Eviction on New York ‘s East Side
Ilargi: The insultingly delusional fake Kabuki theater of bank chiefs being "held to task" by lawmakers which is in full swing on both Anglo sides of the Atlantic is nothing but one more additional proof of how dead and gone our political and economic systems are.
These guys shouldn't be in Congress, they should be either in prison or at home, but certainly not in charge of the companies they helped collect trillions of dollars in losses. Come to think of it, the banks themselves should be closed and cleaned out. By the same token, the US government should liquidate all assets in Fannie Mae and Freddie Mac, and divide all mortgages among the communities where the real estate is situated that the loans are written on. If done right, this would keep most homeowners in their homes, though preferably as tenants of their communities, while the latter would be provided with a desperately needed source of income. Additionally, it would free American taxpayers from the trillions of dollars in inevitable future losses on the paper.
Then, as Nassim Taleb suggested as well, credit default swaps should be banned altogether, like most other forms of securitization. For all the claims about how the loss of these instruments would cripple world trade and individual economies, in truth they are no more beneficial for an economy than are banks that have been allowed to proliferate like so many malignant tumors. Both exist for the benefit of of traders, investors and stock- and bond holders. They deliver no benefit to the population at large.
None of the above will ever happen, or at least not until it's way too late. For one thing, because it would dissolve 95% of existing financial institutions, which are typically largely owned by the richest and most powerful people in the US and abroad. For another, because the majority of the population is incapable of letting go of the tragic hope and belief that things will be fine.
As for world trade, another popular theme in politics and finance, where it is touted as the planet's saving grace, we are about to start seeing and feeling how damaging it has been to our lives and societies. I have often repeated that while it's fine to rely on far away places for your junk and trinkets, basic needs should always be held as close to our chests and homes as humanly possible. We have not done that, and we are beginning to come face to face with the consequences.
When you see a headline that shouts "US trade deficit lowest since 2003", you'd almost think that is positive. But the reality is that it means that Americans can no longer afford all the goods that used to be imported. Nor, increasingly, can the rest of the world afford US exports, which fell 6% in December. Without plunging energy prices, the deficit might still have remained at a similar level, but, bitingly, with lower absolute trade amounts.
Lower US import levels are a major factor in Canada's first trade deficit in 32 years. They play a large role in China's 17.5% fall in exports, as well as Taiwan's 44.1% abysmal plunge, and Japan's 9.6% GDP drop. But still, this is not a US problem, though it is an important player. In economies more removed from North America, industrial output fell 27% in Ukraine and 10% in Russia in December. Latvia's GDP contracted at a 29% annual rate in the fourth quarter.
What is happening is a shatteringly rapid demise of world trade as a whole. US air cargo fell 17% in 2008, while trucking is down 14%. The Baltic Dry shipping index has notoriously dropped well over 90% lately. And while it gained some ground in January, leading maritime news portal (since around 1700) Lloyd's List predicts the recovery will not last:
News that the Baltic Dry Index enjoyed its biggest rise in 24 years with a hefty 14% rise on Thursday has brought much cheer to beleaguered dry bulk shipping stocks. However the upturn needs to be kept in context. This pushed the BDI to just under 1,500 points, a level which if forecast a year ago would have been low enough to turn the average shipowner white. In effect what has been seen over the last week is a very welcome bounce in freight rates driven largely by a pick-up in Chinese iron ore imports that crumbled dramatically in the last quarter of 2008.
Chinese steel traders and mills are now restocking, which has boosted shipping demand. Looking though at the longer term demand trend, major Chinese steel mills are still cutting production 20% to 30% and the figures for the industry in Europe and Japan are even greater. Such figures do not point to a sustained recovery rather a short term spike in demand, with shipping volumes trailing off again once stockpiles are replenished.
The conclusion we should draw from this is that many of the goods that are today still on our store shelves, will soon no longer reach us. We therefore need to figure out how to get the articles we want, starting of course with the basic necessities, control over which we should never have given up.
But that is not what we're doing, is it? We just hope for things to get better, and prepare for a year or two at most of doing with a little less, while our governments turn our economies around and the party can start anew. We simply refuse to ask ourselves what happens if the turnaround never comes, just as we refuse to act as if that were even possible. So we sit around and wait while our money is wasted on doomed rescue attempts for long since lost institutions that have hurt us all our lives to begin with, and we can't get ourselves to rise up and do what must be done to minimize the suffering of our children and friends and mitigate the disasters looming on the horizons of our lives.
Why Obama’s new Tarp will fail to rescue the banks
by Martin Wolf
Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much. If he fails to act decisively, the president risks being overwhelmed, like his predecessor. The costs to the US and the world of another failed presidency do not bear contemplating.
What is needed? The answer is: focus and ferocity. If Mr Obama does not fix this crisis, all he hopes from his presidency will be lost. If he does, he can reshape the agenda. Hoping for the best is foolish. He should expect the worst and act accordingly. Yet hoping for the best is what one sees in the stimulus programme and – so far as I can judge from Tuesday’s sketchy announcement by Tim Geithner, Treasury secretary – also in the new plans for fixing the banking system. I commented on the former last week. I would merely add that it is extraordinary that a popular new president, confronting a once-in-80-years’ economic crisis, has let Congress shape the outcome.
The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. If this "progeny of the troubled asset relief programme" fails, Mr Obama’s credibility will be ruined. Now is the time for action that seems close to certain to resolve the problem; this, however, does not seem to be it. All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency. Under the first view, the prices of a defined set of "toxic assets" have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. This was the rationale for the original Tarp and the "super-SIV (special investment vehicle)" proposed by Henry (Hank) Paulson, the previous Treasury secretary, in 2007.
Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.
Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a "no brainer".
The new plan seems to make sense if and only if the principal problem is illiquidity. Offering guarantees and buying some portion of the toxic assets, while limiting new capital injections to less than the $350bn left in the Tarp, cannot deal with the insolvency problem identified by informed observers. Indeed, any toxic asset purchase or guarantee programme must be an ineffective, inefficient and inequitable way to rescue inadequately capitalised financial institutions: ineffective, because the government must buy vast amounts of doubtful assets at excessive prices or provide over-generous guarantees, to render insolvent banks solvent; inefficient, because big capital injections or conversion of debt into equity are better ways to recapitalise banks; and inequitable, because big subsidies would go to failed institutions and private buyers of bad assets.
Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing. Trying to make up for this mistake by imposing pettifogging conditions on assisted institutions is more likely to compound the error than to reduce it.
Assume that the problem is insolvency and the modest market value of US commercial banks (about $400bn) derives from government support (see charts). Assume, too, that it is impossible to raise large amounts of private capital today. Then there has to be recapitalisation in one of the two ways indicated above. Both have disadvantages: government recapitalisation is a bail-out of creditors and involves temporary state administration; debt-for-equity swaps would damage bond markets, insurance companies and pension funds. But the choice is inescapable. If Mr Geithner or Lawrence Summers, head of the national economic council, were advising the US as a foreign country, they would point this out, brutally. Dominique Strauss-Kahn, IMF managing director, said the same thing, very gently, in Malaysia last Saturday.
The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. It is an important, but secondary, question whether the right answer is to create new "good banks", leaving old bad banks to perish, as my colleague, Willem Buiter, recommends, or new "bad banks", leaving cleansed old banks to survive. I also am inclined to the former, because the culture of the old banks seems so toxic. By asking the wrong question, Mr Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.
Geithner Leaves Key Questions Unanswered, Risking Sabotage for Bank Plan
Treasury Secretary Timothy Geithner ducked the tough questions investors want answered as he rolled out a plan to repair the financial system -- and stock traders made him pay for it. Driving investor doubts was Geithner’s failure to clearly address three issues at the heart of the crisis: Will banks saddled with toxic debt be forced to fail? How will illiquid assets be removed from bank balance sheets? And what will be done to arrest the decline in house prices that triggered the turmoil? The risk is that the market reaction sabotages the plan before it gets under way, forcing Geithner to change his approach in response -- a position that his predecessor, Henry Paulson, frequently found himself in.
That may mean the plan "may just end being an interim step," said Kenneth Rogoff, a former chief economist at the International Monetary Fund who’s now a professor at Harvard. "Tim Geithner did a great job in painting the broad strokes of the problem and laying out general principles, but it was a big disappointment not to have more details," Rogoff said. Rogoff also said Geithner missed an opportunity to send a stronger signal distinguishing his approach from Paulson’s: " I would have liked to see President Obama standing behind the Treasury secretary, considering this speech, more than anything else, was supposed to lay out the policies signaling a decisive break from the past."
The Standard & Poor’s 500 stock index tumbled 4.9 percent as investors dumped bank stocks on skepticism whether the plan will work. Bank of America Corp. plunged 19 percent and Citigroup Inc. dropped 15 percent. Futures on the S&P 500 added 0.3 percent at 10:09 a.m. in London. The program Geithner laid out has three main elements: Injecting fresh government capital into some of the country’s biggest financial institutions; establishing a public-private partnership to buy as much as $1 trillion of banks’ bad assets; and starting a credit facility of up to $1 trillion to promote lending to consumers and businesses. U.S. banks have sustained $756 billion in credit losses since the crisis began and have warned of more to come. "The recession is putting greater pressure on banks," Geithner, 47, said in unveiling the Obama administration’s plan in Washington. "This is a dangerous dynamic, and we need to arrest it."
President Barack Obama, speaking at a Feb. 9 press conference, said it was critical that the government restore investor trust in the financial system. "We’ve got to restore confidence so that private capital goes back in," he said. The trouble is that investors abhor uncertainty and Geithner only seemed to add to that with a proposal short on specifics. "He should have waited until he had his ducks in order," said Ward McCarthy, of Stone & McCarthy Research in Skillman, New Jersey. "The lack of detail leaves too much room for confusion, misinterpretation and speculation." Anil Kashyap, a professor of economics and finance at the University of Chicago Booth School of Business, gave Geithner credit for getting regulators to agree to subject the country’s 18 to 20 largest banks to stress tests to determine whether they have enough capital to withstand an even worse economy.
Geithner said the tests would be used to determine which banks need more capital from the government. Left up in the air is whether the government will shut down banks that the tests show are all but insolvent, rather than putting more money into them. That’s a step that experts such as Rogoff advocate. "You don’t want to try to keep zombie banks on life support," he said. Until it’s clear which, if any, of the big banks the government may take over, investors will be wary of putting any more money into the sector for fear of being wiped out. That’s a problem for Geithner because he is counting on investors to provide the bulk of the financing for his program to lift toxic assets from banks’ balance sheets. The illiquid securities, mainly tied to mortgages, have made lenders loath to extend new credit. The so-called Public-Private Investment Fund that will purchase the securities will have an initial capacity of $500 billion, including some $50 billion backing from the government, and could grow to $1 trillion.
The details of how the fund will work have yet to be decided and Treasury officials suggested it could take months to come up with a final program. "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," Geithner said. Officials said the program will aim to provide potential buyers of the assets, including private equity firms, with longer-term financing that they say they need to carry out deals. "There is a lot of capital that seems to be waiting on the sidelines to acquire the distressed assets," said John Lyons, chief executive officer of Savills LLC, a real estate investment banking firm. "The issues are nobody knows what the value of that product is, and we still have the falling knife syndrome," in which plunging prices make investors reluctant to jump into the market.
Louis Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, said that the Treasury may ultimately have to ask Congress for more money to finance the purchase of the bad assets. Both Geithner and Obama have left open that possibility. Behind some of the uncertainty of what the mortgage- related assets are worth is the continued decline in house prices. Home prices in 20 U.S. cities were down 18.2 percent in November from a year earlier, the fastest drop on record, according to the S&P/Case-Shiller index. The Obama administration has pledged to use at least $50 billion from the bank bailout fund help the housing market by preventing foreclosures. Geithner said the details of the plan will be announced in the next few weeks.
"It would have been helpful to have a little bit more detail on exactly how the package is going to take place, how homeowners can apply, and the impact on financial institutions," Dino Kos, a former Fed official who is now managing director of Portales Partners in New York, said in an interview yesterday on Bloomberg Television. Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, praised Geithner for not moving "too quickly without a lot of thought involved in what the implications would be." Still, he said, "I take this as the first step in the process. We don’t have a lot of time, the window is closing and we’ve got to move."
Geithner Unveils Rescue Plan, but Details Are Scarce
The Obama administration Tuesday announced a wide-ranging financial sector rescue plan that could send $2 trillion coursing through the financial system. The plan, which is designed to involve a mix of government and private capital, aims to stabilize the U.S. financial system by injecting capital into banks, helping to determine prices of toxic assets weighing on firms' balance sheets and stemming foreclosures."We believe that the policy response has to be comprehensive and forceful," Treasury Secretary Timothy Geithner said in his speech Tuesday. "Instead of catalyzing recovery, the financial system is working against recovery. And at the same time, the recession is putting greater pressure on banks. This is a dangerous dynamic, and we need to arrest it."
But critical details of the plan remained unanswered, despite the weeks of planning leading up to Tuesday's announcement. Mr. Geithner said the plan to stem foreclosures would be announced in coming weeks. He also provided few details of the asset-purchase plan, which is designed to be done in partnership with the private sector. Investors greeted Mr. Geithner's speech with dismay and the Dow Jones Industrial Average shed 300 points. Lawmakers Monday night, on being briefed by Treasury officials, were also irked by the lack of details, according to people present. The absence of detail speaks to the thorny issues that lie at the heart of the financial crisis: how to value the toxic assets causing banks to report losses and how to shuffle aid to homeowners and stem the rise of foreclosures. Many of the potential solutions come with a host of fresh problems, which Obama officials have grappled with much as their predecessors did.
The stakes are high for Mr. Geithner and the financial system. The administration pitched this speech as a way to restart the troubled bailout, which has come in for heavy criticism by lawmakers and the Congress for aiding banks on terms that were too easy and for not doing enough to restart lending. As part of the administration's broad plan, the Federal Reserve Tuesday announced that it stands ready to dramatically expand a program to boost consumer lending so that it can also help jumpstart the mortgage market. Treasury plans to put $100 billion toward the Fed's Term Asset-Backed Securities Loan Facility, or TALF, as a way to leverage up to $1 trillion.
Additionally, Mr. Geithner announced plans for a public-private investment fund that would help make financing available to "help leverage private capital to help get private markets working again." The program will be targeted to the legacy loans and assets that are now burdening financial firms, he said. "By providing the financing the private markets cannot now provide, this will help start a market for the real estate related assets that are at the center of this crisis," he said. "Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets." Mr. Geithner added that the administration is still exploring a range of options for setting up the program and it will seek input from the public on how to design it. While the program will ultimately provide up to $1 trillion in financing capacity, it will start off on a scale of $500 billion.
Mr. Geithner presented 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 also announced new conditions on banks receiving aid, including documenting how the money is helping to generate new loans. Many U.S. banks will be subjected to rigorous examinations to see if they are healthy enough to lend before receiving additional financial aid. 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.
The administration is still finalizing details of its a housing plan, which centers on financial incentives for mortgage companies to modify bad loans. Mr. Geithner said the goal is to "help bring down mortgage payments and to reduce mortgage interest rates." The Obama administration has discussed spending $50 billion to create programs to help roughly 2.5 million people avoid foreclosure in the next few years through a number of measures aimed at lowering monthly payments and making it easier for borrowers to modify loans.
Government officials are expected to create national standards for loan modifications that would be adopted by Fannie Mae and Freddie Mac. They are also expected to use tax dollars to incentivize servicers to modify loans and possibly offer a separate incentive to MBS investors who own securities backed by the loans. A key focus has been on how to determine the "net present value" of homes, and government officials believe if they can agree on a common metric for determining a home's value, they can rapidly expedite how mortgages are modified.
What's Missing in Geithner's Bank Plan
The Obama Administration's Financial Stability Plan isn't a clean break with the past, because it doesn't spell out clearly who will lose. The main problem with the Obama Administration's "financial stability plan" announced on Feb. 10 is that it doesn't come clean to the American public about how the losses from the financial meltdown will be divvied up. In an effort to come up with a politically appealing plan, President Barack Obama and his team obscured the answer to the most important question: Who loses? Although Treasury Secretary Timothy Geithner repeatedly promised that the new plan would be transparent, it was precisely the lack of transparency that contributed to the stock market's negative reaction. Stock averages fell as Geithner was speaking, and were down 4% to 5% in late trading. "It was scary watching him," says R. Christopher Whalen, managing director of Institutional Risk Analytics, a consulting firm.
"The markets are tough. As long as they sense that there's bull—and indecision—they're going to reject it." In a nutshell, Geithner promised a stringent "stress test" of banks' balance sheets; more aid to banks through a new Financial Stability Trust; up to $1 trillion for a public-private partnership to buy banks' bad real estate assets; up to $1 trillion to support student, auto, consumer, small business, and commercial-mortgage lending; and a major effort to lower the rates and monthly payments on home mortgages. The biggest plus in Geithner's plan is the sheer size of it. "It's much better than Bush-Paulson because it's owning up to the scale of the problem," says Harvard University economist Kenneth Rogoff, referring to the Troubled Asset Relief Program, or TARP, devised by former President George W. Bush and former Treasury Secretary Henry Paulson. But the new plan was deliberately short on detail, especially on the much anticipated public-private partnership.
The Obama Administration hopes to get private investors to start buying up the toxic mortgage-backed securities that are clogging up banks' balance sheets. But it's not clear what would make those private investors suddenly want to buy assets that until now they have treated as radioactive. Adds Rogoff: "I don't see how you're going to get confidence in the markets with a plan that's so difficult to penetrate." Many economists argue that some of the biggest U.S. banks are in such bad shape that the only reasonable alternative is to nationalize them. That would mean ejecting their top executives, wiping out their shareholders, and forcing creditors (other than government-insured depositors) to take a big hit. Once in full control of the banks, the government could strip out their bad assets for sale later, give them a huge injection of public funds, and then spin them back out to the public. Geithner did not address the possibility of nationalization. But private investors remain well aware of the possibility; they won't put more capital into banks if they fear they could lose it in future government takeovers. That creates a standoff between the private sector and the public sector—and paralyzes the banking system at the worst possible moment.
