Chicago and North Western railroad yards in Chicago
Ilargi: I saw a Washington Post headline today that read: ”Obama Scores Early Victory of Historic Proportions". Now there may be all sorts of political agenda's among reporters and editors, and people may genuinely see things in different ways, but that headline is nothing but a huge pile of horse nonsense. The stimulus plan is a blunder of historic proportions, not a victory. The article touts the speed with which is was set up and pushed through, but that in reality is not exactly a positive aspect. It makes it all worse, not better. There are many voices among economists who have said the plan lacks substance and detail; a large part of the reason why lies in the haste with which it was concocted. Tim Geithner was attacked by his peers yesterday in the G7 meeting for the same reason.
Moreover, we now know that virtually no-one in the Senate and Congress has actually read the plan. You don't get to celebrate $787 billion victories because you're fast, you do that because you're good. Obama has nothing like that to show for the plan, which is a victory only for Wall Street and other corporations that get to profit from it. About 25% of the original TARP funds were completely wasted, and there is zero reason to presume it'll be different this time around. In fact, it's guaranteed to be as bad, simply by the fact that it has been prepared too hastily and with scant attention for details.
Meanwhile, the FDIC closed another 4 US banks, which means 7 closures so far this month (it’s February 14th only), and we're well on our way to over 100 failed banks in 2009. Without TARP it would have been much worse, and TARP has merely delayed the inevitable for many banks, not solved their problems. There is an absolute killer storm on its way in commercial real estate loans, and it's hard to see how 10 or more folding banks per week will not become the norm come spring.
The first warning of Obama's upcoming darkest hour will likely not come from the financial sector, however. General Motors today announced a sort of ultimatum for the administration: give us more money, or we'll file for Chapter 11. I have warned about this throughout 2008: Obama should have solved the Detroit situation before becoming president, in order to not let the Formerly Big Three go down on his watch. GM and Ford are stronger symbols of America than any other companies, and their bankruptcies will be held against the president who allows them to fail, in a big way. Detroit needs a minimum of 15 million cars sold in the US market to stay viable. Forecasts for 2009 are 10 million sales, but I bet that is way too high, even as Washington has started handing out cash for car-buyers. Subsidies or no subsidies, sales may fall to as low as 5 million this year.
It's over, dear people, the dream is broken and cannot be mended. Gerald Celente predicts tax revolts and "another evolution" in the US. Listen to what he has to say in the video below. He is not an idiot, he expresses my views and fears to a T. The way things are going today, I don't see how he could be proven wrong. There are many people who say that European models are no better, or even worse, than the American one, but they fail to acknowledge that the American model is gone, forever. It's over. Until and unless we recognize that, and implement measures to make sure there will not be millions of US citizens thrown into the sort of misery we see on TV reports about Somalia and Ethiopia, we are sure to lose out. There will no longer be an American society, and probably not even a country.
Everything that’s being decided today is making things worse, and necessarily so. All the trillions of dollars spent on trying to revive a vision that is pining for the fjords benefit only the guys and dolls who make those decisions, the rulers on Capitol Hill, Lower Manhattan and the City of London. Those trillions are being taken away for the people who need them most, and more than they presently realize. You cannot and will not maintain a society as a going concern where little children lie dying of hunger and cold in the streets. And that's where we're heading, fast.
Obama keeps on talking about restoring economic growth. But perpetual growth has moved on to the land of the dodo, and it will not return in his or our lifetimes, if ever. We need to use what resources are left to try and keep our societies from spontaneous combustion. That's not a matter of choice, we don't get to choose growth anymore. It's no longer an available option. We're all out of it. There's empty shelves where once growth was on display. If and when the current financial mess is somewhat cleaned out, and that will take until 2020 if not longer, we will run into the mother of all energy conundrums, which will reduce a return to growth to a wet daydream. Yeah, and Happy Valentine.
Ilargi: Please, everyone, watch this video! Celente expresses what I've been warning about for a long time. He is right, and so am I. We are in a political crisis, not just a financial one. Everything we have based out lives and lifestyles on is under threat.
Gerald Celente: An economic collapse the likes of which the world has never seen before
"There will be another revolution in this country".
And another Celente interview is here:
Who is Gerald Celente? Wikipedia:
"After years in politics and lobbying, Gerald Celente founded The Trends Research Institute (initially called the Socio-Economic Research Institute of America) in 1980 in Rhinebeck, New York. According to several media sources published after the events, its successful predictions include Black Monday, the fall of the Soviet Union, the 1997 Asian Financial Crisis, the quarter of the dot.com bubble burst, the subprime mortgage crisis, and the financial Panic of 2008 including the statement that "corporate giants would tumble to their death."
Europe's industrial base may never recover from crisis
The European Commission has issued a red alert over the unprecedented collapse of industrial production, warning that EU states are running out of money for rescue packages. Factory output plunged by a record 12pc in December year-on-year. Spain suffered the steepest fall of countries in the Eurozone with a 20pc drop. Among non-euro countries, the biggest declines were led by Latvia (-21pc), Sweden (-18pc) , and Romania (-17pc). "What's completely new is the extent and speed of this crisis. The credit crunch is a reality, and even member states are having trouble financing their debts," said industry commissioner Gunther Verheugen.
"Blind activism is not going to help. EU states and the commission must not take on the role of white knights. We don't have a single euro in our budget to save companies. The financial options of the EU and member states are reaching their limits." Julian Callow, from Barclays Capital, said an over-valued euro had slowly "hollowed out" Europe's manufacturing core over the last two or three years. "It takes time for currency effects to feed through. The damage was concealed during the global boom but the collapse in demand has exposed the vulnerabilities. We going to see a prolonged period of de-industrialisation," he said.
The commission said core sectors such as shipbuilding might never recover from the slump as Asian competitors lock up the next round of orders by offering "unfairly low prices". "European yards do not have the means to withstand a price war or to operate at below costs for long", it said. Europe still has 150 ship yards supporting almost 450,000 workers, and control 35pc of the global market. The car and truck industry are in dire straits. Orders for heavy duty vehicles collapsed from 38,000 last January to 600 in November. The report said car sales may fall a further 18pc this year, cutting output by 2.5m vehicles. This has led to knock-on effects across industries. Flat steel orders have dropped 57pc. Ominously, Europe's steel output (-19pc) is falling at twice the global rate (-10pc).
While Daimler is still able to raise capital at a penal rate of around 9pc or 10pc, both PSA Peugeot Citroen and Renault have been unable to place bond issues. Renault said its car division had lost €873m (£783m) in the second half of 2008. French president Nicolas Sarkozy has come to the rescue with a €6bn package of soft loans for France's car industry, provided it promises not to fire workers or shift plant abroad. Brussels is examining whether this breaches EU law. Jose Barroso, the Commission's president, said it was imperative aid packages by different EU states do not degenerate into beggar-thy-neighbour protectionism. He said: "We will be studying aid plans to ensure that there are no harmful collateral effects in other countries. If one country takes unilateral measures, the others could do it as well. We would lose Europe's greatest resource: the single market"
China is right to have doubts about who will buy all America's debt
Chinese doubts about the value of US Treasury bonds highlight a crucial question: who will buy the estimated $2.7 trillion (£1.9 trillion) to $4.2 trillion of debt expected to be issued over the next two years? With annual foreign purchases accounting for less than a tenth of the low end of that range, and domestic investors unable to bridge the gap, the Chinese are right to worry. Yu Yongding, former adviser to the People’s Bank of China, recently demanded guarantees for the value of China’s $682bn of Treasury securities. Then Luo Ping, director of the China Banking Regulatory Commission, said that China had misgivings about the US economy, but despite this it would continue to buy Treasuries. The two statements appear designed to raise the issue non-confrontationally before new chief US diplomat Hillary Clinton’s visit to Beijing on February 20.
China worries about the dollar’s value against other currencies, particularly the yuan. With US interest rates so low, the dollar’s value may slide. However, President Barack Obama has repeatedly said he wants a strong dollar, and indeed its trade-weighted value rose 13.9pc between April and December 2008. The other area of concern for China is the value of its Treasuries. Given the US borrowing requirement and its lax monetary policy, Treasury bond yields could well rise sharply, causing a corresponding price decline. If China’s holdings match Treasuries’ average 48-month duration, then a 5pc rise in yields, from 1.72pc on the 5-year note to 6.72pc, would lose China 17.5pc of its holdings’ value, or $119bn.
Foreign buyers have absorbed a little over $200bn of Treasuries annually, a useful contribution to financing the $459bn 2008 deficit, but only a modest help towards the $1.35 trillion minimum average deficit forecast for 2009 and 2010. Unless that changes substantially, there will be $1trillion annually to be raised by the Treasury from domestic sources, more than double the previous record from domestic and foreign sources together, plus whatever is needed to bail out the banks. Even if the US savings rate were to rise from zero to its long-term average of 8pc of disposable personal income, that would create only an additional $830bn of savings -- not enough to fund the domestic share of the deficit. Interest rates would probably have to rise substantially to pull in more foreign investors.
Yu is right to worry.
No one home: 1 in 9 US housing units vacant
A record 1 in 9 U.S. homes are vacant, a glut created by the housing boom and subsequent collapse. "The numbers are further documentation of the gravity of the housing problem," says Nicolas Retsinas, head of Harvard University's Joint Center for Housing Studies. "This inventory is delaying any kind of housing recovery." The surge in empty houses, condominiums and apartments is creating a wave of problems for communities desperate to shore up property values and tax revenues that pay for services. Vacant homes create upkeep and safety problems that ripple through neighborhoods.
"It has a contagion effect," Retsinas says. "A house that is vacant is often a house that is less well kept up." A construction frenzy began pushing the vacancy rate up in 2005 but empty homes sold quickly at that time. "This is a different problem," says Dowell Myers, housing demographer at the University of Southern California. "It's high now because of lack of demand. Now, vacancies we see are from units that have been empty for a period of time." Census numbers show:
- More than 14 million housing units are vacant. That number does not include an estimated 4.8 million seasonal or vacation homes, most of which are occupied part of the year. The combined vacancy rate of almost 15% is higher than during previous recessions: 11% in 1991 and 9.4% in 1984.
- About 3% of owned homes are vacant. In normal times, "maybe 1% should be vacant," Myers says.
- More than 9% of homes built since 2000 are vacant compared with about 2% for older homes.
- Homes priced at $500,000 or more are just as likely to be empty as homes that cost less than $100,000.
Historically, vacant housing was more of a concern in cities that have poor neighborhoods. Now, it has hit suburbs and new subdivisions.
"You have abandoned vacant housing in Detroit but you also have it in Henderson, Nev., and Mesa, Ariz. (suburbs of Las Vegas and Phoenix)," Retsinas says. The stimulus bill before Congress contains $2 billion to help communities buy and fix foreclosed, vacant properties. One place hit hard is Rialto, Calif., an inland town that boomed by offering shelter from astronomical housing prices in coastal Southern California. Property values have dropped 50% since 2007. In a 40-unit development, only four are occupied, says John Dutrey, housing program manager. Vacant homes, he says, bring "squatters, you have maintenance issues, security issues."
Obama Scores Early Victory of Historic Proportions
Twenty-four days into his presidency, Barack Obama recorded last night a legislative achievement of the sort that few of his predecessors achieved at any point in their tenure. In size and scope, there is almost nothing in history to rival the economic stimulus legislation that Obama shepherded through Congress in just over three weeks. And the result -- produced largely without Republican participation -- was remarkably similar to the terms Obama's team outlined even before he was inaugurated: a package of tax cuts and spending totaling about $775 billion.
As Obama urged passage of the plan, he and his still-incomplete team demonstrated a single-mindedness that was familiar from the campaign trail. That intensity may have contributed to missteps in other areas, as the president's White House stumbled repeatedly in the vetting of his Cabinet and staff nominees. And high-minded promises of bipartisanship evaporated as Republicans accused the president and his Democratic allies in Congress of the same heavy-handed tactics that Obama, in his campaign, had often demanded be changed. But even before the plan passed the Senate last night, the president's top advisers were crowing. "We've been in office, what, 2 1/2 , three weeks? We've passed the most major sweeping comprehensive legislation as relates to economic activity ever in a three-week period of time," White House Chief of Staff Rahm Emanuel said Thursday evening in the West Wing.
