French market, New Orleans waterfront
Ilargi: If and when a $2 trillion bail-out leads to a 350+ point plunge on Wall Street, maybe something is structurally wrong. I see pundits claim that the Dow falls today because the plan is "not big enough", but I don't think so. In my view, this comes down to what brought the markets down in the first place: the erosion of confidence. Only this time, it’s not confidence in the markets that is in play, but confidence in the government. The Geithner plan is just another hastily constructed set of vague promises, glued together by Obama, Summers and Geithner with the sort of speed that makes one suspect the devil himself is snapping at their heels. It's not quantity that erodes confidence, but quality.
Someone who puts his finger right where it hurts most is Nassim Taleb, writer of "Black Swan". In the video below, in which he is rudely interrupted by CNBC drillbits all the time, he makes clear that what is happening should be seen from a systems point of view. And the system is dead, and needs a complete overhaul. In between the squeaking heads, he manages to spell out most of what he thinks needs to be done to achieve that.
I for one am relieved to see a voice of sanity, even though I'd like to see Taleb explain his idea of nationalizing banks. I don't think there's a need to do that, while the downside risks are enormous. By the way, if Roubini and Taleb are such rockstars these days, why does the US government ignore them? Here are a few quotes from the video. Don’t miss seeing it though:
"What I see here is the same symptom[s] that caused me to worry about the system. They’re still present, those problems. We have the same people in charge, those who did not see the crisis coming, who took a humongous amount of hidden risk, they’re still around; the bankers that got us here are still around, and we’re giving them more money. So I don't see that we’re doing something to get out of the crisis. Look, for example, Nouriel, he is not in government. There are not many people who saw the crisis coming who are in government. So unless we do something drastic, we’re not going to pull out of this.
First, someone like Nouriel, or Nouriel, should be in government, someone who saw the crisis coming. I was in Davos, and all those people were talking as if they knew what was going on. But a year ago, they spoke a different language. They didn’t see it coming, they’re not going to see the next step and they’re definitely not going to see how we get out of here. That’s the first thing.
Second one, I would like to see the responsible people, not just punished, but out of office. They’re still in office. Mr Bernanke did not understand the risks the system was taking. I want him out of there. People like him, we should immediately remove these people. It’s like someone crashed a plane, and we give him a new plane and say we’re going to fly with you now?
The whose system needs to be changed. Dependence on debt needs to be eliminated. Ban CDS trading. Stop most derivatives and options trading. Punish guilty offenders. Robert Rubin should return his $110 million to the taxpayers. You cannot have someone making a bonus and then hide the risks that society has to pay for.This is just happening. It’s not finished yet; it hasn’t probably started.
As for the Geithner plan, Taleb is sure it will not work:
"I don’t think much of all that class of people managing these plans and society. These people failed, and they are going to fail again”. Roubini agrees: "This is just a patch, it’s not going to solve the fact that the banks are insolvent."
As for investment advice, Roubini say he has only cash, while Taleb says he’s between 100% and 200% in cash."
Oh, and on top of the $2 trillion plan today, we already know that Fannie and Freddie will need another $200 billion, the GSE’s that exist only so that Americans keep overpaying for their homes. What a mess we see today. Nowhere bigger than in the bond markets. Even more than in the Dow Jones numbers, that's where the vote of no confidence increasingly looks to be coming from.
PS: There are more interesting videos below, Jim Rogers, Martin Wolf, and a very scared and scary old Congressman.
Dr. Doom & The Black Swan: You Ain’t Seen Nothin’ Yet
NB: there is a second part of the interview available when you click the title of this article
Nouriel Roubini and Nassim Taleb are widely credited with predicting the current financial crisis, and both told CNBC they see more rough waters ahead. Even if we play our cards right, said Roubini, chairman of RGEMonitor.com, it will take at least 12 months to get out of this recession. "If you don’t do everything right, and I think there’s a large probability that’s going to happen, then we may end up in a multi-year stagnation or near depression like the one that Japan had," he added.
Roubini said there is still a 20 percent downside risk to U.S. global equities, and he advises investors to stay in cash until there is a real bottom. "Officially the write-downs have been about $1 trillion; I see another $2.6 (trillion) coming up," he said. "…Losses are mounting and this severe recession is going to get only bigger."
Nassim Taleb, advisor to Universal Investments and author of The Black Swan, is not as bearish as Roubini but also sees more trouble ahead. "If I follow my logic to the end, what I thought would happen was anything fragile…would break, namely the banks and people who have a lot of debt and private equity," he said.
Geithner Says Bank-Rescue Plans May Reach $2 Trillion
Treasury Secretary Timothy Geithner pledged government financing for as much as $2 trillion of efforts to spur new lending and address banks’ toxic assets, seeking to end the credit crunch hobbling the economy. "Instead of catalyzing recovery, the financial system is working against recovery," Geithner said in unveiling the Obama administration’s overhaul of the government’s financial-bailout plans in Washington today. "At the same time, the recession is putting greater pressure on banks. This is a dangerous dynamic, and we need to arrest it." The main components of the Treasury’s package today are a joint public- and private-sector fund to buy as much as $1 trillion of illiquid assets and a $1 trillion program to supply new credit to consumers and businesses. The administration also will inject additional taxpayer funds into banks, imposing tighter restrictions that will include limits on dividend payments, acquisitions and executive pay.
"I want to be candid: this strategy will cost money, involve risk, and take time," Geithner said today. The initial bailout effort, which he helped administer in his previous job as head of the Federal Reserve Bank of New York, was "essential" while "inadequate" to support the financial system and the secondary-lending market, he said. Stocks dropped as investors expressed concern about a lack of specifics on plans for addressing toxic assets. The Standard & Poor’s 500 Stock Index slumped 3.8 percent to 837.09 at 11:40 a.m. in New York. The S&P 500 Bank index fell 10 percent, with Bank of America Corp. down 17 percent. Regional lender Huntington Bancshares Inc., based in Columbus, Ohio, slid 19 percent to $2.11.
Today’s overhaul of the Treasury’s $700 billion financial- rescue fund is aimed at addressing the failures of the first phase of the program, which has yet to spur a wave of new lending to companies and consumers. Geithner’s warning about the cost of the effort followed signals yesterday by President Barack Obama that the administration is open to seeking more money. "We don’t know yet whether we’re going to need additional money or how much additional money we’ll need until we’ve seen how successful we are at restoring a sense of confidence in the marketplace," Obama said in his news conference last night in Washington. Officials debated the financial-recovery plan for weeks, and encountered the same issues that former Treasury Secretary Henry Paulson did in trying to deal with the toxic assets.
Paulson abandoned an effort to buy the securities after failing to find a quick mechanism for pricing them. He opted for buying stakes in banks as the centerpiece of the first $350 billion of the financial-bailout program. Geithner today outlined the Public-Private Investment Fund, with an initial capacity of $500 billion that could grow to $1 trillion, to provide financing for private investors to buy distressed securities. "We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it," the Treasury chief said today. This fund will be targeted to the legacy loans and assets that are now burdening many financial institutions." The illiquid securities, mainly tied to mortgages, have spooked investors away from putting new money into banks and made lenders loath to extend new credit.
Rather than borrow at the Fed’s target rate for overnight funds -- now as low as zero percent -- to lend, banks have instead parked a surplus of $793 billion of cash at the central bank itself. The Treasury will also work with the Federal Reserve to finance as much as $1 trillion in new consumer and business loans. The newly established Consumer and Business Lending Initiative is modeled on an earlier program to support new credit. Under today’s plan, regulators will subject banks to new tests to determine whether they have enough capital. The Treasury, Fed and other supervisors in the President’s Working Group on financial markets will develop guidelines for the examinations, which are aimed at ensuring that the country’s largest banks can withstand a worsening economy.
Banks that don’t have sufficient capital will be given additional taxpayer funds in the form of convertible preferred securities. Participants will have their dividends and political lobbying efforts restricted, along with limits on stock buybacks, acquisitions, executive compensation and so-called golden parachutes. Luxury spending provisions must also be disclosed. The Treasury’s new investments in banks will be placed in a new entity called the Financial Stability Trust, Geithner said. Today’s package includes $50 billion for measures to stem mortgage foreclosures. Banks receiving federal funds will be required to participate in efforts to mitigate foreclosures. The Treasury and Fed will work to reduce monthly payments and establish loan-modification guidelines.
Treasuries Gain on Speculation Rescue Plan Will Be Inadequate
Treasuries rose on speculation Treasury Secretary Timothy Geithner’s plan to rescue the banking system will prove inadequate, boosting demand for the safety of government debt. U.S. securities advanced amid expectations Federal Reserve Chairman Ben S. Bernanke may tell Congress the central bank is prepared to buy longer-term Treasuries to cut consumer borrowing costs. Geithner pledged government financing for programs aimed at spurring new lending and dealing with banks’ toxic assets, an effort that may grow to as much as $2 trillion. The U.S. will sell a record $32 billion of three-year notes today.
"The Geithner speech is short on details and long on rhetoric," said Maxwell Bublitz, who oversees $3.5 billion in bonds as chief strategist at San Francisco-based SCM Advisors LLC. "In a word, it is weak." The yield on the 10-year note tumbled 11 basis points, or 0.11 percentage point, to 2.88 percent at 11:39 a.m. in New York, according to BGCantor Market Data. The price of the 3.75 percent security maturing in November 2018 climbed 31/32, or $9.69 per $1,000 face amount, to 107 3/8. The benchmark note’s yield exceeded 3 percent yesterday for the first time since Nov. 28 after falling to a record low of 2.04 percent on Dec. 18. Inventories at U.S. wholesalers fell 1.4 percent in December, twice as much as forecast, as businesses tried to keep up with plummeting sales, a Commerce Department report showed.
Geithner pledged government financing for programs aimed at spurring new lending and addressing banks’ toxic assets, an effort that may grow to as much as $2 trillion. The Treasury is creating a Public-Private Investment fund, with an initial capacity of $500 billion, to provide financing for private investors to buy distressed securities, Geithner said. The Treasury will also work with the Fed to finance as much a $1 trillion in new consumer and business loans. "It doesn’t seem to be a forceful enough plan, given market expectations," said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, one of 17 primary dealers that are required to bid in Treasury sales. Fed officials have yet to resolve an internal debate over whether to purchase long-term U.S. debt, according to people familiar with the deliberations. Bernanke first talked about the option of buying Treasuries on Dec. 1.
"The rally is driven off the thinking that Treasuries will get Fed support," said Andrew Richman, who oversees $10 billion in fixed-income assets as a strategist in West Palm Beach, Florida, at SunTrust Bank’s personal-asset management division. "People are thinking the Fed will buy Treasuries to cut rates." The U.S. will sell $32 billion of three-year notes today, followed by $21 billion of 10-year notes tomorrow and $14 billion of 30-year bonds Feb. 12, in the Treasury’s biggest weekly sale. Investors bid for 2.21 times the amount of debt on offer at the prior three-year note sale on Jan. 7. The average for the past 10 auctions is 2.4. Three-year note yields fell six basis points to 1.40 percent today, compared with the high yield of 1.2 percent at last month’s sale.
Foreign investors were "opportunistically making purchases" of Treasuries at the expense of other asset classes, according to Dan Mulholland, a Treasury trader in New York at RBC Capital Markets, the investment-banking arm of Canada’s biggest bank. Central banks and other overseas investors own more than 53 percent of outstanding U.S. public debt, up from 34 percent in 2000, Treasury data show. Treasuries lost 3.6 percent this year, their worst start to a year since 1980, according to Merrill Lynch & Co.’s Treasury Master Index data. Yields climbed on longer-maturity debt in five of the past six weeks as bond prices fell amid concern that the Fed won’t buy U.S. debt to keep yields low while the government increases borrowing. Investors sold Treasuries this year as credit markets began to thaw, reducing the need for the haven of government debt. Three-month Treasury bill rates climbed to 0.32 percent today after plunging to minus 0.04 percent on Dec. 4.
The New York Lottery is proposing moving its $1.3 billion prize fund out of the safety of Treasuries and into investments such as stocks, corporate bonds, real estate and hedge funds. New York would be the first state lottery among the 20 largest to shift to pension fund-style investments from U.S. debt, according to annual reports. Average 30-year fixed mortgage rates rose to 5.25 percent in the seven days ended Feb. 5 from 4.96 percent three weeks earlier, according to loan finance company Freddie Mac. Rates are about 226 basis points higher than 10-year Treasury yields, widening from 162 basis points five years ago.
Investors are adding to inflation bets as President Barack Obama works to push his economic stimulus plan through Congress. The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, was 131 basis points, near the widest since October. New York Fed President William Dudley spoke about TIPS at a closed conference today. Dudley, recently named head of the New York Fed to replace Geithner, has said in the past he supports the TIPS program.
Bond Vigilantes Push U.S. Treasuries Into Bear Market
The bond vigilantes may be making a comeback. A decade after forcing Bill Clinton to abandon his spending plans in favor of a balanced budget, investors in Treasuries are bedeviling President Barack Obama as he embarks on the most costly spending plan in U.S. history, driving up borrowing costs for the government and consumers. Treasuries have lost 3.6 percent this year, their worst annual start since 1980, according to Merrill Lynch & Co.’s Treasury Master Index data. Yields climbed on longer-maturity debt in five of the past six weeks as bond prices fell amid concern that the Federal Reserve may not buy U.S. debt to keep yields low while the government increases its borrowing.
"The bond vigilantes are testing" the administration and Fed policy makers, said Tom di Galoma, managing director of government bonds at Jefferies & Co., a brokerage for institutional investors in New York. Ten-year note yields, which help determine rates on everything from mortgages to auto loans, rose as much as 1 percentage point from a record low of 2.035 on Dec. 18. That was two days after the Fed said it was "evaluating the potential benefits of purchasing longer-term Treasury securities" as a way to keep consumer borrowing costs from rising. The yield on the benchmark 10-year note was 2.95 percent as of 7:30 a p.m. yesterday in New York, according to BGCantor Market Data. It touched 3.05 percent, the highest in almost 11 weeks. The 3.75 percent security due November 2018 traded at 106 23/32.
Since Dec. 31, yields on 10-year notes have increased 77 basis points, or 0.77 percentage point, while those on the 30- year bonds have soared 97 basis points to 3.65 percent. Investors are also selling Treasuries as credit markets begin to thaw, lessening the need for the haven of government debt. Three-month Treasury bill rates have climbed to 0.31 percent after touching minus 0.04 percent Dec. 4. That flight to safety helped U.S. debt rally 14 percent in 2008, the best performance since gaining 18.5 percent in 1995, Merrill Lynch indexes show. "The scarcity and the fear that were driving the bond market are unwinding," said E. Craig Coats Jr., the head of Salomon Brothers’ government securities desk when it was the world’s biggest bond trader.
Coats, who is now co-head of fixed income at Keefe, Bruyette & Woods Inc. in New York, said he considers himself one of the original vigilantes, the bearish traders who drove up long-term interest rates and persuaded Clinton to place deficit- reduction above fulfilling his spending promises. The economic stimulus package sought by Obama cleared a key procedural hurdle in the U.S. Senate yesterday. The chamber voted 61 to 36 to bring debate on the $827 billion measure to a close, a precursor to a vote on the bill itself scheduled for today. To help pay for the plan the Treasury will likely borrow a record $2.5 trillion this fiscal year ending Sept. 30, almost triple the $892 billion in notes and bonds sold in fiscal 2008, according to Goldman Sachs Group Inc. The New York-based firm is one of the 17 primary dealers that are required to bid at the government’s debt auctions. This week, the Treasury Department will sell $187 billion of bills, notes and bonds.
"The supply is never ending," said Jamie Jackson, who oversees government debt trading at RiverSource Investments in Minneapolis. The firm manages $90 billion of bonds. The last time investors drove yields up from such low levels was 2003, when policy makers also commented on buying Treasuries as a way to cap borrowing costs. Yields rose 152 basis points to 4.59 percent on Sept. 3 from a 45-year low of 3.07 percent on June 16 as traders and investors gave up on the idea of Fed purchases after then Fed Chairman Alan Greenspan said July 15 that the central bank was unlikely to buy government debt. "In the end they didn’t pull the trigger," said Vincent Reinhart, the Fed’s former director of monetary affairs and resident scholar at the American Enterprise Institute in Washington. "The markets got ahead of the Fed and the Fed didn’t follow." This time around, investors are once again challenging the Fed to buy Treasuries or watch U.S. borrowing costs increase.
"To some degree it’s challenging the Fed," said David Ader, head of U.S. government bond strategy at Greenwich, Connecticut-based RBS Greenwich Capital, one of the 17 primary dealers. "You can only presume that the trigger is going to be levels higher than we’ve seen them," he said in reference to yields. The so-called bond vigilantes torpedoed President Bill Clinton’s efforts to boost deficit spending in favor of a balanced budget. The resulting rise in yields led Clinton political adviser James Carville to observe at the time: "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody." The cost to protect U.S. government debt against losses is higher than that of France, according to traders of credit- default swaps. Contracts on five-year credit default swaps tied to Treasuries rose to 85 basis points from 67.4 basis points Dec. 31, according to CMA Datavision in London. The cost to insure France’s debt is 70 basis points.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. "A large portion of the rally last year was based on fear rather than fundamentals and we are unwinding that fear trade now," said Thomas Sowanick, who manages $20 billion as chief investment officer of Princeton, New Jersey-based Clearbrook Financial LLC and the former chief global debt strategist at Merrill Lynch. "We are also starting to build in a premium for the huge financing bill that is going to come this year."
