On the first airplane flight across the English Channel to carry a passenger, American aviator John Moissant flew from Paris to London accompanied by both his mechanic and his cat, named either Mademoiselle Fifi or Paree, depending on which newspaper you believe.
Later that year Moisant died in a crash near New Orleans.
Ilargi: I was not going to look at the details of the stillborn Geithner plan that just passed the House, at all. But then I did check a few numbers. You will get about $13 a month from that $787 billion, if I got it right. On Friday 13th, no less. For that amount, you should be able to purchase party hats for the whole family. Would the FDIC take a Friday 13th holiday in bank closures, to celebrate the spending of another $2500 that rightfully belongs to every American man, woman and child? Or will they wait till the next bank bail-out is announced, say, in two weeks?
There's plenty hoolabaloo on the airwaves about the larger than expected losses in Europe, especially Germany. But Germany hasn't had a decade-long personal debt run-up like many other countries. Besides, the 2.1% loss pales compared to the 10% shrinkage in the economy that Japan is facing. The Germans have known all along their export driven society will get hit. 2.1% won't throw them off. Nassim Taleb said he'd rather be in Moscow than in London when the chips and the whips come down. Me, I don’t think Germany would be the worst spot on the globe. They've done it and run it, they know from memory how a society can change seemingly overnight. The shame that has remained part of the country's conscience for 70 years will go a long way towards preventing a sequel. Both politically and economically, Germany has what many other countries don't: Resilience. Capital R.
Sure, the European Central Bank may lower rates soon. At least they have space left to do it. The number one priority in our societies today should be to construct a bottom floor under our economies. To make sure we prevent the weakest amongst us from falling through widening cracks. In many European countries, through political views that Americans ignorantly and mistakenly label "socialism", such a bottom exists to a large extent. Not perfect, mind you, but 1000% more than in North America.
In much of Europe, health care systems are both better and -much- cheaper than in the US. Where Americans have maybe two weeks off per year, many Europeans have 6 or 7 or even more. Without being less productive. When I hear yet another American president claim the US has the best workers in the world, I'm like: prove it in the face of data like that.
Whether you look at the thin veneer quasi-philosophy propagated by Ayn Rand, or the poorly fabricated non-ideas of social Darwinism, you're looking at things that work only when growth is in the air. Well, there's none to be seen anywhere, it's left the building, and rumor has it that it died slumped over a toilet bowl choking in its own vomit. There will, for all I know, be people 4 decades from now who will swear that it's still alive, but I think their traveling companions are ghosts and empty sockets. And in the real world, there's things that desperately need to be done.
The US stimulus plan should have been directed at building a bottom underneath the American society, not at resurrecting growth, but unfortunately it just ain't happening. There will be lots of problems in Germany as well, and in France, but their social and economic systems have been built with resilience in mind, whereas in the US the only God is greed.
There was a first substantial sell-off in US Treasurys today. It looks like the bond market, on the very eve of the acceptance of the $787 billion, has lost faith too. That spells a world full of trouble for an American society that is wholly unprepared for bad times. When you allow too many people to fall through too large cracks, you will effectively have no functioning society left.
Watch the bond markets, that's where the decisions are made. Bond issuance will reach heights never before seen. Not just by the US federal government, but by all levels of government, and by all corporations that try to survive. It will lead to a massacre in bond markets. Free markets do work in a sense, but not the way we like, It's the essence of the credit crunch: there is no more credit, or at least not nearly enough to keep things running.
No stimulus plan can restore that, but all stimulus plans are based on attempts to do just that. They will fail, each and every one. And when that happens, which could be soon, in the next few months, America will not be the best place to be. The quality of any society will always depend on how it takes care of the weakest individuals that live in it. Europe, on the whole, will do much better in that respect.
Debt Supply Concerns Hit Treasurys
Treasurys suffered from a wave of selling Friday morning on concern of a sharp increase in government debt supply amid rising funding needs. Some dealers who bought bonds from $67 billion of government debt supply this week also unloaded some of their holdings ahead of the long weekend, traders said. Lower prices will also make it easier for dealers to sell their inventories to investors next week, they said. The Treasury market will close at 2 p.m. EST Friday and will remain shut Monday for the Presidents Day holiday.
"Some long positions were cut," said Rick Klingman, managing director of Treasury trading at BNP Paribas in New York. He noted that selling accelerated after the 10-year note's yield broke 2.818% while the 30-year yield broke 3.54%. A long is a bet on price gains in bonds. The 30-year bond led the selling, with its price down more than 2 points. The yield, which moves inversely to price, was pushed up by more than 16 basis points. Mid-morning Friday, the two-year note was down 4/32 at 99 27/32 to yield 0.95%, the five-year note was off 18/32 to 99 18/32 to yield 1.84%, the 10-year note was down 1 6/32 to 98 31/32 to yield 2.87% while the 30-year bond tumbled 2 28/32 to 97 30/32 to yield 3.61%.
Selling in bonds started overnight due to a bout of risk seeking following a report late Thursday that the Obama administration is working on a program to subsidize mortgages. A bigger concern is that this program may add to the already bulging cost of the government's effort to stimulate economic growth. Congress is inching closer to passing a $789 billion economic stimulus plan while the funding needs for all the programs to rescue banks and jump-start consumer and business lending may be more than $1 trillion.
The House and the Senate are expected to vote Friday on the final passage of the stimulus plan. Rising borrowing needs may push the U.S. government to sell more Treasury securities, which tend to push down bond prices and lift bond yields. While Treasurys, being the world's most liquid assets, still garner demand amid a bleak economic outlook, investors will demand higher yields to protect their investment. Concern also rose on the credit-worthiness of the U.S. government. The effects of the U.S.'s efforts to solve the financial and economic crisis are taking a toll on the country's ability to uphold a triple-A rating, according to a report published by Moody's Investors Service, though the agency shied away from warning of any ratings downgrade.
Also hurting bonds: The prospect of the Federal Reserve buying long-dated Treasurys as a way to keep mortgage rates low has dimmed. Fed Chairman Ben Bernanke raised the idea of purchasing Treasury bonds in November and the Fed has tipped its hand to the possibility of such purchases in its last two policy statements. However, Mr. Bernanke notably left the idea out of his testimony to the House Banking Committee Tuesday. Fed officials could be preoccupied by a new program aimed at igniting consumer loan markets, an effort being coordinated with the Treasury Department. "The prospects of more supply of government debt increase while the Fed has distanced themselves buying Treasurys in the foreseeable future," said Orlando Green, a fixed-income strategist in London at Calyon, the investment-banking arm of Credit Agricole SA. "This points to higher yields." Treasurys shrugged off a decline in consumer sentiment from the latest Reuters/University of Michigan survey. The preliminary reading for February was 56.2, lower than 60 expected by economists and down from 61.2 in January.
US bonds fall with continued supply worries
U.S. Treasuries fell on Friday on worries an expected flood of new debt from the government will heavily dilute the market, even though this week's quarterly refunding auctions were generally seen as a success. Trade was quiet, however, with a thin data calendar and an abbreviated session, with some investors happy to step to the sidelines after a week of volatile trade. Even with the lower prices on Friday, benchmark yields, which move inversely to prices, were on track for their biggest weekly fall so far this year in relief that the Treasury refunding had gone as well as it had. But supply concerns remained, with the government expected to issue more and more debt to fund various rescue plans for the financial industry. "There is speculation that we are going to see a larger (government) package than we thought we were going to see, including subsidies, and that is weighing on the market," said Thomas di Galoma, head of U.S. Treasury trading at Jefferies & Co. in New York.
The widening scope of such measures was evident in news on Thursday that the Obama administration is working out a program to subsidize mortgage payments for troubled homeowners. Benchmark 10-year notes were trading 15/32 lower in price for a yield of 2.84 percent, from 2.79 percent late on Thursday, while two-year notes were unchanged in price for a yield of 0.93 percent. Some analysts had worried that demand for government securities might be tepid given expectations of the huge wave of debt supply this year. While an auction of 30-year bonds on Thursday was met with a bit of a lukewarm reception, auctions of three-year notes and 10-year notes on Tuesday and Wednesday were generally seen as successful.
Treasuries were also weighed on Friday as investors cautiously turned to riskier investments like corporate debt, which sapped the safe-haven bid for government debt. "Everybody is in the Treasury market because they don't want to be in any other asset class, and to the extent that people are willing to stick their heads out and look for greener pastures, that would be a drain on Treasury demand and a boost to Treasury yields," said William O'Donnell, head of U.S. interest rate strategy at UBS Securities LLC in Stamford, Connecticut. Bond prices were also not helped by news that a Chinese official said that buying U.S. Treasuries was not the only option for his country's central bank, contradicting an earlier comment. Treasuries briefly pared losses after the Reuters/University of Michigan Surveys of Consumers showed consumer confidence fell to its lowest in three months in February. The U.S. bond market will shut early at 2 p.m. Eastern time on Friday and stay closed on Monday for the Presidents Day holiday.
Fed Looking Unlikely to Buy Treasurys
The Federal Reserve is looking increasingly unlikely to purchase long-term U.S. Treasury securities any time soon, as the central bank gears up to launch a different program aimed at jumpstarting the market for consumer loans. Federal Reserve Chairman Ben Bernanke raised the idea of purchasing Treasury bonds in November and the Fed has tipped its hand to the possibility of such purchases in its last two policy statements. Such a move could help to bring down long-term interest rates, something that could indirectly help consumers and businesses since many loans are benchmarked to Treasury yields. But Mr. Bernanke notably left the idea out of his testimony to the House Banking Committee Tuesday.
Fed officials could be preoccupied by a new program aimed at jumpstarting consumer loan markets, an effort being coordinated with the Treasury Department. That program represents an enormous commitment by the Fed. The Term Asset-backed Securities Loan Facility, which will help finance asset backed securities tied to consumer loans, could result in as much as $1 trillion in new Fed loans, a huge expansion in its balance sheet. The central bank’s balance sheet has already swelled from less than $900 billion a few months ago to $1.8 trillion. Moreover, the loans the Fed will be making under the asset backed securities program are three year loans, long-term commitments that could be a challenge to unwind later. Officials don’t want to take any options off the table.
But given those potential long-term encumbrances, a dive into purchases of long-term Treasury bonds looks less likely in the near-term. The big commitment to the asset backed securities program could lead to another change for the Fed and Treasury. Last year, the Treasury helped the Fed to finance the expansion of its balance sheet by issuing short-term bills and leaving the cash from those bills on deposit at the central bank for the Fed to use in lending programs. The Treasury has been winding down that effort. But it might need to gear it up again as the Fed’s long-term commitments grows. Such a move could require the Treasury to ask Congress to rewrite laws governing how the U.S. government debt limit is counted, possibly exempting such deposits at the Fed.
Rescue Efforts Ding U.S.'s Triple-A Rating
The creditworthiness of the U.S. is deteriorating more rapidly than most of its triple-A rated brethren. The effects of the U.S.'s efforts to solve the financial and economic crisis are taking a toll on the country's ability to uphold a triple-A rating, according to a report published by Moody's Investors Service, though the agency shied away from warning of any ratings downgrade. As the government moves forward with President Barack Obama's $789.5 billion stimulus package and the Treasury gears up to borrow as much as $2 trillion with new debt sales this year, Germany, France, Canada and Scandinavian countries are pulling ahead of the U.S. as stronger credits, said the report. While all face headwinds, they remain triple-A.
"By the end of a two year period, the U.S. debt ratios will be higher and moving the country's metrics to the lower end of the pack," said Steven Hess, sovereign credit analyst at Moody's. Mr. Hess said that while the analysis on the U.S. is the current view, "this triple rating isn't assured forever." Regardless of the U.S. spending spree, investors around the world still buy U.S. Treasury bonds when they become anxious about the financial system, as it is the world's largest bond market and functions in dollars, the world's reserve currency. The 10-year Treasury rose in price Thursday to yield 2.732%, while the two-year bond rose as well, to yield 0.883%.
The U.S. and the United Kingdom are what Moody's called "resilient triple-A" rated nations facing big tests as the economic downturn stresses their ability to harvest revenue from taxes and as they take on debt to rescue large financial institutions and restore markets to health. Moody's notes, though, that the U.S. is uniquely positioned to restore its financial health once the crisis abates, given the size of its economy and its tax base. France, Germany, Canada and the Scandinavian nations have suffered less of a shock to their economies, said Moody's, leaving them "resistant" to current challenges. Ireland and Spain, meanwhile, are deemed "vulnerable" to more sustained financial damage.
Moody's has warned of a possible downgrade of Ireland's debt by giving it a negative outlook and noting its low tax rates attracted business in the good times, but could be a problem in the future. =The U.S. government's debt at the end of 2008 totaled $5.8 trillion, or about 41% of the nation's total economic activity, or gross domestic product. By the end of 2010, Moody's expects the nation's debt load to increase to $9 trillion, bringing the ratio of the nation's debt to its GDP to 62%. The U.K.'s ratio of debt to GDP is also expected to jump, while Germany's debt compared to its output, about 40% of GDP, will likely increase to just 47% by 2010. France's debt ratios also aren't likely to rise more than 10%.
High debt levels endanger Britain's AAA credit rating for first time
Britain may face "lasting impairment" from the credit crisis owing to the over-sized role of the City and high levels of private debt, endangering its elite "AAA" credit rating for the first time in history. The US agency Moody's said the UK had slipped from the top rank of "resistant" AAA states, which include Germany, France, Canada, and the Scandinavian countries. British debt is likely to be "tested" over coming years. Moody's warning pushed the cost of default insurance on British Gilts to an all-time high. Five-year credit default swaps (CDS) rose to 148 basis points yesterday. The agency said there had been a startling deterioration across the world with even the strongest states seeing "substantial and rapid" damage to their finances. The massive bank bail-outs and fiscal packages have created a new hazard known as "risk socialisation".
"This is raising questions about the safety of public debt for investors during the very severe and sychronised economic downturn," it said. Moody's said the UK and the US would see their ratings come under strain "because of a shock to their growth model and large contingent liabilities". Both countries have relied heavily on unsustainable credit booms to fuel growth, but Britain faces added difficulties as a hub of global finance at a time when banks are out of favour. The economic fall-out from this broken model may cause "lasting impairment", making it harder for both the US and UK governments to raise the tax revenues needed to restore health to public finances. Britain in particular will be watched to see if it can adjust to a "post-crisis world order". Moody's said the US "exhibits an unrivalled capacity for innovation" and is likely to bounce back quickly. The UK has seen more slippage but still has an "adequate reaction capacity to rise to the challenge".
Wave of Bad Debt Swamps Companies
A growing wave of souring corporate debt claimed another victim on Thursday as Charter Communications Inc., the nation's fourth-largest cable-TV company, said it would seek bankruptcy-court protection by April 1. Charter, which was started by Microsoft Corp. co-founder Paul Allen, said its planned Chapter 11 filing was intended to trim about $8 billion from its $21 billion in debt. After extensive negotiations, a committee of debtholders agreed to the plan, under which Mr. Allen will retain control of the company.
Charter's bankruptcy-court filing would be the latest in a succession of corporate setbacks. Earlier this week, Muzak Holdings LLC, known for producing background music, and packaging company Pliant Corp. sought Chapter 11 protection. On Thursday, Aleris International, which produces aluminum products, and the U.S. operations of Midway Games Inc. did the same. Satellite-radio company Sirius-XM Radio Inc. and mall giant General Growth Properties Inc. both face large debt payments in coming days, and are trying to negotiate out-of-court solutions to their problems.
The U.S. is entering a period likely to feature the most corporate-debt defaults, by dollar amount, in history. By various estimates, U.S. companies are poised to default on $450 billion to $500 billion of corporate bonds and bank loans over the next two years. In percentage terms, the projections from the three main credit-rating agencies for defaults on high-yield bonds approach levels last seen in 1933, according to an 87-year default-rate history compiled by Moody's Investors Service. The agencies expect default rates on these non-investment-grade bonds to triple to about 14% or higher this year, from around 4.5% last year.
The coming default wave is another source of trouble for the global financial system, which already is grappling with hundreds of billions of dollars in defaulted mortgages, credit-card debt, student loans and other consumer debt. Corporate defaults threaten to hurt banks, pension funds and private-equity funds, which in recent years gobbled up high-yield corporate debt and pieces of bank loans. Corporate defaults -- in which companies cannot meet interest or principal payments on borrowed money -- don't always result in Chapter 11 filings. Often borrowers can restructure their debts by working out new payment terms with lenders. Sometimes they agree to give lenders ownership stakes in exchange for reducing or eliminating debt. Such workouts can dilute or wipe out existing shareholders.
The defaults will likely be spread across many industries. At the moment, debt-rating agencies are singling out media, entertainment, casino and hotel companies, car makers and retailers as the most distressed sectors. Standard & Poor's Corp. estimates that nearly 90% of 263 rated media and entertainment companies -- a group that also includes hotels and casinos -- are at risk for default, based on their speculative-grade credit ratings. S&P estimates high-yield-bond default rates will hit 13.9% this year, but could go as high as 18.5% if the downturn is worse than expected. Moody's predicts a default rate around 16.4% this year. The default rates in recent downturns were 11.9% in 1991 and 10.4% in 2002, according to S&P. Such rates peaked at around 15% in 1930, according to Moody's. In 2007, when credit flowed freely, the default rate dipped below 1%, an all-time low.
At present, nearly two of every three nonfinancial companies have below-investment-grade ratings, says Diana Vazza, a managing director and head of fixed-income research at S&P. That compares with 50% during the last downturn earlier this decade, and one in three during the recession of the early 1990s. "This is the most toxic mix of U.S. corporate ratings we've seen," she says. This year, as of Feb. 6, 21 U.S. companies have defaulted on $43.1 billion of high-yield bond and bank debt, according to S&P. That is greater than the dollar value of defaults in 2006 and 2007 combined, and it's more than 25% of the $157 billion of high-yield-loan and bond defaults in all of last year.
Earlier this year, there were bankruptcy filings by technology giant Nortel Networks Corp., chemical and environmental-services firm LyondellBasell Industries and consumer-products giant Spectrum Brands Inc., the maker of Rayovac batteries, Remington shavers and other well-known brands. Many companies are paying the price for buying binges earlier this decade to expand operations or acquire rivals. Charter Communications, which provides cable-TV, broadband and phone services in 27 states, grew rapidly through a series of acquisitions, and then went public in 1999. The purchases saddled it with billions of dollars of debt. Some analysts say Charter overpaid for many of the assets. By last year, with the credit markets in chaos, managing the debt load had become a major concern.
Charter, which has 16,500 employees and reported $6.5 billion in revenue last year, doesn't expect to cut jobs as part of its reorganization. At the start of 2007, the ratio of debt to earnings for all industrial companies stood at 4 to 1, according to Fitch Ratings. As companies borrowed more, that number grew to 6 to 1 by the third quarter of 2008. That left less room for error if the economy slipped. Now the debt is coming due -- and defaults are piling up. "You do the math, and it says we are in the midst of the greatest pool of defaulted debt we have ever seen," says Jeffrey Werbalowsky, co-CEO of the investment-banking firm Houlihan Lokey Howard & Zukin, which works on corporate restructurings and bankruptcies. He estimates that about $450 billion in corporate debt will default by the end of 2010.
Because many corporate defaults turn into bankruptcies or other cutbacks, there is certain to be a spillover effect on U.S. unemployment, which is already at a 16-year high. Over the past three months, 1.77 million jobs have been shed. With credit still tight, more bankrupt companies might have trouble raising money to restructure, forcing them to liquidate. That's what consumer-electronics retail chain Circuit City did; it employed 35,000 before announcing last month it was shutting its doors for good. "Given the credit crunch, many of these companies may just go away, and that hurts vendors, rivals and customers," says Mariarosa Verde, Fitch head of credit-market research. "What we don't know is the impact of all these defaults on the economy and on jobs or on consumer confidence."
Fitch Ratings estimates the biggest prior year for high-yield bond defaults, in dollar terms, was 2002, when $109.8 billion defaulted. In 2008, high-yield bond defaults topped $66.6 billion, up from $9 billion for 2006 and 2007 combined. The rating agencies expect defaults to peak in the second half of the year, based on forecasts that the economy itself will bottom out in the first two quarters of the year. Historically, bondholders recover about 40 cents on the dollar on defaulted high-yield bonds. Fitch's Ms. Verde expects the recovery rate could fall to about 20 cents on the dollar, or lower, in this recession. That's because the economic downturn is so severe, and distressed companies are carrying so much more debt than in the past.
US Consumers Cut Food Spending Sharply
The bad economy is hitting America right in the stomach. Consumers have cut back sharply on food spending, shunning restaurants, opting for generic products over brand names, trading in lattes for home-brewed coffee and shopping for bargains. That is hurting sales and profits at many food processors, grocery chains and restaurants. In 2008's fourth quarter, consumer spending on food fell at an inflation-adjusted 3.7% from the third quarter, according to data from the Commerce Department's Bureau of Economic Analysis.