House Speaker Nancy Pelosi (D-Calif.) credited Obama's leadership on the legislation yesterday, saying, "The American people know, and historians are judging, that this is one remarkable president." Certain that he had succeeded in his goal, Obama left Washington before the Senate vote was completed, returning home to Chicago last night for the first time since becoming president. The feat compares only with President Franklin D. Roosevelt's banking system overhaul in 1933, which cleared Congress within days of his inauguration. For Obama, though, the costs of that rapid pace may be his relationship with Republicans, who derided the bill as the wrong prescription for a national economy that has appeared for months to be on the verge of collapse.
House Minority Leader John A. Boehner (Ohio) described the stimulus package as a "billion-dollar-a-page" spending plan and accused Democrats of not wanting people to read it "because they might actually find out what's in it. And in the days and weeks and months to come, we'll know how this money will be spent." Obama aides had predicted several weeks ago that Republican lawmakers from states such as Michigan, Florida and California, where many communities are struggling, would feel compelled to vote for the bill's final passage because of the impact it promised for their constituents. Instead, opposition to the plan only increased over that time. "This was not an easy vote for me. I had to dig down deep," said Rep. Candice S. Miller (R-Mich.). Her conclusion: "Michigan, we are getting railroaded."
Long before the end of the 100 days that, since FDR's feat, have been used to measure the opening act of a presidency, Obama and his allies who control Congress can point to a major legislative victory earlier than most new administrations. At about this point in Bill Clinton's administration, the president and his new team were putting the final touches on an economic plan that had yet to be publicly announced. That economic plan ultimately passed in August, giving the young president a victory. But his $19 billion stimulus plan -- one-fortieth of the current legislation -- was too controversial to survive the partisan battles. By the end of three weeks, Clinton had named an envoy to Bosnia and announced rules to limit corporate tax deductions for executive pay. And he had announced a plan to save $35 billion in Medicare costs by cutting payments to hospitals and raising premiums for the wealthier elderly. He railed at the cost of prescription drugs. But none of those issues was resolved within that time.
President George W. Bush was similarly without a major achievement by the week of Feb. 8, 2001, three weeks after his inauguration. Bush had begun selling his $1.6 trillion plan to cut taxes, and he had announced a plan for a big investment in new weaponry for the military. He was preparing for his first international trip, to Mexico, and gave a speech to military units warning against "overdeployment." Unlike Obama, by this point Bush had not yet held a prime-time news conference. Like Obama, Bush made an early gesture to encourage bipartisanship: inviting members of the Kennedy family to the White House to see the movie "Thirteen Days." Bush's efforts at bipartisanship largely failed, but not until after he had launched a war in Iraq and pursued controversial efforts to expand the power of the executive branch.
Obama may yet find that his early legislative success amounts to little in a country where the public has a famously short attention span. And other issues will soon intrude on a White House that has largely tried to postpone foreign policy concerns and other domestic issues. Obama moved quickly to announce the closure of the prison facility at Guantanamo Bay, Cuba, but he said it would take a year to study how to make it happen. On issues ranging from Pakistan and Afghanistan to the war in Iraq, he has ordered commissions or study groups to make recommendations. And thus far, he has taken a pass on other hot-button domestic issues: He has not succumbed to pressure to take quick action on stem cell research or new unionizing rules, for example. Obama aides dismiss such points, saying that the deepening economic crisis required the president to focus all of his attention on the stimulus package first. Emanuel, who served as a senior adviser in Clinton's administration, said, "Having been in two separate White Houses, within our third week, given our set of accomplishments -- well, measure them up."
Stimulus Bill Passes in the House With No G.O.P. Support
The House approved a $787 billion economic stimulus package Friday afternoon, with Democrats successfully promoting it as a boost for middle-class Americans and Republicans countering in vain that it will only stimulate wasteful government spending. The vote was 246 to 183, reflecting the Democrats’ considerable majority in the House and the Republicans’ deep dissatisfaction with the measure, whose estimated price tag has fluctuated daily and was finally placed at $787 billion on Friday. Not a single Republican voted in favor of the bill.
The Senate was expected to vote on the final legislation Friday evening, clearing the way for the paperwork to go to President Obama, who is eager to sign the measure. "After all the debate, this legislation can be summed up in one word: Jobs," House Speaker Nancy Pelosi of California said. "The American people need action and they need action now." But Representative John A. Boehner of Ohio, the House minority leader, lamented that a bill that was supposed to be about "jobs, jobs, jobs" had turned into one that was about "spending, spending, spending." "We owe it to the people to get this bill right," Mr. Boehner said.
President Obama and Democrats in Congress contend the package is designed to create or save 3.5 million jobs. There was no suspense about the outcome, since the Democrats hold a 255-to-178 advantage in the House. The real suspense was how many, if any, Republicans would vote for the bill; none did two weeks ago, when the House approved its initial version of the legislation. A handful of Democrats opposed the bill on Friday. "The country needs this package," said Representative David Obey, the Wisconsin Democrat who is chairman of the Appropriations Committee. "I think we ought to get on with it."
But the committee’s ranking Republican, Jerry Lewis of California, asserted that the program would do far too little to finance road construction, flood control projects and other works for the public good. "Facts are stubborn things," Mr. Lewis said, describing the package as a recipe for bloated government programs that would saddle taxpayers with a debt burden "well, well into the future." The legislation is the product of negotiations between the House and Senate, which had favored a somewhat larger stimulus. The final package ended up considerably smaller than either the House or Senate had originally approved.
President Obama, speaking at the White House to the Business Council, an association of chief executives, described the vigorous debate leading to the votes in Congress as "a good thing." "Diverse viewpoints are the lifeblood of our democracy, and debating these viewpoints is how we learn from each other’s perspective and refine our approaches," Mr. Obama said. The president said the program nearing passage would benefit not only middle-class families but "will also provide sensible tax relief to business that are trying to make payroll and create jobs."
But as debate in the House went on, it was clear that the gulf between Democrats and Republicans was as wide as ever. Representative Charles B. Rangel, the New York Democrat who is chairman of the Ways and Means Committee, said the legislation would offer "hope not only for those people who are jobless, but hopeless." But Representative Dave Camp of Michigan, the committee’s ranking Republican, complained that Republicans had been "frozen out" by Democrats. "Most important, the American people were frozen out," he said. "Record me as a ‘no’ on this legislation."
Democratic Senator Predicts None of His Colleagues 'Will Have the Chance' to Read Final Stimulus Bill Before Vote
Sen. Frank Lautenberg (D-N.J.) predicted on Thursday that none of his Senate colleagues would "have the chance" to read the entire final version of the $790-billion stimulus bill before the bill comes up for a final vote in Congress. "No, I don’t think anyone will have the chance to [read the entire bill]," Lautenberg told CNSNews.com. The final bill, crafted by a House-Senate conference committee, was posted on the Website of the House Appropriations Committe late Thurday in two PDF files.
The first PDF was 424 pages long and the second PDF was 575 pages long, making the total bill 999 pages long. The House is expected to vote on this 999-page bill Friday, and the Senate either later Friday or Saturday. [Editor's note: The first PDF, as posted on the House Appropriations Committee website as of 8:20 AM Friday morning, had grown by 72 pages to 496 pages, increasing the length of the total document to 1,071 pages.] Of the several senators that CNSNews.com interviewed on Thursday, only Sen. George Voinovich (R-Ohio) claimed to have read the entire bill--and he was speaking of the preliminary version that had been approved by the Senate, not the final 999-page version that the House-Senate conference committee was still haggling over on Thursday afternoon.
When CNSNews.com asked members of both parties on Capitol Hill on Thursday whether they had read the full, final bill, not one member could say, "Yes." And only one--Voinovich--volunteered that he had actually read the version of the bill that had passed the Senate. Both Republicans and Democrats told CNSNews.com they were eager to read the unseen bill--once they could get get their hands on a copy of the final legislation. Nonetheless, members from both sides of the aisle in both the House and Senate admitted they doubted they would have adequate time to read the bill before they actually voted for it. "Certainly I hope to have the opportunity to go through [the bill] before the vote takes place," said Sen. Bob Corker (R-Tenn.) told CNSNews.com. "But that’s something I’ve found doesn’t always happen around here."
Some lawmakers said one of the reasons they would not vote for the bill was because there would be no time to study it before it came up for a vote. "The Democrats have thrown this at us very last-minute," said Rep. Zach Wamp (R-Tenn.). "That’s why the rule of thumb in the United States Congress should be, ‘When in doubt, vote no,’ because the devil is in the details and that’s why this stimulus is not worthy of support." Rep. John Boozman (R-Ark.) shared that sentiment. "The American public expects for us to get in and know what we’re voting on," Boozman said. "But there are very few members from Congress that are going to have time to actually read this thing." "This is not light reading," Boozman added. "It’s difficult reading, it involves policy and things."
"Right now, because of those things, I will probably vote against it," he added. Sen. Roland Burris (D-Ill.), President Barack Obama's successor in the Senate, seemed baffled by the thought of actually reading the entire bill--as did his press secretary. "I think it’s about 800 pages," Burris's press secretary said before laughing lightly. "We’ll do the best we can." Sen. John Thune (R-S.D.) said that due to the hasty process, he may not have time to read the whole bill. "I will, as much as I can, get through all the changes that occurred in the conference committee," says Thune. "That’s assuming we have time to review it prior to the vote," he added, "This is a very rushed process, the whole process, starting from the beginning has been very rushed."
Voinovich, the only member of Congress who told CNSNews.com that he had taken the time to read through every line of the stimulus bill that had been initially approved by the Senate, said he planned to do the same for the final version of the bill that had been approved by the House-Senate conference committee. But the Ohio Republican wasn’t sure if his colleagues would be as meticulous as he had been. "I don’t know," he said, when asked if he thought others would read every line of the bill. "You’ll have to ask them." The bill is expected to land on President Obama’s desk no later than Monday, and the president is expected to sign it into law--whether the nation's lawmakers have read it or not.
Fannie Mae, Freddie Mac, Citigroup, JPMorgan Chase and Morgan Stanley Suspend Foreclosures
Government-controlled mortgage finance companies Fannie Mae and Freddie Mac said Friday they have immediately suspended all foreclosure sales involving occupied single-family and 2-4 unit properties through March 6. This is to give troubled borrowers more time to work with loan servicers to avoid losing their homes. The move, which doesn't apply to vacant properties in foreclosure, is ahead of the Obama administration's roll-out of its national foreclosure prevention and loan modification program.
The White House said President Barack Obama on Wednesday will outline his much-anticipated plan to spend at least $50 billion to prevent foreclosures in a speech in Arizona, one of the states hardest hit by the foreclosure crisis. Both Fannie Mae and Freddie Mac, which were seized by federal regulators last fall amid the market meltdown, had suspended foreclosure sales during the winter holidays and halted evictions from foreclosed properties until next month. Meanwhile, Citigroup, JPMorgan Chase and Morgan Stanley said they had placed a moratorium on foreclosing on some home loans to give the government time to launch a $50 billion mortgage relief program.
The moratorium announcements come days after major bank chief executives committed to pausing mortgage foreclosures at a Congressional hearing. As reported Thursday, Obama officials are working on a plan to spend $50 billion on foreclosure prevention and establish national standards for modifying home loans. The program would include possible government subsidies for homeowners who qualify. Foreclosures have skyrocketed during the mortgage crisis. The National Association of Realtors said Thursday that sales of foreclosed homes helped drag the median price of existing homes to its lowest level since 2003.
Citigroup said its moratorium, which started on Feb. 12, will last until either President Barack Obama has finalized the details of a program for modifying mortgages, or until March 12, whichever comes first. It applies to mortgages that Citi owns, to borrowers living in their homes. Morgan Stanley's moratorium started this week, and will last until March 6. It applies to the bank's Saxon unit, which collects payments on loans. JPMorgan Chase said its moratorium will last through March 6, which it believes is enough time for the Treasury to announce a new mortgage modification plan.
Treasury Secretary Timothy Geithner Tuesday announced a plan to stabilize the financial system. One element of the plan is $50 billion of assistance to "prevent avoidable foreclosures" of middle-class homes occupied by their owners, according to a document Geithner released. The Obama 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. Under the evolving plan, homes would undergo a standardized reappraisal and homeowners would face a uniform eligibility test, sources said.