Government Bonds May Be Last Bubble: Jim Rogers
Investors will have to short government bonds at some point despite their current attraction, as the amount of debt issued is "staggering" and inflation risks are down the road, Jim Rogers, CEO of Jim Rogers Holdings, told CNBC Tuesday. The low rates policy promoted by central banks is likely to pop a fresh bubble in government bonds sometime in the future, Rogers said. "I was short long-term government bonds in the US, I had to cover a little loss because the head of the central bank said he was going to buy US long-term bonds, and he's got more money than I do," he told "Squawk Box Europe."
"I plan to sell short US government long bonds sometime in the foreseeable future… I don't know when, whether it's this quarter or this year," Rogers said. If long-term interest rates continue to go down, then "you've got to sell short government bonds, because the numbers are just staggering" when it comes to the amount of debt issued by the US and the UK, he explained. "Government bonds may be the last bubble that is developing. I'm not short government bonds right now," Rogers said.
The rise in the US dollar was likely caused by short-sellers covering their bets but the trend was unlikely to last long-term, he said. "There are huge short positions in the dollar, everybody is trying to cover. I'm not selling my yen yet, but it's an artificial rally too." "I sold all of my sterling, I wouldn't buy sterling for the next 5 to10 years. The same is happening to the US economy, I'm not picking on the UK," Rogers added. He reiterated his view that, with North Sea oil reserves dwindling and the City of London shrinking because of the financial crisis, the UK had no big industries to fall back upon. The euro and other currencies from the Continent are likely to fare slightly better than sterling, but they were not a 'buy' in his view, Rogers said.
"I'm not buying any of these currencies at the moment. I still own the euro, I don't own sterling anymore, I still own the Swiss franc. Europe at least is not a huge debtor, like the UK is," he said. Commodities continue to be the safest bet as fundamentals were good because when the economic downturn is over, the world will need raw materials, he said. "The fundamentals of commodities are improving through all of this," Rogers said. "You're not going to see a mine of any kind opening in 10 to 15 years."
Agricultural commodities, where prices fell a lot, oil and gold may also be good for investors, according to Rogers. "I'm buying gold just because I'm periodically buying gold, because I do expect it to be much higher over the next decade," Rogers said, adding that history has never seen all major central banks printing money "as fast as they can" at the same time. "I know we're going to have serious inflation down the road," Rogers said.
'This is the worst recession for over 100 years'
Britain is facing its worst financial crisis for more than a century, surpassing even the Great Depression of the 1930s, one of Gordon Brown's most senior ministers and confidants has admitted. In an extraordinary admission about the severity of the economic downturn, Ed Balls even predicted that its effects would still be felt 15 years from now. The Schools Secretary's comments carry added weight because he is a former chief economic adviser to the Treasury and regarded as one of the Prime Ministers's closest allies.
Mr Balls said yesterday: "The reality is that this is becoming the most serious global recession for, I'm sure, over 100 years, as it will turn out." He warned that events worldwide were moving at a "speed, pace and ferocity which none of us have seen before" and banks were losing cash on a "scale that nobody believed possible". The minister stunned his audience at a Labour conference in Yorkshire by forecasting that times could be tougher than in the depression of the 1930s, when male unemployment in some cities reached 70 per cent. He also appeared to hint that the recession could play into the hands of the far right.
"The economy is going to define our politics in this region and in Britain in the next year, the next five years, the next 10 and even the next 15 years," Mr Balls said. "These are seismic events that are going to change the political landscape. I think this is a financial crisis more extreme and more serious than that of the 1930s, and we all remember how the politics of that era were shaped by the economy." Philip Hammond, the shadow Chief Secretary to the Treasury, said Mr Balls's predictions were "a staggering and very worrying admission from a cabinet minister and Gordon Brown's closest ally in the Treasury over the past 10 years". He added: "We are being told that not only are we facing the worst recession in 100 years, but that it will last for over a decade – far longer than Treasury forecasts predict."
The minister's comments came as the Chancellor, Alistair Darling, admitted the global economy was "seeing the most difficult economic conditions for generations". Writing in today's Independent, Mr Darling said his plans for shoring up Britain's finances included "measures to insure against extreme losses" as well as separating out impaired assets into a "parallel financial vehicle". Unemployment figures out tomorrow are expected to show the number of people out of work has passed two million. The Bank of England's quarterly inflation report, also released tomorrow, is expected to include a gloomy forecast for economic growth.
Yesterday, the Financial Services Authority warned that the recession "may be deeper and more prolonged than expected", adding that the global financial system had "suffered its greatest crisis in more than 70 years". Speaking to Labour activists in Sheffield, Mr Balls conceded that the Government must share some of the blame because it had failed properly to control the banks. But he accused the Tories of blocking Labour's attempts to tighten financial rules. He said: "People are quite right to say that financial regulation wasn't tough enough in Britain and around the world, that regulators misunderstood and did not see the nature of the risks of the dangers being run in our financial institutions – absolutely right."The other great depressions
- *Long Depression, 1873–96
Precipitated by the "panic of 1873" crisis on Wall Street and a severe outbreak of equine flu (Karl Benz's first automobile did not chug on to the scene until 1886), it was remarkable for its longevity as well as its global reach. In Britain, it was the rural south rather than the rich cities of the north that suffered. The UK ceased to be a nation that relied in any way on farming for its livelihood.
- *Great Depression, 1930s
The "Hungry Thirties" were rough on many, at a time when welfare systems were rudimentary. The worst period was from the Wall Street Crash of 1929 to about 1932, but in places such as Jarrow, the unemployment rate hardly dipped below 50 per cent until the economy was mobilised in 1940. However, for many in the south and for the middle classes, the times were relatively prosperous.
Martin Wolf: U.S. Too "Politically Frightened" to Admit Banks are Insolvent, Part I
The next phase of the bank bailout plan presented by Treasury Secretary Tim Geithner (now slated for Tuesday) is expected to be multi-faceted but missing one key element: An admission by policymakers that major U.S. banks are insolvent. There are two explanations why the Obama administration (like its predecessor) refuses to even acknowledge this possibility in public, says Martin Wolf, chief economics commentator for The Financial Times:
- One, policymakers have better information than private economists and really believe the big banks aren't insolvent, i.e. they continue to view the crisis as a "liquidity problem," and believe so-called toxic assets will return from their currently "artificially low" levels once confidence is restored.
- Two, policymakers "are not prepared to admit the truth" because it means existing shareholders and bank managements will be wiped out. It also means "admitting total failure" of efforts to date to stem the crisis, says the author of Fixing Global Finance.
Arguing today's toxic assets are "fundamentally worthless" - and there's lots more losses coming - Wolf says the lack of political will (or outright cowardice) to admit to reality means "we're really in trouble." Why? Because confidence in policymakers will continue to deteriorate as their ill-conceived solutions continue to fail.Once policymakers (ultimately) agree insolvency is really the underlying problem, there are two options for dealing with the banks:
- Nationalize them, and then inject government capital as the U.K. government has started to do with RBS and Lloyds. (a.k.a. The Swedish Solution)
- Put them into FDIC receivership or force them into bankruptcy, whereby common stock and preferred debt shareholders get wiped out and "senior" debt holders end up owning the banks.
Martin Wolf: U.S. Too "Politically Frightened" to Admit Truth About Banks, Part II
Why the U.S. government is seemingly too afraid to declare bad banks insolvent was the subject of part one of this discussion with Martin Wolf, chief economics commentator for The Financial Times. The Obama administration is "really frightened" of nationalizing banks and being tarred as having taken an "extremely left, liberal action," Wolf continues here, in part two. But the bottom line is somebody is going to have to take the loss – whether it's taxpayers or individuals and institutions that own bank shares and debt, says the author of Fixing Global Finance. "We are poorer than we thought we were." Regarding the financial ramifications of an insolvency of a major U.S. bank, i.e. Citigroup or Bank of America, Wolf says:
- It would affect every other banking institutions worldwide, and their shareholders who would rightly fear a similar fate.
- "Very serious repercussions" for the global bond market, potentially creating a new set of financial institutions needing government relief, namely bond funds, pension funds and insurance companies that are big holders of bank debt.
The good news is Wolf does not believe the credit market would freeze, as occurred in mid-September after Lehman Brothers was allowed to go bankrupt.
New Bailout May Top $1.5 Trillion
The gravity of the financial crisis confronting the Obama administration will come into stark focus today when officials unveil a three-pronged rescue program that may commit up to $1.5 trillion in public and private funds, and possibly more, lawmakers and other officials said. In announcing the plan, Treasury Secretary Timothy F. Geithner will not ask Congress for more funds than the roughly $350 billion that remain in the Treasury Department's original rescue package for the financial system, though congressional sources said such a request could come later if the new programs are unsuccessful. The rest of the money would come from other government agencies, such as the Federal Reserve, as well as private-sector contributions.
A senior administration official warned last night that the ultimate cost to taxpayers has not been determined. Several of the programs have not been finalized, and most are designed to ultimately return money to taxpayers. Geithner plans to announce a public-private partnership that would seek to finance the purchasing of toxic bank assets that are at the heart of the credit crisis, officials and congressional sources said. These sources briefed by Treasury officials said the program may initially raise $250 billion to $500 billion in public and private funds to offer low-cost financing to encourage investors to buy the toxic assets. An administration official said the proposal is still subject to a public review and may not take final shape for several weeks.
A second initiative will broaden the scope of a Federal Reserve program aimed at unclogging the markets for auto, student and other consumer loans. That initiative may expand to as much as $1 trillion, using $100 billion from the Treasury's rescue funds, and include aid for commercial real estate markets. A third program would offer direct help to the nation's largest banks. The government plans to conduct a review of major financial firms to determine how much they may need. Any federal aid would come with conditions that would give the firms incentives to pay the money back as soon as possible. The review would determine the ultimate price tag of this program.
The primary goal of the bank-by-bank examination is to help regulators figure out whether these firms could withstand a downturn even worse than the current one, administration officials said. This "stress test" would also help regulators determine whether the nation's major banks have enough capital to continue lending and help them in an effort to set uniform values for the toxic assets clogging their books. "Right now, part of the problem is that nobody really knows what's on the banks' books," President Obama told reporters at a news conference last night. "Any given bank, they're not sure what kinds of losses are there. We've got to open things up and restore some trust."
If these large banks receive federal aid, they would be subject to tougher conditions than the Bush administration imposed and be required to submit reports to prove they are using the aid to do more lending. They would be banned from using government funds to pay dividends above a penny or buy healthy firms until the government investment is repaid. Their chief executives would face compensation restrictions that would limit their annual pay to $500,000. Any compensation above that could come only in the form of stock that could not be sold until the federal loans are returned. The initiatives require all of the nation's bank regulators to work together, which has not been an easy task, an official said. Geithner also plans to push regulators around the world in the coming days to adopt similar approaches to the spreading crisis in their countries, the official added.
Geithner's announcement was originally intended to include a fourth proposal, aimed at stemming the soaring rate of foreclosures. But officials said that plan will be unveiled in about a week. Congressional sources said this program would use about $50 billion in rescue funds, the low end of the range provided by the Obama administration last month. James B. Lockhart III, director of the Federal Housing Finance Agency, said in an interview that the Obama team has developed the broad outlines of a proposal to stem foreclosures by adding incentives for borrowers and lenders to modify home loans that have fallen behind, perhaps by as little as a single month.
The foreclosure relief effort has taken more time to design. Lockhart said it would be a "more aggressive version" of the one launched by mortgage financiers Fannie Mae and Freddie Mac last year. But senior officials are still hammering out the details, he said. Both lenders and borrowers have been frozen by the perception that the government may continue to unveil new and better modification programs, he said. "The early returns show that we may need to be more aggressive" than plans already announced, he said. But the government also needs to send a message to lenders that its new approach would represent the "best and final" offer.
The Fannie and Freddie program allowed borrowers who were 90 days delinquent on a loan to have their payments lowered to 38 percent of their income. The loan could also be extended from 30 years to 40 years, and if that was not enough, the interest rate could be reduced to as low as 3 percent to make the payments more affordable. Consumer advocates say the program was a good start in tackling the foreclosure problem but did not go far enough to help homeowners. For example, the effort did not include measures to cut the principal owed by borrowers whose home values have fallen below their mortgage loan amount. Another requirement -- that borrowers miss three payments before qualifying for help -- has been a troublesome issue, according to some consumer groups.
The government's new approach would make the terms more generous for both the borrowers and lenders. For instance, borrowers who missed only one payment might be able to qualify, Lockhart said. Lenders may be able to reduce payments to a lower percentage of a homeowner's income. Officials are also planning to set national standards for when banks can legally modify a mortgage -- an important concern for loan servicers who can now only perform modifications that improve the value of the mortgage under the terms of their contracts with investors. Lockhart said he hoped the new program would be attractive to loan holders, but he added that they had an obligation to increase their modification efforts.
"It is taking too long," he told an industry group during a speech in Las Vegas yesterday. "It is time to act." The Treasury plans to address rescue funds going to the nation's automakers separately in the coming weeks. By the most conservative estimates, the Treasury and Fed have already committed more than $1.4 trillion in loans, investments and guarantees to the financial system. Other estimates come to several times more. Congressional sources added that if the programs developed by the Treasury were not successful, they expect the administration to return to Capitol Hill to ask for more rescue funds. Obama addressed this issue at the news conference. "We don't know yet whether we're going to need additional money or how much additional money we'll need until we've seen how successful we are at restoring a sense of confidence in a marketplace that the federal government and the Federal Reserve Bank and the FDIC, working in concert, know what they're doing," he said.
Obama Is Open to Expanding Financial Rescue Plan
President Barack Obama signaled he would be open to seeking an expansion of the $700 billion financial-rescue program should the plan fail to restore stability to the U.S. banking system. "We don’t know yet whether we’re going to need additional money or how much additional money we’ll need until we’ve seen how successful we are at restoring a sense of confidence in the marketplace," Obama said in a news conference last night in Washington. Treasury Secretary Timothy Geithner today will announce an overhaul of the bank-bailout fund. The plan, which so far won’t seek additional government money, is designed to support about $1.5 trillion in new lending and handling of distressed assets. It has three main components: more capital for banks, financing for as much as $1 trillion of consumer and business loans, and public financing for investors willing to buy the distressed assets, people familiar with the matter said.
The president’s remarks indicate he acknowledges the assessment of many economists that the $350 billion remaining in the Treasury’s Troubled Asset Relief Program is insufficient to revive credit markets. The International Monetary Fund forecasts financial companies will need to write down over $1 trillion more of their U.S. mortgage debt. "The financial system is working against recovery, and that’s the dangerous dynamic we need to change," Geithner said in remarks prepared for delivery today. "Without credit, economies cannot grow, and right now, critical parts of our financial system are damaged."
Geithner, whose announcement is scheduled for 11 a.m. in Washington, will also rename the $700 billion TARP fund, which will be known as the Financial Stability Plan. Among the plan’s other components is $50 billion for measures to stem mortgage foreclosures, Republican and a Democratic congressional aides said after Treasury officials briefed lawmakers and staff members yesterday. "We are going to have to work with the banks in an effective way to clean up their balance sheets so that some trust is restored within the marketplace," Obama said in his first prime-time news briefing. At "any given bank they’re not sure what kinds of losses are there. We’ve got to open things up and restore some trust."
Regulators plan to subject banks to new tests to determine whether they have enough capital, the people familiar with the matter said. The Treasury, Federal Reserve and other supervisors in the President’s Working Group on financial markets will develop guidelines for the examinations. Banks that don’t have sufficient capital under various scenarios for losses on their assets will be able to get additional taxpayer funds in the form of convertible preferred securities, the people said. The new capital injections would have tougher conditions than the Treasury’s first round of bank-stake purchases. Participating banks will be subject to lending requirements and restrictions on new acquisitions and dividends.
"The American people have lost faith in the leaders of our financial institutions" and are skeptical of the rescue spending so far, Geithner will say today. The administration is also aiming to differentiate the next phase of the financial plan by bringing in private investors. It plans a public-private investment fund to take on older toxic assets. Officials haven’t yet decided on the specific mechanics of the facility, which will be introduced in lieu of the so- called bad bank of earlier proposals. "This comprehensive strategy will cost money, involve risk, and take time," Geithner will say. The initial bailout effort, which he helped administer in his previous job as head of the Federal Reserve Bank of New York, was "essential" and also "inadequate" to support the financial system and the secondary lending market, according to Geithner.
