Asbury Park, New Jersey, the North End Hotel on the Ocean Grove side of the boardwalk
Ilargi: The bad bank theme will continue for a while longer; it's not 100% clear how much we can read into Charlie Gasparino's assertion that the entire concept is dead in the US, but it would not be surprising, if only because the whole idea is too perverse, a 'quality' that can only be avoided by allowing dead assets to go even deeper into hiding.
But does it all even matter anymore? Any bad or aggregator bank is certain to fail anyway. Isn't it perhaps about time to look at real issues? After all, what would be the difference to you personally between being $8 trillion or $85 trillion in the hole? At most it would constitute a choice between being dirt poor and being really dirt poor, and you're not prepared for either anyway.
On a side note, I see that the whole festive media feel good party about Obama closing Gitmo (which may take years) serves mainly to disguise the fact that the new US government still feels it's got the right to abduct people and send them to nations where torture is not a political problem. Ostensibly, the same reasoning that pushing filth deeper into hiding makes it alright applies here too. The LA Times reports: "Under executive orders issued by Obama recently, the CIA still has authority to carry out what are known as renditions, secret abductions and transfers of prisoners to countries that cooperate with the United States."
I have an answer to this, and it just so happens that it consists of words spoken by Obama this week on a different theme, namely Wall Street banker bonuses:"That is the height of irresponsibility. It is shameful. And part of what we’re going to need is for folks [..] to show some restraint, and show some discipline and show some sense of responsibility."
If you want to resurrect the image of America as the land of the just, the brave and the free, that means renditions and torture, whether by you or your filthy friends, are out. No grey areas. Just out. No more.
Back to the money, or rather the lack thereof. My faithful flock of readers (that reminds me, I was going to start a religion) around the globe will remember that I wrote a few months ago that I have no need for banks as they currently exist, and neither do they, that is, my readers. The only thing we truly need is access to our money. And all our governments have to do is guarantee that access, a point that is far more important than pouring our money into banks that are so deep in debt that they are beyond salvation.
Those sorts of doomed attempts, which by the way are all we see from our "leaders" so far, all spring from one thing and only one: They see life as something to be looked at from a rear-view mirror. All we hear is that we need an "economic turnaround", a "return to economic growth”, a situation in which banks will start lending again to individuals and industries. Never mind that individuals are in no position to borrow, and that they can't afford the products the industries would produce. Well, not unless they borrow the money to do so.
One thing I proposed way back when is for the government, having guaranteed people's bank deposits, could make them available through for instance supermarkets or post offices. So it's with great pleasure that today i can announce that's precisely what the British Business Secretary, Lord (?!) Mandelson, is suggesting. Well, not my idea in its entirety, and not exactly for the same reasons, but he's getting there.
Mandelson, according to The Guardian, "backs [a] new 'people's bank' at Post Office". From what I gather, the rationale in England is directed towards preventing a privatization of Royal Mail by giving it a larger and wider role in society, initially through loans and debit cards. Still, this would de facto mean the establishment of a national bank. And what's more important, much more, is that this new national bank would not be burdened by the toxic losses that are drowning (and this is inevitable) the existing big banks, whether in the UK or on Wall Street.
The most interesting question for me is: does Mandelson fully realize that this measure would mean an acceleration of the demise of Britain's banks, which have received hundreds of billions in taxpayer funds? I don't know, simple as that. It would be a great, and I mean great, way to restore an economy while letting its banks die off. And that's what I meant when I first talked about giving people access to their money through supermarkets or post offices a long time ago. This addresses what is most important to the people in the street.
And it's a first step forward into the new world we will inevitably have to adapt to living in. It’s a viable move away from the rear view mirror, away from the notion that what has died needs to be Lazarused no matter what or the end of the earth will fall on our heads. Make no mistake: if the average Britons can keep their money in a government-backed post office account, that assures them access to -small- loans and debit cards, they will en masse pull their deposits out of the private banks. Which will spell the end of those.
While I’m on the theme, I have been pondering another move forward. The rising attention for protectionism, be it through "Buy America", or the British "jobs for locals first", or "eat Italian food", cannot be avoided. And while it runs counter to free trade and all other sorts of inane Chicago School ideologies, I see no reason why it would be so bad. Besides, there's no way you can stop it. In difficult times, people will start to think in terms of a smaller world. They should have all along. One of my long-standing themes is that every country, society and community needs to take charge of their own basic human needs, and play those as close to their vests as possible.
Your supermarket shelves may still be filled, but the the shipping- and other transport indices don't lie. You don't want to be dependent for your food, water and shelter on people living thousands, or even hundreds, of miles away. As far as I'm concerned, by all means globalize the trade in shiny trinkets as much as you want, hey, produce them on Mars for all I care, but not your food, your water, or your homes.
That all just to leads up to the idea I've been toying with lately: A 1 year moratorium on mortgages, in the US, EU and UK. That's right, no new mortgages would be written for the next 12 months. I am fully aware of the weight of the voice of established banks, and what that means for the chances of an idea like this. But please bear with me.
My idea would mean the end for the best part of an entire industry, I know. But then, that industry is only alive because of government support. Fannie and Freddie should be dead entities, but nothing is ever truly dead that feeds on the public vein. What you can do with the $10.6 trillion in Fannie&Freddie mortgage holdings in this: any foreclosure-worthy loan is donated by the federal government to the municipality the home is in. In other words, the community now owns the home, and can decide to leave the occupants in the home. Or not. yes, this will devalue all homes in the community. But that will happen anyway. the advantage is that people can be kept in their homes.
If you have a 1 year mortgage moratorium, you’ll effectively steer yourselves towards a situation in which people cannot buy homes, they can only rent them. But increasingly, they will then rent from the community they are part of. And that harks back to the principle that communities need to keep control of their citizens' basic needs as much as possible. We are talking, in that sense, about the best or all worlds. Why should homes by private property that only enriches bankers and carries the risk the owners treat their properties in ways that hurt the community. I know that Americans will cry "Socialism" now, but that's fine by me. Americans have no idea what socialism means anyway.
There are huge advantages for everyone in a system where basic needs are property of the community, not individuals. The biggest advantages, ironically, are for the individual. In our present system, paying off a $100k mortgage in full costs you $300-400k. And that is money that leaves your community, since the main lenders are not local. If you can pay much less per month, and the money you do pay stays inside your community, you have a situation in which everyone wins except for the fat cat bankers.
Anyway, I should let go of the stream of consciousness for now and start posting this. I'll get back to it one of these days. The British notion of establishing a national bank that belongs to the people, if combined with a way to keep people in their homes that does not hurt their own neighbors, looks to me to be the only way forward. Unfortunately, what I see in the US, and across the board, is only concerned with raising the dead (banks). That will not work. My ideas are far more promising than Obama's so far. So there you are and here you go.
Big banks have failed. The solution? Big banks ...
"This is a solution?" marvelled Stanley Bing incredulously on business website TheStreet.com at the prospect of a new wave of bank consolidations. "Didn't we see what happened to Citigroup and Bank of America? Aren't both now being deconstructed due to unsuccessful, if not heedless, acquisitions? Haven't empires from Rome to ITT fallen into rubble as a result of getting too big, too fast?" He has a point. Most people assume that sorting out the banks is a technical and financial matter - deleveraging, rebuilding reserves and writing down toxic liabilities. But that's just the half of it. What has been grossly neglected is that, even when that's done, many banks face the mother of all challenges on the management front - making business sense of vast, sometimes shotgun, acquisitions carried out in the most hostile economic conditions of our lifetimes.
Consider: at the best of times, mergers are worse business, and harder to do, than managers think. A third fail, and 80% fail to live up to expectations. The financial brainboxes are no better at it than the plodders: a recent City poll on the worst banking mergers of all time identified such turkeys as Citibank-Travellers, Credit Suisse-DLJ, Wachovia-Golden West and Commerzbank-Dresdner Bank - then put RBS-ABN Amro and Bank of America-Merrill Lynch, whose consequences are still ramifying, on top of the list. "Value destruction in financial services isn't new - we just can't afford it any more," says Dustin Seale, managing director of the Europe arm of Senn-Delaney Leadership, a consultancy specialising in corporate culture.
The risk, he fears, is that the perceived remedy makes ultimate success harder to achieve. Thus, while banking is moving towards being smaller, more focused, and more conservative, the entities being cobbled together are bigger and more complex than ever. Banks were once too big to fail; are today's mergers creating organisations that are too big to save? Bank mergers are not just ordinarily difficult. The credit crunch capsized all the assumptions on which they were based. RBS's Sir Fred Goodwin had a good record of making acquisitions work, even expensive ones, but "Fred the Shred" is toast, and his merger rationale and style volatised with him.
His bank's strategy of globalisation no longer makes much sense, believes Andrew Campbell, director of the Ashridge Strategic Management Centre and co-author of a book called Smarter Acquisitions. Lloyds-HBOS, now relabelled Lloyds Banking Group, is a more coherent unit focusing on the UK retail market, but even here the merger will not be plain sailing; integrating the workforce and senior managers of a fierce rival, part of whose identity is bound up with the rivalry itself, never is. The very success criteria on which the mergers were predicated, and on which the current leaders rose to the top, have reversed overnight.
The macho City culture of individual achievement and self-promotion has become the problem; but moving to a culture where words such as engagement, trust and self-determination can be heard without provoking gales of laughter is a monumental management task - made more monumental, points out Ian Johnston, a Senn-Delaney partner, by the fact that the colossal bonuses that were used to paper over other cultural discontents are no longer available. The sense that the world revolves around the banks has to yield to a humbler recognition of the need to serve customers and build relationships. Some banks will make wholesale changes in what they actually do (leadership, recruitment, reward) as well as what they say. Others will find it harder to get beyond spin. Yet, as Seale points out, those that do can contemplate an opportunity as enormous as the challenge.
Without exception, the big banks have been lamentable at dealing with retail customers. This is partly because their minds have been on sexier types of business, but much more because they have remained obstinately wedded to the cost-driven mass-production methods that render them brainless - and, incidentally, have taken General Motors and Chrysler to the brink of extinction. The first major bank to use the opportunities of the merger round to renew itself by providing an honest, transparent and intelligent service to high-street customers will be greeted with tears of joy. OK, I exaggerate a bit, but renewing the link with customers is the best way for the banks both to make amends for the monstrous errors of the past few years and to proof themselves against foolishness in the future. As they consider how to avoid a new wave of merger-driven value annihilation, bank leaders can at least comfort themselves with this unexpected thought: for once, as Seale points out, "no one wants them to fail".
Fix the Accounting, Then Fix the System
Almost all of the bailout plans being discussed fail to consider a simple fact: without the homogenization of accounting rules, any plan will represent a piecemeal approach to the problem. Some banks are holding out their hands to get TARP funds; they are on the brink of failure and are seeking a lifeline. Others are saying "Nah, we don't want them (TARP funds)," because they don't want the more stringent oversight applied to TARP recipients. In both cases, the motivations are less than pure, and neither facilitates greater lending to stimulate the economy.
The system is broken, and current proposals do nothing to address the overarching issue: we don't know the true tangible book value of ANY financial institution, and therefore are unclear as to which have strong capital positions, which are on the verge of failure, and which are essentially bankrupt but have been propped up temporarily with taxpayer dollars. As has been suggested by many, draconian steps must be taken to repair the system. Problem is, the only thing draconian so far is the damage done to the wallets of every US citizen today and tomorrow.
What needs to happen, right now, is to make EVERY financial institution apply mark-to-market accounting to their portfolios. No readily observable market? Have an administrator apply an independent third-party valuation that takes into account polling possible buyers. The only circumstance under which mark-to-market accounting can be avoided is if an institution has the intention of holding an asset to maturity and has the term financing in place to carry it. The two biggest problems with the current accounting regime relate to leverage and illiquidity.
Banks have been financed largely with short-term capital, piled on top of a sliver of equity. But when assets have maturities extended either due to a changing rate environment (e.g., rising term rates cause mortgage-backed securities to experience longer maturities) or to rising illiquidity (e.g., CDOs, CDS', high-yield bonds, leveraged lending commitments, etc.), the lack of term capital puts them in a very precarious position almost overnight. These kinds of surprises could have been avoided by forcing mark-to-market treatment, as we would have seen a precipitous decline in carrying values much faster than we did and dealt with the problem far more quickly.
As it stands today, those who argue against mark-to-market treatment say "This will just exacerbate the capital problem at troubled banks. And after the markets unlock, those assets will be salable at far higher prices." Exactly. Let's smoke out the problems NOW, and figure out the magnitude of the problem NOW. The fact that assets might fetch higher prices in the future is immaterial if you don't have the balance sheet to get to the future, and it is certainly not the taxpayer's responsibility to support those institutions' common stockholders and bondholders in this mission.
On Monday, President Obama should get together with Mary Schapiro of the SEC and insist on a clean accounting of all financial institution balance sheets - IMMEDIATELY. We can then truly put a good bank/bad bank plan into motion that will be built on a strong foundation, instead of continuing to pump money into the Citigroups and Bank of Americas, firms with hopelessly distorted capital structures that need to be redone. NOW. People - Congresspeople, pundits, economists, bankers, President Obama, and everyone else with a vested interest - needs to get over themselves about what it means to be American. We screwed up - big time. Americans are an optimistic, can-do people.
But in the absence of policy clarity, aligned motives and strategic thinking, we will limp out of this crisis like a terminally wounded animal. Alive, but destined to never regains its former swagger. We can get our swagger back, a better swagger, a swagger built on real value and not on vapor, if only we have the guts to effect real change. And it all starts with something as mudane as accounting. But sometimes the most complex problems can be addressed with the most simple solutions. And the beginning of our journey of healing has to be the marking-to-market of financial institution balance sheets. We simply can't afford to wait any longer.
UK business secretary backs new 'people's bank' at Post Office
A groundbreaking "people's bank", offering a full range of financial services and using the UK network of 12,000 post offices, is being promoted by Peter Mandelson, the business secretary. The plan to use the remaining post office outlets as the backbone of a new national bank would head off a Labour revolt over Royal Mail privatisation and provide the country with a fiscal impetus. Last night Pat McFadden, the minister for postal affairs, said he was keen to expand their operations and allow them to function more like fully fledged banks, but with a clear social purpose. "I am warm about the idea," he said. "The secretary of state [Lord Mandelson] has said he wants to see a stronger role for the Post Office. This is something we are working on. We have asked the business and enterprise select committee to look into this."
The Post Office already offers some banking services and bill payments. In 2004 it linked up with the Bank of Ireland in a joint venture that allowed it to offer credit cards, mortgages and personal loans. Last year it was re-awarded a contract to run the card account that distributes benefits and pensions to 4.3 million claimants. But under proposals submitted to the select committee last week by a powerful coalition of business groups, MPs and unions, the new state-owned "people's bank" would do far more, offering all the debit-card facilities, current accounts, savings plans, loans, business services and financial advice currently available in main city-centre banks. The ideas are being worked on as part of a package that they hope will persuade rebel Labour MPs and peers to abandon their fierce opposition to legislation on the part-privatisation of Royal Mail, the parent company of Post Office Ltd.
More than 100 Labour MPs have signed a House of Commons motion demanding that the government drop plans to sell off part of Royal Mail to a foreign operator - a move they believe will lead to further dismantling of the country's most cherished public service. They also fear a part sale will lead to rising prices, the erosion of the "universal service" of six-days-a-week postal deliveries and collections, and the closure of thousands more local post offices. Ministers have been alarmed by the extent of opposition to their privatisation plans, both in the Commons and Lords, and fear Gordon Brown's premiership, and the run-up to an election, could be scarred by a mass revolt. In a further sign of their willingness to compromise, ministers have also backed away from plans to sell a 49% stake in Royal Mail and now say the most they expect to hive off will be 30-35%. But they remain adamant that private-sector capital and expertise must be brought in to shake up the company. The favourite to take a stake is Dutch operator TNT.
MPs opposed to part-privatisation last night gave a cautious welcome to the plans. John Grogan, Labour MP for Selby, said deep public cynicism about the performance of private banks had highlighted the need for a state-run bank that people could trust. "The question that many Labour backbenchers will ask is that, if public-sector managers are good enough to run a 'people's bank' as a successful public enterprise, why can't they do the same with the Royal Mail?" Grogan said. Billy Hayes, general secretary of the Communication Workers' Union (CWU), which is opposed to part-privatisation, said: "The people's bank is an idea whose time has come." Ministers now needed to ensure that all of Royal Mail remained in public ownership.
Lindsay Mackie, of the New Economics Foundation, which has helped drive forward the plans with the CWU, the Federation of Small Business and the centre-left pressure group Compass, said: "It's great that the government is listening to the huge sweep of public, parliamentary, union and business opinion in favour of a trusted 'Post Bank'. "It would be even better if ministers could now say that they are completely committed to an expanding, innovative Post Office network, with no more closures."
Violent unrest rocks China as crisis hits
Bankruptcies, unemployment and social unrest are spreading more widely in China than officially reported, according to independent research that paints an ominous picture for the world economy. The research was conducted for The Sunday Times over the last two months in three provinces vital to Chinese trade – Guangdong, Zhejiang and Jiangsu. It found that the global economic crisis has scythed through exports and set off dozens of protests that are never mentioned by the state media. While troubling for the Chinese government, this should strengthen the argument of Premier Wen Jiabao, who will say on a visit to London this week that his country faces enormous problems and cannot let its currency rise in response to American demands.
The new US Treasury secretary, Timothy Geithner, has alarmed Beijing and raised fears of a trade war by stating that China manipulates the yuan to promote exports. However, a growing number of economists say the unrest proves that it is not the exchange rate but years of sweatshop wages and income inequality in China that have distorted global competition and stifled domestic demand. The influential Far Eastern Economic Review headlined its latest issue “The coming crack-up of the China Model”. Yasheng Huang, a professor at the Massachusetts Institute of Technology, said corruption and a deeply flawed model of economic reform had led to a collapse in personal income growth and a wealth gap that could leave China looking like a Latin American economy. Richard Duncan, a partner at Blackhorse Asset Management in Singapore, has argued that the only way to create consumers is to raise wages to a legal minimum of $5 (£3.50) a day across Asia – a “trickle up” theory.
The instability may peak when millions of migrant workers flood back from celebrating the Chinese new year to find they no longer have jobs. That spells political trouble and there are already signs that the government’s $585 billion stimulus package will not be enough to achieve its goal of 8% growth this year. The American economist Nouriel Roubini said growth figures of 6.8% in the fourth quarter of 2008 masked the reality that China was already in recession – a view privately shared by many Chinese financial analysts who dare not say so in public. Even security guards and teachers have staged protests as disorder sweeps through the industrial zones that were built on cheap manufacturing for multinational companies. Worker dormitory suburbs already resemble ghost towns.
In the southern province of Guangdong, three jobless men detonated a bomb in a business travellers’ hotel in the commercial city of Foshan to extort money from the management. The Communist party is so concerned to buy off trouble that in one case, confirmed by a local government official in Foshan, armed police forced a factory owner to withdraw cash from the bank to pay his workers. “Hundreds of workers protested outside the city government so we ordered the boss to settle the back pay and sent police armed with machine-guns to take him to the bank and deliver the money to his workforce that very night,” the official said. On January 15 there were pitched battles at a textile factory in the nearby city of Dongguan between striking workers and security guards.
On January 16, about 100 auxiliary security officers, known in Chinese as Bao An, staged a street protest after they were sacked by a state-owned firm in Shenzhen, a boom town adjoining Hong Kong. About 1,000 teachers confronted police on the streets of Yangjiang on January 5, demanding their wages from the local authorities. In one sample week in late December, 2,000 workers at a Singapore-owned firm in Shanghai held a wage protest and thousands of farmers staged 12 days of mass demonstrations over economic problems outside the city. All along the coast, angry workers besieged labour offices and government buildings after dozens of factories closed their doors without paying wages and their owners went back to Hong Kong, Taiwan or South Korea.
In southern China, hundreds of workers blocked a highway to protest against pay cuts imposed by managers. At several factories, there were scenes of chaos as police were called to stop creditors breaking in to seize equipment in lieu of debts. In northern China, television journalists were punished after they prepared a story on the occupation of a textile mill by 6,000 workers. Furious local leaders in the city of Linfen said the news item would “destroy social stability” and banned it. At textile companies in Suzhou, historic centre of the silk trade, sales managers told of a collapse in export orders. “This time last year our monthly output to Britain and other markets was 60,000 metres of cloth. This month it’s 3,000 metres,” said one. She said companies dared not accept orders in pounds or euros for fear of wild currency fluctuations. Trade finance has all but ceased. Some 40% of the workforce had been laid off, she added.
Nearby, in the industrial hub of Changshu, all the talk was of Singapore-listed Ferro China, which exported steel products to customers in Britain, Germany, Korea and Japan. Last October its shares were suspended. The company is reported to have been weighed down by $800m in debts and, according to the specialist business magazine Caijing, has started a court-or-dered restructuring. A researcher found the gates closed and under tight guard, 2,000 employees out of work and witnesses who told of company vehicles being seized by impatient creditors. Holders of Ferro China debt include Credit Suisse and Citi-group. Even in the city regarded as the most entrepreneurial in China, Wenzhou, the business community is reeling. “We estimate that foreign companies have defaulted on payments for 20 billion yuan (£20 billion) owed to Wenzhou firms,” said Zhou Dewen, chairman of the city’s association for small and medium-sized businesses.
“British businessmen are better than other customers because even if they owe money they can be contacted and promise to pay their bills if they can raise the cash but many other foreigners just disappear,” he said. Slumping demand for consumer electronics in Britain has been blamed for the crisis engulfing the southern city of Shunde, in Guangdong, where a cluster of 3,000 electrical firms has grown up around big exporters like Kelon, a white-goods manufacturer. “The impact on us from the slowdown in the British market will be huge,” said a manager at Kelon, who asked not to be named. Shunde is one of the amazing one-industry Chinese towns that has come from nothing to generate 20% of China’s export production of domestic electrical appliances, making 60% of its sales to Europe.
Now the whole province is wrestling with sudden, sharp decline. A researcher who watched officials handling complaints at a local labour bureau reported “class hatred” among workers. “Why did the boss cut your salary? You must be lazy or absent from work,” an official told one group of petitioners. “What do you mean? Are you an official of the people’s government or a slave of the bosses?” demanded an irate worker. Their claim dismissed, the group warned onlookers: “We are thinking of taking extreme action.”
A legal advocate for migrant workers, Xiao Qingshan, told a tale of violent intimidation by the state in collusion with unscrupulous businessmen. On January 9, Xiao said, 14 security officers from the local labour bureau broke into his office, confiscated 600 legal case files, 160 law books, his computer, his photocopier, his television set and 100,000 yuan in cash. “That evening I was ambushed near the office by five strangers who forced a black bag over my head and then threw me into a shallow polluted canal,” he said. His landlord has since given him notice to quit his rented home. Xiao said he was defying bribery and threats to speak to the foreign media because he wants international businesses to know what is really happening in “the workshop of the world”.
ECB Drawing Up 'Bad Bank' Guidelines
The European Central Bank is drawing up guidelines for European governments that are considering so-called "bad banks" to house banks' toxic assets. The ECB is also working on guidelines for European governments that plan to guarantee toxic assets remaining on banks' books, another form of bank bailout. Both sets of guidelines are being drawn up with the European Commission. The ECB hopes the guidelines can help avoid competitive one-upmanship across the 27-nation European Union as nations seek to shore up struggling banks. The ECB, which makes monetary policy for the 16 countries that share the euro currency, has no power to enforce any guidelines it develops. But in recent months, euro-zone governments have asked the bank to play a mediating role by developing guidelines for, for instance, European government guarantees of some types of bank debt.