That is the steepest decline in the 62 years the government has compiled the figure. The report is based on receipts from a sampling of food-oriented businesses across the country. The big drop likely comes from two things, said Joseph Carson, an economist at AllianceBernstein who worked at the Commerce Department in the 1970s. First, consumers have been trading down to lower-priced items. Second, he thinks many households dug into their pantries for staples rather than going to the store, a trend that can't continue indefinitely. "You can't contract at this rate for long," he said. "It's just shocking."
Cindy Greco, a 45-year-old Chicago resident, said she's shopping more at Costco Wholesale Corp. stores and buying less expensive meat, such as chicken, shrimp and ground turkey, for her husband and 11-year-old daughter. "I'm someone who used to never ever pay attention to the prices of groceries," Ms. Greco said while shopping Thursday at a Chicago supermarket. "But now it's a different story." She showed off a bottom round roast she had unearthed that was marked down to $7.21 from $18.26. "In recent years, a lot of discretionary income has gone into buying fancier food, whether it's Starbucks coffee or prepared dinner or restaurant meals," said Barclays Capital economist Ethan Harris. Now, he said, that trend seems to be waning.
Last week, Kraft Foods Inc. lowered its earnings forecast for the year, saying customers are cutting back purchases of snack foods and trading down to private labels. Groupe Danone SA said this week that U.S. consumers sharply trimmed their purchases of yogurt and other dairy products at the end of last year. Even makers of chocolates are worried about how well their products will sell for Valentine's Day on Saturday. On Tuesday, Citi Investment Research warned of a "modern-day price war" based on Wal-Mart Stores Inc.'s plan to freshen up its Great Value private-label foods and the analyst's expectation that it will trim national-brand prices. That could force grocery stores to cut prices to compete.
U.S. sales of private-label food rose 10% in 2008 from 2007, to $82.9 billion, according to a spokesman for the Private Label Manufacturers Association, citing Nielsen grocery-sales numbers. At the same time, branded food products saw sales rise 2.8% to $416.6 billion, he said. When times get tough, restaurants are one of the first places where people economize. In its quarterly surveys, research firm WSL Strategic Retail of New York has found that more people are preparing food at home, eating at lower-priced restaurants when they do eat out and picking less pricey items from the menu. "Food expenditures have dropped, but it's not because people have stopped eating," said WSL consultant Shilpa Rosenberg. Declining sales at established locations have forced Starbucks Corp., Ruby Tuesday Inc. and other chains to shut hundreds of outlets and put many independent restaurants out of business.
On Wednesday, P.F. Chang's China Bistro Inc. said same-store sales fell 7.1% at its bistro locations in the fourth quarter, and the deterioration intensified as the quarter progressed. "The lights went out in December," Robert Vivian, the company's co-chief executive, told investors. The shift has a silver lining for some companies. While supermarkets passed along last year's high ingredient costs to customers, McDonald's Corp. and other fast-food chains absorbed some of the expense and kept many items priced at $1. Now, some consumers consider a fast-food meal a bargain. On Monday, McDonald's said same-store sales rose 7.1% in January, including a 5.4% increase in the U.S. Other consumers are opting for home cooking. In Bellevue, Neb., stock broker Kevin Vaughan and his wife cook chicken to make broth from scratch instead of buying it in cans, and use all of the resulting meat for multiple dishes. "You'll have three or four meals off a $10 to $12 investment," he said. And there's another bonus from reduced food purchases, he added: less trash to take out.
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U.S. farm income to drop 20 percent in 2009
U.S. net farm income was forecast at $71.2 billion for 2009, down 20 percent from the record posted in 2008 because of lower prices, the U.S. Agriculture Department said Thursday. Net farm income will remain 9 percent above the 10-year average, USDA said, pointing out that government payments will be at their lowest level since 1997. "It's not unusual that we would see some potential slippage," after posting record income in 2008, Agriculture Secretary Tom Vilsack told reporters. "We're obviously concerned. There are a number of producers that are stressed, and we're in the process of determining what assistance we can provide," he added, noting specific hardships impacting the dairy industry. The global economic recession will weigh on the livestock sector, the USDA said, with export demand slumping for meat and dairy products. A steep drop in milk prices may prompt an 11 percent slump in the value of livestock commodities, the USDA said.
Vilsack said the department hoped to provide additional credit to dairy producers in the next week or so to prevent "a significant sale of dairy cows that would create some difficulties, overall, for beef producers." Expenses will decline by $13.5 billion in 2009 -- the first decline in expenses since 2002 -- but farm expenses are still 9 percent higher than they were two years ago, USDA said. Net farm income is a USDA measurement of the value of production during the calendar year, whether it is sold or held in storage. The current estimate for 2009 net farm income would be the fifth largest on record, the USDA said. The USDA expects cash receipts for almost all crops to decline in 2009 because of lower prices compared with historic highs seen in 2008. Cash receipts for food grains will drop 22 percent, feed crops 15 percent, oilseeds 7 percent and cotton 27 percent, the USDA said.
U.S. consumers' mood falls sharply
U.S. consumer confidence fell to its lowest in three months in February as sentiment grew increasingly gloomy over an economic downturn that most expected to last five more years, a survey showed on Friday. The Reuters/University of Michigan Surveys of Consumers said its index reading of confidence for February tumbled to 56.2 from 61.2 in January. That was the lowest since November, when U.S. stocks hit 11-year lows during one of the worst periods of the current financial crisis. A separate reading in the report showed consumer expectations fell to their lowest since May 1980. "Confidence fell in early February as consumers came to the consensus that the economy would remain in recession throughout 2009," the report said. "Moreover, nearly two-thirds anticipated that the downturn would last five more years."
The main index was well below economists' median expectation for a reading of 61.0 culled from 60 forecasts in a Reuters poll that ranged from 56.5 to 64.0. The University of Michigan confidence index dates back to 1952. Currently it is still near the record low of 51.7 that it hit in May 1980. The index managed to gain in December and January, but February's fall suggested the recovery -- or bottoming at least -- that many economists had hoped for is now in danger. "The index was disappointing, reversing all the gains of the past two months," said Cary Leahey, economist at Decision Economics in New York. U.S. stocks lost more ground after the surprisingly weak report. Government bonds, a safe haven for financial markets during times of economic turmoil, pared their earlier losses.
Reflecting the grim mood, the index measuring consumers' view of the 12-month economic outlook fell to its lowest ever, to a reading of 27 versus January's 47. The February report showed mixed views on inflation. One-year inflation expectations plummeted to 1.6 percent from January's 2.2 percent for the lowest since November 2001, highlighting worries that the United States might be headed for a deflationary period of falling prices, wages and economic activity. However, five-year inflation expectations edged up to 3.0 percent from January's 2.9 percent. That was the highest since September 2008 and is consistent with concerns of some in the financial markets that massive spending and borrowing by the government to bail out the economy might prove inflationary.
Japan Economy Seen Shrinking at 10% Pace in 4Q
Japan's economy likely contracted at an annual pace of more than 10 percent in the fourth quarter, analysts predict, reflecting the collapse in global demand that is battering the world's second-biggest economy. The Cabinet Office is expected to reveal Monday that gross domestic product in the October-December period plunged an annualized 11.7 percent, according to a consensus of market forecasts. That would mark the steepest drop for Japan since the oil shock of 1974 and far outpaces declines of 3.8 percent in the U.S. and an estimated 1.2 percent in the euro-zone. With recovery nowhere in sight, Japan is now in the midst of its worst downturn since World War II, analysts say.
''Since October economic indicators have deteriorated at a pace that defies any rule of thumb,'' Tetsufumi Yamakawa, chief Japan economist at Goldman Sachs, said in a recent report. ''There has been an unprecedented large decline in exports and production-related indicators in particular, not only in Japan but throughout Asia.'' Goldman Sachs predicts GDP, the total value of the goods and services produced in a country, will tumble an annualized 8.8 percent in the fourth quarter -- and fall 3.8 percent for all of 2009. That would be worse than the 2 percent contraction in 1998 during Japan's last financial crisis. JP Morgan predicts GDP will decline at a 9 percent pace in the fourth quarter and expects the figure to worsen to 12 percent this quarter.
''Adding to the dismal forecast, we remain cautious about unexpected events in financial markets -- including a sudden further appreciation of the yen and another plunge in equity prices -- toward the end of the fiscal year in March,'' said Masamichi Adachi, senior economist at JP Morgan in Tokyo, in a note to clients Friday. Japan's exports plummeted a record 23 percent in the fourth quarter, as the deepening global slowdown choked off demand for the country's cars and gadgets. Even demand from emerging markets, which earlier had partly offset declines in North America and Europe, dropped sharply. The figures underscore the vulnerability of Asia's export-driven economies during global downturns and point toward more cuts in jobs, production and profits in the coming months.
Japanese electronics company Pioneer Corp. said Thursday it will cut 10,000 jobs globally, joining a growing list of the country's corporate giants scrambling to slash their payrolls. Sony Corp. is shedding 8,000 workers, while Nissan Motor Co. and NEC Corp. are each cutting 20,000. In the July-September period, GDP shrank at an annual pace of 1.8 percent. The data confirmed that Japan slipped into recession in the third quarter after GDP contracted an annualized 3.7 percent in the April-June period. A recession is commonly defined as two consecutive quarters of negative growth, though many economists using other parameters say that the current downturn actually began in late 2007.
In Japan’s Stagnant Decade, Cautionary Tales for America
The Obama administration is committing huge sums of money to rescuing banks, but the veterans of Japan’s banking crisis have three words for the Americans: more money, faster. Heizo Takenaka, seen in 2002, headed the Japanese efforts that, though resisted, exposed the full extent of bad bank loans. The Japanese have been here before. They endured a "lost decade" of economic stagnation in the 1990s as their banks labored under crippling debt, and successive governments wasted trillions of yen on half-measures. Only in 2003 did the government finally take the actions that helped lead to a recovery: forcing major banks to submit to merciless audits and declare bad debts; spending two trillion yen to effectively nationalize a major bank, wiping out its shareholders; and allowing weaker banks to fail.
By then, Tokyo’s main Nikkei stock index had lost almost three-quarters of its value. The country’s public debt had grown to exceed its gross domestic product, and deflation stalked the land. In the end, real estate prices fell for 15 consecutive years. More alarming? Some students of the Japanese debacle say they see a similar train wreck heading for the United States. "I thought America had studied Japan’s failures," said Hirofumi Gomi, a top official at Japan’s Financial Services Agency during the crisis. "Why is it making the same mistakes?" Many American critics of the plan unveiled Tuesday by Treasury Secretary Timothy F. Geithner said the plan lacked details. Experts on Japan found it timid — especially given the size of the banking crisis the administration faces.
"I think they know how big it is, but they don’t want to say how big it is. It’s so big they can’t acknowledge it," said John H. Makin, an economist at the American Enterprise Institute, referring to administration officials. "The lesson from Japan in the 1990s was that they should have stepped up and nationalized the banks." Instead, the Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying — ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr. Geithner proposed.
One reason Japan’s leaders were so ineffectual for so long was their fear of stoking public outrage. With each act of the bailout, anger grew, making politicians more reluctant to force real reform, which only delayed the day of reckoning and increased the ultimate price tag. Japanese taxpayers are estimated to have recouped less than half what it cost the government to bail out the banks. A further lesson from Japan is that the bank rescue will determine the fate of the wider economy. While President Obama has prioritized his stimulus plan, no stimulus is likely to succeed unless the banking sector is repaired. The Japanese crisis of the 1990s and early 2000s had roots similar to the American crisis: a real estate bubble that collapsed, leaving banks holding trillions of yen in loans that were virtually worthless.
Initially, Japan’s leaders underestimated how badly the real estate collapse would hurt the country’s banks. As in the United States, a policy of easy money had fueled both stock and real estate speculation, as well as reckless lending by banks. Many in Japan thought that low interest rates and economic stimulus measures would help banks recover on their own. In late 1997, however, a string of bank failures set off a crippling credit crisis. Prodded into action, the government injected 1.8 trillion yen into Japan’s main banks. But the injections — too small, poorly planned and based on little understanding of the extent of the banking sector’s woes — failed to stem the growing crisis. Fearing more bad news if banks were forced to disclose their real losses, Japan’s leaders allowed banks to keep loans to "zombie" companies on their balance sheets.
Japan, instead, experimented with a series of funds, in part privately financed, to relieve banks of their bad assets. The funds brought limited results at best, says Takeo Hoshi, economics professor at the University of California, San Diego. For one thing, the funds were too small to make an impact. The depository for bad loans had no orderly way to sell them off. And the purchases that did take place failed to recapitalize banks because the bad assets were priced so low. So far, the Obama administration’s plan avoids the hardest decisions, like nationalizing banks, wiping out shareholders or allowing banks to collapse under the weight of their own bad debts. In the end, Japan had to do all those things. Economists say these blunders meant Japan’s financial system did not start to recover until late 2002, six years after the crisis broke. That year, the government of the reformist leader Junichiro Koizumi ordered a tough audit of the country’s top banks.
Called the Takenaka Plan after Heizo Takenaka, who headed the government’s financial reform efforts, the move finally brought the full extent of bad loans to light. Initially, banks lashed out at Mr. Takenaka. "The government can’t order bank management to do this and that," Yoshifumi Nishikawa, president of the Sumitomo Mitsui Financial Group, complained to the press in October 2002. "It’s absolutely absurd." But Mr. Takenaka stood firm. His rallying cry, he said in an interview on Wednesday, was, "Don’t cover up. Don’t distort principles. Follow the rules." "I told the banks clearly, ‘I am in a position to supervise you,’ " Mr. Takenaka said. "I told them I am not open to negotiation." It took three more years to finally get the majority of bad loans off the banks’ books. Resona Bank, which was found to have insufficient capital, was effectively nationalized.
From 1992 to 2005, Japanese banks wrote off about 96 trillion yen, or about 19 percent of the country’s annual G.D.P. But Mr. Takenaka’s toughness restored faith in the banks. "That was a turning point in the banking crisis," said Mr. Gomi of the Financial Services Agency, who worked with Mr. Takenaka on the audits. By then, other factors had fallen into place that aided economic recovery, including a boom in exports to the United States and China. (Those very share holdings would come back to haunt banks, as the recent market sell-off batters their balance sheets. And as the economy worsens, bad loans are again on the rise, the Financial Services Agency said Tuesday.) The United States will probably not be able to count on growing demand for its products, since the global economy is worsening. "The way things are going right now," said Mr. Hoshi, "the U.S. taxpayers’ burden will keep going up and up."
Eurozone contracts at record rate
Eurozone growth contracted at its fastest ever rate at the end of last year, with an unexpectedly-bad German performance deepening the recession more than had been feared. Gross domestic product in the 16-country region slumped by 1.5 per cent in the final quarter of last year – the same pace of contraction as in the UK but faster than the 1 per cent fall reported in the US. The turnaround in fortunes is particularly dramatic because economic instability had become rare in continental Europe. Until last year the eurozone had never reported a quarterly contraction in GDP growth. But economists expect the eurozone economy to contract by as much as 2 per cent this year – making the recession one of the worst in continental Europe since the second world war.
Economic gloom is spread across the region but Germany has been especially badly hit by the collapse in global demand. Europe’s largest economy contracted by a much larger-than-expected 2.1 per cent in the fourth quarter, the sharpest fall since the country was reunified in 1990. Recent confidence indicators, such as the Munich-based Ifo’s business confidence survey, have suggested the worst point of Germany’s recession is over. Still, economists expect Germany’s economy to contract by a further 2 per cent or more this year – which would make it by far the worst year in the country’s post-second world war economic history. France, meanwhile, reported a 1.2 per cent contraction in fourth quarter – but is still not in a technical recession, defined as two consecutive quarters of negative growth.
Italian GDP, however, fell for the third successive quarter, plummeting by 1.8 per cent in the final three months of last year. Portugal was also among the worst performers, reporting a 2 per cent drop. Spanish data, released on Thursday, had shown a 1 per cent fall. Although eurozone countries such as Spain and Ireland have been hit by collapses in housing markets, the eurozone as a whole has been cushioned from such factors, and its financial sector is relatively unimportant. But German exports, which had previous powered growth, have been badly affected by the slump in global demand since September’s collapse in Lehman Brothers investment bank.
Joerg Kraemer, chief economist at Commerzbank in Frankfurt, said: "The Lehman failure gave the German economy an uncertainty shock, and in the first quarter German GDP is likely to see another dramatic contraction. However, uncertainty has now eased slightly. If it continues doing so, the German economy might at least stop contracting after mid-year." Germany and the eurozone had already fallen into recession before the impact of the Lehman Brothers collapse had been felt. Eurozone GDP contracted by 0.2 per cent in both the second and third quarters of last year as a result of then-high oil prices, higher interest rates and the global economic slowdown that was already underway.
Europe's Economy Shrinks Most Since 1995 as ECB Considers Deeper Rate Cuts
Europe’s economy contracted the most in at least 13 years in the fourth quarter, compounding pressure on the European Central Bank to reduce interest rates to the lowest ever next month. Gross domestic product in the euro region declined 1.5 percent from the previous three months, the European Union’s statistics office in Luxembourg said today. That was more than the 1.3 percent economists expected and the most since euro-area GDP records began in 1995. From a year earlier, GDP fell 1.2 percent in the fourth quarter, the only full-year drop on record.
With the first recession in the euro’s 10-year history deepening, companies from carmaker Renault SA to software-maker SAP AG are cutting jobs and scaling back production. Six ECB policy makers, including President Jean-Claude Trichet, have said the central bank may cut rates to a record low from the current 2 percent and consider other measures to stimulate growth. "The news is dire," said Kenneth Wattret, senior economist at BNP Paribas SA in London who correctly forecast today’s data. "Compared to the early 1990s recession, which was painful, this is twice as big." The economies of both Germany and France, the two largest in the euro region, shrank by the most in more than two decades in the latest quarter. Spain, Italy, the Netherlands and Austria also contracted in the final three months of last year, national statistics offices reported. The U.K. economy, the euro area’s biggest trading partner, shrank 1.5 percent in the quarter.
For the euro region, "we see at least another three quarters of contraction, and we should brace for a huge rise in unemployment," BNP’s Wattret said. "The ECB will cut by at least half a point next month and may have to consider something even more radical." The euro interbank offered rate, or Euribor, for three-month loans fell to a record low on speculation the ECB will reduce its key rate next month. The rate dropped two basis points to 1.94 percent today, the European Banking Federation said. That is the lowest since the euro’s introduction in 1999 and down from a record 5.39 percent on Oct. 10. The three-month euro overnight index average rate, which shows traders’ expectations for the central bank’s key rate, was at 0.98 percent, down from 1.2 percent at the end of January and 1.73 percent on Dec. 31.
ECB board members Lucas Papademos, Juergen Stark and Jose Manuel Gonzalez Paramo as well as Spanish central bank Governor Angel Fernandez Ordonez and Belgian Governor Guy Quaden said this week that the Frankfurt-based bank may cut rates next month. "The latest data and survey indicators point to a substantial decline in real gross domestic product in the fourth quarter," ECB Vice President Papademos said on Feb. 11. "Stormier weather may still lie ahead," and "a further easing of monetary policy may be appropriate" in March. The economic slump may leave European policy makers under pressure at this weekend’s meeting in Rome of finance ministers and central bankers from the Group of Seven industrial nations. U.S. Treasury Secretary Timothy Geithner plans to encourage colleagues to take "bold actions" to reverse the economic and financial crisis, according to a U.S. Treasury official, and the Bank of England has announced plans to start buying commercial paper.
The contraction in Europe "is worse than the U.S.," said Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London. "Given the shock started in the U.S., that’s quite an achievement." The U.S. economy contracted 1 percent in the fourth quarter from the prior three months, when it shrank 0.1 percent, according to the EU statistics office. From the year-earlier quarter, U.S. GDP declined 0.2 percent. In Europe, demand for everything from software to cars is withering. SAP, the world’s biggest maker of business-management software, said on Jan. 28 that it will slash more than 3,000 jobs and freeze salaries this year as the economic slump hurts demand. European car sales plunged 27 percent in January to the lowest level in two decades, the European Automobile Manufacturers’ Association said in Brussels today. Infineon Technologies AG Chief Executive Officer Peter Bauer said yesterday that Europe’s second-largest maker of semiconductors faces a "difficult year" filled with "many tough challenges."