The scope of the investment fund is expected to be as much as $500 billion, backed by roughly $50 billion in public funding, the people familiar said. To kick-start new lending, the Financial Stability Plan will expand a Federal Reserve program for consumer and business loans to as much as $1 trillion from the current $200 billion. The Term Asset-Backed Securities Lending Facility will be backed by as much as $100 billion of Treasury funds in case of losses. Fed officials have yet to start up the TALF, which was intended to be under way this month. It will lend funds to investors in securities backed by student, credit-card and auto loans. Eligible debt will be expanded to include commercial mortgage-backed securities, and more types of lending may be added later on, according to the people familiar with the plan.
The Federal Deposit Insurance Corp. is also set to expand its debt-guarantee program, created late last year to ensure banks’ access to credit markets, the people said. The agency is looking at 10-year guarantees for some kinds of assets. The new approach comes four months after the start of the $700 billion TARP, which both Democrats and Republicans have criticized as ineffective. Geithner faces the task of reviving a U.S. banking system throttled by $752 billion in credit losses and an economy that lost almost 600,000 jobs last month. Economic news this week is expected to show a further deterioration. Sales at U.S. retailers probably fell in January for a seventh straight month, capping the longest slide since comparable records began in 1992. The Commerce Department report will probably show purchases declined 0.8 percent, according to the median estimate in a Bloomberg News survey. With the economic downturn deepening, attracting private money to the financial industry may be difficult. The Standard and Poor’s 500 Banks Index has fallen 33 percent since the start of last month, and 65 percent in the past year.
Bank of America Corp. plunged 53 percent in the past month, closing at $6.89 last week even after the government agreed in January to backstop a portfolio of more than $100 billion of its assets. Citigroup Inc. which in November got a joint federal guarantee for investments in excess of $300 billion, closed at $3.95. The Obama administration will seek to "catalyze and spur private investment" to help solve the crisis, White House National Economic Council Director Lawrence Summers said in an interview on Fox News Sunday two days ago. "This year is going to be a difficult year," Obama warned yesterday. He said he hopes businesses and consumers start spending again and "if we get things right, then, starting next year, we can start seeing significant improvement."
Geithner Said to Have Prevailed on the Bailout
The Obama administration’s new plan to bail out the nation’s banks was fashioned after a spirited internal debate that pitted the Treasury secretary, Timothy F. Geithner, against some of the president’s top political hands. In the end, Mr. Geithner largely prevailed in opposing tougher conditions on financial institutions that were sought by presidential aides, including David Axelrod, a senior adviser to the president, according to administration and Congressional officials.
Mr. Geithner, who will announce the broad outlines of the plan on Tuesday, successfully fought against more severe limits on executive pay for companies receiving government aid. He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid. Because of the internal debate, some of the most contentious issues remain unresolved.
On Monday evening, new details emerged after lawmakers were briefed on the plan. It intends to call for the creation of a joint Treasury and Federal Reserve program, at an initial cost of $250 billion to $500 billion, to encourage investors to acquire soured mortgage-related assets from banks. It wants the Fed to use its balance sheet to provide the financing, and the Federal Deposit Insurance Corporation might provide guarantees to investors who participate in the program, which some people might call a "bad bank."
A second component of the plan would broadly expand, to $500 billion to $1 trillion, an existing $200 billion program run by the Federal Reserve to try to unfreeze the market for commercial, student, auto and credit card loans. A third component would involve a review of the capital levels of all banks, including projections of future losses, to determine how much additional capital each bank should receive. The capital injections would come out of the remaining $350 billion in the Troubled Asset Relief Program, or TARP. A separate $50 billion initiative to enable millions of homeowners facing imminent foreclosure to renegotiate the terms of their mortgages is to be announced next week.
Some of President Obama’s advisers had advocated tighter restrictions on aid recipients, arguing that rising joblessness, populist outrage over Wall Street bonuses and expensive perks, and the poor management of last year’s bailouts could feed a potent political reaction if the administration did not demand enough sacrifices from the companies that receive federal money. They also worry that any reaction could make it difficult to win Congressional approval for more bank rescue money, which the administration could need in coming months.
For his part, Mr. Geithner, who on Tuesday makes his debut as Treasury secretary and as the public face of the bailout, will blame corporate executives for much of the economic crisis, according to officials. But he worried that the plan would not work — and could become more expensive for taxpayers — if there were too much government involvement in the affairs of the companies. Mr. Geithner also expressed concern that too many government controls would discourage private investors from participating. A spokeswoman for Mr. Geithner, Stephanie Cutter, had no comment.
The White House is hoping that its rescue plan will be perceived as a more coherent rescue effort than the Bush administration’s, and one whose breadth and scope are so vast that it begins to restore financial confidence in the battered markets and entices private investors to come off the sidelines. The plan is calibrated to work on multiple fronts, with promises to invest billions of dollars in scores of ailing banks and creation of a new institution to relieve bank balance sheets of their most troubled assets. It will also renew a legislative proposal giving bankruptcy judges greater authority to modify mortgages on more favorable terms to lenders and over the objections of banks.
Officials say that new rules encouraging transparency and limiting lobbying are intended to begin to restore political confidence in a program that has faced withering criticism in Congress, an effort that they view as essential because they expect to return to Congress for more money later this year. But as intended largely by Mr. Geithner, the plan stops short of intruding too significantly into bankers’ affairs even as they come onto the public dole. The $500,000 pay cap for executives at companies receiving assistance, for instance, applies only to very senior executives. Some officials argued for caps that applied to every employee at institutions that received taxpayer money.
Abandoning any pretense about limiting the moral hazards at companies that made foolhardy investments, the plan also will not require shareholders of companies receiving significant assistance to lose most or all of their investment. Some officials had suggested that the next bailout phase not protect existing shareholders. (Shareholders at most banks that fail will continue to lose their investment.) Nor will the government announce any plans to replace the management of virtually any of the troubled institutions, despite arguments by some to oust current management at the most troubled banks.
Finally, while the administration will urge banks to increase their lending, and possibly provide some incentives, it will not dictate to the banks how they should spend the billions of dollars in new money from the government. And for all of its boldness, the plan largely repeats the Bush administration’s approach of deferring to many of the same companies and executives who had peddled risky loans and investments at the heart of the crisis and failed to foresee many of the problems plaguing the markets. In internal discussions, Mr. Geithner is said by officials to have raised the lessons of countries that forced banks to make loans and adopted other, more interventionist measures. Those strategies, he said, wound up costing more and undermining their governments’ credibility. He concluded the wiser course would be to provide economic incentives to encourage lending.
Some Democrats in Congress who have been given previews of the outline of the plan said it struck the right balance. "They want to make sure the plan is a balance of carrots and sticks, which are needed substantively and politically," said Senator Charles E. Schumer, Democrat of New York, vice chairman of the Joint Economic Committee. "They are using every tool in the book because the problem is so vast, but they are also tailoring their response to the individual needs of each institution." For private institutional investors, the question of whether to invest alongside the government will depend on what kinds of carrots and sticks Treasury officials offer.
Managers of hedge funds and private equity funds are closely watching to see how much the government pushes banks to write down the value of troubled mortgages and mortgage-backed securities they want to sell. There is no market value for most of those troubled assets because they are not trading. Investors want to buy them at the lowest price possible, but banks want to avoid selling them at rock-bottom prices and realizing huge losses. The impasse is particularly serious for whole mortgages, which are loans that banks have kept on their own books instead of selling them to Wall Street firms, which bundle mortgages into pools and resell them as mortgage-backed securities.
Under current accounting rules, financial institutions have already been required to write down the value of mortgage-backed securities to reflect their current market value. But banks do not have to write down the value of whole mortgages if the borrowers are still current, and many regional banks collectively hold vast numbers of those loans. Under the category of sticks, private investment managers are closely watching how the Treasury rolls out its "uniform stress test" for grading the health of banks. If the government takes a tougher line with more banks, it could force them to sell off more of their loans and take their lumps sooner rather than later.
Under the category of carrots are various forms of financing and guarantees that the government can offer potential buyers. That is where the Treasury’s joint venture with the Federal Reserve to finance consumer and commercial loans would come into play. The challenge facing policy makers will be drawing the proper lines between helping the banks and reviving the markets on the one hand, and wasting taxpayer dollars on reckless lenders, vulture capitalists or both.
Banks to Get Stress Test Before Aid
Many U.S. banks will be subjected to rigorous examinations to see if they are healthy enough to lend before receiving additional financial aid, according to people familiar with the matter. The stress tests will be part of the bailout revamp to be announced Tuesday by Treasury Secretary Timothy Geithner. In addition to fresh capital injections into banks, the new approach will include programs to help struggling homeowners; a significant expansion of a Federal Reserve program designed to jump-start consumer lending; and a private-public partnership to relieve banks of bad assets. Mr. Geithner is expected to present the moves as a multi-pronged effort to encourage financial institutions to lend again. The administration's goal is to unfreeze dysfunctional credit markets that have dragged the economy into a recession. He will also announce new conditions on banks receiving aid, including documenting how the money is helping to generate new loans.
The expanded effort could see as much as $2 trillion in financing flowing through the system, according to Congressional officials briefed Monday night. The expanded Fed facility and the "bad bank" could each reach $1 trillion in size, both of which would be seeded with bailout funds. The administration is discussing spending between $100 billion and $200 billion investing new funds in banks, up to $100 billion to expand the Federal Reserve facility and $50 billion to help homeowners. The Treasury wants to keep some money available in case of emergencies. These commitments could eat up much of the second half of the $700 billion bailout fund. The Obama administration's initial attempt to sell the plan got off to a rocky start on Capitol Hill Monday evening in briefings with House and Senate staffers. Officials told packed meetings Mr. Geithner would lay out a framework Tuesday for the financial rescue. But a lack of detail was met with skepticism as staffers pressed for more information.
Rep. Brad Sherman (D., Calif.) asked officials how much taxpayers could be on the hook if the situation in the financial system was to further erode. "I appreciate your filibuster, but that's the other side of the Capitol," Mr. Sherman told the Obama officials, according to a person at the briefing. In a press conference Monday night, President Obama said: "We don't know whether we need additional money or how much we need, until we see how successful we are in restoring confidence." In an attempt to cast the program in a new light, the administration is renaming the Troubled Asset Relief Program the Financial Stability Plan. The program will remain a part of Treasury but may eventually be separated.
One of the biggest criticisms of the bailout is that banks receiving aid have sat on the funds instead of loaning them to businesses and consumers. The new bank examinations are designed to ensure that banks that are in need of money but still healthy enough to lend, receive cash. The examinations will be mandatory for banks with assets exceeding $100 billion The move could address disagreements between bank regulators about the viability of scores of institutions. Regulators have struggled to come up with a common set of criteria for deciding which banks should receive money. Setting up a stress test could create a more objective set of standards, which might reveal the depths of the industry's problems.
Banks have complained that the process for applying for bailout funds is arbitrary. At least two that applied, National Bank of Commerce in Illinois and County Bank in California, were denied by the government and failed. Research firm RBC Capital Markets estimated Monday that more than 1,000 banks could fail in the next three to five years, more than triple its previous estimates. Mr. Geithner will also unveil a host of new conditions for banks that receive government aid, including requiring that firms show how the money is being spent and how funds are helping to generate new lending. Banks must show how many new loans they provided with the assistance and how many assets they purchased. They must also agree to implement foreclosure mitigation programs, curb executive pay and not use the funds to purchase healthy banks until the government money is repaid.
The administration is still finalizing details of its a housing plan -- which centers on financial incentives for mortgage companies to modify bad loans -- and may not get into specifics Tuesday. It is expected to express support for a legislative proposal that would allow judges to alter the terms of troubled mortgages in bankruptcy court, but only if borrowers tried to have their loans modified. Another leg of the revamp, a "bad bank" that would buy up toxic assets fouling the financial system, received a cautious welcome on Wall Street. The administration, hoping to avoid spending large sums of taxpayer money, wants the private sector to largely fund the effort. To entice investor participation, the government would limit the risk associated with buying the assets.
Citigroup’s Pandit Vows 'Profitable Investment' for Taxpayers
Citigroup Inc. Chief Executive Officer Vikram Pandit, summoned by Congress to explain his bank’s use of $45 billion of bailout funds, vowed to “make this a profitable investment for the American people.” Pandit, 52, made the remarks in a draft of testimony he plans to deliver tomorrow at a hearing before the U.S. House of Representatives Committee on Financial Services. He’s among the CEOs of eight banks, including JPMorgan Chase & Co. and Bank of America Corp., scheduled to testify at the Washington hearing on the $700 billion Troubled Asset Relief Program.
'You will look back on it and know it was the right decision for our nation’s economy and for American taxpayers,' Pandit said in the draft, which was obtained by Bloomberg News. “My goal is to make this a profitable investment for the American people as soon as possible.” Citigroup spokesman Stephen Cohen declined to comment. Banks and other recipients of U.S. rescue funds have come under fire from lawmakers who said the money had been used for bonuses and other corporate expenses, instead of programs to aid consumers. Citigroup last month reversed a decision to buy a $50 million corporate jet under pressure from the government, and said last week it canceled a convention in Atlanta for its Primerica Financial Services Inc. unit.
Citigroup posted an $18.7 billion net loss last year, eroding the New York-based bank’s capital cushion and forcing it to seek government assistance. The bank got a $25 billion infusion in October, and a month later had to return for an additional $20 billion along with $301 billion of guarantees on mortgages, bonds, low-grade corporate loans and other assets. 'We are committed to providing the American public with a return on its investment in Citi,' Pandit said, noting the bank must pay $3.4 billion a year in dividends on the government’s investment. "The best way for us to make this happen is to strengthen our company and return to profitability." Pandit said he has 'removed people responsible for Citi’s financial distress,' streamlined the company and installed new risk-management controls. The bank also is “supporting American businesses and helping families stay in their homes,” he said.
Private capital may not be on board for bank bailout
The U.S. government may find buyout firms, hedge funds and other private investors reluctant to help it cleanse banks of toxic assets, hampering efforts to jumpstart the economy. Private investors say they are waiting for the details of an Obama administration plan, to be unveiled on Tuesday, that is expected to include buying troubled assets from banks. But they worry about how the assets would be priced and what guarantees they would get against potential losses.
A further concern for investors is likely to be the government's track record on how it handled the first round of the $700 billion rescue for the industry, when it imposed restrictions on such things as dividends and compensation on banks that received taxpayer money. "The aggregator bank is the right idea," said Whitney Tilson, founder of hedge fund T2 Partners LLC, referring to the plan to create a so-called 'bad bank' as a way to take toxic assets off the books. Even so, "the question is how do the assets get into the aggregator bank and right now investors are wondering is this (plan) going to be the same."
To lure in private investors, the bad bank could be allowed to issue debt backed by the Federal Deposit Insurance Corp, a source familiar with the Obama administration's thinking told Reuters. Overall estimates of the amount of assets a bad bank would have to buy have run to more than a trillion dollars and the government is counting on private capital to help revive the economy from its deepest slump in decades. Treasury Secretary Timothy Geithner is looking for ways to use taxpayer funds to attract private investors, White House National Economic Council Director Lawrence Summers told Fox News television on Sunday. But private capital could come at a cost to taxpayers.
"With the model under discussion now, the government is taking all of the downside beyond the initial payment that private investors made, while the investors get all of the upside," said Dan Alpert, managing director and investment banker at boutique bank Westwood Capital. Banks want the government to buy distressed assets, but the administration has struggled with pricing the assets in a way that helps the banks while being fair to taxpayers. "If the prices are deemed too high, then the private sector will not bid aggressively for the assets and will show only a modest interest -- in essence to wave the flag," said Tom Sowanick, chief investment officer for $22 billion in assets at Clearbrook Financial LLC.
The government could sweeten the deal by providing guarantees that protect investors from losses and help in determining the price of those assets. But if guarantees are set too high, taxpayers could lose out and if they are too low, investors might not bite. "It's such a black hole right now. Nobody knows how to price these toxic assets," said Paul Homsy, a principal at Crescent Asset Management. "If they put a floor on these assets, it might be something attractive." The government may also have to consider further incentives such as providing financing when private firms cannot easily get debt elsewhere.
In July, Merrill Lynch agreed to sell $30.6 billion of collateralized debt obligations to buyout firm Lone Star for $6.7 billion, or about 22 cents on the dollar. But the investment bank, which is now part of Bank of America Corp, also agreed to finance about 75 percent of the purchase price. "In essence, presumably the plan is to be designed so that private capital will reengage with the banks and allow us to start moving forward constructively," said Tad Rivelle, founding partner and chief investment officer at Metropolitan West Asset Management LLC. "So (the government) has to sort of establish what rules banks will be operating under a go-forward and how the claims at various levels at the banks will be treated."
Treasury Turns to Fed to Spur Lending
The Treasury Department is leading the U.S. effort to design a revamped financial-rescue plan for damaged markets, but behind the scenes the Federal Reserve will play a key role in making it work. Fed loans stand at the center of an ambitious program meant to jump-start markets for consumer loans. Officials plan to expand the program in scope and substantially in size. The program, known as the Term Asset-backed Securities Loan Facility, or TALF, was announced in November but still hasn't gotten up and running. It originally was meant to provide $200 billion of financing to investors buying securities backed by consumer loans such as car loans, student loans and credit-card debt. Officials hope investor demand for the securities will translate into more credit for consumers.