Governments across Europe are mulling or enacting new plans to help banks deal with souring loans and other assets that remain on their balance sheets. Many European governments have been slow to consider a "bad bank" option, in which governments could sponsor vehicles into which banks could transfer assets that are hard to sell. German Finance Minister Peer Steinbrueck told a German daily newspaper Thursday the government would not set up a centralized bad bank, but indicated the government is considering the idea that banks could set up their own individual entities to house toxic assets. Such banks, Mr. Steinbrueck told the daily Berliner Zeitung, could then use part of the German government's €500 billion ($640.25 billion) banking-sector rescue plan to shore up their remaining sound business.
The ECB is also working on guidelines for governments that hope to offer insurance against the toxic assets that remain on banks' books. One key question: how to price the toxic assets. A central piece of the UK government's latest bank-rescue package is providing insurance that would limit banks' losses on loans and investments that go bad. But uncertainty remains over how the insurance would be priced by the government. The ECB's plans expand a mediation role the bank took on late last year, as the crisis forced many European governments to step in to shore up troubled banks. At the request of euro-zone governments, the central bank calculated a formula to set a benchmark for government guarantees of some kinds of bank debt. In November, ECB policy makers also devised a benchmark for the price of government capital injections into banks.
Choosing Geithner was a mistake
The nomination and confirmation of Timothy Geithner as Treasury secretary was a mistake that will weaken the U.S. income tax system. The confirmation must increase public cynicism about paying income taxes, especially as many taxpayers will find incredible his explanation of his failure to pay the taxes he owed. In addition, the arguments that Mr. Geithner's tax sins have to be forgiven because he is the best — or only — person who can handle the job of Treasury secretary at this critical time also are incredible.
This is hard to believe, given that he was intimately involved in the development and implementation of the Troubled Asset Relief Program, the first rescue package, which is now widely perceived as a failure, and given the extraordinary depth of talent in America's great universities. Many of the academics in these institutions have served in the Department of the Treasury and/or the Federal Reserve. Mr. Geithner failed to pay self-employment taxes on income he earned during the four years he worked for the International Monetary Fund in Washington, which as an international organization is exempt from paying Federal Insurance Contributions Act and Social Security taxes.
The omission was discovered during an audit by the Internal Revenue Service, after which he paid the taxes he owed for two of those years but not the first two years — which weren't covered by the audit due to the statute of limitations. Mr. Geithner claimed that the failure to pay the taxes was an oversight and that he didn't realize he owed the taxes until the audit. Yet he received extra income from the IMF to defray the taxes he was expected to pay but didn't pay, and he signed a form acknowledging that he understood he was receiving compensation for those required tax payments. The explanation doesn't wash. Was it also an oversight when, even after the audit, and Mr. Geithner paid the taxes owed for the two years audited, he didn't pay the taxes owed for the first two years until he was nominated to be Treasury secretary? Granted, he wasn't legally required to do so.
Sen. Robert Byrd (D-W.Va.) had it right when he voted against Mr. Geithner's confirmation. "Had he not been nominated for Treasury secretary, it's doubtful that he would have ever paid these taxes," Mr. Byrd said, according to published reports. This isn't the right mind-set for the person who will be responsible for the nation's Treasury and its income tax system, nor is it an appropriate example for the taxpayers of the country. The damage from this appointment won't be obvious, but it will be real. Mr. Geithner's cavalier attitude toward his tax obligations must weaken taxpayer belief in the fairness of the tax system. Many will wonder how many other important, high-earning people also dodge paying their tax obligations and get off with a slap on the wrist when caught.
As a result, some may be tempted to dodge paying their full tax obligations, thinking: "Others are doing it, so why shouldn't I?" In short, the revelations of Mr. Geithner's failures to pay his full tax obligations, and his subsequent confirmation as Treasury secretary, weaken the country's voluntary tax system. His confirmation also will throw into question Congress' seriousness about cracking down on tax evasion, which, according to government estimates, totaled $345 billion in 2007, 14% of total federal revenue. It is difficult for Congress to claim to be serious about fighting tax evasion while at the same time approving as Treasury secretary someone suspected of an attempt at tax evasion.
Stiglitz Criticizes Bad Bank Plan as Swapping 'Cash for Trash'
Nobel laureate Joseph Stiglitz said any decision by President Barack Obama to establish a so-called bad bank to rid financial companies of toxic assets risks swelling the national debt. Obama’s administration is moving closer to buying the illiquid assets currently clogging bank’s balance sheets and preventing them from boosting lending, people familiar with the matter said this week. That amounts to swapping taxpayers’ “cash for trash,” Stiglitz said yesterday in a panel discussion at the World Economic Forum in Davos, Switzerland. “You shouldn’t chase good money after bad. We’re talking about a national debt that’s very hard to manage.”
Stiglitz, a professor at Columbia University in New York and a former adviser to President Bill Clinton, says the plan would leave taxpayers paying for years of excess lending by banks. It would also deprive the government of money that would have been better spent shoring up Social Security, he said. Whether a bad bank would accelerate an end to the financial crisis split delegates attending the Davos talks. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said such an operation would help if “executed well.” Billionaire investor George Soros said in an interview that “it’s not the measure that would turn the situation around and enable banks to lend.”
Obama said yesterday he’s readying a plan to unlock credit markets and lower mortgage rates. Under the initiative, the government would buy some tainted securities and insure the banks against losses on the rest. “Soon my Treasury secretary, Timothy Geithner, will announce a new strategy for reviving our financial system that gets credit flowing to businesses and families,” Obama said in his weekly radio address. Stiglitz drew criticism from panel participant Angel Gurria, head of the Organization for Economic Cooperation and Development, who says a bad bank is necessary for lending to resume. “I agree about the moral, ethical fallout, but you’ve got to face the music and someone has to take the loss,” said Gurria, Mexico’s former finance minister. “It’s the only way to jumpstart the economy.”
Bank losses worldwide from toxic U.S.-originated assets may double to $2.2 trillion, the International Monetary Fund said in a report released Jan. 28. John Monks, general secretary of the European Trade Union Confederation, told the same audience that governments are getting “close to straining the patience of the public and voters” by repeatedly extending lifelines to banks. Philippines President Gloria Arroyo urged Obama to make a quick decision on his plan. “We want Americans to do something,” she said at the session, which was called “Rebooting the Global Economy.” “We can discuss what to do but the worst thing is to do nothing.”
Can We PLEASE Just Fix Banks The Right Way?
The latest bailout-for-bonuses and cap-Wall Street-pay-at-$400,000 storms have demonstrated the absurdity of our current approach to fixing our bankrupt banking system:
- Wall Street's insistence on paying its executives tens of billions of bonuses because they "work hard" and "might leave" shows that any passive bailout scheme is doomed.
- Washington's rush to seize on the bailouts-for-bonuses scandal and, henceforth, regulate lending and wages shows just how quickly we have veered into socialism (which may sound fair in some moral sense, but which just doesn't work), and
- The understandable refusal of any bank not on death's door to accept bailout money shows that taxpayers will have to vastly overpay for crap assets to get banks to play ball--and, thus, transfer taxpayer money to bank bondholders, shareholders, and managers who don't deserve a cent of it.
What's the alternative? Fix the banks the right way:
- Declare any weak bank insolvent and put it into receivership (with the insolvency decision to be made by the FDIC and Treasury, not the bank). This is what we did with WaMu, Fannie, Freddie, and IndyMac, and it's what we can do with Citi, BofA, and any other wobbly institution.
- Write down the value of ALL the banks' assets to nuclear-winter levels, so private-market investors AND taxpayers can be assured that there will be no further writedowns.
- Recapitalize the banks by converting debt to equity, thus merely forcing those who made the bad decisions to pay for them (instead of hosing 200 million taxpayers who didn't). If necessary, taxpayers can top up the tank.
- Refloat the banks immediately, so the government is not in the business of forcing banks to make stupid loans or determining what is and isn't appropriate for people to get paid.
We've tried halfway measures. They don't work. So it's time to just step up and do the right thing.
Ilargi: The guy who wrote this in the NYT is a professor in economics. Just read this flaming nonsense and think about what it means that there are people in such positions saying things like:
"While these assets are “toxic” to the banks right now because they are illiquid, volatile and at depressed prices, the government can hold on to them until they regain value, making it an investment for the taxpayer that could pay off handsomely in the end."
Good Bank, Bad Bank; Good Plan, Better Plan
There is a growing consensus that Washington has two options if it wants to end the credit freeze and restore confidence in our banking system. One is to, in effect, nationalize the major banks, which would be hugely expensive and would undermine our free-market system. The other is the “bad bank” solution, under which the government would print enormous amounts of money to buy all these banks’ “toxic” assets and to put them into a huge new financial institution that would operate under federal control and sell them off over time. This is a better idea than nationalization, but the proposals along these lines being bandied around Washington would all be prohibitively expensive and probably ignite inflation. However, there is more than one way to pull off a “good bank/bad bank” rescue, and a look at two examples from the 1980s may help show a path forward.
In 1988, as a young analyst at the investment bank Drexel Burnham Lambert, I worked on two major “bad bank” transactions. In the first, the Federal Deposit Insurance Corporation seized First City National Bank of Houston. The government put up $1 billion to create a “bad bank” that took on First City’s bad energy and commercial real estate portfolios; it was able to liquidate those assets over the next 15 years, recouping much of the money it had invested in the bailout. And First City was quickly able to raise $500 million of private capital and get a new lease on life (although it faltered a few years later because of unrelated bad loans).
That success led to a second government-orchestrated rescue that year. The bad commercial real estate and home mortgage portfolios of Mellon Bank of Pittsburgh were transferred to a bad bank called Grant Street National. While the government oversaw the transaction, the money Grant Street used to buy Mellon’s troubled assets came from private investors looking for long-term profits. By 2005, Grant Street’s liquidation was also successfully completed, at a profit. The two bailouts differed in details. But both succeeded because when all of the bad assets were removed from the troubled bank’s balance sheet, it was immediately able to raise new capital. This allowed management to focus on getting back to business without the distraction of dealing with underperforming loans. And the government and the outside investors who took up those loans could afford to be far more patient than the banks that held them.
The lessons for today? So far, the Treasury and the Federal Reserve have done a good job of consolidating the commercial and investment banking sector into four giants: Bank of America, Citigroup, JPMorgan Chase and Wells Fargo. But based on those banks’ continued depressed stock prices and the high cost of credit they are being forced to pay, it is clear that the market is not yet convinced of their health. Instead of printing up money to create a huge, unwieldy “bad bank,” I would recommend creating separate bad banks for each of these four institutions (and perhaps some others), and financing them by having the government assume an amount of each good bank’s corporate debt equal to the value of the troubled assets put into the bad banks.
It would work this way: The managements of each of the four banks would be given a one-time opportunity to sell any assets (from vanilla domestic corporate bonds to the most exotic foreign derivatives) to a new bad bank owned entirely by the government. The only condition would be that the four big banks would have to convey the assets at year-end, audited book values, not at some guess of what they might be worth down the road. While these assets are “toxic” to the banks right now because they are illiquid, volatile and at depressed prices, the government can hold on to them until they regain value, making it an investment for the taxpayer that could pay off handsomely in the end. The public would have transparency, as it would know what the assets are and how they are liquidated over time.
Most important, however, the government would pay for these troubled assets not by printing new cash, as under most current bad-bank proposals, but by taking on an equal dollar amount worth of each bank’s “liabilities” — that is, notes, bonds and other obligations that the bank owes to other lenders or investors. The government, not the banks, would choose which liabilities it would take responsibility for. Presumably, federal officials would assume notes and bonds with maturities roughly in line with the real durations of the troubled assets they are taking off the banks’ hands, mainly 3 years to 10 years. This would allow the government to pay down these liabilities through the cash flow that will be generated from the troubled assets themselves. The bad banks would have a proper match between assets and liabilities, a critical ingredient for managing any investment pool.
The bad banks would then be able to work out their troubled assets over time rather than sell them in a fire sale — similar to the successful solution imposed on the savings and loans that were taken into the Resolution Trust Corporation in the 1990s. The government could hire professional money managers, working under an incentive-heavy compensation plan, to oversee the liquidation. (Disclosure: firms like mine might be potential candidates for such a job.) This would be far wiser than leaving it to government bureaucrats, who might simply seek to sell as many assets as quickly as possible and close the files. The benefit to the good banks would be substantial: they would retain strong asset bases, they would no longer be burdened by toxic securities, and because they would be able to trust their fellow banks’ balance sheets, they could safely extend credit to one another and to American businesses and households.
With their equity capital remaining intact, they would easily meet domestic and international capital requirements. The economy would benefit because the credit squeeze could finally end, as the good-bank employees could concentrate on lending rather than simply surviving. And because no new money would be printed, inflation would be much less of a concern. Insurance companies, smaller banks, money-market funds and other institutions that are the primary holders of these banks’ intermediate-term liabilities would also receive an enormous benefit: in place of “weak” debt they now hold from troubled banks, they would have securities guaranteed by the Treasury.
There are two other issues. First, for the four major banks, the good bank/bad bank transactions should be mandatory; the industry will stabilize only if the four work in tandem. Second, the government should hedge its bets by getting stock warrants — a certificate giving the holder the right to purchase stock in the future at a guaranteed price — equal to a significant percentage of each good bank’s common equity (although certainly not a majority share). After all, assuming the good bank/bad bank asset transfers were successful, the stock prices of the good banks are likely to soar, as they will be the four best capitalized and cleanest banks in the world. The government, in turn, could sell the warrants to private parties, another bonus for taxpayers. And as those private investors exercised the warrants, they would infuse even more common equity capital into the banks, which is, of course, what they really need. With a clean balance sheet and the best capital ratios in the world, the resulting good banks — still under majority private ownership — could get back to doing what our economy most desperately needs from them: start making new loans.
Max Holmes is an adjunct professor of finance at the Stern Graduate School of Business at New York University and the chief investment officer of an asset management firm.
Ilargi: This economics professor, also in the NYT, makes somewhat more sense, but still comes up wanting.
Recession Can Change a Way of Life
As job losses mount and bailout costs run into the trillions, the social costs of the economic downturn become clearer. The primary question, to be sure, is what can be done to shorten or alleviate these bad times. But there is also a broader set of questions about how this downturn is changing our lives, in ways beyond strict economics. All recessions have cultural and social effects, but in major downturns the changes can be profound. The Great Depression, for example, may be regarded as a social and cultural era as well as an economic one. And the current crisis is also likely to enact changes in various areas, from our entertainment habits to our health.
First, consider entertainment. Many studies have shown that when a job is harder to find or less lucrative, people spend more time on self-improvement and relatively inexpensive amusements. During the Depression of the 1930s, that meant listening to the radio and playing parlor and board games, sometimes in lieu of a glamorous night on the town. These stay-at-home tendencies persisted through at least the 1950s. In today’s recession, we can also expect to turn to less expensive activities — and maybe to keep those habits for years. They may take the form of greater interest in free content on the Internet and the simple pleasures of a daily walk, instead of expensive vacations and N.B.A. box seats.
In any recession, the poor suffer the most pain. But in cultural influence, it may well be the rich who lose the most in the current crisis. This downturn is bringing a larger-than-usual decline in consumption by the wealthy. The shift has been documented by Jonathan A. Parker and Annette Vissing-Jorgenson, finance professors at Northwestern University, in their recent paper, “Who Bears Aggregate Fluctuations and How? Estimates and Implications for Consumption Inequality.” Of course, people who held much wealth in real estate or stocks have taken heavy losses. But most important, the paper says, the labor incomes of high earners have declined more than in past recessions, as seen in the financial sector. Popular culture’s catering to the wealthy may also decline in this downturn. We can expect a shift away from the lionizing of fancy restaurants, for example, and toward more use of public libraries. Such changes tend to occur in downturns, but this time they may be especially pronounced.
Recessions and depressions, of course, are not good for mental health. But it is less widely known that in the United States and other affluent countries, physical health seems to improve, on average, during a downturn. Sure, it’s stressful to miss a paycheck, but eliminating the stresses of a job may have some beneficial effects. Perhaps more important, people may take fewer car trips, thus lowering the risk of accidents, and spend less on alcohol and tobacco. They also have more time for exercise and sleep, and tend to choose home cooking over fast food. In a 2003 paper, “Healthy Living in Hard Times,” Christopher J. Ruhm, an economist at the University of North Carolina at Greensboro, found that the death rate falls as unemployment rises. In the United States, he found, a 1 percent increase in the unemployment rate, on average, decreases the death rate by 0.5 percent.
David Potts studied the social history of Australia in the 1930s in his 2006 book, “The Myth of the Great Depression.” Australia’s suicide rate spiked in 1930, but overall health improved and death rates declined; after 1930, suicide rates declined as well. While he found in interviews that many people reminisced fondly about those depression years, we shouldn’t rush to conclude that depressions are happy times. Many of their reports are likely illusory, as documented by the Harvard psychologist Daniel Gilbert in his best-selling book “Stumbling on Happiness.” According to Professor Gilbert, people often have rosy memories of very trying periods, which may include extreme poverty or fighting in a war.
In today’s context, we are also suffering fear and anxiety for the rather dubious consolation of having some interesting memories for the distant future. But this downturn will likely mean a more prudent generation to come. That is implied by the work of two professors, Ulrike Malmendier of the University of California, Berkeley, and Stefan Nagel of the Stanford Business School, in a 2007 paper, “Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking?”
A generation that grows up in a period of low stock returns is likely to take an unusually cautious approach to investing, even decades later, the paper found. Similarly, a generation that grows up with high inflation will be more cautious about buying bonds decades later.
In other words, today’s teenagers stand less chance of making foolish decisions in the stock market down the road. They are likely to forgo some good business opportunities, but also to make fewer mistakes. When all is said and done, something terrible has happened in the United States economy, and no one should wish for such an event. But a deeper look at the downturn, and the social changes it is bringing, shows a more complex picture. In addition to trying to get out of the recession — our first priority — many of us will be making do with less and relying more on ourselves and our families. The social changes may well be the next big story of this recession.
Tyler Cowen is a professor of economics at George Mason University.
Feds allege plot to destroy Fannie Mae data
A fired Fannie Mae contract worker pleaded not guilty Friday to a federal charge he planted a virus designed to destroy all the data on the mortgage giant's 4,000 computer servers nationwide. Had the virus been released as planned on Saturday, the Justice Department said the disruption could have cost millions of dollars and shut down operations for a week at Fannie Mae, the largest U.S. mortgage finance company. Rajendrasinh B. Makwana, 35, of Glen Allen, Va., pleaded not guilty in U.S. District Court in Baltimore to one count of computer intrusion, the U.S. attorney's office said. Makwana's federal public defender, Christopher C. Nieto, didn't return calls seeking comment on the case. The Associated Press was unable to reach Makwana in Glen Allen, Va., a suburb of Richmond. A search of public records found no address or telephone number for him there.
Makwana is an Indian citizen who has lived in the United States since at least 2001, according to public records. He was fired Oct. 24 from his computer programming job at Fannie Mae's data center in Urbana, about 35 miles from the company's Washington headquarters, where he had worked since 2006, according to the Justice Department. He was fired for erroneously writing programming instructions two weeks earlier that changed the settings on the servers, according to an FBI affidavit. Fannie Mae did not immediately terminate Makwana's computer access after telling him he was fired early on the afternoon of Oct. 24, the affidavit states. Before surrendering his badge and laptop computer about 3 1/2 hours later, the indictment accused Makwana of "intentionally and without authorization caused and attempted to cause damage to Fannie Mae's computer network by entering malicious code."
As first reported by The (Washington) Examiner, the code "would have resulted in destroying and altering all of the data on Fannie Mae servers," the indictment states. According to the affidavit signed Jan. 6 by FBI Special Agent Jessica A. Nye, a Fannie Mae engineer discovered the malicious instructions by chance Oct. 29. The virus was removed that day and did no harm, according to the affidavit. Had the virus been released, "it would have caused millions of dollars of damage and reduced if not shut down operations" for at least a week, Nye wrote. Fannie Mae may have had to clean out and restore all 4,000 servers, restore and secure the automation of mortgages and restore all data that was erased, the agent said. Fannie Mae declined to comment.
Fannie Mae owns or guarantees about $3 billion in home loans, or one in every five mortgages in the United States. A slowdown would have affected the investors who rely on Fannie Mae to guarantee the timely payment of mortgage interest and principal, said Guy Cecala, publisher of Inside Mortgage Finance. "To the extent they can't meet those obligations, that's a big problem," Cecala said. The charge against Makwana carries a maximum sentence of 10 years in prison. Makwana was arrested Jan. 7 and released on $100,000 bond Jan. 8, according to court records. The Justice Department didn't disclose the name of the contractor for whom he worked. He was one of 10 to 20 workers with access to the server from which the virus would have launched, according to the FBI affidavit. Fannie Mae and Freddie Mac, both publicly traded, were created by Congress to inject money into the home-loan market by purchasing mortgages and bundling them into securities for sale to investors. Both were taken over by their government regulator in September after mounting mortgage losses put them in distress.
Lenders abruptly cut lines of credit
+Banks and other lenders nationwide, seeking to reduce their debt exposure, are shutting off and limiting consumer credit card lines, even for many customers who carry low balances and pay on time. As much as $2 trillion in consumer credit - nearly half of what is available - could be rescinded, according to an estimate by a prominent banking analyst. Just two years ago, institutions were handing out liberal borrowing lines to almost anyone. But now, drowning in debt and soured investments, lenders are seeking to stop consumers from running up big balances in hard times, bills they might not be able to pay. The credit squeeze doesn't just limit spending potential; it can also damage cardholders' credit ratings by making them appear to be riskier borrowers. And in many cases, the institutions pulling back on credit took government bailout funds that were supposed to encourage them to lend more freely.
Diana Lawton, a 44-year-old freelance writer in Chelmsford, is one of those being affected by the change in credit-line policies. She said American Express Co. called her last week to say her two charge cards - one personal, one for business - had been frozen pending a "financial review." Lawton, who had been using the personal card since 1988, said she was stunned. The company offered no explanation, accord ing to Lawton, but told her she could apply for reinstatement by submitting two years of income tax returns, along with three months of pay stubs and bank records. Outraged at having to undergo a 10-day investigation of her finances, Lawton canceled the cards. "I know the economy's bad," she said, "but this is just shocking to me."
American Express, which has received $3.4 billion in federal bailout money, declined to discuss Lawton's situation. Lisa A. Gonzalez, a company spokeswoman, said that on "isolated occasions" it asks card members to provide financial information. "Though we continually look at the credit limits we offer card members and review them on a case-by-case basis, we are being more targeted in response to economic conditions," Gonzalez said. "This may also include cancellations." Most bankers won't offer details about the cutbacks, but acknowledge they are happening. Betty Reiss, a spokeswoman for Bank of America Corp., the nation's second-largest card issuer, said, "We're taking a more aggressive look at accounts in order to control risk in the current environment." The bank is one of the biggest recipients of federal bailout funds - $45 billion.