Charles Calomiris, a Columbia University economic historian who has studied banking crises, says the key mistake of the Obama Administration is trying to come up with a plan that emphasizes political palatability over economic reality. To buy support, Calomiris says, the plan emphasizes "very careful investments over a period of time with a lot of upside potential for taxpayers, and with all sorts of limits on what bankers can do." The problem with that approach, Calomiris says, is that it doesn't do enough to make the banks truly healthy, and just prolongs the crisis. He favors taking strong action to improve banks' health dramatically and quickly by guaranteeing them a floor price on their real estate assets, even though such action would be criticized as a giveaway. Says Calomiris: "What makes sense economically doesn't make sense politically, so I'm not very optimistic." Of course, making banks healthy doesn't have to mean enriching their executives, shareholders, and debt holders.
In fact, Whalen, the Institutional Risk Analytics analyst, says common and preferred shareholders of the most troubled banks should be wiped out entirely, while the banks' creditors (excepting depositors) should take a substantial hit as well. He faults the Geithner plan for saying nothing about making creditors absorb some of the pain. One possible reason: Many of the owners of the banks' debt are foreign commercial banks and central banks that would suffer serious damage from a big writedown of their holdings. Whalen faults Geithner for not speaking frankly about these issues, saying, "We have to talk to people in a real way." The result of gliding past such questions is that the Obama plan looks like an evolution of the Bush plan rather than a clean break. To hear Geithner criticize the way things were done before, it would have been hard to guess he was a key partner of the Bush Administration in his previous job as president of the Federal Reserve Bank of New York. In his speech, he said that in the past, "Policy was always behind the curve, always chasing the escalating crisis." The question is whether that is still the case. As much as he wants to be an agent of change, Obama risks repeating the mistakes of his predecessor.
European banks' toxic debts risk overwhelming EU governments
The toxic debts of European banks risk overwhelming a number of EU governments and may pose a “systemic” danger to the broader EU banking system, according a confidential memo prepared by the European Commission. “Estimates of total expected asset write-downs suggest that the budgetary costs of asset relief could be very large both in absolute terms and relative to GDP in member states,” said the document, prepared for a closed-door meeting of EU finance ministers. “For some member states, it may be the case that asset relief for banks is no longer an option, due to their existing budgetary constraints and/or the size of their banks’ balance sheet relative to GDP. The extent of any risks to the EU banking system as a whole from an inadequate response in these member states needs to be considered, particularly in the case of cross-border banks”.
While no country was mentioned, the obvious candidates are Ireland, Luxembourg, Belgium, the Netherlands, Austria, Sweden, and Britain -- and non-EU member Switizerland -- which all have oversized banking sectors. EU banks hold balance sheet assets of €41.2 trillion (£36.9 trillion). Brussels refused to comment on the paper, but it is clear that officials are concerned about default risk in the weaker states where interest spreads on government bonds are flashing warning signs. The International Monetary Fund has questioned the lack of a proper lender of last resort in the eurozone. The European Central Bank is not allowed to bail out individual states, yet national goverments do not control the monetary levers.
The IMF says European and British banks have 75pc as much exposure to US toxic debt as American banks themselves, yet they have been much slower to take their punishment. Write-downs have been $738bn in the US: just $294bn in Europe. Global banks have so far written down half the $2,200bn losses estimted by the IMF. On top of this, EU banks have $1,600bn of exposure to Eastern Europe -- increasingly viewed as Europe’s subprime debacle, and EU corporate debts are 95pc of GDP compared to 50pc in the US, a mounting concern as default rates surge.
The EU document also highlighted the “real danger of a subsidy race between member states” if countries start to undercut each other in the way they value toxic debts in their `bad bank’ rescue programmes. This could be used as a means of covert state aid, undermining the unity of the EU single market. It could also lead to an explosion of budget deficits, already threatening to hit 12pc of GDP in Ireland next year and almost 10pc in Spain and Britain. “It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems. Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance,” it said.
Half of all CDOs of ABS failed
Almost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle. The defaults have affected more than $300bn worth of these collateralised debt obligations, which were built from bits of other asset backed securities (ABS) such as mortgage bonds, other CDOs and structured bonds, or derivatives of any of these, according to analysts at Wachovia and Morgan Stanley. So-called CDOs of ABS caused huge losses to banks such as Merrill Lynch, UBS and Citigroup, which held large amounts of the supposedly safest, top-rated chunks of them. They have since been damned by bodies such as the Bank for International Settlements as being too complex to risk manage effectively.
CDOs of ABS were used increasingly at the peak of the credit bubble to keep the securitisation machine moving by recycling hard to sell bits of subprime mortgage bonds and other risky tranches into new structures with top-notch credit ratings. However, the ratings of these deals proved unsustainable, as evidenced by the fact they have accounted for 92.9 per cent of all 16,587 ratings downgrades globally from all rating agencies since the beginning of last year, according to Morgan Stanley. The way these complex and risky transactions were exploited at the peak of the bubble can be seen in data from analysts at Wachovia, who reckon that 47.6 per cent of all CDOs of ABS by volume issued since the market substantively began in 2002 have now hit an event of default.
By their records, the first three years of the market saw less than 100 deals sold per year and less than 10 per cent of those have defaulted. The number of deals done rose to 133 in 2005, less than 20 per cent of which defaulted, and 89 in just the first half of 2006, about one-third of which have defaulted. However, the real peak of the market saw 147 deals done in the second half of 2006 and 172 done in the first half of 2007 – of which 68 per cent and 76.2 per cent, respectively, have now defaulted.
The way these CDOs have performed has especially hurt the new wave of specialist credit hedge funds, which sprang up in recent years and became heavily dependent from creating and managing such deals. They were drawn to such business by a belief in the sustainability and predictability of the fees it would generate. However, about one-third of the CDOs of ABS that have defaulted, or almost $105bn worth, have been or are being liquidated – often ?leading to losses for investors and putting further pressure on market prices of the bits of mortgage bonds and other CDOs they are selling.
Global company default rates poised for record high
Company default rates are forecast to rise to the highest levels on record by the end of the year because of the sharp deterioration in economic conditions, Moody's Investors Service said yesterday, writes David Oakley . The ratings agency expects global default rates for the debt of junk or speculative grade companies to rise to 16.4 per cent in November - higher than the peaks of 15 per cent recorded in 1932 at the height of the Great Depression. Kenneth Emery, director of corporate default research at Moody's, said: "Rapidly deteriorating global economic conditions and the ongoing banking crisis signal a flood of corporate defaulters this year."
Forecasts for global defaults have been rising by the month. Only three months ago, Moody's was predicting defaults at the end of this year would be 10.4 per cent - 6 percentage points lower than the current forecast. The agency forecasts roughly 300 rated corporate issuers will default this year against 104 issuers in 2008 and only 18 in 2007. The default rate for the debt of junk grade companies was 4.8 per cent in January, up from 4.1 per cent in December. This time last year, the default rate was only 1.1 per cent.
Oil falls towards $37 on U.S. inventory data
Oil pared earlier gains to fall toward $37 a barrel on Wednesday after government data showed that U.S. crude oil stockpiles rose by more than expected last week on low demand from refineries. U.S. crude was down 20 cents at $37.35 a barrel by 1600 GMT (11:00 a.m. EST), having earlier set a session high of $38.44. London Brent crude fell 4 cents to $44.58. U.S. crude stockpiles rose by 4.7 million barrels, higher than analyst expectations of a 3.1 million barrel gain, the Energy Information Administration (EIA) figures showed. However, prices took support from data showing gasoline demand rose 0.1 percent from the same time last year, demonstrating demand could be stabilizing after a prolonged slide. Gasoline stocks fell by 2.6 million barrels, contrasting with forecasts for a 600,000 barrel rise.
"The numbers were definitely outside of expectations in a bullish way for products and a bearish way for crude," said Addison Armstrong, director of market research at Tradition Energy in Connecticut. Even though gasoline supplies are lower, the weakness of global demand remained a key focus for the market. In its latest monthly report on Wednesday, the Paris-based International Energy Agency said global oil demand was expected to fall by 980,000 barrels per day (bpd) in 2009, more than its previous forecast of a 500,000 bpd contraction. It linked the revision to the extreme weakness of the global economy. A slew of dismal economic data on Tuesday had dragged oil back below the psychologically important $40 mark.
Until recently, many analysts predicted the relative strength of the Chinese economy would help to sustain demand for oil even though consumption has fallen sharply in developed economies. But on Wednesday, data from the General Administration of Customs showed January crude oil imports to China, the world's second-largest energy consumer after the United States, had fallen by 8 percent to the lowest level for 15 months. The argument is that prices this low will limit investment and lead to a market surge when demand eventually recovers. "If today's low prices continue long enough, they will sow the seeds for future price spikes and volatility," Saudi Oil Minister Ali al-Naimi said in Houston on Tuesday.
Oil demand to fall at fastest rate since 1982
Demand for oil will fall this year at the fastest rate since 1982, the International Energy Agency has forecast. The rich countries’ energy think-tank has again cut sharply its prediction for world oil demand this year, and now expects it to average 84.7m barrels per day, down 1m b/d from last year, because of the steep downturn in the world economy. This year is expected to mark two successive years of falling demand for the first time since 1982-83. Fuel demand has "plummeted" in the US and is falling in many other countries, the IEA said. Even in China, one of the countries that powered the global growth in oil demand up to 2007, the rise in consumption is expected to slow sharply. However, the IEA also warned that sharp production cuts from Opec, the oil producers’ cartel, would mean that by the end of the year there would need to be a "substantial" draw-down in oil stocks, unless demand weakens even further, or supply from non-Opec countries turns out to be stronger than expected.
Opec cut its agreed production levels by 4.2m b/d in the second half of last year, and could well cut production again at its next meeting on March 15 in a bid to raise oil prices from this week’s levels below $40. The IEA’s forecast for oil demand this year is 570,000 b/d lower than it predicted in January, reflecting the sharp deterioration in the assessment of the world economic outlook from the International Monetary Fund. Forecasts for oil demand in the US are unchanged, as the IEA already expected a second year of decline in 2009 following a drop of more than 5 per cent to 19.5m b/d last year. The sharpest revisions come to forecasts of demand in the European Union and Japan. Demand is particularly weak in the industrial sector; consumption of naptha, used as a feedstock for manufacturing plastics and synthetic fibres, "virtually collapsed" in Germany at the end of last year, and has fallen "off a cliff" in Japan.
In China, total oil demand is still growing, but the rate of increase has slowed very sharply. As demand for oil drops, the IEA warns that its estimates of oil supply capacity are also falling, as the financial crisis and the plunge in oil prices from the summer’s peak of over $147 per barrel force companies to delay or cancel planned investment in increasing or sustaining production. That reduction in investment is already likely to have some effect on oil supply this year, the IEA thinks, but the greatest impact will not be felt for a few years. In its next medium-term analysis of the oil market, due out in the summer, the IEA will analyse the effect of project delays on the outlook for supply over the next five years, looking ahead to the hoped-for recovery in the world economy. When economic growth picks up, under-investment could lead to supply shortages and send prices soaring again. As the IEA puts it: "Ultimately, low prices sow the seeds of their own destruction."
U.S. Trade Deficit Narrowed to Lowest Since 2003
The U.S. trade deficit narrowed less than anticipated in December to the smallest in almost six years as the recession pushed oil prices and consumer spending lower, reducing imports. The gap between imports and exports shrank 4 percent to $39.9 billion, the lowest since February 2003, from a revised $41.6 billion deficit in November that was wider than previously estimated, the Commerce Department said today in Washington. Imports fell to the lowest since 2005. Mounting job losses, a lack of credit and a global downturn signal that imports and exports, both of which fell in December for the fifth straight month, will slide further. Some U.S. firms are lobbying for a "Buy American" provision in President Barack Obama’s stimulus plan, while nations such as France and Russia are taking steps to protect local jobs and production.
"The boost from trade has vanished," Jonathan Basile, an economist at Credit Suisse Holdings in New York, said before the report. "U.S. demand is falling even faster than demand from our trading partners. There’s weakness across-the-board in imports, and the global recession will be a damper on exports." The trade gap was estimated to narrow to $35.7 billion, from an initially reported $40.4 billion in November, according to the median forecast in a Bloomberg News survey of 70 economists. Deficit projections ranged from $31 billion to $45 billion. For all of 2008, the U.S. trade deficit narrowed to $677.1 billion from $700.3 billion in the previous year. Treasuries were little changed, with longer-term securities ending a two-day rally, before a record $21 billion auction of 10-year government notes. The 10-year note yield rose 2 basis points, or 0.02 percentage point, to 2.82 percent at 8:36 a.m. in New York, according to BGCantor Market Data.
Imports in December dropped 5.5 percent to $173.7 billion, the lowest since September 2005, from $183.9 billion the prior month as U.S. consumers bought fewer foreign-made cars and trucks and oil prices fell. Purchases of clothing, furniture and household appliances from outside the U.S. also declined, further reflecting shrinking demand for foreign-made goods. The average price of imported oil fell to $49.93 a barrel, the lowest since December 2005, from $66.72 in November, the report said. Exports in December fell 6 percent to $133.8 billion. Sales abroad of U.S.-made automobiles, parts and engines fell to the lowest level since November 2004. After eliminating the influence of prices, which are the numbers used to calculate gross domestic product, the trade deficit widened to $43.3 billion from $40.1 billion.
The trade gap with China narrowed to $19.9 billion, while the trade deficit with Canada shrank to $2.8 billion. Imports from the European Union increased, causing the trade gap with the bloc to widen to $7 billion. U.S. gross domestic product is forecast to contract again this quarter after shrinking at a 3.8 percent annual pace from October to December, the most since 1982, as consumer spending, about 70 percent of the economy, plunged. Trade, which has added to the U.S. economy since the first three months of 2007, will be less of a help in coming quarters, economists predict. PPG Industries Inc., the world’s second-biggest paint maker, said last month that it may cut as many as 4,500 jobs because of weak global demand from automakers and homebuilders.
"The regions outside of North America, which had been really helping PPG in the first three quarters of last year, have sort of caught the disease that started here in the U.S. with the credit crisis," Chief Executive Officer Charles E. Bunch said Jan. 27 in an interview. Steel companies including U.S. Steel Corp. and Nucor Corp. are pushing for a mandate that projects included in Obama’s stimulus plan use American-made iron, steel and other manufactured goods to build roads, bridges and tunnels. Opponents of the provision, such as Caterpillar Inc., Microsoft Corp. and the U.S. Chamber of Commerce, have said it might spur protectionist measures around the world. Congressional leaders are crafting an approach that would give preference to U.S. products only as long as such a move doesn’t violate trade rules.
The White House has demanded that the provisions satisfy U.S. obligations under the World Trade Organization. Russia raised import duties on cars and trucks this year to protect its slumping producers. French automakers PSA Peugeot Citroen and Renault SA will get government loans after promising to keep jobs and production in the country. European Union finance ministers decried protectionism when they met this week in Brussels to discuss how to help banks take toxic assets off their books, rescue carmakers and bring the euro-region economy out of a recession. The global economy will expand 0.5 percent in 2009, the weakest pace since World War II, according to a forecast from the International Monetary Fund.
Canada Has First Trade Deficit Since 1976 on Exports
Canada unexpectedly recorded its first monthly trade deficit in more than three decades in December as demand for the country’s commodities tumbled. The deficit was C$458 million ($373 million), Ottawa-based Statistics Canada said today, marking the first trade gap since March 1976. Economists surveyed by Bloomberg forecast a surplus of C$500 million, the median of 17 estimates. Canada’s economy is struggling because of weak demand in the U.S., the country’s main market, and slumping prices for commodities such as oil, which generate about half of export revenue. The country is the No. 1 exporter of oil and natural gas to the U.S. and sits on the world’s biggest pool of oil reserves outside of the Middle East.
The agency revised its estimate for November’s surplus to C$1.16 billion from an initially reported C$1.28 billion. The Canadian dollar dropped 0.4 percent to C$1.2485 per U.S. dollar at 8:37 a.m. in Toronto. Exports sank 9.7 percent to C$35.3 billion, the biggest drop since 1982, led by a 19 percent plunge in sales of energy products. Exports of crude fell 29 percent, mostly due to falling prices, Statistics Canada said. Exports of fertilizer dropped 37 percent during the month while exports of aluminum decreased 27 percent, the agency said. Imports fell 5.7 percent to C$35.8 billion. Canada’s trade surplus with the U.S. narrowed to C$3.77 billion, the lowest since 1998, from C$4.6 billion in November. Canada’s statistics agency said separately that new housing prices fell 0.1 percent in December, falling for a third straight month.
China's exports down 17.5% in January, imports fall 43.1%
China's export volume decreased 17.5 percent year-on-year to US$90.45 billion in January, the General Administration of Customs said on Wednesday. The import volume, however, fell by a much larger degree of 43.1 percent to US51.34 billion. Total foreign trade was US$141.8 billion, with the trade surplus up 102 percent over the same month of last year to US$39.1 billion. However, the customs administration said, after deducting the effect of the week-long Spring Festival holiday, the year-on-year export growth was 6.8 percent and the import decline was 26.4 percent on real term. On a monthly basis, the export volume was up 10.1 percent on December and the import value down 3.8 percent.
While the January trade figures were "in part distorted by the affect of the Chinese new year, they indicate a continuing deterioration in the underlying fundamentals," said Wang Qing, chief analyst on Chinese economy with Morgan Stanley Asia. Of the total January external trade, foreign-funded companies accounted for 52.2 percent, or US$74.05 billion, down 32.3 percent from a year ago, and state-owned businesses made up 22.3 percent, or 31.65 billion dollars, down 34.8 percent. The total included US$27.93 billion in trade between China and the European Union, down 18.7 percent; 22.25 billion dollars in trade between China and the United States, down 15.2 percent; and US$14.5 in trade between China and Japan, down 28 percent. In January China exported US$10.51 billion worth of clothing, up 5.7 percent on the same month of last year, and US$2.91 billion worth of shoes, up 10.6 percent.