Now officials are looking to apply it to other markets, such as those for securities backed by commercial real-estate loans and "private label" mortgages that aren't tied to the big U.S.-backed mortgage finance firms Fannie Mae and Freddie Mac. The central bank has other roles in the bailout. But the planned expansion of the TALF program is likely the most consequential of its roles. The Treasury originally committed $20 billion as a cushion for the Fed against losses from the program. The Treasury could expand that cushion to $100 billion, giving the Fed room to lend much more. It also marks an effort by U.S. officials to disentangle two related problems: fixing banks and spurring new lending. Officials had hoped that early efforts to pump capital into banks would help to spur lending. For the most part, it hasn't. Expanding the TALF program is a way to create lending while other efforts to repair the banks, such as giving them more capital or helping them to sell or "ring-fence" bad assets are worked out.
"What you see the Fed doing is going market to market and asking, 'Where are the markets where credit flow is impaired?' " said Laurence Meyer, a former Fed governor and now vice chairman of Macroeconomic Advisers LLC, an economic-research firm. The Obama administration's focus on the Fed lending program is an attempt to address another problem that has confounded efforts to stop the credit crisis. Though the Treasury has been pumping new capital into banks for months, many of the financial system's problems lie outside the banking system, in markets in which loans are bundled together into securities and sold to investors. Fed officials see the TALF as a way to get to financial institutions other than banks. Still, the program is fraught with risk. If the conditions are too tough, the effort could backfire. If they are too easy, it could spur reckless lending or be seen as a giveaway to private investors.
A Tale of Two Stimulus Bills
The stimulus bill that passed a Senate test vote is missing $80 billion in spending that is included in the House version. What gives? After several days of tense negotiations, the Senate's $838 billion economic stimulus bill passed a procedural vote, clearing the way for a final vote on the bill Feb. 10. If it passes, as expected, the Senate bill will be reconciled with the House version passed Jan. 28, which totaled $820 billion in spending and tax cuts. At the core of each bill, the House and Senate versions are similar in size and scope. But the difference— about $80 billion in spending cuts in the Senate bill—is attracting sharp criticism from Democrats and from some economists who worry that provisions with the most bang for the taxpayer buck are getting short shrift.
The crux of that debate is whether spending or a combination of tax cuts and incentives is more effective at stimulating the economy. Meanwhile, there are broader questions about how effective the stimulus package can be in the face of the enormity of the economic problem. "I am not getting too excited about this [stimulus bill]," says Rajeev Dhawan, director of the Robinson College of Business at Georgia State University in Atlanta. "I don't know if this amount of money spread over two or three years can make enough of a difference." While a number of economists have expressed similar concerns, some say the overall plan is a necessary starting point. A study released Feb. 6 by Standard & Poor's, which like BusinessWeek is a division of The McGraw-Hill Cos. (MHP), found that overall the stimulus plan will aid economic recovery. Specifically, it will likely hit President Obama's target of creating 3 million jobs by 2010.
"A major stimulus initiative is the wisest course at this juncture," says David Wyss, S&P's chief economist. Still, Wyss estimates that it will take a year, if not longer, for the potential benefits of any stimulus bill to become clear. Critics of the Senate bill are concerned that spending cuts will be displaced by consumer-oriented tax breaks for house and auto purchases. These measures, which together cost about $45 billion, could also fail to attract buyers who weren't already planning on a house or car purchase. In another departure from the House bill, the Senate bill devotes $70 billion to "patch" the alternative minimum tax, saving more than 20 million middle and upper-income taxpayers a 2009 tax increase averaging about $2,000. Economist and New York Times columnist Paul Krugman equates these tax measures with a "comforting the comfortable while afflicting the afflicted" strategy.
The left-leaning Center for American Progress estimates that the Senate bill would create between 430,000 and 538,000 fewer jobs than the House bill. Michael Ettlinger, vice-president for economic policy at the center, calls the Senate bill "a stumble backward" from the $820 billion House legislation. The House and Senate versions of the Economic Recovery and Reinvestment Act include assistance for the unemployed and lower-income individuals. Each includes about $80 billion in unemployment insurance extensions, increases, and modernization; support for training and employment services; a series of low-income housing measures; food stamps; a Low-Income Home Energy Assistance Program; and block grants for community services and development. However the Senate bill cuts about $40 billion in education aid to states, reducing it from $79 billion to $39 billion.
The House provides $19.5 billion to build and repair school and university facilities, which was stripped from the Senate bill. Another difference between the bills is that the House version would establish a temporary option for states to provide Medicaid coverage to more lower-income workers who have become unemployed during the recession but who normally wouldn't qualify. (Both House and Senate packages would also reduce the cost of COBRA health coverage for unemployed workers, but most low-income workers aren't eligible for COBRA.) The question of whether tax cuts or spending can better stimulate the economy will continue until a bill reaches President Obama's desk. But while economists and lawmakers continue that debate, another problem still hinders economic recovery: the credit crisis. Says Dhawan: "If we do not clear up the banking system, nothing else matters."
US treasury aims to unblock credit markets
Tim Geithner will on Tuesday make efforts to unblock securitised markets for credit one of the key planks of the Obama administration’s financial rescue plan. In a speech scheduled for 11am Eastern Standard Time, the US Treasury Secretary will say fixing the securitisation markets is as critical as fixing the nation’s banks. He will say: "In our financial system, 40 per cent of consumer lending has historically been available because people buy loans, put them together and sell them. Because this vital source of lending has frozen up, no plan will be successful unless it helps restart securitisation markets for sound loans made to consumers and businesses – large and small." Mr Geithner is expected to unveil a dramatic expansion of Federal Reserve financing for securitised markets – including financing for commercial real estate bonds and private label (jumbo large denomination and subprime) residential mortgage-backed securities.
There will also be measures to support the municipal bond market and possible support for monoline insurance companies. He is also expected to announce guarantees on portfolios of problem assets and a joint public-private scheme to buy toxic assets in the banking system, alongside plans for further capital injections in the form of convertible preferred shares and subsidies for anti-foreclosure programmes. The Treasury Secretary will warn against assuming that the new plan will produce a rapid turnaround in the markets and the economy. He will say: "This comprehensive strategy will cost money, involve risk, and take time. We will have to adapt it as conditions change. We will have to try things we’ve never tried before." He will add: "We will make mistakes. We will go through periods in which things get worse and progress is uneven or interrupted."
Mr Geithner will describe efforts taken to combat the deepening crisis under the Bush administration as "absolutely essential" but "inadequate" and he will fault his predecessors for failing to demonstrate to the public that bailout money was being used in their interest. He will say "The force of government support was not comprehensive or quick enough to withstand the deepening pressure brought on by the financial crisis." He will add "The spectacle of huge amounts of taxpayer money being provided to the same institutions that help caused the crisis, with limited transparency and oversight added to public distrust." Mr Geithner will promise "transparency and accountability." But he will admit that the challenge is "much greater today because the American people have lost faith in the leaders of our financial institutions, and are skeptical that their government has – to this point -- used taxpayers’ money in ways that will benefit them."
Banks May Keep Skin in the Game
An emerging plan to ensure that banks sell high-quality securities underpinned by well-underwritten mortgages is being met with criticism by some regulators and industry experts. The proposal, which is only under consideration and still in the early stages, would call for issuers of pools of mortgage loans to retain a slice of the debt, which is created through a process called securitization. In simple terms, banks would be required to keep some "skin in the game." A wave of mortgage securitizations in 2005 through 2007 is now seen as a key culprit of the housing mess because banks created and then sold billions of dollars of securities without conducting due diligence on individual loans within the pools. Those offerings helped fuel the surge in housing sales in the U.S. and Europe and ultimately led to the global financial crisis.
The $8.7 trillion securitization market, which also helped fund credit cards and auto loans, is largely dead, forcing the U.S. government to put into place plans such as the Term Asset-backed Securities Loan Facility, or TALF. At the American Securitization Forum's annual conference this week in Las Vegas, where the outlook largely is grim, industry participants are discussing with regulators other ways to bring investors back to buy debt pools. On Monday, several panels also tackled the TALF plan and whether or not it will help shore up the securitization markets. The central topic Monday was the plan to make banks keep a piece of the debt pool. Typically, debt pools are sliced into pieces or tranches based on risk and returns. Opponents of forcing banks to keep a debt slice point to the fact that banks such as UBS AG, Citigroup Inc. and Merrill Lynch & Co. kept the top layers of more complex debt pools known as collateralized debt obligations and then ended up writing down tens of billions of dollars.
Some regulators are behind an effort to force banks and mortgage originators to take more responsibility for what they sell. Sandra Thompson, director of the division of supervision and consumer protection at the Federal Deposit Insurance Corp., said in a speech Monday, "everyone involved should have some skin in the game." Some at the ASF conference said Monday that forcing banks to keep debt slices could further upend the shaky market while also forcing banks to tie up precious bank capital. The consideration is gaining support in Europe where regulators are debating whether lenders should keep as much as 10% of the loans they originate in an effort to encourage responsible loan underwriting. Matthew Eichner, a senior adviser at the Federal Reserve Board's division of research and statistics in Washington, questioned whether rules about retaining exposures will address the real issues that helped topple the mortgage market -- a lack of due diligence and misplaced incentives. "There is skepticism on the Fed staff that if we structure things that way it will distract from the real issue of due diligence," Mr. Eichner said.
Securities group head sees Treasury asset-buy plan
U.S. Treasury Secretary Timothy Geithner on Tuesday will likely announce a plan that involves the purchase of troubled assets from bank balance sheets, Tim Ryan, chief executive officer of the securities' industry's main lobbying group, said on Monday. Ryan, CEO of the Securities Industry and Financial Markets Association and former director of the Resolution Trust Corp, also said he expects the Treasury will announce an expansion of its Term Asset-Backed Securities Loan Facility, or TALF. "I expect Geithner will roll out a couple more strategies" to help boost the availability of credit, Ryan said at a meeting of the American Securitization Forum in Las Vegas. "Probably an expanded TALF ... because the Fed can do an awful lot without legislation."
"I also expect we will see something akin to the original TARP program, something to buy assets. I think that is the critical thing that is missing." Ryan led the Office of Thrift Supervision in the early 1990s, where he managed the savings and loan cleanup which involved closing about 700 insolvent institutions. The RTC ended up selling more than $300 billion in assets. The TARP, or Troubled Asset Relief Program, last year was formed to relieve banks of risky assets that have caused billions of dollars in losses. But former Treasury Secretary Henry Paulson redirected the first $350 billion of the program to instead make direct capital injections into banks.
Asset-backed securities markets, which help provide funds for consumer lending and housing, resumed a year-long slump after Paulson shifted the TARP strategy. Allowing TARP to buy illiquid assets, or expansion of the TALF to allow lending to investors that buy securities backed by mortgages, could help buoy confidence in those markets, analysts said. Difficulty in valuing securities has been a major stumbling block for any plan that involves government purchases. Buying the assets at face value, or slight discounts, could be seen as a bailout of toxic assets at taxpayers' expense. Paying deeper distressed market prices could understate recovery values, and lead to another round of write-downs for banks.
But the government could come up with a method in which it could participate in the upside of distressed assets, as it did in the aftermath of the savings and loan crisis, he said. "If they pay too much, they can make it up in the end," Ryan said. "You can come up with a risk-sharing agreement, which the RTC did very well." Government buying would also establish a floor for the asset-backed bond market, and encourage other investors to come in off the sidelines, Ryan has said.
Fannie, Freddie Funding Needs May Pass $200 Billion
Fannie Mae and Freddie Mac, the mortgage-finance companies seized by regulators, may need more than the $200 billion in funding pledged by the U.S. government if the housing market continues to deteriorate, Federal Housing Finance Agency Director James Lockhart said. The companies’ needs will depend largely on the direction of home prices, Lockhart said in an interview in Las Vegas yesterday. His comments followed statements from Fannie Mae in November and Freddie Mac Chairman John Koskinen last week that the government’s funding commitment through 2009 may fall short of what the companies need to make good on their obligations.
"When we sized the amount in September, we obviously looked at stress tests and what was happening in the marketplace," Lockhart said. "There’s been some significant events since then that weren’t in our forecast." The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes were worth, according to a Feb. 3 report from Zillow.com. Following a record boom, home prices are down 25 percent on average since mid-2006 amid a tightening of lending standards and an economic recession, the S&P/Case-Shiller Composite 20-city price index shows.
Freddie Mac and Fannie Mae are the largest U.S. mortgage- finance companies, owning or guaranteeing $5.2 trillion of the $12 trillion home-loan market. The government seized control of Fannie Mae and Freddie Mac after their losses threatened to further disrupt the housing market, and pledged to invest as much as $100 billion into each company as needed if the value of their assets drops below the amount they owe on obligations. Fannie Mae said in a November regulatory filing that "this commitment may not be sufficient to keep us in solvent condition or from being placed into receivership." Freddie Mac is taking a "hard look" at whether it will need more than $100 billion, Koskinen said last week. "It’s going to be a close question," Koskinen said in an interview on Bloomberg Television’s "Conversations with Judy Woodruff."
McLean, Virginia-based Freddie Mac has taken $13.8 billion in federal aid and said it will need as much as $35 billion more by the end of this month. Washington-based Fannie Mae said it may tap as much as $16 billion in funding. Lockhart, who was in Las Vegas yesterday to speak before the American Securitization Forum’s annual conference, said Fannie Mae and Freddie Mac’s most recent requests for aid, which were larger than some expected, were driven by temporary market disruptions that may not translate into permanent losses. "There were some temporary imbalances that made their numbers pretty dramatic," he said.
Federal officials are now leaning on the government- sponsored enterprises to help stabilize the housing market. House Financial Services Committee Chairman Barney Frank said last week that the companies will be used "very aggressively" to help reduce record foreclosures. Lockhart said Fannie Mae and Freddie Mac aren’t expected to take a loss "under any program" that requires their involvement. "We would expect them to be writing business that’s profitable at this point, not a large profit," he said yesterday. "But we would not expect them to be writing business at a loss under any program." The Treasury, not the companies, would bear the cost under proposals to use the companies to drive down mortgage rates to about 4.5 percent, Lockhart said. That proposal was under consideration as part of a comprehensive housing-recovery plan being developed by the Treasury.
"That was a hot idea for a while: It’s cooled off," Lockhart said. "But Fannie and Freddie wouldn’t be asked to eat the difference. If it happened, that would be the U.S. Treasury." Fannie Mae and Freddie Mac may also be used to provide direct financing to single-family and multifamily residential mortgage lenders, Lockhart said. Currently Fannie Mae and Freddie Mac provide financing by either buying loans from lenders or helping them package the debt as bonds for sale to investors, thus freeing up cash to make more mortgages. The FHFA is reviewing whether the companies’ congressional charters, which generally prohibit lending directly to the public, would restrict expanding into so-called warehouse financing.
Mortgage bankers and other companies that have seen their sources of credit dry up in the past year have been pushing for the change, according to Lockhart. "The problem is that unfortunately bankers have tightened their credit standards and withdrawn from some markets," Lockhart said. "And as interest rates fall, if we have relatively large refinancings, we’re going to need to have mortgage bankers be able to provide mortgages in the interim before they sell them to Fannie and Freddie." The ASF is a New York-based group representing companies that package assets into bonds. More than 3,000 bond traders, sales representatives, lawyers, private equity investors and other financial industry workers registered for the three-day conference, about half of last year’s attendance, according to event organizers.
JPMorgan Analysts Double Jumbo-Mortgage Loss Forecast
JPMorgan Chase & Co. analysts almost doubled their projections for losses on some prime-jumbo mortgages underlying securities, created at the start of the U.S. housing slump, because of soaring defaults. Losses on so-called hybrid adjustable-rate mortgages backing 2006 and 2007 prime-jumbo securities will reach 8 percent to 10 percent, according to a Feb. 6 report by New York- based analysts John Sim and Abhishek Mistry. "The pickup of defaults in prime during the second half of 2008 has caused us to nearly double our loss projections on prime hybrids," the analysts wrote.
Defaults on home loans not labeled as "subprime" that back so-called non-agency mortgage securities, the debt that sparked the global financial-market meltdown, have soared as home prices continue to tumble and the U.S. recession deepens. The share of prime-jumbo mortgages at least 60 days late climbed 0.71 percentage point to 5.29 percent in the month covered by January bond reports, according to JPMorgan. About $500 billion of prime-jumbo bonds exist, according to Memphis, Tennessee-based FTN Financial. Jumbo loans are larger than what government-chartered Fannie Mae and Freddie Mac can buy or guarantee, currently $417,000 in most areas and as much as $625,500. Hybrid ARMs offer a few years of fixed interest rates, before switching to payments that vary with indexes.