The global economy will grow the least since World War II this year as more than $2 trillion of losses from the financial crisis cripple banks, the International Monetary Fund predicted Jan. 28. The euro region will contract 2 percent in 2009, the IMF forecast. Today’s data showed the euro-area economy expanded 0.7 percent last year, down from 2.7 percent in 2007. The ECB in January cut the benchmark rate to 2 percent, the lowest in the bank’s 10-year history, and kept the rate unchanged on Feb. 5. The next decision is due March 5. "The economy took a breathtaking turn for the worse at the end of last year," said Nick Kounis, an economist at Fortis Bank NV in Amsterdam. "The figures so far add to the already strong case for the ECB to do more."
Collapse of European Industry Worse than Expected
New statistics released on Thursday show that Europe's industrial woes are even worse than expected. Many are concerned that the bad economy could lead to more protectionism. There are few left who don't think the current economic crisis is bad. Still, there is still room for surprise when it comes to degree. When it comes to the economy in the European Union, new evidence published on Thursday shows that the crisis has hit the industrial sector with unforeseen force. Eurostat, which compiles statistics on the European Union economy, announced that production had plummeted at the end of 2008. In December, the amount of goods rolling off the conveyor belts was 2.6 percent lower than November -- and fully 12 percent lower than during the same time period a year ago. The numbers confirm a Financial Times Deutschland article, citing an internal EU report, that both construction and manufacturing in Europe were being hit hard. In describing the downturn, Günter Verheugen, the European Union's Industry Commissioner, did not mince words: "The extent and speed of the crisis is completely new," he told the paper.
The report added to a slew of bad news. On Wednesday a closely-watched survey painted a dismal picture of mood of European business. The Ifo Institute for Economic Research survey showed that sentiment within the 16-country euro common-currency zone declined for the sixth consecutive quarter -- sinking to its lowest point since the survey started 16 years ago. Meanwhile, Spanish figures released on Thursday showed the once resilient economy had sunk into its first recession in more than a decade and a half. And with the economic machine stuttering, an every-man-for-himself tone is creeping into politics. French President Nicholas Sarkozy is at the forefront of the new nationalism, clashing with EU officials about his plan to lend €6 billion to French carmakers Renault and Peugeot Citroen on the condition that they protect French jobs and keep French plants open.
His policy, a European echo of the "Buy-American" policy, has this week sparked divisions within the European Union. The clash became public when the Prime Minister of the Czech Republic Mirek Topolanek, who also holds the European Union's rotating presidency, vocally rejected Sarkozy's criticism of auto companies outsourcing production to the Czech Republic. His criticism of the nationalistic slant was later supported by a number of politicans, including German Chancellor Angela Merkel. "These are issues that affect us all ... and we must make sure that there is a level playing field where EU competition law applies," Merkel said on Wednesday. Shortly after, speaking from Kuwait City during a tour of the Gulf, the French leader defended his country's support plan for the car sector, saying it "had nothing to do with protectionism."
Topolanek on Wednesday admitted that the high-profile spat was counter-productive: "I will not continue this media exchange with my friend Sarkozy, which is very damaging for both of us.... It's better to call each other up." But he also noted, without pinpointing specific countries, that "some member states call for more protectionism, others call for adherence to the rules." Indeed, Sarkozy's rhetoric is not unique within Europe. Italian Premier Silvio Berlusconi has warned appliance maker Indesit SpA not to uproot jobs to Poland. Meanwhile, in Britain, workers are calling for: "British jobs for British workers." But protectionism, though politically tempting, will hamper Europe's ability to maneuver itself out of the downturn, experts say. "In an economic crisis there is a tendency that states initially deal with the crisis at home before they think of others," Fabian Zuleeg, a Senior Policy Analyst at the European policy Center, told SPIEGEL ONLINE. "But it is important to recognize that in Europe, cooperation regarding economic problems should not simply be motivated by "good will."
The close linkages within the European economy make it absolutely necessary to work together on a European level, especially within the Euro zone." And the European Union has signalled it wants to challenge protectionism head-on. On Wednesday it scheduled a duo of emergency meetings: on March 1, EU heads of state will discuss their tactics to deal with the financial sector's ills. The gathering is seen as a bid to boost member-states' support for the bloc as a single internal market. A second meeting of national leaders in Prague has been scheduled for May, in addition to a planned gathering in March 19-20, which will primarily tackle the state of the economy. "Only by co-ordinated and united action will we overcome the crisis," stressed Topolanek on Wednesday. "The internal market is the vehicle that will drive us out of it."
Europe set for deep recession, economists warn
Europe's economy is facing its worst recession in at least two deacdes, economists warned today, after figures showed that the region's economy contracted 1.5pc in the final three months of last year. The Eurozone economy, whose biggest members are Germany and France, shrank 1.5pc in the fourth quarter compared with the third quarter - a steeper fall than economists had expected. Germany had the worst fall, with the economy shrinking the most since the country was reunified in 1990. Many of Europe's other economies fared little better during a quarter in which the collapse of Lehman Brothers deepened the financial crisis and helped tip countries into recession.
France shrank 1.2pc; Italy was was down 1.2pc and Spain weakened 1pc. The news will heap pressure on the European Cental Bank to cut interest rates in March after holding them at 2pc earlier this this month. The ECB has been attacked by economists for not moving as quickly as the Federal Reserve in America and the Bank of England to tackle the downturn. The eurozone economy will contract 2.3pc this year, according to Howard Archer of Global Insight, as the "global recession, extended tight credit conditions and financial sector problems" take their toll. Germany's contraction was worse than the 1.8pc economists had expected. Europe's largest economy is suffering from a fall in demand for the cars and household appliances it makes, as large parts of Europe and the US endure their worst economic condition in years.
As a result, German companies are cutting jobs and investment, exacerbating the fall. Germany's economy could shrink 2.5pc in 2008, according to the International Monetary Fund, which would be its biggest contraction since the Second World War. European finance chiefs are expected to confront Chancellor Alistair Darling over the collpase of the pound at the Group of Seven summit later today. Companies in the euro region have complained that Sterling's weakness is making their exports less attractive and causing a switch to British-made goods. "The news is dire," Kenneth Wattret, an economist at BNP Paribas told Bloomberg News. "Compared to the early 1990s recession, which was painful, this is twice as big."
The Audacity of Doing Nothing
I spent a few days recently in the company of some money managers with a total of about $2 trillion to invest, precisely the sort of folks whose confidence the government is currently trying to win. How did they feel about all of the rule and policy changes coming out of Washington and the new more muscular government? Terrified. The “real money” investors didn’t want to invest alongside the government. Their concern is that if things go south, the government will take 100% of the value left in the bank or whatever and leave private investors, including recent ones, with nothing. This is precisely what happened to recent investors in Fannie Mae.
The “real money” investors didn’t want to see judges modifying contracts, e.g., bankruptcy judges resetting mortgage payments at a lower level and reducing the principal owed. As far as they were concerned, a central tenet of the U.S. Constitution is that people are free to make contracts. Given how mortgages are split up among investors, a foreclosure is greatly preferable to these folks than a modification. In a foreclosure the most senior investors get what they expected, i.e., their money back. The holders of the most junior tranches, which carried a higher return and were known to be high risk, would get nothing. This is also what they would have expected. If mortgages are modified by government action, however, it is unclear how the obligations among the various private parties should be adjusted.
“What’s wrong with foreclosures?” some of these folks asked. “The historical rate of home ownership is about 60 percent and we’re probably going to revert to that sooner or later so why slow things down? How does it help the U.S. to have high housing prices? Isn’t it better for housing to be affordable? If we give a lot of money to people to prevent foreclosures in March, how is that fair people who were foreclosed on in January?” Much of the justification for government intervention comes from the assertion that markets have failed. One money manager scoffed at this idea. “The markets are working fine, but they’re giving people answers that they don’t like, so people cry market failure.” Stocks and bonds low? That’s because investors are afraid of a prolonged depression and continued government interference. House in a jobless region of Michigan worth almost nothing? A place with 50% of its former jobs only needs 50% of its houses. There are plenty of former steel towns where the price of a comfortable house stabilized at $20,000 decades ago and has barely moved since.
What did these guys want the government to do? Nothing, basically. “Back in the 19th Century, there were a lot of steep crashes, guys got wiped out, and the economy came back quickly.” What’s different now? The government is a lot bigger and more powerful. Rich companies and people can put some of their wealth into lobbying and demand that the government prevent them from getting wiped out (or at least slow the process). Barack Obama promised on Monday not to rest as long as this economic downturn persisted. He promised to act decisively, change whatever had to be changed, spend whatever had to be spent. This is precisely what worries the investors to whom I spoke. They’d rather see the audacity of doing nothing.
Stimulus will only deepen the depression
Yesterday in his WSJ column, James Stewart wrote:You know, the rush to stimulate reminds me of the rush to war back in late ‘02, early ‘03. If you weren’t on board, you were a traitor. In a positively Orwellian move, Stewart seeks to banish the very vocabulary of those who criticize the stimulus plan. It’s not “spending” and to consider it such is “ludicrous.”
Surely by this point there’s little doubt the moribund economy needs a big jolt of government spending, as President Obama has explained and even most Republicans concede. Economists may debate the size, timing and nature of the spending, but history, from the Great Depression to the Japanese deflation of the 1990s, has borne out the fundamental premises of Keynesian economics. To criticize the stimulus plan as a “spending” plan is ludicrous. Of course it is.
I also find remarkably foolish Stewart’s claim that “history” confirms the truth of Keynesian economics. Question “Keynesian” and you might as well be questioning the law of gravity.
Personally, I’m proud to consider myself a member of the modern-day flat-earth fraternity that says stimulus (spending or tax cuts) is a huge mistake when the government is already facing huge debts. As I’ve said before, too much debt created this crisis. We will not rescue ourselves by piling on more.
The only solution is for Americans to learn to live with less.
In his fantastic book George Cooper shows how Keynesian principles are the shovel we used to dig ourselves into this hole in the first place. Economists have convinced the world that economies naturally converge to a “steady state rate of growth.” Growth, in other words, is normal. If the economy isn’t growing, something is wrong and policy levers should be pulled to fix it. Lower interest rates and/or increase government spending. Both solutions are of a piece: run up debt to finance our way back to “growth.”
As time goes by, however, it takes more units of debt to drive the same amount of growth. Eventually our debts gets so heavy we can’t carry them; either we pay off them off or we default (explicitly by stopping payment or implicitly by inflating away debt’s real value). As the chart shows (click to enlarge), we Americans aren’t good at paying down our debts. We just watch them grow.
[Aside: is it any wonder middle-class wage earners can't get ahead? Working hard and saving money isn't enough to compete for resources in the American economy. No, you need to leverage your savings, marshaling a pile of debt financing in order to acquire assets.]
Preventing the credit cycle from turning over means we inflate ever larger debt bubbles to maintain the level of economic activity we’ve come to believe is “normal.” My belief is that our debt level has grown so oppressively huge that any short-term benefits from government “stimulus” will be washed away by some combination of higher taxes, higher interest rates, and higher inflation later on. All of which will leave us worse off than if we’d done nothing.
One unintended consequence of stimulus will likely be higher interest rates. With the passage of the stimulus bill, the government’s fiscal deficit for 2009 will likely quadruple to $1.6 trillion. 2008’s deficit of $455 billion was already a record. Do we really think flooding the market with Treasuries isn’t going to increase interest rates? Continued financial panic may continue “flight-to-safety” buying, but when things return to “normal” and investors want to trade out of government debt, it will be much more expensive to roll it over. As Treasury interest rates increase, so too will other interest rates. And that will hammer asset values across the economy.
A more normal level for the 10-year bond is 6%, that’s 300 bps above current levels. Assuming the spread of mortgage rates over treasuries holds at about 200 bps, then increasing the Treasury interest rate from its current 3% to a more “normal” 6% would boost mortgage rates from 5% to 8%. Holding all other inputs constant, that would imply a further 27% decline in house prices.* What do we think is going to happen to balance sheets across the country if house prices, which have already fallen 25% nationwide, fall another 27%?
And what about taxes and inflation? The government’s primary source of revenue is tax collections. If it spends more, at some point it will have to collect more. This crisis will not be over in a year. Believing that the stimulus and aggressive Fed action will somehow deliver us back to growth, thus making it easy to raise taxes to pay for the additional spending, is far more ludicrous that anything I’ve said. So we can’t raise taxes to pay the additional debt without also hammering the economy back into a depression.
The only choice left is to inflate. Maybe we think the Fed can extinguish the real value of the debt by inflating the currency. But that’s no solution either. It’s just another tax. Not directly on our income we make, but indirectly on the purchasing power of our income and our savings! Taxes, inflation, and higher interest rates. All will be a consequence of more deficit-spending by the government. And all will make us poorer than if we just did nothing. The reality is this down cycle is going to make us poorer no matter what. Our country’s GDP of $13.5 trillion in 2007 was artificially inflated by a massive and unsustainable debt bubble. Paying down the debt means GDP is going to shrink. Either we learn to live with it, or we use a Keynesian shovel to dig ourselves an even deeper hole.
Ailing Banks May Require More Aid to Keep Solvent
Some of the nation’s large banks, according to economists and other finance experts, are like dead men walking. A sober assessment of the growing mountain of losses from bad bets, measured in today’s marketplace, would overwhelm the value of the banks’ assets, they say. The banks, in their view, are insolvent. None of the experts’ research focuses on individual banks, and there are certainly exceptions among the 50 largest banks in the country. Nor do consumers and businesses need to fret about their deposits, which are federally insured. And even banks that might technically be insolvent can continue operating for a long time, and could recover their financial health when the economy improves.
But without a cure for the problem of bad assets, the credit crisis that is dragging down the economy will linger, as banks cannot resume the ample lending needed to restart the wheels of commerce. The answer, say the economists and experts, is a larger, more direct government role than in the Treasury Department’s plan outlined this week. The Treasury program leans heavily on a sketchy public-private investment fund to buy up the troubled mortgage-backed securities held by the banks. Instead, the experts say, the government needs to plunge in, weed out the weakest banks, pour capital into the surviving banks and sell off the bad assets. It is the basic blueprint that has proved successful, they say, in resolving major financial crises in recent years.
Japan endured a lost decade of economic stagnation in the 1990s before it adopted such measures from 2001 to 2003. The Swedish government took tough steps in 1992 and Washington did so in 1987 to 1989 to overcome the savings and loan crisis. "The historical record shows that you have to do it eventually," said Adam S. Posen, a senior fellow at the Peterson Institute for International Economics. "Putting it off only brings more troubles and higher costs in the long run." Of course, the Obama administration’s stimulus plan could help to spur economic recovery in a timely manner and the value of the banks’ assets could begin to rise. Absent that, the prescription would not be easy or cheap. Estimates of the capital injection needed in the United States range to $1 trillion and beyond. By contrast, the commitment of taxpayer money is the $350 billion remaining in the financial bailout approved by Congress last fall.
Meanwhile, the loss estimates keep mounting. Nouriel Roubini, a professor of economics at the Stern School of Business at New York University, has been both pessimistic and prescient about the gathering credit problems. In a new report, Mr. Roubini estimates that total losses on loans by American financial firms and the fall in the market value of the assets they hold will reach $3.6 trillion, up from his previous estimate of $2 trillion. Of the total, he calculates that American banks face half that risk, or $1.8 trillion, with the rest borne by other financial institutions in the United States and abroad. "The United States banking system is effectively insolvent," Mr. Roubini said. For its part, the banking industry bridles at such broad-brush analysis. The industry defines solvency bank by bank, and uses the value of a bank’s assets as they are carried on its books rather than the market prices calculated by economists.
"Our analysis shows that the banks have varying degrees of solvency and does not reveal that any institution is insolvent," said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, a trade group whose members include the largest banks. Edward L. Yingling, president of the American Bankers Association, called claims of technical insolvency "speculation by people who have no specific knowledge of bank assets." Mr. Roubini’s numbers may be the highest, but many others share his rising sense of alarm. Simon Johnson, a former chief economist at the International Monetary Fund, estimates that the United States banks have a capital shortage of $500 billion. "In a more severe recession, it will take $1 trillion or so to properly capitalize the banks," said Mr. Johnson, an economist at the Massachusetts Institute of Technology.
At the end of January, the I.M.F. raised its estimate of the potential losses from loans and other credit securities originated in the United States to $2.2 trillion, up from $1.4 trillion last October. Over the next two years, the I.M.F. estimated, United States and European banks would need at least $500 billion in new capital, a figure more conservative than those of many economists. Still, these numbers are all based on estimates of the value of complex mortgage-backed securities in a very uncertain economy. "At this moment, the liabilities they have far exceed their assets," said Mr. Posen of the Peterson institute. "They are insolvent." Yet, as Mr. Posen and other economists note, there are crucial issues of timing and market psychology that surround the discussion of bank solvency. If one assumes that current conditions reflect a temporary panic, then the value of the banks’ distressed assets could well recover over time. If not, many banks may be permanently impaired.
"We won’t know what the losses are on these mortgage-backed securities, and we won’t until the housing market stabilizes," said Richard Portes, an economist at the London Business School. Raghuram G. Rajan, a professor of finance and an economist at the University of Chicago graduate business school, draws the distinction between "liquidation values" and those of calmer times, or "going concern values." In a troubled time for banks, Mr. Rajan said, analysts are constantly scrutinizing current and potential losses at the banks, but that is not the norm. "If they had to sell these securities today, the losses would be far beyond their capital at this point," he said. "But if the prices of these assets will recover over the next year or so, if they don’t have to sell at distress prices, the banks could have a new lease on life by giving them some time."
That sort of breathing room is known as regulatory forbearance, essentially a bet by regulators that time will help heal banking troubles. It has worked before. In the 1980s, during the height of the Latin American debt crisis, the total risk to the nine money-center banks in New York was estimated at more than three times the capital of those banks. The regulators, analysts say, did not force the banks to value those loans at the fire-sale prices of the moment, helping to avert a disaster in the banking system. In the current crisis, experts warn, banks need to get rid of bad assets quickly. The Treasury’s public-private investment fund is an effort to do that. But many economists and other finance experts say that the government may soon have to take on troubled assets itself to resolve the credit crisis. Then, they say, the government could wait for the economy to improve.
Initially, that would put more taxpayer money on the line, but in the end it might reduce overall losses. That is what happened during the savings and loan crisis, when the troubled assets, mostly real estate, were seized by the Resolution Trust Corporation, a government-owned asset management company, and sold over a few years. The eventual losses, an estimated $130 billion, were far less than if the assets had been sold immediately. "The taxpayer money would be used to acquire assets, and behind most of those securities are mortgages, houses, and we know they are not worthless," Mr. Portes said.
A Proposal to Shore Up Banks With Pension Funds
Financial institutions in the United States probably need hundreds of billions of dollars in additional assistance, and one congressman wants to harness state and local pension funds to help them. Rather than rely more heavily on the Treasury, which has already put $350 billion in the nation’s banks, Representative Gary L. Ackerman sees an opportunity in the trillions of dollars in public pension funds. Most of the funds suffered giant losses last year in the market turmoil. But they do not need all of their assets immediately, because their time horizon for paying benefits is decades long.
Mr. Ackerman, Democrat of New York, is sponsoring legislation that would allow public pension funds to pool some of their money and use it to create a sole-purpose entity that would buy $50 billion to $250 billion worth of preferred stock in America’s banks. That would strengthen the banks’ balance sheets and, Mr. Ackerman hopes, get them lending again. "Some of us are getting tired of writing checks with public money" and seeing no results, Mr. Ackerman said. He said pension fund officials who had heard about the measure so far were eager to participate. Since the nation’s banks are shaky, and pension funds cannot afford more investment losses, Mr. Ackerman’s measure also calls for the Treasury to guarantee the funds’ principal, plus an annual return of about 8.5 percent.
This guarantee would solve one of the biggest problems now facing most public pension funds: They need to achieve average annual investment returns of 8 percent, and in today’s markets, they cannot do so with the types of securities they are required to invest in. Plan rules generally limit the amount of market risk the plans can take on. At the moment, risk-free assets like Treasury bills are paying next to nothing. The benchmark 10-year Treasury is yielding just under 3 percent. If public pension funds had to adjust their numbers to reflect the bleak state of the stock and bond markets, many would no longer be viable. Even if they lowered their investment-return assumptions by three percentage points — to 5 percent, which is the rate of return the Treasury has been promised on its bank investments — their business models would no longer make sense.
The models typically call for two-thirds of the cost of the benefits promised to retirees to be covered by investment gains. At 5 percent a year, on average, the investments will not generate enough cash. Getting the plans back into balance would then mean pumping in lots of cash, which presumably would come from taxpayers in the states and municipalities that sponsor the plans. Local governments would be hard-pressed to come up with extra money in this downturn. A federally guaranteed return of 8.5 percent, meanwhile, would avoid such misery, and give the public pension funds a new lease on life. There would, of course, be considerable risk that the banks would not be able to generate those returns, in which case the federal government would be on the hook, as it would for any loss of the funds’ principal, under the proposal.