Zhang Yansheng, senior economist on foreign trade and international cooperation with the National Development and Reform Commission, noted that given shrinking demand from the European Union and the US, the monthly change in exports was a result from tax rebates, efforts by central and local governments to ensure credit extension to exporters and the stability of foreign exchange of Chinese currency. January export value of machines and electronics, which accounted for 54.3 percent of China's total exports, fell 20.9 percent to US$49.14 billion, and export volume of new- and high-tech products dropped 28 percent to US$21.66 billion. According to the customs administration, in January China bought from abroad 32.65 million tonnes of iron ores, down 11.2 percent from a year earlier; 12.82 million tonnes of crude oil, down 8 percent; 2.39 million tonnes of refined oil, down 26.2 percent. Arrivals of finished industrial products were 37.49 billion dollars worth, down 39.9 percent.
China faces the worst international economic environment since the Second World War, with lingering high pressure on its exports, said Fan Jianping, head of the economic prediction department under the government think tank State Information Center. "The large trade surplus stemmed from the big decline in arrivals, which indicated that China's domestic demand and consumption remained lukewarm," Fan noted. Zhang Xiaoji, a senior economist on foreign trade and international cooperation with the Development Research Center of the State Council, another major government think tank, agreed. "The larger import decline showed that policies to boost domestic demand and consumption were yet to pay off. China must stick to such policies against the international financial crisis."
China Needs U.S. Guarantees for Treasuries, Yu Says
China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by "reckless policies," said Yu Yongding, a former adviser to the central bank. The U.S. "should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way," Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing. He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.
Benchmark 10-year Treasury yields climbed above 3 percent this week on speculation the government will increase borrowing as President Barack Obama pushes his $838 billion stimulus package through Congress. Premier Wen Jiabao said last month his government’s strategy for investing would focus on safeguarding the value of China’s $1.95 trillion foreign reserves. China may voice its concerns over U.S. government finances and the potential for a weaker dollar when Secretary of State Hillary Clinton visits China on Feb. 20, according to He Zhicheng, an economist at Agricultural Bank of China, the nation’s third-largest lender by assets. A People’s Bank of China official, who didn’t wish to be identified, declined to comment on the telephone.
"In talks with Clinton, China will ask for a guarantee that the U.S. will support the dollar’s exchange rate and make sure China’s dollar-denominated assets are safe," said He in Beijing. "That would be one of the prerequisites for more purchases." Chinese Foreign Ministry Spokeswoman Jiang Yu said yesterday that talks with Clinton would cover bilateral relations, the financial crisis and international affairs, according to the Xinhua news agency. The dollar fell 0.6 percent to 89.96 yen today on concern that the U.S. government’s bank-rescue plan will fail to revive lending. Treasuries declined as investors prepared to bid for a record $21 billion sale of 10-year notes today. The yield on the benchmark 10-year note rose three basis points to 2.83 percent.
"These comments are some sort of a threat but of course China can never get such a guarantee," said Thomas Harr, a currency strategist at Standard Chartered Plc in Singapore. The U.S. may assure China that it will clean up the financial system and that it "won’t push for a weaker dollar but they can’t promise not to increase the fiscal deficit," he said. U.S. government bonds returned 14 percent last year including price gains and reinvested interest, the most since rallying 18.5 percent in 1995, according to indexes compiled by Merrill Lynch & Co. Concern that the flood of bonds would overwhelm demand caused Treasuries to lose 3.08 percent in January, the steepest drop in almost five years, Merrill data show.
China’s loss of more than $5 billion from investing $10.5 billion of its reserves in New York-based Blackstone Group LP, Morgan Stanley and TPG Inc. since mid-2007 may increase its demand for the relative safety of Treasuries. "The government will be a net buyer of Treasuries in the short term because there’s no sign they have changed their strategy," said Zhang Ming, secretary general of the international finance research center at the Chinese Academy of Social Sciences in Beijing. "But personally, I don’t think we should increase holdings because the medium- and long-term risks are quite high."
Bill Gross, co-chief investment officer of Pacific Investment Management Co., said on Feb. 5 the Federal Reserve will have to buy Treasuries to curb yields as debt sales increase. Fed officials said Jan. 28 they were "prepared" to buy longer-term Treasuries. "The biggest concern for China to continue buying U.S. Treasuries is that if Obama’s stimulus doesn’t work out as expected, the Fed may have to print money to cover the deficit," said Shen Jianguang, a Hong Kong-based economist at China International Capital Corp., partly owned by Morgan Stanley. "That will cause a dollar slump." China’s foreign-exchange reserves grew about $40 billion in the fourth quarter, the least since mid-2004, as an end to yuan appreciation since July prompted investors to pull money out. The world’s third-biggest economy grew 6.8 percent in the fourth quarter, the slowest pace in seven years. Policy makers announced a 4 trillion yuan ($585 billion) economic stimulus plan in November to spur domestic demand.
Yu said China has no plans to channel its reserves toward stimulating its own economy because its trade surplus is sufficient to fund any import needs. China’s trade surplus was $39 billion in January. China "should diversify its reserves away from U.S. Treasuries if the value of China’s foreign-exchange reserves is in danger of being inflated away by the U.S. government’s pump- priming," he said. China may try to link trade and currency policy disputes to its future investment in Treasuries, said Lu Zhengwei, an economist in Shanghai at Industrial Bank Co., a Chinese lender partly owned by a unit of HSBC Holdings Plc. U.S. Treasury Secretary Timothy Geithner accused China on Jan. 22 of "manipulating" the yuan to give an unfair advantage to its exporters. The currency has dropped 0.16 percent this year to 6.8342 per dollar, following a 21 percent gain since a peg against the dollar was abandoned in July 2005. "China can also use this opportunity to get a promise from the U.S. not to make inappropriate requests on bilateral trade and the Chinese yuan," Lu said. "We can’t afford more yuan appreciation as the economy is facing a serious slowdown."
China takes small steps toward establishing yuan as regional currency
While cynics scoff at the idea that the yuan could some day become a regional or a global currency, China's efforts to push loans and trade in yuan in Asia suggest it is taking the first, albeit tiny, step in that direction. The yuan's journey from a controlled, partially convertible currency to a liquid, regional medium of exchange will be a long one, because of the desire of the Beijing government for economic stability. In addition, Beijing has always been wary of moving too quickly to open up its markets, fearing that such a move might leave its economy vulnerable to sudden shifts in capital. Still, for now, it is testing the waters.
In December, China said the yuan could be used for the settlement of trade between the industrial areas of the Pearl River Delta and Yangtze River Delta and the Chinese territories of Hong Kong and Macao. And members of the Association of Southeast Asian Nations will be permitted to use yuan in their trade with the southeast China provinces of Guangxi and Yunnan. "This is a fascinating development and clearly part of Beijing's ambition to regionalize the yuan and to help local trading companies," said Stephen Green, head of China research at Standard Chartered Bank. China has offered inexpensive loans to foreign importers who buy Chinese goods. Most of these borrowers are now compelled to use the yuan to settle their loans with China.
The Chinese government has also urged banks to offer more inexpensive yuan loans to foreign companies. The Export-Import Bank of China, which is owned by the state, extended a $200 million loan to Myanmar in January to pay for imports of equipment from China to build a power station. The bank offered $4.6 billion in such loans to foreign companies to buy Chinese goods from 1994 to 2007. "This is good to help educate regional traders about the yuan and give them a chance to get familiar with the currency," said Mei Xinyu, a researcher for the Chinese Commerce Ministry. Beijing has said these efforts are geared to promoting the country's international trade and to helping Chinese companies limit their currency exposure, while giving foreign companies a chance to familiarize themselves with the yuan.
"Making yuan a regional currency will serve China well," said Zhang Bin, an analyst at the Chinese Academy of Social Sciences, a government research institute. "It can reduce the troubles of managing huge foreign exchange reserves," Zhang said. "And looking forward, it will eventually give China more power in the financial market to match its economic size and foreign exchange reserve levels," he said. China's foreign reserves, the world's largest with a value of $2 trillion, are mainly held in dollar assets, like U.S. Treasury securities. Wu Xiaoling, a lawmaker who was once deputy governor of the central bank, wrote in a recent edition of the financial magazine Caijing that for now there is no substitute for the dollar as the main international currency.
"However, from a long-term perspective, the world should have more choices," Wu wrote. "And the yuan can possibly become one of them, as long as we make good preparations on the economic and financial fronts." Releasing the reins significantly on the closely managed currency, however, could prove far more difficult for a government that puts economic stability above all else. The more the yuan moves offshore, the more that companies using it will want access to hedging markets to manage their currency exposure and trading risks. Until there are active hedging markets, like those for swaps and futures, companies offshore might remain lukewarm about adopting the yuan.
Is the Rally in Baltic Index a Storm Surge?
Storm-tossed investors are finding hope at sea. The Baltic Exchange's Baltic Dry Index, which measures the cost of shipping raw materials and is widely considered a leading economic indicator, has bounced 174% from a 22-year low last December. The rebound is the latest hint of a slight easing of the global recession. Shipping costs probably have seen their bottom for the cycle. But the Baltic Dry can send false economic signals, having done so at least twice in the past two years. It soared through the summer and fall of 2007, heralding nothing of the recession around the corner. It jumped to a record high in the spring of 2008, as the financial markets and economy were preparing for another swan dive.
The Baltic Dry is heavily influenced by commodity demand from China. Snowstorms, the Olympic Games and other China-centric phenomena sparked the index's leaps and swoons last year. The current rally is largely due to China's rebuilding iron-ore inventories after the Lunar New Year holiday. Many observers doubt that the restocking will last much longer and see little appetite for commodities outside of China. Investors seeking confirmation of demand for commodities will need to look elsewhere. One place to start is the world's biggest steelmaker, ArcelorMittal, due to report fourth-quarter 2008 earnings Wednesday morning. Analysts, on average, expect ArcelorMittal to earn 44 cents a share, down 74% from a year ago. Like the Baltic Dry, ArcelorMittal's stock has bounced recently, up more than 80% from its deep trough last November. Both rallies have short-term momentum but limited upside without a lasting economic recovery.
U.S. MBA’s Mortgage Applications Index Slid 24.5% Last Week
Mortgage applications in the U.S. slid last week to their lowest level since November, led by plummeting demand for refinancing amid tighter credit and a worsening economic outlook. The Mortgage Bankers Association’s index of applications to purchase a home or refinance a loan decreased 24.5 percent to 600.6 in the week ended Feb. 6, from 795.4 in the prior week. The group’s refinancing measure plunged 30.3 percent and the purchase index fell 9.8 percent to its lowest level since December 2000. Stricter credit availability and surging job losses are squeezing demand for loans, while falling home prices and increased foreclosures signal the real-estate slump has farther to go.
President Barack Obama’s administration is crafting measures to ease credit, stem foreclosures and rekindle housing sales as part of a broader economic stimulus plan. "Lenders are reluctant to underwrite mortgages to any potential homeowner without pristine credit," Ryan Sweet, an economist at Moody’s Economy.com in West Chester, Pennsylvania, said before the report. "New homebuyers are still few and far between because of the measurable deterioration in the labor market and reduced access to credit." The mortgage bankers’ purchase index declined to 235.9 last week from 261.4 the prior week. The refinancing gauge fell to 2,722.7 from 3,906.3 the prior week. "Demand for refinancing has waned after surging in December," said Michelle Meyer, an economist at Barclays Capital Inc. in New York.
The average rate on a 30-year fixed loan fell to 5.19 percent from 5.28 percent the prior week. The rate reached a record low of 4.89 percent in mid-January. At the current rate, monthly borrowing costs for each $100,000 of a loan would be $548.50, compared with $534.38 four weeks ago. The share of applicants seeking to refinance loans decreased to 66.7 percent of total applications from 73.2 percent. The average rate on a 15-year fixed mortgage fell to 5.0 percent from 5.14 percent the prior week. The rate on a one-year adjustable mortgage rose to 6.22 percent from 6.10 percent. Home sales have been falling since mid-2005, while prices have declined since 2006, leaving homeowners with less equity to tap to fund the consumer spending that makes up two-thirds of the economy.
Defaults on subprime mortgages infected credit markets worldwide, worsening the deepest recession in a quarter century. With the economy unraveling, job losses have totaled 3.6 million in the last 13 months. Homebuilders are reeling. Pulte Homes Inc., the largest U.S. homebuilder, last week reported its ninth consecutive quarterly loss as the recession and falling house prices drove away buyers. During the last three months of 2008, as credit markets seized up, "consumers faced unprecedented levels of financial uncertainty that dramatically impacted purchases of all large- ticket items, especially homes," Richard Dugas, Pulte’s chief executive officer, said in a statement.
'Exponential Rise' in Mortgage Fraud Seen by FBI, U.S. Says
The economic crisis has sparked an increase in criminal fraud, including an "exponential rise" in mortgage scams that is straining the FBI’s resources, a leader of the agency said. The Federal Bureau of Investigation had more than 1,600 open investigations into mortgage fraud last fiscal year, almost double the number in 2006, Deputy FBI Director John Pistole told a Senate hearing today. The FBI also has more than 530 open corporate fraud investigations, he said. "The FBI has experienced and continues to experience an exponential rise in mortgage fraud investigations," Pistole said in prepared testimony. "The increasing mortgage, corporate fraud and financial institution failure case inventory is straining the FBI’s limited white-collar crime resources."
Today’s Senate Judiciary Committee hearing is focusing on whether there should be beefed-up enforcement to cope with the economic decline. Senate Judiciary Committee Chairman Patrick Leahy, a Vermont Democrat, is pushing legislation to authorize funds to hire fraud prosecutors and investigators.
The government’s Troubled Asset Relief Program and proposed economic stimulus legislation likely will result in increased criminal activity, said Neil Barofsky, special inspector general of the TARP program, in prepared testimony. "History teaches us that an outlay of so much money in such a short period of time will inevitably draw those seeking to profit criminally," he said.
Reviews, 'Stress Tests' May Reveal Deeper Bank Troubles
The rigorous review the Obama administration plans to conduct across the nation's largest banks as part of its revamped bailout could reveal a troubled network of financial institutions that have been slow to acknowledge bad loans and are struggling to build reserves. If the condition of many banks is as weak as some analysts predict, regulators could be faced with tough decisions: Do they use federal money to help prop up flailing banks, or do they shut down some firms and limit the cost to taxpayers?
"If they are trying to dig deeper and essentially do some sort of quasi-appraisal of the underlying assets behind the loans, both on commercial and residential real estate, then they are going to see very widespread problems," said Matthew Anderson, a partner at Foresight Analytics in Oakland, Calif., who conducts extensive reviews of troubled banks. The "stress tests" are mandatory for close to 20 of the country's largest banks, regardless of whether they are seeking additional federal aid. Any of the 8,500 other federally insured financial institutions can voluntarily submit to the review, people familiar with the matter said. It's not clear yet whether the Treasury will use the tests as a condition of granting aid for these smaller banks.
Government officials are saying the tests, in which they try and gauge a bank's condition under the worst case scenario in two years, won't be used to separate banks that survive from those that are liquidated. "I don't think there is a pass-fail on the stress test," a government official said. "This stress test is not a test for who is insolvent or not." Rather, government officials say the tests will be used to gauge how much extra capital big banks might need as a buffer to continue lending through the economic downturn. The Treasury Department said Tuesday that it would invest an additional $100 billion and $200 billion into banks on top of the $250 billion it has already said it would put in.
Lawmakers, analysts, and some bankers argue the banking system is worse off than many acknowledge. David Burg, a portfolio manager at Alpine Mutual Funds in Purchase N.Y., said a severe stress test could show that 98% of banks "need a lot more capital." Regulators are moving aggressively to contain the wobbling banking sector after being accused of moving too slowly in the past year. Thirty-four banks have failed in the past twelve months, a faster pace than any period since the savings and loan crisis. Scores more banks are on the verge of collapse and the FDIC had 171 banks on its "problem" list at the end of the third quarter.
"Essentially what you've got are a set a banks that have not been as transparent as we need to be in terms of what their books look like," President Barack Obama said in an interview with ABC News Tuesday. "And we're gonna have to hold out the Band-aid a little bit and go ahead and just be clear about some of the losses that have been made because until we do that, we're not going to be able to attract private capital into the marketplace." Regulators said Tuesday the purpose of their new comprehensive reviews and severe "stress tests" is to "clean up and strengthen" the banks they oversee. They said if they find institutions that need more capital that the government will offer funds as a "bridge" to money from private investors.
"We are going to bring together the government agencies with authority over our nation's major banks and initiate a more consistent, realistic, and forward looking assessment about the risk on balance sheets, and we're going to introduce new measures to improve disclosures," Treasury Secretary Timothy Geithner said Tuesday. The regular exams that banks undergo with state and federal examiners tend to focus on bank's current health. The new uniform reviews will submit their finances to the worst-case scenarios and could create a better way for the government to assess the state of the industry.
The tests could signal a willingness by the Obama administration to extend money to troubled banks, whereas the Bush administration resisted giving money to banks it deemed weren't "viable." For example, National City Corp. was forced to sell itself after regulators argued it wouldn't qualify for federal aid. National City had more than $100 billion in assets and would likely have undergone the government's new stress test. Some bankers and finance executives were alarmed by the purpose of the stress test, alleging it could cause investors to flee from suspect banks and paint a gloomy picture of the industry's condition.