Losses on prime-jumbo mortgages with completely fixed rates in "recent vintage" bonds will be lower than losses on hybrid ARMs, partly because more of the borrowers will be able to qualify to refinance out of the loans, JPMorgan said. "Although historical experience would lead us to increase prime fixed losses to 4 percent, faster prepayments could prevent many future defaults, keeping losses in the 2 percent range, a decrease from last month’s 2.3 percent to 2.8 percent" projection, the analysts wrote. The share of Alt-A mortgages underlying bonds at least 60 days late, in foreclosure or already turned into seized properties climbed 1.53 percentage points last month to 22.88 percent, JPMorgan said. Defaults on so-called option ARMs rose 2.47 percentage points to 30.96 percent, the report said.
With the market for prime-jumbo mortgage bonds closed since early 2008 and banks issuing fewer loans to keep on their books, the average rate on a typical 30-year fixed-rate jumbo mortgage was 6.91 percent on Feb. 6, compared with 5.44 percent on similar "conforming" loans, according to Bankrate.com data. Shares of Thornburg Mortgage Inc., a mortgage real-estate investment trust that specializes in jumbo-loan debt, and Redwood Trust Inc., a REIT with a similar focus, have fallen almost 100 percent and 75 percent over the past 24 months. Santa Fe, New Mexico-based Thornburg gained 2 cents to 10 cents in over-the-counter trading as of 4:00 p.m. in New York today, while Mill Valley, California-based Redwood climbed 42 cents to $15.30 in New York Stock Exchange composite trading.
Obama Administration Expanding Mortgage Modification Plan
The Obama administration has developed the broad outlines of a plan to stem the soaring rate of foreclosures by adding incentives for borrowers and lenders to agree to modify home loans that have fallen behind, perhaps by as little as a single month. The plan is a "more aggressive" version of an initiative launched by mortgage financiers Fannie Mae and Freddie Mac late last year, James Lockhart, director of the Federal Housing Finance Agency, said in an interview here. The administration has said it will spend between $50 billion and $100 billion from the financial bailout package to help struggling homeowners.
Senior officials are still hammering out the initiative and are not expected to provide the details tomorrow when they unveil their rescue plan for the financial system, two sources familiar with the matter said. The foreclosure strategy could be announced at the end of this week or next week, they said. Lockhart said both lenders and borrowers have been frozen by the perception that the government may continue to unveil new and better modification programs. "The early returns show that we may need to be more aggressive" than plans already announced, he said. But the government also needs to send a message to lenders that its new approach would represent the "best and final" offer.
The Fannie and Freddie program allowed borrowers who were 90 days delinquent on a loan to have their payments lowered to 38 percent of their income. The loan could also be extended from 30 years to 40 years, and if that was not enough, the interest rate could be reduced to as low as 3 percent to make the payments more affordable. Consumer advocates say the program was a good start in tackling the foreclosure problem but did not go far enough to help homeowners. For example, the effort did not include measures to cut the principal owed by borrowers who have seen the value of their home fall below their mortgage loan. Another requirement -- that borrowers miss three payments before qualifying for help -- has been a troublesome issue identified by some consumer groups.
The government's new approach would make the terms more generous for both the borrowers and lenders. For instance, borrowers who missed only one payment might be able to qualify, Lockhart said. Lenders may be able to lower payments to a lower percentage of a homeowner's income. Officials are also planning to set national standards for when banks opt to participate in the government plan -- an important concern for loan servicers who can now only perform modifications that improve the value of the mortgage under the terms of their contracts with investors. Lockhart said he hoped the new program would be attractive to loan holders, but he added that they had an obligation to increase their modification efforts. "It is taking too long," he told an industry group during a speech in Las Vegas. "It is time to act."
Ilargi: Rep. Kanjorski gives a chilling account of his own cluelessness, as well as the way Washington works. "They" said this and this, so "we" did so and so. It's scary to watch. These are the people who get to actually vote on what happens, and they're just ignorant scared little chickens, willing to do whatever their masters tell them. They said, so we did. There's dozens like him on Capitol Hill. A frightening perspective.
Who withdrew the $550 billion? Who threatened to withdraw $5.5 trillion? We don't know, because he doesn't say. He doesn't say, because he doesn't know. He never bothered to ask. Or was afraid to.
Rep. Kanjorski: $550 Billion Disappeared in "Electronic Run On the Banks"
GM Cutting 10,000 Jobs, Reducing Pay as Much as 10%
General Motors Corp., the largest U.S. automaker, will cut 10,000 salaried jobs globally and reduce pay for other U.S. white-collar workers by as much as 10 percent to slash costs and keep $13.4 billion in government loans. About 3,400 of GM’s 29,500 U.S. salaried jobs will be cut by May 1, the company said. The Detroit-based automaker said in a statement it will cut pay temporarily by 10 percent for U.S. executives and by 3 percent to 7 percent for many other U.S. salaried employees. GM is reviewing salaried worker pay and benefits in other countries. GM needs to accelerate cost-cutting plans after the automaker’s U.S. auto sales fell 49 percent in January. GM and Chrysler LLC must submit progress reports by Feb. 17 on their efforts to restructure their businesses, return to profit and repay $17.4 billion in U.S. loans by the end of 2011.
GM started offering buyouts to 62,000 union workers last week and is in talks with the United Auto Workers about trimming benefits. People familiar with those buyouts said the automaker is targeting more than 10,000 union jobs and expects more than half that number to accept. Most non-union workers will see pay cut at least 3. Last month, the company forecast U.S. industrywide sales this year of 10.5 million cars and light trucks, compared with 13.2 million last year and an average of 16 million this decade. GM said it expects global sales will fall to 57.5 million autos from 67.1 million last year, or about 10 percent worse than a December forecast for global sales.
GM: Who's Going To Blink?
The federal bailout of General Motors and Chrysler, intended to help speed the restructuring of the ailing auto industry, might be doing just the opposite. With a week to go before the companies must submit new restructuring plans to the government under terms of their $17.4 billion taxpayer loans, negotiations with bondholders and the United Auto Workers union to reduce the companies' huge debt burden seem to be going nowhere. "Everybody is just looking at each other," said Sen. Bob Corker, R-Tenn., who has been briefed on the companies' progress. "There's no real action happening as it relates to restructuring."
Under terms of its government loan, GM must reduce its $45 billion in debt by two-thirds, most likely through a debt-for-equity swap, and must also convince the UAW to accept stock instead of cash for half of its $26 billion obligation to a retiree health care trust. So far, neither bondholders nor the UAW are willing to move until they know what sacrifice the others will make. "There's uncertainty," says Corker, noting that the Obama administration has yet to appoint an oversight board, led by a so-called "car czar," to monitor the companies' restructuring. "When there is uncertainty, it's difficult for parties to come together. People are unwilling to sacrifice unless they know the true lay of the land."
But the bailout itself might be the true culprit. By extending loans to the carmakers, the government removed the primary incentive for bondholders and the union to bargain: fear of a bankruptcy filing. The Fed went even further by giving another $6.5 billion in loans to the automakers' finance arms, GMAC and Chrysler, and by granting GMAC bank-holding status even though it appeared to fall short of required capital levels. "All of these steps by the government were likely to have emboldened bondholders (and perhaps also the UAW) to feel that the government lacks the political will to bankrupt GM," JPMorgan automotive analyst Himanshu Patel wrote in a research note for clients.
Patel said he wouldn't be surprised if GM and Chrysler submit restructuring plans to the government that allow them to "muddle along" with too much debt, labor costs that are still too high and too many brands and dealers. That could turn into a "political lightning rod" for the Obama administration, however, said Patel, which might force the government to take tougher action. "We are increasingly thinking that such a development might force the White House to more seriously consider allowing GM/Chrysler to go into bankruptcy." David Cole, director of the Center for Automotive Research, says the various stakeholders still have plenty of incentive to make sacrifices now in hopes of a greater payoff later. "The best alternative is you make the company successful." Easier said than done.
GM mulls move to break free of Delphi quagmire
General Motors Corp has been trying to wash its hands of Delphi Corp since it spun off the troubled auto parts supplier a decade ago. But after taking on billions of dollars of liabilities and charges related to Delphi since 1999, GM is now being forced to consider taking back some unprofitable Delphi plants at a time when the automaker can least afford it. Delphi, which filed for bankruptcy in 2005 and has been trying to emerge from it since last April, is once again looking to its former parent for a rescue.
The automaker started talking with Delphi last month about buying back parts of the supplier, including some plants, a source with direct knowledge of the talks told Reuters. The talks could pave the way for GM to request U.S. government funding beyond the $13.4 billion it has already been pledged and resolve the lingering uncertainty over Delphi, analysts said. Kirk Ludtke, senior vice president at CRT Capital Group, said taking back Delphi assets makes a lot of sense for GM as it could look to transfer the business to another supplier.
"It also will make GM more financeable because it's difficult for GM to raise third-party financing with the uncertainty surrounding Delphi," he said. "It makes sense for Delphi because they need to eliminate these money-losing plants and they need to reduce their reliance on GM." Standard & Poor's equity analyst Efraim Levy said that GM's apparent willingness to take back some of Delphi's struggling operations could bolster its case for more federal money. "Part of the strategy appears to be a way to apply for more federal assistance," he said in a note to clients.
GM faces a February 17 deadline to submit new restructuring plans to the U.S. government that would show the automaker was a viable entity. Addressing the Delphi issue will have to be a key part of the plan as the long-running troubles at the parts supplier remain a big financial risk for GM, analysts said. Delphi remains GM's biggest parts supplier, and GM is Delphi's biggest customer. The automaker has taken more than $11 billion in charges to help along Delphi's reorganization. The potential move by GM to take back some of Delphi's assets would be similar to the bailout of rival auto supplier Visteon Corp by former parent Ford Motor Co.
Ford, which spun off Visteon in 2000, helped the ailing supplier in 2005 by taking back some plants and workers. Since then it has been trying to sell the parts plants -- but with limited success. Ludtke said selling off individual plants was one option for GM. "It could be that the assets are moved from Delphi to another supplier and GM doesn't take them back but pays for the transition," he said.
Delphi is also running out of options. It warned last week that the value of its business will be substantially below the $6.3 billion it had estimated in October and sought to eliminate health care benefits for its salaried retirees. Fitch Ratings Managing Director Mark Oline said GM would want to ensure that it has a strong say in what happens with Delphi. "It doesn't want to cede decision-making to Delphi and the banks." Delphi's exit from bankruptcy was held up when an equity plan to support the move fell through last April. The risk that GM would have undue influence over the restructuring of Delphi was one of the reasons investors, led by Appaloosa Management, backed out of a $2.55 billion plan to support the parts maker's reemergence last April.
Delphi and other auto parts makers are under intense pressure after steep production cuts from all three U.S. automakers. U.S. auto sales plunged 18 percent to 13.2 million vehicles in 2008. Analysts say the market is certain to fall further in 2009 after January sales plunged to a 27-year low. "Most suppliers will have to make sure they can generate cash and operate in a 10 to 12 million unit market," Oline said. "That is a big challenge with Delphi's current leverage."
Europe ambushes Germany on debt bail-out
The European Union has called an emergency summit of national leaders this month to halt the drift towards protectionism and stem the risks of a debt crisis as the slump deepens. EU finance ministers are to discuss proposals over breakfast in Brussels today for some form of "debt-agency" or mechanism for the EU to raise bonds, a move seen by diplomats as a ploy to ambush Germany into accepting shared responsibility for EU debts – anathema to Berlin.
Concern is mounting over the dramatic deterioration of public finances across the EU. Ireland's deficit is heading for 12pc of GDP, and there are doubts over whether Italy and Greece can roll over some €250bn (£218bn) in state debt between them this year. EU company debt is a worry too, now 95pc of GDP compared to 50pc in the US. "The amount of debt to roll over in the eurozone is huge, at a time when banks are tightening credit standards," said Gilles Moec, from Bank of America. "Spanish businesses are in a dire situation." Mirek Topolanek, Czech premier and holder of the EU presidency, said the crisis summit was aimed at thrashing out a joint "recovery plan" and curbing the nationalist reflexes that are tearing the EU apart. The Czechs are livid over comments by French president Nicolas Sarkozy, who threatened to withold aide for French car companies unless they spend it at home.
" If we give money to the auto industry to restructure, we don't want to hear about plant moving to the Czech Republic," he said. Mr Topolanek said the comments were "unbelievable" and could cause the Czech Republic to reject the Lisbon Treaty. "If somebody wanted to seriously threaten ratification, they couldn't have picked a better means," he said. The French plan fleshed out yesterday offers €6.5bn in soft loans to Renault and PSA Peugeot Citroen on condition that they promise not to close any sites in France. The Brussels competition police said they will examine the details to determine whether the terms breach EU law.
EU tensions mount over French car bail-out
European Union finance ministers were struggling on Tuesday to define a common response to the financial crisis and recession, with the atmosphere full of tensions over protectionism, public finances and bank rescue schemes. Several ministers voiced concern about a French government plan, announced on Monday, to give €6bn in preferential loans to Peugeot-Citroën and Renault, the national carmakers, in return for keeping jobs in France. "It’s problematic for Sweden," said Anders Borg, Swedish finance minister, alluding to the risk that the French aid could put his country’s car industry at a competitive disadvantage. There appeared to be equally little common ground on Monday evening when finance ministers of the 16-nation eurozone convened informally to discuss public finances and the European stance at the April 2 meeting in London of the world’s 20 main developed and emerging economies.
Asked whether the eurozone ministers had managed to forge a common position, Christine Lagarde, France’s finance minister, said acidly: "I must have been ill at that point." There was even an unseemly scramble among governments to win credit for calling an emergency summit of EU leaders in Brussels at the end of February to discuss Europe’s response to the financial crisis. Mirek Topolanek, prime minister of the Czech Republic, which has held the EU’s rotating presidency since January 1, said on Monday that he had decided to summon leaders to Brussels because of the rising risk of protectionism and economic nationalism. He cited in particular "protectionist steps and statements" on the part of Nicolas Sarkozy, France’s president. However, shortly after Mr Topolanek’s announcement, the Elysée palace in Paris released a joint letter from Mr Sarkozy and Angela Merkel, Germany’s chancellor, in which they themselves proposed a summit and made no mention of the Czech leader’s initiative.
EU diplomats said the letter reflected the impatience of France, and to some extent other member-states in western Europe, with the Czech Republic’s performance in the EU presidency. But the dispute also pointed to the Czechs’ frustration at what they see as sniping and interference from Paris, which held the EU presidency for the second half of last year. As ministers arrived for Tuesday’s talks, Miroslav Kalousek, finance minister of the Czech Republic, continued the tussle with France, declaring: "The presidency thinks that the biggest risk at the moment is the risk of protectionism." Ms Lagarde said on Monday that the French car aid plan contained "not a whiff of protectionism" and that its aim was "to focus on research and development". The ministers were expected on Tuesday to review proposals to create "bad banks" where toxic assets brought to light by the credit crisis would be quarantined, allowing confidence to return to financial markets and banks to resume normal levels of lending to customers. However, Mr Kalousek said: "There will not be an agreement on a single methodology of how to deal with toxic assets today."
Ed Balls: minister fears rise of fascism amid economic gloom
Ed Balls, the Children's and Schools Secretary, said the downturn was likely to be the most serious for 100 years, and his comments appeared to raise the prospect of a return to the Far Right politics of the 1930s and the rise of Facism. His warning, in a speech to activists at the weekend, came after a trade union baron warned that far right parties were trying to hijack the campaign for "British jobs for British workers". The row over foreign workers has gathered momentum in recent weeks and Mr Balls seemed to suggest the recession could trigger a return to the Far Right politics that prospered in the Great Depression of the 1930s.
He told Labour's Yorkshire conference: "The economy is going to define our politics in this region and in Britain in the next year, the next five years, the next 10 and even the next 15 years. "I think that this is a financial crisis more extreme and more serious than that of the 1930s and we all remember how the politics of that era were shaped by the economy." The remarks are significant because Mr Balls was a key adviser to Mr Brown during his decade at the Treasury as Chancellor of the Exchequer. Mr Balls said that he believed this to be "the most serious global recession for over 100 years".
He said: "We now are seeing the realities of globalisation, though at a speed, pace and ferocity which none of us have seen before. The reality is that this is becoming the most serious global recession for, I'm sure, over 100 years as it will turn out." Last week Derek Simpson, the general secretary of Unite, gave warning that far right elements were hijacking a campaign against foreign firms bringing in non-British workers. He said: "We are deeply concerned that other organisations like the BNP are latching onto the movement for their own racist agenda."
Last night, George Osborne, the shadow Chancellor, said Mr Balls' comments were at odds with Treasury forecasts suggesting a recovery in the third quarter this year. He said: "This is a staggering and very worrying admission from a Cabinet Minister and Gordon Brown's closest ally in the Treasury over the past ten years. "We are being told that not only we are facing the worst recession in 100 years, but that it will last for over a decade – far longer than Treasury forecasts predict. "In this time of recession, a Cabinet rift over the economy could be deeply damaging. "We need immediate clarification of whether Ed Balls is speaking for his colleagues in the Government."