As far back as July, 60 percent of card issuers reported they were constricting lines of credit, according to Javelin Strategy & Research, a Pleasanton, Calif., firm that tracks the credit card industry. And a Federal Reserve Bank survey in October, the latest available, found the same portion of bankers reporting tighter lending standards on credit cards. Meredith Whitney, the Oppenheimer & Co. banking analyst who in November predicted a $2 trillion drop in credit availability, has said the loss will hurt the economy because consumers rely on credit cards for regular spending. In part, banks and credit card companies are reacting to an increase in the number of cardholders who fail to pay their bills. For example, American Express said it wrote off 6.7 percent of its $63 billion US loan portfolio in the fourth quarter, up from 3.4 percent a year ago. To counter such losses, some institutions, including Citibank, have raised the interest rates they charge certain customers as a way to generate revenue.
Citibank said it is primarily raising interest rates for customers who haven't seen a change in two or three years. In a statement, the company said, "We have taken actions such as lowering credit limits, adjusting rates, tightening credit standards, and closing inactive accounts, particularly in certain geographies and where we can use mortgage data to enhance our decision-making capabilities." In addition, as investor demand for credit card debt that is usually packaged into securities has plunged, banks are being forced to keep the debt on their books longer. Many of the credit lines being taken away or reduced have not been used recently, according to people who track the business. Dennis Moroney of TowerGroup, a Needham research firm, called it the "kitchen drawer" syndrome because some consumers keep cards they don't need or don't use often. Card issuers are trying to rein in such accounts before they get tapped for emergencies in the slumping economy, Moroney said.
In addition to limiting spending, a reduced credit line can have a lasting effect on personal credit scores. For instance, someone who carries $1,000 balance on a card with $10,000 limit is suddenly tapping into a higher percentage of their credit if the limit is dropped to $3,000 - even though they haven't spent additional money. Using more than 30 percent of total available credit can make a consumer look riskier on paper, according to credit bureaus. "In general, if a credit limit is reduced, and therefore the amount of credit utilized increases, it could have a negative impact on your credit score," said Tim Klein, a spokesman for Equifax, one of the three major companies that track consumers' credit lines and payment records. None of the banks contacted for this story would discuss how their actions might affect credit scores.
The company that calculates scores, Fair Isaac Corp., said it is examining the impact that creditline cuts are having. The results are expected to made public within the next month and could lead to a shift in the way scores are calculated. Still, Fair Isaac spokesman Craig Watts defended banks' moves to reduce credit lines. "It's only unfair if you regard credit as a right instead of a privilege," Watts said. Tom McNiff, a retiree in Winthrop, said he received a letter Jan. 7 informing him the credit line on his Eastern Bank card was being reduced from $12,000 to $2,700 "to reflect your spending." The letter was sent on behalf of Barclay Card US, the company that owns his account. Kevin Sullivan, a Barclay spokesman, said, "We think we have a [credit] policy that's appropriate for this economic environment."
McNiff said he rarely carries a card balance, unless he makes a large purchase, and even then he typically pays the balance within two months. He said the letter troubled him because he had a hunch it would hurt his credit rating. After McNiff called to complain and the Globe made inquiries about his situation, the company reinstated his $12,000 credit line. Leslie McFadden, a writer for Bankrate.com, a consumer banking and finance website, said banks are targeting people with inactive accounts as well as those with large balances. "You can't prevent your credit card issuer from lowering your limit," she said. "The advice is to pay on time and keep your balances low." And if you have a card you haven't used in a while that you want to keep, McFadden said, "Buy something inexpensive and pay it off that month."
Obama Records Pledge Tested By Citigroup Guarantees
U.S. government guarantees on securities totaling $419 billion for bank bailouts provide an early test of President Barack Obama’s pledge to be open with taxpayers about what they have at risk in the credit crisis. Bloomberg News asked the Treasury Department Jan. 26 to disclose what securities it backed over the past two months in a second round of actions to prop up Bank of America Corp. and Citigroup Inc. Department spokeswoman Stephanie Cutter said Jan. 27 she would seek an answer. None had been provided by the close of business yesterday. As Congress debates an $875 billion economic stimulus bill, the guarantees represent a less publicized commitment. The public’s stake has grown along with assurances tying the Treasury to the fate of corporate loans and securities backed by home mortgages, car loans and credit card debt.
“Guarantees are only meaningful if there’s a real chance that someone will have to pay out for them,” said Representative Alan Grayson, a Florida Democrat and a member of the House Financial Services committee that is reviewing the bailouts. “The conception that guarantees cost nothing is a misconception.” Obama promised a new era of government openness as he took office last week, issuing a statement telling agencies “to adopt a presumption in favor of disclosure” in responding to requests under the Freedom of Information Act. Treasury Secretary Timothy Geithner and Lawrence Summers, head of the National Economic Council, said they would emphasize accountability and transparency in using the second half of a $700 billion bank bailout fund. Late yesterday, Geithner’s office put hundreds of pages about the fund on the department’s Web site. They did not include documents describing the guaranteed assets.
Members of Congress from both parties have complained about the Bush administration’s lack of disclosure about the spending of the first $350 billion from the fund. “We have requested information in the past three months and have been rebuffed by the administration,” said Representative Scott Garrett, a New Jersey Republican and member of the House Financial Services Committee. “President Obama comes down the pike now, and maybe, in a week or a month, we’ll know.”
Last fall, the Federal Reserve declined to identify the recipients of about $2 trillion in emergency loans from U.S. taxpayers or the assets the central bank is accepting as collateral. Bloomberg News asked for details of the lending on May 21 and filed a federal lawsuit against the Fed Nov. 7 seeking to force disclosure. The loans were made under the terms of what became 11 programs in the midst of the biggest financial crisis since the Great Depression. Arguments in the suit may be heard by a judge as soon as next month, according to the court docket.
Bloomberg filed a FOIA request yesterday for the list of what was covered by the Citigroup and Bank of America guarantees. Bloomberg asked for records on the fees paid by banks to the government, which securities were rejected for guarantees, as well as any contracts for data services and experts to assess the value of the securities. Under the information law, passed by Congress in 1966, Treasury has 20 working days to respond to Bloomberg’s request. The measure allows nine exemptions, such as trade secrets or national security, for blocking disclosure. During his confirmation, Geithner, the former president of the Federal Reserve Bank of New York, didn’t directly answer a senator’s request for more information about Maiden Lane LLC, a special-purpose entity that holds assets from the takeover of Bear Stearns Cos. by JPMorgan Chase & Co.
“If confirmed, I look forward to working with you and with Chairman Bernanke on ways to respond to your suggestions and concerns,” Geithner said in a written response to the senator, Charles Grassley, an Iowa Republican. Geithner said it was important to keep details about loans in the portfolio confidential “in order to allow the asset manager the flexibility to manage the assets in a way that maximizes the value of portfolio and mitigates risk of loss to the taxpayer.” Lucy Dalglish, executive director of the Arlington, Virginia-based Reporters Committee for Freedom of the Press, said “People are trying to get a handle on where the money went and how it’s being used. One would hope that we’ll get to see something. Personally, I want to know what my tax dollars are being used for.” Consumer confidence fell in January to the lowest since records began in 1967, the Conference Board said Jan. 27. Home prices plunged 18.2 percent in November from a year earlier, the biggest drop since the data was started in 2001, according to the S&P/Case-Shiller index that covers 20 metropolitan areas.
Citigroup’s guarantee package, completed Jan. 16, totals $301 billion. It kicks in after the bank goes through its $9.5 billion in current loan loss reserves and the first $29 billion of losses. The government also gets $1 billion of the bank’s benefit from hedging contracts. The Treasury, the Federal Deposit Insurance Corp. and the Fed then assume 90 percent of losses from those assets. Citigroup’s guarantees include $191 billion of consumer loans, with $55.2 billion of them second mortgages, according to a Jan. 16 news release from the bank. Securities backed by commercial real estate total $12.4 billion and corporate loans add $13.4 billion.
Citigroup has received $45 billion in cash from selling preferred securities to the government under the Troubled Asset Relief Program.
Bank of America’s agreement, announced the same day, is similar: $20 billion in cash aid, bringing the total to $45 billion, and $118 billion in asset guarantees. The government said the assets included securities backed by residential and commercial real estate loans and corporate debt and associated derivatives and hedges. Scott Silvestri, a spokesman for the Charlotte, North Carolina-based bank, declined comment. Merrill Lynch & Co., which was bought by Bank of America, was the underwriter for $49.4 billion in defaulted collateralized debt obligations, the most of any bank, since October 2007, according to data compiled by Standard & Poor’s and Bloomberg. Merrill was the biggest CDO underwriter from 2005 to 2007, with more than $102 billion, said Sanford C. Bernstein & Co. research analyst Brad Hintz.
Since October 2007, Bank of America underwrote under its name $15.1 billion in failed CDOs, according to S&P and Bloomberg. Banks have so far understated losses on such securities, and “the tsunami is on the horizon,” Hintz said. Past sales of CDOs valued them at pennies on the dollar. In July, New York-based Merrill sold $30.6 billion of the securities to an affiliate of the Dallas-based investment firm Lone Star Funds for $6.7 billion. Merrill provided financing for about 75 percent of the purchase price, and the sale valued the CDOs at 22 cents on the dollar. “By June, it’ll become clear that these guarantees are being drawn and they’re going to be huge,” said Christopher Whalen, managing director of Institutional Risk Analytics, a financial-services research company in Torrance, California. “Every day that goes by, Congress figures it out just a little more.”
Give Back The Bonuses
It is refreshing to have a president capable of telling economic truths. On Thursday, Barack Obama called the nearly $20 billion to be handed out in Wall Street bonuses this year "the height of irresponsibility." He continued: "It is shameful. And part of what we're going to need is for the folks on Wall Street who are asking for help to show some restraint and show some discipline and show some sense of responsibility." Obama is dead right, not only on moral grounds but on business grounds, too. In fact, he didn't go far enough: Wall Street should give the bonuses back to American taxpayers, at least until investment banks begin to show a profit and have paid back every cent of welfare they've taken from the government.
Let's leave aside the broader argument that Wall Street's compensation structure—even in good times—is irresponsible, because it creates irrational incentives for executives and firms to create unproductive forms of wealth. Let's grant for purposes of this article that in normal times, Wall Street firms are companies that are accountable to their directors, partners, and shareholders, and therefore may reward their employees in any legal way they see fit. These are not normal times. There is not a single large brokerage firm in the United States that would be operating today as a going concern without massive and unprecedented aid from the government. Even those that haven't taken government funds are dependent on those that have. Indeed, in our new form of Wall Street socialism, the U.S. taxpayer is effectively a shareholder in the Wall Street firms, and I believe that any reasonable poll of us shareholders would show that we overwhelmingly don't want to pay our managers bonuses this year.
Of course, 2008 is hardly the first time that corporate bonuses have been out of whack with performance; the typical argument that corporations (especially on Wall Street) make is that talent is their principal asset and that failure to pay outlandish bonuses will cause talent to flee. The only way to make that argument work this year is to bend the meaning of the word talent into an unrecognizable cipher. Virtually every Wall Street employee works for a division of a bank that last year lost tons and tons of money. That's not talent; it's incompetence. Such "talent" is not an asset; employees who lose you money are a liability; when liabilities outweigh assets, you have bankruptcy, which is exactly where every Wall Street firm would be right now if not for government help.
Think of it this way: If half the employees of AIG (not technically a Wall Street broker, but a mega-insurance company that played fast and loose in the Wall Street arena) had lost their jobs in, say, January 2007, there is a high probability that AIG would have lost less money in 2008 than it did, and at least a reasonable chance that the government would not now own 79.9 percent of the firm. A very high proportion of Wall Street revenues go back to employees in the form of pay; get rid of some of your "talent," and you might well reduce your losses and dependence on the government dole. If that kind of live-by-the-market discipline seems harsh, well, it's precisely the way that Wall Street for decades has demanded that public companies—and even governments—conduct themselves.
Indeed, some investment firms have recognized that they have no business paying traditional Wall Street bonuses this year. UBS, after accepting nearly $60 billion in aid from the Swiss government, has announced that its bonuses will be 80 percent lower this year than last. Back in November, the top executives at Goldman Sachs also announced that they would receive no bonuses for 2008. This isn't to say that there aren't other ways to give Wall Street executives incentives to stay at their firms. If they want to give restricted stock grants—giving executives more equity in the company, redeemable after taxpayers have been paid back—few will object. It might even be acceptable to offer them cash bonuses in 2010 if they can get back onto solid ground this year. Until then, though, the banks should do with these bonuses what Citigroup was shamed into doing with its jet: reverse course. Give taxpayers back the bonuses, and get on with trying to salvage your companies.
It’s Theirs and They’re Not Apologizing
Getting between a broker and his bonus is like getting between a schnauzer and his lunch bowl. He may not bite you, but you are going to smell his breath. “People come here because they want to work hard and get paid a lot for working hard,” one investment banker said Friday as he wended his way, lunch bag in hand, through the World Financial Center. “I think there’s a disconnect between Wall Street and Main Street.” That certainly was the case this week when Main Street learned that, despite the craters of a down economy, Wall Street bonuses were more than $18 billion last year — roughly what they were in the fatty, solvent days of 2004. The media hollered, the president scolded, and ordinary people checked their wallets. But downtown, in the caverns of finance, the moneymakers shrugged and took it on the chin.
It is a complicated thing, they said, to apportion compensation in a bear market. First of all, profits do not stop; they often ebb. Second of all, losses move unequally, so the law of the jungle should still apply: you eat what you can kill. “My bonus is ‘shameful’ — but I worked hard to get it,” said John Konstantinidis, a wholesale insurance broker, lunching Friday at Harry’s at Hanover Square. “I’m a HENRY,” Mr. Konstantinidis added. “High Earner but Not Rich Yet.” Nonetheless, it was rather remarkable on Friday how many white shirts denied getting a bonus altogether when they were asked. Indeed, if the data obtained by reporters in the district was any measure, there is no telling where that $18 billion really went. What can be told, however, is that President Obama is substantially less popular on Wall Street this week than he was last week. Words like “outrageous,” “shameful” and “the height of irresponsibility” — especially when applied to a man’s paycheck — tend not to make you many friends.
“I think President Obama painted everyone with a broad stroke,” said Brian McCaffrey, 55, a Wall Street lawyer who was on his way to see a client. “The way we pay our taxes is bonuses. The only way that we’ll get any of our bailout money back is from taxes on bonuses. I think bonuses should be looked at on a case by case basis, or you turn into a socialist.” That, indeed, was a recurring equation: Broad strokes + bonuses = socialist. “It’s a very slippery slope to go down,” said another insurance broker as he waited to be seated for lunch at Cipriani Downtown. “A blanket statement like that borders on” — you guessed it — “socialism.” There were, of course, those downtown who were disgusted by the thought of this year’s bonuses, though they were mainly wage earners like Ashton Johnson, 32, a courier who was chatting outside the Stock Exchange with a buddy wearing a sandwich board reading, “We buy gold.”
“It definitely is ‘shameful,’ ” Mr. Johnson said. “With the fact that stock is going down, they shouldn’t be paid so much.” Meanwhile, around the corner, Larry Meyers and Gerard Novello, who work for an Italian securities firm, ducked into a Mexican cantina for a drink. It was Mr. Meyers’s 43rd birthday, and he ordered the tequila.
“On Main Street, ‘bonus’ sounds like a gift,” he said. “But it’s part of the compensation structure of Wall Street. Say I’m a banker and I created $30 million. I should get a part of that.” “There’s got to be a better term for it,” he added, turning to Mr. Novello. “Earned income credit?” he wondered aloud.
Obama administration says rescue plan 'on track'
An official in U.S. President Barack Obama's administration said on Saturday the announcement of a rescue plan for the financial system was running on schedule. "We are on track," the administration official said in response to a question about a CNN report the plan's announcement would take extra time due to its complex nature. The official said the administration had never announced a formal date for the roll-out of the plan to bolster the banking system and credit markets that have been battered by the collapse of the U.S. housing market and a spike in mortgage failures. The official declined to provide further details. A source familiar with the administration's thinking said the plan could be announced as early as next week.
But CNN, citing administration officials, said the announcement of the plan would be pushed into the second week of February as officials sort out details. "Administration aides are saying that they want to get the details right, that there are a lot of moving pieces, and so it's going to take an extra week," CNN said. Key lawmakers such as Democratic Representative Barney Frank are expected to meet with Obama over the next few days to discuss the financial services rescue plan, according to the source. One of their priorities is to ensure there is more transparency in how banks use the government funds, the source said.
Obama said earlier in the day the plan would be announced soon and would help lower mortgage costs for homeowners and spur the flow of credit to businesses and households. So far, about half the $700 billion of the Treasury Department's Troubled Asset Relief Program has been used up since it was rushed out late last year to tackle the crisis, and economists have said a lot more money may be needed to fund the next phase of the rescue. Mohamed El-Erian, chief executive of bond firm Pacific Investment Management Co, or Pimco, said a long delay in announcing the plan would be badly received by markets.
Rollout of rescue package delayed
After initially vowing to unveil a new financial rescue package this coming week, senior officials in President Obama's administration now say the rollout date is being pushed back an extra week. It is a sign of just how difficult it may be to craft such a massive plan -- especially while the White House is simultaneously trying to sell a separate $819 billion economic stimulus plan. Two senior administration officials told CNN Friday that the full rescue plan, which is being put together by Treasury Secretary Timothy Geithner and other top economic advisers, is now expected to be unveiled the second week of February.
But the officials held out the possibility that Geithner could start dribbling out some aspects of the rescue plan this coming week. In his weekly radio address Saturday, Obama said, "Soon my Treasury secretary, Tim Geithner, will announce a new strategy for reviving our financial system that gets credit flowing to businesses and families." Officials said the plan will include a crackdown on bonuses and other compensation for companies that receive federal bailout money. Obama lashed out this week at Wall Street firms that handed out more than $18 billion in bonuses last year, calling it "shameful" that they did that while teetering on bankruptcy and seeking federal handouts.
White House Senior Adviser David Axelrod told Bloomberg TV on Friday that "limiting some of this executive compensation" is important to help sell the broader financial rescue plan to the American people. That broader plan could include a so-called "bad bank" set up by the federal government to buy up troubled assets from faltering banks, according to the senior administration officials. The plan is also expected to include provisions dealing with the foreclosure crisis to help taxpayers restructure their mortgages to stay in their homes.
Crisis marks era of big government
The world is entering an era of big government with only state muscle powerful enough to fight the economic crisis, top leaders signalled at the Davos summit. News of mass job losses and fears of social unrest and protectionism reverberated around the gloomy halls of the World Economic Forum. But the absence of any senior member of President Barack Obama's US administration in the Swiss resort and nationalist rumblings in Washington left doubts about how closely the major powers will take up the battle together.
The 'go-go years' are over, admitted HSBC chairman Stephen Green talking for beleaguered bankers at the elite gathering. And Europe's main leaders made it clear that they want a greater grip on the international financial system. German Chancellor Angela Merkel proposed a UN economy council on the lines of the Security Council that kept squabbling nations apart after World War II. 'Freedom is a necessary precondition for market forces to operate,' she said in a speech which condemned 'unfettered markets'. 'Individual freedom needs to be limited if it takes freedom away from others.'
Britain's Prime Minister Gordon Brown called for a 'global regulatory system' with a toughened up International Monetary Fund and World Bank. Governments have already spent one trillion dollars bailing out banks, he reasoned. The government does not want to be a shareholder in banks but 'you cannot leave everything to the market', Mr Brown declared. Several ministers raised the spectre of dark days ahead. Police fought anti-forum demonstrators in Geneva and Bern and kept other protesters at bay in Davos, as Brazil's Foreign Minister Celso Amorim warned: 'For more vulnerable nations there is the threat of instability and social unrest with all its dire consequences.'
French Finance Minister Christine Lagarde said 'social unrest and protectionism are the two major risks of the world economic crisis. I think it's a risk in Europe, it's a risk elsewhere as well'. Nearly every prime minister and minister present vowed to fight protectionism. But with alarm bells ringing over a US Congress measure proposing that only US steel be bought with US stimulus package money, World Trade Organisation director general Pascal Lamy said there are already protectionist 'spots on the radar'. 'The more governments get involved in the market, the more probable that protectionist measures will come about and that is vicious circle,' said South Korea's Trade Minister Kim Jong Hoon.
The world is now waiting for a Group of 20 summit in April and world trade talks to send important signals about the intent of governments to work together to ease the pain of the crisis. The French finance minister said the world was 'working against the clock' to get proposals ready for the G20 summit in London. For most ministers the attitude of the United States will be crucial. China's Premier Wen Jiabao and Russian Prime Minister Vladimir Putin both took Davos pot shots at the US role in the causes of the crisis and the dominance of the dollar. There was no high ranking American in Davos to reply and little is known about what Mr Obama thinks about the global regulation advocates.
'I think the world is heading for an era of multi-lateral cooperation,' said Howard Dean, until recently the chairman of Mr Obama's Democratic Party who was in the Davos audience. 'There is going to be enormous pressure because of the direction of the economy, there are going to be politicians who appeal to nationalist interests which is always destructive'. 'But I think we are so inter-related now that I don't think you can avoid the conclusion that we have to work together.' Prof Robert Lawrence, professor of international trade at Harvard University, said the United States will be ready for more intense multi-lateral moves. 'But there is still going to be a very great reluctance to have those activities dominated by people whose votes don't reflect reality.' Ms Merkel's proposal for a UN economic council would ring 'negative bells' in the United States where the United Nations has a poor reputation, he said. -
Gordon Brown says: London is not 'Reykjavik on the Thames'
Gordon Brown mounted a spirited defence of his government’s economic record at the World Economic Forum in Davos yesterday, pointing to the country’s low inflation, low interest rates and low public debt. He dismissed suggestions that London was “Reykjavik on the Thames” and rejected the comments of Jim Rogers, the investor, who warned a few days ago Britain was finished. “You’re not going to build your policy around the remarks of self-interested speculators,” the prime minister said. Brown refused to say when he thought the global economy would pull out of recession, saying it was dependent on international co-operation and, in particular, the G20 summit on April 2 in London. He said it was important to avoid financial protectionism. Other business leaders and policymakers at Davos warned that economic recovery was unlikely before the end of the year.
Brown’s comments come as the Bank of England prepares to cut interest rates to a record low this week. The Bank’s monetary policy committee (MPC), which has cut rates from 5% to 1.5% since October, is expected by the City to reduce them further, to 1%, this week. This would mark a new low for rates in the Bank’s 315-year history, and some analysts think it will go further. Michael Saunders, an economist with Citigroup, predicted a reduction to 0.5% on the back of new gloomy forecasts from the Bank, set to be published in its quarterly inflation report later this month. However, the “shadow” MPC, which meets under the auspices of the Institute of Economic Affairs, believes rates have fallen far enough and the Bank should concentrate on other “unconventional” measures to boost the money supply.
For the second successive month, the shadow MPC has voted 6-3 to leave rates on hold, while calling for the Bank to introduce so-called quantitative easing. The majority on the committee said further rate cuts were futile because the key issue was the supply of money, not its price. Hope was expressed at Davos that the world economy could pick up by the year’s end. John Lipsky of the IMF said: “The economic news is going to be bad for a while, but we believe we can return the global economy to growth by the end of this year and towards trend growth during next year.”
Iceland on the Thames: Can Countries Really Go Bankrupt?
"There's a rumor going around that states cannot go bankrupt," German Chancellor Angela Merkel said recently at a private bank event in Frankfurt. "This rumor is not true." Of course she's right. Countries can go bankrupt if they allow their deficit spending to spin out of control and are no longer able to service their interest payments. Merkel's comments can be read as a warning that countries need to keep their deficit spending in check. The message is: If governments go too far in trying to bail out companies and the economy, they could face insolvency themselves. And so far, national governments have gone very far. Be it in the United States or in Europe, the sums governments are having to cough up to prevent the financial system from collapse are staggering.