Other industry officials said the review, if done properly, could reassure the public about the overall health of most banks. "I think if done right, it can be a positive in terms of perception and confidence," said Ed Yingling, chief executive of the American Bankers Association trade group. "There are so many exaggerated views in the marketplace of the strength of these institutions that assuring the public that a full scale review is taking place could be helpful in terms of confidence." Mr. Anderson estimated that more than 100 banks will fail this year, while RBC Capital Markets estimated this week that more than 1,000 banks will fail over the next three to five years.
"As a bank regulator, there is a tendency to look at the glass as half empty," said former Comptroller of the Currency Eugene Ludwig, who is now chief executive of Promontory Financial Group. "Can you paint a scenario in many banks in a financial storm where they have too many bad assets and don't have enough capital? Absolutely. Do we have a fundamentally sound, diversified financial system? Yes."
Buyback halts may spell more trouble for Wall Street
If the rising tide of suspended share buyback programs is any indication, corporate America is now in survival mode. The deepening recession is not only forcing U.S. households to live within their means, but corporations too. The list of companies putting their share buyback plans on hold since the start of 2009 has raised concerns that the stock market could be in the throes of losing a key underpinning. The amount of announced share repurchases so far this year is less than one tenth what had been announced in the same time period last year.
Bellwethers 3M Co and Altria Group Inc are among companies that have said they would rather conserve cash this year. Strained credit markets have made it tougher for corporations to borrow, driving companies to conserve cash for more urgent uses and drying up a source of funding for share purchases. "The suspension of buybacks hurts the market," said Eric Kuby, chief investment officer at NorthStar Investment Management Corp. in Chicago. "Corporations are basically saying we're taking this conservative approach, we're conserving our cash." The latest bit of bad news arrives as Wall Street attempts to recover from an 11-year low reached in November. Buybacks serve as crucial underpinnings of market psychology and sentiment, according to analysts.
"The buybacks have totally fallen off," said Howard Silverblatt, senior index analyst at Standard & Poor's in New York. "The companies are shy about commitment. We're seeing companies pulling back in order to conserve cash." Around this time last year, corporate America had more than $63 billion of share repurchases announced, but through February 5 there have been $4.32 billion of announced buybacks, according to data from market research firm Birinyi Associates. The benchmark S&P 500 .SPX is down more than 40 percent since hitting a record in October 2007, and down more than 8 percent since the start of 2009. With share repurchases, companies tread a fine line between returning wealth to shareholders and maintaining a sufficient financial cushion.
Credit rating agencies often take a dim view of share buybacks, because of the constraints they place on cashflow and because of the reliance by some companies on debt to fund the share buybacks. The current buyback squeeze didn't just begin in January. The suspension in share buybacks picked up pace in the fourth quarter, with announcements from other bellwethers including Alcoa, Starbucks and Walt Disney Co, which have all been smarting from the effects of the economic downturn. Wal-Mart Stores Inc, the world's largest retailer, in early December said it had suspended its share repurchase program "as a result of the current economic environment and instability in the credit market." Even companies in the most defensive sectors, such as Altria, are scaling back share buybacks.
For its part, Philip Morris, the cigarette maker that was spun off by Altria, forecast the amount of share repurchases in 2009 to be similar to what it spent last year. Other companies that recently said they were scaling back repurchases include AT&T, which last month said it did not see significant share repurchases in 2009, and exchange operator NYSE Euronext, which on Monday said it would halt share repurchases to preserve capital after posting a big quarterly loss. The suspensions may also mean that companies are willing to forgo giving shareholders any bottom-line windfall in the near term. Share repurchases reduce the amount of shares outstanding, which helps boost earnings per share and tend to support higher stock prices.
But unlike a company slashing a dividend, some investors tend to be somewhat forgiving about tinkering with share repurchases as the first option when the going gets tough. "A share repurchase suspension is certainly a psychological negative as it says the company doesn't have the confidence to get out there and buy their own stock," said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co in San Francisco. "But by the same token, there's a certain amount of understanding that maintaining a strong balance sheet through the worst of the economy is primary, whether it means cutting dividends, or employees or a buyback suspension."
Investors nervous about record-large US 10-year note auction
U.S. Treasury debt prices were little changed on Wednesday as concern over pending debt supply ahead of a record large monthly offering of benchmark notes offset the safe-haven appeal of government debt. Bonds rallied on Tuesday as investors bought up lower-risk assets in disappointment over the Treasury's financial rescue plan as laid out by Treasury Secretary Timothy Geithner. But Treasuries safe-haven appeal was tarnished on Wednesday by nervousness over a $21 billion auction of 10-year notes. The Wednesday auction is part of the Treasury's $67 billion quarterly refunding, and is seen as a true test of investor appetite for U.S. government securities in expectations of soaring debt issuance.
"Basically the market is setting up for supply," said Kim Rupert, managing director of global fixed income analysis at Action Economics in San Francisco. Benchmark 10-year notes were trading unchanged in price for a yield of 2.81, while the two-year note was trading 1/32 lower in price for a yield of 0.92 percent, from 0.90 percent late on Tuesday. An auction of $32 billion of three-year notes on Tuesday was met with robust demand, but the shorter-term notes were seen as more appealing to investors, who are nervous the 10-year note auction may not go so well today. Government debt is expected to soar to $1.5 trillion to $2.5 trillion in fiscal 2009, and investors are sceptical the market will be able to digest all of the new debt issuance.
Treasury Secretary Geithner will testify before Congress again on Wednesday, although analysts do not expect much more in the way of details on the government's rescue plans for the economy and the financial industry. The plan outlined on Tuesday was met largely with disappointment, and stocks plunged while Treasuries rallied. Data early on Wednesday showed demand for U.S. mortgage applications fell nearly 25 percent last week, the Mortgage Bankers Association said, as potential home buyers held out for better terms and possible government help. Also, the U.S. Commerce Department said the U.S. trade deficit shrank 4 percent in December to $39.9 billion, marking the smallest trade gap since February 2003
States Counting on Stimulus Aid to Balance Budgets
If the House version of the federal stimulus package becomes law, Ohio will save 300 youth services jobs, 130 more in addiction counseling and at least 20 positions for aides who provide a respite to relatives of Alzheimer's patients. It would mean keeping as many as 8,000 children in state-supported child care and saving 500 corrections jobs in a state where prisons are well over capacity. If the Senate version triumphs, all of those jobs and subsidies -- plus many more -- will disappear, said Gov. Ted Strickland (D), who has joined with other governors to press members of Congress to back the more generous House approach.
The two chambers began to resolve their differences yesterday on how much money to send to states and other sticking points, after the Senate passed an $838 billion stimulus package. Senate and House leaders played down discrepancies between the two versions, saying that both would provide a boost to the economy and that an agreement on a final bill could come as soon as the end of the week. But for states, the differences are potentially enormous. The House included $79 billion in direct aid to states, $40 billion more than the Senate, and governors are counting on that money to help balance budgets that are billions in the red. "If the Senate version holds, there will be very deep cuts," said Wisconsin Gov. Jim Doyle (D), who added that the cost to the state and its 5.3 million residents would be $600 million. "We're going to see teachers and firefighters and police officers lose their jobs."
In Maryland, a legislative staff analysis found that the state would lose nearly $1 billion under the Senate version, including $454 million in discretionary funding, nearly $200 million in school construction money and nearly $100 million more for higher education projects. Virginia lawmakers are counting on stimulus funding to help close a $3 billion budget gap. "If the Senate will just move a little closer to the House version, that will provide some very significant tax relief, funding of Medicaid and an extension of unemployment insurance," Gov. Timothy M. Kaine (D) told reporters yesterday. The Senate halved the $79 billion as part of a deal to win the support of centrists in both parties who doubted the value and necessity of untargeted aid to states. Some Republicans also had ideological objections, based on a belief in tax cuts and skepticism about expanding the federal government's role in local projects such as school construction.
The discussions between House and Senate negotiators over state aid are likely to be heated, predicted Rep. Anthony Weiner (D-N.Y.), who emerged from a meeting of the House Democratic caucus yesterday to say that the removal of the money was "the source of a lot of gnashing of teeth." If the funding is not restored, he said, many members fear that state governments will pass on the pain to localities. He added that New York would lose $1.6 billion from its share of stimulus money if the Senate version prevails. "This is the unstoppable force and the immovable object," Weiner said. "The unstoppable force is the Democratic majority in the House. The immovable object seems to be the 60-vote margin they need to have in the Senate."
The House bill provided $39 billion for state education budgets, $15 billion for incentive grants and innovation, and $25 billion that governors could use at their discretion. The Senate cut the education aid to $31.3 billion and the incentive money to $7.5 billion, and it eliminated the $25 billion in discretionary funding. Strickland, coping with a projected $7.3 billion budget deficit in the next two years, said he was "puzzled" by the Senate decision. He blamed Republicans, especially moderates, for insisting on tax cuts, including a $70 billion fix to the alternative minimum tax. To him, the "most direct, effective and quickest way" to inject money into the economy is to save state jobs. "One senator said to me, 'I'm not sure there's any willingness on the part of the Senate to give money to governors to pay your bills with,' " Strickland said in a telephone interview. "To hear this referred to as a 'slush fund' causes me to think that there's a failure to understand what's going on in the states."
In the budget he delivered this month, Strickland estimated that Ohio would receive $3.4 billion from the federal government for general expenses over the next two years. If the Senate version passes, he said, that number would drop to $2.5 billion or less. Strickland's office reported that without the extra money, 51,000 fewer Ohioans would receive mental health services, 40 percent of college students would pay more tuition and 17,000 needy young people would not get help. Wisconsin is facing a $6 billion deficit in the next 2 1/2 years because of falling employment and tax revenue, and the House bill would provide about $2.5 billion to help close the gap, Doyle said. "The schools are going to have to do with less over the next few years. We all understand that, but we really hope that there will be further help," he said. "We can't just say to a second-grader, 'Come back in five years and do second grade when the economy's better.' "
Washington Gov. Chris Gregoire (D) worried that $500 million in aid not included in the Senate version would mean cuts in higher education, human services and corrections. Special assistant Dick Thompson described the governor's staff as "pretty disappointed" but not giving up. One governor who is neither complaining nor lobbying for money is Indiana's Mitchell E. Daniels Jr. (R), who is known as "The Blade" for his budget-cutting style during his tenure as director of the Office of Management and Budget in George W. Bush's administration. "He has misgivings, but he is concentrating efforts on preparing to use stimulus funds that come to Indiana to the best advantage of Hoosier workers and taxpayers," press secretary Jane Jankowski said. "We have not been lobbying."
The $9.7 Trillion Pledged to Fix the Financial Mess Could Have Paid off 90% of America’s Mortgages
As Senate Republicans and Democrats continue to bicker over the details of President Barack Obama’s stimulus plan, Treasury Secretary Timothy Geithner waits in the wings ready to unveil yet another bank bailout bill. But almost forgotten in the headlong rush to devise measures to create jobs and save the financial system is the total cost of the government’s commitment to solving the economic crisis. Bloomberg News reported yesterday (Monday) that the tally of U.S. government spending could reach as much as $9.7 trillion - enough to pay off more than 90% of the nation’s home mortgages.
Already, the U.S. Federal Reserve, Treasury Department and Federal Deposit Insurance Corp. (FDIC) have lent or spent almost $3 trillion over the past two years and pledged another $5.7 trillion if needed. That adds up to almost two-thirds of the value of the entire gross domestic product (GDP) for the U.S. economy last year. As astonishing as the number itself is a continuing lack of transparency in how and to whom the funds are being distributed.
"We’ve seen money go out the back door of this government unlike any time in the history of our country," Sen. Byron Dorgan, D-N.D., said on the Senate floor Feb. 3. "Nobody knows what went out of the Federal Reserve Board, to whom and for what purpose. How much from the FDIC? How much from TARP? When? Why?" Notably, only the stimulus package currently on the table - along with the $700 billion Troubled Asset Relief Program (TARP) and last year’s $168 billion tax rebate - have actually been voted on by lawmakers. An additional $8 trillion is in the form of government lending programs and guarantees.
In fact, Bloomberg filed a federal Freedom of Information Act (FOIA) lawsuit against the Federal Reserve Bank Nov. 7 seeking to force disclosure of borrower banks and their collateral. Arguments in the suit may be heard as soon as this month. Meanwhile, the spending goes on. The Senate is to vote this week on a stimulus package totaling at least $780 billion that President Obama says is needed to avert a deeper recession. If it passes the Senate, it would have to be reconciled with an $819 billion plan the House approved last month.
Treasury Secretary Geithner delayed announcing his new plan for addressing the banking crisis, details of which were reported yesterday in Money Morning. The tab for that bailout is widely expected to total near $1 trillion. But questions remain as to what effects the stimulus package and bank bailout will actually have on the economy, both near and long term. The nonpartisan Congressional Budget Office reported last week that the measure is likely to create between 1.3 million and 3.9 million jobs by the end of 2010, lowering a projected unemployment rate of 8.7% by as much as 2.1 percentage points.
But the CBO also warned the long-term effect of that much government spending over the next decade could "crowd out" private investment, lowering long-term economic growth forecasts by 0.1% to 0.3% by 2019. And simple mathematics calls into question assertions that another bailout will rescue banks teetering on the edge of insolvency. Bank losses from the write-offs of bad loans and faulty derivatives add up to $1.5 trillion so far. Additionally, regulators are forcing banks to account for $5 trillion to $10 trillion worth of off-balance-sheet structured investment vehicles.
Given that banking rules require banks to keep assets on hand equal to 10% of those funds, banks will need as much as $1 trillion in the next year. Adding $1.5 trillion in losses means banks will need as much as $2.5 trillion in new capital to remain solvent under current rules. "The banking system simply has no capital. All the money that’s been allocated so far has been like pouring water into a bucket with a hole in the bottom." Satyajit Das, a credit expert from Johannesburg, South Africa, told MSNBC. So is the $9.7 trillion pledged by the government going to be enough to pull the U.S. economy out of the fire? Who knows?
But here are a few facts:
- $9.7 trillion would be enough to send a $1,430 check to every man, woman and child alive in the world, Bloomberg reported.
- It’s 13 times what the U.S. has spent so far on wars in Iraq and Afghanistan.
- And it’s almost enough to pay off every home mortgage loan in the United States, calculated at $10.5 trillion by the Federal Reserve.
Although economists have been throwing around words like "trillion" like it’s nothing, $9.7 trillion is still is a lot of money.
U.S. is looking to the 'vultures' to rescue banks
Howard Marks is the sort of financier who Washington hopes will help fix the tumbledown U.S. banking sector. Trouble is, he is not quite sure he wants the job. Marks is a former banker who became a pioneer in the graveyard of Wall Street. He is one of the biggest players in distressed investing - putting money into risky investments that few others will touch. With its plan to shore up banks that was announced Tuesday, the administration of President Barack Obama hopes to entice investors like Marks, who has $55 billion at his command, to buy troubled assets from the nation's banks to allow them to make the loans needed to jump-start the economy. It hopes, in short, to counterbalance some of the fear gripping the financial world with a bit of old-fashioned greed.
To combat the bust, Washington wants to marshal some of the same financiers who got rich during the boom: hedge fund managers and corporate buyout specialists. But Marks and other investors like him say they are in no hurry to wade into this mess. Distressed investors - "vultures" is the Wall Street term for them- aim to buy investments on the cheap in hopes of reaping big returns. But even for the vultures, the risks - political, as well as financial - seem daunting. Some worry about being seen as profiteers who benefit at taxpayers' expense, even though the economy could get worse unless they swoop in. "You have to ask whether this is an attractive deal," said Marks, the chairman of Oaktree Capital Management, a big money management firm in Los Angeles. It all depends on the price, the terms and the risks, he said.
Wall Street, of course, wants what it always wants: a lot of potential profit on the upside, and not much risk of losses on the downside. But as Treasury Secretary Timothy Geithner outlined his sweeping rescue plan Tuesday, the questions kept piling up. What kind of assets would the banks sell - and at what price? What role would the government play? And, of course, the big one: What are these investments really worth? The banks themselves are struggling to place values on them. Hundreds of billions of dollars of these assets are hanging over banks. Until there is a clear way to purge them, the industry and the broader economy are likely to languish. That is where the vultures come in. Hedge funds and other institutions dominate the field of distressed investing, and they are known for driving hard bargains. In recent weeks, several prominent hedge fund managers met Lawrence Summers, the head of the National Economic Council, to discuss their interest in the planned public-private partnership.
Few of these investors were willing to discuss their plans publicly Tuesday. Some were worried that their investors, which include large public pension funds, might view the potential investments as too risky. And some would not be allowed to buy such assets under their investment guidelines. But if the vultures do alight, their rewards could be enormous. Funds specializing in distressed investments earned annual returns in excess of 30 percent in the early 1990s, as the economy pulled out of recession. "There are plenty of guys who are willing to take the risk, but they want the high returns," said Chip MacDonald, a partner at the law firm Jones Day. Some private investment firms, like Apollo Global Management, headed by Leon Black, first made their names and fortunes after the U.S. savings and loan crisis, when the government's Resolution Trust Corp. sold off assets to other investors on the cheap.
Others, like the Blackstone Group, the large buyout firm run by the billionaire Stephen Schwarzman, and Paulson & Co., whose chief, John Paulson, made billions betting against subprime mortgages, have told their investors they are hunting for the bargains in the ruins of the financial sector. Still others, like the Pacific Investment Management Co., the big bond fund, and BlackRock, another money management firm, could also emerge as big buyers of the troubled assets. Pimco and BlackRock have trillions of dollars at their disposal. Howard Newman, the chief executive of Pine Brook Road Partners, a private equity firm that invests in financial companies, said such investors draw a distinction between potentially valuable assets and those that are outright toxic. Some good assets simply cannot be sold right now, given the turmoil in the financial markets. "If the purpose of the partnership is to find a place to house the loss, I don't think private equity will be willing to do that," he said.