The Liberal Democrats compared the comments with those made by Treasury minister Baroness Vadera, when she claimed she was seeing "green shoots" of economic recovery, echoing remarks by former Tory Chancellor Norman Lamont in 1991. She was criticised for saying last month: "I am seeing a few green shoots, but it's a little bit too early to say exactly how they'd grow." Vincent Cable, the LibDems' Treasury spokesman, said: "Instead of giving clear and consistent leadership, government ministers are oscillating between complacent optimism and this doom laden picture of Armageddon. "Surely the truth lies between the two? This is a serious crisis but not hopeless." The news came as the Financial Services Authority, the City watchdog, warned that the UK was at risk of a deeper-than-expected recession.
The authority said that the worst financial meltdown "in more than 70 years" has far from run its course and the British economy was predicted to shrink by 2.2 per cent this year. It also said that Britain's 'vulnerable' banks need to make huge culture changes to survive the recession. A spokesman for Ed Balls denied he had been trying to draw parallels with the Far Right. He said: "The speech was about the difference between Labour and the Tories on the economy. It was not about trying to draw parallels with the Far Right. "The Tories are completely isolated in their opposition to a fiscal stimulus that is essential to combating what most economists agree is an unprecedented financial sector recession. "He said that this difference between the parties will define this country’s politics for many years to come."
Bank of England challenged by new independent Monetary Policy Forum
A group of former members of the Bank of England's Monetary Policy Committee have started an independent forum to challenge the decisions made by current UK policy makers. DeAnne Julius, Willem Buiter, and Sushil Wadhwani will be part of the Monetary Policy Forum, created by Fathom Financial Consulting to present the shortcomings of the MPC and present alternative options for policy makers. Launching today, a day before the Bank presents its latest Quarterly Inflation Report, the MPF is calling for a radical overhaul of the policy framework and immediate quantitative easing to halt the deepening crisis.
The forum plans to meet once a quarter, just before the Bank's inflation report is published. "We are approaching the end of monetary policy as we know it, but alternatives such as quantitative easing bring new risks and no guarantees of success. The Monetary Policy Forum aims to make a constructive contribution to this debate," said Dr Julius. Danny Gabay, director at Fathom and a former economist at the Bank said the financial crisis had exposed the UK's lack of bold thinking in monetary policy, adding the MPF would "provide a much needed balance to the Threadneedle Street establishment."
HBOS sacked and gagged bank risk whistleblower
HBOS sacked and gagged a senior executive who four years ago warned the board of the bank that they were taking excessive risks, according to evidence given in Parliament this morning. MPs on the Treasury Select Committee were given details of a submission from the former head of risk at HBOS who claimed that he warned the board repeatedly that they were taking risks with financial stability and consumer protection. Paul Moore, a former partner of KMPG and head of group regulatory risk at HBOS between 2002 and 2005, accused the bank of "a total failure of all key aspects of corporate governance" and said that he was repeatedly rebuffed and thwarted when he tried to register concern.
In a highly sensitive development he also pointed the finger of blame firmly at Sir James Crosby, the former chief executive of HBOS, who is deputy chairman of the chief City regulator the Financial Services Authority and a senior adviser to the Government. By dismissing him without good reason HBOS had broken in-house rules and then replaced him with a "personal" appointment of a woman sales manager with less experience of risk management and against the wishes of other directors. In his submission to the committee Mr Moore said that he warned HBOS it was growing too fast, warned that it was culturally indisposed to being challenged and warned that its sales culture was "significantly out of balance with their systems and controls".
He also said that he told the board the bank needed to slow down but that he was over-ruled by the then finance director when he tried to get his views put in writing in the board minutes. After being sacked he went to an industrial tribunal, at which point HBOS settled for "substantial damages". "I was subjected to a gagging order but have decided to speak out now because I believe the public interest demands it," he said in the submission. The details of that agreement were unclear today but Mr Moore gave an interview to the BBC in October criticising the approach to risk taken by HBOS. "I think a concern everybody had [was] whether or not the business was under control," he said, claiming that the bank's priority was switched from risk management to growth under Sir James, who was subsequently appointed by the Government to lead a review of the mortgage market.
"The retail bank was going at breakneck speed and an internal risk and compliance function feels like a man in a rowing boat trying to slow down an oil tanker. I'm not saying that there were any bad intentions in that but it was difficult to slow things down," Mr Moore said. Mr Moore said in a previous interview that HBOS had been chasing sales too aggressively and with little regard for risk as early as 2002. HBOS collapsed last year after lending too aggressively and relying too much on wholesale funding and had to be rescued by Lloyds TSB. The two banks took £17 billion of taxpayers' money to beef up their balance sheets and the Government now owns 43 per cent of the combined bank. Mr Moore concluded by saying, "One final observation I would make about HBOS disaster is this: wasn't it actually Sir James Crosby, rather than Andy Hornby [his successor as chief executive], who was the original architect of the HBOS retailing strategy? Shouldn't the Committee be asking him to testify?"
The dismissal of the whistleblower emerged as Lord Stevenson answered questions from MPs on the Treasury Select Committee about the British banking crisis. Lord Stevenson told MPs: "We are profoundly and, I think I would say, unreservedly sorry at the turn of events." In evidence to the committee today Lord Stevenson, the former HBOS boss, emphatically denied suggestions from Andrew Tyrie MP, that Mr Moore had been "subject to threatening behaviour" by the bank. He rejected Mr Moore's allegations, saying that the bank commissioned an independent study and the matter was closed to the satisfaction of the FSA. "I remember the incident very well. It was taken very seriously by the board."
George Mudie MP said, "At the end of the day, you sacked your group risk fellow. Now four years later it turns out he was right and you were wrong. You're all in bloody denial." Lord Stevenson was appearing alongside Sir Fred Goodwin and Sir Tom McKillop, the former chief executive and former chairman respectively of the Royal Bank of Scotland (RBS). RBS and HBOS, which is now part of the Lloyds Banking Group after a rescue by Lloyds TSB, have been bailed out with £37 billion from the taxpayer. Sir Fred has been blamed widely for the demise of RBS, which is now nearly 70 per cent owned by the taxpayer, after the bank pressed ahead with the takeover of ABN Amro, the Dutch bank. Sir Tom admitted to MPs this morning that the takeover of ABN Amro was a mistake and that RBS had overpaid for the company.
Record Swiss loss of $17 billion for UBS
UBS on Tuesday announced the highest loss in Swiss corporate history as Europe’s biggest casualty of the credit crisis said it lost nearly SFr20bn ($17bn, €13.2bn) in 2008. The loss, which was above market expectations, was swollen by a SFr8.10bn loss in the fourth quarter, and came in spite of a surprise SFr1.73bn tax benefit and a reclassification of assets that allowed the bank to avoid recognising a further trading loss of about SFr3bn. UBS, which has come under severe political pressure in Switzerland after a government bail out last October, said it was slashing bonus payments. Variable compensation in the investment bank, the heart of its problems, will be 95 per cent lower than the previous year, and 80 per cent lower for the group overall. Total bonuses paid will fall to SFr2.2bn. Separately, the bank announced a limited reorganisation to allow greater focus on its core Swiss and wealth management businesses, with the appointment of a new chief executive for the home market and a strengthening of wealth management’s representation on the group’s executive board.
UBS said it would reduce headcount at its securities business to 15,000 by the end of the year, below a previous target of 17,000. The bank eliminated 1,782 jobs in the fourth quarter, with most of the losses falling in the investment banking business. However, in spite of the problems at the investment bank, UBS emphasised its commitment to investment banking, again scotching rumours that the unit may be sold. "The investment bank remains a core business of UBS," the group said in a statement. Virtually the same comment was used for institutional asset management, once also seen by outsiders as a sale candidate. The shares rose as much as 7.1 per cent before settlling back to stand 4.9 per cent higher at SFr13.53 in afternoon Zurich trading. Marcel Rohner, chief executive, also played down speculation that the group might sell its US wealth management activities, based on the former PaineWebber brokerage businesses. He said in a conference call that the wealth management Americas business was "an integral part of our business." Clients continued to withdraw large quantities of money from the group in the fourth quarter. Net new money outflows in wealth management and business banking reached SFr58.2bn in the fourth quarter – bigger than the already high amount for the previous quarter. Institutional asset management saw net withdrawals of SFr27.6bn in assets.
More positively, the group’s outlook for 2009 was slightly more upbeat than in the past, while Mr Rohner repeated the forecast of Peter Kurer, UBS’s chairman, that the bank would be profitable this year. "UBS has had an encouraging start to the year... However, financial market conditions remain fragile", it said. Mr Rohner said net new money in both wealth management and asset management had been positive in January, but gave no figures. The group said its risk positions further declined in the fourth quarter, and said it was transferring fewer toxic assets than expected to the special fund set up with the Swiss National Bank. The total will now amount to $39bn from up to $60bn before. The tier 1 capital ratio, a measure of financial strength, amounted to 11.5 per cent at the end of last year. Risk weighted assets fell by 9 per cent to SFr302bn.
Swiss National Bank cuts value of toxic UBS asset fund by a third
The Swiss National Bank has cut the size of a fund created to mop up toxic assets owned by UBS by a third to just under $40 billion, due mainly to a change in accounting treatment for certain securities. UBS would keep securities backed by student loans and assets that have been wrapped by monoline insurers on its balance sheet, reducing the maximum volume of assets to be transferred to the central bank-run fund to $39.1 billion from an originally announced $60 billion. "Owing to amendments made to accounting standards in mid-October 2008 which apply to UBS, it is now possible to classify certain assets as loans and receivables, with the result that they no longer need to be valued at market prices," the SNB said in a statement on Tuesday.
UBS Chief Financial Officer John Cryan told Reuters the bank -- which earlier on Tuesday posted the biggest annual loss in Swiss corporate history at 19.7 billion Swiss francs ($17 billion) -- had formally reduced the total amount it would use. "We agreed we will give (up) the entire additional $20 billion and never use it," he said. UBS' position had improved since the announcement of the plan, Cryan said. "We said to the SNB there have been accounting changes that have helped us. We feel in better shape." UBS would finance 10 percent of the new amount in the fund, the SNB said.
Under the original plan from last October, UBS was allowed to transfer up to $60 billion to the fund. The bank was supposed to provide $6 billion of the fund's capital while $54 billion would have been financed with a SNB loan. In addition, the government gave UBS a 6 billion franc capital injection. UBS said in its yearly report its inventory of student loan auction rate securities (ARS) was reclassified as 'loans and receivables', as were student loan ARS repurchased from clients in the fourth quarter. Most of the collateral backing the securities is backed by the U.S. Federal Family Education Loan Program (FFELP), which is reinsured by the US Department of Education, the bank said. The SNB said in the statement an impairment charge would now only be necessary if there are permanent doubts regarding the repayment of the outstanding amounts.
Sweden's Banks Need Money, Too
Sweden is frequently held up as the best example to follow when it comes to bank crises. In the early 1990s, after a burst real estate bubble pulled the rug out from under the financial sector, the Swedish government quickly forced banks to write down their assets, tap the state for capital and sell possessions to repay taxpayers. Although the current crisis is nowhere near this bad for Sweden's lenders, the economic slowdown in Scandinavia and the Baltic states is pushing banks like SEB--and now Nordea--to recapitalize once again.
On Tuesday, after reporting a disappointing fall in fourth-quarter net profit of 25.2%, to 637 million euros ($820.9 million), Swedish lender Nordea was the latest to propose a rights issue to raise cash. The bank is looking for 2.5 billion euros ($3.2 billion) in capital from shareholders, and said it would cut its dividend to add an extra 500 million euros ($644.3 million) to the pot. It has already obtained guarantees from its three largest shareholders--the Swedish government, Sampo and Nordea-fonden--that 49.0% of the rights issue will be taken up. JPMorgan Chase and Merrill Lynch will guarantee the rest.
The announcement came nearly a week after rival SEB said it would raise an extra 19.5 billion Swedish kronor ($2.4 billion), combining a 15 billion-kronor ($1.8 billion) rights issue and the withdrawal of its dividend. Swedbank, which has the biggest exposure to the recession-plagued Baltic states of the three, raised 12.4 billion kronor ($1.5 billion) last year. Shares of Nordea sank 5.6%, or 2.90 kronor (35 cents), to 48.60 kronor ($5.94), during morning trading in Stockholm. SEB also fell 5.0%, to 47.20 kronor ($5.77).
"There is the risk that there is going to be so much supply of rights issues that investor appetite might decline," said Matti Ahokas, an analyst with Handelsbanken Capital Markets. "But a positive factor is all [Nordic] governments have said that they will participate in market terms. That kind of limits the problem." Sweden's banks are still better-positioned than their Western peers when it comes to surviving the slowdown. Handelsbanken's Ahokas expected the Swedish government to maintain, rather than increase, its 20.0% stake in Nordea, and on Tuesday the Swedish Financial Markets Minister reiterated the state's wish to reduce its ownership in Nordea eventually.
Will China have to choose between social stability and long-term growth?
Wow! There are now rumors that Chinese net credit growth in January was substantially higher than the already-astonishing rumors of RMB 1.2 trillion I reported last week. I will get to that at the end of this entry, but I wanted first to discuss a possibly important issue related to credit intervention.
It is probably not at all controversial to suggest that the way governments in the US, China and elsewhere respond to the current crisis will determine economic growth prospects for the next decade and more, but it is probably also worth repeating this point as often as possible. In the panic to respond swiftly to some of the short-term problems facing policymakers, it would be easy for them sometimes to forget the longer-term impact of current policy responses, and so saddle us for many years with unwanted consequences.
Over the weekend I was reading a paper by Gonzalo Fernández de Córdoba (Universidad de Salamanca) and Timothy J. Kehoe (University of Minnesota), called "The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century?" Basing their work on Great Depressions of the Twentieth Century, published in 2007 by the Federal Reserve Bank of Minneapolis, in which Timothy Kehoe and Edward Prescott, together with a team of 24 economists from around the world, analyze a number of "great depressions" experienced by various countries in the 20th Century, they try to determine the impact of policy on the subsequent severity of the contraction.
Although I always worry about ideological predispositions in these kinds of analyses (one group of economists always seems to find that government intervention made things worse, while another always seems to find that in fact specific policies helped), some of the examples they use – in Latin America primarily – involve countries and histories with which I am pretty familiar, and at least this part of their analysis rings true to me.
Based on the data analyzed in the book, they conclude that massive public interventions in the economy to maintain employment and investment during a financial crisis will, if they distort incentives enough, make things much worse. I guess that probably wouldn’t come as a very controversial statement to anyone, but what interested me was that they seemed to focus especially on ways that governments have intervened in credit markets and in investment decisions. Two examples were especially illuminating, Mexico and Chile – which both experienced massive crises beginning in 1982, the year which usually signals the beginning of the LDC Debt Crisis (or the "lost decade", as Latin Americans call it). Their policy responses in the financial sector were radically different:
In 1982 in Chile, banks that held half of the deposits were suffering severe liquidity crises. The government took control of these banks. Within three years, the Chilean government had liquidated the insolvent banks and reprivatized the solvent banks. The government set up a new regulatory scheme to avoid mismanagement. These new regulations allowed the market to determine interest rates and the allocation of credit to firms. The short-term costs of the crisis and the reform in Chile were severe, and real GDP fell sharply in 1982 and 1983. By 1984, however, the Chilean economy started to grow, and Chile has been the fastest-growing country in Latin America since then.
In 1982 in Mexico, the government nationalized the entire banking system, and banks were only reprivatized in the early 1990s. Throughout the 1980s, in an effort to maintain employment and investment, the government-controlled banks provided credit at below-market interest rates to some large firms and no credit to others. Even the privatization of banks in the early 1990s and the reforms following the 1995 crisis have not been effective in producing a banking system that provides substantial credit at market interest rates to firms in Mexico. The result has been an economic disaster for Mexico: Between 1982 and 1995, Mexico experienced no economic growth and has grown only modestly since then.
The differences in economic performance in Chile and Mexico since the early 1980s have not been in employment and investment, but in productivity. In Chile, unproductive firms have died and new firms have been born and grown. Workers and capital have been channeled from unproductive to productive firms. In Mexico, a poorly functioning financial system has impeded this process.
GDP per working age person in Mexico declined substantially in the 1980s and only began recovering by 1988, but a second banking crisis in 1995 eroded much of the recovery and as of today it has still not reached its 1982 peak. In Chile, the decline at first was much sharper. In two years GPP per worker in Chile dropped by around 20%, which it took six years to happen in Mexico. However productivity growth surged thereafter so that by 1988 it had fully recovered to 1982 levels and as of today it has doubled. Chile, as most of us know, has been for the past twenty years the fastest growing country in Latin America, even though it as among the worst hit by the debt crisis.
The main point the paper seems to want to make is that intervention in the allocation of credit had a huge impact on the way the country was able (or not) to recover from the crisis and regain productivity growth:
Japan suffered a financial crisis in the early 1990s and followed similar sorts of policies as Mexico, keeping otherwise insolvent banks running, providing credit to some firms and not others, and using massive fiscal stimulus programs to maintain employment and investment. Japan has stagnated since then. Finland also suffered a financial crisis in the early 1990s and followed similar sorts of policies as Chile, paying the costs of reform and letting the market dictate the allocation of credit to the private sector. The Finnish economy has grown spectacularly since then.