Germany alone has already provided credit guarantees of €42 billion ($52.28 billion) to prevent the collapse of Munich's Hypo Real Estate, a bottomless pit that most now believe will have to be fully nationalized. The only thing holding up such a move is a legal provision in Germany that limits state holdings in banks to 33 percent. Meanwhile, Germany's second-largest consumer bank, Commerzbank, has been bailed out, with the state taking a one-quarter stake in the company. And the recent fourth-quarter loss of €4.8 billion at Germany's leading financial institution, Deutsche Bank, suggests that it too may ultimately require state assistance.
The image is even bleaker in the United States, where economist Nouriel Roubini estimates that losses in the financial sector will total $3.6 trillion. In the United Kingdom, the government has partially nationalized the Royal Bank of Scotland and Lloyds TSB -- and many experts see a full nationalization as inevitable. There are few who would disagree with such moves. Should large systemically-vital banks go bust, the global financial system would collapse. But how much can countries afford to pay before the deficit-spending bubble bursts? An unimaginable scenario? Less than a year ago, a nationalization of banks in the US, Germany and Britain would have been inconceivable. Today, even the US -- the home of unbridled capitalism -- sees these moves as inevitable. The borrowing being done by countries to finance the bailouts, economic stimulus programs and shortfalls in tax revenues will create a lasting burden. Worse, with the decline in the banking sector continuing, it is unclear that such massive spending will be effective. Especially when other, less economically stabile countires surrounding Germany have gone into a tailspin.
Take the example of Great Britain. The country is on the brink of financial ruin. Real estate is overvalued, private households are overly indebted and its vast financial sector has been badly hit by the crisis. Confidence in Britain's ability to overcome the economic turmoil is sinking by the day, as evidenced by the precipitous decline of the pound, which has almost reached parity with the euro. Just 13 months ago, it was worth €1.40. "I wouldn't invest any more money in Great Britain," says American investor Jim Rogers. And economist Willem Buiter, a former consultant to the Bank of England, warns of the "risk that Great Britain will become a second Iceland." One can also look to the example of Italy, which is on track to join a rather exclusive -- and undesirable -- club. At 106 percent of gross domestic product, Italy will have the third-largest national deficit in the world.
In a country that has long had a solid savings rate, deficit spending hasn't proven to be a huge problem in the past. The greatest challenge the government had was luring people to buy bonds at a set interest rate. The country's finance minister has described these investments as the "most solid and secure thing available." Of course, not everyone shares that opinion at the moment -- particularly not the Italians themselves. One bond that was floated in mid-January only found takers after the government markedly increased the interest rate offered. This year, Rome has to pay back €220 billion in short-term bonds. Finance officials have been quoted as saying that were a single bond issue to find no takers, it "would be a disaster for the state." In December, Italian Labor Minister Maurzio Sacconi warned that Italy could go bankrupt if the country were no longer able to sell public bonds because of the glut of offers in other countries. "It would create a liquidity problem for paying salaries and pensions and we would end up like Argentina."
Great Britain as a second Iceland, Italy as a second Argentina. Iceland today is as a good as bankrupt, and Argentina actually became insolvent in 2001. It's no wonder then, that quotes like that from government officials are making people nervous. There has been no other time in history since the end of the Great Depression that the risk of national bankruptcies was this great in Europe as it is right now. The national budgets in most of the European Union member states are in a miserable state. Finance experts at the European Commission in Brussels estimate that, this year alone, deficit spending in the 16-member euro zone will total 4 percent of GDP, with that figure rising to 4.4 percent next year. The euro Stability Pact, however, only allows 3 percent. The Commission estimates that in 2010, 17 EU states will surpass this total. The list includes countries like Germany (4.2 percent), France (5 percent), Spain (5.7 percent) and Britain (9.6 percent). Ireland is expected to top the list with deficit spending of an anticipated 13 percent.
These predictions, of course, exist only on paper for the moment. But Austrian Finance Minister Josef Pröll warns that "someday, payment day will come." Last week, Pröll and his colleagues formulated a call for a change of course, saying a coordinated fiscal stimulus was needed and that it must include a "coordinated budget consolidation" across Europe. Just how that might happen, though, is unclear. In a hearing before the economic affairs committee of the European Parliament last week, EU Economics and Currency Commissioner Joaquin Almunia was showered with questions for which he had few answers. As a first step, he suggested that six to eight countries should reduce their deficits. But he didn't suggest how they might go about doing that. For some governments, budget consolidation is the furthest thing from their minds at the moment. Instead these countries are doing everything they can to find ways of securing credit, which is getting increasingly difficult. "Smaller countries are being pushed out of the credit markets because the larger countries are borrowing billions," members of parliament told Almunia. His response: That's true, but you still can't "do away with capital markets."
In order to solve the problem, Luxembourg Prime Minister Jean-Claude Juncker, who is also his country's finance minister, proposed that the 16-member euro zone states should create common "Euro Bonds." Smaller countries praised the proposal, but it met with instant rejection in Berlin. Germany, so far, has been able to borrow cheaply because it still has an excellent credit rating. If the country were to fill its coffers by floating Euro Bonds, it would have to pay €3 billion more this year. Austrian Finance Minister Pröll also seemed uninterested, dismissing the Euro Bonds as giving carte blanche for creating new debt at the expense of others. Many European leaders have been critical of Germany's approach to the financial crisis -- it was slow to implement an economic stimulus package and some derided Chancellor Angela Merkel as "Madame Non." But in Germany, the government has been concerned about the risk of over-borrowing and burdening future generations with debt. The government has already abandoned its plan for a balanced budget by 2011, and Merkel has warned of the limits of Berlin's role in any bailout.
Merkel is concerned that the bailouts will overstrain the government. After all, if the government's debt continues to rise, at some point it will no longer be capable of paying the interest. Already, 2009's planned borrowing of €18.5 billion is higher than the previous year, and this week the government is now in the process of approving a second economic stimulus package that, combined with other borrowing, could push 2009 deficit spending past the €50 billion mark. No German government has ever had to borrow that much money. To ensure that future generations aren't saddled with massive debt, the plan contains a provision that will funnel €1 billion a year in revenues from Germany's central bank, the Bundesbank, that previously went into the government budget starting in 2011. Currently, the Bundesbank pumps €3.5 billion a year into the budget. Until 2012, any profits at the bank exceeding €3.5 billion would go toward paying down the growing national debt.
Most experts believe the German government still has room to maneuver, but further deficit spending may be inevitable and few know how much will be needed. Berlin may soon have to establish one or more so-called "bad banks" where troubled financial institutions can park their bad loans -- a program that would require yet further government borrowing. The government has exercised a degree of caution in deficit spending in recent years that has often been lacking in some other EU states. And politicians in Berlin have been reluctant to push through massive economic stimulus programs that might encourage others to abandon any sense of fiscal responsibility.
In the past, a handful of EU member states borrowed and borrowed without giving it a second thought. Now, they've been hard hit by the current downturn because their credit ratings have been lowered and they are being forced to borrow at higher interest rates. Spain, Italy, Ireland and Greece have been particularly hard hit. Countries that have to borrow so expensively are threatened with constantly rising interest rates that in turn increase their debt. In response, credit ratings agencies further lower ratings, pushing interest rates even higher in what becomes a vicious circle. Market speculators create additional pressures. The tensions could escalate even further and create a real test for the euro zone.
Iceland on the Thames: The Euro Safety Net
Prior to their adoption of the euro, countries like Italy, Greece or Spain simply devalued their currencies in troublesome times and lowered their interest rates to increase the export opportunities for their economies. As members of the euro zone today, however, this option is no longer available because of stringent budget rules in place to ensure the common currency's stability. The potential collapse of the euro zone has been a hot topic in financial market circles recently. One problem is that the euro treaty doesn't have provisions aimed at allowing highly indebted countries to voluntarily exit the common currency.
Even if it did, though -- any countries to leave the euro zone would simply exacerbate their problems. Their credit ratings would plummet further, loans would get more expensive. And old debts would have to be repayed in euros. If their own currency devaluated, that would get even more expensive. Germany's EU commissioner, Günter Verheugen, considers the debate over exiting the euro to be "purely cheap propaganda against the euro from speculators in the Anglo-American capital markets." But what would actually happen if a euro zone member state went bankrupt? During the next 24 months, for example, Greece will have to come up with €48 billion in order to service old debts, while at the same time plugging holes in its budgets.
If a country like Greece became insolvent, it would be initially be spared of the worst consequences of bankruptcy because of its membership in the euro zone. The euro would lose some of its value, certainly, but the Greek economy doesn't play huge role in Europe and the depreciation would be limited. The consequences for Greece would also be limited. Because the currency would remain relatively strong, there would be no crisis in the retail sector, there wouldn't be any consumer hoarding and no black market -- in other words, it wouldn't create an economic crisis any greater than the one that would already exist. Nor would it lead to an increase in unexmployment. Under the protective shield of the European Union, life in a bankrupt state would be relatively comfortable. The more important question, though, is how the EU would react.
One scenario is that it could declare Greece to be an exceptional case and provide bridge loans in order to prevent the bankruptcy. But it would have disastrous consequences. After all, why would weak countries make any effort to balance their budgets if they knew the EU would bail them out in the worst-case scenario? If the EU remained firm against Greece, that would certainly be fair to the member states who have practiced balanced budget discipline in the past. But that would also be politically untenable because it would drive investors away from any country that showed even the slightest signs of not being able to service its debt. They would have to continue raising the interest rates on bonds, and eventually the Greek virus would spread further, driving other countries into bankruptcy. In this highly theoretical scenario, the euro would, indeed, collapse. The currency could survive the bankruptcy of one member state, but it couldn't sustain a series of them. Euro-skeptics have long warned that tension inside the euro zone could destroy the currency one day. They now feel their convictions have been affirmed -- even if the aforementioned scenarios remain far from reality.
Germany itself has little trouble getting money. But even here, in light of the multibillion euro shortfalls in the national budget, investors are slowly starting to get nervous about German bonds. Many uncertain investors are starting to ask "what the future looks like for countries with AAA ratings," says Moody's analyst Alexander Kockerbeck. Experts at the US ratings company are already feeding worst-case scenarios into their computers. In one, they input test data for 2010 and 2011 assuming the economy would shrink by 3 percent each year. In that model, the national deficit rose quickly from today's close to 70 percent to 80 percent of GDP. "The interest burden would be around 7 percent of government revenues," Kockerbeck said, saying Germany could still manage to preserve its high credit rating. But if that figure got up to 10 percent, the country might lose the best rating, causing its financing costs to soar. Competing ratings agency Standard & Poors, which last week cut Spain's rating, holds a similar view. Analyst Kair Stukenbrock last week confirmed Germany's AAA rating. He also said he currently "assumes that the German economy and government budget can weather the current financial crisis without losing its credit worthiness."
In normal times, assuming a country has a solid credit rating and a good economy, borrowing is routine. Germany routinely floats short- and long-term bonds that pay interest. They can have a duration from anywhere between one day and 30 years. But some other countries, including Spain and France, even issue 50-year bonds. They are mostly sold through auctions -- and the higher the price, the cheaper it is for countries to borrow, but that also reduces profits for investors. Repaying that debt is far more complicated. In the simplest case, the country just pays back the debt. It's extremely rare, of course, for a country to do that. In most cases countries renew their debt rather than repay it -- and by doing so they create new debt. Already today, the German government must pay €43 billion a year in interest. It's the second-biggest chunk in the federal budget after social expenditures.
But that could quickly change. If, for example, interest rates were to rise to their 1995 levels, the country would be faced with an additional €20 billion in payments, and that's without factoring in any new debt. Of course, given the nature of the current crisis, the debt burden will rise. Nobody knows how high, nor how the country can eliminate that debt before it starts to get strangled by interest payments. One way to pay down debt, of course, is massive spending cuts and austere savings probrams. That, though, is difficult. Much more attractive is the inflation route. The state can just print money and pay its bills. Or the central bank prints money and pumps it into the economy. The currency becomes devalued, but the state doesn't care because that makes it easier to pay off its debts. No matter how a country elects to pay down its debt, it's the taxpayers who are left to foot the bill in the end. Indeed, the only time it is possible to repay the deficit by government savings is during boom phases, periods when the government can increase taxes, or if it can reduce its expenditures.
The people also pay the price of inflation because as the currency get devaluated, prices increase. Up until now, the process has been subtle. Since the end of the 1990s, the major central banks in the US and Europe have trippled the volume of money in circulation. In recent months, the volume of money in circulation in the US and Europe has increased by almost half. Central banks are trying to use the flood of liquidity to prevent a collapse of the global financial system and, as a result, of economies. At the same time, they may also be laying the path for the next crisis. Money is already insanely cheap: the US Federal Reserve has sunk its key interest rates to almost zero, and the European Central Bank is already down to 2 percent. It is extremely likely that interest rates will be lowered even further.
But if the bailout packages take effect and the economy starts to rebound, then central banks will again raise interest rates -- otherwise we would be threatened with a massive wave of inflation and the next, even worse crisis, would be inescapable. But the move may also lead many highly indebted countries to go bankrupt. In a study for the International Monetary Fund, US economists Carmen Reinhart and Kenneth Rogoff researched financial crises of the last 800 years and concluded that state bankruptcies were a "universal phenomenon." Many countries have, in fact, gone bankrupt more than once. Between 1500 and 1800, France became insolvent eight times. Spain went bankrupt seven times during the 19th century. Insolvency is a common phenomenon in every period of history, they concluded, and it would be erroneous to think that state bankruptcies are a "distinctive feature of the modern financial world."
Iceland on the Thames: Nothing Is Unimaginable Anymore
In most cases the country's coffers were wiped out by war. But in each case, the countries managed to bring themselves back from ruin. They proved to be incredibly resourceful in using their connections to banks, companies and, especially, the people. The simplest solution was for states to just outright refuse to pay back their debts. In 1557, Spain's King Philipp II refused to pay his country's debts after its expensive military battles against the Dutch and the Ottomans. It was a decision that seriously damaged lender banks in Augsburg, Germany, and they never fully recovered. Even after the Revolution, France's new regents had an even more extreme answer. They expropriated property from churches, major landowners and executed some lenders.
A similarly brutal option was to go to war to in order to plunder occupied areas. But such methods of budget consolidation tended to only happen when things started to collapse. Even in the old days, inflation was the preferred method of dealing with debt. They created more money and devaluated it. It's a method that was adopted as early as ancient Rome, where the Romans devaluated their coins by using fewer precious metals in them. It became a standard practice. In Vienna, the silver content in the Kreuzer coin was reduced by 60 percent between 1500 and 1800 and the Ausgburg pfennig lost more than 70 percent of its value. Once paper money was introduced, the process was further simplified, since you could just print it. The first country to start printing money on a grand scale was France in the 18th century, when it needed to pay off the mountain of debt accrued by Louis XIV. In times of crisis, French governments ever since have fallen for this temptation.
In 1914, with the start of World War I, the German Reich also began to unpeg its currency from gold. Until then, anyone could trade paper money for precious medals. Unpegging the currency meant that the amount of money in circulation rose from 13 to 60 billion marks by the end of the war, while the products on offer were reduced by one-third. Prices skyrocketed. The disastrous development reached its peak in 1923 with hyperinflation. The exchange rate at the time was 4.2 trillion marks to the dollar. Bank notes were printed in 130 private printing presses, often on one side only to save ink. The only thing that could stop the mass devaluation was to change currencies.
In November 1923, the government issued the so-called Rentenmark. The previous currency could be exchanged at a rate of 1 trillion marks for 1 Rentenmark. Inflation quickly stopped. People spoke of the "miracle of the Rentenmark." But the truth is that it wiped out the savings and investments of large swaths of the German middle class as well as wealthy people who had been forced to finance the war by buying government bonds that had now been rendered worthless. Banks and insurance companies also lost their capital. The greatest winner, besides people who had loans or mortgages they no longer had to pay back, was the government. Its war debt shrank into insignificance.
These traumatic events remain a part of the Germany's collective memory and they fuel a latent fear of hyperinflation here today. Should people be afraid? For the moment they don't need to be. Compared to many other countries, Germany is well positioned to ride out the crisis. The economy in recent years has been a lot stronger than other EU members and it is not as dependent on the financial sector as Great Britain. And unlike the United States, it isn't dependent on foreign lenders. Iceland, for its part, is already as good as bankrupt. In Eastern Europe, a number of countries are wobbling -- Latvia has already had to request aid from the IMF and the Eastern European Development Bank. In the capital city of Riga, 40 people were injured in a violent protest that took place on Jan. 13.
Great Britain is also in trouble. And if it weren't for the protection that their membership in the common currency provides them with, some euro zone countries would be fighting for financial survival right now. America, on the other hand, is banking on the fact that it is still considered stabile despite it's enormous problems -- and that the Chinese still hold a huge chunk of their currency reserves in US bonds. So will things get better? It would be an illusion to believe that countries have learned from their past mistakes, US economists Reinhart and Rogoff warn. In fact, another state could go bankrupt at anytime and take its people down with it. In this crisis, nothing is unimaginable anymore.
Riots in Riga
Isolationists are now going global
When Democrats wrote a "Buy American" clause into President Obama's economic rescue plan, to ensure that the $825bn of fiscal stimulus is only spent at home, they thought they were doing US business a favour; but this weekend the White House said it was rethinking the idea, after alarm from US multinationals, including General Electric, fearing a potential backlash in their lucrative overseas markets. As Obama is quickly learning, protectionism has a powerful populist appeal, but in the complex and interdependent global economy of the 21st century, it could cause devastating collateral damage on his own doorstep. Baroness Ashton, the EU trade commissioner, quickly responded to the US move last week by saying Europe would not "stand idly by" and watch its firms shut out of the spending bonanza - sparking fears of a major transatlantic trade war.
As recession claims a growing number of victims worldwide, pressure is rising for governments everywhere to throw up walls around their economies. Angry workers staged wildcat strikes in the UK on Friday over an oil company's plans to give jobs to foreign construction workers, while in France, more than a million ordinary workers went on strike last week to protest that they, and not just the banks, should benefit from President Sarkozy's bail-outs. Ostensibly, the industrial action - which later sparked rioting - was not against foreign workers nor imports, but the protesters made clear that they felt they deserved government support more than the banking elite.
For many people, tariffs making imported goods prohibitively expensive to help domestic industries seem like a good idea. Howard Wheeldon, senior strategist at BGC Partners, says: "For the public, protectionism is what you want to see. Deep down, if you ask people, they think it's the rest of the world which is causing the problem and if the barriers are put up, all will be well." At Davos last week, politicians pleaded for co-operation. "Protectionism protects nobody," Gordon Brown told the World Economic Forum annual shindig. "This is the time for the world to come together as one." Wheeldon says such pleas are counterproductive. "The more one hears politicians and others air their views of protectionism, the more the issue creeps into the rest of the mind," he says.
Besides, you can hardly blame people for thinking in these terms: these same politicians, after all, started us down the protectionist path when they announced their own bail-outs. Many of the bail-outs unveiled for industry, particularly carmakers, have been dressed up as packages to help them meet new stringent environmental laws. In Europe, this is partly because competition law forbids governments from granting long-term state aid unless it leads to technological advances. In fact, any state support of domestic businesses could be seen as protectionist if it gives them an advantage over foreign competitors.
As Philip Shaw, chief economist at stockbroker Investec, says: "It's very difficult to know where to draw the line between governments giving their own economies and industries incentives and trade protectionism. If a government is running a large budget deficit, but still cuts corporation tax, is that protectionism?" Even Brown is guilty. In the UK, the bailed-out banks have been ordered to rein in their lending overseas. According to the Bank for International Settlements, foreign assets of UK-owned banks stand at 145% of UK GDP, which is well above the level for other major economies. Now that these banks, and all their liabilities, are effectively owned by the state, it's not surprising the government wants them to reduce their exposure to losses from lending overseas.
Citigroup analysts warn: "While it may be tempting for governments and central banks to encourage their banks to retreat to their home countries, the collective effect would be to further undermine the collective supply of credit and hence deepen the downturn." The analysts say the UK economy would be a big casualty were this to happen: foreign banks provide a quarter of lending to the private sector. Whatever the politicians, strikers and protestors may think, economists agree that full-blown trade barriers would be disastrous, restricting global trade just when we need to encourage it. Shaw says: "Given the impact of the credit crunch, the global economy needs a drop in international trade like a hole in the head."
If We Buy American, No One Else Will
World trade is collapsing. The United States trade deficit dropped sharply in November as imports from the rest of the world plummeted in response to the financial crisis and global recession. United States imports from China, Japan and elsewhere declined at double digit rates. The last thing the world economy needs is for governments to give a further downward shove to trade. Unfortunately, we may be doing just that. Steel industry lobbyists seem to have persuaded the House to insert a “Buy American” provision in the stimulus bill it passed last week. This provision requires that preference be given to domestic steel producers in building contracts and other spending.
The House bill also requires that the uniforms and other textiles used by the Transportation Security Administration be produced in the United States, and the Senate may broaden such provisions to include many other products. That might sound reasonable, but history has shown that Buy American provisions can raise the cost and diminish the effect of a spending package. In rebuilding the San Francisco-Oakland Bay Bridge in the 1990s, the California transit authority complied with state rules mandating the use of domestic steel unless it was at least 25 percent more expensive than imported steel. A domestic bid came in at 23 percent above the foreign bid, and so the more expensive American steel had to be used.
Because of the large amount of steel used in the project, California taxpayers had to pay a whopping $400 million more for the bridge. While this is a windfall for a lucky steel company, steel production is capital intensive, and the rule makes less money available for other construction projects that can employ many more workers. American manufacturers have ample capacity to fill the new orders that will come as a result of the fiscal stimulus. In addition, other countries are watching closely to see if the crisis becomes a general excuse for the United States to block imports and favor domestic firms. General Electric and Caterpillar have opposed the Buy American provision because they fear it will hurt their ability to win contracts abroad. They’re right to be concerned.
Once we get through the current economic mess, China, India and other countries are likely to continue their large investments in building projects. If such countries also adopt our preferences for domestic producers, then America will be at a competitive disadvantage in bidding for those contracts. Remember the golden rule, or the consequences could be severe. When the United States imposed the Smoot-Hawley Tariff in 1930, it helped set off a worldwide movement toward higher tariffs. When everyone tried to restrict imports, the combined effect was a deeper global economic slump. It took decades to undo the accumulated trade restrictions of that period. Let’s not make the same mistake again.
Protectionism is a dangerous road to walk - remember the Thirties
One lesson policymakers have learned from the past is that protectionism is dangerous. But the big question is whether their good intentions will be enough to prevent a pulling up of national drawbridges. The Smoot-Hawley Tariff Act has been hovering like a spectre over the meeting of the world's economic elite at Davos; in the 1930s, the US raised tariffs on thousands of goods, which exacerbated the Great Depression and arguably paved the way to the Second World War. It's an accepted truth that protectionism, with countries implementing measures to safeguard their own domestic businesses and workers, can turn a recession into a depression.