Mr. Ackerman, a member of the House Financial Services Committee, has been circulating a draft bill and assessing support. The bank investment program would be available only to public pension funds, not pension funds sponsored by companies. The corporate plans are covered by federal funding rules and as a result tend to be stronger. Some public plans have made mistakes during the boom years. The state of New Jersey, for instance, used its pension fund to balance the state budget for a number of years and parted with hundreds of millions of dollars, something a corporation would not be allowed to do.
The state of Illinois has a pension model that assumes the benefits will never be entirely funded instead of covered over 30 years, as is generally required. In Pennsylvania, the state legislature passed a law in the 1980s allowing local governments to contribute smaller amounts than what is actuarially required to meet their obligations. Mr. Ackerman and his advisers acknowledged that some public pension funds had made missteps, but said there was not time to tighten up the whole sector’s practices before starting a bank bailout. There are about 2,700 public pension funds in the United States. "Sometimes, you have to do things to benefit people who didn’t behave so well," Mr. Ackerman said, explaining that the need to keep public pension funds afloat and promote bank lending were too urgent to wait. How such a plan would work with the Treasury’s newest assistance package for banks, set to be unveiled Tuesday, was not clear.
Pensioners face deflation cut to benefits
Pensioners could face a cut in benefits this autumn as UK inflation looks to head negative. The Bank of England's Inflation Report shows the consumer prices index (CPI) – which the monetary policy committee aims to keep at two per cent – is likely to drop below one per cent this year and roughly stay there until 2012. However, the Retail Prices Index (RPI), which is used to ensure pensions keep line with the cost of living, is expected to become negative. RPI has fallen sharply recently as interest rate cuts have lowered mortgage repayments – which are included in the index but not in the CPI.
The bank warned in its report further interest rate cuts would "push down further on RPI inflation". RPI stood at 0.9 per cent in December, down from three per cent in November and five per cent in the summer. Further falls are expected when inflation data is published next week. Tony Dolphin, senior economist at the Institute for Public Policy Research, predicted RPI falling to as low as -3 per cent – the UK's first experience of deflation since 1960. "A negative rate of inflation in September, measured using the retail price index, will be a particular problem for the government because this is the inflation rate used to index the State pension and other welfare benefits," he said.
"A cut in benefit rates is extremely unlikely, but in deciding by how much to increase them the Government will have to balance the pressures to constrain public spending growth and the risk of a repeat of the furore in 2000 when the State pension was increased by just 75p." He added ensuring benefit payments rose would also aid the economy. "Increasing benefits would alleviate hardship amongst some of the most vulnerable sections of society, boost their spending power and so encourage consumer spending," Mr Dolphin said. "This would help to counter the recessionary forces in the economy."
Matthew Furniss, senior consultant at financial services group Punter Southall, claimed deflation could be an aid to pensioners and provided "at least one glimmer of positivity". "Deflation is clearly of concern to the UK economy as a whole but, surprisingly, may actually impact pensioners favourably thanks to their spending habits and the way that both company and state pensions are calculated," he said. He explained recent energy, food and fuel price hikes had hit pensioners particularly hard. "Although pensioners were the worst hit from recent inflation, they are, for the same reasons and to a similar extent, those most likely to benefit from falling prices particularly in energy," Mr Furniss said.
He added low inflation will aid those pensioners relying on savings will benefit from deflation. "Low nominal interest rates would become higher real interest rates when compared with negative inflation." He added the rise in the basic pensions for April – set on last September's RPI standing of five per cent – will be the largest increase since 2001. "The government has also recently ensured that the basic state pension will increase by a minimum of 2.5 per cent each year which will safeguard any future increases from deflation. "Company pensions are also protected from deflation as they cannot normally be reduced and a proportion of pensions are increased by fixed percentages, normally between 2.5 per cent and five per cent per year."
Fannie And Freddie Redux
Washington seems to be reviving FannieMae and FreddieMac to stave off foreclosures among American home owners, putting the mortgage financiers to work to modify millions of souring loans. Wall Street was abuzz late Thursday with a Reuters report that quoted sources as saying the government-run agencies would use their size and expertise to help restructure loans that are primed to go bust amid a deteriorating economy. The Dow Jones industrial average reversed a 200-plus-point loss to end the day relatively unchanged on the idea that homeowners who have not missed payments but are likely to do so, would receive aid including some measure of government subsidy.
"It could well be that Fannie Mae and Freddie Mac could be refinancing vehicle for loan modifications," said Thomas Lawler, a former Fannie Mae chief economist. "They could set the standards for what a good loan modification should be and then make those systems available so lenders could use them. "They have the best underwriting systems in the world and they are just being wasted right now," Lawler added. "They’ve spent tens, maybe hundreds, of millions of dollars on these systems. Why not take advantage of this? They’re already part of the government." The quasi-public Fannie and Freddie were placed under conservatorship last year amid fears that they could collapse in the wake of the subprime mortgage crisis.
Obama eyes home loan subsidies in rescue plan
The Obama administration is hammering out a program to subsidize mortgages in a new front to fight the credit crisis, sources familiar with the plan told Reuters on Thursday, boosting financial markets. In a major break from existing aid programs, the plan under consideration would seek to help homeowners before they fall into arrears on their loans. Current programs only assist borrowers that are already delinquent. Wall Street stock indexes quickly retraced earlier losses on the report, with the blue-chip Dow Jones industrial average jumping 245 points, or 3.0 percent, to close just 6 points lower on the day. Earlier in the session, stock prices had been testing lows seen last November on investor worries about the economy.
Under the evolving plan, sources said homes would undergo a standardized reappraisal and homeowners would face a uniform eligibility test. The administration may also lower the trigger level that decides who would be eligible for relief. Under an existing program, loans are reworked if a borrower is spending more than 38 percent of their gross income on their mortgage. In an interview, James Lockhart, the regulator who oversees government-controlled mortgage finance companies Fannie Mae and Freddie Mac, told Reuters the industry was eager to have a standardized loan modification standard. "I've talked to all the major servicers -- both the big bank ones and the big independent ones -- and they are all ready to go, they're chomping at the bit," Lockhart, the director of the Federal Housing Finance Agency, said. "The other thing they're asking for standardization." However, he declined to speculate on any plans the administration may be considering. The Treasury Department, which is taking the lead role in financial rescue efforts, did not respond to a request for comment.
A rising wave of U.S. mortgage delinquencies has saddled the global banking system with big losses that have led banks to recoil from lending, choking economies around the globe. U.S. Treasury Secretary Timothy Geithner this week outlined a plan to take up to $1 trillion in bad assets off the banks' books in the hope of restarting lending. He also vowed the administration would spend $50 billion to combat foreclosures. Geithner said on Thursday the administration would soon put a housing program in place that uses "a mix of incentive and persuasion" to get mortgage companies to rewrite loans. "The key elements of the strategy are going to bring mortgage interest rates down to help avoid the foreclosures that we can reasonably expect to avoid," he said.
Late mortgage payments and home foreclosures hit record highs last year. Foreclosure filings eased last month, but were still 18 percent higher than a year ago, industry research firm RealtyTrac said on Thursday. Sources said Fannie Mae and Freddie Mac would play a supporting role in the new plan, but said the two companies are not expected to repackage the reworked loans as securities for investors, a main line of their business. Homeowners would have to make a case of hardship to qualify for new loan terms, according to the sources. Officials weighed, but have shelved for now, another plan that would have the government stand behind low-cost mortgages of between 4.0 percent and 4.5 percent, the sources said.
Howard Glaser, a housing official in the Clinton administration, said the type of program under discussion would give officials more "bang for the buck" than the government would get by guaranteeing troubled loans. "Federal purchase or guarantee of these same distressed mortgages would be vastly and prohibitively expensive," he said. Subsidizing existing mortgages would have the added benefit of using the mortgage companies' existing infrastructure, rather than creating a new bureaucracy. Lockhart said policy-makers are eager to prevent a large drop in home values from their current, deflated levels. "Just as we had a large overshooting to the upside. Is there any way to prevent going much further to the downside? That will cause tremendous harm to the U.S. economy, to the financial system and it's not necessary," he said.
Winners and losers in the final stimulus bill
Here is a breakdown of who gained, who lost and who survived in the final economic stimulus bill that the House and Senate are expected to vote on Friday:
• High-speed and inner-city rail: Went from $300 million in House bill to $2.25 billion in Senate to $8 billion in final version. There also is a $6.9 billion provision for public transit.
• Amtrak: Picked up $500 million from both House and Senate versions to total $1.3 billion. The bill stipulates that no more than 60 percent can go to the Northeast Corridor.
• National Institutes of Health: Ends up with $10 billion in the final bill. The House proposed $3.5 billion and the Senate wanted $10 billion -- $8.2 billion goes to the NIH director for his discretion.
• Government oversight: Board to oversee stimulus bill spending will get $84 million to do the job. House bill allocated $14 million while the Senate bill called for $7 million. There is also more than $100 million more for various inspectors general in different agencies.
• NASA: Banked just more than $2 billion, including $400,000 for science/global-warming research. Watch congressional comments on the stimulus bill »
• Veterans: Nearly all items for Veterans Affairs were reduced and the $2 billion the Senate wanted for VA construction was wiped out altogether. The VA did get one thing: $1 billion for medical facilities renovation and retooling.
• Military construction: Cut and put into a general pot, a change from targeted money for each branch of the services. Army construction alone went from $600 million in the Senate and $900 million in the House to $180 million in the final bill. But negotiators compromised over a general military construction fund -- the House wanted $3.75 billion while the Senate allocated $118 million and settled on $1.45 billion for all services.
• FBI: Senate had allocated $475 million but all was cut out of final bill.
• Pandemic flu research: Although senators agreed it wouldn't produce jobs, it's getting $50 million in the final bill, down from nearly $900 million. W »
• Foreclosures: $2 billion is set for a neighborhood stabilization program that helps areas plagued with foreclosures by buying back properties and preventing blight.
• Homeless: $1.5 billion is directed to homelessness prevention.
• Passports: $90 million is going to the State Department to deal with domestic facilities that deal with passports and training.
• Social Security: $500 million goes to replace its 30-year-old computer system.
• Car buyers: Anyone who buys a new car in 2009 gets to deduct the sales tax. To qualify, buyer must make $125,000 individually or $250,000 jointly. Cost is $1.7 billion.
• Homebuyers: First-time homebuyers who purchase this calendar year get an $8,000 tax credit which does not have to be repaid like a similar measure last year. This phases out for people making more than $75,000 individually or $150,000 jointly. "First-time homebuyer" is defined as someone who has not owned a home for the past three years. Cost: $6.63 billion.
Paying for college
• Pell grants: will increase to a maximum of $5,350 per student in 2009-2010 year thanks to two provisions in the stimulus.
• Tax credits: Individuals making less than $80,000 or families making less than $160,000 can get up to $2,500 in tax credits for college tuition. 40 percent ($1,000) of the credit is refundable. Cost: $13.9 billion over 10 years.
Making work pay
•Tax credits: Anyone making $75,000 individually or $150,000 as a family will get refundable tax credit up to $400 per person or $800 per family.
Derivatives Oversight Spurs House Turf Battle
The House agriculture committee voted Thursday to give an agency it oversees expanded control over financial products, an opening shot in a congressional turf battle over regulatory overhauls. President Barack Obama wants to toughen control over Wall Street products blamed for exacerbating the financial crisis, such as the betting on debt defaults that contributed to American International Group Inc.'s downfall. But the effort faces obstacles, among them the traditional bailiwicks in Congress for overseeing regulation. The agriculture committees in the House and Senate oversee the Commodity Futures Trading Commission, the agency that long regulated agriculture-linked products like soybean futures but has seen its ambit grow to include some financial instruments. Meanwhile, financial committees in both houses of Congress are setting their own plans for a regulatory overhaul. The House agriculture committee approved a bill by voice vote Thursday that would give the CFTC primary oversight of derivatives that trade outside of traditional exchanges such as the New York Stock Exchange. The bill would limit the role of the Federal Reserve in the oversight.
The bill said over-the-counter derivatives must be cleared through a firm regulated by either the CFTC or, in the case of financial derivatives, the Securities and Exchange Commission. Certain transactions could be excluded, but the CFTC would still collect information on them and impose some requirements. The move by the House committee jumps ahead of the Obama administration, which hasn't laid out its vision for overhauling regulation of financial institutions and markets. And it directly conflicts with what Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee, has said he would like to get done. Mr. Frank opposes the derivatives bill and is disappointed that the House agriculture committee moved ahead without his committee's input, an aide said. Mr. Frank's committee has oversight of the Fed and the SEC. Mr. Frank is beginning work on legislation that would establish a systemic-risk regulator with oversight over financial institutions and markets that could damage the system at large, including over-the-counter derivatives. The Massachusetts Democrat has said that role could go to the Fed, but he remains open to suggestions. An outline is expected by April.
Jurisdictional battles have long been a feature of financial regulation and stand to pose problems as Congress and the Obama administration turn to regulatory questions. In recent weeks, Mr. Frank asked Rep. Collin Peterson (D., Minn.), chairman of the House agriculture committee, to split jurisdiction. Mr. Frank suggested giving the agriculture committee oversight of commodities that are "edible," meaning futures on agricultural products, with the Financial Services Committee getting everything else. Mr. Frank said the proposal was rejected. Rep. Peterson has been opposed to waiting to address derivatives as part of a broader reorganization of financial regulation. At the center of the regulation debate is the credit-default swap -- a way for market participants to bet on the likelihood that a company or other debt issuer will default on its obligation. One estimate puts the size of the credit-default-swap market at $54 trillion.
The government bailout of AIG was driven in part by the positions AIG took on credit-default swaps. The collapse of Lehman Brothers, another big player in the market, triggered trauma in the financial system. Regulators have been calling for a clearinghouse that would impose capital and margin requirements and stand between players to absorb risk. The SEC approved the first of these in December. Use of it isn't mandatory, and the turf war between that agency and others over the ultimate shape of the clearinghouses continues. The House agriculture committee bill dropped a provision that would have banned market participants from trading in credit-default swaps unless they had a position in the underlying security. The provision on so-called naked credit-default swaps was widely criticized by Wall Street groups. The bill does give the CFTC the authority under certain circumstances to suspend trading in naked credit-default swaps after conferring with the president. It would also require the CFTC to set limits on the size of positions taken on nonfinancial commodities.
Insurers Get Regulatory Approvals
Hartford Financial Services Group Inc. said state regulators had approved the easing of certain requirements, boosting the capital level of its life-insurance units by nearly $1 billion, or about 20%, while Lincoln National Corp. won approval for about $300 million in relief. The regulatory approvals give the insurers more breathing room in how they deploy their capital and reduce the odds that they will raise capital. Hartford disclosed the approval in a regulatory filing that also confirmed that recent ratings downgrades make the company ineligible to participate in a program under which the government serves as a backstop to U.S. issuers of commercial paper. Hartford has $375 million outstanding under the program, which it said it would pay upon maturity from existing sources of liquidity.
Hartford shares ended the day down nearly 8% to $12.54 in 4 p.m. composite trading on the New York Stock Exchange, and Lincoln ended flat at $14.77. Hartford's effort to seek an easing of the rules has been one of the highest-profile of a growing number to surface in recent weeks as insurers wrap up filings for calendar year 2008. The regulatory approvals are coming in the face of opposition from consumer-advocacy groups and some independent experts, who fear a weakening of protections for policyholders. One chunk of relief for Hartford is tied to the calculation of reserves to back the minimum-return guarantees of variable annuities. The market downdraft has ratcheted up the liability for these guarantees. Hartford has been one of the nation's leading sellers of these products for much of this decade. Insurers have argued that the existing reserve methodology is overly conservative, because it ignores some fees paid by consumers that can be used to offset the liability. Before last year's market slide, the National Association of Insurance Commissioners debated a new methodology and voted to put it in place for filings for calendar year 2009.
In effect, Hartford won permission to speed up adoption of the new methodology. The other relief relates to the accounting treatment of deferred-tax assets, which are credits that a company aims to use to offset future taxes. They have value to the extent that a company generates a profit in future years and can put them to use. Lincoln similarly sought to book more of these as assets, and said its regulators in Indiana have given approval. In a recent letter, the Center for Economic Justice and the Consumer Federation of America asked Connecticut's insurance commissioner, Thomas Sullivan, if it would "be appropriate" to recuse himself from a Hartford decision, as he previously was an executive there. Mr. Sullivan responded that it had been nearly two years since he left the job, and his family didn't have a financial interest that would pose a conflict under Connecticut's ethics code. Meanwhile, Moody's Investors Service on Thursday downgraded the life-insurance units of Protective Life Corp., which is seeking regulatory relief from two states, to A2 from A1. Separately, Hartford said its property-casualty unit doesn't expect losses to be material from exposure to the alleged fraud of Bernard L. Madoff Investment Securities.
French growth tumbles in Q4, government sees 2009 in red
France's economy shrank at the fastest pace in 34 years in the fourth quarter of 2008 as business investment and exports collapsed, prompting the government to say it expected negative growth this year. National statistics office INSEE said on Thursday gross domestic product fell 1.2 percent in the last three months of last year compared with the previous quarter, more than expected, bringing economic growth for 2008 to 0.7 percent. Economists had predicted a quarterly fall of 1.1 percent after growth of 0.1 percent in the third quarter. "This bad figure reflects in large part a very significant destocking by companies, which indicates a wait-and-see attitude in the face of uncertain growth and the crisis in the automobile sector," Economy Minister Christine Lagarde said in a statement.
The figures were published a day early after a group of statisticians leaked them in protest at the government's early announcement of some statistics. The announcement by the euro zone's second biggest economy came a day before fellow heavyweights Germany and Italy were expected to announce their own steep GDP falls, and it followed a similarly grim statement by Spain. Spain's economy shrank 1 percent in the fourth quarter, its biggest quarterly fall in 15 years, pushing it into recession for the first time since 1993. Lagarde said she expected GDP to fall by at least 1 percent in 2009 but took heart from the fact that household consumption, a key driver of French growth, had held up in the last quarter of 2008, rising 0.5 percent.
French President Nicolas Sarkozy has struggled to convince a sceptical public that he has chosen the right strategy to fight the economic downturn sparked by the global financial crisis. More than 1 million people took to the streets this month to protest at his economic policies, which favour public investment in projects such as building roads and modernising train lines rather than giving more help directly to consumers. Sarkozy made a live television appearance last week to try to win support for measures including his 26 billion euro ($33.16 billion) stimulus plan but polls have shown his approval rating has fallen since then. Much of the GDP data published on Thursday will heighten fears about the state of the economy.
"The fourth-quarter contraction is the worst since the fourth quarter of 1974, after the first oil shock," BNP Paribas analyst Dominique Barbet said. Business investment fell 1.5 percent in the fourth quarter while public investment dropped 1.6 percent. Exports tumbled 3.7 percent and imports slid 2.2 percent, while stocks declined by 0.9 percent, data showed, confirming grim news from companies. France has announced it will provide 6 billion euros in loans to its carmakers Renault and PSA Peugeot Citroen, which have been hit hard by the slowdown and complained of draconian credit conditions. Peugeot said on Wednesday it expected to remain in the red until 2010 after spending nearly 1 billion euros to slash stocks of unsold cars last year and on Thursday Renault scrapped its 2009 profit targets, dropped its divided and slashed output.
There were, however, some bright spots in the French data. "The breakdown comes as a real surprise," Barbet said, citing the robust household consumption figure. "Other components of domestic demand also slightly exceeded expectations, housing down only 0.3 percent quarter on quarter and business investment down 1.5 percent," he said. Lagarde said France, like its neighbours, had suffered in the downturn at the end of last year, and highlighted the fact that French economy grew in the third quarter, a better performance than many western European countries.
Lloyds Shares Tumble 40% on HBOS’s 10 Billion-Pound Pretax Loss
Lloyds Banking Group Plc fell the most in at least 20 years in London trading after saying it expects HBOS Plc, the U.K. lender it took over last month, to report a 10 billion-pound ($14.5 billion) pretax loss. HBOS posted about 7 billion pounds of losses on loans to companies in 2008, London-based Lloyds said in a statement today. That’s more than double HBOS’s own forecast of two months ago. "It worries you about what’s coming up, and how quickly things are deteriorating," Leigh Goodwin, a London-based analyst at Fox-Pitt Kelton Ltd. with an "in-line" rating on the shares, said in a telephone interview today. "The important question is whether this is a trend or is a particular situation at the end of the year."
