves part of an economy that was likely to experience a severe downturn this year.
China Manufacturing Shrinks for 5th Month on Exports
China’s manufacturing contracted for a fifth month in December as recessions in the U.S., Europe and Japan sapped demand for exports, a survey showed. The CLSA China Purchasing Managers’ Index stood at a seasonally adjusted 41.2, compared with a record low of 40.9 in November, CLSA Asia-Pacific Markets said today in an e-mailed statement. A reading below 50 reflects a contraction. Manufacturers in industries from metals to toys are reducing production or closing down. Aluminum Corp. of China Ltd., the nation’s biggest maker of the metal, and Yunnan Tin Co., the world’s largest producer of tin, cut output as prices fell. “Chinese manufacturing was very weak in December,” said Eric Fishwick, head of economic research at CLSA in Singapore.
“With five back-to-back PMIs signaling contraction, the manufacturing sector, which accounts for 43 percent of the Chinese economy, is close to technical recession.” The output index fell to a record low of 38.6 last month from 39.2 in November, while the measure of new orders rose to 37 from 36.1. The index of export orders jumped to 33.6 from 28.2, CLSA said. “Chinese manufacturers reduced the size of their workforces at the fastest rate recorded by the series to date,” today’s report said. An employment index tracked by CLSA has contracted for five consecutive months to 45.2 in December.
China’s economic growth may have slipped to 5.5 percent last quarter, the weakest pace in at least 15 years, according to Shanghai-based Industrial Bank Co. The economic slide may intensify pressure on the central bank to keep cutting interest rates after five reductions in three months and as the government rolls out a 4 trillion yuan ($586 billion) spending package announced in November. Central bank Governor Zhou Xiaochuan pledged Dec. 31 to continue a “flexible” monetary policy. Capital Economics Ltd. forecasts the key one-year lending rate will fall by at least 81 basis points from 5.31 percent in the first half of this year. A drastic slowdown in industrial-output growth is mainly due to companies running down excess inventory, central bank Vice Governor Yi Gang said Dec. 26. That process may continue until the end of the second quarter, Yi said.
Exports fell for the first time in seven years in November, imports plunged and industrial output grew at the slowest pace in almost a decade. The government has responded to the deepening slowdown with the stimulus package running through 2010, interest-rate cuts and reductions in export taxes. It has also stalled the yuan’s gains against the dollar since mid-July. A weaker currency helps exporters by keeping down prices in overseas markets. China needs to boost consumption and prepare more measures to tackle the global financial crisis, the central bank said Dec. 31. It reaffirmed a “moderately loose” monetary policy. The CLSA index, started in 2004, is based on a survey of more than 400 manufacturing companies and tracks changes in output, orders, employment, inventories and prices.
Credit Freeze Puts Chill on M&A Dealmaking, Volume Down 29%
What a difference a year makes. With the virtual collapse of credit markets and the drying up of money from private equity firms, 2008 turned out to be a very slow year for mergers and acquisitions. Globally, there were 37,445 deals, totaling $3.3 trillion, down 29 percent from record volume in 2007, according to Dealogic, a data research firm in New York. In the United States the value of deals dropped 29 percent to $1.1 trillion. "There were record highs in 2006 and 2007 in terms of the volume of deals," said Josh Lerner, a professor of investment banking at Harvard Business School. "What ended up happening with the credit crunch is that people couldn't get access to debt financing at the very generous, cheap terms they had before."
The value of mergers and acquisitions was largest in the U.S. financial sector as the credit crisis spurred linkups. The sector did $157.9 billion in deals, with Bank of America's $44.4 billion acquisition of Merrill Lynch accounting for the lion's share. The health-care and consumer products industries, which did $138.6 billion and $135.6 billion in deals, respectively, ranked next, according to Dealogic. The company's data extends to Dec. 22. Dealogic plans to release an updated year-end report early next week. In the United States, the number of buyouts -- deals undertaken by private equity firms -- dropped roughly 32 percent to 635 deals valued at $61 billion, from 930 deals valued at $375 billion in 2007. Financial industry buyouts were the largest in value, at $15.6 billion.
By comparison, the utility and energy sector, which led 2007, had deals valued at $46.43 billion. Greg Peters, chief credit strategist at Morgan Stanley, said the declines show how challenging the environment is. "Deals are typically debt financed," he said. "With debt markets essentially frozen, the ability to do a transaction just isn't there." One of the biggest consumer products deals in 2008 highlighted the difficulties in the market. When Mars wanted to buy William Wrigley Jr. for $23 billion, it had trouble raising financing and ended up going to billionaire investor Warren Buffett for money, analysts said. Not every deal went through. Globally, a record 1,309 deals, valued at $911 billion, were withdrawn. In the United States, $245.6 billion in deals fell through. Leading the way, Microsoft withdrew its bid for Yahoo, valued at $47.5 billion. Deals fell through because in many cases in poor economic times, buyers want to renegotiate the terms and sellers are hesitant.
In other cases, buyers might still be eager but can't raise the financing. Many analysts say 2009 is unlikely to see a major resurgence in dealmaking. "The financial sector is the one to watch," Peters said. "You're going to see continued consolidation, either government-induced or businesses that just have to consolidate. The industry is too fragmented. You have too many small institutions that are struggling. The big will get bigger." Some analysts said they expect health-care companies, particularly pharmaceutical firms, to seek mergers with smaller drug companies that have many new drugs under development. The M&A activity in the financial sector was extraordinary in 2008, Lerner said, adding that if the economy gets worse there could be even larger waves of mergers. If the downturn became very severe, he said, it would be nearly impossible to predict what would happen in the world of mergers and acquisitions.
FDIC Agrees to Sell IndyMac to Investor Group
The federal government has agreed to sell the skeleton of IndyMac Bank, the aggressive California mortgage lender whose July failure portended the autumn crisis of the financial system, to a group of private investors. It is the first failed bank in almost two decades that the Federal Deposit Insurance Corp. has sold to a buyer outside the banking industry, underscoring both the dearth of banks able to bid and the increased interest of wealthy investors in the ailing but historically lucrative industry.
The investing group, IMB HoldCo, is led by Steven Mnuchin, a former Goldman Sachs executive, and includes the veteran banking investor J. Christopher Flowers, computer maker Michael S. Dell and hedge fund manager John Paulson, who made billions betting on the very collapse of the mortgage market that killed IndyMac. The sale of IndyMac has a total value to the government of about $13.9 billion. That is mostly the value of liabilities that the investors will take off the government's books, plus a cash payment for the balance.
The FDIC estimates that even after that payment, IndyMac's failure ultimately will cost the agency between $8.5 billion and $9.4 billion, consistent with the agency's earlier estimate of $8.9 billion. There is no direct cost to taxpayers because the agency is funded by fees collected from the banking industry. The deal is consistent with the FDIC's emerging model for selling failed banks, hammered out over a string of recent failures. The agency agreed to limit the buyer's potential losses on a portfolio of IndyMac's outstanding loans by promising to cover almost all losses in excess of 20 percent of the portfolio. In exchange, the buyer is required to offer mortgage modifications to IndyMac customers on terms specified by the FDIC.
The agency already has modified mortgages for 8,500 IndyMac customers, generally by reducing interest rates to make monthly payments more affordable. The agency said 9,500 modifications are in process and at least another 28,500 borrowers are eligible. The FDIC, which wants the program adopted nationwide, said it calculates the modifications will save $423 million by avoiding foreclosures. "The FDIC and IndyMac staff accomplished a tremendous amount of work in a short period of time to help thousands of struggling homeowners stay in their homes," said John Bovenzi, who will end a turn as IndyMac's chief executive and return to his role as the FDIC's chief operating officer.
IndyMac's collapse was the fourth-largest bank failure in U.S. history and the second-largest this year behind Washington Mutual's in September. IndyMac was weakened by massive and mounting losses on its portfolio of home mortgage loans, then finished when depositors lost confidence in its viability and drained more than $1 billion in deposits, leaving it without enough money to cover its obligations. The Treasury Department's inspector general reported last week that a senior official of the Office of Thrift Supervision knowingly allowed IndyMac to conceal the depth of its financial problems only weeks before it failed by falsifying a key financial filing.