The problem is that, from Barack Obama downwards, political leaders are confronting a global crisis, but have only national tools at their disposal to fight it. And however much they believe in free trade, they are accountable to voters at a national level, who want to see their leaders putting domestic interests first. The risk is that politicians, however well intentioned, will find it impossible not to succumb to nationalist and protectionist rhetoric. This is not idle, chin-scratching speculation. A million French workers staged a one-day strike on "Jeudi Noir"; there have been demonstrations in Greece and Latvia; in the UK, wildcat strikes spread from Lincolnshire to Wales and the north-east over the arrival of foreign workers at the Lindsey oil refinery, near Grimsby. In a sinister overtone, the far-right British National Party is sounding jubilant.
The protests at the refinery are not surprising - in fact, I'm slightly surprised there have not been more episodes like this before now. The benefits of globalisation went primarily to capital, not to labour; workers in the UK and other developed countries have been under pressure for some time from low-wage economies. In times of prosperity, being undercut by poorly paid overseas competition is an irritant, but one that people lived with; now reactions are more atavistic and tribal. Demonstrations over foreign labour are likely to increase. Responses from governments have been contradictory; politicians don't want to stoke protectionism, but they do want to placate their electorates. Gordon Brown warned on Friday against protectionism and a retreat from globalisation, yet it is his jingoistic talk about "British jobs for British workers" that strikers have embraced.
The new US treasury secretary Tim Geithner has ratcheted up tensions with the Chinese, accusing Beijing of manipulating the currency to stimulate exports, yet vice-president Joe Biden has defended a "Buy America" steel provision in the economic stimulus bill. French finance minister Christine Lagarde, mindful of protesters on the streets of Paris and Marseille, has called for a temporary period of protectionism to shield consumers and firms against market risks, until new global regulations can be agreed. World trade has already contracted sharply, but it is not the erection of old-style barriers against imported goods that is the main worry. The real fear is of financial protectionism, an insidious new variant. As European Central Bank president Jean-Claude Trichet warned in Davos, the pressure on banks to hoard capital is making the recession worse by stopping the flow of funds to businesses.
Government bail-outs, whether of banks or of other industries, such as car manufacturing, may also be ushering in financial protectionism by the back door; the Russians have already accused America of this, saying the fiscal stimulus is leeching liquidity away from the rest of the world. A nationalistic element has been implicit in the UK bank bail-outs, where they have been told to shrink their balance sheets and concentrate on boosting lending to British customers. Although it has not been spelled out, the implication is that they should scale back drastically on activities overseas - an impression reinforced by Brown's outburst against Sir Fred Goodwin, the former Royal Bank of Scotland chief, for reckless lending to the likes of Russian tycoon Leonid Blavatnik.
There are likely to be instances of banks in receipt of taxpayers' money being called upon to do their patriotic duty: there is one such controversy on Teesside, after work was moved from the Haverton Hill shipyard to Singapore, putting 800 jobs at risk. Local MP Frank Cook suggested the contract collapsed because Lloyds TSB, which was bailed out with billions of pounds of public money, is unwilling to maintain backing. Crises lead inevitably to introspection and to a concentration on putting one's own house in order; banks will inevitably focus their limited resources at home. They have been told to shrink their balance sheets and concentrate on boosting lending to British customers.
Financial protectionism cuts both ways, however, and the UK is particularly vulnerable, since we rely on overseas banks for about a third of our personal borrowing. The exit of banks from Iceland, Ireland and elsewhere is leaving a large funding gap, threatening mortgages and businesses, and putting the domestic players under even more pressure. The City could lose heavily from financial nationalism, as it has always been outward-looking, much more so than Wall Street. If Britain is suffering from this repatriation of funds, some emerging economies are feeling far greater pain. Russia, which relied heavily on foreign investment flows, has been hard hit; capital flows to developing markets overall will drop to £116bn this year, around a fifth of their level two years ago, according to the Institute for International Finance.
The west has a moral responsibility not to turn its back on emerging markets, particularly those which have followed our economic prescriptions, now the climate is harsh. If we are looking to even out the global imbalances that have contributed to the credit crunch, we need financial markets to be deep, broad and open. There is no easy answer to the threat of protectionism; the only consolation is that so far, governments are making the right kind of noises and no one has done anything really provocative. It would be a brave person who is prepared to bet on that continuing, since the temptations to put immediate self-interest over trust are both strong and persistent. What the 1930s should have taught us, though, is that it is worth prioritising the greater good, because the alternative is unthinkable.
Canada optimistic it will be exempted from "Buy America"
Canada, America's top trading partner, is cautiously optimistic it will be exempted from protectionist provisions in the economic stimulus bill moving through the senate that call on major public works projects to favor U.S. iron, steel and manufactured goods over imports, Canada's international trade minister said Saturday. Canada and other U.S. trading partners warn that favoring U.S. companies would breach Washington's trade commitments and could set off a retaliatory trade war.
Canadian International Trade Minister Stockwell Day voiced strong objections when he met with interim U.S. trade representative Peter Allgeier at the World Economic Forum in Davos, Switzerland, this weekend. U.S. President Barack Obama does not have a trade representative yet, but was represented by Allgeier, a Bush administration holdover who served as ambassador to the World Trade Organization. Former Dallas Mayor Ron Kirk, Obama's nominee for U.S. trade representative, is awaiting Senate confirmation.
"Following the discussions I've had, and with the interventions we've made on a number of levels I'm cautiously optimistic that something can be worked out," Day said in a conference call with reporters on Saturday. Day said Allgeier was very much aware how big of a concern it is to Canada. He said the president has certain abilities to waive parts of the legislation if they go against the obligations of the North American Free Trade Agreement — which links the U.S., Canada and Mexico — and other international pacts aimed at liberalizing world trade.
"They are looking for ways to handle our concerns," Day said. "The administration is very aware. There seems to be a desire to do something to mitigate the effects of the legislation going through, if it does go through." Asked about the protectionist provisions Friday, White House press secretary Robert Gibbs would say only that the administration was reviewing them. The provisions are likely to find support among Americans outraged that money from a stimulus package likely to top $800 billion could go to foreign competitors of U.S. companies.
The U.S. House of Representatives passed the $819 billion stimulus bill on Wednesday that included "buy American" provisions that would call on major public works projects to favor U.S. steel and iron. Canada's trade minister noted the Senate is considering expanding the measure to include manufactured goods, a more far-reaching provision. The proposed Senate provision states that none of the funds may be used for a project "unless all of the iron, steel and manufactured goods used in the projects are produced in the United States."
Day said the provisions in the stimulus bill are similar to the U.S. Smoot-Hawley Act of 1930, a tariff law which he said had exacerbated the Great Depression of the 1930s. "In a time of global downturn countries should not be lapsing backwards into protectionist activity. That only results in other countries then wanting to put up barriers and the last thing we need now is a retaliatory trade war," Day said. U.S. trade with Canada totaled about $560 billion in the first 11 months of last year, well ahead of trade with second-place China, which was about $379 billion in the January-November period.
Canada and the EU are waiting to see if the measure is included in the final economic-recovery package that is expected to emerge from the Senate next week. Democratic leaders have pledged to deliver it to the White House for Obama's signature by mid-February. Obama is scheduled to make his first foreign trip as president to Canada on Feb. 19. Day said it is a major issue for Canadian Prime Minister Stephen Harper. "If it's not resolved by the time the president arrives here, I just know how concerned our PM is on this," Day said.
Unions: Labour was warned about jobs for foreigners
The government was warned five years ago that European laws governing the employment of foreign workers in the UK would result in the current industrial unrest sweeping the country. The revelation comes amid fears that the row is playing into the hands of the far right and claims that similar strikes could affect other key projects. The disruption has come back to haunt the prime minister, Gordon Brown, who in 2007 - in his first speech to the Labour party as its leader - promised to bring in "British jobs for British workers". The former Labour minister Frank Field last night called on Brown to make an emergency statement to parliament tomorrow. Field wants a new law to compel companies operating in the UK to offer contracts to domestic workers first. "We have got to get ahead of this debate rather than react to it," Field said. "Unless we do, we are supplying oxygen to the BNP."
Jon Cruddas, the Labour MP for Dagenham, said there was a real risk that "prestige projects", such as the 2012 Olympics, would be hit by similar protests unless ministers acted. At the last count, only 63% of workers on the Olympics site were British. "If the government is planning big infrastructure projects to keep the economy moving - including the Olympics - this needs to be resolved now, because it is in the construction and engineering sectors where these issues are most acute," Cruddas said. Last night the Unite union demanded urgent talks with Brown. It called for the government to ensure contractors on public infrastructure projects agreed to sign new corporate social responsibility clauses that will ensure free access for local labour. "If the government can bail out the banks, it can deliver a level playing field for engineering and construction workers in the UK," said Derek Simpson, joint general secretary of the union.
The prime minister's spokesman said the government would hold talks with the construction industry in the next few days "to ensure they are doing all they can to support the UK economy". When asked about the growing unrest, Brown - speaking from the World Economic Forum in Davos, Switzerland - said he "understood" people's worries. In an interview with the BBC's Politics Show to be broadcast today the Prime Minister condemned those threatening wildcat strikes, saying "that's not the right thing to do and it's not defensible." He also said that when he had talked about British jobs for British workers he was referring to "giving them the skills" so that they could get jobs that were going to foreigners. As the row threatened to become increasingly xenophobic, the business secretary, Lord Mandelson, warned it should not jeopardise the UK's relationship with Europe. "It would be a huge mistake to retreat from a policy where, within the rules, UK companies can operate in Europe and European companies can operate here. Protectionism would be a surefire way of turning recession into depression."
This weekend the conciliation service, Acas, was continuing to try to calm the crisis that has seen workers at oil and power plants up and down the country stage unofficial protests in support of employees at the Lindsey refinery at North Killingholme. Lincolnshire. They are protesting at a decision by the refinery's owner, Total, to hand a £200m construction contract to the Italian company Irem, which employs only Italian and Portuguese workers on the site. Similar protests have been made at two other construction projects -a refinery in Staythorpe, Nottinghamshire, and a power station on the Isle of Grain, Kent. In both cases, contractors working on behalf of foreign firms have said they will not use local labour. Further industrial unrest is likely this week. Tomorrow, workers at Sellafield will consider a walkout. Labour MPs are to table a Commons motion demanding changes to the law to prevent foreign companies undercutting national agreements negotiated by unions on behalf of British work forces.
Colin Burgon, Labour MP for Elmet, said that, if the law remained as it was, "there is going to be social unrest". It has emerged that unions negotiating the 2004 Warwick agreement - the manifesto commitments made by Labour to the unions in return for financial backing - warned ministers that EU laws were being used to preclude domestic workers from applying for jobs in the UK. The unions told the government that the way it had introduced the EU's "posted workers directive" - which guaranteed rights for temporary workers in EU countries - was being circumvented by foreign construction and engineering companies operating in the UK. The 1996 directive was introduced in the UK in 1999 via a series of minor amendments to the Employment Relations Act.
The unions told the government it had missed an opportunity to introduce comprehensive laws in the spirit of the directive that would guarantee a level playing field for all workers by barring the sort of exclusive practices that have triggered the current protests. "We raised these fears with the government at the time of the Warwick agreement in 2004 and they now need to get on with resolving it," said Paul Kenny, general secretary of the GMB union. A series of recent rulings by the European Court of Justice has also raised fears the directive is being interpreted in a way that undermines the rights of EU member states' domestic workers. Adolfo Urso, Italy's undersecretary for economic development, yesterday claimed the protests "are the product of an ignorance which verges on racism". Italian and Portuguese workers at the centre of the row are said to be in fear for their safety as they remained on board a barge in Grimsby docks.
How will Sarkozy respond to workers' show of strength?
To demonstrate against a recession may look quaintly French. All the same, the more militant British union leaders could have been forgiven for staring jealously across the Channel last Thursday. Some 2.5 million people marched in union rallies to protest against the global crisis and demand more efforts from the Sarkozy government to defend jobs and boost wages. Question: why are the French unions so powerful and militant? Answer (or at least one possible answer): they are militant because they are NOT powerful. Here is one of the great conundrums of French public life.
France has one of the lowest percentages of trade union membership in Europe. Just 9 per cent of its 25 million wage earners are in a union (only 6 per cent in the private sector), against 29 per cent in Britain and 27 per cent in Germany. French trade unionists do not belong to one federation, like the TUC. They are divided among eight mutually loathing federations with different political perspectives and industrial strategies, ranging from the moderate Catholic federation, the CFTC, to the fiercely anti-capitalist SUD. Several of these detest the idea of competition as an economic principle, but they engage enthusiastically in perpetual political competition with one another to appear more effective, or more militant, than their rivals.
French unions are best seen, perhaps, not as trade-based unions on the UK model, but as political parties of the workplace. Their influence depends not just on how many members they have but on how many employees vote for them in industry-wide elections and how many people obey their calls to strike or march. It is these rivalries that make French industrial relations such a bear-pit, especially in the state sector – not the "strength" or solidarity of the unions but their fragmentation. So last Thursday's march was first and foremost a political show of strength by the sprawling trade union movement, as well as an act of political awakening by a Left that has been humiliated by a right-wing President, who cheerfully steals left-wing ideas and poaches its politicians.
It was also an internal display of strength by the federations as they approach industry-by-industry elections in March. The placards on the Paris march called for everything from higher wages, to the replacement of all temporary contracts with permanent jobs, to the outright abolition of capitalism. Worryingly for President Sarkozy, the marches occurred before the global recession has even begun to bite deeply. Even more worryingly, the moderate federations are calling on him to throw more billions on to the "demand" side of the economic scales by allowing large pay rises. The President's strategy in his €26bn (£24bn) anti-crisis package has been to boost "offer" by public works and, for example, underwriting credit for the purchase of cars or aircraft. Can he afford to boost both offer and demand? Judging by Thursday's demos, can he afford not to?
Italy bans kebabs and foreign food from cities
The tomato comes from Peru and spaghetti was probably a gift from China. It is, though, the “foreign” kebab that is being kicked out of Italian cities as it becomes the target of a campaign against ethnic food, backed by the centre-right Government of Silvio Berlusconi. The drive to make Italians eat Italian, which was described by the Left and leading chefs as gastronomic racism, began in the town of Lucca this week, where the council banned any new ethnic food outlets from opening within the ancient city walls. Yesterday it spread to Lombardy and its regional capital, Milan, which is also run by the centre Right. The antiimmigrant Northern League party brought in the restrictions “to protect local specialities from the growing popularity of ethnic cuisines”.
Luca Zaia, the Minister of Agriculture and a member of the Northern League from the Veneto region, applauded the authorities in Lucca and Milan for cracking down on nonItalian food. “We stand for tradition and the safeguarding of our culture,” he said. Mr Zaia said that those ethnic restaurants allowed to operate “whether they serve kebabs, sushi or Chinese food” should “stop importing container loads of meat and fish from who knows where” and use only Italian ingredients. Asked if he had ever eaten a kebab, Mr Zaia said: “No – and I defy anyone to prove the contrary. I prefer the dishes of my native Veneto. I even refuse to eat pineapple.”
Mehmet Karatut, who owns one of four kebab shops in Lucca, said that he used Italian meat only. Davide Boni, a councillor in Milan for the Northern League, which also opposes the building of mosques in Italian cities, said that kebab shop owners were prepared to work long hours, which was unfair competition. “This is a new Lombard Crusade against the Saracens,” La Stampa, the daily newspaper, said. The centre-left opposition in Lucca said that the campaign was discrimination and amounted to “culinary ethnic cleansing”. Vittorio Castellani, a celebrity chef, said: “There is no dish on Earth that does not come from mixing techniques, products and tastes from cultures that have met and mingled over time.”
He said that many dishes thought of as Italian were, in fact, imported. The San Marzano tomato, a staple ingredient of Italian pasta sauces, was a gift from Peru to the Kingdom of Naples in the 18th century. Even spaghetti, it is thought, was brought back from China by Marco Polo, and oranges and lemons came from the Arab world. Mr Castellani said that the ban reflected growing intolerance and xenophobia in Italy. It was also a blow to immigrants who make a living by selling ethnic food, which is popular because of its low cost. There are 668 ethnic restaurants in Milan, a rise of nearly 30 per cent in one year. The centre Right won national elections in April last year partly because of alarm about crime and immigration. This week there was a series of attacks on immigrants in bars and shops after the arrest of six Romanians accused of gang-raping an Italian girl in the Rome suburb of Guidonia.
Filippo Candelise, a Lucca councillor, said: “To accuse us of racism is outrageous. All we are doing is protecting the culinary patrimony of the town.” Massimo Di Grazia, the city spokesman, said that the ban was intended to improve the image of the city and to protect Tuscan products. “It targets McDonald’s as much as kebab restaurants,” he added. There is confusion, however, over what is meant by ethnic. Mr Di Grazia said that French restaurants would be allowed. He was unsure, though, about Sicilian cuisine. It is influenced by Arab cooking.
UK lenders are demanding 50% deposits on new homes
If you thought it was difficult getting a standard mortgage just now, then try getting one for a newly built home. Banks and building societies already require buyers to pay large deposits to secure a second-hand place. Yet they want you to pay even more up front when purchasing a brand new property. The problem has deepened over recent weeks because of the growing economic crisis. Some mortgage providers will not lend on a recently constructed place, full stop. Those that do, ask for up to a 50% deposit. Buyers may therefore need a mammoth £100,000 down-payment on a £200,000 home. In theory, plummeting house prices should make buying a home more affordable but not if you require a sky-high deposit, meaning first-time buyers are worst hit.
"First-time buyers often relied on buying new homes," says Richard Morea, from mortgage broker London & Country. "The current criteria make it even harder for them." Housebuilders agree, claiming there is still demand for new homes. "People still want to buy but they can't get funding," says Steve Turner, from the Home Builders Federation. "First-time buyers, especially, are being driven away. A 50% deposit is not feasible for many." West Bromwich building society raised the minimum deposit required on new flats from 40% to 50% earlier this month, while Stroud & Swindon BS demands 40%. Building societies Britannia, Scarborough and Skipton do not offer mortgages on newbuild flats at all.
When it comes to recently constructed properties, it is also proving difficult to get a mortgage. Scarborough requires a 30% downpayment, for example, while Chelsea, HSBC, Stroud & Swindon and West Bromwich demand 25%. In contrast, major lenders usually require a minimum 10% or 15% deposit on a second-hand home - though loans with this size of deposit have become scarce. To make things even more difficult for buyers, new homes are usually classified as those not previously inhabited, or those constructed or that have undergone major refurbishment during the past two years. But not always. West Bromwich defines a newbuild flat as anything built or converted post-2000.
So why are many lenders making life difficult for buyers? The Council of Mortgage Lenders blames concerns that new homes may be overpriced and that they may lose value quickly. This problem is exacerbated at present by falling house prices. The surplus of new flats nationwide mean they are even more likely to lose value, it adds. It is not just buyers hit by lenders' restrictions. Turner describes the past few months as the "worst in living memory" for house builders, with many construction sites left unfinished because of financial problems. Housebuilders have responded to this crisis by offering schemes to entice buyers. One property developer in London, Ipsus, has just launched a lifestyle package to anyone buying one of a select number of its newbuild flats in Wandsworth, including incentives such as a year's supply of Waitrose vouchers and a mortgage subsidy of £10,000 for those buying its two-bed flats.
"We are trying to kickstart sales and entice people back into the market," says a spokesman for Hamptons, which is marketing the flats for Ipsus. If you can afford a newbuild, many developers offer seemingly large discounts. Developer Crest Nicholson's Easybuy plan allows you to pay 75% now and nothing on the remainder for five years, while Barratt Homes says its advertised prices in London are between 9% and 21% down on late 2007 prices. However, a typical home in the capital fell in value by 15.1% over the past year, according to the Nationwide House Price Index. So it could be argued many of those buying at Barratt's advertised rate may still be paying too much.
Property experts, like lenders, think some advertised newbuild prices may be too high at the outset. "While discounts look good on paper they are often set against over-inflated prices to start with," says Nick Maugham, from property acquisition firm Khalil & Kane. "If there are only a few plots remaining in a development the builder will be anxious to sell, which gives you more of an advantage, so make sure you haggle."
Can we fix it? No, we can't - not during a credit crunch
It was a financing deal that nearly turned into a car crash. For months, lawyers, bankers, advisers and construction chiefs laboured to raise cash for the extension and upgrade of the M80 motorway, one of the busiest roads in Scotland. The sum needed was £350m. Plan A was for two banks to lend cash and pass on the risk to a dozen other banks via a loan syndication, with the Scottish government repaying the debt over 32 years. But the credit crunch meant that no bank was prepared to shoulder such a burden. To keep the project on track, the chief M80 adviser, PricewaterhouseCoopers, organised a "club" of four banks to come up with £200m to spread the burden, with the European Investment Bank (EIB) contributing £100m and German construction firm Bilfinger Berger, the lead contractor, stumping up £50m.
But around Christmas, the internal credit committees of the four banks grew increasingly concerned that too much of their cash was exposed on the deal. When they cut the amount that they were prepared to lend, the project collapsed. That was until a last-ditch appeal persuaded the EIB, funded partly by European taxpayers, to up its stake by £50m. "They saved the deal," said Rod Cameron, PricewaterhouseCoopers's director of corporate finance, who advised Bilfinger Berger. He described the whole funding process as "like nailing jelly to a wall". What followed was a frantic week of late nights and one all-night session at the end of last month in which 40 bankers, lawyers and advisers racked up fees but managed to get sign-off. It was a rare piece of good news in the most constrained lending environment for decades. The M80 PFI was just about the only major infrastructure project to have secured funding in the last six months.
Its tortuous funding journey illustrates the huge challenge for Gordon Brown. The prime minister wants to rescue the British economy, which has shed 300,000 jobs in four months, with Keynesian-style infrastructure spending. Brown promised to keep the country working by spending £50bn this year on building homes, schools, hospitals and roads. The government's infrastructure splurge relies on the banks to supplement taxpayers' cash. But everywhere he looks deals have either fallen apart or are facing delays. From the London Olympic athletes' village and media centre, through to the £5bn M25 widening, a £600m recycling project in Manchester, new hospitals, schools, colleges and tens of thousands of social housing schemes, Britain's great infrastructure push is in danger of collapsing because of a lack of bank lending.
Olympic chief John Armitt last week conceded that the taxpayer may have to stump up the funds to pay for every single venue needed for the east London games in 2012, threatening to eat further into the £2.7bn contingency budget. The £1.2bn M25 widening project is hanging by a thread. The £45bn Building Schools for the Future programme, already way behind schedule, requires not just a £300m bail-out from the EIB to keep it on track but government money paid upfront to buy time before private debt is secured - a high-risk strategy. Hospital projects and further education colleges have all been kicked into the long grass. Plummeting land values, meanwhile, have decimated the housebuilding industry. Both private builders and housing associations have canned virtually all developments, stymieing tens of thousands of affordable homes.
Unions and even some financiers have declared that the old PFI model of paying for new buildings and roads is dead and that new mechanisms must be found and quickly. Otherwise, the problem will move from an economic crisis into a social one. A shortage of affordable homes as large swathes of the population lose their jobs and houses could be devastating. Furthermore, construction chiefs warn that the estimated 100,000 who have lost their jobs in the downturn so far will rise steeply. In the 1990s recession, 300,000 construction workers lost their jobs. One building boss told the Observer this week that he expects even more will lose their jobs this time. And this month will see the biggest job losses so far as companies have to pay bills without the revenue - which tends to peak towards the end of the year - to sustain them.