Some executives said they want the government to subsidize their purchases with low-cost loans. Others said the Treasury should put a floor under their potential losses. One model might be the government-brokered sale of IndyMac Bancorp, the large California mortgage-lender that failed last summer. IndyMac was bought by a group of private firms last month for $13.9 billion. As part of the deal, the investors agreed to assume the first 20 percent of the bank's losses, while the government picked up the rest. Another big issue is the price at which the troubled assets would be valued by the banks. While potential investors want to buy as cheaply as possible, the banks might have to take debilitating write-downs if they sold at fire-sale prices. Such an outcome might not be in the government's - or taxpayers' - interests.
But competing interests are bound to bedevil this kind of public-private arrangement, said Campbell Harvey, a professor at the Fuqua School of Business at Duke University. "Given the conflicting objectives, I'm not sure I'd be interested in this kind of altruistic investing," he said. And the potential political costs, money managers said, are real. Some managers said that if they do their job well, they could earn double-digit returns and, with them, public scorn. "We can't really win," one private equity executive said. "When we made money, people criticized us. This year, we lost money, and people are criticizing us."
Pelosi Stimulus Casts Shadow Over Obama, America, World
In a sign that may reveal much about the current deal-making environment in Washington, House speaker Nancy Pelosi has outmaneuvered the Obama Administration in the design of the massive $827 billion so-called Economic Stimulus Package. With the collusion of three moderate Republican Senators - Collins, Snowe and Specter - Pelosi may succeed in steering President Obama into supporting a package with which he may secretly disagree.
Despite the Presidential rhetoric of change, the Pelosi plan is Washington at its most habitual. Her version is a massive, pork-laden monster. Tilted heavily towards consumption, only 10 percent of the bill is allocated toward the infrastructure spending that the President talked about so frequently during the campaign. President Obama initially favored a middle-way. It was to be based on massive public spending, but specifically on infrastructure.
Far from restoring the economy to health, the 'pork-barrel' Pelosi plan will likely force the U.S. economy into the catastrophe of acute stagflation and decline, with grave long-term repercussions at home and abroad. It is clear that we are now headed into an abnormally severe recession, and we may be face-to-face with Second Great Depression. Tell-tale symptoms of Depression include competitive currency devaluations and protective trade measures. Of even greater concern is the historic fact that trade wars too often lead to hot wars. The times of peace and unprecedented prosperity that we have enjoyed for decades are now under threat.
With the stakes this high, Pelosi should have restrained her urge to flex political muscle. Most economists agree that America has enjoyed unprecedented prosperity, based primarily on excessive U.S. dollar liquidity and unmanageable levels of debt. Thus, any healthy correction would necessarily involve serious deleveraging and a severe recession. After a lot of pain, the economy would rebuild with healthier fundamentals. Infrastructure improvement would aid, but not cause, the eventual recovery.
Recession is the natural cure for the politically inspired profligacy that America has enjoyed for almost 40 years. Unfortunately, the side effects of this medicine, namely the rapid reallocation of labor resources and deflationary damage to debtors, are still unpalatable to pandering politicians. The Washington regime, particularly members of the Democrat persuasion, leans towards a socialist solution of avoiding recession at any cost. After all, the bills are paid by others, such as taxpayers and holders of U.S. dollars. This results in an increasing amount of other peoples' money being spent on 'public' works that would in other times carry the label 'pork barrel.'
Washington is choosing to pursue the policy of continued and ever-increasing false prosperity, financed eventually by hyper-taxation, hyper-debt and hyper-inflation accompanied by a gradually eroded standard of living. The jobs created by the Bill are by and large non-productive, and will divert resources from the private sector and rob consumers of their power to make free choices in the marketplace. America's infrastructure is in great need of restoration. By some estimates, for every $1 billion spent on infrastructure, some 35,000 real, wealth-creating jobs are born in the private sphere.
For 'just' $100 billion, 3.5 million jobs would result. Furthermore, this middle-way of Obama's likely would have commanded much greater bi-partisan support than the lonely Republican trio which attached their names to Pelosi's bill. Unfortunately for American and international investors, Speaker Pelosi pressured the President into the worst of all plans. It will likely bring on a economic catastrophe, characterized by depression followed by hyper-stagflation and civil unrest. Pelosi's power-play may buy her political status, but the entire world will pay the price.
Bank Failures May Reach 1,000 on Bad Loans, RBC Says
As many as 1,000 U.S. banks may fail in the next three to five years, almost double the one-year tally at the height of the saving-and-loan collapse, as losses mount on commercial real-estate loans, RBC Capital Markets analysts said. Most of the failures will probably occur at banks with less than $2 billion in assets as their commercial customers default, said Gerard Cassidy, an analyst at RBC, in an interview today. "There are billions of dollars of losses embedded in the system, and the system has to flush them out," Cassidy said. "The people that are going to take the losses are the taxpayers and bank stockholders, and if regulators say there won’t be much loss to taxpayers, they will be lying."
Regulators are taking steps to help lenders avoid losses as President Barack Obama’s administration readies a rescue package that may include guarantees for toxic assets, according to people familiar with the plan. The Federal Deposit Insurance Corp. closed nine banks so far this year after shutting 25 in 2008 and identified 171 "problem" institutions as of the third quarter. The FDIC has already raised the estimate for the cost of U.S. bank failures through 2013 after fourth-quarter financial reports from banks signaled possible additional losses to the deposit insurance fund. The agency said failures through 2013 may cost more than the $40 billion estimated in October. The U.S. seized 534 lenders in 1989, including 327 saving- and-loan associations, during the peak of a crisis among thrift institutions, FDIC data showed.
The FDIC on Dec. 16 doubled premiums it charges banks to replenish its reserves, which totaled $34.6 billion as of the third quarter. The agency and Congress are taking steps to offer safeguards for the banking industry, including more than tripling the FDIC’s borrowing authority from the Treasury Department, to $100 billion, to support consumers against bank failures. "The sooner the bank regulators can shut down the troubled banks, the faster the industry will get back on its feet," Cassidy said in the report. "We are nowhere near the end of this down leg in the current credit cycle." Cassidy had previously said as many as 300 banks would fail in the next three years. RBC bases its estimates on discussions with industry experts and by calculating the loans for which banks aren’t receiving interest as a percentage of tangible capital and reserves for losses, Cassidy said.
RBC calls it the "Texas ratio" because it was crafted during the state’s 1980s bank crisis. RBS said lenders that exceed 100 percent are at risk of collapse. While the RBC benchmark tops 100 percent for dozens of small U.S. banks, RBC Centura’s research shows two of the 50 largest banks have Texas ratios in excess of 50 percent. Sterling Financial Corp. of Spokane, Washington, is 54 percent, and Colonial BancGroup Inc. of Montgomery, Alabama, is 53.4 percent, RBC said. Sterling in December sold preferred shares to raise $303 million from the U.S. Troubled Assets Relief Program and ended 2008 with liquidity that topped $3 billion, Chief Executive Officer Harold Gilkey said on Jan. 28. Colonial is negotiating with several investors to raise $300 million to qualify for $550 million from the Treasury’s program, CEO Robert Lowder said on Jan. 27.
Bank of America Corp., the largest U.S. bank, has a Texas ratio of 21.6 percent, compared with No. 2 JPMorgan Chase & Co.’s 5.6 percent and No. 3 Citigroup Inc.’s 18.4 percent. The U.S. is backing $301 billion of Citigroup securities and $118 billion at Bank of America, and injected $45 billion into each lender. "Many of Bank of America and Citigroup’s problems stem from securities portfolios that have run into trouble when they are marked to market," Cassidy said. "The commercial credit problems of the big banks are just beginning and we expect the ratio to rise steadily this year." Banks charged off $3.9 billion of real-estate construction and development loans in the third quarter, a more than eightfold increase from a year earlier, according to the FDIC. The agency hasn’t reported data from the fourth quarter.
Some Banks Want to Return Government Money
Wall Street banks have taken billions of taxpayer dollars. Now some of them are starting to wonder if they should give the money back. Even before the government announced its latest efforts to fix the troubled banking industry on Tuesday, executives at Goldman Sachs and Morgan Stanley said they wanted to repay the money quickly. Both banks received $10 billion under the first rescue plan last fall. Paying back all those funds would be difficult in this tough economic environment. But banking executives worry that the government may intrude further into their businesses as long as they are beholden to Washington.
"We just think that operating our business without the government capital would be an easier thing to do," said David A. Viniar, the chief financial officer of Goldman. "We’d be under less scrutiny, and under less pressure. Not that we’d be out of the public eye; we’re still going to be in the public eye." The issue is likely to draw close scrutiny on Wednesday, when executives from eight banks are scheduled to testify on Capitol Hill. The efforts to break free of government support reflects a growing trepidation among Wall Street’s largest players about their independence and the new rules that may be imposed on them because they accepted federal capital.
In recent weeks, the Obama administration has announced that banks will have to disclose more information about their spending and cap executive pay at $500,000. Several lawmakers have gone further with proposed measures about compensation for all bank employees as well as halting certain types of immigration visas for companies that received government money. Industry groups say the new rules are unfair. "The contract says that Congress can change the law, and we were obviously concerned," said Scott Talbott, senior vice president for government affairs for the Financial Services Roundtable. "But we didn’t think they would tip the scales this far. The more of these retroactive rules they place on institutions, the more institutions will look for an exit strategy."
But the banks are likely to find that escape is a distant hope, analysts said. The government required banks to replace taxpayer money with new equity — in the form of common stock or preferred shares — before any repayment. And the markets for raising capital are all but dead, especially for financial companies. Banks are not allowed to repay the government money out of their earnings for three years, though some bank executives are privately saying they think the government may reverse that rule for banks if they start earning money again. After all, bank executives said, it may be beneficial for the government to show taxpayers that some banks are regaining their financial strength.
Still, it is unclear that it would make sense for banks to repay the government money, given the uncertain outlook for their businesses, analysts said. One chief executive of a major bank said last week that he feared returning the money first would leave his bank as "the only one in the water without shark repellent." And, in a market of quickly shifting fortunes, any bank that returned capital could find itself in need again months later. Bank of America, for instance, was among the companies that appeared to be in a stronger position last fall when regulators met with chiefs of the eight banks. But at the end of the year, as the outlook for its merger with Merrill Lynch soured, the bank returned to the government for a second round of assistance. Citigroup has also received a second bailout.
And government funds are cheap with interest payments of only 5 percent and a few percentage points more for related warrants. Banks are unlikely to find other parties that would offer them such low rates, analysts said. "I don’t think anyone should be in a hurry to pay it back," said Jeffery Harte, a banking analyst at Sandler O’Neil. "But if you could prove able to pay it back, especially when other institutions are coming back for a second or third helping, it would send a pretty strong message to the market."
Many banks have also issued new debt in recent months backed by the government. The program, run by the Federal Deposit Insurance Corporation, has received far less attention than the capital injections, but it represents another subsidy to banks, which otherwise would have found issuing debt more expensive, or impossible. Banks that repay taxpayer money may still be beholden to the government if they issued these government-backed bonds.
Bernanke Begins ‘Thorough Review’ of Fed Disclosure
Federal Reserve Chairman Ben S. Bernanke initiated a review of the information it provides the public after lawmakers criticized the central bank’s disclosure policies during the unprecedented expansion of its holdings. "We at the Fed have begun a thorough review of our disclosure policies and the effectiveness of our communication," Bernanke said today in remarks prepared for testimony before the House Financial Services Committee. Board Vice Chairman Donald Kohn will lead a panel for the review.
Bernanke has invoked emergency authority and more than doubled the size of the Fed’s balance sheet to $1.8 trillion to combat the worst credit crisis in seven decades. His moves have prompted concern that the central bank is encouraging excessive risk-taking, distorting pricing in financial markets and jeopardizing the Fed’s independence. The Fed hasn’t disclosed many of the assets and participants in its programs. "It does not seem to me healthy in our democracy for the amount of power that is now lodged in the Federal Reserve with very few restrictions to continue," said Representative Barney Frank, a Democrat from Massachusetts and the committee chairman.
Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure. The Kohn panel will have a "presumption" that the public has a right to know and that "nondisclosure of information must be affirmatively justified by clearly articulated criteria for confidentiality," Bernanke said. Bernanke also said the Fed is preparing a Web site where the public can find more details and analysis about the Fed lending effort. He defended the programs, saying they helped restore liquidity and buffer risk during a severe credit crisis. "Our lending to financial institutions, together with actions taken by other agencies, has helped relax the severe liquidity strains experienced by many firms and has been associated with considerable improvements in interbank lending markets," Bernanke said.
Policy makers cut the benchmark lending rate to as low as zero in December and are now focusing on expanding emergency credit programs to reduce borrowing costs. The Fed said today that it may expand a program aimed at supporting consumer loans to $1 trillion from $200 billion. Separately, the Fed is buying $600 billion of debt sold by government-backed mortgage finance companies and mortgage-backed securities they guarantee. Under section 13.3 of the Federal Reserve Act, the Federal Reserve Board "in unusual and exigent circumstances" can authorize lending by reserve banks to individuals, partnerships and corporations that are unable to obtain "adequate credit."
Bernanke, 55, and the Fed governors used the authority for the first time since the Great Depression last March in a $13 billion emergency loan to Bear Stearns Cos., which faced a run by creditors. Since then, Bernanke has broadened the use of emergency powers to support financial institutions and entire markets. The use of emergency powers to support markets "is well justified in light of the breakdowns of these critical markets and the serious implications of those breakdowns for the health of the broader economy," Bernanke said. He said the use of emergency powers to support institutions "might not have been necessary" if the U.S. had a system in place for the resolution of failing investment banks and financial firms other than banks. "The Federal Reserve believes that the development of a robust resolution regime should be a top legislative priority," Bernanke said.
The Fed chairman started the Primary Dealer Credit Facility, a direct loan program for government bond dealers, and the Commercial Paper Funding Facility, which now finances $258 billion in short-term notes issued by corporations. The Fed said today that its latest program, known as the Term Asset-Backed Securities Loan Facility, could expand to as much as $1 trillion and include additional assets such as commercial and private label residential mortgage-backed securities and bonds backed by student loans, credit cards debts, auto loans, and small business loans. The central bank’s holdings have surged over the past year by $979 billion. Some reserve bank presidents have argued for a more impartial approach to credit markets. Richmond Fed President Jeffrey Lacker, 53, dissented against the central bank’s credit programs last month, preferring the injection of money into the economy through purchases of Treasuries.
The Fed should be "neutral in its effects across different credit markets" rather than favoring specific credits, such as consumer loans, Lacker said in a Feb. 1 press conference. Kansas City Fed President Thomas Hoenig, 62, said Jan. 7 the central bank "must design an exit strategy" that allows the Fed to withdraw as a bank of last resort to the economy. "Government must think carefully about the incentives that are created by its efforts to restore both confidence and the financial strength of these institutions so as not to exacerbate moral hazard or to engender undesirable outcomes down the road," Philadelphia Fed President Charles Plosser said in an interview last week. The Fed’s actions have helped stabilize the financial system, pushing interbank borrowing rates closer to the federal funds rate as risk aversion dissipated.
The yield difference between the London interbank offered rate, or Libor, that banks say they charge each other for three-month loans in dollars, and the benchmark federal funds rate stood at 1 percentage point today. The spread widened to 4 percentage points on Oct. 10. "We believe that the aggressive liquidity provision by the Fed and other central banks has contributed to the recent declines in Libor," Bernanke said. The dramatic expansion of Fed credit hasn’t prevented a severe contraction in growth. The U.S. unemployment rate rose to 7.6 percent last month, the highest level since 1992, as companies shed 598,000 jobs. Losses spanned almost all industries from trucking and construction, to retailing and finance. U.S. gross domestic product will contract 1.5 percent this year, according to the median estimate of economists surveyed by Bloomberg News.
Merrill secretly moved up bonus payments: Cuomo
Merrill Lynch secretly accelerated bonus payments and gave at least $1 million to each of nearly 700 employees as the brokerage was amassing billions of dollars of losses, New York Attorney General Andrew Cuomo said in a letter to Rep. Barney Frank. Cuomo's letter comes as Frank's House of Representatives Financial Services Committee on Wednesday gets set to grill executives from eight banks that received $125 billion from the Treasury last fall. Among the chief executives answering questions on how they spent the taxpayer money will be Ken Lewis of Bank of America Corp, which acquired Merrill Lynch last month.
Merrill executives have drawn fire because they paid 2008 performance bonuses in December, earlier than usual and despite the fact that Merrill had losses of $15.3 billion in the fourth quarter. Bank of America initially received $25 billion from the Treasury and later was forced to seek $20 million more, plus $188 billion in asset guarantees. Cuomo, who began questioning Wall Street banks about their 2008 bonus plans in October, said in the letter to Frank that Merrill may have taken steps to pay lavish bonuses so that taxpayers would foot the bill. "It appears that instead of disclosing their bonus plans in a transparent way as requested by my office, Merrill Lynch secretly moved up the planned date to allocate bonuses and then richly rewarded their failed executives," Cuomo wrote. A copy of the letter was obtained by Reuters.
Merrill, with Bank of America's knowledge, paid $3.6 billion in bonuses for 2008. That's an average of $91,000 per employee, Cuomo said, but the lion's share went to a select group. The top four recipients received a combined $121 million; the next four received a combined $62 million; and the next six received a combined $66 million, according to Cuomo. The top 149 executives received a total of $858 million, and 696 received at least $1 million each, he wrote. "These payments and their curious timing raise serious questions as to whether the Merrill Lynch and Bank of America boards of directors were derelict in their duties and violated their fiduciary obligations," Cuomo said. Former Merrill CEO John Thain, after initially seeking a bonus for arranging the deal with Bank of America that saved his company from collapse, ultimately declined to receive a year-end payment. Officials from Bank of America were not immediately available for comment. Cuomo's office confirmed the existence of the letter but declined further comment.