Since the seizure, the FDIC has operated the bank as a government subsidiary, gradually winding down its operations. The bank, which held roughly $18 billion in deposits at the time of its failure, now holds about $6.5 billion. IndyMac's remaining value is in its network of 33 branches in the Los Angeles area, a profitable national business as a "reverse mortgage" lender helping seniors tap the equity in their homes, and a considerable portfolio of loans that borrowers continue to repay. IMB HoldCo also agreed to inject $1.3 billion into the bank when the deal closes, which is expected to happen at the end of the first quarter.
Regulators prefer to sell failed banks to healthy banks, which are best equipped to operate them. An FDIC spokesman declined to comment on whether banks submitted bids, saying only that the investor group was the highest bidder. But the industry's financial problems increasingly have limited the ranks of banks that are in a position to close such a large deal. Recognizing that reality, federal regulators sought to attract private equity and hedge funds in September by easing restrictions on bank owners, including allowing companies that buy banks to continue investing in other areas, and exempting private investors from some oversight and disclosure requirements.
Regulators said they view private investors as a prime source of needed money. Critics warn that some investors will use federally subsidized banking subsidiaries to finance high-risk investment activities. The last experiment in the early 1990s produced mixed results. IndyMac continues to face demands from Fannie Mae and Freddie Mac that it provide compensation for problematic loans it sold the two companies, but an FDIC spokesman said those negotiations had no impact on the sale of the company. The spokesman, David Barr, said the deal was signed on New Year's Eve, as expected, but the announcement was delayed until today because the buyers could not complete a required escrow deposit before the bank closed.
What I really think about Finance
I have been almost as blunt and direct as I am ignorant so far here at Angrybear, but I would like to be much more frank in this post. The question, roughly, is which innovative financial instruments and trading strategies are socially useful. This is important, because people argue against draconian regulation on the grounds that it will block financial innovation and/or interfere with the trading strategies of legitimate arbitrageurs. My honest opinion is that all recently developed instruments are harmful and that the typical activities of law abiding financial operators destroy value. I don't see any downside risk of excessive regulation basically because I think that, on balance, the allegedly undesirable side effects are desirable.
It should be possible to guess that I don't think that "market liquidity" is a good thing. I use quotes as I would define assets as liquid or illiquid and markets at thick or thin. The issue is whether one can quickly buy or sell a large amount of an asset without causing its price to shift much. I believe (without proof as usual) that assets are liquid when trading volume is high. Thus my question becomes whether high trading volume is a good or a bad thing. A sudden decline in the liquidity of assets can create problems as firms can't unwind leveraged positions without extreme market disruption. If the assets had always been illiquid, those leveraged positions would never exist. I think that would be a good thing.
Now there is a class of arguments that rational investors will take highly leveraged positions to profit from asset miss pricing and that this is socially desirable as they will drive asset prices towards their fundamental values. It is hard find these arguments convincing given the enormous increase in asset price volatility which has accompanied the enormous increase in gross long positions and gross short positions not to mention the huge increase in trading volume. My sense is that the average super smart highly trained trader is driving asset prices away from fundamentals. Thus I think honestly reported legal trading strategies are, on average, worsening the quality of the signals financial markets send to the real economy.
In particular, hedging strategies require constant trading. They are not feasible if there are significant bid ask spreads. The scale of hedged positions is limited if assets aren't perfectly liquid as the hedging trades drive prices against the hedger. So ? There is no huge amount of trading by people who don't follow hedging strategies such that a huge amount of hedged trading is required to balance it. Rather the huge volume consists of roughly equally sophisticated traders, all of whom know how to hedge, taking bets against each other. The cure is the disease.
It doesn't have to be this way. It would be possible for trading volume to be tiny compared to current volume -- the way it was in the 50s. Trading for reasons other than perceived asset misspricing would be very rare. There would be investors who save when young and dissave when old, investors who liquidate financial assets to make downpayments on houses and maybe a tiny bit of investors hedging their labor income risk (has anyone ever met anyone who ever did that ?). Now the most archaic market in which there are specialists who sell for one eighth of a cent more than they pay when they buy would be a tiny tiny problem for life cycle investors. If people aren't trying to beat the market, liquidity barely matters to them.
As noted above, if no one tries to beat the market no one gathers information on, say, firms prospects. That would imply that price earnings ratios of shares would depend on rough guesses. That wouldn't be strong form efficient. I don't think any sensible person can look at the history of asset prices and doubt that the old market in the 50s was closer to a strong form efficiency.
Who Saw The Housing Bubble Coming?
The current economic crisis is raising many legitimate questions about the failure of economists and financial analysts to foresee the housing bubble and warn of its collapse. There were, in fact, many warnings dating back more than seven years--but in the euphoria of rising home prices, no one listened. As time went by and no crash occurred, many of those doing the warning lost credibility or decided that perhaps they were wrong and moved on to other issues. I first created a folder on the housing bubble back in 2001 and began collecting material on the subject. The very first piece I filed was an article from a September 2001 issue of Forbes called "What If Housing Crashed?" by Stephane Fitch and Brandon Copple. Read today, the article was remarkably prescient.
Federal Reserve Chairman Alan Greenspan first addressed the question of a housing bubble in testimony before the Joint Economic Committee on April 17, 2002. He dismissed the idea--or, for that matter, any comparison to the stock market, which had recently gone through a high-tech bubble--on the grounds that housing was different because of substantial transaction costs and more limited opportunities for speculation. Greenspan also argued that there really wasn't a single national market for housing, but rather a collection of many local markets. Even if a bubble emerged in one market, he said, there was no reason to think it would spill over into other markets. In June 2002, I filed a report by economist Ed Leamer of UCLA noting that the ratio of home prices to rent was rising rapidly and that this represented a kind of price to earnings ratio for the housing market.
Like the stock market's P/E ratio, when it rises rapidly above historical norms in a short period of time, it's is a good sign that there is a bubble--and that it could burst quickly. But in March 2003, Greenspan continued to deny the possibility of a housing bubble. In a speech to the Independent Community Bankers of America he said that any comparison between the housing market and a stock market bubble was "rather a large stretch." Greenspan repeated his view that one could not generalize about the national housing market from other possible bubbles in a few isolated markets. He went on to argue that there was no evidence of excess supply in newly constructed homes and that the rate of housing starts was consistent with the growth of incomes and population.
Despite Greenspan's assurances that there was nothing alarming, it was apparent that a number of local markets, especially in California, were experiencing bubble-like conditions, with prices rising to clearly unsustainable levels. UCLA's Leamer proclaimed that a bubble definitely existed in the Los Angeles and San Francisco real estate markets in a June 2, 2003 report. In September, economists Karl Case and Robert Shiller presented a very detailed analysis of the housing market to the Brookings Institution's panel on economic activity. While conceding that economic fundamentals were favorable to rising home prices, they also noted that there were elements of bubble psychology in the housing market. Case and Shiller pointed to an increase in the buying of real estate for investment purposes and high expectations of housing price increases.
They also observed an increasing sense of urgency and opportunity among home buyers, who were plunging into real estate for fear of being left behind as they perceived their friends and neighbors growing richer--classic signs of a bubble. By 2004, concerns about a housing bubble were pervasive throughout the popular media. But responsible authorities continued to throw cold water on them. For example, in February, the Federal Deposit Insurance Corporation denied the existence of a housing bubble. It noted that there had not been a decline in national housing prices since the Great Depression. Advances in the structure of mortgage finance since that time, the FDIC concluded, made any repeat very unlikely. The first report I have pointing to the potentially disastrous effects of a collapse in housing on financial institutions came from economist Paul Kasriel of Northern Trust on July 30, 2004. He noted that 60% of banks' earning assets were mortgage-related--twice as much as was the case in 1986.
If the housing market were to go bust, Kasriel warned, the banking system would suffer significant damage. And since the banking system is the transmission mechanism between the Fed and the economy, any serious downturn in that sector could make monetary policy impotent, thus pulling down the entire economy. That same day, however, I received a report from Bear Stearns economist David Malpass arguing that the housing market was healthy and that much of the rise in prices simply represented a "catch-up" because they had lagged behind the rise in equity prices since the mid-1990s. The Bear Stearns report also noted that rising household formations, declining unemployment, low interest rates, a decline in the inventory of unsold homes and the 1997 cut in capital gains taxes on owner-occupied homes as other reasons for its continued optimism.