Attacked by unions and academics as an expensive bonanza for banks and their advisers, PFI is the funding formula that Labour has encouraged over the last 12 years. Once the only game in town to supply Britain's roads, hospitals and schools, the model has now all but collapsed. Prior to July 2007, there were about 80 banks eager to lend to infrastructure. Banks and new-style dedicated funds enthusiastically eyed up the secure income streams on offer from governments around the world. But in Britain today there are no more than 12 banks willing to lend to such projects. And infrastructure funds have been burnt badly. Babcock & Brown, the Australian giant with a large exposure to Britain's schools and hospitals, is reeling under the weight of a £1.2bn debt burden. Last month, it had to suspend its shares on the Australian stock market as it seeks to renegotiate covenants with its banks.
The model that supplied affordable housing in Britain, predicated on private builders taking advantage of rising land values, is broken. For the past 15 years, developers secured planning permission if they agreed to turn over to housing associations at least 25% of units. Housebuilders also supplied roads, schools and other amenities in what are known as Section 106 agreements. While house price inflation produced margins of 20% all was well. But those days are gone. Margins for builders selling homes are now as low as 2%. Housing associations also borrowed huge sums from banks to buy chunks of land, forming joint ventures with mainstream builders. It is estimated that banks have lent £50bn to housing associations. With many housing associations in financial trouble, unable to sell homes and with significant bank borrowings, there is concern that some could go to the wall, dragging down dozens of regeneration projects throughout the country.
Meanwhile, banks are keen to claw back as much cash as possible from housing associations. In recent weeks, when housing associations have sought to alter loan agreements, banks have used the opportunity to ratchet up interest rates. Consequently, housing associations are starting to turn to the bond market for finance. In the past six months, three have raised £750m via bonds, yielding investors more than 6%. The associations have been advised by RBC, formerly Royal Bank of Canada, which is also working on plans with the government to lever insurance firms and pension funds into a housebuilding funding pool. Housing secretary Margaret Beckett is due to decide whether to press ahead with the plan this month. But what is worrying construction chiefs is that, as an election comes into focus, business minister Baroness Vadera seems less interested in long-term projects and that her overriding priority are measures that produce results in the short term.
"It seems to me that it's time to knock PFI on the head," said Margie Jaffe, a Unison policy officer. "Given what it costs the government to borrow money compared with the private sector, it's mad." Critics believe the "madness" has been compounded by the bail-outs of Royal Bank of Scotland and HBOS. Both banks, in which the government now has large shareholdings, are big lenders to PFI projects. So the government is in the position of bailing out banks that are charging it to supply debt for public amenities. It is the M25 project that is seen as the PFI litmus test. Costing £1.2bn to build plus £3.8bn to maintain over the life of the contract, there is speculation, denied by the Highways Agency, that it may be put on hold as banks shy away from it. To ensure the eastern section of the M25 is widened in time for the 2012 Olympics, a funding package needs to be in place by April.
But with 20 banks involved, and many of them wanting to downgrade their exposure, there is panic in Whitehall. To give comfort to the banks, there are suggestions that the government is prepared to put in more than £200m in direct equity to get the project rolling. "PFI and PPP deals are at the very low end of the risk spectrum," said Richard Tierney, corporate finance partner at BDO Stoy Hayward. "If the banks are shying away from lending to them, that really underlines the depth of the problems facing UK plc. The real issue is that many banks are now focused almost entirely on providing funds for their existing borrowers. There is very little appetite for lending on new infrastructure projects, even those with government backing." A Highways Agency spokeswoman said: "The contract is not on hold. We remain confident of a successful outcome, and start of work on widening the M25 is still programmed for spring this year. Our preferred bidder is in constructive and regular dialogue with the potential funding banks and we know they are keen to participate."
Least affected ought to be the £45bn Building Schools for the Future programme to build or refurbish 3,500 schools. The size of debt required for each school - generally about £20m - ought to make finance less onerous, especially as the government puts in 40% of equity with banks supplying the rest. But even this programme has faced immense delays. Before Christmas, banks all but pulled out of the programme. But there are signs, according to government sources, that their appetite may have returned. Speaking to the New Local Government Network last Thursday, Gordon Brown made clear that he was prepared to allow councils to build homes on land that they own and that has planning permission. While that may not generate a huge amount of homes, Brown's announcement marked a sea change. Perhaps more significantly, Brown also gave encouragement to a plan that could see each council earmark a tiny proportion of its reserves for a new local authority bank with money used to kickstart housing schemes and local transport projects.
This could assume importance because of the small number of banks that currently supply debt to infrastructure. They include Barclays, HSBC, Sumitomo Mitsui Banking Corporation, National Australia Bank and KfW from Germany. But the few remaining players may decide that they are too exposed to infrastructure debt and could either demand better terms or pull out of the sector altogether. The Treasury this weekend said: "The government is on track to invest more than £50bn this year and is determined that important investment in schools continues ... But like all private sector investment projects, the global credit crunch is affecting PFI projects, and that is why we have been working with individual projects and local authorities to help them close ... In addition, the measures announced last week to remove barriers to lending are intended to help anyone seeking finance." That may be, but as things stand it is hard to believe that Britain is truly building its way out of recession.
Centrica chief issues UK 'energy crunch' warning
The UK faces an energy crunch leading to much higher electricity and gas bills within three years because power companies are shelving investment plans, the chief executive of Centrica has warned. Sam Laidlaw also told the Observer that unless the government increased the level of financial support available for offshore wind farms soon, the UK would have little chance of meeting its 2020 renewable energy targets. Laidlaw said the "big six" energy suppliers were in talks with government officials about how to make the economics of offshore wind power work. EDF is understood to be in favour of special rates known as "feed-in tariffs" for offshore wind farms, which guarantee operators a higher fixed price for the electricity they generate.
He said: "If we have a long hiatus [because of the credit crunch] of more than a year, then it's going to be a bigger challenge to meet our renewable targets to ensure we have security of electricity supply. We have to find some solutions in the next few months." He added: "Investment is starting to fall off quite quickly. The big fear I have is that in two or three years, the next cycle [of high energy prices] will repeat, and security of supply will go right back to the top of the agenda, and we will be even less prepared to cope with it unless we make the investment now." Today is the deadline for bids for licences to operate the third round of offshore wind farms, which would cost about £50bn to build. But existing projects are already at risk of being scrapped.
Downturn is shunting British railway industry towards bail-out
A looming passenger and fare revenue downturn could force the government to bail out the rail industry or rewrite spending plans for the next five years, experts have warned. The funding settlement for Britain's railways was struck at the height of the economic boom 18 months ago, cutting public expenditure and requiring farepayers to nearly double their contribution by the middle of the next decade. But rail industry sources say an expected reversal in passenger numbers and a fall in ticket turnover mean the government will miss ambitious revenue targets at the heart of its 2009-14 spending plan.
"If franchising and passenger revenues do not meet expectations then that creates a gap that the government will have to fill," said a senior rail industry source. Another added that the government, which does not have legislative power to rewrite the 2009-14 plan, could ask the Office of Rail Regulation - the industry's spending watchdog - to revisit proposals which include upgrades of Reading station and the London Thameslink route. The 2009-14 settlement underpins the £28.5bn maintenance and expansion programme carried out by the owner of Britain's rail infrastructure, Network Rail, and is detailed in the 2007 rail white paper.
The document expects fare income to rise at an average of 7% a year, from £6.7bn this year to £9bn by 2014 - accounting for more than two-thirds of the network's funding. But the Association of Train Operating Companies predicts a fall in passenger numbers in 2009 and 2010; the white paper expected growth of 3% a year. The revenue target could also be jeopardised by deflation. Six out of 10 rail fares in the UK have rises price-capped at 1% above the retail prices index. The white paper based its assumptions on average inflation of 2.5%. Chris Cheek, editor of the Rail Industry Monitor, said his concerns had grown. Cheek warned soon after publication of the white paper that "very tight" passenger and fare revenue targets could be derailed by an economic downturn.
€7bn to be pumped into Irish banks
The Irish government is to invest €7 billion (£6 billion) in Ireland’s two biggest banks and insure them against more than €24 billion in bad loans as part of a recapitalisation scheme to be put in place this week. Allied Irish Banks (AIB) and Bank of Ireland will each receive €3.5 billion in new state investment in the form of preference shares. In addition, a scheme will be put in place that will transfer the risk attaching to 80% of the value of property-related loans on the banks’ books to the taxpayers. The Irish bailout comes just two weeks after Gordon Brown unveiled Britain’s revised bank-support deal, which led to British taxpayers increasing their stake in Royal Bank of Scotland to 70% alongside hundreds of billions of pounds of additional support for the banking sector. The Irish banking bailout is expected to offer better terms to the banks than the UK scheme.
The Irish preference shares will carry an interest rate of 8%, representing an annual payment to the state of €560m. The scheme has been radically overhauled since it was unveiled late last year. Under the original deal, the Irish government intended to invest €2 billion each into AIB and Bank of Ireland. It also promised to underwrite a €1 billion share issue by each of the banks. The collapse in share prices since then has made it impossible for the banks to raise money from investors. The state is not only picking up the shortfall but is also increasing its initial commitment to the two banks from €6 billion to €7 billion. By investing in the banks in the form of preference shares the shareholdings of existing investors will be preserved. The insurance scheme will cover outstanding loans on development land and on part-completed construction projects that are now considered to have an uncertain future.
AIB and Bank of Ireland, which sells financial products through the Post Office, are believed to have more than €37 billion in speculative property loans on their books. International risk consultants have identified the portion of those loans that are considered “most distressed” and these will be written off by the banks themselves in the first instance. The risk on the balance of the speculative loans, approximately 80% of the total, will then be transferred to taxpayers, with the state in effect providing insurance on loans that subsequently have to be written off as bad. The banks will pay an upfront insurance premium to the government representing 2.5% of the value of the assets transferred. This will give the government an immediate cash injection of more than €750m. The scheme is to last until 2014, which will give the banks five years to “work out” their most problematic loans.
In Britain, details of the loan-insurance scheme being extended to UK banks are still being hammered out. RBS is expected to place up to £100 billion of loans into the scheme, which is designed to protect the bank from further losses. RBS is also poised to receive a further £1.2 billion of taxpayers’ money when it unveils losses of up to £28 billion this month. The bank is in line for a rebate of all the corporation tax it paid last year. The rebate comes amid mounting concerns over the true cost of the bank bailout. The Institute for Fiscal Studies has warned that the credit crunch would cost the Exchequer £50 billion in lost tax revenues – about 3.5% of national income. The institute said the government would need to find an extra £20 billion a year in tax increases and spending cuts by the end of the next parliament to repair the holes in the public finances. Financial-sector profits accounted for 27% of the £50 billion in corporation tax the government received last year. Analysts estimate RBS will be able to avoid paying tax in its UK business until 2013.
Fate of UBS hangs on tax evasion case
The future of UBS, the giant Swiss bank, rests on the outcome of tense negotiations with US investigators as its long-running multi-billion-dollar tax evasion case concludes this month. A series of hearings in Washington over the next four weeks will determine whether UBS faces criminal prosecutions and possibly even the loss of its US bank licence. The bank is being investigated by US authorities for its alleged part in what is claimed to be a massive tax evasion scheme. The US has accused UBS of helping rich Americans hide billions of dollars. Last November, a senior member of the executive board of UBS was charged by US authorities with tax evasion. He has resigned from the board to defend himself. UBS has been co-operating with investigators and has made it plain that it is taking the issue seriously.
The case dates back to when a senior UBS banker signed a US court statement seven months ago detailing how he smuggled diamonds in toothpaste tubes, destroyed offshore bank records on behalf of clients and helped a Florida property tycoon evade taxes of $200m on offshore assets worth $7.26bn. In a seven-page deposition, the senior manager claimed that he was encouraged to win clients at UBS-sponsored tennis tournaments and art events. UBS bankers, according to legal papers, are accused of helping wealthy Americans conceal ownership of their assets by creating "sham" offshore trusts. In November, UBS stopped using offshore trusts on behalf of its US customers.
The Observer has been told by well-placed sources that the authorities are determined to force UBS to hand over account details of its 17,000 US clients. The bank has indicated it is willing to release details of only 300 of them. UBS, according to Swiss newspaper reports, offered to pay a large fine to the US, thought to be more than $1bn, in return for immunity from prosecution. The Swiss government is desperate to limit the number of clients' details handed over to investigators to protect the cornerstone of its banking sector - secrecy. The US Internal Revenue Service and UBS declined to comment.
The expected conclusion of the UBS case comes as greater scrutiny is placed on the role of tax avoidance and evasion on behalf of the world's richest individuals and companies. New figures show that the UK is missing out on £18.5bn in taxes because of wealth and profits held in tax havens, enough to take 4.5p off the basic rate of tax. The figures combine estimates of tax avoidance from wealthy individuals, large companies and criminal activities. The figures will be included in a BBC Panorama programme tomorrow. And tomorrow's Guardian will expose the tax avoidance strategies of large multinational companies and name more than 20 leading British companies involved in avoiding paying millions in tax.
California to Delay $4 Billion in Payments
California's chief accountant on Monday will begin delaying nearly $4 billion of scheduled state payments, postponing income-tax refunds, grants to college students and welfare checks in an effort to prevent the state from running out of cash. The delays will hurt an already wilting state economy, economists said, calling them the opposite of stimulus checks because people won't get money they expect to receive. Controller John Chiang has said the delays will last 30 days. In an interview Friday, Mr. Chiang said further deferments are possible. "I am very concerned about the potentially devastating impact to individuals, to families, to businesses," he said. But "my principal responsibility at this time is to make sure that California does not go into default."
For many weeks, Mr. Chiang has warned the state would run out of cash in late February if legislators didn't agree on a balanced budget. Now, as lawmakers continue to haggle over how to erase a budget deficit projected to reach $42 billion by mid-2010, the state's chief accountant has said he must delay payments to meet constitutionally mandated debt obligations. Included in the delayed payments are personal income-tax refunds totaling nearly $2 billion, as well as bank and corporate tax refunds, among other things. Jason Dickerson, a budget analyst for California's Legislative Analyst's Office, said the postponement of income-tax refunds means local retailers and businesses won't receive the expected annual short-term jolt of cash. Mr. Dickerson also said that, for many social-service programs, counties and cities will have to cover the costs.
With many municipalities also ailing from the downturn, it isn't clear how they will handle their new responsibilities. "It's a substantial problem when billions in tax refunds don't go out, because they are considered a kind of economic stimulus," Mr. Dickerson said. "If payment delays continue into April and March, it will be a disaster." While many counties have enough cash to get through February, Trinity County in Northern California has only two to three weeks of reserves, said Dero Forslund, Trinity's administrative officer. Once the money runs out, the county will issue IOUs to its 320 workers, he said, and then see if service reductions will be necessary as well. Trinity was expecting $2 million from the state in February, he said.
For years, California has relied on borrowing, by selling municipal bonds, to help get through difficult budgetary situations. But with a bond market that has nearly dried up -- and with a poor credit rating -- the state is hard-pressed to borrow. Moody's Investors Service last week joined two other major credit-rating agencies -- Fitch Ratings and Standard & Poor's -- in warning it may further downgrade California's rating. California is already tied with Louisiana for the lowest credit rating among states. To help close the budget gap, California Gov. Arnold Schwarzenegger last month ordered some state employees to take two days off a month without pay, starting Feb 6. The order applies to tens of thousands of state workers -- out of a total of 238,000 -- and Mr. Schwarzenegger said the plan will save about $1.4 billion over 17 months. A state Superior Court judge in Sacramento earlier this week ruled the governor had the authority to order the furloughs, rejecting a challenge by two unions.
Since Mr. Schwarzenegger first declared a fiscal emergency in early November, budget talks have stalled because of a three-way stalemate: Democratic lawmakers want tax increases and moderate spending cuts, Republican legislators want deep cuts and no new taxes, and the Republican governor wants a combination of the two approaches, as well as relaxations of environmental rules to hasten public-works projects. Caught in the impasse are hundreds of thousands of California residents, companies and counties that depend on the state for aid or are waiting for payment of services rendered. Many are concerned that budget negotiations could last months.
One such company is Sacramento Technology Group. Officials at the information-services firm in Folsom, Calif., said the delays are forcing them to renegotiate contracts to stave off payments on bills for 15 days to a month. The company depends on the state for half its business, or about $1.5 million a year. The other half comes from private companies, which are also state contractors, said company President George Usi. If the delays last three months, Mr. Usi said, he will have to lay off some of his 19 employees. "This sure is a great way to stymie innovation among young entrepreneurs like myself," he said.
Ilargi: There is more on state budget troubles from the Center on Budget and Policy Priorities when you click the link.
State Budget Troubles Worsen
States are facing a great fiscal crisis. At least 46 states faced or are facing shortfalls in their budgets for this and/or next year, and severe fiscal problems are highly likely to continue into the following year as well. Combined budget gaps for the remainder of this fiscal year and state fiscal years 2010 and 2011 are estimated to total more than $350 billion. States are currently at the mid-point of fiscal year 2009 - which started July 1 in most states - and are in the process of preparing their budgets for the next year. Over half the states had already cut spending, used reserves, or raised revenues in order to adopt a balanced budget for the current fiscal year — which started July 1 in most states. Now, their budgets have fallen out of balance again.
New gaps of $46 billion (over 9% of state budgets) have opened up in the budgets of at least 42 states plus the District of Columbia. These budget gaps are in addition to the $48 billion shortfalls that these and other states faced as they adopted their budgets for the current fiscal year, bringing total gaps for the year to over 14 percent of budgets. The states’ fiscal problems are continuing into the next two years. At least 41 states have looked ahead and anticipate deficits for fiscal year 2010 and beyond. These gaps total almost $88 billion - 16 percent of budgets - for the 34 states that have estimated the size of these gaps and are likely to grow as gaps are re-estimated in the next few months.
Figure 2 shows the size and duration of the deficits in the recession that occurred in the first part of this decade, and estimates of the likely deficits this time. This recession is more severe - deeper and longer - than the last recession, and thus state fiscal problems are likely to be worse. Unemployment, which peaked after the last recession at 6.3 percent, has already hit 7.2 percent, and many economists expect it to rise to 9 percent or higher, which will reduce state income taxes and increase demand for Medicaid and other services. With consumers’ reduced access to home equity loans and other sources of credit, sales taxes are also likely to fall more steeply than they did in the last recession. These factors suggest that state budget gaps will be significantly larger than in the last recession. Based on past experience and the depth of this recession, it appears likely that all but a handful of states will face shortfalls in fiscal year 2010 and these deficits will end up totaling about $145 billion. If, as is widely expected, the economy does not begin to significantly recover until the end of calendar year 2009, state deficits are likely to be even larger in state fiscal year 2011 (which begins in July 2010 in most states). The deficits over the next two-and-a-half years are likely to be in the $350 billion to $370 billion range.
It may be particularly difficult for states to recover from the current fiscal situation. Housing markets may be slow to fully recover; the decline in housing markets has already depressed consumption and sales taxes as people refrain from buying furniture, appliances, construction materials, and the like. Property tax revenues are also affected, and local governments will be looking to states to help address the squeeze on local and education budgets. And as the employment situation continues to deteriorate, income tax revenues will weaken further and there will be further downward pressure on sales tax revenues as consumers are reluctant or unable to spend.
The vast majority of states cannot run a deficit or borrow to cover their operating expenditures. As a result, states have three primary actions they can take during a fiscal crisis: they can draw down available reserves, they can cut expenditures, or they can raise taxes. States already have begun drawing down reserves; the remaining reserves are not sufficient to allow states to weather a significant downturn or recession. The other alternatives — spending cuts and tax increases — can further slow a state’s economy during a downturn and contribute to the further slowing of the national economy, as well.
Some states have not been affected by the economic downturn but the number is dwindling. There are a number of reasons why. Some mineral-rich states — such as New Mexico, Alaska, and Montana — saw revenue growth as a result of high oil prices. However, the recent decline in oil prices has begun to affect revenues in some of these states. The economies of a handful of other states have so far been less affected by the national economic problems. In states facing budget gaps, the consequences sometimes are severe — for residents as well as the economy. Unlike the federal government, states cannot run deficits when the economy turns down; they must cut expenditures, raise taxes, or draw down reserve funds to balance their budgets. As a new fiscal year begins in most states, budget difficulties are leading some 39 states to reduce services to their residents, including some of their most vulnerable families and individuals.
For example, at least 26 states have implemented or are considering cuts that will affect low-income children’s or families’ eligibility for health insurance or reduce their access to health care services. Programs for the elderly and disabled are also being cut. At least 22 states and the District of Columbia are cutting medical, rehabilitative, home care, or other services needed by low-income people who are elderly or have disabilities, or significantly increasing the cost of these services. At least 25 states are cutting or proposing to cut K-12 and early education; several of them are also reducing access to child care and early education, and at least 30 states have implemented or proposed cuts to public colleges and universities.
In addition, at least 36 states and the District of Columbia have proposed or implemented reductions to their state workforce. Workforce reductions often result in reduced access to services residents need. They also add to states’ woes by contracting the state economy. If revenue declines persist as expected in many states, additional budget cuts are likely. Budget cuts often are more severe in the second year of a state fiscal crisis, after reserves have been largely depleted and thus are no longer an option for closing deficits. The experience of the last recession is instructive as to what kinds of actions states may take. Between 2002 and 2004 states reduced services significantly. For example, in the last recession, some 34 states cut eligibility for public health programs, causing well over 1 million people to lose health coverage, and at least 23 states cut eligibility for child care subsidies or otherwise limited access to child care. In addition, 34 states cut real per-pupil aid to school districts for K-12 education between 2002 and 2004, resulting in higher fees for textbooks and courses, shorter school days, fewer personnel, and reduced transportation.
Expenditure cuts and tax increases are problematic policies during an economic downturn because they reduce overall demand and can make the downturn deeper. When states cut spending, they lay off employees, cancel contracts with vendors, eliminate or lower payments to businesses and nonprofit organizations that provide direct services, and cut benefit payments to individuals. In all of these circumstances, the companies and organizations that would have received government payments have less money to spend on salaries and supplies, and individuals who would have received salaries or benefits have less money for consumption. This directly removes demand from the economy. Tax increases also remove demand from the economy by reducing the amount of money people have to spend.
Many states have never fully recovered from the fiscal crisis in the early part of the decade. This fact heightens the potential impact on public services of the deficits states are now projecting. State expenditures fell sharply relative to the economy during the 2001 recession, and for all states combined they remain below the FY2001 level. In 18 states, general fund spending for FY2008 - six years into the economic recovery - remained below pre-recession levels as a share of the gross domestic product. In a number of states the reductions made during the downturn in education, higher education, health coverage, and child care remain in effect. These important public services were suffering even as states turned to budget cuts to close the new budget gaps. Spending as a share of the economy declined in FY2008 and is projected to decline further in FY2009.
One way states can avoid making deep reductions in services during a recession is to build up rainy day funds and other reserves. At the end of FY2006, state reserves - general fund balances and rainy day funds - totaled 11.5 percent of annual state spending. Reserves can be particularly important to help states adjust in the early months of a fiscal crisis, but generally are not sufficient to avert the need for substantial budget cuts or tax increases. In this recession, states have already drawn down much of their available reserves; the available reserves in states with deficits are likely to be depleted in the near future.