What implications this might have for Chinese policy-making in response to the current crisis? Again, we always need to protect ourselves from conclusions that owe more to ideology than evidence, but at the very least we should consider the possibility that massive intervention in the banking system, for all the short-term countercyclical benefits (i.e. banks are forced to expand, to satisfy policy interests, rather than contract, to satisfy commercial interests) can create serious enough distortions that Chinese growth for the next decade or so might be sharply constrained. In their words:
We need to avoid implementing policies that stifle productivity by providing bad incentives to the private sector. With banks and other financial institutions in crisis, the government needs to focus on providing liquidity so that banks can provide credit at market interest rates, and using the market mechanism, to productive firms. Unproductive firms need to die. This is as true for the automobile industry as it is for the banking system. Bailouts and other financial efforts to keep unproductive firms in operation depress productivity. These firms absorb labor and capital that are better used by productive firms. The market makes better decisions than does the government on which firms should survive and which should die.
Of course someone will inevitably argue that it actually makes commercial sense for Chinese banks to expand loans now, since there is likely to be an implicit, or even explicit, guarantee that makes most new lending essentially risk-free. Yes, of course, but that doesn’t change the underlying logic. Banks will be channeling capital to companies not based on their economic prospects but rather based on the guarantee, and so little commercial distinction will be made between healthy and unhealthy borrowers. My guess, and not a particularly controversial one I suppose, is that the provision of implicit or explicit government guarantees will have more to do with a company’s impact on employment than its economic prospects.
I don’t want to overstate the relevance of market versus government allocation of credit, but by the late mid-1980s, when I first started trading Latin American debt, it was pretty clear that Chilean banks were in much better shape than were Mexican banks, and were much more independent (Mexican banks were not privatized until the early 1990s). I specialized primarily in Mexican debt and bonds until I ended up running the Latin American trading desk, so losing my country focus, but it did always seem to me that the Mexican financial system was a lot less prudent than the Chilean, and government "guidance" had a very big impact on credit allocation.
Before someone suggests that perhaps poor guidance leading to credit misallocation might be less of a problem in well-governed China than in poorly-governed Mexico, I would argue that much of China’s recent growth came about because of the massive expansion in credit, and while the sheer size of the expansion guaranteed that there would be many years of bubble-like growth, we will only now, over the next three to five years, discover whether or not the capital was indeed misallocated on a massive scale. I think it was.
The paper makes a point of saying that the difference in subsequent GDP growth between countries that intervened heavily in credit allocation versus countries that didn’t was not a function of different levels of employment, but rather different growth rates in worker productivity. There were no noticeable differences in employment levels between countries that followed one strategy versus the other.
In that case one can make the argument that if the goal of policy is to minimize social disruption, the "Mexican model" may actually be better than the "Chilean model" because while neither model created a noticeable difference in employment levels, in Mexico an economic contraction roughly similar in magnitude took six years, versus the two years it took in Chile. Mexico may have achieved this socially less disruptive adjustment at the expense of sharply lower levels of productivity growth over the long term, and perhaps this is the tradeoff that governments face in dealing with crises. Japan, it seems to me, also chose a socially less disruptive model, in exchange for a lost decade of growth.
In other words the best policy advice for the government to maximize China’s growth prospects, based on the Fernandez and Hehoe paper, is probably politically unpalatable. It would involve acknowledging that too much capital was allocated to production, and that a period of consolidation is necessary. Unfortunately this consolidation means that capital migrate in a major way from less productive users to more productive users, which is just a bloodless way of saying that a lot of companies are going to have to be allowed to fail, and banks and financial markets should be weaned away from political control and encouraged to make their own commercial decisions.
But should this happen in the midst of a global crisis? On the one hand, in China – and probably most other countries – real reform only seems to occur after a crisis, and so this is an important opportunity to get things right. On the other hand global conditions are too ugly for China to allow bankruptcies to take their swiftest course, and so undermining the social pact, so a strong case can be made for intervening heavily now and reforming later. Ultimately this is a political question that the Chinese must make: is there a tradeoff between long-term growth and short-term instability, and if so, which should China choose?
As I noted at the beginning of this entry, hot off the press is some related news about credit intervention. In an entry last week I mentioned the astonishing RMB1.2 trillion increase in loans that had been unofficially reported for January. This was a full 50% more than the previous monthly record, and nearly one-quarter of the total increase in 2008 (to be fair however January is traditionally always a big month for new lending).
Although this was seen widely as good news for the economy, since credit expansion will probably goose up the short-term GDP and employment numbers, I of course worried about exactly how much of this was real and, more importantly, how much of this will end up as future NPLs. It seemed to me that even the most prudent and commercial banking system in the world cannot expand at this rate without shoveling in an awful lot of garbage, and loan expansion of this base represented a gamble on the duration of the global contraction.
Well, it seems I was wrong. Reuters has just announced that net new lending may have actually been and even more surprising RMB 1.6 trillion – twice the previous monthly record and an amazing one-third of credit growth in all of 2008. We will know by February 15 at the latest, when the PBoC publishes lending data, but if this is true (and the report was seen as highly credible by one of my friends at Reuters) it will probably goose the stock market up further while making people like me more worried then ever. Since for me much of the Chinese growth explosion of the past several years was caused by a badly allocated credit boom, the idea that the solution to a slowdown is to jack up the credit boom even further is very worrying. It is a little like the idea that the best way for the US to adjust to the decline in its debt-fueled household consumption binge is to replace it with a debt-fueled government consumption binge, although perhaps the US and China would choose very differently in the possible trade-off between long-term growth and short-term social stability.
At any rate if this number is true, and if these credit growth levels persist, at least it suggests China is very serious about contributing its share of global fiscal expansion. This should be part of China’s negotiations with the US on trade relationships.
Calpers to ride herd on Wall Street, says pension plan's CEO
Calpers, the largest U.S. public pension fund, is planning to rally big investors nationwide to demand changes to the way Wall Street operates, its chief executive Anne Stausboll told the Los Angeles Times in an interview. The fund will work with other state pension funds and retirement systems to insist on greater openness in the way companies are run, tougher regulation by federal agencies, stricter rules on investment-rating groups and better international financial oversight, Ms. Stausboll told the paper.
"Calpers will be a leader in trying to drive reforms to change the market both here in the United States and globally in order to restore trust and full transparency," Ms. Stausboll told the paper. Initial partners in the campaign include the California State Teachers Retirement System and pension funds in New York state and Connecticut, the paper cited Ms. Stausboll as saying. The pension fund, which has lost more than a quarter of its value in the last seven months, also plans a thorough review of its investments in May, Ms. Stausboll told the paper. The review "is designed to look at whether we want to make any adjustment based on what’s going on in the market," the paper quoted Ms. Stausboll as saying.
Air freight drops as global trade siezes up
The scale of the downturn in world trade was underlined by figures on Tuesday from airport operator BAA showing a 16pc plunge in cargo moved by air. BAA, which runs Heathrow, Gatwick and Stansted airports, said the number of tonnes of air cargo declined by 15.9pc in January, on top of a 15.1pc fall in December. The airport operator said cargo volumes are dropping at all UK airports as a "direct result of the global economic downturn". It said freight volumes in the whole of 2008 were down 1.4pc compared to 2007, largely due the sustained drop at the end of the year. It comes as the cost of sending cargo by ship has dropped to virtually nothing on some routes.
Lloyds List, the shipping newspaper, reported last month that spot freight rates for Asia to Europe fell to zero last month as shippers were prepared to carry some goods for free just to keep their ships in operation. Passenger traffic at BAA airports in January also dropped 6.3pc to 9.4m. The decline was felt the hardest in domestic UK travel which declined 12pc. European traffic was down 6pc, followed by transatlantic routes down 5.9pc, and other long-haul traffic down 1.9pc. Traffic at Gatwick and Stansted airports declined by 10.8pc and 11.2pc, respectively. Gatwick suffered a 24pc decline in long-haul flights, due largely to the collapse of Zoom and XL airlines. Southampton airport recorded am 11.5pc drop in passenger numbers and traffic at the group's Scottish airports – Glasgow, Edinburgh and Aberdeen – dropped 8.7pc.
Bullion sales hit record in rush to safety
Investors are buying record amounts of gold bars and coins, shunning risky assets for the relative safety of bullion amid renewed fears about the health of the global financial system. The US Mint sold 92,000 ounces of its popular American Eagle coin last month, almost four times that which it sold a year ago and more than it shipped during the whole of the first half of 2007. Other countries’ mints have also reported strong sales. "Large purchases of coins are perhaps the ultimate sign of safe-haven gold buying," said John Reade, a precious metals strategist at UBS. Inflows into gold-backed exchange traded funds surged in January, pushing their bullion holdings to an all-time high of 1,317 tonnes. Last month’s flows of 105 tonnes were above September’s previous record of 104 tonnes, and absorbed about half the world’s gold mine output for January, said Barclays Capital. "We estimate that investment demand [into gold] could double in 2009 compared to 2007," said Mr Reade. "Purchases of physical gold have jumped over the past six months as investors’ fears about the current financial crisis ... have intensified."
The move into gold is being driven by the very rich, with bankers saying that some clients are hoarding gold in their vaults. UBS and Goldman Sachs said last week that investor hoarding would drive prices back above $1,000 an ounce. On Monday gold was trading at $892 an ounce. Traders and analysts said jewellery demand, historically the backbone of gold consumption, had collapsed under the weight of the high prices. Sharp falls in demand in the key markets of India, Turkey and the Middle East have capped the potential of any price rally. But the lack of jewellery demand has not discouraged investors. Jonathan Spall, director of commodities at Barclays Capital in London, said: "We have seen more new enquiries about investing in gold so far this year than during the whole 2008." Philip Klapwijk, chairman of GFMS, the precious metal consultancy, said that investors were buying gold because of fears about the global financial system rather than looking for a quick gain. "This is a new round of safe haven buying," Mr Klapwijk said. GFMS estimated bullion coin demand last year reached its highest level in 21 years.
How Government Created the Financial Crisis
by John B. Taylor
Many are calling for a 9/11-type commission to investigate the financial crisis. Any such investigation should not rule out government itself as a major culprit. My research shows that government actions and interventions -- not any inherent failure or instability of the private economy -- caused, prolonged and dramatically worsened the crisis. The classic explanation of financial crises is that they are caused by excesses -- frequently monetary excesses -- which lead to a boom and an inevitable bust. This crisis was no different: A housing boom followed by a bust led to defaults, the implosion of mortgages and mortgage-related securities at financial institutions, and resulting financial turmoil.
Monetary excesses were the main cause of the boom. The Fed held its target interest rate, especially in 2003-2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust. Researchers at the Organization for Economic Cooperation and Development have provided corroborating evidence from other countries: The greater the degree of monetary excess in a country, the larger was the housing boom.
The effects of the boom and bust were amplified by several complicating factors including the use of subprime and adjustable-rate mortgages, which led to excessive risk taking. There is also evidence the excessive risk taking was encouraged by the excessively low interest rates. Delinquency rates and foreclosure rates are inversely related to housing price inflation. These rates declined rapidly during the years housing prices rose rapidly, likely throwing mortgage underwriting programs off track and misleading many people. Adjustable-rate, subprime and other mortgages were packed into mortgage-backed securities of great complexity. Rating agencies underestimated the risk of these securities, either because of a lack of competition, poor accountability, or most likely the inherent difficulty in assessing risk due to the complexity.
Other government actions were at play: The government-sponsored enterprises Fannie Mae and Freddie Mac were encouraged to expand and buy mortgage-backed securities, including those formed with the risky subprime mortgages. Government action also helped prolong the crisis. Consider that the financial crisis became acute on Aug. 9 and 10, 2007, when money-market interest rates rose dramatically. Interest rate spreads, such as the difference between three-month and overnight interbank loans, jumped to unprecedented levels. Diagnosing the reason for this sudden increase was essential for determining what type of policy response was appropriate. If liquidity was the problem, then providing more liquidity by making borrowing easier at the Federal Reserve discount window, or opening new windows or facilities, would be appropriate. But if counterparty risk was behind the sudden rise in money-market interest rates, then a direct focus on the quality and transparency of the bank's balance sheets would be appropriate.
Early on, policy makers misdiagnosed the crisis as one of liquidity, and prescribed the wrong treatment. To provide more liquidity, the Fed created the Term Auction Facility (TAF) in December 2007. Its main aim was to reduce interest rate spreads in the money markets and increase the flow of credit. But the TAF did not seem to make much difference. If the reason for the spread was counterparty risk as distinct from liquidity, this is not surprising. Another early policy response was the Economic Stimulus Act of 2008, passed in February. The major part of this package was to send cash totaling over $100 billion to individuals and families so they would have more to spend and thus jump-start consumption and the economy. But people spent little if anything of the temporary rebate (as predicted by Milton Friedman's permanent income theory, which holds that temporary as distinct from permanent increases in income do not lead to significant increases in consumption). Consumption was not jump-started.
A third policy response was the very sharp reduction in the target federal-funds rate to 2% in April 2008 from 5.25% in August 2007. This was sharper than monetary guidelines such as my own Taylor Rule would prescribe. The most noticeable effect of this rate cut was a sharp depreciation of the dollar and a large increase in oil prices. After the start of the crisis, oil prices doubled to over $140 in July 2008, before plummeting back down as expectations of world economic growth declined. But by then the damage of the high oil prices had been done. After a year of such mistaken prescriptions, the crisis suddenly worsened in September and October 2008. We experienced a serious credit crunch, seriously weakening an economy already suffering from the lingering impact of the oil price hike and housing bust.
Many have argued that the reason for this bad turn was the government's decision not to prevent the bankruptcy of Lehman Brothers over the weekend of Sept. 13 and 14. A study of this event suggests that the answer is more complicated and lay elsewhere. While interest rate spreads increased slightly on Monday, Sept. 15, they stayed in the range observed during the previous year, and remained in that range through the rest of the week. On Friday, Sept. 19, the Treasury announced a rescue package, though not its size or the details. Over the weekend the package was put together, and on Tuesday, Sept. 23, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified before the Senate Banking Committee. They introduced the Troubled Asset Relief Program (TARP), saying that it would be $700 billion in size. A short draft of legislation was provided, with no mention of oversight and few restrictions on the use of the funds.
The two men were questioned intensely and the reaction was quite negative, judging by the large volume of critical mail received by many members of Congress. It was following this testimony that one really begins to see the crisis deepening and interest rate spreads widening. The realization by the public that the government's intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks. And this was likely amplified by the ad hoc decisions to support some financial institutions and not others and unclear, seemingly fear-based explanations of programs to address the crisis. What was the rationale for intervening with Bear Stearns, then not with Lehman, and then again with AIG? What would guide the operations of the TARP? It did not have to be this way. To prevent misguided actions in the future, it is urgent that we return to sound principles of monetary policy, basing government interventions on clearly stated diagnoses and predictable frameworks for government actions. Massive responses with little explanation will probably make things worse. That is the lesson from this crisis so far.
Mr. Taylor, a professor of economics at Stanford and a senior fellow at the Hoover Institution, is the author of "Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis"
Bankers' excesses require retribution, not reviews of pay
Alistair Darling, the Chancellor, seems to have hopelessly underestimated the public mood on bankers' pay. For Mr Darling, a Labour stalwart, to find himself outmanoeuvred on the issue by David Cameron, who as far as I can see is largely financed by the excesses of the City, almost defies belief. I've thought for a long time that Mr Darling is basically too measured and reasonable to be a career politician, and so it now appears. The mob is at the gates: it's time for executions, not civilised reviews. Of course, we all know why Mr Darling is pulling his punches. Bankers may be despised and may be guilty of bringing the country to its knees, but the City is still an important part of the UK economy, and in reforming the system, you don't want entirely to kill off what until less than two years ago was widely thought an outstanding British success story.
What's more, City bonuses have proved as important a cash cow to the Treasury as they were to wheeler dealing bankers. Don't forget that 40 per cent of the rewards go to financing the social security budget, new hospitals and schools, or used to anyway. When the Government took controlling stakes in three of the big banks, it said they would continue to be run on a fully commercial basis at arms length to the politicians. Is this principle now to be abandoned? The public's anger is entirely understandable, but if it were followed to its logical conclusions, Royal Bank of Scotland and Lloyds Banking Group would end up as little more than competing versions of the Post Office, with their entire capital market functions disappearing to organisations still willing and able to pay. The world will always have capital markets and there will always be excessive levels of remuneration paid somewhere. I won't be popular with some readers for arguing this, but it would not benefit Britain in the least to see its entire talent pool in financial services disappear to Switzerland and the Far East.
Barclays has tried to avoid the inevitable backlash against bonuses by raising its new capital in the Middle East, where they are – how shall we put it? – rather less sensitive about public opinion on pay differentials, or anything else, for that matter, than here. None the less, even Barclays now faces a conundrum, with the UK Government promising to make its "asset protection scheme" (APS) dependent on entering into commitments both on pay and lending. John Varley, the chief exec-utive, insists pay as such won't figure in his decision on whether to tap the APS: his chief consideration will be whether the size of the premium makes use of the APS commercially advantageous. In any case, he insists the balance sheet is still capable of withstanding a severe recession with-out recourse to the facility. We'll see.