In September, the International Monetary Fund called attention to the highly synchronized movements in housing prices internationally in its World Economic Outlook. This suggested that there was greater liquidity in the housing finance market than others had generally assumed. The IMF further noted that interest rates were unusually low and bound to rise at some point as central banks necessarily tightened monetary policy to fend off inflation. Indeed, the interest rate increases that had already occurred in 2004 were expected to sharply reduce the growth of housing prices in 2005, the IMF predicted. But in October, Greenspan was still saying that the housing market was nothing to be concerned about. In a speech to America's Community Bankers, he pointed out that the vast majority of homeowners lived in their own homes--so if they sold one, they would have to buy another.
Consequently, there was little possibility of a general downturn in housing prices. While Greenspan acknowledged that there had been some increase in home buying for investment purposes, this represented only a small portion of the overall housing market. And while there was evidence of a rise in debt service ratios, he nevertheless saw household balance sheets as being in good shape. Greenspan's view was shared by economists at the Federal Reserve Bank of New York. In December, they directly addressed the housing bubble question. Their report's bottom line? There was no bubble; housing prices were rising due to positive fundamentals and not from expectations of rapid price appreciation. And even if fundamentals turned negative, there was little likelihood that prices would drop significantly.
I published my first column on the housing bubble on Dec. 15, 2004. In hindsight, I see that I was overly impressed by the views of Alan Greenspan and the New York Fed. But I did raise red flags about loans becoming too easy, the decline in down payments and the spread of adjustable rate mortgages. I concluded it would be "unwise to buy a house in the expectation of future price increases like those we have seen." I advised every homeowner to get out of adjustable-rate mortgages and into a fixed-rate mortgage as soon as possible. I'm ending my discussion of this issue in 2004, but throughout the years since, a number of analysts have emerged on both sides of the housing bubble question. So I do not claim to be comprehensive in my review. I just wanted to call attention to a few of the more prominent analyses that crossed my desk when the housing bubble first caught my attention.
There were many economists who did see it coming, but there were many others of equal or greater prominence and authority who repeatedly insisted that there was nothing to worry about. Under the circumstances, ordinary investors can hardly be faulted for taking actions that unwittingly fueled the bubble and are now having disastrous consequences for themselves and the nation. Unfortunately, it is in the nature of economic and financial forecasting that being right too soon is insignificantly different from just being wrong. And forecasters that are wrong when most of their community is also wrong never suffer for it. The trick is to be right just a little bit sooner than everyone else--but only a little bit.
Blame Television for the Bubble
So now we know what happens when too many people who have too few assets buy too much house with the help of too many risky mortgage products and too little oversight. And while there's plenty of blame to go around -- unethical mortgage brokers, greedy bankers and irresponsible homeowners -- one culprit continues to get off scot-free: HGTV. That's right. The cable network HGTV is the real villain of the economic meltdown. As the viewership reached a critical mass over the past decade -- HGTV is now broadcast into 91 million homes -- homeowners began experiencing deep angst. Suddenly no one but the most slovenly and unambitious were satisfied with their houses. It didn't matter if you lived in an apartment or a gated community, one episode of "House Hunters" or "What's My House Worth?" and you were convinced you needed more. More square feet. More granite. More stainless steel appliances. More landscaping. More media rooms. More style. You deserved it.
If you had any doubts about your ability to afford such luxuries, all you had to do was look at the 20-something couple in the latest episode choosing between three houses. Should they go for the fixer-upper, priced at $425,000? Or the one with the pool for $550,000? What about the one with room to grow for $675,000? "How much money can these people possibly make?" I shout at my wife before wrestling the remote from her house-hungry little hand and switching it to the nearest sports program. "The guy can barely string together two sentences!" And yet on episode after episode for this entire irrational decade, HGTV pumped up the housing bubble by parading the most mediocre, unworthy-looking homeowners into our living rooms to watch while they put their tacky, run-of-the-mill tract homes on the market for twice what they paid and then went out and bought houses with price tags too obscene to repeat. You couldn't watch these shows without concluding that you must be an idiot and a loser if you lived in a house you could actually afford.
HGTV is an evil empire that never rests. You can loathe your current domicile 24/7 with programs such as "Stagers" (move a few things around and double the value of your home); "Designed to Sell" (you can sell your house, even if the house next to yours is in foreclosure); "Design on a Dime" (see, it's cheap); and "Property Virgins" (losing your virginity was fun, wasn't it?) Every show features highly attractive hosts who show you how to "unlock the hidden potential" in your home, how to turn a $10 thrift-store table into a "wow" media center, and how to make everything "pop." Pop is the word of choice on HGTV. Ironic, isn't it, given the fact that pop is the sound we keep hearing from the McMansion-sized housing bubble HGTV created.
Ilargi: Nice analysis. I find the conclusion a tad puzzling in its motivation, but still.
December's JPMorgan Global PMI Shows Just How Far The Infection Has Spread
Well, here's the chart I think everyone really need to see (below). The JPMorgan Global Manufacturing PMI hit 33.2 in December, a series record. More to the point you can get a comparison between what is happening now and the 2001 "recession lite" with only a swift glance, and, of course, the 2009 long recession is only just getting started.
Now let's stick it alongside the one Paul Krugman put up last week of the US Great Depression:
Arguably, what we can see here is that the current collapse in industrial activity is starting to get near the US historic one in terms of proportions, but we still aren't quite there yet. What we could note that JP Morgan in their monthly report suggest that the present rates of output are equivalent to an annual fall of between 12% and 15%. Really to compare with the fall in the US we need to get up into the 20% region, but remember the global index is based on an average for 26 countries, and some of these are much worse than others (Japan, Spain, possibly Russia) and will already be around the 20% annual contraction rate in December. The point is also that the situation is still deteriorating, so hang on a bit, since it is not at all excluded that we will hit a 20% annualised contraction rate for the whole aggregate 26 sometime during the first quarter."The second half of 2008 has been dreadful for global manufacturing and the sector enters the new year mired in its deepest recession for decades. Manufacturing will therefore continue to weigh on world GDP figures, with December PMI data consistent with a drop in global IP of around 12%-15% saar as indexes for output, new orders and employment slumped to record lows.The weakest performance was registered by Japan, whose output and new orders indexes fell to levels unprecedented in the histories of any of the national manufacturing surveys included in the global manufacturing PMI. Employment fell for the fifth successive month in December, and to the greatest extent in survey history. All of the national manufacturing sectors recorded a drop in staffing levels, most at series-record rates including all of the Eurozone nations, China and the UK. The sharpest falls in employment were signalled for Denmark, Spain, the US, Russia and the UK."And watch out for the deflation backslap:"The Global Manufacturing Input Prices Index posted 31.3, its lowest ever reading. The rate of deflation was especially marked in the US, were purchase prices fell to the greatest extent since June 1949. Rates of decrease in costs hit series records in the Eurozone, Russia, Switzerland, the Czech Republic and Denmark."And for those of you who are still sceptical that any of this has any validity, here's a PMI/GDP comparison chart for Japan - GDP rates to the left, diffusion index PMI readings to the right (click over image if you can't view too well). Not perfect, but not a bad guide I would say, if you like your football live, that is.
So never mind the depth, what about the duration? Well that is where I think that all of this will differ from what happened back then. As you can see in the US Great Depression Chart the 20% annual decrease went on for several years. At the present time I think there is no reason to assume that this will happen, ie that we will keep getting massive year on year contractions (in some cases maybe, Latvia perhaps?????), but activity does look set to fall to quite a low level, and there is no strong reason at present for believing it will simply bounce back up again. More than likely we will simply trawl the bottom, at least for some months, and who knows, maybe a couple of years.Well that's it for the big picture stuff, but I have actually been pretty hard at it all day down at the individual country level, so there is plenty more detail to come. In forthcoming posts.
If this is like 1932, there will be hope as well as pain
Everyone became an expert on the deeper reaches of financial history last year. With almost any relationship on which market traders had come to rely in the past three decades breaking down, they had to delve deeper for precedents. Early in the year, we were looking at the Long-Term Capital Management disaster of 1998 and the savings and loan scandal of the early 1990s. Once it became obvious that the new crisis was deeper than these and oil prices started to surge, comparisons with 1973 and 1974 grew fashionable. Now the oil price has dropped by more than $100 a barrel and we fear the first great deflation since the Depression, attention has turned to the 1930s. Some have disinterred long-forgotten incidents such as the panic of 1907 (which led to the creation of the Federal Reserve), or the panic of 1873, which followed a boom in investing in railroads.