Lloyds Chief Executive Officer Eric Daniels said this week the bank would have done "three to five times" more due diligence on the government-brokered takeover had it not been for time pressures. Lloyds agreed to buy HBOS as the U.K.’s biggest mortgage lender came close to collapse when credit markets froze after Lehman Brothers Holdings Inc.’s bankruptcy. Lloyds shares tumbled as much as 40 percent, the most since at least September 1988, and traded down 28 percent at 65.9 pence at 3:45 p.m. in London, valuing the company at 10.9 billion pounds. Lloyds TSB originally agreed to pay 10.4 billion pounds in stock for HBOS. Three weeks after announcing the deal, the banks cut the price and accepted 17 billion pounds from the government to boost capital. The U.K. government now has a 43 percent stake in Lloyds through ordinary and preference shares.
Chancellor of the Exchequer Alistair Darling said he was "aware" of the figures. Speaking to reporters in Rome today, he declined to comment further. "It looks increasingly as if Lloyds is being dragged under by the dead weight of HBOS," said Vince Cable, who speaks on Treasury matters for the U.K.’s opposition Liberal Democrat party. "It looks increasingly as if Lloyds HBOS will now go into majority public ownership, followed inevitably by nationalization." HBOS has been hit by a decline in real estate values and corporate earnings as the U.K. economy entered a recession. The bank was also hurt by 4 billion pounds of writedowns linked to the turmoil in the credit markets. About 40 percent of HBOS’s 117 billion-pound corporate loan book was allocated to real estate, mostly commercial property.
"The impairments are principally as a result of applying a more conservative provisioning methodology consistent with that used by Lloyds TSB," the bank said. Lloyds TSB said it expects to report a 2.4 billion-pound pretax profit on continuing operations for 2008. Lloyds Banking Group said it its Tier 1 capital ratio, its cushion against losses, will probably be more than 9 percent as of Dec. 31. Pro-forma core Tier 1 capital ratio will be between 6 percent and 6.5 percent, the bank added. "Lloyds Banking Group possesses too little core capital confidently to address shareholder concerns in 2009, given the recent performance of the acquired loan portfolio," Deutsche Bank AG analysts Jason Napier and Andrew Hill said in a note to clients today. They advise investors to sell the stock.
Bit by bit, Gordon Brown's fantasy is being pulled apart by the facts
In China, they have show trials. The Communist Party's disciplinary inspection group doesn't mess about. Those it suspects of involvement in bribery and corruption are ritually humiliated, forced to confess and shot. The process is often put on video tape. Alleged culprits can be seen crying on cue, apologising to the people and reciting an ancient saying, the rough translation of which is: "One mistake and sorrow for a thousand years." In Britain, we do things differently. Which is just as well for the nine bankers (seven Britons, one American and a Spaniard) who this week appeared before the Treasury Select Committee, accused of wrecking the economy. Had the inquiry occurred in Beijing, it is likely that firing-squad rifles would have been loaded even before the chairman's opening remarks. For, in addition to destroying shareholder value and causing mayhem in the markets, bankers have embarrassed the Government. By their folly, they have helped expose, albeit unwittingly, the ignorance of ministers, flaws in the Financial Services Authority and impotence at the Bank of England. This will never do. What's more, they have established beyond dispute the Prime Minister's inability to pick a winner. Or, put another way, the Curse of Brown.
The Prime Minister's choice of banker to compile a report on ideas for improving public health was Sir Derek Wanless. This is the same D Wanless who was a Northern Rock director when it spontaneously combusted in 2007. Then came Sir James Crosby, the former HBOS chief executive, who was asked by Downing Street to look at how the mortgage market might be made more effective. More delicious still, he was appointed to the board of the FSA. Yes, the very same J Crosby who resigned this week after becoming embroiled in the who-said-what-to-whom row over failings of risk management at HBOS. When it comes to coincidences, the French believe "jamais deux sans trois". And blow me, it now seems that Glen Moreno will be forced out of his job as chairman of UK Financial Investments Ltd – the company set up to oversee the taxpayer's stake in the bailed-out banks – because of his links with a Liechtenstein trust accused of tax evasion. Had the issues not been so serious, Bankers on Trial would have made a jolly soap opera for enthusiasts of courtroom dramas. As it was, episode one turned into a depressing spectacle. Lord Stevenson and Andy Hornby, both formerly of HBOS, and their counterparts from RBS, Sir Tom McKillop and Sir Fred Goodwin, apologised profusely without ever appearing to have understood what went wrong, how it went wrong, or why it went wrong.
It was as though they were saying sorry for having been knocked over by an express train that whizzed in from nowhere. Mr Hornby, in particular, looked shocked and dazed; a forlorn figure whose elevation from marketeer at Asda to banking big-shot had been so rapid that his ears went pop. Along with others in the Gang of Four, Mr Hornby's excuse was, in essence, that nobody could have spotted the locomotive of destruction which smashed into the banks. It was beyond detection by even the most rigorous stress-testing models, a Black Swan event. Except that it wasn't. The growth of unsustainable borrowing did not happen overnight. Debt, vast unmissable mountains of it, had been building up on the balance sheets of consumers and companies for years. The banks had it shipped to their customers in pantechnicons. As long as it seemed that interest charges were being serviced, debt-delivery lorries kept arriving. Repayment in full of the monies lent was for wimps. Kidology became a currency of conviction. One did not need fancy banking qualifications to work out that such an accumulation of credit would eventually destabilise irresponsible borrowers and reckless lenders. A little common sense and a sub-GCSE command of adding-up were all that was required to identify looming disaster.
Banking, when done properly, is a simple business. As a reader reminded me, it requires the banks to ask just three questions. What is the borrower's ability to repay? What is the borrower's willingness to repay? What are we going to do if he doesn't repay? It's now clear that for much of the dodgy business done in sub-prime markets – mortgages for people on welfare – the answers to these questions were: don't know, haven't a clue and write off billions. For policy-makers, Bankers on Trial provided a welcome distraction from a rapidly deteriorating economy and the emergence of the D word in polite society. Paul Krugman, professor of economics at Princeton University and Nobel prize-winner, wrote recently, "this looks an awful lot like the beginning of the second Great Depression". Such a prospect cannot be accepted, at least not in public, by Mr Brown. He clings to the fantasy that, thanks to his genius of administration, British citizens are far better placed than competitors to handle a battering. Bit by bit, however, the credibility of that claim is being pulled apart by brutal facts, not least of which was the Office for National Statistics' revelation that while the number of foreign workers getting jobs in the UK continues to grow (up by 175,000 to 2.4 million last year), domestic unemployment is rising sharply.
Alistair Darling has given himself until April 22 to prepare his Budget, much later in the year than normal. At this rate, he'll need every minute. According to Business Monitor International, a research company specialising in country risk, "Britain is facing an unprecedented fall in its economic world ranking… from 12th place in 2007 to 21st in 2010". Its report, Britain on the Brink, says the UK economy is sliding out of the global premier league: "Despite enjoying 11 years of growth between 1997 and 2007, the UK ran a budget deficit of 1.7 per cent of GDP over this period, fuelling a fiscal time bomb. Faced with the financial burden of bailing out the banking sector and kick-starting the economy, the budget deficit will swell to an unsustainable 9.3 per cent of GDP in 2009." The scale of our problems is at last being recognised by the Bank of England, which has been way behind the curve in forecasting the speed and depth of recession. Mervyn King, the governor, whose style of communication is that of an Oxbridge professor addressing a village idiot, is preparing the way for unconventional measures to turn back the tide. "It is at this point," as Orwell wrote, "that the special connection between politics and the debasement of language becomes clear." For when the Bank talks of "quantitative easing", what it really means is printing money: increasing the amount of paper stuff swishing through the economy. You get more, I get more and, in a flash, we'll all be millionaires. You can see where this is going. From here, all roads lead to Harare.
Fed Calls Gain in Family Wealth a Mirage
The leap in wealth that Americans thought they were enjoying over the last several years has already turned out to be a mirage, according to new estimates by the Federal Reserve. In its triennial survey of consumer finances, released Thursday, the Fed found that the median net worth of American households increased by a seemingly healthy 17 percent between the end of 2004 and the end of 2007. But the gains were wiped out by the collapse in housing and stock prices last year. Adjusting for those declines, Fed officials estimated that the median family was 3.2 percent poorer as of October 2008 than it was at the end of 2004. The new survey offers one of the first glimpses of how American families were positioned financially as the roof fell in on the economy, and it provides some sense of how much wealth has been destroyed since then. Indeed, the destruction of wealth is still in full swing: housing prices are still falling, more than two years after the bubble peaked.
The survey suggests that the boom years were not all that wonderful even before the crisis set in. And it indicates that many households will have to greatly increase savings rates, which were below 1 percent, to make up for some of the lost wealth. Adjusted for inflation, the median household income actually edged down slightly over the three years ending in 2007. The mean, or average, household income jumped by a respectable 8.5 percent. But a growing share of that income came from investment profits rather than from wages and salaries. And the wealth that Americans were building was overwhelmingly in the form of paper profits that vanished as quickly as they had appeared.
Fed analysts estimated that 35.8 percent of the average family’s assets in 2007 were in "unrecognized capital gains," such as gains in the market value of houses that people had yet to sell. Slightly more than half of those unrecognized gains came from real estate, and the second biggest source was increases in the value of business assets. The Fed’s estimates, which are based on a survey of 4,422 households, are in line with estimates that economists have made about the aggregate plunge in wealth since the housing bubble began to deflate in 2006. Dean Baker, co-director of the Center for Economic Policy Research, estimated that the United States had lost $6 trillion in housing wealth since the peak of the bubble.
The Case-Shiller index of housing prices in 20 major cities, considered one of the most accurate barometers of such prices, has declined about 25 percent since mid-2006. On top of that, Mr. Baker estimated, an additional $6 trillion evaporated as a result of the plummeting stock market, for a total loss of $12 trillion since 2006. "I’m actually surprised that you didn’t see higher values on stock holdings," Mr. Baker said, noting that the median value of household stocks, adjusted for inflation, was slightly lower in 2007 than it was in 2001. "Even when we were near the peak of the bubble, things didn’t look that good, and they’re looking worse today," he said.
Debt Be Not Proud
"Are You Better Off Than You Were Four Years Ago?" Ronald Reagan famously asked during the 1980 presidential campaign. There aren't too many people who can answer in the affirmative, especially readers of Barrons.com, at least based on the Federal Reserve's latest Survey of Consumer Finances. Confirming what you already know, the wealthiest suffered the biggest hits to their net worth. Moreover, Americans, especially those aged 55 to 64 -- the peak earnings and wealth-accumulation years -- wound up worse off in 2008 than in 2004. The Fed Thursday released results of its latest exhaustive survey of the finances of American household. The triennial study covers 2004 to 2007, but the central bank's staff attempted to interpolate the impact of the massive collapse of asset prices in 2008.
The official survey period covered the happy days of 2004-07 that saw households' median net worth -- their assets minus liabilities -- rise 17.7%. During that period, the mean gain was 13.0%. (For those who snoozed through statistics, the mean is the average change. The median is the change right in the middle of the range, 50% above and 50% below.) We were sitting on a mound of unrealized capital gains in real estate, businesses, stocks and mutual funds back in 2007. But we added on debt to keep pace with the asset price increase, with borrowing for "residential real estate other than a primary residence" the fastest growing category. Remember condo flipping? Meanwhile, debt burdens for households in aggregate barely increased, the Fed said. But the incidence of families with high payments relative to income "increased notably." That sounds a lot like subprime borrowers.
Elsewhere, the Fed's data counters the notion that Americans weren't saving during that period. Now the Fed's definition differs from the usual income and spending data that get widely reported. By that measure, we were spending everything we made, and then some. The Fed's survey, by contrast, asks people whether they're salting anything away. In that case, most Americans were saving, in part because the Fed counts capital gains as income. So, no problem. As long as asset prices kept rising faster than liabilities, households could consume more than they took home in their pay packets. But, to paraphrase former Citigroup CEO Chuck Prince, the music stopped last year. The Fed estimates households' median net worth fell 17.8% in 2008 while the mean net worth plunged 22.7%. Consider what the difference between the two measures means: There were a lot of big hits to wealth that pushed the mean decline above the median drop.
Compared to 2004 levels, the median household net worth is down 3.2% by 2008, so the bull market in stocks and house prices were wiped out. The mean household wealth is down 12.7% during that period, which indicates the big guys and gals took big hits. By the way, the Fed's estimates for the declines in 2008 are based on the DJ Wilshire 5000 (their researchers omit the "DJ," which I'm loath to do as long as Dow Jones & Co. issues my paychecks) as of October. For residential housing, the Fed uses the LoanPerformance Home Price Index. In any case, the Fed's survey doesn't capture the loss in wealth resulting from the alleged $50 billion Ponzi scheme perpetrated by Bernie Madoff, which only came to light in December. These aren't just Palm Beach dowagers but professionals whose retirement accounts have evaporated or families who have sell their houses and move in with grandma and grandpa as the result of Madoff's alleged deeds.
It's only possible to skim the surface of the Fed's triennial survey of Americans' finances here. (You can get the entire report at the Fed's Web site, www.federalreserve.gov.) But the data confirm what's become evident in this credit crisis: Debt pumped up Americans' wealth during the bubble years. And after the bubble burst, assets shriveled but the liabilities remain. That's the problem policymakers face. Americans who are tapped out are reluctant to borrow and spend. Financial intermediaries that face losses are loath to lend and invest. A conundrum, indeed, for both the Obama administration and the Fed.
Geithner faces tough debut at G-7 meeting in Rome
U.S. Treasury Secretary Timothy Geithner makes a tough international debut Friday as the Group of Seven finance ministers meeting gets underway with the global economy tanking and governments searching for ways to ease the slump. Officials from the leading industrial nations will discuss new financial market rules, concerns about protectionist measures, and the effect of the crisis on poorer countries. But a major breakthrough would be a surprise, as the meeting comes ahead of a broader, 20-country summit in April. "I don't think I have heard anything imaginative to get the problem resolved. I think they are using worn out prescriptions from a different time," says Peter Morici, a University of Maryland business professor. "I expected there would be more progress on bank reform. But the basic problem is the global trading system is broken, and that is even more fundamental to the banks." As the finance ministers reached Rome, the echo of the global slowdown could be felt on the streets of the Italian capital, where tens of thousands of workers and laid-off employees staged demonstrations against the government's handling of the crisis.
Geithner arrived Friday morning with Federal Reserve Chairman Ben Bernanke, and was spending the day in meetings with his counterparts from Britain, Canada, Italy, Germany and Japan — saving a one-on-one with the French finance minister for her visit to Washington next week. Geithner was also holding discussions Friday with Russian Finance Minister Alexei Kudrin, who is joining the meeting. The group was to come together for a dinner Friday night before a day-long meeting Saturday. Geithner will update finance ministers on the Obama administration's efforts to deal with the USA's financial crisis and recession, and hear what their countries are doing to address the downturn. The absence of rising global economic stars China and India, among others, has created a growing consensus that the G-7 isn't the right forum to tackle some of the tough questions facing the world. Those countries will be at the G-20 summit in April bringing together industrial and developing nations to advance efforts to cope with the economic crisis and prevent a reccurence.
There will likely be discussions about common rules for financial markets to improve transparency, governance and the circulation of capital. Morici said the group — home to some of the world's biggest banks — is the right forum to tackle bank reform. Germany is warning against protectionism as a knee-jerk reaction to the crisis. Such measures would be devastating to the German economy, which is powered by exports — and German Chancellor Angela Merkel already has voiced concern about the U.S. bailout plan for automakers. The meeting will also focus on the impact of the crisis on poor countries and on what measures can be taken to mitigate the consequences, particularly where food security is threatened. German Finance Minister Peer Steinbrueck will advocate an action plan to reform the world financial system and a collective exit strategy, deputy minister Joerg Asmussen told reporters Wednesday. While many experts discuss how to prevent a future crisis, "the priority really is how to get out of this one," Pierpaolo Benigno, an economist at Rome's LUISS University said. "Obviously the design of the financial architecture, I think, is a second step objective. The priority is how long will it take to exit this crisis."
Laid-Off Foreigners Flee as Dubai Spirals Down
Sofia, a 34-year-old Frenchwoman, moved here a year ago to take a job in advertising, so confident about Dubai’s fast-growing economy that she bought an apartment for almost $300,000 with a 15-year mortgage. Now, like many of the foreign workers who make up 90 percent of the population here, she has been laid off and faces the prospect of being forced to leave this Persian Gulf city — or worse. "I’m really scared of what could happen, because I bought property here," said Sofia, who asked that her last name be withheld because she is still hunting for a new job. "If I can’t pay it off, I was told I could end up in debtors’ prison."
With Dubai’s economy in free fall, newspapers have reported that more than 3,000 cars sit abandoned in the parking lot at the Dubai Airport, left by fleeing, debt-ridden foreigners (who could in fact be imprisoned if they failed to pay their bills). Some are said to have maxed-out credit cards inside and notes of apology taped to the windshield. The government says the real number is much lower. But the stories contain at least a grain of truth: jobless people here lose their work visas and then must leave the country within a month. That in turn reduces spending, creates housing vacancies and lowers real estate prices, in a downward spiral that has left parts of Dubai — once hailed as the economic superpower of the Middle East — looking like a ghost town.
No one knows how bad things have become, though it is clear that tens of thousands have left, real estate prices have crashed and scores of Dubai’s major construction projects have been suspended or canceled. But with the government unwilling to provide data, rumors are bound to flourish, damaging confidence and further undermining the economy. Instead of moving toward greater transparency, the emirates seem to be moving in the other direction. A new draft media law would make it a crime to damage the country’s reputation or economy, punishable by fines of up to 1 million dirhams (about $272,000). Some say it is already having a chilling effect on reporting about the crisis. Last month, local newspapers reported that Dubai was canceling 1,500 work visas every day, citing unnamed government officials. Asked about the number, Humaid bin Dimas, a spokesman for Dubai’s Labor Ministry, said he would not confirm or deny it and refused to comment further. Some say the true figure is much higher.
"At the moment there is a readiness to believe the worst," said Simon Williams, HSBC bank’s chief economist in Dubai. "And the limits on data make it difficult to counter the rumors." Some things are clear: real estate prices, which rose dramatically during Dubai’s six-year boom, have dropped 30 percent or more over the past two or three months in some parts of the city. Last week, Moody’s Investor’s Service announced that it might downgrade its ratings on six of Dubai’s most prominent state-owned companies, citing a deterioration in the economic outlook. So many used luxury cars are for sale , they are sometimes sold for 40 percent less than the asking price two months ago, car dealers say. Dubai’s roads, usually thick with traffic at this time of year, are now mostly clear.
Some analysts say the crisis is likely to have long-lasting effects on the seven-member emirates federation, where Dubai has long played rebellious younger brother to oil-rich and more conservative Abu Dhabi. Dubai officials, swallowing their pride, have made clear that they would be open to a bailout, but so far Abu Dhabi has offered assistance only to its own banks. "Why is Abu Dhabi allowing its neighbor to have its international reputation trashed, when it could bail out Dubai’s banks and restore confidence?" said Christopher M. Davidson, who predicted the current crisis in "Dubai: The Vulnerability of Success," a book published last year. "Perhaps the plan is to centralize the U.A.E." under Abu Dhabi’s control, he mused, in a move that would sharply curtail Dubai’s independence and perhaps change its signature freewheeling style.
For many foreigners, Dubai had seemed at first to be a refuge, relatively insulated from the panic that began hitting the rest of the world last autumn. The Persian Gulf is cushioned by vast oil and gas wealth, and some who lost jobs in New York and London began applying here. But Dubai, unlike Abu Dhabi or nearby Qatar and Saudi Arabia, does not have its own oil, and had built its reputation on real estate, finance and tourism. Now, many expatriates here talk about Dubai as though it were a con game all along. Lurid rumors spread quickly: the Palm Jumeira, an artificial island that is one of this city’s trademark developments, is said to be sinking, and when you turn the faucets in the hotels built atop it, only cockroaches come out. "Is it going to get better? They tell you that, but I don’t know what to believe anymore," said Sofia, who still hopes to find a job before her time runs out. "People are really panicking quickly."
Hamza Thiab, a 27-year-old Iraqi who moved here from Baghdad in 2005, lost his job with an engineering firm six weeks ago. He has until the end of February to find a job, or he must leave. "I’ve been looking for a new job for three months, and I’ve only had two interviews," he said. "Before, you used to open up the papers here and see dozens of jobs. The minimum for a civil engineer with four years’ experience used to be 15,000 dirhams a month. Now, the maximum you’ll get is 8,000," or about $2,000. Mr. Thiab was sitting in a Costa Coffee Shop in the Ibn Battuta mall, where most of the customers seemed to be single men sitting alone, dolefully drinking coffee at midday. If he fails to find a job, he will have to go to Jordan, where he has family members — Iraq is still too dangerous, he says — though the situation is no better there. Before that, he will have to borrow money from his father to pay off the more than $12,000 he still owes on a bank loan for his Honda Civic. Iraqi friends bought fancier cars and are now, with no job, struggling to sell them. "Before, so many of us were living a good life here," Mr. Thiab said. "Now we cannot pay our loans. We are all just sleeping, smoking, drinking coffee and having headaches because of the situation."