Bank regulators have used 38 percent of gross income as a benchmark for one mortgage relief program. If a homeowner is spending more than that amount on housing, they may qualify for a streamlined loan program, but the Obama administration may choose a lower percentage as a trigger for relief in any new plan. In an interview, James Lockhart, the regulator that 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.''
Four More U.S. Banks Are Shut, Bringing Total for Year to 13
Banks in Florida, Illinois, Nebraska and Oregon were shut by state regulators, boosting the toll of failed institutions to 13, as a worsening economy and slumping housing market pushes home foreclosures to records. Riverside Bank of the Gulf Coast in Cape Coral, Florida; Sherman County Bank in Loup City, Nebraska; Corn Belt Bank and Trust Co. of Pittsfield, Illinois; and Pinnacle Bank of Beaverton, Oregon were closed by state regulators yesterday. The Federal Deposit Insurance Corp. was named receiver.
TIB Bank of Naples, Florida, will buy Riverside’s $424 million in deposits, except $142.6 million in brokered deposits, for a 1.3 percent premium. Heritage Bank of Wood River, Nebraska, will pay a 6 percent premium for Sherman County’s $85.1 million in deposits. Carlinville National Bank of Carlinville, Illinois, will assume Corn Belt’s $234.4 million deposits for a 1.75 percent premium. Washington Trust Bank of Spokane, Washington, assumed Pinnacle’s $64 million of deposits, the FDIC said.
Regulators seized six banks in January, the highest monthly toll since 1993. State and federal agencies shuttered 25 banks last year, matching the combined total for 2001-2007, as home foreclosures soared and bank profits tumbled. The Obama administration is seeking to jolt the economy with a bank rescue using $350 billion from the Troubled Asset Relief Program, a $787 billion stimulus package and a plan to stem foreclosures. The U.S. will subsidize interest-rate reductions to help borrowers avoid losing their home, said a person briefed on the proposal, costing $50 billion.
Treasury Secretary Timothy Geithner outlined the bank rescue and pledged to remove illiquid assets from banks’ balance sheets and spur lending. Private investors have expressed an interest in joining the government in the fund, Lawrence Summers, director of the National Economic Council, said on Bloomberg Television’s "Political Capital with Al Hunt." The FDIC, other bank regulators and Congress are taking steps to help banks avoid losses. Legislation that would more than double deposit insurance coverage is being considered by Congress. The House Financial Services Committee unanimously approved a measure Feb. 4 that would raise coverage to $250,000 per depositor per bank, from $100,000.
Congress also may extend the FDIC’s line of credit with the Treasury to $100 billion from $30 billion to replenish the deposit fund. The FDIC said bank failures through 2013 may cost the fund more than the $40 billion estimated in October. Yesterday’s bank closings will cost the Deposit Insurance Fund a total of $341.6 million, the FDIC said. On Dec. 16, the FDIC doubled premiums it charges banks to replenish its reserves, which had $34.6 billion as of the third quarter. The Washington- based agency oversees 8,384 institutions with $13.6 trillion in assets. The FDIC classified 171 banks as "problem" in the third quarter, a 46 percent jump from the second quarter, and said industry earnings fell 94 percent to $1.73 billion from the previous year. The agency doesn’t identify problem banks by name. A new report may be released this month.
As many as 1,000 U.S. banks may fail in the next three to five years from mounting losses on commercial real-estate loans, RBC Capital Markets analysts have said, almost double the one- year tally at the height of the saving-and-loan collapse. Most of the failures will probably occur at banks with less than $2 billion in assets. More than 250,000 foreclosures were filed in January, the 10th straight month of a quarter-million filings, RealtyTrac Inc., the Irvine, California-based provider of real estate data, said in a statement this week. Washington Mutual Inc., the biggest savings and loan, sold its assets to JPMorgan Chase & Co. Sept. 25 after customers drained $16.7 billion in deposits in less than two weeks. Wachovia Corp., the sixth-biggest bank, was pushed by regulators to sell itself to Wells Fargo & Co. for $11.7 billion.
Failed Banks Pose Test for Regulators
When regulators took over the First National Bank of Nevada last year, they faced a showdown with the Terrible Herbst, the mustachioed cowboy who boasts of being the "best bad man in the West." This was no real gunslinger, but the name and logo of a chain of gas stations and convenience stores in Nevada that feature slot machines next to candy and beer. The family-owned Herbst chain, auditors at the Federal Deposit Insurance Corporation concluded, did not generate enough sales at its Reno-area gas stations to support the repayment of a loan, leaving auditors with three bad choices: Move to take over those stations and put the government in the gambling business. Cut off any flow of additional loan money. Or sell the loan at a steep loss.
The F.D.I.C. faces tough choices like this every day as it struggles to manage $15 billion worth of loans and property left from failed banks. If still-to-be-sold assets from IndyMac Bancorp of California, whose demise last year was the fourth-largest bank failure, are included, the number jumps to $40 billion. The F.D.I.C. inherited the collection of loans and property after the failure of 25 banks in 2008, compared to just three in 2007. Thirteen more have failed this year, including four on Friday night, and no one doubts that more are on the way. The F.D.I.C., which insures bank deposits and ultimately has responsibility for liquidating failed banks, is selling hundreds of millions of dollars worth of loans through eBay-like auction sites.
DebtX of Boston and First Financial Network of Oklahoma City, for instance, sell loans at auction to investors who typically pay 5 cents to 85 cents for each dollar of outstanding principal, according to Bliss A, Morris, First Financial’s president. It is unloading hundreds of houses across the country at bargain basement prices. In November, Lula Smith, 86, of Kansas City, Mo., bought a two-bedroom house across the street from her home for $4,000, one-tenth of its value two years ago. "I am real satisfied with that price, yes sir," she said, adding that after about $1,000 in additional costs to repair the house, and some new carpet, her son and daughter-in-law will move in. "It was a nice little deal, indeed." And — in the most closely watched tactic — the F.D.I.C. is negotiating a series of billion-dollar deals with private equity partners who will take over huge batches of loans in exchange for a chunk of the sale proceeds.
Even as the solutions to the financial crisis are debated in Congress and among economists, the F.D.I.C., one of the agencies that deals most closely with the nation’s banks, has already been transformed. The rising tide of foreclosed real estate is so overwhelming that the agency, which had shrunk to a relatively tiny 4,800 employees from as many as 15,000 in the last period of bank meltdowns in the 1990s, is in the midst of a military-scale buildup as it undertakes one of the greatest fire sales of all time. The agency is frantically calling in retirees and holding job fairs, looking to hire as many as 1,500 people. It has rented a high-rise office building in Irvine, Calif., the new headquarters for a West Coast branch of 450 employees who are wrestling with a real estate crisis in one of the hardest-hit regions. It is also budgeted to pay hundreds of millions of dollars for a small army of contractors to augment its staff. "We are trying to be ready for the inevitable," said Mitchell L. Glassman, director of the F.D.I.C.’s division of resolutions and receiverships.
The budget for that division is increasing to $1 billion this year, from $75 million last year. Nearly $700 million of the increase is set to go to contractors like RSM McGladrey of Minneapolis, which provides temporary workers to help the agency close banks. These workers come at an hourly rate of $50 to $250. It is a high price, but the F.D.I.C contends the cost is much less than it would have to pay to hire permanent staff. "It was so painful downsizing after the last banking crisis," James Wigand, deputy director of the F.D.I.C. receivership division, said, referring to the layoffs after the last cycle of bank failures. "We’re really trying to avoid going through that again." The blitz by the F.D.I.C. may offer lessons for the Treasury Department, which is separately struggling with an even more monumental challenge: how to help still-operating banks move giant loads of toxic debt off their balance sheets, in the hope that the banks will begin taking risks again and stimulate the economy.
Tuesday, for example, is the deadline for online bids for $108 million in loans left from the default of Freedom Bank of Bradenton, Fla., which DebtX is selling at auction. Particularly instructive for Treasury may be the partnerships the F.D.I.C. has formed with private equity groups and other profit-seeking investors, who are being given a chance to earn a big return in exchange for their help in managing billions of dollars worth of troubled loans acquired from defunct banks. Last month, the F.D.I.C formed a partnership with a company called Private National Mortgage Acceptance Company, based in Calabasas, Calif., which paid $43 million to take possession of $560 million in loans left from First National Bank of Nevada. Private National, a company set up last year to profit from the bad-debt market, paid the equivalent of 38 cents on the dollar for the 3,800 loans, which were left after another bank took over First National’s branches and deposits.
The company will try to collect payments from borrowers after renegotiating mortgages, or, if necessary, foreclose on loans and sell the property. Private National said it hoped to make an annual profit of more than 20 percent for its investors. Despite the small upfront price Private National paid, F.D.I.C. officials said they considered it a good deal. The government will receive, at least initially, 80 percent of any money Private National can generate from the loans. As a bank teeters, the F.D.I.C. swoops in virtually overnight and shifts as many good loans and deposits as possible to a healthy bank. The F.D.I.C. persuades the healthy bank to accept some of the bad loans by agreeing to take a share of certain future losses. What is left is a miserable stew of failed real estate projects, vacant land, boarded-up houses and loans to defunct or bankrupt businesses, among other stories of misery from these recessionary times. About 4 percent of the assets from bank closures last year were bad, totaling some $15 billion in loans and property that once belonged to institutions like the Douglass National Bank of Kansas City, Mo., and Sanderson State Bank of Sanderson, Tex.
This is the stuff that no healthy bank wanted to buy, losing propositions, or in the diplomatically bureaucratic language of government, "assets in liquidation." The F.D.I.C.’s new workload is bringing back retirees like Gary Halloway, 58, of Spicewood, Tex., who has had assignments in seven states since he returned to work last year as the leader of regulatory SWAT team, moving from one failed bank to another. "I wake up, I don’t know where I am, much less which time zone," Mr. Halloway said in Jackson, Ga., last month, where he was working out of a former funeral home as he helped close First Georgia Community Bank. Next stop: Houston, to work on the failure of Franklin Bank. "Sometimes I am driving on the highway and I see a sign and I even forget what state I am in," he said.
For the F.D.I.C staff, the hardest part of taking control of failed banks may be deciding which outstanding loans to cut off, even in cases where perhaps a house development is only half built. Ending a loan almost certainly shuts down a project. In the case of Terrible Herbst and its Reno-area gas stations, officials at the F.D.I.C. considered taking the highly unusual step of applying for a temporary casino license, allowing the agency to operate the gas stations and the electronic games after perhaps foreclosing on the nearly $10 million loan, one official involved in the effort said. Another option, simply cutting off additional advances of cash from the loan, was ruled out because the business might close, making it nearly impossible to collect any of the outstanding principal.
The resolution of the case turned out to be a windfall for Terrible Herbst. The government put the loan on sale, and who should buy it directly from the government but the Herbst family, at a discount of more than 50 percent. The government ate the loss, but at least it collected on some of the bad debt, the F.D.I.C. official involved in the deal said. Executives at Terrible Herbst, who said they never formally refused to pay off the loan in full, were hardly disappointed. "It worked out just fine," said Sean Higgins, the company’s general counsel. "At least for Terrible Herbst."
Wells Fargo expects community banks to suffer more with commercial mortgages
Wells Fargo Chairman Dick Kovacevich and CEO John Stumpf told an analyst that they expect their community bank rivals to suffer more than the bigger banks from problems with commercial real estate loans. The San Francisco company's top brass told RBC analyst Joe Morford that they expect Wells Fargo will benefit from its customer relationships and underwriting standards as the financial health of borrowers for commercial mortgages deteriorates, according to a research report that Morford shared with clients Friday.
Commercial mortgages are being closely watched as another source of pain for the nation’s bankers. At the height of the credit bubble, one industry observer said commercial real estate loans had become the crack cocaine of community banking, reflecting the pace of growth some were achieving with such loans. On the consumer front, Morford said Wells Fargo anticipates that it can cover any rise in consumer credit losses from net interest income. Many expect banks will experience rising losses in credit cards, auto and other consumer loans as the recession deepens and unemployment rises.
Morford also addressed a frequent topic when it comes to Wells Fargo: prospects for a cut in the dividend, now yielding about 8 percent. "Wells seems unlikely to cut the dividend near-term, preserving it as a key component for long-term shareholder returns," Morford said. But the analyst cut his 12-month price target on Wells Fargo to $21 from $25 per share, reflecting the general sell-off in financial stocks. The bank’s shares traded at the $16 level Friday.