No historical parallel can be perfect. But perhaps two years offer the best point of reference. What if last year was 1931? If so, this year could be 1932. In some ways this is good news. It was when the US stock market finally began its recovery. At one point the Dow Jones Industrial Average more than doubled in barely two months. But it still saw equity indices end the year worth less than when they had started. Intriguingly this is almost exactly in line with the apparently self-contradictory consensus of wisdom about the stock market this year: that it has not yet hit bottom but should do so this year and that at some point there will be an explosive rally. There are differences. The bear market was already more than a year old when 1931 started, while 2008 started only shortly after equities had reached a final peak. And the point in the political cycle was different, as President Franklin Roosevelt was not elected until November 1932, some months after the stock market bottom. Policymakers took far longer to embrace monetary or fiscal easing.
But in the markets, 2008 looks a lot like 1931. It was the worst year of the 1930s for stock markets, with the S&P 500 falling 47 per cent, driven by fears for the banking system and by seismic shifts in foreign exchange rates. As 1931 turned to 1932, the extra spread that investors required to buy the bonds of investment-grade companies, rather than US Treasury bonds, reached an all-time high – closely approached in the past few weeks. Then, as now, the Fed was about to buy back Treasury bonds, in a bid to push up their prices and push down their yields – a drastic way to lower interest rates payable in the broader economy, now known as "quantitative easing". So 1931 is a better comparison for the year just gone than most.
A look at how 1932 unfolded shows how the conventional wisdom about 2009 may yet come true. The year started with a rally as optimism took hold that the financial sector’s problems were over. That took the S&P 500 up almost 20 per cent by early March. Compare this with the current rally since the rescue of Citigroup in November. But in spring 1932 gold started flowing out of the US, as foreign investors were convinced the dollar would be devalued, and this sparked a devastating sell-off in US stocks. By midsummer (at what turned out to be the bottom of the bear market), the S&P was down 50 per cent from its high for the year. For 2009, a renewed run on the dollar is quite conceivable. Another fear is that investors grasp the scale of the damage to corporate profits only in the next few weeks, and this sparks another sell-off. Brokers’ forecasts suggest the scope for serious disappointment is real – and conceivably even enough to drive a sell-off like the one of early 1932.
In July 1932, optimism suddenly took hold that the economy was improving. This, according to Russell Napier’s definitive book Anatomy of the Bear, was based largely on evidence that deflation was coming to an end. The result: stocks gained 111 per cent in two months. Then in September they staged another sell-off as it became clear the economy was not out of the woods, and fell 25 per cent from there to the end of the year. Overall the index was down almost 15 per cent for the year but it never went back to its July 1932 lows. How could this be repeated in 2009? An explosive rally at some point is possible, simply because record amounts of money are sitting in bonds and cash. And, as in 1932, what might move that money in a hurry would be a clear sign that inflation was returning. At present the risk is deflation and governments are actively trying to engineer a return to inflation: if that were to happen, bonds and cash would become horrible assets to be in, and so the chance of a race at the first sign of inflationary pressure is real.
As in 1932, when economic hope proved illusory, it is possible that could be a false alarm. But in these conditions, even a false alarm could spark a big rally. As for fundamental valuations, long-run indicators that have signalled market turning-points most successfully in the past, such as the multiple of stocks to long-term average earnings, suggest stocks are fairly valued, whereas they already looked cheap in early 1932. A drastic sell-off like the one in early 1932 would help address this. The precondition for a sustainable rally is that share prices fall to a level where investors are widely convinced they are cheap. As 1932 demonstrated, getting there could yet involve a lot more pain. But it is fair to hope that we get there this year.
Credit Card Companies Willing to Deal Over Debt
Hard times are usually good times for debt collectors, who make their money morning and night with the incessant ring of a phone. But in this recession, perhaps the deepest in decades, the unthinkable is happening: collectors, who usually do the squeezing, are getting squeezed a bit themselves. After helping to foster the explosive growth of consumer debt in recent years, credit card companies are realizing that some hard-pressed Americans will not be able to pay their bills as the economy deteriorates.
So lenders and their collectors are rushing to round up what money they can before things get worse, even if that means forgiving part of some borrowers’ debts. Increasingly, they are stretching out payments and accepting dimes, if not pennies, on the dollar as payment in full. "You can’t squeeze blood out of a turnip," said Don Siler, the chief marketing officer at MRS Associates, a big collection company that works with seven of the 10 largest credit card companies. "The big settlements just aren’t there anymore." Lenders are not being charitable. They are simply trying to protect themselves.
Banks and card companies are bracing for a wave of defaults on credit card debt in early 2009, and they are vying with each other to get paid first. Besides, the sooner people get their financial houses in order, the sooner they can start borrowing again. So even as many banks cut consumers’ credit lines, raise card fees and generally pull back on lending, some lenders are trying to give customers a little wiggle room. Bank of America, for instance, says it has waived late fees, lowered interest charges and, in some cases, reduced loan balances for more than 700,000 credit card holders in 2008.
American Express and Chase Card Services say they are taking similar actions as more customers fall behind on their bills. Every major credit card lender is giving its collection agents more leeway to make adjustments for consumers in financial distress. Debt collectors, who are typically paid based on the amount of money they recover, report that the number of troubled borrowers getting payment extensions has at least doubled in the last six months. In other cases, borrowers who appear to be pushed to the brink are being offered deals that forgive 20 to 70 percent of credit card debt.
"Consumers have never been in a better position to negotiate a partial payment," said Robert D. Manning, the author of "Credit Card Nation" and a longtime critic of the credit card industry. "It’s like that old movie ‘Rosalie Goes Shopping.’ When it’s $100,000 of debt, it’s your problem. When it’s a million dollars of debt, it’s the bank’s problem." The recent wave of debt concessions is a reversal from only a few years ago, when consumers usually lost battles with their credit card companies. Now, as bad debts soar, it is the lenders who are crying mercy.
Credit card lenders expect to write off an unprecedented $395 billion of soured loans over the next five years, according to projections from The Nilson Report, an industry newsletter. That compares with a total of about $275 billion in the last five years. All that bad debt is getting harder to collect. In the past, troubled borrowers might have been able to pay down card loans by tapping the equity in their homes, drawing on retirement savings, taking out a debt consolidation loan, or even calling a relative for help. But with credit tight, consumers are maxed out.
"Knowing that the sources of funding have dried up, having someone pay the balance in full isn’t a viable strategy," said Tim Smith, a senior executive at Firstsource, one of the biggest debt collection companies. Lenders are reluctant to admit they will accept less than full payment, lest they encourage good customers to stop paying what they can. Industrywide data is scarce. Unlike the huge mortgage loan modification programs that are taking place, which address thousands of mortgages at once, workouts for credit card customers are still being handled on a case-by-case basis.
In addition to debt forgiveness, debt collectors are allowing many delinquent borrowers to pay down their debt over the course of a year rather than the standard six months. Paul Hunziker, the chairman of Capital Management Services, said that before this downturn, his firm put only about a quarter of all borrowers into longer-term repayment plans. Now, it puts about half on such plans. Some lenders are also reaching out to borrowers shortly after they fall behind on their payments to try to avoid having to write off the account. Others are reaching out to customers who seem likely to fall behind. Just as lenders competed for years to be the first card to be taken out of the wallet, they are now competing to be the first ones paid back.
And realizing that millions more consumers are likely to default on their credit card bills in the coming months, the banking industry has started lobbying regulators to make it more advantageous to lenders to extend payment terms or forgive debt. In an unusual alliance, the Financial Services Roundtable, one of the industry’s biggest lobbyists, and the Consumer Federation of America recently proposed a credit card loan modification program, which was rejected by regulators. Under the plan, lenders would have forgiven about 40 percent of what was owed by individual borrowers over five years. Lenders could report the loss once whatever part of the debt was repaid, instead of shortly after default, as current accounting rules require. That would allow them to write off less later. Borrowers would have been allowed to defer any tax payments owed on the forgiven debt.