Mayor Bloomberg paints grim economic picture for New York City 2009 budget
Mayor Bloomberg's bad-news budget tries to plug a $4 billion hole with less than $2 billion worth of spending cuts and new sales taxes - and counts on unions, Albany and the federal govermment to come up with the rest. He proposed a $43.4 billion budget Friday for the fiscal year starting July 1, up $123 million from the year before - one that slices deep into the pockets of city residents and the ranks of city workers. "Are we going to go through some difficult times? I don't think there's any question about that. But we have a plan to balance our budget," Bloomberg said. "It is serious, but I think it is manageable."
The new cuts and taxes come on top of $1 billion in cuts and $1.5 billion in tax hikes he already pushed through, as administration economists predict the national economy and Wall Street will continue to pummel the city's revenues. The mayor's budget counts on city workers paying 10% toward the cost of their health benefits, raising $350 million, as well as $200 million more from reining in health costs. While municipal unions have begun discussions with Bloomberg's labor team, it is unclear whether any such agreement can be reached. Bloomberg also wants to cut services: 30 ambulance tours, one firefighter from each of 64 engine companies, homeless prevention and child care.
He wants to raise taxes and fees: charging 5 cents per plastic bag to raise $84 million, raising parking meter rates, issuing more fines to unsanitary restaurants, repealing the sales tax exemption on clothes and raising the sales tax another 1/4 of a percent. And he wants to cut more jobs: 1,000 cops, 1,440 school employees, 167 seasonal Parks Department aides, 549 child welfare workers, and more than 14,000 teachers and classroom employees. His plan calls for 22,919 fewer city jobs, of which only 7,686 would come from attrition. The other 15,233 employees would be simply laid off - including 13,930 Education Department employees. "When you talk about reducing city expenditures, you are really talking about reducing headcount," Bloomberg said. "You can only get so much blood out of a stone."
In a bit of brinksmanship, Bloomberg laid the blame for those 14,000 teacher layoffs on Gov. Paterson's proposed budget, which cuts $771 million from city school spending. While Bloomberg's budget counts on more than $1 billion in new Medicaid money from the federal stimulus bill, it does not count on more than $1 billion included for education. Administration officials say they left that figure out because it will be routed through Albany, which may siphon some of the cash for itself. Bloomberg's budget assumes that property tax revenues will rise 7.2%, as tax rates catch up with property values that have shot higher in recent years. But taxes that depend on the economy - like income, sales and real estate transfer - are expected to fall 13.2%.
"Nobody prepared for the severity of the downturn that we have been experiencing," Bloomberg said. "Nobody's ever seen a boom like this and nobody's ever seen a decline like this." There is no easy relief in sight, either: Bloomberg's forecasters expect jobs, wages and taxes will keep falling this year and won't bottom out until sometime in 2010. Almost 300,000 New Yorkers will have lost their jobs by the time the market bottoms out in mid-2010, down from the peak of 3,777,000 employed last fall. That means a loss of $33 billion in wages this year and another $6 billion next year. An estimated 46,000 of those jobs will come from Wall Street, which traditionally pays the fat salaries and bonuses that drive New York's economy - and its municipal budget.
Hard times give government jobs greater allure
Thamayya Dobbs works at a call center in Arizona. But in the current economy, he says he is thinking very hard about retraining as a U.S. Border Patrol agent. "There's more job security, stability for my family," said Dobbs, 35, as he visited a U.S. Customs and Border Protection recruitment fair in Tucson this weekend. While the U.S. economy shed tens of thousands of jobs last week, the government agency responsible for securing the country's borders is seeking to hire 11,000 workers in a national recruitment drive this year. In the current downturn, those jobs have a special allure.
Thousands of people turned out for the agency's 15 "National Career Day" hiring events from California to Florida on Saturday, to find out about retraining as border police officers or working in support roles such as mechanics, program analysts and information technology specialists. In Tucson alone, 800 people flocked to the hiring event in just the first three hours. While the jobs on offer are statistically a drop in the bucket at a time when the broader U.S. economy has lost more than 210,000 thousands jobs since the start of the year, they highlight the appeal of working for the federal government at a time of economic uncertainty.
"At Customs and Border Protection, we offer very good career opportunities within one agency, and all under the one premise of securing America," spokeswoman Tara Dunlop told Reuters. "As federal (government) positions, the conditions are also very good and the salaries very competitive, with very competitive benefits," she added. The recruitment events came at the end of a particularly bleak week for jobs in the United States, where companies including Sprint, Home Depot, Caterpillar, Texas Instruments and Eastman Kodak Co announced they would slash more than 60,000 jobs. In addition, the latest figures showed the U.S. economy shrinking at its fastest rate in 27 years, and the number of Americans seeking jobless benefits hitting a high.
Amid the carnage, government has been one of only a few sectors in the U.S. economy continuing to hire in recent months. It added 181,000 employees to the payroll during 2008. Analysts caution that many of those jobs may also be in jeopardy in coming months as state and local authorities, facing shrinking revenues, try to balance their books. But federal jobs such as those offered by Customs and Border Protection -- paying $35,000 to $80,000 with health care and a full pension -- are likely to be safe, and have a growing appeal for both the unemployed and those with jobs -- like Dobbs -- who are looking for greater stability.
"If you have a choice between jobs, you will probably very much try and pick one that will have some durability, that will last," said Susan Houseman, a labor expert at the Upjohn Institute in Michigan. "Federal government jobs would be kind of the gold standard. A federal job would be very stable." President Barack Obama has set a mid-February target for Congress to pass an economic stimulus bill with more than $800 billion in tax cuts and spending. The Democratic president's advisers say it could create 3.7 million jobs by the close of 2010, through a mix of tax cuts and spending on infrastructure such as road building, among other areas. In another measure aimed at boosting job security, Obama signed three executive orders on Friday to bolster unions in the workplace and increase workers' rights, reversing labor policies of his predecessor, Republican George W. Bush.
As Washington seizes the initiative on the economy, labor analysts say working for the government may also gain a certain sparkle that was missing before, when Wall Street boomed, banks readily lent money and the private sector flourished. "Part of it is that (federal government jobs offer) a safe port in a storm ... but there's also a cultural and generational shift," said Alec Levenson, a labor economist at the Center for Effective Organizations at the University of Southern California. "Before, in many ways working for the federal government was kind of demeaned. But the federal government is going to end up playing a much more critical role in stabilizing the economy and thinking about the changes we face as a society," he added. "At this time, government looks like it's the only thing that's sustainable," distribution firm worker Michael Derby said as he strolled around the job fair. "It's not going anywhere any time soon.
Look at the Time
It looks like a win but feels like a loss. The party-line vote in favor of the stimulus package could have been more, could have produced not only a more promising bill but marked the beginning of something new, not a postpartisan era (there will never be such a thing and never should be; the parties exist to fight through great political questions) but a more bipartisan one forced by crisis and marked by—well, let's call it seriousness.
President Obama could have made big history here. Instead he just got a win. It's a missed opportunity. It's a win because of the obvious headline: Nine days after inauguration, the new president achieves a major Congressional victory, House passage of an economic stimulus bill by a vote of 244-188. It wasn't even close. This is major. But do you know anyone, Democrat or Republican, dancing in the street over this? You don't. Because most everyone knows it isn't a good bill, and knows that its failure to receive a single Republican vote, not one, suggests the old battle lines are hardening. Back to the Crips versus the Bloods. Not very inspiring.
The president will enjoy short-term gain. In the great circle of power, to win you have to look like a winner, and to look like a winner you have to win. He did and does. But for the long term, the president made a mistake by not forcing the creation of a bill Republicans could or should have supported. Consider the moment. House Republicans had conceded that dramatic action was needed and had grown utterly supportive of the idea of federal jobs creation on a large scale. All that was needed was a sober, seriously focused piece of legislation that honestly tried to meet the need, one that everyone could tinker with a little and claim as their own. Instead, as Rep. Mike Pence is reported to have said to the president, "Know that we're praying for you. . . . But know that there has been no negotiation [with Republicans] on the bill—we had absolutely no say."
The final bill was privately agreed by most and publicly conceded by many to be a big, messy, largely off-point and philosophically chaotic piece of legislation. The Congressional Budget Office says only 25% of the money will even go out in the first year. This newspaper, in its analysis, argues that only 12 cents of every dollar is for something that could plausibly be called stimulus. What was needed? Not pork, not payoffs, not eccentric base-pleasing, group-greasing forays into birth control as stimulus, as the speaker of the House dizzily put it before being told to remove it.
"Business as usual." "That's Washington." But in 2008 the public rejected business as usual. That rejection is part of what got Obama elected. Instead the air of D.C. dithering continues, and this while the Labor Department reported Thursday what everyone knew was coming, increased unemployment. The number of continuing claims for unemployment insurance as of Jan. 17 was 4.78 million, the highest in the 42 years they've been keeping records. Starbucks, Time Warner, Home Depot, Pfizer: The AP's count is 125,000 layoffs since January began.
People are getting the mood of the age in their inboxes. How many emails have you received the past few months from acquaintances telling you in brisk words meant to communicate optimism and forestall pity that "it's been a great ride," but they're "moving on" to "explore new opportunities"? And there's a broad feeling one detects, a kind of psychic sense, some sort of knowledge in the collective unconscious, that we lived through magic times the past half-century, and now the nonmagic time has begun, and it won't be over next summer. That's not the way it will work. It will last a while.
There's a sense among many, certainly here in New York, that we somehow had it too good too long, a feeling part Puritan, part mystic and obscurely guilty, that some bill is coming due. Hard to get a stimulus package that addresses that. (The guilt was part of the power of Blago. He's the last American who doesn't feel guilt. He thinks something is moral because he did it. He's like a good-natured Idi Amin, up there yammering about how he's a poor boy who only wanted to protect the people of Chicago from the flu. You wish you could believe it! You wish he really were what he is in his imagination, a hero battling dark forces against the odds.)
I think there is an illness called Goldmansachs Head. I think it's in the DSM. When you have Goldmansachs Head, the party's never over. You take private planes to ask for bailout money, you entertain customers at high-end spas while your writers prep your testimony, you take and give huge bonuses as the company tanks. When you take the kids camping, you bring a private chef. Goldmansachs Head is Bernie Madoff complaining he's feeling cooped up in the penthouse. It is the delusion that the old days continue and the old ways prevail and you, Prince of the Abundance, can just keep rolling along. Here is how you know if someone has GSH: He has everything but a watch. He doesn't know what time it is.
I remember the father in the movie script of "Dr. Zhivago," inviting what's left of his family, huddled in rooms in what had been their mansion, picking up the stump of a stogie and inviting them to watch the lighting of "the last cigar in Moscow." When you have GSH, you never think it's the last cigar.
But you don't have to be on Wall Street to have GSH. Congress has it too. That's what the stimulus bill was about—not knowing what time it is, not knowing the old pork-barrel, group-greasing ways are over, done, embarrassing. When you create a bill like that, it doesn't mean you're a pro, it doesn't mean you're a tough, no-nonsense pol. It means you're a slob. That's how the Democratic establishment in the House looks, not like people who are responding to a crisis, or even like people who are ignoring a crisis, but people who are using a crisis. Our hopeful, compelling new president shouldn't have gone with this bill. He made news this week by going to the House to meet with Republicans. He could have made history by listening to them.
A final point: In the time since his inauguration, Mr. Obama has been on every screen in the country, TV and computer, every day. He is never not on the screen. I know what his people are thinking: Put his image on the age. Imprint the era with his face. But it's already reaching saturation point. When the office is omnipresent, it is demystified. Constant exposure deflates the presidency, subtly robbing it of power and making it more common. I keep the television on a lot, and somewhere in the 1990s I realized that Bill Clinton was never not in my living room. He was always strolling onto the stage, pointing at things, laughing, talking. This is what the Obama people are doing, having the boss hog the screen. They should relax. The race is long. As a matter of fact, they should focus on that: The race is long. Run seriously.
Newspaper companies make more cutbacks
The grim news in the newspaper industry continues, with Gannett planning a $5 billion write-down and a possible reduction of its dividend, and The Los Angeles Times and A.H. Belo each announcing major job cuts. A.H. Belo, publisher of The Dallas Morning News and other papers, said Friday that it would eliminate 500 jobs, or one-seventh of its work force. The Los Angeles Times said it would cut 300 jobs, including 70 positions, or nearly 12 percent, in its newsroom staff of more than 600. Gannett reported a fourth-quarter profit of $158 million, down 35.6 percent from the fourth quarter of 2007. For all of 2008, the company had a loss of $1.8 billion, compared with profit of $1.06 billion a year earlier, after write-downs it has already taken that total $2.5 billion.
The company announced plans to write down the value of its assets by $4.5 billion to $5.2 billion after taxes. Gannett owns USA Today, The Arizona Republic and about 100 other daily papers in the United States and Britain, along with hundreds of smaller publications and 23 television stations. Revenue was down 8.5 percent for the quarter, to $1.7 billion, and 9 percent on the year, to $6.8 billion. But newspaper advertising, which accounts for more than half of overall revenue, fell much faster, dropping 22.7 percent in the fourth quarter and 16 percent for the year. Several other newspaper companies, including The New York Times Co., which owns the International Herald Tribune, have cut dividends recently to preserve cash. Gannett has paid a large dividend, 40 cents a quarter, relative to its stock price, and analysts have advised lowering it. Shares of Gannett fell $1.13 on Friday to $5.77.
Gracia Martore, Gannett's chief financial officer, said during a conference call with analysts that when the board met in February, "there will be significant conversation around that." A.H. Belo and The Los Angeles Times did not give timetables for their job cuts, nor did they say whether the cuts would be achieved through layoffs or buyouts. A.H. Belo also said it would also stop contributing to its employee savings plan. "The revenue trends we continue to experience simply do not support or require the same number of people," Robert Decherd, the chief executive, wrote in a note to employees. For now, he wrote, the company would not impose unpaid furloughs or wage cuts, as others have done, but added, "I assure you that we are considering any and all opportunities to improve the company's revenues and preserve cash internally." Shares of A.H. Belo fell 8 cents, to $2.
The Los Angeles Times has gone through several rounds of downsizing since it was acquired by Tribune Co. in 2000. Its newsroom, once one of the largest in the country, has gone from more than 1,200 people to barely half that many. Tribune Co. filed for bankruptcy protection in December, after falling revenue left it unable to sustain the debt it took on when it transformed itself into a privately owned company a year earlier.
Goldilocks' economy is too cold, and the bears are prowling Davos
This much-publicised meeting of the World Economic Forum was not meant to happen. By this I mean that as recently as two years ago the prevailing mood among what I like to call the international debt set was that a combination of globalisation and free-market economics had brought an era of sustainable, rapid economic growth. The problems faced by policymakers were not macroeconomic - after all, central bankers knew how to control inflation and that was all that mattered, was it not? Yes, in the Goldilocks world of low inflation and continual expansion, the real problems concerned the environment, African debt, water shortages, disease and so on.
The Goldilocks metaphor was much used, and abused. It was a reference to a pace of economic activity that was neither too hot nor too cold.
Unfortunately, it turned out that there were far more than three bears out there in the forest. Most of the world now seems to have become bearish about the economy. There had been a handful of vociferous dissenters, even in Davos, who agreed with the famous US economist Herb Stein that "things that can't go on forever, don't". But, vociferous though they were, their voices were drowned by those of the financial masters of the universe. (Yes, gaining the whole world was not enough for them.)
The press and the airwaves are now jam-packed with news about the crisis. It is now generally accepted that this is the worst recession since the 1930s (Alistair Darling was right!) and we face a new phenomenon in economic reporting - some headlines proclaim the increase in unemployment figures for the entire industrialised world. When I first encountered such a headline the other week, it looked for a moment as if an entire British city had been declared redundant overnight.
The official theme of this year's chastened and almost humble World Economic Forum was "Shaping the Post-Crisis World". This rather begs the question that we are anywhere near "post-crisis". I gather that, when drawing up plans in December, the organisers were assuming that the banking crisis would be over and the debate would focus on the threat of deflation and depression. Well, there was certainly a lot of focus on those, but much of the discussion was also about the continued banking crisis and the obvious implications for the scale of the economic horrors now facing the world.
There was an interesting exchange during the main economic debate when Stephen Roach, the Morgan Stanley economist who was so bearish two years ago that he was, in his own words, "dropped" from the panel, challenged the Financial Times's Martin Wolf for suggesting that we now faced a "proto-Depression". Roach preferred the word "recession" and, bear or no bear, could even see a recovery next year - albeit an "anaemic" one. Which brings us to the second episode in this sorry saga - a saga that brought the Russian president and the Chinese prime minister to Davos to lecture western capitalism on its deficiencies. Depressions on the scale of what scarred a whole generation in the 1930s were supposed never to occur again. Successive generations of economists, whatever their philosophical, doctrinal or methodological differences, took it for granted that that particular threat had been banished.
True, when there were concerns about inflation or the balance of payments, restrictive economic policies would cause the growth of output to slow down, or even fall, and unemployment to rise; and true, as in the UK in the early 1980s, misguided economic policies could overdo the pain. But from 1945 to 2007 there was a functioning banking system. I have quoted Gladstone before, and I shall quote him yet again: "Finance is, as it were, the stomach of the country, from which all the other organs take their tone." But, in those other immortal words - this time of Joseph Heller - "something happened". The financial system became a kind of pyramid scheme writ large. Now governments in the US and UK (not Canada) are having to rescue the banks with taxpayers' money, and in France they have taken to the streets.
It is not strictly true, as is often asserted, that the banks are not lending. But they are drawing in their horns; and, to return to Gladstone's metaphor, the other organs of the economy are badly, very badly, afflicted by the financial sector's need for a stomach pump. As the veteran former central banker and International Monetary Fund official Jacob Frenkel said here in Davos: "In the old days, banks were providers of the liquidity and financial resources. Now they are dependent on obtaining liquidity and resources from the rest of the economy." To cap it all, with official interest rates close to zero, the limits of monetary policy have been reached. We know it is supposed to operate with "long and variable lags", but this is all taken account of in the IMF's gloomy economic forecast.
The Nobel laureate Paul Samuelson has questioned the assumption of Federal Reserve chairman Ben Bernanke that Milton Friedman was right about appropriate monetary policies being the guard against, and cure for, economic depression. What matters is fiscal policy: governments, via increases in public spending and tax cuts (especially for the poor), can ensure that the money is spent. In which context, the right note, as it were, was struck here by my new friend, our great bass-baritone Bryn Terfel, when, at a Standard & Chartered dinner, he ended a recital with a topical reference to President Obama's $800bn-plus "fiscal stimulus" and proceeded to sing the Gershwins' I've Got Plenty of Nothing and Flanders and Swann's The Gasman Cometh: "It all makes work for the working man to do ... "
Davos finds no answers to crisis
The World Economic Forum has ended with a call to rebuild the global economic system. Founder Klaus Schwab announced a "global redesign initiative" to reform banking, regulation and corporate governance. For five days, more than 2,000 business and political leaders discussed what some here called the "crisis of capitalism". However, most discussions described the problems, not solutions. The forum's official theme this year had been "shaping the post-crisis world", but that turned out to be premature. Rather, the debates proved the widespread uncertainty amongst both politicians and corporate bosses, as they tried to gauge the depth of the economic crisis and explore ways how to get out of it.
Nobody in Davos tried to refute the prediction that the global economy is heading into a deep and long recession. One top money market manager said: "If you believe that the world economy will turn the corner at the end of this year, or in [the first quarter] of 2010, I tell you we have not turned the corner, we can't see the corner, we don't even know where the corner is." Another participant summed up the state of the discussion as "we don't know what to do, only that we need to do something and we need to do it fast". With the old certainties of the free market gone, even free marketeers accepted the need for more regulation, quick. Professor Schwab said the current situation was a perfect example of where banks could take the lead and devise a system of self-regulation, and not wait for governments to regulate it. It may be too late for that, though, with politicians from Germany's Chancellor Angela Merkel to UK Prime Minister Gordon Brown calling for a global regulator to ensure a smoother running of the international financial system.
South African Archbishop Desmond Tutu said "we worshipped in the temple of cutthroat competition, and so some cooked the books, because the treasure is so great". "We spend billions on banks," Mr Tutu said, "when we know that a fraction of this money could save all the children in the world." Not every intended recipient of this message was present, though. The top bosses of most Wall Street banks had cancelled their trips to the Swiss mountains and stayed in the office. It might have been for the better, because even here, in this temple of arch-capitalism, there were calls for swift criminal punishment of the people who caused the crisis coming from fellow chief executives. Nonetheless, nearly everybody agreed that while capitalism needed fixing, it wasn't irreparably broken. Nouriel Roubini, one of the few economists that accurately predicted the credit crunch, was not the only one to use a variation of a Churchill quote: "Capitalism is the worst system except for all those others that have been tried."
The annual Davos meeting is also a good place to take stock of the geopolitical landscape. It was here that one could track the rise of emerging economies like India and China. Record numbers of heads of state and government had come to Davos, mostly cloistered away in face-to-face meetings with their counterparts and key business leaders. It was no coincidence that the keynote speeches on the first day had been reserved for China's Premier Wen Jiabao and Russia's Prime Minister Vladimir Putin. However, with even China's economy at a crawl, and the value of Russia's oil wealth plummeting, their speeches proved that the economic crisis is truly global, and hurting around the world. In April, the spotlight will be on the G20 meeting in London, where leading politicians both from industrialised and emerging economies will debate ways out of the crisis. Professor Schwab attempted some expectation management. "The G20 will not solve everything," he said, "it won't address the totality of the issue."
Probably the biggest worry, apart from getting the world economy "out of intensive care" (Prof Schwab), was the threat of protectionism. Raising trade barriers now, politicians, business leaders and campaigners agreed, would have a devastating impact, for starters on the economies of rich countries, but even more so on poorest people in the world. The Davos organisers tried hard to ensure that the crisis of the financial system did not take away all the attention from the fight against poverty, but it was difficult. After all, it was a long list of problems that the global elites had to discuss during their five days of soul-searching. What had once been seen as a long schmoozefest, a show-off party of the rich and powerful, had bumped into reality. The strikes in France and the UK had not gone unnoticed, and business leaders were acutely aware that millions of people hurt by the crisis were angry, very angry. And in case they forgot, there were plenty of social activists and trade unionists here to remind them.
Davos: Don't let crisis breed more corruption
Here's yet another danger from the global economic crisis. It could breed more corruption, as recession-starved officials increasingly demand bribes and hungry companies compete for shrinking resources. Yet few words were dedicated to fighting graft at the World Economic Forum of business and political decision-makers last week. Instead, new financial rules, the U.S. stimulus plan and trade barriers dominated speeches and small talk. "Corruption is a real cancer," Kofi Annan, former U.N. secretary-general, said in a private meeting Saturday. "It deprives the poor from benefiting from some business activities or assistance," and drains enormous amounts of money from the legitimate economy, he added.
Annan urged rich world companies to pressure each other more to clean up — by posting internal audits on their Web sites, for example. "There's a tendency to say that corruption is in the third world. But it takes two to tango," he said. "The receiver is often from the south and the briber is often from the north." Angel Gurria, secretary-general of the Organization for Economic Cooperation and Development, warned that governments and businesses should be especially vigilant against corruption amid the crisis. "It becomes particularly relevant at a time when countries are scraping the bottom of the barrel to make ends meet," he said, suggesting that governments made poorer by recession are more likely to demand bribes for lucrative contracts. He also urged a crackdown on tax havens — something a few political leaders have demanded amid the crisis but that barely came up at Davos. Host country Switzerland is itself often seen as a tax haven.