OPEC states struggle to pump less yet keep spending
Uncertainty about how far world fuel demand and oil prices will fall has made it harder than ever for OPEC members to agree on how to balance group output policy against the divergent needs of their individual budgets. Oil's collapse from almost $150 a barrel last July cut OPEC earnings by $356 billion in six months and they could drop by a further 50 percent this year, the group's Secretary-General Abdullah al-Badri said. But in 2008, the Organization of the Petroleum Exporting Countries made about $1 trillion, some of which it squirreled away for leaner times. With oil around $40, member countries can still turn a profit, especially as output costs have dropped.
"They're all laughing now in terms of operating costs," said Mike Wittner of Societe Generale. "But this isn't about operating costs. It's about funding the budget of the country." In a swift and collective supply response to oil's rapid descent, OPEC has already agreed to remove 4.2 million barrels per day (bpd) to try to build a floor under prices. To redress the fiscal balance, many members, such as Kuwait, Nigeria, Angola, Ecuador and some say Iran, have also cut their domestic spending in lock step with production. Official figures are unavailable, but the various OPEC members have widely divergent requirements, with Qatar needing as little as $10 a barrel and Venezuela requiring 10 times as much, analysts have estimated.
In terms of the narrow economics of getting their oil out of the ground, it costs less than $10 a barrel to pump in the Middle East and at least double that elsewhere. In addition to spending billions on oil and gas projects, some OPEC members, especially those with big populations, have to contend with high social costs and ambitious public projects. Venezuelan President Hugo Chavez's lavish public spending plans require oil prices of around $100 and Iran needs roughly $90, in part because of its presidential election this year. "For Iran and Venezuela, their main recourse is to draw down their accumulated reserves, but these are not as plentiful as in Gulf Cooperation Countries," said David Kirsch of PFC Energy.
Even within the Arab Gulf states, Kuwait, which has a tiny population, revised its budget to include lower welfare and infrastructure investment. Leading exporter Saudi Arabia has pledged to build "economic cities," costing billions of dollars, designed to tackle chronic unemployment and over-reliance on oil. Analysts say it needs a price of about $50 to avoid deepening its foreign debt. The desert kingdom has projected a deficit -- its first in seven years -- of $17.3 billion (65 billion riyals) in 2009. Saudi has led the cuts, reducing its own output by 2 million bpd from a peak of an estimated 9.7 million bpd last August.
Its production has fallen well below its OPEC target, giving support to the oil market, but doing little to reduce its debt. John Sfakianakis at HSBC's Saudi unit SABB bank said Saudi Arabia would still be in deficit if it pumped 7.7 million bpd all year and oil averaged around $45 -- above current levels. Other OPEC members, either because they do not have pressing financial requirements or because they think it would be better to pump as much as possible to maximise revenue, are happy to let Saudi Arabia do the work. "OPEC still needs to cut another million, but naturally they would all feel better if they leave the heavy lifting to Saudi Arabia," said a Saudi insider, who requested anonymity.
OPEC's smallest producer, Ecuador, has said there would be no benefit in further cuts when the group meets in Vienna on March 15. Algeria has also downplayed the need for action. Bucking a global trend for cost-cutting, the north African producer has said it would increase spending and some analysts have said it could break even with oil below $20. Individual members' budgets had much less influence over collective supply policy during the six years when the oil price boomed, as all enjoyed surpluses. Setting aside now pressing price needs, OPEC has in the past found it harder to maintain output discipline as production curbs have deepened. There are "growing signs of cutting fatigue," said Antoine Halff of Newedge brokerage.
OPEC economists have been relatively conservative in revising oil demand forecasts downwards, which "could provide the rationale for resisting further output cuts even in the event of renewed price drops," Halff said. While Saudi Arabia faces a struggle to enlist help from within the producer group, OPEC members have said other producers should join in, especially the biggest non-OPEC exporter, Russia, which has also revised its budget. In its quest for higher oil prices, the oil and gas giant has made overtures to OPEC but stopped well short of membership -- and of any voluntary output cuts. Instead, lower prices and consequent lower spending have effectively cut production, which could drive prices higher. "Most of them (Russian oil companies) still hope the oil price will magically go right back up," said Chirvani Abdoullaev, analyst at Alfa Bank. "Drilling volumes in Russia will probably decline by 20 to 25 percent this year."
Chrysler faced with equity carve-up
Chrysler’s restructuring plan could see the combined equity of owners Cerberus and Daimler shrink to less than 10 per cent, with the rest of the company divided between the US government, the United Auto Workers’ union, bank lenders and Italian carmaker Fiat, according to people close to the US carmaker. Chrysler and General Motors, which have been granted a combined $17.4bn in government loans, must present restructuring plans to the Obama administration by February 17 in order to retain that financing. Chrysler is currently trying to reorganise without seeking protection under US bankruptcy laws. As part of this effort, Chrysler is likely to take on additional loans from the government. Existing bank lenders are being asked to swap some of their debt for equity, while other stakeholders divide the rest.
Cerberus currently owns 80 per cent of Chrysler with Daimler holding 20 per cent. That equity is likely to be wiped out as part of the restructuring. However, Cerberus and Daimler could trade their debt in the carmaker for a small equity stake. The UAW is expected to demand a slug of equity in both Chrysler and GM, its larger crosstown rival, in exchange for letting the companies slash their retiree health obligations in half. Fiat has requested a 35 per cent stake in Chrysler in exchange for giving Chrysler access to its technologies as part of a proposed alliance between the two carmakers. Chrysler is also weighing its options without Fiat as a partner, according to one person close to the matter. But if the partnership stands, it will leave Chrysler’s bank debtholders and the union to fight over the rest of the company – assuming that they believe that equity in a reorganised Chrysler would have value.
Chrysler said it was "premature" to be discussing details of its restructuring plan. An even more complex situation is playing out at GM, which is trying to formulate a business plan that would persuade unsecured bondholders to accept equity in exchange for debt. Chrysler has no unsecured debt, but its bank lenders may balk at swapping their claims on secured assets for equity. Chrysler requested $7bn from the government and received $4bn, while GM has been granted $13.4bn, of which it has received $9.4bn. GM’s loan agreement says it could receive the extra $4bn once it submits its proposal next week. Chrysler’s document does not explicitly state when it could receive more money. Chrysler’s restructuring plan details that if it partnered with Fiat, it might pull a range of car models off the market to focus on its Dodge and Jeep brands and smaller, more fuel-efficient cars, according to people close to the matter.
Chrysler braces for long auto sales slump
Chrysler's U.S. government-required viability plan would have the automaker viable even if U.S. auto sales stay at current depressed levels for four years, a top executive said on Thursday. And it would be "a mistake" to assume that the plunge in U.S. auto sales to an annual market of roughly 10 million units is only an aberration, Chrysler Vice Chairman Jim Press said. "We need to accept and come to grips with it," Press said in a speech at an Economic Club of Chicago lunch on the sidelines of the Chicago Auto Show. U.S. auto sales fell 18 percent to about 13.2 million units in 2008, but the monthly sales rates have been running at roughly the 10 million unit annual rate range for several months and January's sales were at a 9.57 million rate.
Chrysler, 80 percent held by private equity firm Cerberus Capital Management, and larger rival General Motors Corp must submit viability plans to the government by February 17 under a $17.4 billion bailout program. The automaker remains in talks with various constituents, including debt holders, suppliers, unions, dealers and others. "We feel very good about our plan," Press told reporters after the speech. "We are confident that we are able to show our need and our requirements are going to be met. But we still have to work through the discussions with the different constituents." Press declined to comment on a report from a Japanese news organization that Nissan Motor Co Ltd had frozen progress on an alliance with Chrysler, saying he was not familiar with it.
Kyodo news agency reported on Thursday that Nissan had frozen preparations for the alliance with Chrysler. In his speech, Press made a reference to the Nissan partnership as going forward. The April 2008 agreement calls for Nissan to provide a small car for Chrysler and Chrysler to build a pickup truck for Nissan. Since then, Chrysler has announced a nonbinding agreement for an alliance with Italy's Fiat that would bring small cars to the United States and open international markets to Chrysler. The agreement with Fiat is contingent on Chrysler receiving an additional $3 billion of government loans. The Fiat alliance would give Chrysler access to small car platforms it lacks and Fiat access to the U.S. market.
Fiat also would receive a 35 percent stake in Chrysler without providing any cash. However, Press described Fiat's contribution to Chrysler as billions of dollars of platforms that would accelerate its entry into the small car market by five or six years. "The basic viability plan does not have a specific partner," Press said. Chrysler product development chief Frank Klegon told reporters on Wednesday that it would be "a tough call" as to whether all of the automaker's current plans for alliances on small cars would go forward. "At some point, we will have to make some choices; do we move forward as a singular partner or is there still multiple partners along the way?" Klegon said.
Global economic crisis called biggest U.S. security threat
The nation's new intelligence chief warned Thursday that the global economic crisis is the most serious security peril facing the United States, threatening to topple governments, trigger waves of refugees and undermine the ability of America's allies to help in Afghanistan and elsewhere. The economic collapse "already looms as the most serious one in decades, if not in centuries," said Dennis C. Blair, director of national intelligence, in his first appearance before Congress as the top intelligence official in the Obama administration. Blair's focus on the economic meltdown represents a sharp contrast from the testimony of his predecessors in recent years, who devoted most of their attention in the annual threat assessment hearing to the issues of terrorism and the wars in Afghanistan and Iraq.
Blair's conclusions are likely to bolster President Obama's case for swift action on a nearly $800-billion stimulus package nearing final approval in Congress. "Time is probably our greatest threat," Blair said. "The longer it takes for the recovery to begin, the greater the likelihood of serious damage to U.S. strategic interests." He said that one-quarter of the world's nations had already experienced low-level instability attributed to the economic downturn, including shifts in power. He cited anti-government demonstrations in Europe and Russia, and he warned that much of Latin America and the former Soviet satellite states lacked sufficient cash to cope with the spreading crisis. "The most likely potential fallout for U.S. interests will involve allies and friends not being able to fully meet their defense and humanitarian obligations," Blair said. "Potential refugee flows from the Caribbean could also impact homeland security."
The decline in oil prices in recent months might benefit consumers in the short term and "put the squeeze on the adventurism of producers like Iran and Venezuela," Blair said, but he warned that prolonged price drops could result in a supply crunch if they lead to cuts or delays in investment in oil development and infrastructure. Economic crises in recent decades have tended to be confined to specific regions -- such as the Asian financial meltdown of the 1990s -- meaning affected countries could rebuild by focusing on exporting more of their goods. But "countries will not be able to export their way out of this one because of the global nature" of the crisis, Blair said. U.S. intelligence analysts fear there could be a backlash against American efforts to promote free markets because the crisis was triggered by the United States. "We're generally held to be responsible," Blair said.
Blair's written testimony also looks at other security threats. The United States' most dangerous enemy remains Al Qaeda, he said, but he noted that the terrorist network "is less capable and effective than it was a year ago" because of the toll U.S. missile strikes and other measures have taken on the militants' sanctuary in Pakistan. Some of Blair's most pessimistic language was reserved for Afghanistan, where the security situation has deteriorated substantially because of rampant government corruption and a resurgent Taliban, which carried out fresh attacks in the nation's capital this week. As a result, Blair said, the upcoming Afghan presidential election "will present a greater security challenge" than the most recent campaign, in 2004, and he added that "insurgents probably will make a concerted effort to disrupt it." Blair's comments came as the Obama administration is close to a decision on sending tens of thousands of additional troops to Afghanistan. On Iran, Blair said that the Islamic nation "is clearly developing all the components of a deliverable nuclear weapons program" and that only an internal political decision might prevent the country from crossing the weapons threshold. Otherwise, he said, "they could have a weapon as early as 2010, but it might take them until 2015."
Why "Expert" Economists Don't Have The Answers
As we discussed earlier, economists can't actually forecast, and the best and the brightest of the profession often have radically different prescriptions and methodologies. And yet we're constantly told that in times of crisis, it's important to listen to the experts -- to defer to the people that know what they're talking about. But why is it that economists are so useless? It's not that they're not smart. And it's not that economics is a completely silly endeavor that teaches us nothing -- in fact the opposite. The problem is that the economy is too complex for any individual or group to handle. Radley Balko puts it well:What exactly is "expert opinion," and who gets to pick the experts? Tim Geithner? Paul Krugman? How about the 200+ economists, including three Nobel Prize winners, Cato rounded up who oppose the stimulus? Silver is right to humbly acknowledge that he doesn’t have the answers. He’s wrong to assume anyone else does.
It’s the height of arrogance to assume, as this administration and the one before it have, that you can manage a dynamic, infinitely complicated $13 trillion economy by plucking a trillion from some sectors, handing them over to others, because you’re smart enough to pull all the right levers. And it seems rather naive to assume that even if there were enormous-brained "experts" capable of pulling that off, that those experts would just happen to be the same people who also have the political acumen to ascend to the few political positions in the country powerful enough to make it happen.
Bingo. Any stimulus bill is inherently going to be about redistribution, not wealth creation. It's about transferring resources to certain areas from either the future (long-term taxes, debt burden, inflation) or from other groups in the present (higher taxes now). That's all the government can do: redistribute. And for a stimulus to work, it assumes that the planner knows better than the market where the mal-distribution resides, in this complicated ecosystem, and where it could be better placed. And as Balko notes, even if there were some rocket scientist economist who knew the answer, the odds that we'd find that person through some kind of meritocratic process, rather than the pundit lottery is slim to none.
Ilargi: A long article from the deeply fallen and flawed magazine The Economist about Britain. Note that all the graphs are ridiculously skewed towards positivism. Economists are hopelessly stuck in belief systems.
Britain's fallen star
In Swindon, a town 80 miles to the west of London which thrived during the boom years now ended, the recession is biting hard. Regent Street is busy on a cold Friday afternoon, but the most favoured shops are those selling cheap goods, such as Poundland, where everything costs just £1 ($1.44). And if Poundland is busy, the government-run Jobcentre Plus in Princes Street is teeming with people looking for work after recent lay-offs. The rest of the country has run into even greater economic turbulence. For a decade the British economy won plaudits for its good behaviour, not least from foreign investors whose confidence kept sterling strong and stable. Since the global financial crisis began in August 2007, that image has been thoroughly trashed: growth has turned to recession; unemployment is mounting; and the pound has suffered its biggest fall since the 1970s.
What appeared to be a model and well-run economy, expanding steadily for 16 years without inflationary strains, now looks a Heath Robinson affair. It was fuelled by debt—both public and private—and involved a star role for City bankers currently vilified for their excesses. Gordon Brown’s boast of ending boom and bust has returned to haunt the prime minister. Economic policymakers at the Treasury and the Bank of England, as well as banking regulators at the Financial Services Authority, are newly humbled. How justified is Britain’s status these days as (some say) Europe’s new sick man? It is tempting to see in its fall from grace a simple morality tale: an economy with a swollen financial sector that borrowed a lot, ran a current-account deficit and had a huge housing boom has got its just deserts. But this caricature tells us little, for it is already apparent that supposedly virtuous countries such as Germany, which had current-account surpluses and avoided housing booms, are also in trouble. Among big economies, Britain is neck and neck with Germany and Japan in the race to the bottom, and there is plenty to worry about beyond the downturn. But its swing from paragon to pariah has gone too far.
A crisis that started 18 months ago in the City and other financial centres spread to provincial towns like Swindon through a collapse in mortgage finance. The first sector to keel over was residential construction, as demand for new homes dried up. The figures from Swindon are stark. Before the crisis began, roughly 2,000 homes a year were being built; in the year from April 2008 to March 2009 the council expects only 800 to be completed. The demise of housing investment is most apparent at Wichelstowe, a development of 4,500 new homes to the south of Swindon. In a buoyant market the builders would be going full tilt, but so far only around 100 homes have gone up, most for publicly supported housing. The developer’s flags flutter gallantly in a keen wind by the four show houses of Bryant Homes, a subsidiary of Taylor Wimpey, but it is hard to put a brave face on the fact that it has built only 17 other private homes.
Official figures show that the decline in residential investment was the single most important thing pushing the economy into recession in the third quarter of 2008, when GDP fell by 0.6% from its level in the spring. But since then both the extent of the downturn and its reach have increased dramatically. Output fell by a further 1.5% in the final three months of 2008, the biggest quarterly decline since 1980. Manufacturing was particularly clobbered, dropping by 5.1%—its sharpest fall since 1974. If Wichelstowe is Swindon’s unfortunate showcase for the retreat in housing, the nearby Honda factory at South Marston exemplifies the gravity of the manufacturing setback. On January 30th employees turned up for their final day’s work for four months. The factory, which had 4,500 workers when it was running at full capacity and producing 250,000 cars a year, will not reopen its assembly lines until June; and then it will be operating only one shift. Around a thousand workers are leaving voluntarily (helped on the way financially). The remaining employees will receive their basic pay for two months, and then 60% of it in April and May.
A similar story could be told in many countries. Britain was not alone in having a housing boom; Japan and Germany have suffered far more from the recent vicious downdraft in manufacturing, as global demand for the investment goods and vehicles in which their industries specialise has evaporated. Recent forecasts from the International Monetary Fund suggest that GDP will contract this year by 2.6% in Japan and by 2.5% in Germany. Even so, the IMF tipped Britain for the biggest fall of all the G7 economies, forecasting that its GDP would tumble by 2.8% (see chart 1). This grim outlook was underscored on February 11th by the Bank of England. Its central forecast is that British GDP will shrink by almost 4% in the year to the second quarter of 2009, its steepest decline since the early 1980s.
The gloom reflects growing worries about underlying weaknesses that make Britain especially vulnerable to a recession spawned by the most serious financial crisis since the early 1930s. To start with, its housing boom was among the most extreme, measured by real price increases and resulting overvaluations. Property prices have fallen by around 20% since their peak in autumn 2007, pushing an increasing number of households into negative equity; some reckon prices have the same again to fall. Another bubble, in commercial property, has burst in even more spectacular fashion. Over the past 18 months office blocks and shops and the like have lost more than 30% of their value.
Both these booms were fuelled by debt, another reason why Britain looks particularly vulnerable now. Ten years ago, British households were the fourth most indebted among the G7 economies. By 2002 they had taken the lead, building up a burden equal to 185% of disposable income by the end of 2007. At the same time the public finances swung into the red. Associated with the boom in asset prices and rising indebtedness was a related and pernicious macroeconomic imbalance: a persistent current-account deficit. A third reason why Britain looks worse off than other countries is the prominence of its financial sector. Although at its peak it accounted for only 8% of GDP, finance has been producing about a quarter of corporate-tax revenues. Once the glory of the economy, the City of London has been hit hard by the credit crunch and its sequel.
So Britain’s prospects do look bleak. Experience of past banking crises suggests that countries hit by them suffer deep and long recessions, and generally manage no more than a sluggish recovery. The aftermath of housing bubbles also tends to be unhappy. With Britain’s invidious combination of the two, it is easy to see why forecasters are vying to produce the grimmest predictions of economic performance. The pessimism may be overdone. Britain has plunged rapidly into recession but it might pull out more steeply too. One reason to think so is that sterling has fallen sharply, its trade-weighted value down by a quarter since January 2007 (see chart 2). Though some see it as a national misfortune, sterling’s slide will help to cushion the economy this year and pave the way for eventual recovery. While global trade is in free fall, exports will drop too, despite the weaker pound. But profit margins on foreign sales will improve and, with imports dearer, domestic producers will grab a bigger share of the home market.
There are other reasons too why some forecasters are less glum. David Miles, an economist at Morgan Stanley, a bank, thinks the economy may shrink this year by just 1.3%—much less than the IMF’s forecast—though he concedes that the outcome could well be worse. A crucial issue is what happens to consumer spending, which comprises over 60% of GDP. Mr Miles accepts that private consumption will fall, but thinks it will be more resilient than many fear. He makes three main points. After being squeezed last year by rising food and fuel prices, households will benefit from the sharp fall in inflation (which is likely to tip into deflation during part of this year). Spending will be boosted by the unprecedented cuts in interest rates since last autumn. And consumers will gain from the temporary reduction in value-added tax, worth about £12.5 billion over 13 months.