Landmark changes to bankruptcy legislation passed in 2005, for which the industry aggressively lobbied, seem to have hurt card debt collections. Credit card industry data indicate the average debt discharged in Chapter 7 bankruptcy has nearly tripled since 2004. And in Chapter 13 bankruptcies, secured lenders like auto finance companies routinely elbow out unsecured lenders like card companies, trends that have contributed to the card lenders’ willingness to settle. Borrowers should not expect sweetheart deals. Card companies will offer loan modifications only to people who meet certain criteria. Most customers must be delinquent for 90 days or longer. Other considerations include the borrower’s income, existing bank relationships and a credit record that suggests missing a payment is an exception rather than the rule.
While a deal may help avoid credit card cancellation or bankruptcy, it will also lead to a sharp drop in the borrower’s credit score for as long as seven years, making it far more difficult and expensive to obtain new loans. The average consumer’s score will fall 70 to 130 points, on a scale where the strongest borrowers register 700 or more. For the moment, it may be easier for troubled borrowers to start negotiating a modification by contacting the card company or collection agency directly. Credit counselors can help borrowers consolidate their debts and get card companies to lower their interest payments and other fees, but they currently cannot get the loan principal reduced. Another option is for a borrower to sign up a debt settlement company to negotiate on her behalf. But regulation of this business is loose, and consumer advocacy groups warn that some firms prey on troubled borrowers with aggressive marketing tactics and exorbitant upfront fees.
U.S. gas tax needs hike, overhaul: commission
U.S. drivers need to pay more gas taxes and new user fees to fix crumbling roads and bridges and ease congested highways, a transportation commission is set to recommend to Congress later this month. U.S. gasoline taxes should be raised 10 cents a gallon to help fund improvements, at least until new systems are created to charge drivers for how much they use roads, according to a draft copy of recommendations from the National Surface Transportation Infrastructure Financing Commission.
"We've basically had a 30-year experiment in this country in under-investing in surface transportation infrastructure," said Robert Atkinson, president of the Information Technology and Innovation Foundation and chairman of the commission. Atkinson said the gasoline tax hike combined with more aggressive use of tolls and "congestion pricing" would help cover those costs. Some estimates say federal, state and local governments would need to spend about $80 billion per year more than current levels to begin to reduce congestion, improve roads, and expand transit, Atkinson said.
The commission will recommend that Congress implement the gas tax hike, a 15-cent increase in the federal diesel tax, as well as tax increases for other fuels as short-term measures to raise nearly $20 billion more each year than is currently collected, the draft report said. The Highway Trust Fund, the federal government's primary source for transportation infrastructure, is mostly funded through federal gasoline taxes. The Surface Transportation Act, which includes the fund, is due for reauthorization by Congress this year.
Record high fuel prices and an economic slowdown caused sharp declines in driving by Americans in fiscal 2008, lowering the revenue collected for the fund, but federal highway spending rose $2 billion. The Highway Trust Fund took in $31 billion between October 2007 and September 2008, $3 billion less than the prior year. As vehicles become more fuel-efficient, Americans will be able to drive more miles as they pay less in fuel taxes, making a highway maintenance system that depends on gasoline taxes unsustainable, said Adrian Moore, vice president at the Reason Foundation and a member of the commission. Moore does not support raising fuel taxes, but said it is the only tool Congress can immediately implement.
"The gas tax is broken, so any increase in gas tax is just a Band-Aid. It gets you through a very short term. It doesn't even remotely solve the problem," Moore said. Moore and Atkinson said America must shift to a system whereby Americans pay for the number of miles they drive instead of being taxed per gallon of gasoline. Under such a system people would pay more for driving in some areas such as heavily congested freeways and less in areas such as rural highways. Americans pay an 18.4 cent federal tax on each gallon of gasoline they buy, plus an extra 29 cents on average in combined state and local taxes.
Ilargi: Ever wonder why so many "experts" get it so wrong? Here’s a few great one-liners:
"They base their forecasts on computer models that tend to see the American economy as basically sound, even in the worst of times."
“Most of our models are structured in a way that the economy is self-righting,”
Still, I had thought higher of Robert Shiller than this silly out of left fielder:
There is a psychological factor that Robert Shiller, a Yale economist, hopes will come into play. “If we have massive infrastructure spending and people feel that it is working, it could create a sense that we are O.K. and people will go back to normal,” he said. “The real problem is that we are on hold. Everyone is.”No, Robert, the real problem lies somewhere else altogether. Your own housing index can tell you that. maybe you need someone to give you a proper definition of "normal". See, you say housing prices are down well over 25%. But which then is the "normal" price, the higher or the lower one? Or the even lower one we will see this year? By normal, do you mean getting back to the higher prices?
Because if you don’t, the next question automatically pops up. You yourself report that US homeowners have lost trillions of dollars in what they mistook for value in their abodes. Do you mean to say that they'll get it all back? If not, how can they get back to normal, right? If we turn this around and assume you mean the lower prices are the norm(al) ones, you're looking at a nation that's just lost $10 trillion in one year, and is still in debt for much more. These people, then, are not "OK", and you can't create the "sense" that they are. What you CAN create, you and all the other "experts", is a false sense of being OK, one that will drag people deeper in debt. I sometimes wonder how you guys sleep at night.
Some Forecasters See a Fast Economic Recovery
Economics as the dismal science? Not in some quarters. In the midst of the deepest recession in the experience of most Americans, many professional forecasters are optimistically heading into the new year declaring that the worst may soon be over. For this rosy picture to play out, they are counting on the Obama administration and Congress to come through with a substantial stimulus package, at least $675 billion over two years. They say that will get the economy moving again in the face of persistently weak spending by consumers and businesses, not to mention banks that are reluctant to extend credit.
If the dominoes fall the right way, the economy should bottom out and start growing again in small steps by July, according to the December survey of 50 professional forecasters by Blue Chip Economic Indicators. Investors seemed to be in a similarly optimistic mood on Friday, bidding up stocks by about 3 percent. But in the absence of that government stimulus, the grim economic headlines of 2008 will probably continue for some time, these forecasters acknowledge. “Without this federal largess, the consensus forecast for 2009 is for the recession to continue through most of the year,” said Randell E. Moore, executive editor of Blue Chip Economic Indicators, which conducts the monthly survey of forecasters.
Many economists are more pessimistic, of course. Nouriel Roubini at New York University, who called the 2008 market disaster correctly, wrote in a recent commentary on Bloomberg News that he foresees “a deep and protracted contraction lasting at least through the end of 2009.” Even in 2010, he added, the recovery may be so weak “that it will feel terrible even if the recession is technically over.” But Mr. Roubini is not among the economists surveyed by Blue Chip Economic Indicators. These professional forecasters are typically employed by investment banks, trade associations and big corporations. They base their forecasts on computer models that tend to see the American economy as basically sound, even in the worst of times. That makes these forecasters generally a more optimistic lot than the likes of Mr. Roubini.
Their credibility suffered for it last year. They did not see a recession until late summer. One reason they were blindsided: their computer models do not easily account for emotional factors like the shock from the credit crisis and falling housing prices that have so hindered borrowing and spending. Those models also take as a given that the natural state of a market economy like America’s is a high level of economic activity, and that it will rebound almost reflexively to that high level from a recession. But that assumes that banks and other lenders are not holding back on loans, as they are today, depriving the nation of the credit necessary for a vigorous economy.
“Most of our models are structured in a way that the economy is self-righting,” said Nigel Gault, chief domestic economist for IHS Global Insight, a consulting and forecasting firm in Lexington, Mass. Even if the economy begins to right itself by this summer, the recession would still be the longest since the 1930s, which was the last time the government engaged in widespread public spending to overcome the persistent inertia in consumer and business spending. “The consensus says we are in the deepest part of the recession now,” Mr. Moore said. “But the stimulus package and much lower gasoline prices are expected to somewhat restore consumer confidence and personal spending and that will put us on the road back.”
There is a psychological factor that Robert Shiller, a Yale economist, hopes will come into play. “If we have massive infrastructure spending and people feel that it is working, it could create a sense that we are O.K. and people will go back to normal,” he said. “The real problem is that we are on hold. Everyone is.” The expectation of most forecasters, several report, is that most of the Obama administration’s stimulus will go for public works projects and tax cuts. With this sort of stimulus, the gross domestic product, the chief measure of the nation’s output, should begin to rise — if not in the third quarter, then certainly in the fourth, the forecasters say, and the unemployment rate will finally peak at 8 to 9 percent by early next year.