Top Four Merrill Bonus Recipients Got $121 Million
Merrill Lynch & Co.’s top four bonus recipients received a combined $121 million just before the firm was acquired by Bank of America Corp., according to New York Attorney General Andrew Cuomo. In all, Merrill "secretly and prematurely" awarded $3.6 billion in bonuses, with Bank of America’s "apparent complicity," Cuomo said in a Feb. 10 letter to Representative Barney Frank, the Massachusetts Democrat who heads the House Committee on Financial Services. The letter was made public today as chief executives from the eight largest U.S. banks face off against lawmakers at a committee hearing in Washington.
Cuomo, a Democrat, has been examining whether Merrill broke securities laws when it paid the bonuses. He also is cooperating with Special Inspector General Neil Barofsky in a federal probe of executive pay at banks that got money from the U.S. Treasury’s Troubled Assets Relief Program. "One disturbing question that must be answered is whether Merrill Lynch and Bank of America timed the bonuses in such a way as to force taxpayers to pay for them through the deal funding," Cuomo said in the letter. Cuomo, who has subpoenaed the testimony of former Merrill Lynch Chief Executive Officer John Thain and Bank of America Chief Administrative Officer J. Steele Alphin, said in the letter he would require top officials to answer the question. He said he plans to seek the testimony of other top executives at the firms.
Cuomo said the $3.6 billion in bonuses were distributed to "a small number of individuals." He said Merrill "chose to make millionaires out of a select group of 700 employees," and that an even smaller group was awarded "gigantic bonuses." After the top four recipients received $121 million, the next four received a combined $62 million, he said, and the next six a combined $66 million. He didn’t identify the recipients. Overall, the top 149 people who got bonuses received a combined $858 million, according to Cuomo’s letter, and 696 people got bonuses of $1 million or more. Merrill Lynch was an independent company last year, Scott Silvestri, a spokesman for the combined company, said in an e- mailed statement. Merrill management proposed and its compensation committee approved incentives, according to the statement.
"Bank of America did urge the bonuses be reduced, including those at the high end," Silvestri said in the statement. "Although we had a right of consultation, it was their ultimate decision to make. In addition, a substantial amount of the Merrill bonuses were contractually guaranteed." Bank of America said its top eight senior executives took no "incentive compensation" in 2008. At the next level, the annual incentive pool was reduced by 80 percent, it said. Cuomo said he is probing whether the bonus payments violated New York’s debtor-creditor laws and whether the lack of disclosure violated the state’s Martin Act, New York’s principal securities law. He also said the payments and their timing raised questions about whether the firms’ senior officials and boards of directors violated their fiduciary obligations.
Cuomo said Merrill and Bank of America must have been aware in December that fourth-quarter and yearly earnings results were "disastrous." Merrill reported Jan. 16 that it lost $15.31 billion in the fourth quarter alone and $27 billion for the year. Asked about Cuomo’s letter that said Merrill secretly and prematurely moved up the bonuses, apparently with Bank of America’s complicity, Frank said this morning on CNBC that Bank of America CEO Kenneth D. Lewis will be at today’s committee hearing, and "obviously we will expect him to address this." "I am very disappointed in what we learned about Merrill," said Frank, who hadn’t yet seen the letter. "I think Mr. Thain caused a lot of damage to the climate in which we’re trying to operate." The Merrill bonuses were reported earlier today in the New York Daily News.
JPMorgan Cuts Unused Credit as Banks Free Up Capital
JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp., the three biggest U.S. lenders, are among banks cutting back on $1.6 trillion of credit lines as they face increased demand for loans that threaten to drain capital. Banks negotiated with retailers Rite Aid Corp. and Ethan Allen Interiors Inc., and with homebuilder Ryland Group Inc., in the past month to reduce credit limits and raise interest rates. After more than $1 trillion of writedowns and credit losses, lenders are moving to lessen the chance that troubled companies will withdraw funds.
While President Barack Obama demands they extend more credit, banks are reluctant to do so until they know how much they’ll need to back with more funds, according to a Jan. 23 Citigroup research report. Companies may need to issue $450 billion of bonds to replace loans that won’t be renewed when they mature in the U.S. and Europe this year, the bank said. "For those companies unable to get credit, it’s economic Darwinism," said Josh Rosner, a managing director at Graham Fisher & Co. In early 2007, he predicted mortgage bonds would spark a global financial crisis. "It’s a tightening of credit to rational standards."
New York-based JPMorgan and Citigroup are among lenders scaling back Rite Aid’s $650 million bank line by $200 million after the company tried to extend it last month. That prompted the Camp Hill, Pennsylvania-based drugstore chain to obtain a new $225 million term loan arranged by Citigroup with annual interest payments of 15 percent, Kimberly Noland, an analyst at Gimme Credit LLC in New York, wrote in a report on Feb. 4. The old loan paid 1.25 percentage points more than the London interbank offered rate, a lending benchmark, according to a regulatory filing on Jan. 23. Karen Rugen, a Rite Aid spokeswoman, declined to comment beyond the filing. Banks can only shrink credit lines when a loan matures or a company needs to amend an agreement to avoid breaking the terms, unless the company volunteers.
Over the past three months, 65 percent of domestic banks tightened standards on loans to large and mid-sized firms, the Federal Reserve said Feb. 2. U.S. lenders raised spreads on loans over their funding costs about 90 percent of the time, it said. Syndicated lending, where banks form a group to share the risk of dealing with a borrower, totals $11.8 billion this year in the U.S., compared with $132 billion in the same period in 2007, according to data compiled by Bloomberg. This year marked the slowest start in the U.S. since 1999, when Bloomberg records began.
Charlotte, North Carolina-based Bank of America had $385 billion in lending commitments that hadn’t been borrowed as of Sept. 30, and JPMorgan had $248 billion, according to regulatory filings. Citigroup had $401 billion of so-called unfunded commitments to corporations and consumers, not including credit cards, according to a filing. The three banks were part of a group that arranged a five- year, $1.1 billion credit line for Calabasas, California-based Ryland in 2006. After reducing the loan as new home sales fell to a 17-year low, lenders last month cut the line by $350 million more to $200 million in exchange for changing net worth and debt requirements, Ryland said in a Jan. 27 regulatory filing. "It’s give and take," said Drew Mackintosh, Ryland’s vice president for investor relations. "We wanted more room on the net-worth covenant and don’t necessarily need the capital right now."
JPMorgan decreased its share of the loan to $26.6 million from $73.3 million, and Bank of America’s declined $30.9 million to $17.6 million, according to the filing. Lenders led by JPMorgan cut Ethan Allen’s credit line in half to $100 million in exchange for relaxed terms on debt-to- earnings ratios. "We made the decision to reduce the amount of the line of credit because we have not drawn on it except to support letters of credit since its inception," Ethan Allen Chairman Farooq Kathwari said in an e-mailed statement. "The reduced amount is appropriate." "We continue to support our existing business lending relationships throughout the corporate, middle market, and business banking segments," Bank of America said in an e-mailed statement. "Similarly, we continue to provide credit capital to prospective clients who meet our client selection criteria." Revolving credit lines allow companies to borrow and pay back money whenever they need it.
"Banks are asking companies, ‘Do you really need $50 million in unused revolver capacity?’" said Randy Schwimmer, managing director and head of capital markets at New York-based Churchill Financial Group LLC, a lender to mid-sized businesses. In Europe, companies are paying higher fees to lock in bank loans years before their current agreements expire, following a 45 percent decline in syndicated loans last year. Customers are proposing that banks agree to provide a new credit line when outstanding loans mature, offering one-time payments, higher fees and increased interest rates. Obama will require banks to use government support to spur lending, Treasury Secretary Timothy Geithner said today in a speech announcing the administration’s rescue plan in Washington. That comes in response to congressional criticism that firms accepting funds from the first $350 billion installment failed to pass on the aid.
Citigroup will use $1.5 billion of government funds to invest in commercial loan securitizations and promote lending, according to a draft of testimony Chief Executive Officer Vikram Pandit plans to deliver tomorrow at a hearing before the U.S. House of Representatives Committee on Financial Services. The bank led lenders on $22 billion in U.S. syndicated loans in the fourth quarter of 2008, Pandit said in the draft. Cutting credit lines may free up capital that banks set aside to cover potential borrowing and allow them to make new loans. It also lowers the risk that struggling companies will take advantage of backup revolving lines of credit at rates agreed to before the credit crisis began in August 2007. General Motors Corp. and Ford Motor Co. led companies in drawing on at least $37 billion of the loans in the past year, according to Bloomberg data.
On Jan. 29, Dearborn, Michigan-based Ford borrowed $10.1 billion from a revolving credit line with an interest rate 2.25 percentage points above Libor -- set today at 1.22 percent. That compares with the 10.6 percentage-point spread on the average high-risk, high-yield loan, according to Standard & Poor’s LCD. Yields on so-called leveraged loans have climbed from 3.94 percentage points more than Libor since the start of last year. Textron Inc., the maker of Cessna planes and Bell helicopters, drew down on $3 billion of credit lines last week because there wasn’t enough demand for its debt in the commercial-paper market, Doug Wilburne, vice president of investor relations, said at the Cowen & Co. Aerospace and Defense conference in New York on Feb. 5. He said the Providence, Rhode Island-based aircraft-maker is now paying 0.41 percentage point more than Libor, which amounts to $49 million annually on the loans.
At the same time, banks seeking to protect that amount of Textron’s debt from default using derivatives would pay an upfront fee of $855 million and $150 million annually, according to Credit Derivatives Research LLC in Walnut Creek, California. Lower spreads on loans arranged before the credit crisis are limiting bank earnings, said David Goldman, the former head of fixed-income research at Bank of America and now a private investor. The net interest margin, which measures lending profitability, fell in 2008 to the lowest since records began in 1984, according to the Fed Bank of St. Louis. In the recessions of 1991 and 2001, the margin climbed as the central bank cut its target lending rate, Fed data show.
"For the banks, this is unlike all other recessions because it hasn’t shown any relief in terms of net interest margin," Goldman said. "The poor performance of net interest margin, which is a critical measure of bank profitability, is a stern warning to the banks that they have to take a much more old-fashioned approach to lending." Companies paid an average of 8 to 10 basis points for access to untapped credit lines, Goldman said in an October report written for research firm Laffer Associates. A basis point is 0.01 percentage point. "They gave away these revolving credit deals like party favors," Goldman said. "They should be changing those deals. If banks have to lend money at their own cost of funds, we’ll never get out of this mess."
Selling AIG to Scarce Buyers Is Mission Impossible
Paula Rosput Reynolds was arranging knickknacks in her Seattle home last September when the phone rang. Edward Liddy, who had just been appointed chief executive officer of American International Group Inc., was on the line. "I wish you’d come talk to me," Liddy told her. "I really need the help." Today, Reynolds, 52, is AIG’s chief restructuring officer and U.S. taxpayers’ best hope for recovering some of the $150 billion the government pumped into the company last fall in the biggest corporate bailout ever.
Charged with dismantling as much as two-thirds of what was once the world’s largest insurer, she’s running simultaneous auctions of dozens of units around the world, including insurance companies, consumer lenders, asset managers and an aircraft-leasing business. AIG couldn’t have picked a worse time to be a seller. Most potential buyers are hobbled by the global credit crisis, and those that aren’t would rather conserve capital than gamble it on a big acquisition. The KBW Insurance Index has dropped 31 percent since the restructuring plan was announced on Oct. 3. "They have a daunting task in trying to sell insurance companies into a market where there are no buyers," said Gary Ransom, a Hartford, Connecticut-based analyst at Fox-Pitt Kelton Cochran Caronia Waller. "It’s not at all clear what they can do."
Reynolds has shepherded her share of companies through what she refers to as "cathartic" moments: retooling a natural gas distributor facing deregulation, helping guide Delta Air Lines Inc. through bankruptcy and selling off her most recent employer, Safeco Corp., an auto insurer squeezed by competitors. Liddy’s call promised a challenge on a different scale. With more than $1 trillion in assets, 116,000 employees and hundreds of subsidiaries and operations in 130 countries, AIG may prove to be the biggest restructuring job ever attempted. "For somebody who has been a casual user, this is like starting to mainline a drug," Reynolds said in an interview on Jan. 28, sitting in an 18th-floor corner office in New York that she hasn’t bothered to redecorate.
The stakes are high. Wrong-way bets on credit-default swaps pushed AIG to the brink of collapse last year. The government, fearing a failure would wreak havoc with the world’s financial system, propped up the insurer with aid, including a $60 billion loan facility and a $40 billion preferred-equity investment. It now controls about 80 percent of the voting shares. Liddy, 63, the former chairman and CEO of Allstate Corp., has pledged to repay "every penny" to the government. Since joining the company in November, Reynolds has sold just $2.3 billion of units, including businesses in Canada, the Philippines and Brazil. The biggest chunks, including life insurers from Hong Kong to Houston, have yet to find buyers.
"You come in here every day, and it seems impossible, because there are so many constraints," Reynolds said. "And yet at the end of the day, for the good of the country, the world, the institution, you’ve got to make some decisions to move things along." Reynolds, who hails from Newport, Rhode Island, started her career at a Massachusetts consulting firm after majoring in economics at Wellesley College. She took executive positions at several utility companies and ran a unit of AGL Resources Inc. before ascending to AGL’s top spot in 2000. AGL, the former Atlanta Gas Light Co., was a Georgia gas distributor whose traditional business was being eroded by deregulation.
Broadening AGL’s reach, Reynolds was behind the push to add gas pipelines from New Jersey to Florida, and start units that traded energy and ran fiber-optic networks. Shareholders got an 18 percent annualized return during her five years there, beating the Standard & Poor’s Midcap Gas Utilities Index by 2 percentage points. The Atlanta connection led Reynolds to the board of Delta, another experience she says prepared her for AIG. She joined in 2004 and remained through Delta’s bankruptcy filing the following year. The airline cut jobs and pay, and shed redundant aircraft before emerging and buying Northwest Airlines Corp. last year to form the world’s largest airline by passenger miles. Reynolds also sits on the board of Anadarko Petroleum Corp. and was once a director of Circuit City Stores Inc.
In 2004, she married Stephen Reynolds, CEO of Puget Energy Inc. in Bellevue, Washington. When a job running Safeco, a Seattle auto insurer, came open the following year, she seized the chance to move closer to her husband. Reynolds had no experience in insurance, and equity analysts were skeptical she could adapt quickly enough. Meyer Shields, a Baltimore-based analyst at Stifel Nicolaus & Co., said in a June 2007 research note that Safeco’s management team was still on "the early stages of the learning curve." Safeco’s biggest challenge was contending with a wave of price competition that was lowering profit margins on the auto policies it sold. By mid-2007, Reynolds says she and her board were worried that the contraction in global credit markets would multiply their problems.
So when Edmund "Ted" Kelly, CEO of Boston-based Liberty Mutual Group Inc., called Reynolds that November to talk about a business combination, she was ready to listen. By March 2008, Reynolds was juggling negotiations with three other suitors and had elicited a $5.8 billion cash offer from Kelly. Then her bankers at Morgan Stanley called Hartford Financial Services Group Inc., according to a filing with the U.S. Securities and Exchange Commission that gives an account of the negotiations. Safeco identified Hartford Financial in the filing as "Party D." Three people knowledgeable about the sales process and unaffiliated with Reynolds, who spoke on condition of anonymity, say Party D was Hartford Financial.
Ramani Ayer, Hartford Financial’s CEO, indicated he could match or even beat Kelly’s offer, and Reynolds dove into exclusive talks. The Hartford-based insurer spent more than a week poring over Safeco’s books and got as far as trading drafts of a merger agreement. When Ayer refused to raise his offer above $6.1 billion, Reynolds went back to Kelly. Reynolds says she calculated that her original suitor was in the best position to see the deal through in a worsening economic climate. Safeco reached an agreement to sell itself to Liberty Mutual last April for $6.2 billion in cash. In the two and a half years that Reynolds ran Safeco, the stock rose at an annualized rate of 8.9 percent, compared with the 7.6 percent decline of the KBW Insurance Index. Her bearish bet on the insurance business was vindicated in the month following the sale, when the index dropped 32 percent.
"Her peers felt she never really grasped the complexity of insurance and didn’t add any value to the business," said Brian Sullivan, editor of Auto Insurance Report, an industry newsletter. "That said, she sold it at a really nice premium, and then the world came to an end." "In retrospect it was sensational," said Robert Cline, a Safeco board member and former CEO of Airborne Inc. in Seattle. Reynolds didn’t stay unemployed for long. Two or three days after she came home from her Safeco office for the last time, she got the call from Liddy, who had just been appointed to run AIG by the Federal Reserve. Her post probably won’t be as lucrative as her work at Safeco, where she made $6 million in 2007 and became eligible for $17.6 million in severance after the sale to Liberty Mutual.
At AIG, Reynolds was paid nothing for her work in 2008 and will collect an undisclosed salary this year, along with a bonus that depends on her success in selling units. She’s commuting from Seattle to New York. "Society has the right to demand a little retribution for the enormous toll that has been exacted on the economy by a lot of these actions that have taken place in financial services," she said. Reynolds said she may not stick around at AIG "till the job is done." She said she wants to establish a clear plan for the mammoth restructuring and to show progress before leaving. "What we’ve done, on a 100-yard field, we’ve only come about three yards so far," she said. "We’ve still got 97 yards to go."
Europeans Fear Wave of Protectionism
With anger mounting over a French plan to bail out its domestic automobile industry and protectionist comments made by President Nicolas Sarkozy, European leaders are calling for a discussion on the perils of protectionism at an upcoming special summit. European leaders fear a new wave of protectionism is starting to sweep across the continent, and that an every-man-for-himself attitude will prevail as countries move to approve massive economic stimulus packages. The worries were triggered by news of a French plan to bail out its automobile industry to the tune of billions of euros and recent protectionist remarks made by President Nicolas Sarkozy.