The pace of monetary easing also looks set to accelerate. Having cut the base rate to 1% this month (still higher than America’s near-zero rate but below the euro zone’s 2%), the Bank of England plans to drive down the spread between the yields on corporate and government debt by buying the former. Mervyn King, the bank’s governor, said this week that the monetary-policy committee may recommend increasing the money supply by "quantitative easing" in March, though the decision must be authorised by Alistair Darling, the chancellor of the exchequer. Even with this help is Mr Miles a touch Panglossian? Swindon’s busy high street shows that people are still shopping. Yet even if shoppers are out in force, their purse strings are likely to be tightened by rising unemployment. In Swindon the number of people claiming jobless benefit jumped last month to 4,350, over double the claimant count of 1,795 in January 2008. That is a particularly severe outcome: though unemployment is climbing steeply in Britain (see chart 3) it is still lower than in many European countries. But fear of the dole may lead to an increase in precautionary saving.
Falling house prices are another force bearing down on consumption. At Henry George, an estate agency with an office in the heart of Swindon, Robert Skerten says turnover is down 60% on the year before. While they think prices will keep declining, potential purchasers—especially first-time buyers—will hold off, waiting for better deals, says Fionnuala Earley, an economist at Nationwide Building Society, also headquartered in Swindon. That will curb purchases of the big-ticket home goods that people buy when they move. More controversial is the broader effect of falling property prices on consumer spending. The Bank of England argues that the link between real house prices and consumption reflects swings in income expectations by households. But others disagree. Declining house prices both reduce wealth and curtail access to credit, says Charles Collyns, deputy director of the IMF’s research department: it is one of the main reasons why the fund believes the British economy is especially vulnerable at the moment.
Some fret that things could get even worse. They portray Britain as Iceland writ large, horribly exposed because of its big banking sector and intimate involvement in the sort of global finance that has gone so spectacularly wrong. This is overwrought stuff. Little Iceland had banking liabilities worth close to ten times its GDP, all piled up by its own banks and mostly in foreign currency. Britain’s banking liabilities are equal to some 4.5 times GDP. Over half of these are attributable to foreign-owned banks that have clustered in the City; they hold two-thirds of the British-based banking system’s liabilities and assets in foreign currencies. As a result, Britain is much less exposed to a run on its own banks by depositors holding foreign currencies than Iceland was. And although Britain has exceptionally high external liabilities, thanks to the City’s status as the world’s biggest international financial centre, it also has very large foreign assets. The gap between the two peaked at the end of 2006, when Britain owed £370 billion—28% of GDP—more than it owned. Since then it has narrowed, helped by sterling’s fall (almost all of Britain’s external assets are in foreign currency but only around 60% of its liabilities). The gap is now some £150 billion, or 10.5% of GDP—hardly cause for alarm. The current-account deficit has fallen from an average 2.2% of GDP in the ten years to 2007 to 1.6% in the first nine months of 2008.
Yet Britain’s banks are ailing. Taxpayers have had to rescue two big ones—Royal Bank of Scotland and HBOS (now absorbed into Lloyds Banking Group)—with emergency recapitalisations, prompting apologies this week from those in charge. The state has also nationalised two mortgage lenders and is proposing to insure banks’ toxic assets against catastrophic losses. The questions bothering the markets—and prompting feverish talk in January about national bankruptcy—is how costly all this will prove, and whether the Treasury has the fiscal capacity to pay for it. The answer to the first question depends in large part on how deep and protracted the recession turns out to be. Ben Broadbent, an economist at Goldman Sachs, a bank, has estimated that the Treasury’s insurance plan for bank assets could cost up to 8% of GDP. If other measures (recapitalisations, support for the two nationalised lenders and the rescue of British depositors with failed Icelandic banks) are included, the bail-out could take around 14% of GDP. That would be a lot more than the cost to Sweden of sorting out its banking crisis in the early 1990s (around 4% of GDP) but in line with Japan’s 14%.
If Britain’s bill turns out to be more like Japan’s than Sweden’s, the Treasury would gulp but could swallow it, for Britain’s official debt has been relatively smaller than that of other G7 countries. In 2007 Britain’s gross government debt was 47% of GDP; in France, for example, it was 70%. That is no cause for complacency. Even excluding financial bail-outs, public debt as a share of GDP may rise by 20-30 percentage points by 2011, as recession pushes up public borrowing (see chart 4). If it does, Britain would end up somewhere in the middle of the pack. But the rapid rise in indebtedness is creating another vulnerability: markets need to feel sure that the government will make fiscal amends when recovery has set in, rather than seeking to inflate away the debt. So far investors seem to be giving the Treasury the benefit of the doubt. Long-term borrowing costs remain low despite the mountain of new debt that will be issued over the next few years. That is vital; if gilt yields were to rise sharply it could lead to a vicious circle of rising debt-servicing costs and higher debt. Mr Darling laid out plans for higher taxes after the recession in his pre-budget report in November. In his spring budget he will need to reinforce his commitment to retrenchment.
Painful measures to restore health to the public finances will be all the more important because Britain’s longer-term prospects have dimmed too. The economy’s potential growth will be lower than before, and with it growth in the tax base. There are two main reasons, argues Martin Weale, director of the National Institute of Economic and Social Research (NIESR), a think-tank. The first is that the economy’s expansion for most of the past decade was boosted by the apparent success of the financial-services industry. As that model turns out to have been unsustainable, the resulting retrenchment in finance will curb overall growth. The second reason is that falling investment means companies will have less capital to enhance productivity. Recovery in investment is likely to be muted because firms will face higher long-term borrowing costs, as banks and investors charge more for the risk of lending to them. Despite this setback, the NIESR forecasts growth of 2.2% in 2011 and 2.4% in 2012, not least thanks to the greater competitiveness a lower pound will bring. The City may take a back seat this time. But Britain remains a diversified economy, and it retains a flexible labour market that will allow companies to adapt to new conditions, notes Trevor Cullinan of Standard & Poor’s, a credit-rating agency that reaffirmed Britain’s AAA status as a sovereign borrower earlier this year.
Swindon had to cope with the collapse of the local railway industry in the 1980s, points out Bill Cotton, its director of economic development—one reason why he thinks the town can come through its latest trial. Tough times lie ahead, debt will have to be repaid and growth will be slower. But just as there was too much optimism during the good times, so there can be too much pessimism in the bad times. RWE npower, an energy firm based in Swindon, for example, says it is going to boost its investment in Britain. Provided sound policies are pursued, above all credible plans to restore the public finances once a sustainable recovery has started, there is a way out of the mess. And, given the vigour with which monetary and fiscal policy has been eased, that recovery might just come sooner to Britain than to countries that look more resilient now.
How Banks Are Worsening the Foreclosure Crisis
The bad mortgages that got the current financial crisis started have produced a terrifying wave of home foreclosures. Unless the foreclosure surge eases, even the most extravagant federal stimulus spending won't spur an economic recovery. The Obama Administration is expected within the next few weeks to announce an initiative of $50 billion or more to help strapped homeowners. But with 1 million residences having fallen into foreclosure since 2006, and an additional 5.9 million expected over the next four years, the Obama plan—whatever its details—can't possibly do the job by itself.
Lenders and investors will have to acknowledge huge losses and figure out how to keep recession-wracked borrowers making at least some monthly payments. So far the industry hasn't shown that kind of foresight. One reason foreclosures are so rampant is that banks and their advocates in Washington have delayed, diluted, and obstructed attempts to address the problem. Industry lobbyists are still at it today, working overtime to whittle down legislation backed by President Obama that would give bankruptcy courts the authority to shrink mortgage debt. Lobbyists say they will fight to restrict the types of loans the bankruptcy proposal covers and new powers granted to judges.
The industry strategy all along has been to buy time and thwart regulation, financial-services lobbyists tell BusinessWeek . "We were like the Dutch boy with his finger in the dike," says one business advocate who, like several colleagues, insists on anonymity, fearing career damage. Some admit that, in retrospect, their clients, which include Bank of America, Citigroup, and JPMorgan Chase, would have been better off had they agreed two years ago to address foreclosures systematically rather than pin their hopes on an unlikely housing rebound. In public, financial institutions insist they've done their best to prevent foreclosures. Most argue that giving bankruptcy courts increased clout, known as cramdown authority, would reward irresponsible borrowers and result in higher borrowing costs. "What we're trying to do now is target the bill to make it as narrow as possible," says Scott Talbott, a lobbyist for the Financial Services Roundtable.
On the defensive, the industry nevertheless benefits from one strain of popular opinion that home buyers who took on risky mortgages—even if the industry pushed those loans—don't deserve to be rescued. However the skirmish ends, the industry's contention that it has done as much as possible to limit foreclosures seems hollow. Some statistics it cites appear to be exaggerated. Even pro-industry figures such as Steven C. Preston, a Republican businessman who headed the Housing & Urban Development Dept. late in the Bush Administration, concede that many lenders have dragged their heels. "The industry still has not stepped up to the volume of the problem," Preston says. One program, Hope for Homeowners—which Bush officials and banks promised last fall would shield 400,000 families from foreclosure—has so far produced only 25 refinanced loans.
Meanwhile, an already glutted market sinks beneath the weight of more foreclosed homes. Borrowers whose equity has evaporated have nothing to tap into if the recession costs them their jobs. Some lawmakers and regulators are calling for a foreclosure moratorium. "People are falling through the cracks," Preston says. "That's bad for communities, bad for the individuals losing their homes, and bad for investors." In early 2007, as overextended borrowers began to default on too-good-to-be-true subprime mortgages, housing experts sounded an alarm heard throughout Washington. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, wanted to push a bill requiring banks to modify loans whose enticingly low "teaser" interest rates soon give way to tougher terms. But he knew that with Republicans strongly opposed, he lacked the muscle, according to Senate aides.
So Dodd did what politicians often do. He convened a talkfest: the Homeownership Preservation Summit. A who's who of banking executives gathered on Apr. 18, 2007, behind closed doors in an ornate hearing room in the marble-faced Dirksen Senate Office Building. Dodd told them they needed to get out in front of the foreclosure fiasco by adjusting loan terms so borrowers would continue to make some payments, rather than stopping altogether. Foreclosure proceedings typically cost banks about 50% of a property's value. That's assuming the home can be resold—not a certainty when empty houses multiply in a neighborhood. "What are you doing?" Dodd asked the executives. "What do you need me to do to help you modify loans?"
Some from the industry denied a foreclosure problem existed, including Sandor E. Samuels, at the time chief legal officer of subprime giant Countrywide Financial. They vowed to continue selling loans with enticing introductory rates as well as those requiring minimal evidence of borrowers' income. "We are going to keep making these loans until the last second they are legal," Samuels later told a fellow participant. On May 2, 2007, Dodd's office issued a "Statement of Principles" stemming from the summit. It outlined seven vaguely worded industry aspirations, such as making "early contact" with strapped borrowers and offering modifications that could include lowering loan balances. The principles had no effect, some summit participants now concede.
Much of Dodd's attention shifted to his campaign for the Democratic Presidential nomination. Senate Banking Committee spokeswoman Kate Szostak says Dodd aggressively pursued the foreclosure issue, but "both the industry and the Bush Administration refused to heed his warnings." The lawmaker accepted $5.9 million in contributions from the financial-services industry in 2007 and 2008. Asked about his role at the summit, Samuels confirmed in an e-mail that he "did speak—formally and informally—about the performance" of subprime loans. But he declined to elaborate. He now works as a top in-house lawyer for Bank of America, which acquired Countrywide in July 2008.
A major reason financial institutions and investors are so determined to avoid modifying loan terms more aggressively has to do with accounting nuances, say industry lobbyists. If, for example, a bank lowered the balance of a certain mortgage, there would be a strong argument that it would have to reduce the value on its balance sheet of all similar mortgages in the same geographic area to reflect the danger that the region had hit an economic slump. Under this stringent approach, financial industry mortgage-related losses could far surpass even the grim $1.1 trillion estimated by Goldman Sachs (GS) in January. A desire to postpone this devastating situation helps explain lenders' intransigence, says Rick Sharga, vice-president of marketing at RealtyTrac, an Irvine (Calif.) firm that analyzes foreclosure patterns. By mid-2007, Bush Administration officials were deeply worried about the financial industry's unwillingness to confront the growing catastrophe. Even banking lobbyists say they realized that their clients had lapsed into denial.
The K Street representatives agreed that Treasury Secretary Henry Paulson needed to step in, says Erick R. Gustafson, then the chief lobbyist for the Mortgage Bankers Assn. "It was like an intervention," he says. "We had to get Treasury involved to get the banks to give us information." That summer, Paulson, a former CEO of Goldman Sachs, summoned industry executives to the Cash Room, one of Treasury's most elegant venues. There, beneath replica gaslight chandeliers, Neel T. Kashkari, a junior Goldman banker whom Paulson had brought to Treasury, urged industry leaders to move swiftly to keep more consumers from losing their homes. Bankers know how to adjust interest rates, extend loan durations, and, if necessary, lower principal, said Kashkari, who has temporarily remained in his post. A couple of months later, Paulson summoned the executives again, this time to his conference room. "We told them we need to get over the goal line," recalls a former top Treasury official. "Cajoling is a euphemism for what we did. We pounded them."
One product of the Treasury conclaves was the Hope Now Alliance, a government-endorsed private sector organization announced by Paulson on Oct. 10, 2007. Lenders promised to cooperate with nonprofit credit counselors who would help borrowers prevent defaults. Faith Schwartz, a former subprime mortgage executive, was put in charge. The alliance got off to a shaky start. An early press release contended that there had been more foreclosures nationally than the Mortgage Bankers Assn. was conceding at the time. "We looked like the Keystone Kops," says an industry lobbyist. Soon it became apparent that the program was primarily a public-relations effort, the lobbyist says. "Hope Now is really just a vehicle for collecting and marketing information to the Treasury, people on the Hill, and the news media." In a press release last Dec. 22, Hope Now said it had prevented 2.2 million foreclosures in 2008 by arranging for borrowers to catch up on delinquent payments and, in some cases, easing terms.
But the data don't reveal how many borrowers are falling back into default because many modifications don't, in fact, reduce monthly payments. The alliance doesn't receive this information from banks, says Schwartz. There's reason for skepticism. Federal banking regulators reported in December 2008 that fully 53% of consumers receiving loan modifications were again delinquent on their mortgages after six months. Alan M. White, a law professor at Valparaiso University, says the redefault rates are high because modifications often lead to higher rather than lower payments. An analysis White did of a sample of 21,219 largely subprime mortgages modified in November 2008 found that only 35% of the cases resulted in lower payments. In 18%, payments stayed the same; in the remaining 47%, they rose. The reason for this strange result: Lenders and loan servicers are tacking on missed payments, taxes, and big fees to borrowers' monthly bills.
Consider the case of Ocbaselassie Kelete, a 41-year-old immigrant from Eritrea who called Hope Now last fall. Kelete, a naturalized U.S. citizen, bought a $540,000 townhouse in Hayward, Calif., in November 2006 with no down payment and 100% financing from First Franklin Financial, a subprime unit of Merrill Lynch. At the time, he and his wife earned $108,000 a year from his two jobs, with a pharmacy and an office-cleaning service, and hers as a janitor. Kelete says First Franklin and his realtor convinced him that he could afford a pair of mortgages, one with a 7.5% initial rate that would rise after three years, and a second with a fixed 12% rate. His monthly payment would total $3,600. "The realtor said, 'Just make sacrifices for two years. Home prices will go up, and you can refinance at a lower rate,' " Kelete recalls. He regrets signing a mortgage he couldn't afford—a mistake many people made during the subprime craze. Home prices didn't go up. He lost his office-cleaning job.
First Franklin modified his loans, but added on property taxes it had failed to collect earlier. Kelete's monthly bill rose to $3,900. In October 2008, he called Hope Now. A counselor set up a conference call with First Franklin. The lender's representative said Kelete should get another job or give up the house, the borrower says. Kelete responded that he'd already lost his second job cleaning offices and couldn't find another in a faltering California economy. "Why don't you work with me?" he asked First Franklin. The lender declined. The Hope Now counselor said there was nothing more to do. "Foreclosure is the only future I see," Kelete says. A spokesman for BofA, which acquired Merrill in December, declined to comment, citing the borrower's privacy. After BusinessWeek's inquiries, however, First Franklin contacted Kelete about lowering his monthly payments.
Hope Now's Schwartz acknowledges she is fighting an uphill battle. By her calculation, 45% of the borrowers her organization advises still end up in foreclosure. "If I seem frustrated," she says, "it's because we are dealing with nothing but an exploding problem." She has a full-time staff of four in Washington; 500 counselors participate in the industry-funded hotline. "You shouldn't take it lightly, what we have achieved," Schwartz says. She bristles at suggestions that the statistics she disseminates are misleading. "I print what I know," she says, noting that some of her bank members aren't forthcoming about loan modifications. "It's like herding and juggling cats." By early 2008 it was obvious that Hope Now wasn't halting a significant percentage of foreclosures. Democrats in Congress began gathering ideas for a government-sponsored remedy. Many of those ideas came from the industry. Lobbyists and congressional aides referred to one concept as "the Credit Suisse plan."
Another, "the Bank of America plan," would allow borrowers to refinance mortgages with loans guaranteed by the Federal Housing Administration. Representative Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, had solicited BofA's advice via an old Boston acquaintance, Anne Finucane, the bank's chief marketing executive and a politically active Democrat. He assigned several aides, including Michael M. Paese and Rick Delfin, to work out the details. Francis Creighton, a Democratic former staff member on the Financial Services panel who had gone to work as a lobbyist for the Mortgage Bankers Assn., negotiated with Paese and Delfin. Creighton's Republican colleague Gustafson huddled with aides to such GOP lawmakers as Representative Spencer Bachus and Senator Richard Shelby, both of Alabama.
Before long, the anti-foreclosure provisions were being altered in ways the industry favored. Shelby, the ranking Republican on the Senate Banking Committee, along with other Republicans insisted on the pro-industry language in exchange for their support, aides say. In the end, the program included stiff up-front and annual fees and a requirement that homeowners pay the government 50% of any future appreciation in the property's value—all of which made it much less attractive to borrowers. Moreover, the banks' participation was made entirely voluntary; there was no way to pressure them to cooperate. Congress approved Hope for Homeowners on July 26, 2008, as part of a larger measure imposing restrictions on the mortgage finance firms Fannie Mae and Freddie Mac.
At the Mortgage Bankers Assn., lobbyists gathered in Gustafson's corner office to lift plastic cups of wine in celebration. Those familiar with Hope for Homeowners anticipated that its fine print would discourage all but a few borrowers. "We knew it was likely to have limited appeal," says Preston, the former secretary of HUD, which oversees the FHA. George Miller, executive director of the American Securitization Forum, a Wall Street trade group, calls the program and its 25 refinanced loans "useless" because of the onerous details. Shelby, for his part, never expected Hope for Homeowners to accomplish much, according to Republican Senate aides. He agreed to it to gain Dodd's support for greater regulation of Fannie and Freddie—and only when assured the program wouldn't drain tax dollars. "My consistent aim throughout this crisis has been to protect the American taxpayer," Shelby told BusinessWeek in a statement. He accepted $565,000 in contributions from the financial-services industry in 2007-2008.
Frank, whose industry contributions totaled $948,000 over the same period, says he became skeptical Hope for Homeowners could achieve its initial goal of helping 1 million people. But he expected much more progress than the mere 25 refinancings that have occurred so far, according to HUD. He blames Republicans and the industry for undercutting his legislation. "I didn't have the votes to do more," he says. The Massachusetts liberal hasn't given up hope of repairing Hope for Homeowners. He is working on changes that would cut borrowers' up-front fees and provide bonus money for mortgage servicers that agree to participate in the voluntary program. Frank aides Paese and Delfin aren't assisting with the fixes: They have left their congressional staff positions for lobbying jobs with the Securities Industry & Financial Markets Assn. in Washington. They say they are observing the one-year federal ban on speaking with their former boss about business they did on the Hill.
In the first days of 2009 it appeared that progress might be possible on a different front. A slumping Citigroup came back to the Treasury Dept. for a second round of bailout money. Bowing to pressure from regulators, Citi broke ranks with its rivals and dropped its opposition to bankruptcy cramdown. Senator Dick Durbin (D-Ill.), who since 2007 had led unsuccessful efforts in Congress to give bankruptcy judges authority to modify home loans, dispatched his senior economic policy adviser, Brad J. McConnell, to talk with lobbyists for JPMorgan Chase and Bank of America. "Each agreed to take [the idea] back to their folks to see what they could do," says a person familiar with the talks. Citi's concession, the imminent Obama inauguration, and intensifying public hostility toward big banks contributed to an atmosphere Democrats assumed would be conducive to compromise.