“The job insecurity is very serious; that is the worst aspect of all this,” said Albert Wojnilower, a consulting forecaster at Craig Drill Capital. “But most upturns in the economy have begun with upturns in consumption, when people who still have jobs stop worrying about losing them.” Like other forecasters, Mr. Wojnilower expects the just-ended fourth quarter to be the recession’s worst, with the G.D.P. having contracted at a 4 or 5 or even 6 percent annual rate. Also like the others, he expects the economy to be growing again by the end of the year, although at an annual rate of 1 percent or less, which feels like a recession and is not enough to generate new jobs.
But the economy will no longer be contracting, and the recession that started in December 2007 will end at 18 or 21 months of age. The previous record holders, severe recessions in the mid-1970s and early 1980s, each lasted 16 months. “I think that consumers are certainly in a state of shock right now, but their behavior is fundamentally rational,” said Martin Regalia, chief economist at the United States Chamber of Commerce. “They want to work, they want to make money and they want to spend that money. Above all they are resilient. They lick their wounds and with some help from government, they start back again and we come out of this quickly.”
A key to the revival, in every forecast, is home construction and home prices. The latter are still falling, at an even faster pace, adjusted for inflation, than in the Great Depression, according to the S.& P./Case-Shiller Home Price Indices. That has the knock-on effect of multiplying foreclosures and trapping millions of people in homes that are worth less than their outstanding mortgages. Such circumstances inevitably depress spending and business investment. But housing will probably bottom out by spring, many forecasters now argue. The Federal Reserve will play a role in making this happen by buying mortgage-backed securities and, in doing so, lowering the rate on 30-year mortgages to less than 5 percent, which is roughly the present level. That will encourage not only home buying, but also refinancing.
“In the midst of recession, with very sour moods, housing activity begins to improve because we get a big decline in mortgage rates,” said Robert Barbera, chief economist for ITT Investment Technology Group. Then, too, the basic demographic demand for new homes, the forecasters say, is 1.7 million units a year. That many are not being built today, but with inventories shrinking and prices stabilizing, home construction will revive, many forecasters argue, contributing once again to economic growth. “It is not fun to be a portent of doom,” Mr. Barbera said. “And even now in these doomlike times, we in the forecasting profession say it won’t last.”
Madoff Accepted $10 Million From New York Investor Six Days Before Arrest
Just six days before he was charged with running a $50 billion Ponzi scheme, Bernard Madoff allegedly agreed to invest $10 million for a family that had turned an ice delivery business into one of the largest independent heating oil distributors in New York City. Rosenman Family LLC, managed by Martin Rosenman, president of Bronx-based Stuyvesant Fuel Service Corp., sued Irving Picard, the trustee appointed to supervise the unwinding of Madoff’s business. He is seeking a ruling that Picard has no claim to the $10 million. Rosenman, who hadn’t previously invested with Bernard L. Madoff Investment Securities LLC, said he spoke by phone with Madoff Dec. 3 about investing the money, according to a complaint filed Jan. 1 in bankruptcy court in Manhattan.
"Madoff stated that the fund was closed until Jan. 1, 2009, but that Mr. Rosenman could wire money" before that date into a Madoff account, "where it would be held until the fund opened after the new year," according to the complaint. Rosenman’s lawyers said Madoff was recommended as "safe and reliable." Madoff’s firm collapsed last month after he told his sons it was a fraud, according to a criminal complaint by the FBI. The firm is liquidating under the Securities Investor Protection Corp., whose funds cover securities and cash claims of as much as $500,000 per customer, including as much as $100,000 in cash.
Stuyvesant, acquired by Hess Corp. last year, was launched in 1934 by Rosenman’s grandfather as an ice delivery firm and evolved into a coal supplier. The company owns a 22-million gallon deep-water oil terminal in the Bronx and a natural gas business called Stuyvesant Energy. Unlike the midtown Manhattan skyscraper housing Madoff Securities, Stuyvesant’s headquarters on Southern Boulevard in the Bronx is located among a mixture of bleak apartment blocks, delis and storefront churches. A two-story, brick building painted red with no windows, Stuyvesant takes up a third of a city block and is situated between the Cathedral of Deliverance and the Citizens Advice Bureau.
In his lawsuit, Rosenman said he received a fax from Madoff Securities employee Jodi Crupi on Dec. 5 instructing him to transfer the $10 million to a JPMorgan Chase & Co. account, which he did. Four days later, Rosenman received a confirmation from Madoff Securities telling him he’d sold short $10 million in U.S. Treasury bills, a transaction he "never authorized," according to the court filing. "The confirmation contains a CUSIP number (an identification number) for the transaction," Rosenman said in his complaint. "Multiple electronic searches for securities under this number have shown that it does not exist. In other words, BMIS never transacted a trade of U.S. Treasury Bills," on Rosenman’s behalf, according to the suit.
Rosenman declined to comment, said attorney David Yeger of New York-based Wachtel & Masyr. Messages left at his homes in Great Neck, New York, and Palm Beach Gardens, Florida, weren’t returned. Crupi didn’t return a call seeking comment. The day after Rosenman allegedly received the trade confirmation, Madoff revealed the fraud to his sons, saying no more than $300 million was left in his accounts, according to the FBI. The next day, Madoff, 70, was arrested and charged by federal prosecutors with one count of securities fraud. He faces as much as 10 years in prison and a $5 million fine if convicted.
"Like many of the victims, word spread through the community that investments with the Madoff firm were safe and reliable," Howard Kleinhendler, another lawyer for Rosenman, told Bloomberg Television. "Madoff was planning on distributing between $200 million and $300 million to his friends, family and loyal" employees, Kleinhelder said. "This was part of the collection process to increase the amount to distribute." The attorney said that "we feel pretty good that our money we wired to Chase bank is still there," adding that $10 million has been set aside by lawyers for the trustee until the claim is resolved. He declined to estimate what percentage of the Rosenman family fortune the funds represented. "It was not their nest egg," he said. "While it is a lot of money, it is not something that will dramatically affect their life."
Picard said the $10 million claimed by Rosenman is property of the firm’s estate, according to court papers. Rosenman Family LLC is seeking an order from U.S. Bankruptcy Judge Burton Lifland requiring New York-based JPMorgan to turn over the funds. Picard, tasked with maximizing assets for the firm, reached a deal with Bank of New York Mellon Corp. to access about $28 million of Madoff Securities’ funds to pay for the liquidation process. On Dec. 31, Picard filed a motion seeking subpoena power to "conduct a broad investigation" of the firm’s property, liabilities and conduct.
Madoff filed a list of his remaining assets with the U.S. Securities and Exchange Commission on Dec. 31, according to the SEC. George Stamboulidis, an attorney at Baker & Hostetler who represents Picard, didn’t return a call seeking comment. JPMorgan spokesman Joseph Evangelisti and Ira Sorkin, Madoff’s personal defense attorney, declined to comment. Picard will mail claim forms to customers and creditors of Madoff Securities by Jan. 9, the SIPC has said. Madoff’s firm was the 23rd-largest market maker on Nasdaq in October, handling an average of about 50 million shares a day, according to exchange data. It took orders from online brokers for some of the largest U.S. companies, including General Electric Co. and Citigroup Inc.
Madoff, who hasn’t formally responded to the securities fraud charge, is due in court Jan. 12, unless he is indicted before then. Prosecutors and defense lawyers may also agree to postpone the court date. Sorkin has said previously Madoff’s company is cooperating with the government. Jon Pepper, a spokesman for New York-based Hess Corp., the fifth-biggest U.S. oil producer, said his company purchased Stuyvesant last summer. "Stuyvesant was a good fit for our energy marketing business, which sells fuel oil, gas and electricity to commercial and industrial customers in the eastern U.S.," Pepper said.
Why We Keep Falling for Financial Scams
Intelligent people have long been ruined by frauds. Psychologist Stephen Greenspan, who specializes in gullibility, explores why investors continue to be swindled -- and how he came to lose part of his savings to Bernard Madoff.