Morford remains optimistic on the bank’s long-term outlook, especially with the growth potential in the recently acquired Wachovia territory. "At this point, the 10 percent cost-savings projection looks conservative, and many potential revenue synergies seem realistic including opportunities to reprice deposits or improve cross-sell ratios and add sales capacity at Wachovia," Morford said. "Furthermore, not only has customer retention been better, but also Wells is gaining market share."
GM to say: 'more aid or bankruptcy'
General Motors Corp. will offer the government the choice of giving it billions more in bailout money or seeing it file for bankruptcy when it presents a restructuring plan next week, according to a report published Saturday. The online edition of The Wall Street Journal, citing unnamed sources, said the competing choices present a dilemma for the Obama administration, which may fear seeing the industrial icon carmaker fall into bankruptcy and cut more jobs if it's refused more aid. The government has already committed $13.4 billion to GM as part of a federally-funded bailout. The automaker is expected to include its call for more funds in a restructuring plan it's required to submit to the Treasury Department by Tuesday, though the company isn't expected to include a dollar amount, according to the Wall Street Journal report.
However, Treasury Department officials believe GM needs at least $5 billion more in loans to keep operating beyond the first quarter, according to the report. While filing for bankruptcy may be the best way for GM to cut costs and revitalize, if the company chooses that option it may include politically unpalatable moves to sell off assets and cut more jobs. GM and other automakers have been slammed by a drop-off in car sales as the recession has worsened. GM and Chrysler LLC have asked for and received government bailout money, while Ford Motor Co., like its peers, has also seen sales fall sharply in recent months, but has not asked for aid.
Chrysler is also expected to submit a restructuring plan on Tuesday.
House Speaker Nancy Pelosi and Financial Services Chairman Barney Frank sent a letter Friday to GM Chief Executive Rick Wagoner and Chrysler Chief Executive Robert Nardelli reminding them that the White House expects to hear about restructuring plans that include a willingness "to make tough decisions," but which also will "protect American jobs in the future." GM said earlier this week that it plans to cut some 3,400 jobs, or 12% of its U.S. salaried workforce. Shares of the automaker have fallen nearly 15% in the past three months. The shares closed Friday down more than 5% at $2.50. Also this week, Toyota Motor Corp., the largest automaker in the world by sales, said it plans to cut back production in North America and offer buyouts to employees.
GM believes that if it is forced to seek bankruptcy, it would need government funds for debtor-in-possession financing, because such funding wouldn't be available from private sources, according to the Wall Street Journal report. In addition, the automaker may also seek permission to extend its March 31 deadline for some restructuring actions "by at least several months." While GM's Wagoner previously opposed filing for bankruptcy protection, the CEO in early December hired bankruptcy lawyers and advisers to prepare a "contingency plan," the report said. Chrysler, which has received $4 billion in federal loans, is attempting to have Italian automaker Fiat take a 35% stake in the company in exchange for providing technology for small and mid-size cars that Chrysler would build and sell. Chrysler is controlled by private equity firm Cerberus Capital Management LP. Chrysler is expected to request $3 billion in additional loans from the government, and it has recently been asking dealers to order more vehicles in order to give it enough revenue to keep going through the end of March, according to the report.
U.S. Auto-Parts Suppliers Seek $18.5 Billion in Aid
U.S. auto-parts suppliers, struggling with losses as sales dwindle, made a formal request for about $18.5 billion in aid to the U.S. Treasury Department. Two groups representing the companies submitted a proposal outlining three types of financial assistance, the Motor & Equipment Manufacturers Association said in a statement today. Original Equipment Supplier President Neil De Koker provided the amount in an e-mail. Parts suppliers are seeking aid after automakers cut production in the U.S. to a near-halt in the last weeks of December and into January because of plunging sales. About one- third of suppliers are in "imminent financial distress" and another third indicated they may reach that point during this quarter, MEMA said, citing industry surveys.
"The dramatic downward spiral that the supplier community witnessed in the last few months necessitates immediate action," Bob McKenna, chief executive officer of MEMA, said in the statement. The proposal asks the government to back payments promised to suppliers by General Motors Corp., Ford Motor Co. and Chrysler LLC, so partsmakers can use the so-called receivables as loan collateral. The plan also seeks funding so automakers can pay suppliers faster, as well as a government guarantee of commercial loans for the parts companies. De Koker said $10.5 billion would be used to back receivables, with as much as $7 billion of that amount being used in a "quick pay" program to get money to suppliers faster. About $8 billion would go toward guaranteeing commercial loans, he said.
Trade publication Automotive News reported the figures, citing De Koker, earlier today. One million jobs may be at risk if financial assistance is not provided, MEMA said in the statement. That group is based in Research Triangle Park, North Carolina. De Koker’s Troy, Michigan-based group, an affiliate of MEMA, represents more than 400 suppliers with combined sales exceeding $300 billion. His group includes companies such as Johnson Controls Inc., which reported its first quarterly loss since 1992 in January, and American Axle & Manufacturing Holdings Inc., which relied on GM for about 78 percent of its sales in the fourth quarter. GM and Chrysler already have been approved for a combined $17.4 billion in U.S. emergency loans and face a Feb. 17 deadline to file progress reports on their viability plans.
UAW Objects to GM, Chrysler Proposals as U.S. Deadline Looms
The United Auto Workers union is objecting to proposals from General Motors Corp. and Chrysler LLC to modify a retiree health-care fund as required by the U.S. so the automakers can keep $17.4 billion in aid. The UAW stopped negotiations with GM last night, a person familiar with the talks said. A delay in the talks could risk the automakers missing a Feb. 17 deadline to show progress in a government-ordered plan to cut labor and debt costs. It’s not clear what that would mean. The GM and Chrysler proposals on the Voluntary Employee Beneficiary Association "contradict the explicit terms of the Treasury loan agreements, and would severely hurt retirees," UAW legislative affairs director Alan Reuther said in an e-mail last night. "These proposals are a non-starter as far as the UAW is concerned."
The terms of the Dec. 19 loan agreements from the U.S. Treasury require GM and Chrysler to convince the UAW to accept half of scheduled payments into a union-run retiree health-care fund next year in equity instead of cash. The automakers are also seeking to eliminate supplement unemployment pay and change plant work rules to trim labor expenses. In GM’s case, the union must sign off on a cash contribution of $10.2 billion to the VEBA instead of $20.4 billion, GM said Jan. 15. The UAW already agreed to accept reduced cash payments into the health-care fund, which was established under the 2007 contract that let automakers pay new workers half as much as traditional union employees.
UAW President Ron Gettelfinger said in 2007 that the union was confident the VEBA could pay the health-care benefits of retirees for the next 80 years. He’s said he’s willing to make additional sacrifices to help the automakers avoid bankruptcy if auto executives, debt holders and others also sacrifice. "We are committed to meeting the terms of the bridge loan and submitting a restructuring plan on Feb. 17," GM spokesman Tony Sapienza said, without commenting on specific bargaining proposals. "We will continue to engage our union partners in discussions around labor issues that will be a part of that plan." Chrysler, owned by Cerberus Capital Management LP, said it also plans to meet the government deadline. "We continue to engage all of our stakeholder groups as we work through this process," Chrysler spokeswoman Shawn Morgan said. She declined to otherwise comment on the negotiations.
The automakers are also asking the union to end a 54-year- old benefit that ensures almost full pay during layoffs. The so-called "supplemental unemployment benefit," or "SUB" pay, gives laid-off workers most of their take-home wages. Automakers and the UAW are discussing the future of the program, said people familiar with the talks, who asked not to be named because the negotiations are private. The UAW isn’t negotiating cuts in core wages or benefits, the people said. Lacking that cushion, older union members may retire and make way for new hires who are paid half as much, people familiar with the bargaining strategy said. Members of Congress who opposed an auto bailout criticized the benefits, and the U.S. Treasury loans require the automakers to stop all but "customary severance pay" to laid-off employees. GM and Chrysler are offering buyouts for most of their 91,000 UAW workers.
"This would really be unwinding five decades of gains and that would be very, very tough for the union," said Harley Shaiken, labor-relations professor at University of California in Berkeley. "It was part of Walter Reuther’s dream to have the person on the line treated the same as the white-collar worker," he said, referring to the longtime UAW president. The automakers in the last two weeks eliminated the so- called jobs bank, a 25-year-old program that paid UAW employees their full salary to report to work with no duties to perform, which was also criticized by Congressional Republicans last year. SUB pay gives laid-off workers as much as 95 percent of net pay. For example, a UAW assembly-plant worker takes home about $855 after taxes. If that worker were laid off in Michigan, he would receive about $782, made up of $362 in state unemployment benefits and $420 in company-paid SUB pay, according to union documents and estimates prepared by automakers.
"When workers are on layoff, this is critically important in enabling people to pay their mortgage, put food on the table and pay their heating bills," said Alan Reuther, a nephew of Walter Reuther, who won the benefit at the bargaining table in 1955. Ford Motor Co., the only U.S. automaker to forego federal aid, has said it expects to receive whatever concessions the UAW grants GM and Chrysler. Ford negotiators weren’t involved in talks at the union’s Detroit headquarters yesterday, said a source familiar with the situation. Ford spokesman Mark Truby declined to comment. Advisers to GM’s debt holders are also in discussions to reduce $27.5 billion in unsecured debt to about $9.2 billion by swapping for equity, said two people close to the talks. If GM and Chrysler can’t persuade the UAW and bondholders to agree to new terms, the government could force the automakers to return the loans or convert them into funding for a government- backed bankruptcy. GM Chief Executive Officer Rick Wagoner told Congress in November that Chapter 11 would lead to liquidation because shoppers won’t buy from a bankrupt automaker.
Toyota Seeks To Shed U.S. Workers
Toyota Motor's incoming president, Akio Toyoda, has promised to make aggressive changes. They're already happening. The Japanese automaker will try to buy out American workers for the first time as it cuts production, and will slash compensation for North American executives. But it seems no matter what it does, Toyota will simply not make money until at least 2010. Facing its first-ever full-year loss, of around $5 billion, Toyota is operating in crisis mode, conserving cash and hunkering down to ride out a deepening demand slump. Toyota said Thursday it will make buyout offers to about 18,000 workers at three U.S. assembly plants and three U.S. auto parts factories, cut salaries of its North American executives by 5% and eliminate their bonuses, and further slash output at U.S. plants.
Toyota will idle some U.S. factories for two to eight days, starting in April, based on inventory levels, and reduce the number of work hours at some plants. The changes will affect the automaker's assembly plants in Indiana, Kentucky, Mississippi and Texas and auto parts factories in Alabama, Missouri and West Virginia. The company doesn't expect a large number of workers to accept the buyout offer given the poor state of the economy, so most of the savings likely will come from the reduction of compensation and work hours. "If no one decides to leave, that is fine by Toyota," said Toyota spokesman Paul Nolasco, who added that Toyota has no target for how many employees will exit.
The moves are part of Toyota's effort to save 800 billion yen ($8.8 billion) for the fiscal year ending March, through reduction of fixed costs by 500 billion yen ($5.5 billion) and savings of 300 billion yen ($3.3 billion) from lower input costs. But Toyota is maintaining output of about 7 million vehicles, while its fixed cost base is designed to handle production of 10 million units. Even if it hits its $5.5 billion cost-cutting target, "we still think the road to profitability will be long and steep," Goldman Sachs said a Feb. 7 note. Toyota will have to cut inventory until the second half of 2009, and it is on track to rack up losses until January to March 2010, Goldman Sachs.
The buyout program offers 10 weeks of pay, a lump sum cash payment of $20,000, and two weeks of pay for every year of service with the company. It won't apply to Toyota's two unionized plants. Toyota will also slash production team bonuses and eliminate bonuses for all salaried and executive employees, who make up 10% of Toyota's 30,000 North American manufacturing jobs. Toyota is indefinitely delaying the opening of its Prius plant in Mississippi. It has also cut contract workers and idled factories in Japan. The automaker suffered a third-quarter loss of nearly $4 billion, and its U.S. sales fell 32% in January. In Tokyo, Toyota shares closed unchanged at 3,050 yen ($33.58).