On Tuesday in Brussels, the Czech Republic, which currently holds the six-month rotating presidency of the European Union, said it would call on EU member states to address the issue at a special summit in February. Czech Finance Minister Miroslav Kalousek called on EU leaders to send "a clear no to protectionism" and to coordinate their economic stimulus programs. Meanwhile, Czech Prime Minister Mirek Topolanek warned of a "specter of protectionism" that could prolong and intensify the global economic downturn. And Germany Finance Minister Peer Steinbrück of the center-left Social Democrats said he was concerned about what he described as latent protectionism within the EU, and called on leaders to "speak openly" about the issue. Germany's new economy minister, Karl-Theodor zu Guttenberg, said he viewed French moves to prop up the country's automobile industry skeptically.
"The move made by the French yesterday must be measured by the definition of protectionism," he said. His comments came after the French said they would move to provide government-backed, five-year loans at favorable interest rates to Renault and PSA Peugeot Citroen of €6 billion ($7.8 billion) each as well as €500 million for Renault Truck. Auto industry banks which provide consumer loans used to purchase cars were also expected to be given €2 billion in state aid. In exchange, the carmakers have provided guarantees that they will not close any plants in France and that they will seek to do everything in their power to avoid cutting French jobs. The car manufacturers justified their decision to take government money by stating that they were unable to obtain loans from banks. Christian Streiff, CEO of PSA Peugeot Citroen, had threatened to suspend his company's research and development investments. "I now hope that the state loan will help us to secure further bank loans," he told reporters. Politicians in Germany have roundly criticized the French plans.
Norbert Röttgen, a senior politician with Chancellor Angela Merkel's conservative Christian Democrats (CDU), said his party's parliamentary group opposed any form of protectionism, adding that Germany is a country that believes in free trade. That's also Merkel's officially stated position. The government has noted that a successful part of the German government's economic stimulus package -- the so-called Abwrackprämie, or car trade-in provision, which provides a bonus to German car buyers who trade-in their old cars as they buy new ones -- also promotes the purchase of foreign-built automobiles. Outside Germany, other EU member states also criticized the move. British Finance Minister Alistair Darling said EU member states should be concerned about any forms of protectionism, whether intentional or not.
A spokesperson for EU Competition Commissioner Neelie Kroes, said the politician was "worried" about reports on the deal. "If the aid was linked to conditions to keep production at home, then it would be illegal and will not be approved by us," spokesman Jonathan Todd told journalists. Kroes' office has said it will decide as quickly as possible on the package and that it has written to French government officials for further information. "We want to know all the details," Todd said. The French first presented their car plan to EU finance ministers on Monday evening, claiming it wasn't intended as a protectionist measure -- a view that many ministers disputed. Czech government officials have been particularly critical of Sarkozy following statements about production in the Eastern European country made during an interview on French television last week.
"It is justifiable if a Renault factory is built in India so that Renault cars may be sold to the Indians," Sarkozy said. "But it is not justifiable if a factory of a certain producer, without citing anyone, is built in the Czech Republic and its cars are sold in France." His comments were an indirect reference to PSA Peugeot Citroen, which has a plant in the Czech city of Kolin. Sarkozy is seeking to keep car manufacturing at home in France and he has said that companies receiving state aid should think about moving their plants back home. Despite this pressure from Paris, however, the company has said it will continue to manufacture vehicles in the Czech Republic. For its part, the EU has warned that if the payments include provisions "like the obligation to keep production centers in France" or if they would require manufacturers to only buy French products or invest only in France, then they would clearly violate EU law.
Bank of England Governor Mervyn King says UK economy is in 'deep' recession
The Bank of England Governor Mervyn King has warned that the UK is in 'deep' recession and delivered its clearest signal that it will move beyond cutting interest rates to help revive the economy. The risks to the economy remain "heavily weighted to the downside," the Bank of England said today in is its gloomiest assessment so far. The speed of deterioration is accelerating, the Bank said in its latest Quarterly Inflation Report, and the economy may shrink by 4pc by the middle of thus year. Inflation will drop to 0.5pc at the end of next year, it added. Governor King also gave a sharp signal that interest rates are heading below 1pc as the Bank steps up efforts to prevent what's already the deepest recession since the early 1980s turning into something worse. The news drove sterling lower against the dollar. The report provides "strong support for our view that rates are heading to zero or very close," said Jonathan Loynes, an economist at the Capital Economics.
Today's assessment of the economy comes as the barrage of bad news from most parts of the UK economy continues. Official figures released last month showed the UK economy shrank by 1.5pc in the last three months of the year. Figures released earlier today showed unemployment reached nearly two million, its highest level for almost 12 years. Governor King and the rest of the Monetary Policy Committee have so far reacted to the downturn by aggressively cutting interest rates, the speed of which increased after the collapse of Lehman Brothers in October deepened the crisis and its fall-out on the wider economy. The Bank today also signaled it will take measures to inject more money into the economy as earlier moves to make money cheaper become redundant. These measures include buying assets such as corporate and Government bonds.
Bank prepares to deploy ‘quantitive easing’
Mervyn King on Wednesday said the Bank of England could begin so-called "quantitive easing" as soon as next month, as he warned that the UK economy was in deep recession. He was speaking as the Bank unveiled its latest inflation report that suggested inflation will fall to 0.5 per cent and may remain well below the Bank’s 2 per cent target for much of 2010 and 2011. In order to get more money flowing in the economy as interest rates approach zero, Mr King said he was preparing to deploy quantative easing - creating money to buy assets. He said that interest rates would not have to fall to zero before starting quantitive easing, signalling that the Bank’s monetary policy committee could vote for such a move at its next monthly meeting. It also suggests that such unconventional measures could begin with gilt purchases. Quantitive easing is aimed at increasing the money supply, getting banks to lend more, lowering interest rates and raising the level of inflation. Mr King warned that the risks to economic growth lay "heavily to the downside". The Bank expects GDP to decline until the final quarter of this year, hitting a low of minus 4 per cent in the second quarter compared with the year before.
This is much worse than the Bank’s last forecast in November, which foresaw a maximum year-on-year GDP drop of 1.9 per cent in 2009. The pound extended its losses on Wednesday after the release of the Bank’s latest warning on the UK economy. Expectations that the Bank would embark on a policy of quantitative monetary easing undermined sterling. The pound fell 1 per cent to $1.4385 against the dollar, lost 1.2 per cent to £0.8987 against the euro and fell 1.6 per cent to Y129.36 against the yen. "Mr King is talking about turning on the printing press, which would effectively de-base the value of the pound," said Paul Mackel at HSBC. "On the back of Mr King’s comments the path of least resistance is for sterling to weaken." The inflation report also reflected a dismal outlook for the economy. The Bank forecasts that the decline in GDP this year will be amplified as companies run down stocks rather than make new orders as they fall short of working capital and their business prospects weaken. But it expects that companies will then ease their rate of destocking and begin to rebuild them, increasing output again.
At the lowest end of its forecast, the Bank said there was a chance that GDP could fall by as much as 6 per cent in the second quarter compared with the year before. The Bank also spelled out its views on monetary policy as interest rates approach zero. It said that cuts in the Bank rate so far – from 4.75 per cent to 1 per cent since late 2008 – had fed through to consumers and businesses with longer term variable rate loans. But it said that the transmission of lower interest rates to lending had been severely disrupted by the financial crisis, with interest rates for new lending to households tending to drop by much less than the fall in the bank rate. "The net effect of these factors has blunted the impact of reductions in bank rate," the report says. In order to supplement normal interest rate policy, the Bank has been granted powers to use its asset purchase facility to buy up high-quality corporate debt to ease credit. However, the Bank outlined its concerns about creating money, saying that there was a risk that banks would choose to hoard the funds rather than expand the supply of credit – as happened in Japan in the 1990s.
The Bank also said it was unclear how much using such purchases of assets improved liquidity or encouraged new issuance. But it said it remained prepared to do whatever was needed to reach the inflation target. "Whatever the uncertainties about the strength of the transmission mechanism, the private sector should be assured that the MPC will take the necessary to bring inflation back to target," it said. The Bank expects credit conditions over the forecast period to be tighter than had been expected in the November report, mainly because credit conditions for households had deteriorated. As a result of the extraordinary measures by the Bank and the government to stabilise financial markets – including the Bank’s £50bn asset purchase facility – lending to companies is expected to be better than assumed in its last report.
Danish support for euro in free fall
Danes are increasingly wary of swapping the Danish krone for the euro. Over the past three months, support has plummeted from 51 percent to 42 percent. According to a new Gallup poll published in Berlingske Tidende, support for the euro in Denmark has not been lower since 2001. The poll suggests that the population is divided into two equal groups – 42% in favour and 42% against. As late as November last year, 51% of the Danes were willing to replace their currency. The Liberal-Conservative minority government’s euro-sceptical support party, the Danish People’s Party, hopes the new poll will make Prime Minister Anders Fogh Rasmussen drop his plans for a euro-referendum. "Now that the worst turmoil in connection with the financial crisis has subsided more people can see that the krone is a highly stable project," said DPP EU-spokesman Morten Messerschmidt.
"It is a good idea to stay away from changing a country’s currency policy if it is only possible to find support in half of the population," he added. Messerschmidt believes the government is to blame for the population’s reaction because the prime minister and the rest of the government led a scare campaign, while the central bank Nationalbanken raised the interest rate in order to defend the krone. At the time Fogh Rasmussen maintained that it would be expensive for the Danes to stay outside the Eurozone . Since then the interest rate gap has been reduced to one single percentage point. The opposition Socialist People’s Party also believes Fogh Rasmussen’s strategy has been a mistaken one. SPP Chairman Villy Søvndal says it was wrong of the prime minister to use the financial crisis as a stepping stone for a campaign to replace the krone with euro. "(To exchange the krone) is a long-term decision.
It should not be made on the basis of an atypical situation such as the financial crisis," Søvndal told politiken.dk. The accusations were rejected by Liberal EU spokesman Michael Aastrup Jensen: "It is actually expensive , both in economic and political terms, to remain outside the euro. There is still an interest rate gap that can be felt, and once the Lisbon Treaty has been ratified the influence of the euro-group will be even greater," he says. Several EU experts, however, believe that Fogh Rasmussen has scored an own goal by linking a euro referendum to the financial crisis. In a referendum on September 28, 2000, Danish voters rejected the euro with 53.9 percent against and 46.9 percent in favour.
Commodity Price Dive Hits Latin Economies
Gustavo Grobocopatel is called "the Soybean King" here because he oversees a farming empire the size of Luxembourg. Nowadays, that distinction brings more grief than glory. Soybean prices have plunged about 40% since last July amid a global commodities crash. For Argentine growers, the pain has been especially acute. Leftist President Cristina Kirchner, who once disparaged soybeans as "practically a weed," taxes them heavily and maintains a heavy hand in the economy. On top of that, the worst drought to hit Argentina in 70 years is scorching the fields during the growing season. "All of our worst nightmares are happening, one after another," says Julio Mayol, an agronomist employed by Mr. Grobocopatel's privately held company, Grupo Los Grobo SA.
For almost six years, rising commodities prices and favorable weather were a boon to corporations and governments throughout Latin America. Natural-resources tycoons were born, Andean mining towns and coastal oil towns boomed, and foreign investors piled into Latin stocks whose names they could barely pronounce. Governments paid off debts and spent freely on social programs. Economic growth averaged 5% between 2003 and 2008, up from 3.5% over the prior three decades. But that cycle has taken a sudden, vicious turn. Prices of soybeans, copper and oil -- the region's meal tickets -- have tumbled as the global economic crisis undercuts demand. Big natural-resource investments, including a $1 billion refining project in Peru and a $2 billion mining expansion in Brazil, are being reviewed or shelved. Farmers who bet that grain prices would continue rising are seeing their tractors and harvesters repossessed. The International Monetary Fund projects the region will grow just 1.1% this year, insufficient for its burgeoning population.
Brazil is paying a steep price for relying on natural resources such as iron ore and soybeans for 40% of its exports. Eike Batista, who emerged as the country's richest man amid the boom, with a mining and energy empire he said was worth $16 billion, has seen its value cut in half. Brazil's once hefty trade surplus swung into the red in the first month of this year. With corporations like mining giant Cia. Vale do Rio Doce cutting workers, Brazil lost more jobs at the end of last year than at any time in 16 years. The region's big oil and gas producers -- Venezuela, Bolivia and Ecuador -- have also been hit hard. Ecuador, for example, recently defaulted on some of its foreign bonds, partly because its leftist president considered them "illegitimate," and partly because lower oil prices will mean less revenue to pay debt. Its economy is projected to contract by 3% to 4% this year.
In Argentina, the Peronist government of President Kirchner has come to rely on globally competitive agriculture companies such as Los Grobo as an important source of revenue. Last year, soybeans and their byproducts accounted for about 25% of Argentina's exports. The government taxes soybean exports at 35%, which generated around 10% of its tax revenue last year. The U.S. and Europe, by contrast, support their agriculture industries with heavy subsidies. As a result, the problems facing companies like Los Grobo could indirectly sow political unrest. Soybeans have been a backbone of Argentina's economy. The $7 billion generated by the soybean tax last year was roughly equal to the subsidies the Kirchner government doled out to keep electricity and public transportation cheap. Over the past couple of months, as the soybean collapse hit home, Mrs. Kirchner has started raising power and subway rates, triggering lawsuits and sporadic protests.
With big payments on Argentina's debt coming due, Mrs. Kirchner is scrambling for dollars to replace the declining soybean windfall. One result: Argentina's tax agency is considering sending letters to renters of 500,000 safe-deposit boxes, advising them of an amnesty program for those who pay back taxes on previously undeclared money. Some of the government's emergency measures could make life harder for Los Grobo. In October, Mrs. Kirchner nationalized private pension funds holding $26 billion in assets, including most of the $20 million in debt that Los Grobo issued in 2007. "Argentina basically destroyed its capital market," says Pablo Giorgi, Los Grobo's planning director, who worries that the nationalized funds now will focus more on holding government debt than the private sector's. The government says the private funds did a poor job of managing Argentines' savings.
So far, the government has refused to lower its tax on soybean exports. "In this scenario of low prices and drought," predicts Mr. Grobocopatel, many farmers will go bankrupt. In recent weeks, there have been scattered rural protests over the tax. Some farmers in the town of Tornquist dragged two dried-out cow carcasses to a clearing near an intersection and erected a large sign reading, "Today it's them. Tomorrow?" Farm leaders have threatened bigger protests in the future. Agriculture Secretary Carlos Cheppi says the government has provided tens of millions of dollars in aid. He has suggested that farmers exaggerate their problems and always complain about the government. The setbacks have been humbling for Los Grobo, which is located in the windswept town of Carlos Casares, a few hours southwest of Buenos Aires. Los Grobo owns only a tiny bit of the land it farms. It rents the overwhelming majority, paying owners a flat fee or a part of the crop. This year, the company is farming 670,000 acres, including land in Uruguay, Paraguay and Brazil. In addition to soybeans, it grows corn and wheat and provides farming services. It has projected sales of about $800 million this year.
Prices of soybeans peaked about $600 a ton last July, then began falling as the global financial crisis took hold. Traders worried that the recession would slow soybean demand; selling by commodities speculators further depressed prices. Prices have rebounded a bit from their December lows, and are currently around $365 a ton. In Argentina, the drought is only making matters worse, scorching Los Grobo's acreage on the pampa. In a field the company farms in Tornquist, the scrawny plants are wilted and yellowing. Grasshoppers have attacked. Meteorologists say the drought stems from the La Niña effect, in which cooler surface water temperatures in the Pacific Ocean lead to dry weather in the southern regions of South America. Marcelo Rey, who oversees three dozen Los Grobo agronomists, says that in some soybean fields plants are producing only a fraction of the normal number of seed pods, portending lower yields.
Soybeans are a resilient crop, and additional rains, like the ones falling over part of the farm belt on Tuesday, could salvage the harvest. But some damage is irreversible by now. And much of Los Grobo's farming territory is especially vulnerable because it received below-average rains during the past 12 months, which left little residual moisture in the ground. "A little rain isn't enough at this point," says David Esevich, who rents 1,500 acres to Los Grobo and says his stricken soybeans are "sad to look at." In the town of Salliqueló, where Los Grobo's crop is imperiled, the local Roman Catholic parish has taken to saying prayers for rain to Saint Joseph, the town's patron. Mr. Grobocopatel, who is 47 years old and a trained agronomical engineer, says the blistering weather portends "a great deterioration in production." Argentina's soybean crop, which had been expected to surge this year, will instead fall by more than 10% from last year's levels, according to the Agritrend SA, a consulting firm in Buenos Aires.
The wheat and corn crops also are projected to fall this year by 45% and 35%, respectively, according to Agritrend. Besides drought damage, the decline reflects reduced planting of those two crops, which are subject to strict government export controls that farmers don't like. Mr. Giorgi, Los Grobo's planning director, says the drought's impact on the company's bottom line could be "devastating." Los Grobo's planting costs -- land rental and fertilizer -- remain exceptionally high this season, he explains. They were set in the middle of last year, near the peak of the global commodities boom. Fitch Ratings recently lowered its rating on the debt of Los Grobo's unit in Argentina, home to 45% of its farmland. It cited the erosion of the company's margins due to a mismatch between boom-era expenses and bust-era revenues. Mr. Giorgi says the industry's cost structure tends to realign quickly, and land rents and fertilizer prices are already falling back in line with crop prices. Mr. Grobocopatel says he is optimistic about soybeans long-term, and that he anticipates continued growth from China, Argentina's main market. "The Chinese aren't going to stop eating," he says.