There are few areas where skepticism is more important than how one invests one's life savings. Yet intelligent and educated people, some of them naïve about finance and others quite knowledgeable, have been ruined by schemes that turned out to be highly dubious and quite often fraudulent. The most dramatic example of this in American history is the recent announcement that Bernard Madoff, a highly regarded money manager and a former chairman of Nasdaq, has for years been running a very sophisticated Ponzi scheme, which by his own admission has defrauded wealthy investors, charities and other funds of at least $50 billion. Financial scams are just one of the many forms of human gullibility -- along with war (the Trojan Horse), politics (WMDs in Iraq), relationships (sexual seduction), pathological science (cold fusion) and medical fads.
Although gullibility has long been of interest in works of fiction (Othello, Pinocchio), religious documents (Adam and Eve, Samson) and folk tales ("The Emperor's New Clothes," "Little Red Riding Hood"), it has been almost completely ignored by social scientists. A few books have focused on narrow aspects of gullibility, including Charles Mackey's classic 19th-century book, "Extraordinary Popular Delusion and the Madness of Crowds" -- most notably on investment follies such as Tulipmania, in which rich Dutch people traded their houses for one or two tulip bulbs. In my new book "Annals of Gullibility," based on my academic work in psychology, I propose a multidimensional theory that would explain why so many people behave in a manner that exposes them to severe and predictable risks. This includes myself: After I wrote my book, I lost a good chunk of my retirement savings to Mr. Madoff, so I know of what I write on the most personal level.
A Ponzi scheme is a fraud in which invested money is pocketed by the schemer and investors who wish to redeem their money are actually paid out of proceeds from new investors. As long as new investments are expanding at a healthy rate, the schemer is able to keep the fraud going. Once investments begin to contract, as through a run on the company, the house of cards quickly collapses. That is what apparently happened with the Madoff scam, when too many investors -- needing cash because of the general U.S. financial meltdown in late 2008 -- tried to redeem their funds. It seems Mr. Madoff could not meet these demands and the scam was exposed.
The scheme gets its name from Charles Ponzi, an Italian immigrant to Boston, who around 1920 came up with the idea of promising huge returns (50% in 45 days) supposedly based on an arbitrage plan (buying in one market and selling in another) involving international postal reply coupons. The profits allegedly came from differences in exchange rates between the selling and the receiving country, where they could be cashed in. A craze ensued, and Ponzi pocketed many millions of dollars, mostly from poor and unsophisticated Italian immigrants in New England and New Jersey. The scheme collapsed when newspaper articles began to raise questions about it (pointing out, for example, that there were not nearly enough such coupons in circulation) and a run occurred.
Another large-scale scandal that some have called a Ponzi scheme involved famed insurance market Lloyd's of London. In the 1980s, the company rapidly brought new investors, many from the U.S., into its formerly exclusive market. The attraction to these new investors, aside from the lure of good returns, was the chance to become a "name," a prestigious status which had been mainly limited to British aristocrats. These investors were often lured into the most risky and least productive syndicates, exposing them to huge liability and, in many cases, ruin.
The basic mechanism explaining the success of Ponzi schemes is the tendency of humans to model their actions -- especially when dealing with matters they don't fully understand -- on the behavior of other humans. This mechanism has been termed "irrational exuberance," a phrase often attributed to former Federal Reserve chairman Alan Greenspan (no relation), but actually coined by another economist, Robert J. Shiller, who later wrote a book with that title. Mr. Shiller employs a social psychological explanation that he terms the "feedback loop theory of investor bubbles." Simply stated, the fact that so many people seem to be making big profits on the investment, and telling others about their good fortune, makes the investment seem safe and too good to pass up.
In Mr. Shiller's view, all investment crazes, even ones that are not fraudulent, can be explained by this theory. Two modern examples of that phenomenon are the Japanese real-estate bubble of the 1980s and the American dot-com bubble of the 1990s. Two 18th-century predecessors were the Mississippi Mania in France and the South Sea Bubble in England (so much for the idea of human progress). A form of investment fraud that has structural similarities to a Ponzi scheme is an inheritance scam, in which a purported heir to a huge fortune is asking for a short-term investment in order to clear up some legal difficulties involving the inheritance. In return for this short-term investment, the investor is promised enormous returns. The best-known modern version of this fraud involves use of the Internet, and is known as a "419 scam," so named because that is the penal code number covering the scam in Nigeria, the country from which many of these Internet messages originate. The 419 scam differs from a Ponzi scheme in that there is no social pressure brought by having friends who are getting rich. Instead, the only social pressure comes from an unknown correspondent, who undoubtedly is using an alias. Thus, in a 419 scam, other factors, such as psychopathology or extreme naïvete, likely explain the gullible behavior.
Two historic versions of the inheritance fraud that are equal to the Madoff scandal in their widespread public success, and that relied equally on social feedback processes, occurred in France in the 1880s and 1890s, and in the American Midwest in the 1920s and 1930s. The French scam was perpetrated by a talented French hustler named Thérèse Humbert, who claimed to be the heiress to the fortune of a rich American, Robert Henry Crawford, whose bequest reflected gratitude for her nursing him back to health after he suffered a heart attack on a train. The will had to be locked in a safe for a few years until Ms. Humbert's youngest sister was old enough to marry one of Crawford's nephews. In the meantime, leaders of French society were eager to get in on this deal, and their investments (including by one countess, who donated her chateau) made it possible for Ms. Humbert -- who milked the story for 20 years -- to live in a high style. Success of this fraud, which in France was described as "the greatest scandal of the century," was kept going by the fact that Ms. Humbert's father-in-law, a respected jurist and politician in France's Third Republic, publicly reassured investors.
The American version of the inheritance scam was perpetrated by a former Illinois farm boy named Oscar Hartzell. While Thérèse Humbert's victims were a few dozen extremely wealthy and worldly French aristocrats, Hartzell swindled over 100,000 relatively unworldly farmers and shopkeepers throughout the American heartland. The basic claim was that the English seafarer Sir Francis Drake had died without any children, but that a will had been recently located. The heir to the estate, which was now said to be worth billions, was a Colonel Drexel Drake in London. As the colonel was about to marry his extremely wealthy niece, he wasn't interested in the estate, which needed some adjudication, and turned his interest over to Mr. Hartzell, who now referred to himself as "Baron Buckland."
The Drake scheme became a social movement, known as "the Drakers" (later changed to "the Donators") and whole churches and groups of friends -- some of whom planned to found a utopian commune with the expected proceeds -- would gather to read the latest Hartzell letters from London. Mr. Hartzell was eventually indicted for fraud and brought to trial in Iowa, over great protest by his thousands of loyal investors. In a story about Mr. Hartzell in the New Yorker in 2002, Richard Rayner noted that what "had begun as a speculation had turned into a holy cause."
While social feedback loops are an obvious contributor to understanding the success of Ponzi and other mass financial manias, one also needs to look at factors located in the dupes themselves. There are four factors in my explanatory model, which can be used to understand acts of gullibility, but also other forms of what I term "foolish action." A foolish (or stupid) act is one in which someone goes ahead with a socially or physically risky behavior in spite of danger signs or unresolved questions. Gullibility is a sub-type of foolish action, which might be termed "induced-social." It is induced because it always occurs in the presence of pressure or deception by other people.
The four factors are situation, cognition, personality and emotion. Obviously, individuals differ in the weights affecting any given gullible act. While I believe that all four factors contributed to most decisions to invest in the Madoff scheme, in some cases personality should be given more weight while in other cases emotion should be given more weight, and so on. As mentioned, I was a participant -- and victim -- of the Madoff scam, and have a pretty good understanding of the factors that caused me to behave foolishly. So I shall use myself as a case study to illustrate how even a well-educated (I'm a college professor) and relatively intelligent person, and an expert on gullibility and financial scams to boot, could fall prey to a hustler such as Mr. Madoff.
Situations. Every gullible act occurs when an individual is presented with a social challenge that he has to solve. In the case of a financial decision, the challenge is typically whether to agree to an investment decision that is being presented to you as benign but may pose severe risks or otherwise not be in one's best interest. Assuming (as with the Madoff scam) that the decision to proceed would be a very risky and thus foolish act, a gullible behavior is more likely to occur if the social and other situational pressures are strong. The Madoff scam had social feedback pressures that were very strong, almost rising to the level of the "Donators" cult around the Drake inheritance fraud. Newspaper reports described how wealthy retirees in Florida joined Mr. Madoff's country club for the sole reason of having an opportunity to meet him socially and be invited to invest directly with him. Most of these investors, as well as Mr. Madoff's sales representatives, were Jewish. The fact that Mr. Madoff was a prominent Jewish philanthropist was undoubtedly another situational contributor.