G-7 Predicts 'Severe' Downturn to Persist, Vows to Reverse It
Group of Seven finance chiefs vowed to tackle a "severe" economic downturn that will persist for most of 2009 without spelling out new steps to do so. The G-7’s finance ministers and central bankers said in a statement released after talks in Rome today that they were working to restore confidence to markets and growth to the world economy. They predicted the full effect of individual rescue packages would "build over time." "We reaffirm our commitment to act together using the full range of policy tools to support growth and employment and strengthen the financial sector," the statement said. "The stabilization of the global economy and financial markets remains our highest priority."
The policy makers met after reports yesterday showed Germany’s economy contracted the most in 22 years in the fourth quarter and U.S. consumer confidence neared its lowest since 1981. With the worst global slump since World War II battering state finances, International Monetary Fund Managing Director Dominique Strauss-Kahn said he expects more countries to need emergency aid. That’s putting governments and central banks under greater pressure to end the malaise and U.S. Treasury Secretary Timothy Geithner demanded "exceptional measures" from his counterparts. The authorities are still at a loss on the best course of action 18 months after the credit crisis broke out. That’s left them pursuing a disjointed approach with stimulus efforts and bank rescue plans varying across borders.
"The statement ticks all the right boxes, but as expected does not go beyond generic statements of principle and commitments that we have heard before," said Marco Annunziata, chief economist at Unicredit MIB in London. "The commitment to act in a coordinated way flies in the face of the rather uncoordinated approach that followed similar commitments last October." While Geithner pressured colleagues to take more action to kick-start the global economy, German, French and Canadian officials raised questions about his new strategy, which commits up to $2 trillion to reviving lending and tackling toxic assets. Canadian Finance Minister Jim Flaherty said in Rome the proposals are "less than clear," echoing comments by Germany’s Peer Steinbrueck. French counterpart Christine Lagarde said she wants Geithner to "clarify the modalities, the calendar, the way he’s going to implement his plan."
Investors complain Geithner hasn’t fully outlined whether banks saddled with illiquid debt will be forced to fail, how tainted assets will be removed from their balance sheets and what will be done to stop falling house prices. Geithner’s response is that he won’t rush his flagship policy and risk making a hash of it. U.S. stocks fell the most this week since November. The G-7 earlier called the steps its members have taken to fight the turmoil "exceptional," noting they ranged from spurring liquidity in markets and bolstering capital in banks to slashing interest rates and easing fiscal policy. Amid signs some are attempting to shield domestic companies and workers from the fallout, the G-7 said it remains committed to avoiding protectionist measures, which risks exacerbating the downturn. A package of tax cuts and spending increases passed late yesterday by the U.S. Congress encourages companies to "Buy American," while France is demanding carmakers keep production at home in return for aid.
Papering over differences sparked by a weaker pound and a stronger yen, the G-7 singled out the yuan by saying China’s efforts to boost its economy should lead to further gains in the currency’s value. The group repeated its traditional message that "excessive volatility" and "disorderly movements" in exchange rates must be avoided. The omission of any G-7 currency from the communiqué meant "there’s likely to be only a muted reaction" in markets, said Brian Dolan, chief currency strategist at FOREX.com, a unit of online currency trading firm Gain Capital in Bedminster, New Jersey. Geithner also had questions of his own about whether foreign governments and central banks are doing as much as the U.S. to tackle the crisis. Its stimulus plan, now headed to President Barack Obama, totals $787 billion. Deutsche Bank AG calculates that the U.S.’s fiscal policy will swell GDP by about 3.6 percent, more than double what the European plans amount to. While the Federal Reserve has cut its benchmark interest rate to as low as zero, the European Central Bank’s is still 2 percent.
U.S. National Economic Council Director Lawrence Summers said in a Bloomberg Television interview in Washington that Europe, China and Japan are "probably not" doing enough to aid the world economy. "Extraordinary times call for exceptional and complementary measures by all," Geithner’s office said yesterday. As he predicted a "second wave" of countries seeking assistance, the IMF’s Strauss-Kahn signed a deal with Japan to give the lender access to an extra $100 billion after it issued loans from Iceland to Pakistan to Hungary. The G-7 officials also probed ways of strengthening oversight of markets before they convene next month in the U.K. with colleagues from the broader Group of 20 nations. The scope of regulation, compensation packages and risk management are all under review, their statement said. The G-7 oversees about two-thirds of the world economy and is composed of the U.S., Japan, Germany, U.K., Italy, Canada and France.
G-7 Welcomes China’s Efforts to Boost Economy, Strengthen Yuan
Group of Seven finance chiefs eased their criticism of China’s exchange-rate policy as the world’s most populous country moved to bolster its economy during the global recession. Less than a month ago, U.S. Treasury Secretary Timothy Geithner, who attended today’s meeting in Rome, said President Barack Obama thought that China was "manipulating its currency." "We welcome China’s fiscal measures and continued commitment to move to a more flexible exchange rate, which should lead to continued appreciation of the Renminbi," the G- 7 said today in its final communiqué. China announced 4 trillion yuan ($585 billion) in spending in November to support the economy amid the global recession.
China, the world’s second-biggest energy consumer, may approve a stimulus plan for the oil refining and petrochemicals industries by next week to help spur the slowing economy, two industry officials said yesterday. "We very much welcome the steps they’ve taken to strengthen domestic demand, and welcome" China’s commitment to exchange rate reform, Geithner told reporters today in Rome, a view echoed by French Finance Minster Christine Lagarde. "The more conciliatory tone on China is the key departure from previous statements," Geoffrey Yu, a London-based foreign-exchange strategist at UBS AG, said in an e-mailed statement. "The G-7 has realized that China needs to be brought into the fold of the global financial system rather than be treated as a pariah just because of yuan inflexibility."
Since first describing flexible exchange rates as "desirable" after a 2003 meeting in Dubai, the G-7 has swung between pressuring and praising China’s exchange rate policy. Having cheered a July 2005 revaluation, the officials said the following December that further shifts would aid the world economy and four months later said China "especially" should adjust its currency. In February 2007 the G-7 encouraged the yuan to "move" more on a trade-weighted basis and at the three meetings between October 2007 and last April pressed China to allow an "accelerated appreciation."
The Worst-Case Scenario
Between 1990 and 2007, the total mortgage debt held by Americans rose from $2.5 trillion to $10.5 trillion. This rise was part of a societal credit bubble that burst in 2008. To cushion the pain of that collapse, federal authorities decided to replace private debt with public debt. In 2008, the Bush administration increased spending by about $1.7 trillion, and guaranteed loans, investments and deposits worth about $8 trillion. In 2009, the Obama administration spent $800 billion on a stimulus package, $1 trillion on a second round of bank bailouts and committed another trillion on health care reform and other bailout plans.
Americans generally welcomed the burst of public activism. In "Democracy in America," Alexis de Tocqueville wrote about what happens to a people beset by anxiety: "The taste for public tranquility then becomes a blind passion, and the citizens are liable to conceive a most inordinate devotion to order." In normal times, Americans would have been skeptical of proposals to double or triple the size of federal programs, but amid the economic fear, that skepticism fell away. Wall Street traders hungered for a huge federal bailout replete with strings. Economists produced models that assumed that government could efficiently spend huge amounts of money, and these models were accepted.
The Obama administration was staffed with moderates who found that there was no reward for moderation. Liberals attacked them for being tepid. Republicans attacked them because it was enjoyable to see Democrats attacked. Over time, the administration drifted left and created what you might call Split Level Technocratic Liberalism. President Obama defended spending initiatives in broad terms. He had enormous faith in the power of highly trained experts and based his arguments on models and projections. The actual legislation was cobbled together by Democratic committee chairmen, often acting beyond the administration’s control.
During 2010, the economic decline abated, but the recovery did not arrive. There were a few false dawns, and stagnation. The problem was this: The policy makers knew how to pull economic levers, but they did not know how to use those levers to affect social psychology. The crisis was labeled an economic crisis, but it was really a psychological crisis. It was caused by a mood of fear and uncertainty, which led consumers to not spend, bankers to not lend and entrepreneurs to not risk. No amount of federal spending could change this psychology because uncertainty about the future remained acute.
Essentially, Americans had migrated from one society to another — from a society of high trust to a society of low trust, from a society of optimism to a society of foreboding, from a society in which certain financial habits applied to a society in which they did not. In the new world, investors had no basis from which to calculate risk. Families slowly deleveraged. Bankers had no way to measure the future value of assets. Cognitive scientists distinguish between normal risk-assessment decisions, which activate the reward-prediction regions of the brain, and decisions made amid extreme uncertainty, which generate activity in the amygdala. These are different mental processes using different strategies and producing different results. Americans were suddenly forced to cope with this second category, extreme uncertainty.
Economists and policy makers had no way to peer into this darkness. Their methods were largely based on the assumption that people are rational, predictable and pretty much the same. Their models work best in times of equilibrium. But in this moment of disequilibrium, behavior was nonlinear, unpredictable, emergent and stubbornly resistant to Keynesian rationalism. The failure to generate a recovery led to a collapse of public confidence. President Obama’s promises of 3.5 million jobs now seemed a sham and his former certainty a delusion. The political climate grew more polarized. That meant it was impossible to tackle entitlement debt. That and the economic climate meant it was impossible to raise taxes or cut spending or do anything to reduce the yawning deficits. Federal deficits were 15 percent of G.D.P. and growing.
Far from easing uncertainty, the exploding deficits led to more fear. The U.S. could not afford to respond to new emergencies, like hurricanes or foreign crises. Other nations sensed American overextension. Foreign debt-holders grew nervous. Interest rates rose. Congress indulged its worst instincts, erecting trade barriers, propping up doomed companies. Scholars began to talk about the American Disease, akin to the British Disease of the 1970s. The nation had essentially bet its future on economic models with primitive views of human behavior. The government had tried to change social psychology using the equivalent of leeches and bleeding. Rather than blame themselves, Americans directed their anger toward policy makers and experts who based estimates of human psychology on mathematical equations.
Alistair Darling risks rift with Germany and France over bank rescue
Alistair Darling on Friday risked a rift with Germany and France when he called for other countries to follow the US and British lead in bailing out ailing banks. The Chancellor, speaking ahead of the G7 meeting of leading finance ministers in Rome, said the longer other countries hesitated the more likely it was that the world would slide into financial protectionism. His comments were seen as a rebuke to Germany and France which have so far held back from bank rescue measures. Germany is expected to produce details of a banking package next week as it pushes ahead with a E50bn package to stimulate the economy but France has yet to show its hand.
Mr Darling said: "If we take action together it will have greater effect. It's clear that although so far nearly a trillion dollar's worth of recapitalisation has taken place from public and private sector support for banks around the world more needs to be done in relation to impaired assets and that we act together to get banks lending again." Both Mr Darling and Tim Geithner, the US Treasury Secretary, have faced criticism over their bank rescue moves because the emphasis on encouraging lending to domestic businesses is seen as protectionist.
Mr Darling attempted to counter the charge, declaring: "If you are asking taxpayers in our country or any country to provide support for the financial system it's right that they should expect to see the benefit, all the more reason to ensure that this is happening in countries right across the world so you lessen the risk of lending being reduced in other countries. That is why co-ordinated action is so important." His appeal came as the EU released figures showing the 27 member free trade area is now officially in recession. A record 1.5pc drop in economic activity in the eurozone countries in the last three months of 2008 provided the final but hardly surprising confirmation that the EU has gone ex-growth.
Germany, with a fall of 2.1pc in gross domestic product, was the poorest performer with the exception of tiny Lithuania in the final quarter of the year. Figures from Eurostat underlined the sharp differences between the buoyancy of the first half and the slide in the second. The EU overall still managed growth of 0.9pc for the year overall and the eurozone states 0.7pc A slew of depressing economic announcements from member states accompanied the formal announcement. European carmakers added to them with figures showing January sales down 27pc compared with a year earlier, biggest slump for more than 20 years. Holland and Hungary dipped into recession in the fourth quarter while Spain and Italy plunged more deeply into negative territory. France continued to insist it was too early to bracket it with other EU members. The fourth quarter slump in Germany was the biggest since unification. The Italian economy shrank by 1.8pc. Spain edged closer to deflation as the inflation rate fell to 0.8pc.
Britain’s bankers plumb new depths
Jon Moulton, the private equity chief, warned a City lunch this week that he feared serious civil unrest. There was, he said, a 25 per cent chance of one of the 15 member countries of the eurozone pulling out of the currency club. That, he said, would be a catastrophic shock leading to a "far greater financial crisis" than the current one. The mind boggles at a financial crisis far worse than the current one. Is such a thing possible? Even with this one, it may already be too late to prevent social unrest, especially in Britain, which is tipped to be one of the worst-hit countries economically. The spectacle of bankers continuing to award themselves bonuses while taking taxpayer support is feeding an extraordinary public rage and a fierce sense of injustice. With 40,000 people losing their jobs each month, it is a recipe for trouble, come the traditional rioting months of the summer.