Both Annan and Gurria touted international programs aimed at fighting corruption, but acknowledged that none has the power to jail officials or executives who skirt rules. "Of course, we don't have an army to go out and enforce," Gurria said. Peer pressure, he said, can be the most effective tool in getting big companies to clean up and level the playing field. "There's an ethical dimension, and a moral dimension, but there's also a business dimension," he said. If you want others to play fair, he said, you have to play fair, too. One program, the Partnering Against Corruption Initiative, includes 129 major world corporations who agree to conduct yearly self-evaluations of their practices. The group has kicked out some companies who didn't meet its clean conduct standards. David Seaton, group president of engineering and construction giant Fluor Corp., called the initiative "a moral compass" in a competitive global marketplace.
He said Fluor refuses to deal with some national oil companies because of their questionable practices and has pulled out of countries where it felt corruption was too rife. He would not name the companies or countries. Individual countries have passed measures such as the U.S. Foreign Corrupt Practices Act, aimed at punishing American companies who offer bribes even if it is outside the U.S. Some American companies complain the measure puts them at a disadvantage in foreign markets against businesses from other countries that are not held to the same rules. So those at Saturday's meeting urged more governments follow that path. They shied away from estimating how much bribe money has been thwarted by international anti-corruption programs started in recent years — if any.
"If you save 10 percent that's quite a bit of money going back into communities," Seaton said. Annan himself had trouble fighting corruption within the United Nations. Under his watch, the world body faced several bribery scandals involving U.N. purchasing officials. Serious flaws in U.N. purchasing operations were exposed in the probe into the $64 billion oil-for-food program in Iraq. The former head of the program, Benon Sevan, a Cypriot national, was indicted in New York in January 2007 on charges of bribery and conspiracy to commit fraud.
The credit crunch according to Soros
On Friday, August 17 2007, 21 of Wall Street’s most influential investors met for lunch at George Soros’s Southampton estate on the eastern end of Long Island. The first tremors of what would become the global credit crunch had rippled out a week or so earlier, when the French bank BNP Paribas froze withdrawals from three of its funds, and in response, central bankers made a huge injection of liquidity into the money markets in an effort to keep the world’s banks lending to one another. Although it was a sultry summer Friday, as the group dined on striped bass, fruit salad and cookies, the tone was serious and rather formal. Soros’s guests included Julian Robertson, founder of the Tiger Management hedge fund; Donald Marron, the former chief executive of PaineWebber and now boss of Lightyear Capital; James Chanos, president of Kynikos Associates, a hedge fund that specialised in shorting stocks; and Byron Wien, chief investment strategist at Pequot Capital and the convener of the annual gathering – known to its participants as the Benchmark Lunch.
The discussion focused on a single question: was a recession looming? We all know the answer today, but the consensus that overcast afternoon was different. In a memo written after the lunch, Wien, a longtime friend of Soros’s, wrote: “The conclusion was that we were probably in an economic slowdown and a correction in the market, but we were not about to begin a recession or a bear market.” Only two men dissented. One of those was Soros, who finished the meal convinced that the global financial crisis he had been predicting – prematurely – for years had finally begun. His conclusion had immediate consequences. Six years earlier, following the departure of Stan Druckenmiller from Quantum Funds, Soros’s hedge fund, Soros converted the operation into a “less aggressively managed vehicle” and renamed it an “endowment fund”, which farmed most of its money out to external managers. Now Soros realised he had to get back into the game. “I did not want to see my accumulated wealth be severely impaired,” he said, during a two-hour conversation this winter in the conference room of his midtown Manhattan offices. “So I came back and set up a macro-account within which I counterbalanced what I thought was the exposure of the firm.”
Soros complained that his years of less active involvement at Quantum meant he didn’t have the kind of “detailed knowledge of particular companies I used to have, so I’m not in a position to pick stocks”. Moreover, “even many of the macro instruments that have been recently invented were unfamiliar to me”. Even so, Quantum achieved a 32 per cent return in 2007, making the then 77-year-old the second-highest paid hedge fund manager in the world, according to Institutional Investor’s Alpha magazine. He ended 2008, a year that saw global destruction of wealth on the most colossal scale since the second world war, with two out of three hedge funds losing money, up almost 10 per cent. Soros’s main goal was to preserve his fortune. But, as has been the case throughout his career, his timing and financial acumen enhanced his credibility as a thinker, and never more so than in 2008. In May and June, after more than two decades of writing, he hit bestseller lists in the US and in the UK with his ninth book, The New Paradigm for Financial Markets. In October, he received an invitation to testify before Congress about the financial crisis. In November, Barack Obama, whom he had long backed for the presidency, defeated John McCain.
“In the twilight of his life, he’s achieved the recognition he has always wanted,” Wien said. “Everything is going for him. He’s healthy, his candidate won, his business is on a solid footing.”
. . .
Many comparisons have been drawn between 2008 and earlier periods of turmoil, but the historical moment with most personal resonance for Soros is not one of the conventional choices. The parallel he sees is with 1944, when, as a 13-year-old Jewish boy in Nazi-occupied Budapest, he eluded the Holocaust. Soros credits his beloved father, Tivadar, with teaching him how to respond to “far from equilibrium situations”. Captured by the Russians in the first world war, Tivadar was imprisoned in Siberia. He engineered his own escape and return home through a Russia convulsed by the Bolshevik revolution. That sojourn stripped him of his youthful ambition and left him wanting “nothing more from life than to enjoy it”. Yet on March 19 1944, the day the Germans occupied Hungary, the 50-year-old sprang into action, rescuing his immediate family and many others by arranging false identities for them. Before the invasion, George was still enough of a child, his father thought, to need a bit of parental coddling. Yet the teenager who spent the war living apart from his parents under a false name found the danger exhilarating. “It was high adventure,” Soros wrote, “like living through Raiders of the Lost Ark.” And as the latest financial crisis gathered momentum, he admitted to the same thrill. “I think the same thing applies again. I feel the same kind of stimulation as I felt then,” he told me.
Part of the stimulation is intellectual. Soros’s experiences in 1944 laid the groundwork for the conceptual framework he would spend the rest of his life elaborating and which, he believes, has found its validation in the events of 2008. His core idea is “reflexivity”, which he defines as a “two-way feedback loop, between the participants’ views and the actual state of affairs. People base their decisions not on the actual situation that confronts them, but on their perception or interpretation of the situation. Their decisions make an impact on the situation and changes in the situation are liable to change their perceptions.” It is, at its root, a case for frequent re-examination of one’s assumptions about the world and for a readiness to spot and exploit moments of cataclysmic change – those times when our perceptions of events and events themselves are likely to interact most fiercely. It is also at odds with the rational expectations economic school, which has been the prevailing orthodoxy in recent decades. That approach assumed that economic players – from people buying homes to bankers buying subprime mortgages for their portfolios – were rational actors making, in aggregate, the best choices for themselves and that free markets were effective mechanisms for balancing supply and demand, setting prices correctly and tending towards equilibrium.
The rational expectations theory has taken a beating over the past 18 months: its intellectual nadir was probably October 23 2008, when Alan Greenspan, the former Federal Reserve chairman, admitted to Congress that there was “a flaw in the model”. Soros argues that the “market fundamentalism” of Greenspan and his ilk, especially their assumption that “financial markets are self-correcting”, was an important cause of the current crisis. It befuddled policy-makers and was the intellectual basis for the “various synthetic instruments and valuation models” which contributed mightily to the crash. By contrast, Soros sees the current crisis as a real-life illustration of reflexivity. Markets did not reflect an objective “truth”. Rather, the beliefs of market participants – that house prices would always rise, that an arcane financial instrument based on a subprime mortgage really could merit a triple-A rating – created a new reality. Ultimately, that “super-bubble” was unsustainable, hence the credit crunch of 2007 and the recession and financial crisis of 2008 and beyond.
As an investor and as a thinker, Soros has always thrived in times of upheaval. But he has also remained something of an outsider. He recalls how he “discovered loneliness” when he arrived to study at the London School of Economics in 1947. Later on, as he worked his way up from being a journeyman arbitrage trader in London and then New York, to running one of the world’s most successful hedge funds, Soros remained, in the words of one private equity acquaintance, a bit of “an oddball”, both on Wall Street and in the academic world. He is frequently described as “charming”, yet few see the fit, tanned, twice-divorced billionaire as an emotional confidant. “If I had an idea about India-Pakistan, I would talk to him about it,” Wien said. “If I were having a problem in my marriage, I don’t think I would go and talk to George about it.”
Strobe Talbott, now the president of the Brookings Institute and a former deputy secretary of state, said: “He likes to think of himself as an outsider who can come in from time to time, including to the Oval Office, where I took him on a couple of occasions. But simply hobnobbing with the powerful isn’t important.” That lack of clubbiness, and the associated trait of iconoclasm, may explain why, for all his worldly success, Soros has had a rather mixed public reputation. His speculative plays, which have often targeted currencies, have earned him the wrath of political leaders around the world. The ambitious, global reach of his richly funded Open Society foundation has prompted some critics to accuse him of suffering from a Messiah complex. He was so effectively demonised by the US right earlier this decade that he kept fairly quiet about his support of Obama, lest the association hurt his candidate. Probably most painfully, his forays into economics and philosophy often have met with considerable scepticism, especially from academia.
The one time and place where he instantly became a highly regarded insider was in the former Soviet Union and its satellites, at the moment the Berlin Wall came down. More completely and more swiftly than any other foreigner, Soros grasped and embraced the systemic transformation that was unfolding, and was rewarded with influence and respect. The question for Soros today is whether, as the west undergoes its own once-in-a-century systemic shock, this arch-outsider will finally find himself in the mainstream in the society which has been his main home for more than half a century.
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Soros’s most famous – or infamous – speculative play as an investor was his bet against sterling in 1992, a wager which won him more than $1bn and earned him the epithet from the British press of “the man who broke the Bank of England”. That bet also turns out to be a perfect illustration of the specific talent which his past and present fund managers agree has been central to his investing success. Soros’s best-known investment was not, in actual fact, his own idea. According to both Soros and Druckenmiller, who was managing Quantum at the time, it was Druckenmiller who came up with the plan to short the pound. But when Druckenmiller went through his rationale with Soros, in one of their twice- or thrice-daily conversations, Soros told his protégé to be bolder: “I said, ‘Go for the jugular!’.” Druckenmiller duly raised their stake – Quantum and several related funds wagered nearly $10bn, according to interviews Soros gave afterwards – and Soros earned both a fortune and an international reputation. Druckenmiller, who spent 12 years at Quantum, says that conversation exemplifies Soros’s singular financial gift: “He’s extremely good at using the balance sheet – probably the best ever. He is able to use leverage when he likes it, but he is also able to walk away. He has no emotional attachment to a position. I think that is an unusual characteristic in our industry.”
Chanos agrees: “One thing that I’ve both wrestled with and admired, that [Soros] conquered many years ago, is the ability to go from long to short, the ability to turn on a dime when confronted with the evidence. Emotionally, that is really hard.” Soros denies any great degree of emotional self-control. “That’s not true, that’s not true,” he told me, shaking his head and smiling. “I am very emotional. I am as moody as the market, so I’m basically a manic depressive personality.” (His market-linked moodiness extends to psychosomatic ailments, especially backaches, which he treats as valuable investment tips.) Instead, Soros attributes his effectiveness as an investor to his philosophical views about the contingent nature of human knowledge: “I think that my conceptual framework, which basically emphasises the importance of misconceptions, makes me extremely critical of my own decisions … I know that I am bound to be wrong, and therefore am more likely to correct my own mistakes.”
Soros’s radar for revolution is the second key to his investing style. He looks for “game-changing moments, not incremental ones”, according to Sebastian Mallaby, the Washington Post columnist and author who is writing a history of hedge funds. As examples, Mallaby cites Quantum’s shorting of the pound and Soros’s 1985 “Plaza Accord” bet that the dollar would fall against the yen – his two most famous currency trades – as well as a lesser-known 1973 bet that, as a consequence of the Arab-Israeli war, defence stocks would soar. “It’s not that reflexivity tells you what to do, but it tells you to be on the look-out for turn-around situations,” Mallaby said. “It’s an attitude of mind.” Some Soros-watchers intimate that his vast network of international contacts might be an important source of his market prescience. But it was in the one part of the world where Soros really did have an inside track – the former Soviet bloc – that he made his most disastrous deal. In Russia, as in much of the former Soviet Union, he was intensely engaged with the country’s political and economic transformation. In June 1997, as the Kremlin struggled to pay overdue wages, Soros extended a bridge loan to the Russian government, acting as a one-man International Monetary Fund.
He came to believe in Russia’s commitment to reforms, and to see himself as an insider – two convictions that were his financial undoing. He invested $980m with a consortium of oligarchs who acquired a 25 per cent stake in Svyazinvest, the national telecoms company, deciding to participate because “I thought that this is the transition from robber capitalism to legitimate capitalism”. But instead, the Svyazinvest privatisation turned out to be the moment when the oligarchs redirected their energies from fleecing the state to fleecing one another. Soros, as an outsider, was an obvious casualty. “Never have I been screwed so much since Russia. For them, they get a satisfaction out of doing it. “It was the biggest mistake of my investment career. I was deceived by my own hope.” In his most recent book he dismisses Russia with a single sentence, further diminished by parenthesis: “(I don’t discuss Russia, because I don’t want to invest there.)”
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On a chilly Monday night in December, Soros took the hour-long drive from Manhattan to the Bruce Museum in Greenwich, Connecticut. He was due to speak at a benefit for the Scholar Rescue Fund, a programme he has partly financed and which, since 2002, has provided safe havens for 266 persecuted academics from 40 countries. After his talk (on the global financial crisis, of course), Soros filed out of the auditorium chatting with Stanley Bergman, a founding partner of the law firm that had sponsored the evening. “You like the game?” Soros asked his host with a smile. “Yes,” the white-haired Bergman replied. Then, in a flash of the competitive spirit that makes Soros an avid skier and player of tennis and chess, Soros asked: “And how old are you?” “75.” “I’m 78,” Soros replied. “But what’s the use of good health if it doesn’t buy you money?” The vigorous septuagenarians flashed each other a complicit smile. According to Wien, Soros likes the game, too: “George loves to be able to show from time to time that he can do it.” But while he loves to play, he is disdainful of a life lived purely to accumulate more chips. His epiphany came in 1981, when he had to scramble to raise money to pay for an investment in bonds. “I thought I would have a heart attack,” he told me. “And then I realised that to die just for the sake of getting rich, I would be a loser.”
For Soros, the solution was philanthropy. “To do something really that would make a significant difference to the world, that would be worth dying for,” he said. “The Foundation enabled me to get out of myself and to somehow be concerned with other people than myself.” Soros’s fortune has given his causes enormous firepower: according to Aryeh Neier, the human rights activist who has been running the Open Society Foundation since 1993, its budget was $550m in 2008 and will increase to $600m this year. By his own calculation, Soros has donated a total of more than $5bn to his causes, primarily directing his giving through his foundation. “No philanthropist in the second half of the 20th century has done better in deploying resources strategically to change the world,” Larry Summers, the newly appointed head of Barack Obama’s National Economic Council, told me in a conversation early last autumn. Talbott compares Soros’s impact to that of a sovereign nation. In the 1990s, says Talbott, “when I got word that George Soros wanted to talk, I would drop everything and treat him pretty much like a visiting head of state. He was literally putting more money into some of the former colonies of the former Soviet empire than the US government, so that merited treating him as someone with a very high impact.”
Soros’s philanthropic lieutenants report an approach remarkably similar to the investing style observed by his fund managers: he knows how to make big, original bets, and he isn’t afraid to cut his losses when a project isn’t working out. Anders Aslund, an economist who has studied Russia and Ukraine and who has worked with Soros on various projects, believes his philanthropic style “is very much formed by the money markets, which are always changing. He assumes any idea he has now will be wrong in a few years. He is always asking himself, when he has a wonderful project going, ‘When should I stop this project?’.” Soros’s war chest, and his determination to deploy it beyond the usual blue-chip charities of hospitals, universities, museums or even poverty in Africa, had long made him an occasionally controversial figure outside the US. He was among the western culprits accused by the Kremlin of inciting Ukraine’s 2004 Orange Revolution; his foundation’s offices have been raided in Russia and he was forced to close them down in authoritarian Uzbekistan.
America, it turns out, can also be sensitive to plutocrats using their wealth to address socially contentious subjects. In recent years, his foundation became more active in the US, taking on issues including drug policy. His engagement became more intense during the George W. Bush presidency, when Soros decided that the open society he had worked to foster in repressive regimes abroad was imperilled in his adopted home. Some admired his chutzpah. The famously independent-minded Paul Volcker, who was appointed to lead the Fed by Jimmy Carter and reappointed by Ronald Reagan, said: “The drug thing is a perfect example that he doesn’t adopt a conventional view. I think drug policy needs a new look and he’s been one of the people who say that.”
Soros’s money has been crucial in enabling him to voice maverick views: “That’s what led me to oppose Bush very publicly, because I was in a position that I could afford to do it,” he said. But he also believes his fortune and the automatic credibility it gives him in America has drawn the fire of conservative pundits such as Fox’s Bill O’Reilly and extremist pamphleteer Lyndon LaRouche. “Given the excessive esteem in which people who make money are held in America, I had to be demonised,” he said. Their attacks worked. So much so that last year, as the Obama bandwagon gained speed and American financiers, along with much of the rest of the country, clamoured to jump on, his earliest heavyweight Wall Street backer kept a low profile. “Obama seeks to be a unifier,” Soros said. “And I have been a divisive figure because I’ve been demonised by the right. I thought my vocal support for him would not necessarily benefit him.”
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At around 1.00am on November 5 2008, Soros sat on a peach-coloured sofa in his elegant Fifth Avenue apartment, with Queen Noor of Jordan to his left and Steve Clemons, of the New America think-tank, perched on the edge of a chair to his right. Around them milled a crowd of eclectic and jubilant guests, many still teary-eyed from Obama’s Grant Park victory speech, which had been broadcast on four flat-screen television sets in the apartment. Like most Soros soirées, the gathering included more artists and statesmen than Masters of the Universe: Michèle Pierre-Louis, the prime minister of Haiti and former head of her country’s Soros foundation; former World Bank chief James Wolfensohn; Volcker; and twentysomething Kwasi Asare, a hip-hop music promoter, were among the visitors.
Soros drank an espresso and, a few minutes later, a final champagne toast with the last of his guests. Alexander, his 23-year-old son, perched on the arm of his chair and ruffled his father’s hair in farewell. Everyone else took that as a signal to depart, too.
Soros was in a mellow, triumphant mood that night – and with good reason. He had spotted Obama early on. His ubiquitous political consigliere, Michael Vachon, still has among his papers a rumpled itinerary from a trip he and Soros took to Chicago in February 2004. In the upper right-hand corner of the page, Vachon had scrawled, “Barack guy”. The Senate candidate had been keen to meet Soros and called the pair repeatedly during their visit. But it was a packed schedule and Soros could only offer a 7.30am breakfast slot at the Four Seasons. Soros left that meal “very impressed”, a view that was confirmed when he read Obama’s autobiography and deemed him “a real person of substance”. A few months later, on June 7, Soros hosted a packed fundraiser for Obama’s Senate campaign at his upper east side home. Soros and his family contributed roughly $80,000, then the legal maximum.
Obama was impressing a lot of people at that time. But once it became clear that Hillary Clinton would be in the presidential race, nearly all of the established New York Democrats, particularly the older Wall Street crowd, lined up behind their local Senator and her machine, driven by a combination of loyalty and calculation. Dominique Strauss-Kahn, now the head of the IMF and then a possible French presidential candidate, said Soros told him in 2006 he was supporting “this young guy, Barack Obama. He was the first one to tell me this and he was right.” On January 16 2007, the day Obama formed a presidential exploratory committee, Soros contributed to his campaign and officially offered his backing. Before doing so, Soros called Hillary Clinton to let her know. “I look forward to your support in the general election,” she told him. His decision to back Obama was consistent with his life-long affinity for moments of radical change. “I felt that America had gone so far off base that there was a need for discontinuity,” he said. As in the markets, Soros’s political bet on systemic transformation – his support for Obama, but also his early opposition to the war in Iraq and the “war on terror” – has come good.
For Soros, one happy consequence of now being in tune with the zeitgeist is that he is being taken seriously as a thinker on American public policy issues, particularly to do with the financial crisis. When he, along with the other four highest-earning hedge fund managers, testified before Congress in November, he was treated with respect and even deference – not the prevailing attitude towards billionaire financiers at the moment. Before Soros had even taken his coat off, he was greeted in the corridors by Democratic New York Congresswoman Carolyn Maloney. “Give him a nice office,” she told a staffer who was looking for a place where Soros could wait before his testimony. “He creates a lot of jobs in my district and supports a lot of good people.” After the hearing, a lawmaker and a staffer both approached Soros and asked him to autograph their copies of his book.
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Being listened to on Capitol Hill, and by global policymakers more generally, is important to Soros. But what matters to him most of all – more than money, more than the political and social accomplishments of his foundation – is leaving an enduring intellectual legacy. He describes reflexivity as “my main interest”. Even as Soros met with increasing financial and public success through his fund and his foundation, he was deeply frustrated by his failure to be accepted as a serious thinker. He titled one chapter in his latest book “Autobiography of a Failed Philosopher”, and once delivered a lecture at the University of Vienna called “A Failed Philosopher Tries Again”. As a young man, he wanted to become an academic, but “my grades were not good enough”. He writes that his first book, The Alchemy of Finance, was “dismissed by many critics as the self-indulgence of a successful speculator”. That reaction still prevails in some circles. Paul Krugman, the Nobel prize-winning economist, devotes half a chapter to Soros in his latest book, characterising him as “perhaps the most famous speculator of all times”. He also raises an eyebrow at Soros’s intellectual “ambitions”, tartly observing that he “would like the world to take his philosophical pronouncements as seriously as it takes his financial acumen”.
Another barrier to academic respectability is Soros’s self-confessed “phobia” of formal mathematics: “I understand mathematical concepts but I’m afraid of mathematical symbols, because you can easily get lost in them.” That fear proved no impediment to success in the quantitative world of finance, but it has hurt Soros’s street cred in economics departments. “Among academics, he suffers from the additional liability of not expressing it in the language of mathematics that has become fashionable,” Joe Stiglitz, another Nobel prize-winning economist, said. But Stiglitz believes his friend’s writing has become more current, partly thanks to the financial crisis: “By those economists interested in ideas, I think his work is taken seriously as an idea that informs their thinking.” In the view of Larry Summers: “Reflexivity as an idea is right and important and closely related to various streams of existing thought in the social sciences. But no one has deployed a philosophical concept as effectively as George has, first to make money and then to change the world.”
Paul Volcker delivered a similar verdict: “I think he has a valid insight which is not always expressed as clearly by him as I might like.” Overall, he said, Soros is “an imaginative and provocative thinker … he’s got some brilliant ideas about how markets function or dysfunction.” This is as close to mainstream intellectual acceptance as Soros has come in his two decades of writing and more than five decades since he gave up on academia. It feels like a breakthrough. When I asked him if he would still describe himself as a failed philosopher, he said no: “I think that I am actually succeeding as a philosopher.” For him, that is “obviously” the most important human accomplishment. “I think it has to do with the human condition,” he said. “The fact that we are mortal and we would like to be immortal. The closest thing you can come to that is by creating something that lives beyond you. Wealth could be one of those things, but evidence shows that it doesn’t survive too many generations. However, if you can have an artistic or philosophical or scientific creation that withstands the test of time, then you have come as close to it as possible.”