A non-social factor that contributed to a gullible investment decision was, paradoxically, that Mr. Madoff promised modest rather than spectacular gains. Sophisticated investors would have been highly suspicious of a promise of gains as spectacular as those promised decades earlier by Charles Ponzi. A big part of Mr. Madoff's success came from his apparent recognition that wealthy investors were looking for small but steady returns, high enough to be attractive but not so high as to arouse suspicion. This was certainly one of the things that attracted me to the Madoff scheme, as I was looking for a non-volatile investment that would enable me to preserve and gradually build wealth in down as well as up markets.
Another situational factor that pulled me in was the fact that I, along with most Madoff investors (except for the super-rich), did not invest directly with Mr. Madoff, but went through one of 15 "feeder" hedge funds that then turned all of their assets over to Mr. Madoff to manage. In fact, I am not certain if Mr. Madoff's name was even mentioned (and certainly, I would not have recognized it) when I was considering investing in the ($3 billion) "Rye Prime Bond Fund" that was part of the respected Tremont family of funds, which is itself a subsidiary of insurance giant Mass Mutual Life. I was dealing with some very reputable financial firms, a fact that created the strong impression that this investment had been well-researched and posed acceptable risks.
I made the decision to invest in the Rye fund when I was visiting my sister and brother-in-law in Boca Raton, Fla., and met a close friend of theirs who is a financial adviser and was authorized to sign people up to participate in the Rye (Madoff-managed) fund. I genuinely liked and trusted this man, and was persuaded by the fact that he had put all of his own (very substantial) assets in the fund, and had even refinanced his house and placed all of the proceeds in the fund. I later met many friends of my sister who were participating in the fund. The very successful experience they had over a period of several years convinced me that I would be foolish not to take advantage of this opportunity. My belief in the wisdom of this course of action was so strong that when a skeptical (and financially savvy) friend back in Colorado warned me against the investment, I chalked the warning up to his sometime tendency towards knee-jerk cynicism.
Cognition. Gullibility can be considered a form of stupidity, so it is safe to assume that deficiencies in knowledge and/or clear thinking often are implicated in a gullible act. By terming this factor "cognition" rather than "intelligence," I mean to indicate that anyone can have a high IQ and still prove gullible, in any situation. There is a large amount of literature, by scholars such as Michael Shermer and Massimo Piattelli-Palmarini, that show how often people of average and above-average intelligence fail to use their intelligence fully or efficiently when addressing everyday decisions. In his book "Who Is Rational? Studies of Individual Differences in Reasoning," Keith Stanovich makes a distinction between intelligence (the possession of cognitive schemas) and rationality (the actual application of those schemas). The "pump" that drives irrational decisions (many of them gullible), according to Mr. Stanovich, is the use of intuitive, impulsive and non-reflective cognitive styles, often driven by emotion.
In my own case, the decision to invest in the Rye fund reflected both my profound ignorance of finance, and my somewhat lazy unwillingness to remedy that ignorance. To get around my lack of financial knowledge and my lazy cognitive style around finance, I had come up with the heuristic (or mental shorthand) of identifying more financially knowledgeable advisers and trusting in their judgment and recommendations. This heuristic had worked for me in the past and I had no reason to doubt that it would work for me in this case. The real mystery in the Madoff story is not how naïve individual investors such as myself would think the investment safe, but how the risks and warning signs could have been ignored by so many financially knowledgeable people, including the highly compensated executives who ran the various feeder funds that kept the Madoff ship afloat. The partial answer is that Madoff's investment algorithm (along with other aspects of his organization) was a closely guarded secret that was difficult to penetrate, and it's also likely (as in all cases of gullibility) that strong affective and self-deception processes were at work. In other words, they had too good a thing going to entertain the idea that it might all be about to crumble.
Personality. Gullibility is sometimes equated with trust, but the late psychologist Julian Rotter showed that not all highly trusting people are gullible. The key to survival in a world filled with fakers (Mr. Madoff) or unintended misleaders who were themselves gulls (my adviser and the managers of the Rye fund) is to know when to be trusting and when not to be. I happen to be a highly trusting person who also doesn't like to say "no" (such as to a sales person who had given me an hour or two of his time). The need to be a nice guy who always says "yes" is, unfortunately, not usually a good basis for making a decision that could jeopardize one's financial security. In my own case, trust and niceness were also accompanied by an occasional tendency toward risk-taking and impulsive decision-making, personality traits that can also get one in trouble.
Emotion. Emotion enters into virtually every gullible act. In the case of investment in a Ponzi scheme, the emotion that motivates gullible behavior is excitement at the prospect of increasing and protecting one's wealth. In some individuals, this undoubtedly takes the form of greed, but I think that truly greedy individuals would likely not have been interested in the slow but steady returns posted by the Madoff-run funds.
In my case, I was excited not by the prospect of striking it rich but by the prospect of having found an investment that promised me the opportunity to build and maintain enough wealth to have a secure and happy retirement. My sister, a big victim of the scam, put it well when she wrote in an email that "I suppose it was greed on some level. I could have bought CDs or municipal bonds and played it safer for less returns. The problem today is there doesn't seem to be a whole lot one can rely on, so you gravitate toward the thing that in your experience has been the safest. I know somebody who put all his money in Freddie Macs and Fannie Maes. After the fact he said he knew the government would bail them out if anything happened. Lucky or smart? He's a retired securities attorney. I should have followed his lead, but what did I know?"
I suspect that one reason why psychologists and other social scientists have avoided studying gullibility is because it is affected by so many factors, and is so context-dependent that it is impossible to predict whether and under what circumstances a person will behave gullibly. A related problem is that the most catastrophic examples of gullibility (such as losing one's life savings in a scam) are low-frequency behaviors that may only happen once or twice in one's lifetime. While as a rule I tend to be a skeptic about claims that seem too good to be true, the chance to invest in a Madoff-run fund was one case where a host of factors -- situational, cognitive, personality and emotional -- came together to cause me to put my critical faculties on the shelf. Skepticism is generally discussed as protection against beliefs (UFOs) or practices (feng shui) that are irrational but not necessarily harmful. Occasionally, one runs across a situation where skepticism can help you to avoid a disaster as major as losing one's life (being sucked into a crime) or one's life savings (being suckered into a risky investment). Survival in the world requires one to be able to recognize, analyze, and escape from those highly dangerous situations.
So should one feel pity or blame toward those who were insufficiently skeptical about Mr. Madoff and his scheme? A problem here is that the lie perpetrated by Mr. Madoff was not all that obvious or easy to recognize. Virtually 100% of the people who turned their hard-earned money (or charity endowments) over to Mr. Madoff would have had a good laugh if contacted by someone pitching a Nigerian inheritance investment or the chance to buy Florida swampland. Being non-gullible ultimately boils down to an ability to recognize hidden social (or in this case, economic) risks, but some risks are more hidden and, thus, trickier to recognize than others. Very few people possess the knowledge or inclination to perform an in-depth analysis of every investment opportunity they are considering. It is for this reason that we rely on others to help make such decisions, whether it be an adviser we consider competent or the fund managers who are supposed to oversee the investment.
I think it would be too easy to say that a skeptical person would and should have avoided investing in a Madoff fund. The big mistake here was in throwing all caution to the wind, as in the stories of many people (some quite elderly) who invested every last dollar with Mr. Madoff or one of his feeder funds. Such blind faith in one person, or investment scheme, has something of a religious quality to it, not unlike the continued faith that many of the Drakers continued to have in Oscar Hartzell even after the fraudulent nature of his scheme began to become very evident. So the skeptical course of action would have been not to avoid a Madoff investment entirely but to ensure that one maintained a sufficient safety net in the event (however low a probability it might have seemed) that Mr. Madoff turned out to be not the Messiah but Satan. As I avoided drinking a full glass of Madoff Kool-Aid -- I had invested 30% of my retirement savings in the fund -- maybe I'm not as lacking in wisdom as I thought.
Stephen Greenspan is emeritus professor of educational psychology at the University of Connecticut and author of the 2009 "Annals of Gullibility." A longer version of this essay appeared at skeptic.com and will be in Skeptic magazine in early 2009.