It won’t be bankers being lynched, of course, but small shopkeepers in inner-city areas having their windows smashed and their stock looted. The only surprise is there haven’t already been antibanker demonstrations in Threadneedle Street – secretly cheered on by 99 per cent of Middle England. The seething sense of unfairness is almost palpable. The view that a small elite not only caused the crisis, but continues to profit at the expense of everyone else, is near universal. Gordon Brown’s promise of no rewards for failure in state-supported banks is looking ever more threadbare. We now know that Peter Cummings, the highest-paid person on the HBOS board, headed a division responsible for £7 billion of losses last year, yet he was still given a reported £660,000 payoff when he left in early January clutching his £6 million pension pot.
The suggestion by Lord Myners, the City minister, that some bankers simply have no sense of the broader society around them is getting harder to refute. To be preparing to pay out billions of pounds in discretionary bonuses over the next few weeks suggests an ignorance of the public mood and a single-mindedness bordering on sociopathic. All this may be a bit of a side show for Sir Victor Blank and Eric Daniels, chairman and chief executive, respectively, as they try to stop the water slopping over the gunwales of the combined Lloyds/HBOS. Yesterday’s bombshell was grave for the bank, dispiriting for taxpayers and damaging to the chief executive. The timing is acutely awkward, coming just 48 hours after he appeared before the Commons Treasury Select Committee. MPs might have pressed him rather harder if they had known what was just around the corner.
The £10 billion loss at HBOS is humiliating enough, but the admission that the losses are £1.6 billion worse than when shareholders were asked to approve the deal in November is worse. Lloyds got HBOS to sweeten the terms twice. With hindsight it still wasn’t enough. Mr Daniels admitted to Parliament this week that he was not able to conduct as much due diligence as in a normal deal. His shareholders and UK taxpayers are now paying a heavy price for that failure. The 32 per cent slump in the Lloyds share price yesterday speaks volumes about the market’s fears. Although Lloyds insists its balance sheet is still strong, the need for additional capital will be back on the agenda. If HBOS’s corporate loans could have soured by £1.6 billion in the space of just a month, its surplus capital cushion could quickly be wiped out. That could lead to full nationalisation eventually.
Lloyds says that one of the reasons for the losses was the more conservative methodology it uses for gauging potential loan losses. That comes close to suggesting the old HBOS board was somewhat less than conservative itself. If the reputation of the old guard at HBOS, including Gordon Brown’s former favourite Sir James Crosby, is capable of sinking any lower in the public estimation, it will now be doing so.
UK taxpayers face multi-billion pound superbank bailout
Taxpayers could have to spend billions bailing out the banks again after massive and unexpected losses were disclosed by Britain’s new superbank.
Shares in Lloyds Banking Group fell 32 per cent to 61.4p yesterday after it reported losses of £10 billion in HBOS, making it worth far less than thought when it was taken over in November. The news, a huge embarrassment for Gordon Brown, who helped to broker the deal, triggered speculation that the bank will have to come back to the Government for more capital.
George Osborne, the Shadow Chancellor, suggested that the cash pumped in for the first bailout in October was "all but wiped out" by these losses. He said: "HBOS bankers like James Crosby bear a heavy responsibility, but so too does his ally Gordon Brown who created the system of bank regulation that allowed this reckless risk-taking to run amok." Alistair Darling, the Chancellor, defended his role in helping to push through the takeover, saying: "We had a matter of days and then hours to stop the entire banking system collapsing." The timing of the profits warning to the Stock Exchange was particularly embarrassing the Lloyds chief, Eric Daniels, who gave no hint of it three days ago when he was grilled by MPs on the Treasury Select Committee. Lloyds said that it had only just appreciated the scale of the problem, having completed the purchase on January 19.
The losses were £1.6 billion worse than Lloyds expected in November when it gave shareholders its reasons for buying HBOS. The Government put £17 billion into the banks just before the deal was completed and owns 43 per cent of the enlarged Lloyds. That stake is now worth £8.3 billion less, a loss equivalent to 2?p on income tax. The brunt of the losses were incurred in HBOS’s corporate division, which was investing in property-backed deals long after other banks had stopped. It lost £7 billion. Peter Cummings, who headed the division, is said to have left in January with a payoff of about £660,000 and a £6 million pension pot. John McFall, chairman of the select committee, said its inquiry showed that due diligence checks should be at the centre of any takeover. Mr Daniels had admitted that he had not been able to conduct as much of it as he would have liked. "That is now shown to be a massive understatement," Mr McFall said.
Save banking, not the bankers or the banks; the case of ING
by Willem Buiter
I had been planning to blog today on US Treasury Secretary Timothy Geithner’s proposals for saving/reviving financial intermediation in the USA. However, picking through the entrails of this multi-faceted, surprisingly incomplete, seriously underfunded, occasionally well-designed but mostly inadequate, counterproductive and unnecessarily moral-hazard-creating set of proposals was just too depressing. I will wait till I am at my parents’ home this weekend, mollified and mellowed by my father’s good claret, before I review the Geithnerbharata. But as a four-finger exercise before the main concert, I shall discuss here the second Dutch government bail-out of ING. Many of the issues involved in and principles raised by this deeply unfortunate exercise also are central to the Geithnerbharata. On 26 January 2009 (my sister’s birthday - happy birthday, Hens!) the Dutch government mounted a second financial support operation for ING Group. The state had earlier injected 10bn euro worth of capital into ING.
The assistance takes the form of a back-up guarantee facility for a portfolio of $39bn (face value) worth of securitised US Alt-A mortgages. Under the deal, the state shares with ING any gains and losses on this portfolio relative to a benchmark value for the portfolio of $35.1 bn. The shares of the state and ING in any gains/losses are 80% and 20% respectively. The bank pays a guarantee fee to the state. The state document I saw did not specify the magnitude of the guarantee fee, or how it was arrived at. The state pays ING a management and funding fee. Again, I don’t know the amount or how it was arrived at (it would be cute, however, if the guarantee fee and the management and funding fee just happened to cancel each other out!). The other relevant conditionality is that ING is to provide 25 bn euro of additional credit to businesses and households and that there will be no bonuses for 2009 and until a new remuneration policy is adopted. The CEO was told to fall on his sword.
I am sure the stock market loved this deal. And I am sure the politicians and civil servants that put it together loved this deal. Politicians and their advisers love off-balance-sheet and off-budget financing. Guarantees are great from this perspective. Because they represent a contingent liability, they are off-balance sheet. Only if and when the guarantee is called, will the payments under the guarantee show up in the budget. The tax payer, however, should hate it. And so should all those concerned about moral hazard: the effect on future incentives for excessive risk taking by ING and other Dutch banks. It is also unfair: it bails out the shareholders and unsecured creditors of the bank, who made lousy investment decisions and should pay for that. Except for the departure of the CEO (which was appropriate, and indeed overdue), the rest of the executive and supervisory boards are still in place.
I am not a Dutch taxpayer, but I too think this is a dreadful deal. The objective of strengthening financial stability and fighting the economic downturn by encouraging new lending could have been achieved at much lower cost to the tax payer, without distorting incentives for future risk taking and without doing violence to fundamental notions of fairness. It is a good deal for ING and a bad deal for the tax payer because the market valuation of the Alt-A portfolio did not imply the 10% discount (from $39 bn to $ 35.1 bn) that was used to define the reference value for the guarantee, but a 35% discount (from $39 bn to $25.4bn). It is possible that the hold-to-maturity value of the portfolio (the present discounted value of its current and future cash flows, discounted at an interest rate that is not distorted by illiquidity premia, is $35.1 bn or more. Possible, but not likely.
It is possible that the guarantee fee appropriately prices the risk assumed by the state. Until I see the numbers and can verify the assumptions on which they are based, I consider it possible but not likely. It is possible that the management and funding fees reflect the true incremental cost to ING of the deal with the government. Possible, but extremely unlikely. ING was and remains the owner of the portfolio. They would have had to manage and fund the portfolio even if the state had not guaranteed it. For the state to pay ING a management and funding fee is ludicrous. The guarantee is a good deal for ING and a bad deal for the tax payer because the market valuation of the Alt-A portfolio did not imply the 10% discount (from $39 bn to $ 35.1 bn) that was used to define the reference value for the guarantee, but a 35% discount (from $39 bn to $25.4bn). It is possible that the hold-to-maturity value of the portfolio (the present discounted value of its current and future cash flows, discounted at an interest rate that is not distorted by illiquidity premia, is $35.1 bn or more. Possible, but not likely.
It is possible that the guarantee fee appropriately prices the risk assumed by the state. Until I see the numbers and can verify the assumptions on which they are based, I consider it possible but not likely. It is possible that the management and funding fees reflect the true incremental cost to ING of the deal with the government. Possible, but extremely unlikely. ING was and remains the owner of the portfolio. They would have had to manage and fund the portfolio even if the state had not guaranteed it. For the state to pay ING a management and funding fee is ludicrous. The Dutch state is heavily exposed to its oversized banking and insurance sectors. It is possible that those Dutch banks and insurance companies that are technically solvent today only because of past, present and anticipated future state financial support collectively have bad assets on their balance sheets that makes them to large to save. The Netherlands is not as exposed as Iceland (where the banking sector was to large to save), Belgium (where the fate of Fortis can be viewed as evidence that the Group was too large to save), or Ireland (which will in all likelihood provide the next test of the too large to save theory). At least one Dutch bank, Rabobank ( a mutual bank!) is widely held up as an example of viable cross-border banking. But there is at least a material risk that the fiscal spare capacity of the Dutch authorities would be insufficient to fill the solvency gap in the balance sheets of the Dutch banking and insurance sectors.
Let’s ask ourselves how the Dutch authorities could stimulate lending to the real economy by the two largest banks, ING and the Dutch rump of ABN-AMRO/Fortis. ABN-AMRO and Fortis Nederland (which contains insurance as well as banking) is 100 percent state-owned. State ownership does not, of course, imply that there is a sovereign guarantee for the unsecured creditors of the bank, including its bond holders. Only the retail depositors are insured and guaranteed by the state, up to a limit of €100,000. But the state can and should make it clear that it will not guarantee the other creditors of the bank. It can do this easily, because it is the sole shareholder, by splitting ABN-AMRO and the banking parts of Fortis it owns into a good bank and a bad bank. The good bank would get the deposits and the good assets of ABN-AMRO and Fortis Nederland. It would get adequate new capital, probably from the state, although private participation could be invited also. Government guarantees would be provided only for new lending and/or new borrowing by the good bank.
The bad bank would be left with the toxic, bad and dodgy assets of ABN-AMRO and Fortis Nederland and the capital of the original banks. No new capital would be injected by the government into the bad bank. The bad bank would lose its banking license and would simply manage the inherited portfolio of bad assets so as to maximise the discounted value of its future cash flows. It would not be allowed to invest in any new assets or to engage in any other activities. It would not receive any further guarantees for its assets or its funding. The assets could be held to maturity or sold if and when a liquid market for securitised US Alt-A mortgages ever revived.
It is quite possible (likely?) that the bad bank would go into administration and would be declared insolvent. In that case the existing shareholder (the state) would lose its investment and the other creditors would effectively end up owning the assets of the bad bank. The state would of course have to make good on any guarantees it has already, unwisely, provided. These unsecured creditors (mainly pension funds, insurance companies and other institutional investors) would be quite likely to suffer large losses. That is too bad, but it is better than shifting the burden of these losses onto the tax payer. The losses have been made. It minimises moral hazard to have these losses born by those who made the bad lending and investment decisions. When this can be done without aggravating the financial crisis, it certainly ought to be done. The bad bank is not systemically important. It should be left to sink or swim on its own. The same approach can be applied to the fully state-owned insurance company.