Farmers note that soybean prices didn't skyrocket until late in 2007, so currently they aren't as far out of line with historic norms as those of some other commodities. Mr. Grobocopatel, whose great-grandfather was part of a wave of Eastern European immigrants known as the "Jewish Gauchos," helped create the modern Argentine soybean industry in the 1990s with his land-rental-based business model. Renting land allowed him to operate on a scale big enough to compete internationally, without huge outlays of capital. He uses contractors for planting and harvesting. The spread of the rental model has helped make Argentina the world's third-largest soybean producer, behind the U.S. and Brazil, and the low-cost producer among the big three. Last February, an investment fund launched by Brazilian financiers Gilberto Sayão and André Esteves, who sold the Banco Pactual investment bank to UBS of Switzerland for around $2.6 billion in 2006, bought a 21% stake in Los Grobo for $100 million. The Grobocopatel family continues to hold a controlling stake.
Los Grobo didn't anticipate the growing tensions with Mrs. Kirchner and her husband and political partner, Nestor, who preceded her as president. Farmers have grumbled about bankrolling the Kirchners' brand of populism, which involves a heavy state role in the economy and wariness of foreigners and free markets. Mr. Kirchner paid off Argentina's entire $9.8 billion debt to the International Monetary Fund in 2005, and told it to keep its nose out of the country's business. Mr. Grobocopatel pointed out that the payment was nearly equivalent to what the country brought in from soybean exports that year. The biggest irritant has been the soybean export tax, imposed as an emergency measure during a crisis in 2002. The Kirchners have steadily increased the tax to 35%. Last March, Mrs. Kirchner tried to impose a new system of assessing the tax, which would have meant a nine-percentage-point increase. That sparked months of protests by farmers. The Argentine Senate voted down the tax increase in July.
The tax dispute was "an exemplary lose-lose situation," Mr. Grobocopatel says. Mrs. Kirchner lost standing in the polls. Local futures markets where shut down during the tax fight, so Los Grobo and other farmers lost the opportunity to hedge against a soybean slump by selling some of the 2009 crop in advance. This year, the unusual weather is creating big problems. In Tornquist, the wheat harvest that came in last November was paltry. The soybeans in one field are about half as high as they ought to be by now. In a nearby field, Los Grobo couldn't even plant a crop in the hard, dry soil. Argentina's farm export revenue is projected to decline this year by 38%, or some $12 billion, according to Agritrend, the consulting firm.
Mrs. Kirchner waited weeks before finally declaring a state of emergency in the countryside last month. That will allow farmers to defer some taxes -- though not the crucial export tax -- and to receive other benefits. Some government officials had argued that if the situation were really critical, growers wouldn't still have an estimated eight million tons of soybeans, about 15% of last May's harvest, stowed in their silos. Fernando Miguez, a professor of agrarian science at Argentina's Catholic University, says the hoarding is partly Mrs. Kirchner's fault because producers are "afraid that if they do sell, this government will confiscate their money." Farmers say the government's actions so far are too little, too late.
The Geopolitics of Food Scarcity
by Lester R. Brown
In some countries social order has already begun to break down in the face of soaring food prices and spreading hunger. Could the worldwide food crisis portend the collapse of global civilization? One of the toughest things for us to do is to anticipate discontinuity. Whether on a personal level or on a global economic level, we typically project the future by extrapolating from the past. Most of the time this works well, but occasionally we experience a discontinuity that we failed to anticipate. The collapse of civilization is such a case. It is no surprise that many past civilizations failed to grasp the forces and recognize signs that heralded their undoing. More than once it was shrinking food supplies that brought about their downfall. Does our civilization face a similar fate? Until recently it did not seem possible, but our failure to deal with the environmental trends that are undermining the world food economy -- most importantly falling water tables, eroding soils, and rising temperatures -- forces the conclusion that such a collapse is possible. These trends are taking a significant toll on food production: In six of the last eight years world grain production has fallen short of consumption, forcing a steady drawdown in stocks. World carryover stocks of grain (the amount remaining from the previous harvest when the new harvest begins) have dropped to only 60 days of consumption, a near record low. Meanwhile, in 2008 world grain prices have climbed to the highest level ever.
The current record food price inflation puts another severe stress on governments around the world, adding to the other factors that can lead to state failure. Even before the 2008 climb in grain prices, the list of failing states was growing. Now even more governments in many more low and middle-income countries that import grain are in danger of failing as food prices soar. With rising food costs straining already beleaguered states, is it not difficult to imagine how the food crisis could portend the failure of global civilization itself. Today we are witnessing the emergence of a dangerous politics of food scarcity, one in which individual countries act in their narrowly defined self-interest and subsequently accelerate the deterioration of global equilibrium. This began in 2007 when leading wheat-exporting countries such as Russia and Argentina limited or banned exports in an attempt to counter domestic food price rises. Vietnam, the world's second-largest rice exporter after Thailand, banned exports for several months for the same reason. While these moves may reassure those living in exporting countries, they create panic in the scores of countries that import grain. In response to restrictions by these and other grain exporters, grain-importing countries are trying to nail down long-term bilateral trade agreements in order to secure future food supplies. The Philippines, no longer able to count on rice from the world market when it needs it, negotiated a three-year deal with Vietnam for a guaranteed 1.5 million tons of rice each year. Other importers are seeking similar arrangements.
Food import anxiety is also spawning an entirely new genre of trade agreements as food-importing countries seek to buy or lease large blocks of land to farm in other countries. Libya, which imports close to 90 percent of its grain and is understandably anxious about access to supplies, has leased 250,000 acres of land in Ukraine to grow wheat for its own people in exchange for access to one of its oil fields. Egypt is seeking similar land acquisition in Ukraine in exchange for access to its natural gas. China has the most ambitious "farming abroad" goals of all: In 2007 the country signed a memorandum of understanding to farm 2.5 million acres in the Philippines, an area equal to roughly 10 percent of that country's farmland. But this agreement, quietly entered into by government officials, was later abandoned by Manila as rice supplies tightened and as local farmers voiced concern. China is now looking for long-term leases of land in other countries, including Australia, Russia, and Brazil. The current surge in world grain prices is trend-driven; some of these trends expand demand and others restrict growth in supply. On the demand side, these trends include world population growth of 70 million people a year, a growing number of people consuming more grain-intensive products, and the massive diversion of US grain to ethanol-fuel distilleries. During the last few years, the United States's use of grain for ethanol has nearly doubled the annual growth in world grain consumption from 19 million metric tons to more than 36 million metric tons. The additional demand for grain associated with rising affluence varies widely among countries. People in low-income countries where grain supplies 60 percent of calories, such as India, directly consume nearly 200 kilograms of grain per year. In affluent countries like the United States and Canada, annual grain con-sumption per person is close to 800 kilograms, but about 90 percent of that is consumed indirectly as meat, milk, and eggs. The potential for additional grain consumption as incomes rise among low-income consumers is huge. To illustrate, the current world grain harvest of around two billion metric tons could feed 10 billion Indians at current consumption levels but only 2.5 billion Americans.
This potential growth in demand for grain is huge but it pales next to that for automotive fuel production. The automotive demand for crop-based fuels is insatiable. If the food value of grain is less than its fuel value, the market will move the grain into the energy economy. Thus as the price of oil rises, the price of grain follows it upward. The United States, in a misguided effort to reduce its dependence on foreign oil by substituting grain-based fuels, is generating global food insecurity on a scale not seen before. Of all the environmental trends that are shrinking the world's food supplies, the most immediate is water shortages. In a world where 70 percent of all water use is for irrigation, this is no small matter. The drilling of millions of irrigation wells has pushed water withdrawal in many countries beyond recharge rates from rainfall, leading to groundwater mining. As a result, water tables are now falling in countries that contain half the world's people, including the big three grain producers -- China, India, and the United States. Aquifer depletion poses a particularly serious threat to China and India where between roughly 80 and 60 percent, respectively, of the grain harvest comes from irrigated land. This compares with only 20 percent in the United States. Most aquifers can be replenished. When they are depleted, the pumping is necessarily reduced to the rate of recharge. Fossil aquifers, however, are not replenishable: For these, depletion brings pumping to an end. Farmers who lose their irrigation water can return to lower-yield dryland farming if rainfall permits, but in more arid regions, such as the southwestern United States or the Middle East, it can mean the end of agriculture altogether.
Nowhere is the shrinkage of irrigated agriculture more dramatic than in Saudi Arabia, a country as water-poor as it is oil-rich. After the Arab oil export embargo in the 1970s, the Saudis realized they were vulnerable to a counter embargo on grain. To become self-sufficient in wheat, they developed a heavily subsidized irrigated agriculture based on pumping water from a fossil aquifer over a half-mile below the surface. In early 2008, with the aquifer largely deplet-ed, the Saudis announced that they will phase out wheat production by 2016 -- after being self-sufficient in this staple food for over 20 years. Saudi Arabia will then be importing roughly 14 million metric tons of wheat, rice, corn, and barley for its Canada-sized population of 30 million people. It is the first country to publicly reveal how aquifer depletion will shrink its grain harvest. Falling water tables are also adversely affecting harvests in many other countries. In China, a groundwater survey revealed that the water table under the North China Plain, an area that produces over half of the country's wheat and a third of its corn, is falling fast. Overpumping has largely depleted the shallow aquifer, forcing well drillers to turn to the region's deep aquifer, which is not replenishable. The aquifer is dropping at a rate of nearly three meters per year. A 2001 World Bank report predicted "catastrophic consequences for future generations" unless water use and supply can quickly be brought back into balance. As water tables fall and irrigation wells go dry, China's wheat crop, the world's largest, is shrinking. After peaking at 111 million metric tons in 1997, the harvest fell to 103 million metric tons this year, a drop of seven percent within a decade. During the same period, production of rice, a water-guzzling crop, dropped six percent from 127 million to 119 million tons. Already dependent on imports for nearly 70 percent of its soybeans, China may soon be importing massive quantities of grain as well.
In India the margin between food consumption and survival is even more precarious. The country's farmers have drilled 21 million irrigation wells, with the result that water tables are falling in almost every state. In a survey of India's water situation, British author and journalist Fred Pearce reported in August 2004 in New Scientist magazine that "half of India's traditional hand-dug wells and millions of shallower tube wells have already dried up, bringing a spate of suicides among those who rely on them. Electricity blackouts are reaching epidemic proportions in states where half of the electricity is used to pump water from depths of up to a kilometer." The progressive worldwide depletion of aquifers is making further expansion of food production more difficult. After nearly tripling from 94 million hectares in 1950 to 276 million hectares in 2000, the world's irrigated area abruptly stopped growing. For the world's farmers, peak water apparently has arrived. In addition to losses from erosion, cropland is also being converted to non-farm uses. Although there are no reliable worldwide data on cropland conversion, it is clear that whether it is housing developments marching up California's Central Valley, the thousands of factories being built each year in the Yangtze River Basin, or similar losses elsewhere, some of the world's most productive cropland is being lost to construction. Meanwhile, the world automobile fleet is growing by 23 million cars per year, and is claiming ever more cropland for roads, highways, and parking lots. To illustrate this, imagine if China were one day to achieve the Japanese automobile ownership rate of one car for every two people. The country would then have a fleet of 650 million motor vehicles, compared with only 35 million today. Since at least 0.4 hectares of land has to be paved for every 20 vehicles added to the fleet, this would require paving nearly 13.3 million hectares of land -- an area equal to half the riceland in China. Worldwide, the average grainland per person shrank from 2.4 hectares in 1950 to well below 1.2 hectares in 2007. This area, smaller than a building lot in an affluent US suburb, will soon shrink to 0.8 hectares if current population growth trends continue.
Global warming is another pervasive environmental threat to food security. Agriculture as it exists today was shaped by a climate system that despite occa-sio-nal blips has remained remarkably stable over farming's 11,000-year history. Since crops were developed to maximize yields in this long-standing climate regime, climate change means agriculture will be increasingly out of sync with its natural environment. In a July 2004 study published by the US National Academy of Sciences, a team of scientists from several countries confirmed the rule of thumb emerging among crop ecologists -- that a one-degree Celsius temperature rise above the norm lowers wheat, rice, and corn yields by 10 percent. The scientists concluded that "temperature increases due to global war-ming will make it increasingly difficult to feed earth's growing population." Aside from the direct effect of higher temperatures, ice melting indirectly affects agriculture over the longer term. The Greenland ice sheet, which is melting at an accelerating rate, will raise sea level seven meters if it melts entirely. If we continue with business-as-usual, sea level could easily rise by two meters during this century. This would quickly inundate rice-growing river deltas such as those of the Ganges in Bangladesh and the Mekong in Vietnam. A World Bank map shows that a one-meter rise in sea level would flood close to half of the riceland in Bangladesh, proportionately shrinking the rice supply of the country's 161 million people. Even as these multiple environmental and resource trends threaten future food security, the shrinking backlog of unused agricultural technology is slowing the rise in land productivity. Between 1950 and 1990, the world's farmers raised grain yield per hectare by more than two percent a year, exceeding the growth of population. But since then yield growth has slowed to just over one percent a year, scarcely half the earlier rate. Some commentators point to genetically modified crop strains as a way out of our predicament, but GM crops have not dramatically raised yields, nor are they likely to do so in the near future.
The bottom line is that new harvest-expanding technologies are ever more difficult to come by as crop yields move closer to the inherent limits of photosynthetic efficiency. This limit in turn establishes the upper bounds of the earth's biological productivity, which ultimately will determine the earth's human carrying capacity. The question -- at least for now -- is not will the world grain harvest continue to expand, but will it expand fast enough to keep pace with rapidly growing demand. If we continue down the current path it is not likely to do so, which means that food supplies will tighten further. There is a real risk that we could soon face civilization-threatening food shortages. Signs of food stress are everywhere. After declining for several decades, the number of chronically hungry and malnourished people in developing countries bottomed out in 1996 at 800 million and has been climbing since. In 2006 it exceeded 850 million and in 2007 it climbed to over 980 million. The US Department of Agriculture projects the number will reach 1.2 billion by 2017. For the first time in several decades this basic social indicator is moving in the wrong direction, and it is doing so at a record rate and with disturbing social consequences. No country is immune to the effects of tightening food supplies, not even the United States. If China turns to the world market for massive quantities of grain, as it recently has done for soybeans, it will undoubtedly look to the United States, which dominates world grain exports. For US consumers, the prospect of competing for the US grain harvest with 1.3 billion Chinese consumers with fast-rising incomes is a nightmare scenario. It would be tempting for the United States to restrict exports, but this is not an option with China which now holds well over one trillion US dollars. Like it or not, US consumers will share their grain with Chinese consumers regardless of how high food prices rise. If the food crisis worsens, national restrictions on grain exports coupled with various bilateral arrangements could tie down much of the exportable supply of grain, making it increasingly difficult if not impossible for weaker, less affluent countries to find grain to import. Many countries heavily dependent on imports could be left out, and the result would be hundreds of millions of desperate people. Desperate people do desperate things: They riot, they fight over food, they overthrow governments, and they mass migrate to more food-secure countries.
In many countries the social order has already begun to break down in the face of soaring food prices and spreading hunger. Deadly food riots broke out in a number of countries in 2008. In Egypt several people died in fights in government-subsidized bread lines. Food riots in Yemen turned deadly, taking at least a dozen lives. In Cameroon the food riot death toll was twice as high. The deteriorating world food situation is not occurring in a vacuum: it comes at a time when there is a growing backlog of unresolved problems, many of them associated with a failure by developing countries to slow population growth. Continuing population growth on a planet already overburdened with human demands is politically weakening scores of countries. Under stress, inter-nal social conflicts develop between differing religious, ethnic, tribal, and racial groups, sometimes leading to genocide as in Rwanda and Sudan. Nearly all of the projected 2.4 billion people to be added to world population by mid-century will be born in countries where agriculture's natural support systems are already deteriorating in the face of excessive demands. As water tables fall, soils erode, and temperatures rise in countries like India, Pakistan, Ethiopia, Nigeria, and Mexico, the risk of social collapse grows. We have entered a new era in international affairs: In the last century it was heavily armed superpowers that threatened security, but today it is failing states. It is not the concentration of power but its absence that now threatens us. Business as usual is no longer a viable option. The current world food crisis can be alleviated only by altering the trends that are causing it.
We need to go to Plan B. This involves extraordinary measures such as stabilizing climate, stabilizing population, eradicating poverty, and restoring agriculture's natural support systems, including soils and aquifers. Plan B has four components: cut carbon emissions 80 percent by 2020, stabi-lize the world population at eight billion by 2040, eradicate poverty, and restore forests, soils, and aquifers. The 80 percent cut in net carbon dioxide emissions can be achieved by systematically raising energy efficiency throughout the world economy, investing massively in the development of renewable sources of energy, banning deforestation worldwide, and planting billions of trees to sequester carbon. The transition from fossil fuels to renewable energy is driven by tax restructuring, namely raising the tax on carbon while offsetting it with a reduction in income taxes. Stabilizing population and eradicating poverty go hand in hand. The key to accelerating the shift to smaller families is eradicating poverty. This means ensuring education for all children, girls as well as boys. It means providing rudimentary, village-level health care so that people can be confident their children will survive to adulthood. And it means giving women everywhere access to reproductive health care and family planning services. The fourth component, restoring the earth's natural systems and resources, encompasses a worldwide initiative to arrest the fall in water tables by raising water productivity, similar to the highly successful worldwide initiative to raise land productivity that was launched a half century ago and that has nearly tripled grain yield per hectare. Raising water productivity means shifting to more efficient irrigation systems and to more water-efficient crops. In some countries this means, for example, more wheat and less rice. And for industries and cities, it means continuously recycling water. As industries and cities recycle water, more will be available for irrigation. This component also includes a worldwide soil conservation effort, with such measures as terracing, planting tree shelter belts, and adopting minimum tillage practices. Within the environmental community, we have talked for decades about saving the planet. But now we have a new challenge: to save civilization itself. To adopt Plan B is to embrace hope. We can continue with business as usual, leaving the next generation a world where failing states multiply until civilization descends into chaos. Or we can start working now to leave our children a better world, a world that is more secure, not less so.
Lester R. Brown is president of the Washington, D.C.-based Earth Policy Institute and author of "Plan B 3.0: Mobilizing to Save Civilization."