By the time McConnell talked to the JPMorgan and BofA representatives the next day, however, "they had gone on full defense mode and started to complain about how lousy a deal Citi had struck," says the person familiar with the exchanges. Bank opposition, Durbin says, "was very shortsighted in light of the mess they have created in our economy." In the following weeks, banking lobbyists launched a renewed attack on the cramdown legislation, enlisting as an ally Republican Representative Lamar Smith of Texas, among others. Apart from Citi, "the industry remains united in that bankruptcy cramdown would destabilize the market" by creating widespread uncertainty about the value of numerous troubled mortgages, says Steve O'Connor, senior vice-president for government relations at the Mortgage Bankers Assn. His group is distributing talking points to key congressional aides laying out reasons why "Congress should defeat bankruptcy reform legislation." These include the argument that if lenders can't be confident that loan terms will survive, they will raise rates and reject riskier borrowers. Industry lobbyists are organizing home state bankers to pressure moderate Democrats they hope will be receptive to limiting the kinds of loans eligible for cramdown.
One target: Senator Evan Bayh of Indiana. Stefanie and James Smith of Santa Clarita, Calif., fear they may need the help of a bankruptcy court if they are to keep the subdivision home they bought for $579,000 in November 2005. Stefanie, 37, a university human resources coordinator, and James, 40, a federal law enforcement agent, borrowed the entire amount in two subprime loans that required a total monthly payment of $3,000. A representative of their lender, Countrywide, told them not to worry, says Stefanie: They would be able to refinance in a year. By mid-2007 they were running late on payments, and refinancing options had dried up. With their monthly bill scheduled to jump to more than $4,000 this January due to a rising mortgage rate, Stefanie contacted Countrywide last summer. She asked for a loan modification so they could avoid default. In December the lender said it would be willing to increase their payment by $600. That was better than the scheduled rise of $1,100, so the Smiths agreed. But now they are struggling to pay the higher amount. Countrywide's parent, BofA, declined to comment, citing the Smiths' privacy. After BusinessWeek's questions, though, Countrywide called them to discuss cutting their payments. "We knew when we bought that the payments would be a stretch," says Stefanie. She regrets assuming they would be able to refinance at a lower rate. "We are not deadbeats," she adds. "All we want is a mortgage we can afford."
"It's like confessing to a murder"
200 years after the birth of Charles Darwin, his theory of evolution still clashes with the creationist beliefs of some organized religions. For him personally, it meant the end of his belief in creation by God.
Before marriage, Charles Darwin had confessed everything to her. That he was in the process of rewriting the history of life. That, according to his convictions, all living things descended from a common ancestor. And that species were not to be attributed to God's endless creativity, but were the product of a blind, mechanical process that altered them over the course of millions of years. This alone was pure heresy. Darwin even nursed doubts about the very survival of human beings. And this man, who had gone around the world once, and was going to marry Emma Wedgwood, did not believe a single word of the biblical story of creation. "Reason tells me that honest and conscientious doubts cannot be a sin," wrote the deeply religious Emma to her betrothed in a cautioning letter in November 1838. "But I felt that it would be a painful rift between us." Charles was supposed to find his way back to the right faith by reading the Bible: "I implore you to read the parting words of our Savior to his apostles, beginning at the end of the 13th chapter of the Gospel according to John," she wrote.
But for Charles Darwin there was no turning back. He definitely assured Emma in his reply that he would take her concern seriously. But in fact he was experimenting at that time with all kinds of heretic theories. "Love of godhood is a result of intellectual organization, oh you materialist!" he confided to himself in revolutionary words in his secret notebook. And although his theories were not yet mature, he was completely aware of their explosive nature: By dissociating intellect and morality from god's power of creation, and attributing them instead to self-evolving forces, Darwin undermined the very foundations of a society shaped by the Anglican Church, with its hopes of eternal life and the omnipresent threat of punishment. "As soon you realize that one species could evolve into another, the whole structure wobbles and collapses," he remarked. And if man were nothing but a superior animal, where would that leave his spiritual dignity? And if he himself is the product of evolution, then what about his moral accountability to God?
"Charles' confession was a big shock for Emma," explains the science historian John van Wyhe from the University of Cambridge. "On the other hand, he impressed her with his openness and honesty. Nothing would have hurt her more badly than the feeling that her future husband was keeping secrets from her." But Emma's worries over the well-being of Charles's soul could not come in the way of her wedding at the end of January 1839. His habit of "never believing anything till it is proven" had apparently prevented him from "taking into account other things that cannot be proved in the same manner, and which, if they are true, would probably go far beyond our power of imagination," she complained in another letter. Emma's worst fear was that Charles was forfeiting his salvation through his religious disbelief, and this threatened to separate them in death. Her letter was to go unanswered. "Charles respected Emma's faith and probably kept his religious doubts to himself," van Wyhe says. The man from the English town of Shrewsbury, northwest of Birmingham, had drawn his theories from it. His wife's reactions had shown him how difficult it was to convince other people of his ideas: The criticism would be devastating were he to publish his theories without adequate proof; and his scientific career would be ruined.
If he wanted his theories to be accepted, he would have to leave the tricky "issue of apes" on the periphery and write only about how oranges or animals changed gradually. And he would need collaborators, respected naturalists who would stand by his side—scholars like Charles Lyell, whose Principles of Geology had given him important intellectual stimuli. He had collected enough facts. Charles Darwin had spent five long years in the remotest corners of the Earth and observed, described and dissected with inexhaustible meticulousness. But his proud booty was to reveal its secrets only gradually; small bits of a puzzle that fell into place slowly, forming a larger, overall picture, and gave shape gradually to his theory of the evolution of species. "The journey on the Beagle was, by far, the most important event in my life, and shaped my whole career," Darwin once said, looking back on his time on board the ship.
In August 1831 the British Admiralty was looking for a young gentleman to provide company for Capt. Robert Fitzroy, a small, dark haired man with fine features and an aristocratic arrogance during his long mission. The HMS Beagle was supposed to chart the South American coast on its survey journey. "You are exactly the person they are looking for," the old botany professor John Stevens Henslow wrote to his former student, the 22-year-old Darwin. Fitzroy wanted a natural scientist as companion, because this would mean unprecedented opportunities for him to engage in research on the extended stopovers on land. The ship was equipped for scientific research; a man of "commitment and intelligence could do wonders," Henslow gushed. Darwin was indeed not a full-fledged natural scientist, but he could still make up for this deficit by taking along some books. The young man plunged into the preparations as if electrified, and in all haste: the journey was to begin soon. It was the chance of a lifetime. But sober reality didn't dawn on him until after the Beagle set out from Plymouth, shortly after Christmas in 1831.
If only he had listened to his father! Robert Waring Darwin had been against Charles's feverishly embraced the adventure, right from the start. Another of these useless ideas that had gotten into this fickle son's head—further proof of his aimlessness. The aspiring natural scientist had abandoned his study of medicine, and the homeless years in the company of rough seamen were going to ruin him completely. It was only the appeal of an uncle that persuaded the elder Darwin to consent. But after just three days on rough seas, the aspiring natural scientist was already yearning for the soft meadows of his Shropshire home, on the Wales border. Even a lonely parish in the country would have been an utterly welcome prospect to him now: firm land beneath the feet, above all!
All day he could not hold down anything but rusks (breads) and raisins or, if even these repulsed him, glögg (spiced wine), offset with sago. And when he tried to stand up in his tiny cabin, he almost knocked himself out cold. From the deck, he could hear the shrill voices of four crewmen, who were being punished by Fitzroy with a total of 134 lashes for their Christmas escapades. "Before the journey, I used to say often that I was certainly going to thoroughly regret the whole enterprise," he wrote in his dairy that day. "But I had never thought how vehemently I was going to do so." Fitzroy, who swore by physiognomy (judging character based on outward appearance), had also known it all along: Darwin's nose pointed to a deficiency in energy and resoluteness; his knowledge of people indicated that this young gentleman was never going to make it till the end of the journey.
And how wrong he was! Once the Beagle reached the South American coast on the 28th of February 1832, Darwin became enraptured by what seemed to him to be paradise. While the crew chartered and plotted the harbor of Salvador in the Baía de Todos os Santos (the Bay of All Saints), Darwin wandered in astonishment through the Brazilian rainforest, caught in the "chaos of rapture," completely bewitched by its wealth of vegetation. "The landscape in Brazil is like looking into a Thousand and One Nights, with the advantage that this is real," he wrote in his diary. Resting in a shaded spot, he listened to the humming, squeaking and pulsating life around him. He heard parakeets screeching, saw hitherto unimagined varieties of orchids and anthills standing more than 10 feet (three meters) tall. Not a single bizarre detail seemed to escape the young researcher: He once discovered a spider that preyed on alien webs and played dead and fell down if it sensed danger. Then he came across a wasp that stung caterpillars and used them as food for its own larvae in its nest of loam. "And imagine," he cried out after having shot a particularly magnificent lizard, "calling a pleasure such as this duty!" but the journey had some more surprises waiting.
In the bay of Punta Alta in Argentina, Darwin chiseled out the fossilized bones of a colossal protozoan from the cliffside. Beside himself with joy, he lugged the valuable find on board the Beagle. The booty, scorned by Captain Fitzroy as "a box full of useless stuff," was to make him famous later. There was only one comparable specimen in England at that time. When he returned to the site a few months later, he was able to free from the cliff almost the complete skeleton of a bizarre mammal, the size of a horse, with an enormous pelvis and a narrow, long face, resembling that of an anteater. "Formerly, this place must have been teeming with large monsters", he recorded later in his travel log. But why did they die out? And why were the extinct giants so similar to the animals now found in South America, except for their size?
Darwin began to ask questions. The gauchos told him about a unique variety of a South American bird called a rhea, smaller and darker than usual in form. Very few had seen one, but their nests had been found, and everyone confirmed that it was found more frequently farther south. After a long search, he found the unique creature: on his plate for dinner! Incredible: he had finally found the unique bird and almost eaten it inadvertently! Fortunately, it was still possible to save the "head, neck, legs and one wing," and some large feathers; they were conserved promptly and stacked away in the hold. Why is a type of ostrich found only in North Patagonia, and the others are found only in the south? Why did the Almighty have to create two such closely related species, whose environments hardly differed?
In the beginning of the year 1835 the Beagle reached the coast of Chile. After a morning ramble through nature, Darwin was stretched on the ground when it began to shake. "The Earth—the epitome of firmness," the natural scientist wrote, trembled under his feet "like the crust on a liquid."
It was only in the following days that the terrifying dimension of the catastrophe that lasted about two minutes, became evident to Darwin as the Beagle sailed up the long Chilean coast. "The entire coast was strewn with balconies and household objects, as if a thousand ships had been stranded", he reported. The city of Concepción at the foot of the Andes offered a terrible scene: "The ruins were so scattered and the whole scene had so little of anything akin to a habitable place, that it was barely possible to still imagine the earlier state." The inhabitants spoke of the worst earthquake mankind had ever known. The shock waves had reached Concepción, "rumbling like distant thunder"; fires had broken out everywhere. Those who had managed to salvage their material possessions were living in fear of plunderers. And then the wave came: a tsunami, taller than 20 feet (six meters), broke over the city. Innumerable people drowned or were washed away.
Once he had recovered from the initial shock, the young researcher went looking for the cause of the quake. The local people along the coast told him about a shallow edged by cliffs, which was earlier covered completely by water, but had become exposed after the earthquake. And on the island of Santa Maria, barely 30 miles (50 kilometers) or so away, he came across fresh banks of mollusks just above the flood line, which had already begun to rot away. The land must have heaved just a few meters away! That was the unequivocal evidence for the hypotheses postulated by Charles Lyell in his "Principles of Geology": mountains such as the Andes had not been formed in one colossal upheaval, but grew, barely perceptibly, over the course of millions of years, as the result of countless small quakes, to which Darwin had just been a witness. But had not the Archbishop of Armagh, James Ussher, calculated in 1658 the Earth's age accurate to the day? Accordingly, god must have created our planet on the night preceding October 23, 4004 B.C. on the Julian calendar.
Toward the middle of the year the Beagle left behind the South American continent and set sail for the Galápagos islands, where the crew came upon a cheerless scenario: "A jagged field of [irregular or wavelike layers of] black, basaltic lava pockmarked with huge fissures, and covered everywhere with stunted, sun-burnt brushwood," Darwin complained in his report. The land, overheated by the midday sun, lent the sweltering air a closed and oppressive feeling, like an oven; and it smelled very unpleasant. Countless crabs and iguanas ran helter-skelter in all directions as the new arrivals clambered from cliff to cliff, "like one might imagine the cultivated part of hell," Darwin wrote. The birds were not afraid of human beings and were very tame; where was the joy of hunting, then?
Conscious of duty, he added the animals to his collection. He thought he had collected wrens, finches, black and spotted thrushes. But the forms of the beaks puzzled him: some were thick and strong, like those of the grosbeaks, others, on the contrary, were thin like those of songbirds. But he did not stop to figure out which bird came from which island. It was too late when Darwin realised that he had missed an opportunity. Shortly after departure, the vice governor of the English penal colony at the Galápagos Islands told him that each of the colossal turtles that were native to these islands could be assigned to its respective island of origin, based on the appearance of its shell. In other words, the turtles of those islands were unique variants, perhaps even separate species; Darwin had already suspected something similar for the plants. Could it possibly be true for the birds as well? It was no longer possible to discover the truth, because his specimens were not adequately labeled and the Beagle was already on its way home across the Pacific.
On October 1836 the ship reached England. Barely had he touched shore when Darwin handed over the birds from the Galápagos to the renowned ornithologist John Gould. The latter was not too bothered about how the bills had evolved on the birds. In the case of the spotted thrushes, Darwin had suspected that they were distinct varieties (ranks below that of a species). Gould, however, found that these were in fact three new species, closely related to the species that are native to the South American continent. Darwin had made another mistake: Gould recognised that what were supposed to be black thrushes and wrens were also types of finches. They were so unique that he later put them under a new group of finches that consisted of 14 species, each of which had its own ecological niche on the Galápagos. Was it possible that something similar applied to the species Darwin had originally classified as finches as well? Darwin contacted Captain Fitzroy, whose crew members had put together their own collections, and had been more conscientious in labeling them. And indeed, like in the case of the thrushes, every island had its own species of finch! Had God created separate kinds of birds for each island? Darwin had his doubts.
In his notebook, he speculated on the uniqueness of animals: Darwin's finches now no longer lived in the 6,000-year-old world created by God in seven days, but on an archipelago that must have risen, not too long ago, at least in geologic terms, from the Pacific. Once they had appeared, birds from the South American continent could have reached the group of islands. Over generations, the animals changed and adapted themselves to their respective environments, finding their way into as yet unoccupied ecological niches. In his notebook, he drew a branched genealogical tree showing how old species gradually evolve into new ones, or else they would die out, like the large mammals that Darwin had chiseled out of the stone in Patagonia. In his thoughts, he slowly came closer to the question of the origin of humans. At the London Zoo he studied the latest attraction, a female orangutan called Jenny. In her face he recognised traits that babies also have. "Man from monkey?" he asked himself in his notes.
Now the young researcher stood on the threshold of heresy. While he made preparations for his wedding, Darwin also looked for the mechanisms through which species underwent change. One evening he came across the bleak book An Essay on the Principle of Population written by the British economist Thomas Robert Malthus (1766 to 1834). In it, Malthus showed why the population was destined to explode in the course of a few years unless checked by hunger catastrophes or epidemics. His calculations were simple: Whereas the sources of food followed an arithmetic progression (1, 2, 3, …), the rate of propagation followed a geometric one (1, 2, 4, 8, 16, 32, …). "Hence, it can be claimed with certainty that the population will double every 25 years unless controlled", Malthus concluded. Darwin immediately drew parallels in the natural world: "Every species must have the same number killed year [after] year by hawks and cold and other reasons, even one species of hawk decreasing in number must affect instantaneously all of the rest…. One may say there is a force like a hundred thousand wedges trying [to] force every kind of adapted structure into the gaps in the economy of nature, or rather forming gaps by thrusting out weaker ones."
The idea of natural selection as the driving force in evolution was thus born. Accordingly, there is a relentless competition for survival going on in nature. Some individuals have an advantage because of certain characteristics they possess, which improve their chances of survival in the environment they inhabit. Hence, their chance of bearing offspring is disproportionately higher so that these characteristics can be passed on from generation to generation. The changes are no doubt too small to be observable from one generation to the immediate next one, but as a passionate geologist, Darwin was thinking in terms of entirely different timeframes. "I now had a theory, finally, with which I could work," he wrote later. However, it was to take several years until it was published.
One day in June 1858 Darwin received mail from overseas. The sender, Alfred Russel Wallace, a young and enthusiastic natural scientist who had traveled around the world at his own expense, and earned his livelihood by exporting exotic animals. Darwin had requested two years earlier the bellows (lungs) of pigeons and poultry breeds from the Malayan archipelago; since then, Wallace had been in touch with the already well known private scholar. The package, which was collected from the Moluccan island of Ternate, however, did not contain information about Malayan bird species that Darwin had requested, but a scientific manuscript of about 20 pages. In an accompanying letter, Wallace requested that Darwin forward the essay to Lyell for publication, if he felt it was significant enough. He hoped his ideas would contribute to filling the "missing link" in the evolution of species. As Darwin read the article, he saw his life's work "shattered": someone else had pulled ahead of him. "Wallace could not have prepared a better resume if he had my handwritten draft of 1842", he finally wrote, in an embittered missive to Lyell. Even the vocabulary was the same: Wallace, too, wrote of "variants" that had been eliminated through a "fight for survival" from their original species. Darwin's comment in response was simple and to the point: "This has destroyed all my originality."
Charles Lyell was not surprised. He had urged Darwin time and again in the past to speed up his work, having read an article by a hitherto unheard of researcher that had appeared in a scientific journal that encompassed the essential arguments of the theory advanced by Darwin, and later even by Lyell himself. But Darwin had ignored the dangers, informing his old teacher that only an extensive tome with appropriate footnotes would be capable of convincing the public of his theory. Hesitatingly, he had revealed to a few other natural scientists his godless theory, over a period of nearly two decades: "It is as if one were confessing to a murder," he wrote to his closest confidante, the botanist Joseph Dalton Hooker. And Wallace had even read Malthus's work. While he was confined to bed following a serious attack of malaria in Ternate, he applied the overpopulation theory of the British economist to the natural world, around 20 years after Darwin had done the same. Now, was a rank outsider going to steal the well deserved laurels from the famous natural scientist Charles Darwin?
Together with Hooker, Lyell hatched a plan that was to go down in the history of biology as a "delicate arrangement". Yes, they would publish Wallace's manuscript, but only along with two extracts from Darwin's work which would precede the article, so that their priority would be recognizable. Charles Darwin, who was mourning the death of a son, consented. "I will do everything I am told to do." And even Wallace consented to it after his return. "Wallace never criticized this arrangement and acknowledged Darwin's priority," according to science historian John van Wyhe. "He acknowledged without envy that he could never have documented the evidence of the mechanisms of evolution so well." At a meeting of the Linnaean Society of London on July 1, 1858, both works were read without receiving much attention. The society's annual report noted that the year 1858 had drawn to an end "without any discoveries that could revolutionize the research disciplines". Now out in the open, Darwin did not want to lose any time. He completed his work in haste. The day on which the work On the Origin of Species by Means of Natural Selection or the Preservation of Favored Races in the Struggle for Life was published, November 24, 1859, started a new epoch in biology. This time, the response was overwhelming: all 1,250 copies of the book were sold out on the very first day of its appearance.
Under the chairmanship of Henslow, there was confrontation between supporters and opponents on June 30, 1860, at the meeting of the British Association for the Advancement of Science in Oxford. Darwin himself was ill and could not attend. Nevertheless, the proceedings were heated. When Bishop Samuel Wilberforce asked if Darwin's close friend Thomas Henry Huxley had descended from the apes on his grandfather's side or his grandmother's side, he replied: "Had the question been addressed to me, whether I would rather have a miserable ape for a grandfather or a man highly talented by nature and with great influence and importance, but who uses his skills and influence merely for the purpose of bringing in ludicrousness into a serious scientific discussion, then I would without hesitation confirm my preference for the ape." Captain Fitzroy burst in on the commotion: Clad in military uniform and holding up a Bible, the former commander of the Beagle swore in the presence of all that he believed more in God than in human beings. The book published by his travel companion of yore had apparently caused him a lot of pain.
It was not until 1871 that Darwin commented on The Descent of Man, on the origins of our own species. Eleven years later, he died in his country home near London. Until the very end, his wife Emma, with whom he had been married happily for 43 years, had watched by his bedside. Darwin's ideas were to survive, his much quoted prophecy, which was the only place in the On the Origin of Species to give any insight into his own view on whether the "ape question," was to become true. It is said there: "Light will fall on the origin of man and his history."