The simplicity of this solution is due to the fact that the state already owns all of ABN-AMRO and Fortis Nederland. What should be done about ING, where the state does not own any common equity? The easiest solution is to create a new ‘good bank’, New ING, say, with capital provided by the state and possibly also by the private sector. The good bank would take the deposits of ING and purchase any of the good assets of ING it is interested in. The valuation of these good assets would not represent a problem, because part of the definition of ‘good asset’ is that there either is a liquid market price for it or, in the case of non-traded assets, that the buyer can determine their value in a straightforward and transparent manner. It is possible that none of the existing assets of ING would be bought by New ING. In that case, the assumption of ING’s deposit liabilities by New ING would be effected by a loan from the state to ING, and the asset-side counterpart on New ING’s balance sheet to the deposits acquired from ING could be a matching amount of government debt. ING (now Old ING) would also have its banking license withdrawn and would not be able to engage in any new lending or investment activities. It would not receive any further government guarantees, nor would the government purchases any of its assets. It would be left to sink or swim on its own.
Scarce public funds should not be used to purchase or to guarantee stocks of existing assets. They should instead be used to guarantee or fund new lending and borrowing by the new good banks (like New ING) or directly by non-financial enterprises. Again, this preserves systemically important banking activities (new lending and borrowing to enterprises and households), without saving either the bankers or the banks. This minimizes moral hazard and creates the right incentives for the future exercise of prudence in investment and lending decisions. To be able to achieve the economic efficiency objective of stimulating flows of new lending and borrowing without subsidising existing stocks of assets and liabilities, it is necessary to achieve a legal and institutional separation between the owners of the existing stocks and the owners of the entity that will be engaging in the new lending. The Good Bank model is one way to achieve this. Soros’s ‘Side Pocket’ solution is economically equivalent to the Good Bank solution.
Often government financial assistance to banks imposes conditionality, costs and constraints on the bank’s management and existing shareholders without taking full ownership and control of the bank. Examples are; onerous financial terms; constraints on bonuses and other aspects of executive and board remuneration; constraints on dividend pay-outs and share repurchases; constraints on new acquisitions and on foreign activities; guidance and direction on how much to lend and to whom. All these encumbrances last until the state has had its stake repaid. This creates terrible incentives encouraging banks that are already in hock to the government to hoard liquidity and hold back on new lending activities to get rid of the government’s interference. Banks that are not yet financially dependent on the government will likewise pursue extremely cautious and conservative strategies, hoarding liquidity and capital to stay out of the clutches of the state. Such half-way houses are inherently dysfunctional. To get banks to lend again, you have to move towards one of the two extremes: either give the banks state money without any strings attached and at a very low financial cost or take full control (possibly but not necessarily through full state ownership) of the banks that are the beneficiaries of state money. Towards the end of the Bush administration, US policy was evolving towards throwing money at the banks with little or no conditionality or cost. Under the Obama administration, much more onerous conditionality is likely to be imposed. The willingness to move towards full public control and ownership does not yet exist in the USA, however.
Throwing unconditional money at wonky banks creates terrible moral hazard. It is also very wasteful of public resources, as it often subsidizes and makes up for past losses on existing assets rather than focusing on stimulating new flows of lending and borrowing. The Good Bank solution saves resources, because it leaves the existing bad assets to the old bank’s owners and creditors, and minimizes moral hazard. The Good Bank solution has two problems associated with it. First, the state is likely to be the main, perhaps for a while the only, owner of the new good bank. The state is a lousy banker. So of course, is the private sector, at least for most border-crossing universal banks in the North Atlantic Region for the past ten years. The question of how to get the state out of the banking business again has to be addressed as soon as the state goes in. Second, the Good Bank solution has to be imposed swiftly and preferably as a surprise. If the public anticipates that a wonky existing bank is likely to be transformed into a bad bank, there will be a flight of depositors and other creditors, and the existing bank might collapse before the new Good Bank has been put in place. As the new Good bank would use most of the real assets and personnel of the old bank (the bad bank would really be just a balance sheet with the bad assets and a few fund managers), it could be set up and functioning almost instantaneously.
Inevitably but regrettably, the ING guarantee package involves a form of economic protectionism - a repatriation of cross-border banking. The requirement that ING is to provide 25 bn euro of additional credit to businesses and households is unlikely to be satisfied by ING lending and additional 25bn euro to businesses and households in Turkey, South America or even Germany. This is meant to be lending to Dutch businesses and households. As it is Dutch tax payer money that is funding the bail-out, such financial protectionism is hardly surprising. But it will limit the scope for global diversification of assets and of funding compared to what would be possible in a world with a supranational fiscal authority and compared to a world in which the importance of the fiscal authority as the recapitaliser of last resort and the ultimate source of bail-out support had been forgotten, as it had been in the North Atlantic region since the Nordic banking crises of 1992 and 1993.
So the Dutch state’s ING guarantee got it 100 percent wrong. It does very little to stimulate new lending to the real economy. Instead it subsidises/bails out the owners and unsecured creditors of a bank that holds large stocks of (bad) assets, that is, those who in the past have (carelessly/unwisely) extended credit to the bank. This maximises moral hazard for very little gain in systemic financial stability and for very little direct stimulus to new lending. It also incentivises the bank to hoard capital and liquidity to enable it to pay off its obligations to the state and regain its operational independence as soon as possible. Finally, it exacerbates the tendency to restrict cross-border banking, quite possibly to a degree that could harm the efficient diversification of asset and funding risk. This deeply defective bail-out should not be repeated, in the Netherlands or elsewhere.
Economists paint gloomy picture
In a freewheeling discussion about "The Great Recession" and energy, top economists painted dark scenarios that could be ranked as bad, worse and horrendous. "2009 is basically a write-off," Harvard University economics professor Kenneth Rogoff told a packed audience at CERAWeek, the annual Houston conference that has come to be known as the Davos of the energy world. The other economists agreed. The good news: "All economic crises end," he said. The bad news: Rogoff’s forecast was the most optimistic .
Nouriel Roubini, an economist with New York University’s Stern School of Business, predicted an "L-shaped stagnation" similar to what Japan suffered in the 1990s when that country lost a decade of economic growth. Roubini offered a caveat, though — when the financial crisis hit Japan it was a nation of savers with a current-account surplus. The U.S. has neither of those advantages. Roubini, who’s been labeled "Dr. Doom" by some, said the stimulus package and bailout plan is needed but comes at a huge price. "It’s not a free lunch. We have to finance it. Let’s not kid each other," he said. "We need a stimulus, but the cost of it will be massive down the line."
But Rogoff said the stimulus plan could turn out to be worse than doing nothing if President Barack Obama’s administration doesn’t get its act together and fix the banking system. He likened the trillion dollars as giving a blood transfusion to someone who’s bleeding to death without fixing the reason they’re bleeding to death. "It makes it easier to fix the banking system if they’re going to fix the banking system," he said. "Otherwise it’s worse than nothing."
Nariman Behravesh, chief economist for IHS Global Insight, offered the most positive outlook of the night, although it could hardly be classified as bright. "This is the Great Recession. It is not the Great Depression 2.0, and it is not Japan’s lost decade," he said. Behravesh predicted a modest rebound starting in 2010 with the possibility that crude oil’s benchmark price could go back up to $50 or $60 a barrel.
Roubini would not predict where oil prices could go past 2009, but said a slump closer to $20 a barrel this year would not surprise him. He scoffed at the idea that either $140-plus oil this summer or subprime mortgages could have caused the sharp downturn in the economy, citing myriad debt loads from over-leveraged banks to bad student loans to credit card debt and government bonds as the primary drivers. Roubini predicted job losses have only just begun and will continue through 2010. Whether an economic turnaround is possible in 2011 or 2012 depends entirely on how policymakers do their jobs, he said.
Harvard’s Rogoff said the hubris of officials to think that the U.S. could continue to borrow two-thirds of the world’s savings year over year without ever having to deal with that debt was "utterly delusional," adding, "The political system can’t get its head around the problem." "2009 is a lost cause. We’re working on 2010 here, but if they don’t do anything in the next couple of months, 2010 is going to be a lost cause, too."
Australia Passes $28 Billion Economic Stimulus Package After Senate Fight
Australian Prime Minister Kevin Rudd won parliamentary approval for a A$42 billion ($28 billion) stimulus plan at the second try, allowing for cash handouts and public works spending to prevent the first recession in 18 years. The package includes A$12.7 billion in payments to low and middle income earners and A$28.8 billion for schools, bicycle paths and environmental projects. The package is equivalent to 1.3 percent of gross domestic product this fiscal year and 2 percent next, according to Treasury forecasts released last week. Rudd, 51, was forced to increase spending on the environment and reduce the cash handouts to win support today for the bills, which he says will prevent the economy from contracting next year. The first ballot in the Senate yesterday was defeated by one vote.
"This will unlock infrastructure spending, incentives for business to invest in new plants and equipment and add a stimulus to household incomes," Australian Chamber of Commerce and Industry general manager Peter Anderson said in a statement. "Today’s decision is the right one for these extraordinary times." The government was forced to alter its original package to gain support from the upper house, where it needed seven opposition or minor party votes to ensure passage. Independent Senator Nick Xenophon today reversed his no vote after the government promised more money for his home state. "We have been able to reach a compromise," Xenophon told the Senate today after obtaining A$900 million in spending for the Murray-Darling river in South Australia. "I’m willing to support the government’s economic stimulus package."
The Liberal-National coalition opposed the bills, saying the proposed cash payments were too large. The five Australian Greens Senators, Family First Senator Steve Fielding and Xenophon joined the government to approve the amended bills today. The government’s package will create a A$22.5 billion deficit in the year ending June 30, the first shortfall in seven years and the biggest as a percentage of GDP since 1996. The Reserve Bank of Australia last week cut the benchmark interest rate to 3.25 percent, the lowest since 1964, and the government since September has announced almost $88 billion of fiscal stimulus to prevent the economy entering its first recession since 1991.
The Australian dollar rose to 65.63 U.S. cents at 12:30 p.m. in Sydney from 65.57 before the vote. Retail stocks led a gauge of consumer discretionary stocks on the benchmark S&P/ASX 200 index to a 1.8 percent gain, the biggest among ten industry groups. Harvey Norman Holdings Ltd., Australia’s biggest furniture and electronics retailer, rose 3.4 percent and David Jones Ltd., the nation’s second-biggest department store chain, climbed 3.5 percent. Australia’s economy grew 0.1 percent in the third quarter from a month earlier, the weakest pace in eight years. It expanded 1.9 percent from a year earlier. By comparison, Japan’s economy contracted 0.5 percent in the same period and the U.S. shrank 0.2 percent in the fourth quarter from a year earlier. The Australian economy would contract in 2009-10 without the stimulus, Treasury forecasts showed last week. The spending will help gross domestic product grow 1 percent this fiscal year and 0.75 in the year ending June 30, 2010, Treasury said.
Investment bank Macquarie Group Ltd. and mining operator BHP Billiton Ltd. are among companies firing workers, while job advertisements slumped for a ninth month in January, according to a report this week. Australian employers added 1,200 jobs in January and the unemployment rate rose to 4.8 percent from 4.5 percent as more people looked for work, the Australian Bureau of Statistics said today. The government reduced its one-off payments to people earning up to A$100,000 by A$50 to win Senate support. Japan’s 10 trillion yen ($111 billion) economic package is worth about 2 percent of its GDP and the U.S.’s $819 billion stimulus is equivalent to around 6 percent of the world’s biggest economy.
"There are some signs of hope," International Monetary Fund Managing Director Dominique Strauss-Kahn said on Feb. 12, according to a statement on the IMF Web site. "Large stimulus packages have been implemented, especially in the United States." President Barack Obama had to offer concessions to U.S. lawmakers to pass his stimulus plan. The bill is headed for passage in Congress by the end of this week after lawmakers agreed on a $789 billion plan that aims to stem the recession through a mix of government spending and tax cuts. Voter support for Rudd’s Labor government increased after the package was unveiled last week, according to a Newspoll published in the Australian newspaper this week. Support for Labor rose four percentage points to 58 percent, according to a poll of 1,133 people. The poll had a margin of error of plus or minus three percentage points.
Number of Russian billionaires halves in a year as financial crisis destroys fortunes
The number of Russian billionaires has halved in a year to 49 as the financial crisis destroyed the fortunes of bankers, developers and retailers, Russian magazine Finans said on Friday. Last year, with 101 dollar billionaires on the Finans' rich list, Russia trailed only the US as a home for the mega-rich, as record oil and metals prices fuelled a decade-long economic rise. But a collapse in commodity and stock prices, a 35 per cent rouble devaluation and high inflation have made Russian billionaires more scarce now than in 2007 and 2006, when Finans counted 61 and 50, respectively. Finans said the list would be published on Monday.