The Government's "review" of City bonuses is fine as far as it goes but does little to assuage growing public anger over banking excess and is rightly dismissed by many as just another way of playing an awkward political issue off into the long grass. New Labour is a dab hand at government reviews. Many of them are so long in the reviewing that everyone has plain forgotten their existence by the time ministers get round to publishing. Some reviews never publish at all, but rather get rolled up into something else. In any case, the Government is not handling the bank-bashing issue well. The public mood requires something more immediate than a former City regulator wading into an already well understood debate, and rightly so. We don't need a public inquiry to tell us what went wrong or the part City bonuses played in it.
For what it is worth, here is my three-point prescription. First, a number of high-profile bankers need to be prosecuted and sent to jail. Only through retribution is public anger properly answered. Obviously, it would not be possible to prosecute bankers for plunging us into recession, though many might think it worth a try. Instead, we need to adopt the American approach, where prosecutors trawl the books and already burgeoning number of allegations of miscreant behaviour until there is suffic-ient evidence to bring a prosecution. Eventually, some minor, or even major, example of deception will be found from which a case could be constructed. This might affront our British sense of fair play, but the mood is ugly and the mob won't be calmed until there are heads on stakes at Traitors Gate. There's no point in urging bankers to give up their contractual rights to bonuses, as impotently the Prime Minister did yesterday. Bang the worst of them up, then they might get the message.
Second, bankers need to be made personally liable for gambling with other people's capital, so that excessive pay and accumulated assets can be confiscated in the event of failure. Such action would both limit reckless risk-taking and introduce an element of "partnership" into the returns made by bankers. Third, and most important, much more competition needs to be introduced into banking, which at both retail and wholesale level is dominated by a cosy cartel of self-interested skimmers. Right through the system, fees and charges are excessive, never mind the churning of risk that these excesses encouraged. Interestingly, this powerful oligopoly of banking elites was encouraged by regulators in the mistaken belief that a small number of bigger players would be easier to regulate, could be more easily relied on to look after their own and their customers' interests, and would therefore be safer. Barriers to entry were kept deliberately high. How wrong can you be? In reforming capital and liquidity controls, it is most important that they are not made so onerous that it shuts out new entrants. More competition equals a safer and less extortionate system.
Foreclosure Protesters Target Executives' Homes
The Obama administration is about to announce a new plan for the foreclosure mess, but the government and industry responses thus far have done little to stop millions of people from losing their homes. Over the past several days, some of those people have been protesting outside the homes of bank industry executives in New York and Connecticut. In the superexclusive neighborhoods in Westchester County, N.Y., things don't get very loud or crazy too often. Which is why it definitely got the neighbors' attention on Sunday when a housing group brought in 50 van-loads and two tour buses full of upset homeowners.
About 300 homeowners with bullhorns marched past a police cruiser, up the driveway and to the front door of the house where Morgan Stanley CEO John Mack lives. "John! Where are you, John?" one protester called up to the castle-like stone walls of the house. Bruce Marks is the housing advocate behind what he calls a "predators tour." "This guy, he has a net worth of over $400 million," Marks says. "Look at his house. He gets lost in his own house. It's so outrageous." Marks, who is with the Neighborhood Assistance Corporation of America, is singling out big Wall Street executives personally to try to pressure them to do more to help homeowners facing foreclosure.
"While Americans are losing their homes by the millions, he's living in the lap of luxury here in his beautiful house, isolated — and he thought he was safe," Marks says. "Well, it's Sunday, and it's family day, and we're bringing our families to his family." The protesters also went to a hedge-fund manager's house, where they dumped a couch and a bunch of old furniture. Morgan Stanley says its mortgage-servicing company is working with Marks' group to help qualified borrowers stay in their homes. But many homeowners say they are not getting any help. Nick Fresolone and his family drove four hours from New Jersey to attend the protests and seek help at a foreclosure-prevention workshop run by Marks' nonprofit.
"You know, I have four kids," Fresolone says. "They love the home. We just want a fair payment." In 2007, Fresolone, a corrections officer, and his wife, Tanya, were making close to $100,000 a year. They put money down on a house they thought they could afford for $350,000. "We did it the legal way … the right way, with proof of income and pay stubs and everything," he says. The Fresolones say they got scammed by a crooked mortgage broker. They said he told them they would have a loan of around 6 percent with payments of $2,500 a month. In fact, they got a 9 percent loan with payments above $3,500 a month. Fresolone says he knew at the closing that something was not right, but he was told he would lose his down payment to the home-builder if he didn't sign.
"You wait 10 years to buy a home. You put $20,000 — every penny we had at the time — into our dream," he says. "And to have somebody swindle us at the closing table, I felt taken advantage of, lied to, and I felt cheated." Fresolone says the mortgage broker shut down, but he has missed payments and cannot refinance. His loan is now being managed by Wells Fargo, and he says he has been calling for a year, asking the bank to lower his interest rate before he loses the house. Economists says the Fresolones are the sort of people who could stay in their homes if there was a better system for fixing the bad loans that were approved in recent years. Companies have pledged to do that, but in the vast majority of cases, it's not happening. "When you ask for the loan-modification people, they give you a name and a fax number," Fresolone says. "That's it."
Fresolone says he faxes paperwork and hears nothing back. But the counselors at this NACA event have better contacts with the lenders. They are documenting homeowners' incomes and making direct proposals to lower their payments. Many lenders are cooperating. The group says it has restructured more than 25,000 loans over the past year. This is the kind of thing some economists would like to see on a much larger scale. But there were all kinds of people at this event. And it's harder to see some of them as victims. "I was two months out of college, and they gave me $465,000," says Chris Donohue, a structural engineer who makes about $40,000 a year. He clearly couldn't afford the house he bought. He got the loan from IndyMac bank, which collapsed last year after many of its loans went sour. "Every single other bank in the country told me no — wisely," Donohue says. Still, Donohue would like his payments lowered. Deciding where to draw the line on loan workouts will be a challenge for the government going forward.
The "Best Men" Fall
Obtuse hardly does justice to the social stupidity of our late, unlamented financial overlords. John Thain of Merrill Lynch and Richard Fuld of Lehman Brothers, along with an astonishing number of their fraternity brothers, continue to behave like so many intoxicated toreadors waving their capes at an enraged bull, oblivious even when gored. Their greed and self-indulgence in the face of an economic cataclysm for which they bear heavy responsibility is, unsurprisingly, inciting anger and contempt, as daily news headlines indicate. It is undermining the last shreds of their once exalted social status -- and, in that regard, they are evidently fated to relive the experience of their predecessors, those Wall Street "lords of creation" who came crashing to Earth during the last Great Depression. Ever since the bail-out state went into hyper-drive, popular anger has been simmering. In fact, even before the meltdown gained real traction, a sign at a mass protest outside the New York Stock Exchange advised those inside: "Jump, You Fuckers."
You can already buy "I Hate Investment Banking" T-shirts on line. All the Caesar-sized salaries and the Caligula-like madness as the economy crashes and burns, all the bonuses, dividends, princely consulting fees for learning how to milk the Treasury, not to speak of those new corporate jets, as well as the government funds poured down the black hole of mega-mergers, moneys that might otherwise have spared citizens from foreclosure -- all of this is making ordinary Americans apoplectic. Nothing, however, may be more galling than the rationale regularly offered for so much of this self-indulgence. Asked about why he had given out $4 billion in bonuses to his Merrill Lynch staff in a quarter in which the company had lost a staggering $15 billion dollars, ex-CEO John Thain typically responded: "If you don't pay your best people, you will destroy your franchise. Those best people can get jobs other places, they will leave."
Apparently it never occurs to those who utter such perverse statements about rewarding the "best people," or "the best men," that we'd all have been better off, and saved some serious money, if they had hired the worst men. After all, based on the recent record, who could possibly have done more damage than the "best" Merrill Lynch, Wachovia, Wamu, Citigroup, A.I.G., Bank of America, and so many other top financial crews had to offer? Now even the new powers in Washington are venting. Vice President Biden has suggested that our one time masters of the universe be thrown "in the brig"; Missouri Senator Claire McKaskill has denounced them as "idiots… that are kicking sand in the face of the American taxpayer," and even the new president, a man of exquisite tact with an instinct for turning the other cheek, labeled Wall Street's titans as reckless, irresponsible, and shameful. To those who remember the history, all this bears a painfully familiar ring. Soon enough, that history tells us, Congressional investigators will start hauling such people into the public dock and the real fireworks will begin. It happened once before -- a vital chapter in the ongoing story of how an old regime dies and a new one is born.
After the Great Crash of 1929, those at the commanding heights of the economy who had enriched themselves and deluded others into believing that, under their leadership, the United States had achieved "a permanent plateau of prosperity" -- sound familiar? -- were subject to a whirlwind of anger, public shaming, and withering ridicule. Like the John Thain's of today, Jack Morgan, Charles Mitchell, Richard Whitney, Albert Wiggins, and others who headed the country's chief investment and commercial banks, trusts, insurance companies, and the New York Stock Exchange never knew what hit them. They, too, had been steeped in the comforting bathwaters of self-delusion for so long that they believed, like Thain and his compadres, that they were indeed the "best," the wisest, the most entitled, and the most impregnable men in America. Even amid the ruins of the world they had made, they were incapable of recognizing that their day was done.
Under the merciless glare of Congressional hearings, above all the Senate's Pecora Committee (named after its bulldog chief counsel Ferdinand Pecora), it was revealed that Jack Morgan and his partners in the House of Morgan hadn't paid income taxes for years; that "Sunshine" Charlie Mitchell, head of National City Bank (the country's largest), had been short-selling his own bank's stock and transferring assets into his wife's name to escape taxes; that other financiers just like him, who had been hero-worshiped for a decade or more as financial messiahs, had regularly engaged in insider-trading schemes that made them wealthy and fleeced legions of unknowing investors. The Pecora Committee was not the only scourge of the old financial elite. Franklin Delano Roosevelt, as publicly mild-mannered as and perhaps even more amiable and charming than President Obama, began excoriating them from the moment of his first inaugural address. He condemned them in no uncertain terms for misusing "other people's money" and for their reckless speculations; he blamed them for the sorry state of the country; he promised to chase these "unscrupulous money changers" from their "high seats in the temples of American civilization."
Jack Morgan, called to testify by yet another set of Congressional investigators, had a circus midget plopped in his lap to the delight of a swarm of photo-journalists who memorialized the moment for millions. It was an emblematic photo, a visual metaphor for a once proud, powerful elite, its gravitas gone, reduced to impotence, ridiculed for its incompetence, and no longer capable of intimidating a soul. What happened to Jack Morgan or later Richard Whitney -- a crowd of 6,000 turned out at New York's Grand Central Station in 1938 to watch the handcuffed former president of the New York Stock Exchange be escorted onto a train for Sing Sing, having been convicted of embezzlement -- was the political and social equivalent of a great depression. It represented, that is, a catastrophic deflation of the legitimacy of the ancien régime. It was part of what made possible the advent of something entirely new.
Under normal circumstances, most Americans have been perfectly willing to draw a relatively sharp distinction between the misguided speculator and the confidence man's outright felonious behavior. One is a legitimate banker gone astray, the other an outlaw. Under the extraordinary circumstances of terminal systemic breakdown, that distinction grows ever hazier. That was certainly true in the early years of the first Great Depression, when a damaging question arose: just exactly what was the difference between the behavior of Charles Mitchell, Jack Morgan, and Richard Whitney, lions of that era's Establishment, and outliers like "Sell-em" Ben Smith, Ivar Kreuger, "the match king," Jesse Livermore, "the man with the evil eye," William Crappo Durant, maestro of investment pool stock kiting, or the one-time Broadway ticket agent and stock manipulator Michael Meehan, men long barred from the walnut-paneled inner sanctums of white-shoe Wall Street?
Admittedly, their dare-devil escapades had often left them on the wrong side of the law and they would end their days in jail, as suicides, or in penury and disgrace. Nonetheless, as is true today, many Americans then came to accept that between the speculating banker and the confidence man lay a distinction without a meaningful difference. After all, by the early 1930s, the whole American financial system seemed like nothing but a confidence game deserving of the deepest ignominy. In that sense, Bernie Madoff, a former chairman of the NASDAQ stock exchange, already seems like a synecdoche for a whole way of life. Technically speaking, he ran a Ponzi scheme out of his brokerage firm, as strictly fraudulent as the original one invented by Charles Ponzi, that Italian vegetable peddler, smuggler, and after he got out of an American jail, minor fascist official in Mussolini's Italy.
Ponzi, however, was a small-timer. He gulled ordinary folks out of their five and ten dollar bills. Madoff's $50 billion game was something else again. It was completely dependent on his ties to the most august circles of our financial establishment, to major hedge funds and funds of funds, to top-drawer consulting firms, to blue-ribbon nonprofits, and to a global aristocracy of the super-rich. True enough, people of middling means, as well as public and union pension funds, got taken too. At the end of the day, however, Madoff's scheme, unlike Ponzi's, was premised on a pervasive insiderism which had everything to do with the way our financial system has been run for the past quarter century. Once Madoff was exposed, everybody questioned the credulousness of those who invested with him: why didn't they grow suspicious of such consistently high rates of return? But the equally reasonable question was: why should they have? Not only did you practically need an embossed invitation before you could entrust your loot to Madoff, but the whole financial sector had been enjoying extraordinary returns for a very long time (admittedly, with occasional major hiccups like the Dot-com bust of 1999-2000, which somehow seemed to fade quickly from memory).
Keep in mind as well that these lucrative dealings were based on speculative investments in securities so far removed from anything tangible or comprehensible that they seemed to be floating in thin air. The whole system was a Ponzi-like scheme which, like the Energizer Bunny, just kept on going and going and going… until, of course, it didn't. After 1929, when the old order went down in flames, when it commanded no more credibility and legitimacy than a confidence game, there was an urgent cry to regulate both the malefactors and their rogue system. Indeed, new financial regulation was at the top of, and made up a hefty part of, Roosevelt's New Deal agenda during its first year. That included the Bank Holiday, the creation of the Federal Deposit Insurance Corporation, the passing of the Glass-Steagall Act, which separated commercial from investment banking (their prior cohabitation had been a prime incubator of financial hanky-panky during the Jazz Age of the previous decade), and the first Securities Act to monitor the stock exchange.
One might have anticipated an even more robust response today, given the damage done not only to our domestic economy, but to the global one upon which any American economic recovery will rely to a very considerable degree. At the moment, however, financial regulation or re-regulation -- given the last 30 years of Washington's fiercely deregulatory policies -- seems to have a surprisingly low profile in the new administration's stated plans. Capping bonuses, pay scales, and stock options for the financial upper crust is all well and good and should happen promptly, but serious regulation and reform of the financial system must strike much deeper than that. Instead, the new administration is evidently locked into the bail-out state invented by its predecessors, the latest version of which, the creation of a government "bad bank" (whether called that or not) to buy up toxic securities from the private sector, commands increasing attention. A "bad bank" seems a strikingly lose-lose proposition: either we, the tax-paying public, buy or guarantee these securities at something approaching their grossly inflated, largely fictitious value, in which case we will be supporting this second gilded age's financial malfeasance for who knows how long, or the government's "bad bank" buys these shoddy assets at something close to their real value in which case major banks will remain in lock-down mode, if they survive at all. Worse yet, the administration's latest "bad bank" plan does not even compel rescued institutions to begin lending to anybody, which presumably is the whole point of this new financial welfare system.
Why this timidity and narrowness of vision, which seems less like reform than capitulation? Perhaps it comes, in part, from the extraordinary economic and political throw-weight of the FIRE (finance, insurance, and real estate) sector of our national economy. It has, after all, grown geometrically for decades and is now a vital part of the economy in a way that would have been inconceivable back when the U.S. was a real industrial powerhouse. Naturally, FIRE's political influence expanded accordingly, as politicians doing its bidding dismantled the regulatory apparatus installed by the New Deal. Even today, even in ruins, many in that world no doubt hope to keep things more or less that way; and unfortunately, spokesmen for that view -- or at least people who used to champion that approach during the Clinton years, including Larry Summers and Robert Rubin (who "earned" more than a $115 million dollars at Citigroup from 1999 to 2008), occupy enormously influential positions in, or as informal advisors to, the new Obama administration.
Still, popular anger and ridicule of the sort our New Deal era ancestors once let loose are growing more and more common, which explains, of course, the newly discovered voice of righteous anger of some of our leading politicians who are feeling the heat. Certain observers have dismissed popular resistance to the bail-out state as nothing more than right-wing, Republican-inspired hostility to government intervention of any sort. No doubt that may account for some of it, but much of the anger is indeed righteous, reasonable, and coming from ordinary Americans who simply have had enough. Progressive-minded people in and outside of government must find a way to make re-regulation urgent business, and to do so outside the imprisoning, politically self-defeating confines of the bail-out state. Just weeks ago, the notion of nationalizing the banks seemed irretrievably un-American. Now, it is part of the conversation, even if, for the moment, Obama's savants have ruled it out. The old order is dying. Let's bury it. The future beckons.