It said the main losers included developers Sergei Polonsky of Mirax, and Kirill Pisarev and Yury Zhukov of PIK Group. Also dropping off the list are banker Ruben Vardanyan, core owner of Troika Dialog brokerage, Vyacheslav Kantor, of fertiliser firm Acron, and Alexander Mamut, who owns part of gold and silver miner Polymetal. Finans publishes its list two months ahead of the benchmark US Forbes Russia list. Last year, it was the first to put metals magnate Oleg Deripaska on top, with $40 billion, ahead of Roman Abramovich. Mr Deripaska also topped the Forbes list.
Mr Deripaska's empire, which spreads from aluminium to construction, now faces major challenges as the Kremlin-friendly businessman struggles to refinance debts. He has lost assets in Canada and Germany put up as collateral on bank debts. Mr Deripaska himself has long argued that calculations of his fortune were wrong, as they did not count his debts, which are estimated - though not confirmed by Mr Deripaska - at over $20 billion. Last year, Finans listed Roman Abramovich second behind Mr Deripaska, with $23 billion. Mr Abramovich, owner Chelsea Football Club, has probably seen fewer troubles, as he was among the earliest Russians to cash out of major industrial assets.
We've Only Just Begun?
by Brian Pretti, ContraryInvestor.com
Yeah, that’s pretty much how we see it at this point. We’re referring to the process that is macro or systemic deleveraging. It was way back in March of 2007 that we penned a discussion entitled, “It’s Delightful, It’s Delovely, It’s Deleverage”. At that time very few folks were talking about deleveraging as a concept and economic force to come. Fast forward to the present and it’s now consensus thinking. Although the theme has been very much popularized in the mainstream press, we see very little attention to specific detail. So, in that spirit, this discussion is all about a check in on the concept and detail as to where we now stand. Nothing like the facts to illuminate the true picture, no?
To the point, deleveraging is not an event, but a process. As we've explained in the past, the multi-decade credit cycle phenomenon was key to economic and financial market outcomes in the US, as well as globally for close to three decades. The whole concept of deleveraging dramatically interrupts, or really derails that cycle. Coincidentally, the Fed/Treasury/Administration are in do or die reflation mode at present. Reflation really meaning an attempt to restart what is a critically wounded credit cycle. Mortally wounded? We’re going to find out. In this light, monitoring the process that is deleveraging becomes very meaningful in terms of trying to interpret just what the financial markets are pricing in at any point in time. We believe it's also helpful in terms of trying to monitor the economic slowdown magnitude and duration issues so key to near term investment outcomes.
Looking at the hard data, it's our interpretation that deleveraging has barely begun when looking at the economy and financial market broadly. Below are a number of highlight data points. Through the third quarter of last year, US consumers have not yet gone into a net debt contraction mode, but have slowed their borrowing dramatically YTD. It's a darn good bet net debt contraction is here now and will show up in quarterly numbers very shortly as official 4Q numbers are published. Below is the near half-century history of the quarter over quarter nominal dollar change in household debt obligations. In this and all like charts that follow we are not using seasonally adjusted, so we're pretty much looking at the real thing. For perspective we've included the 12-month rate of change which smoothes an incredible amount of monthly volatility. To suggest what has transpired at the household level is dramatic both on the upside and downside is an understatement.
From taking on close to $350 billion quarterly in new leverage some years back, household debt grew by only $14 billion in the last quarter (3Q 2008) for which info is available. That’s absolutely a rounding error set against a $14 trillion+ economy. As we stated in the chart, the last time households actually paid down debt on a quarterly basis was 1975. We’re convinced net debt reduction at the household level lies ahead. Although we will not drag you through another chart, both revolving and non-revolving consumer credit balances have contracted with 4Q data available as of now. Bottom line being, for households the deleveraging process has just begun despite all the sound and fury over deleveraging as a concept last year. As with the macro economy, magnitude and duration of the deleveraging to come at the household level will be a key data point for 2009. The Fed/Treasury/Administration (the F/T/A) may be begging the banks who’ve received TARP money to lend, but households are telling us by the trend in these numbers that they are not necessarily willing borrowers, regardless of cost and availability of credit.
As we see it, the financial markets have priced in the F/T/A response to the credit market freeze/economic slowing, but as of now the household response to borrowing inducement remains a question mark. Maybe the key question mark of the moment. If households begin a process of net debt contraction (which we believe they will), then financial markets trying to anticipate a turn in the US economy by the second half of this year will be jumping the gun in a big way. Moreover, existing 2H 2009 bottom up analyst earnings estimates are a good bet to be far too high at the moment. For now, we believe the markets have not priced in household indifference to monetary stimulus.
The chart below tangentially documents the rhythm of household balance sheet cycle reconciliation over the prior half century. As is clear, never in the half-century plus period that is covered has the year over year change in household debt growth been at the record low level we see today. Does this trend dip into negative territory before the current cycle is over? We think so, which will be unprecedented, but we’ll just have to see what happens. From our perspective, equities have not yet fully priced in the ramifications of actual household debt contraction. Remember, the reality of prior half year auto sales, retail sales and residential property activity all occurred during a period characterized by slowing in household debt assumption, not net debt contraction. And in this environment we already see the year over year change in headline retail sales as the lowest level in the history of the data (dating back to the late 1940’s).
As we have stated in the past, actual deleveraging has been occurring in the financial sector during 2008. THE poster child example for this phenomenon is the asset backed securities markets. The following chart is self-explanatory. Since the dawn of the asset backed markets in the mid-1980’s, there had never been a quarter over quarter decline in asset backed securities market leverage until 4Q of 2007. We already know that it’s the non-bank credit creation arena (the shadow banking system necessarily inclusive of Wall Street) that has been ground zero for broader credit cycle reconciliation in the current period. Have the markets already priced in contraction/deleveraging in the non-bank financial sector? To a large extent, you bet. Yet confidence in the sector will never be restored until investors can truly assess balance sheet risk. Given the revelations of companies like Citi, State Street and BofA lately, it’s clearly what we don’t know that’s the issue. And we’re miles away from confidence restoration. Miles.
In terms of specifics, and we will not drag you through a myriad of long term charts as within the financial sector actual deleveraging (net debt contraction) is evident as we look at the REITs, funding corporations and the asset backed markets, but outside of that continued leverage acceleration is still evident looking at the banks, insurance companies, GSEs, the broker/dealer community and credit unions. As such, this data and the trends underpinning recent experience suggests there is still a good deal of deleveraging potential within the broad US financial sector itself. Although the financial sector stocks have been resoundingly hit over the past year and one half, true recovery seems a long way off given that actual deleveraging in the sector has been meaningful, but isolated as opposed to broad based. Further potential deleveraging in the US financial sector remains a high probability outcome well into 2009. The importance of this will be its ramifications for the broader economy as a whole.
The non-financial corporate sector, much like its household sector counterpart, has only experienced a slowing in leverage assumption as opposed to outright contraction through 3Q of last year. As you can see in the chart, in the prior two recessions the non-financial corporate sector actually engaged in net debt reduction/deleveraging. We think it’s a very safe bet that occurs again in the current cycle. The dramatic drop in debt assumption is occurring now. The markets know this and we believe have priced this in. What remains to be discounted is once again magnitude and duration of net debt contraction that we believe lies dead ahead.
Collectively the data points we have briefly reviewed above are strongly suggesting that a broad based deleveraging process has not yet gained maximum wind speed. In fact in strict definitional terms the real deleveraging process has not even yet begun outside of the asset backed securities markets as a component of the financial sector. As of 3Q 2008, quarter over quarter total US credit market debt grew by almost $730 billion. YTD that number is just shy of $2 trillion in growth. Of these numbers, federal debt grew $525 billion in 3Q of last year (accounting for 72% of total US credit market growth) and $675 billion YTD (accounting for a third of total credit market growth) at that time. We will not belabor the point as we discussed it many a time last year, but we all know Federal debt is set to mushroom ahead. A little preview of what may be to come in comparison to past experience lies below. Talk about the antithesis of deleveraging.
In summation, debt growth throughout the broad US economy, exclusive of the asset backed securities markets (that is in clear deleveraging mode) and the Federal government (that is in clear leverage acceleration mode), has only slowed, but not gone into net contraction. As per the nearer term directional trends seen in the charts above, it appears households and the non-financial corporate sector are either in or will enter the process of net leverage contraction (deleveraging) very soon. Consumption, production and price deflation trends in a number of asset classes (primarily residential real estate and equities) has occurred up to this point against a backdrop of only slowing household and corporate debt growth. Just what will happen if/when household and non-financial corporate leverage begins to actually contract in nominal terms? THAT’s the key question for us as investors over the quarters directly ahead. The markets have priced in sector implosion (financial sector) and the potential for a recession of a mid-1970’s/early 1980’s magnitude. But, the broad deleveraging process has really just begun. We have a very hard time seeing this process truncated in the quarters ahead. The potential clearly exists for a multi-year reconciliation process. Have the markets already priced in a multi-year deleveraging process, with specific emphasis and implications as per consumers? That we do not believe has happened, except maybe in the Treasury market. You already know we will be monitoring and discussing these very issues as we move forward. Deleveraging is not done. As you can see, it has barely begun.
Moving Toward A New Normal?
We all know by now that Microsoft missed its 4Q 2008 earnings a few weeks back. Moreover, for the first time in their history they are beginning to reconcile labor costs, as are so many firms domestically. But probably THE most important aspect of the Microsoft announcement we believe simply did not receive enough headline attention, and it had absolutely nothing to do with earnings or layoffs.
Getting to the point, we want to quickly cover a very brief comment made by Microsoft big cheese Steve Ballmer with the earnings report. Without sounding melodramatic, we have to hand it to Ballmer in a big way. As we see it, his comments were absolutely spot on regarding what we believe is one of the key macro themes of the moment. We’re convinced by these simple comments that he gets it in a very big way. Sorry if you have already seen these comments, they are just so dead on we had to reprint them.
“We’re certainly in the midst of a once-in-a-lifetime set of economic conditions. The perspective I would bring is not one of recession. Rather, the economy is resetting to a lower level of business and consumer spending based largely on the reduced leverage in the economy.”
We never thought we’d say it, but BRAVO Mr. Ballmer. You hit it right on the head thematically, baby. We're moving to a "new normal" for the economy and corporate profits. That’s EXACTLY what is occurring, as far as we are concerned, and this is the exact set of circumstances the equity markets are in the process of adjusting to and discounting right now. Late last year we ran a series of charts comparing the longer cycle of total credit market debt growth in the US relative to the like period directional movement in after-tax US corporate profits. A snippet is seen below. Apparently like Ballmer, we are convinced the credit cycle clearly enhanced corporate profits and lifted asset values, both physical and financial. Our question at the time that still stands today is, “what happens to profits, and by extension US GDP, in a credit reconciliation process of perhaps generational magnitude?” Wouldn’t ya know it, Ballmer seems to be asking the same question. We have the distinct feeling this theme will be one of the most important to investment decision making and economic outcomes in the year ahead, and will gain in popularity as it works its way into consensus thinking.
Hopefully expressed in simple terms, the prior period credit cycle was a massive anomaly. That anomaly raised US nominal GDP, corporate profits and asset values to levels they never would have experienced in the absence of maniacal credit creation. Now that the meaningful deleveraging process we have been ranting and raving about is evidenced all around us and is really still in its infancy, we believe the US economy, corporate profits and asset values are in the process of shifting downward to a “new normal.” THIS is what the current equity bear market is all about. Corporations are adjusting to this new normal by cutting costs as their revenues shift downward. Households are adjusting to this by massively lowering their intake of leverage, and we believe soon to be paying it down. Even Ballmer recognizes the anomaly is over and is acting appropriately as far as Microsoft is concerned. When will this most important of messages and conceptual thinking make it to Washington? Answer: Don’t hold your breath, okay? After all, everything we've seen from the powers that be so far suggests to us they have absolutely no intention of adjusting to a new normal, but rather are doing everything in their power to recreate the old anomaly.
The Complexity Theory
A discernible change is taking place in the forum of environmental awareness. As the subject matures and our insights deepen, specific concerns are now accompanied by a general uneasiness as leading philosophers and scientists begin to examine the structure of our modern civilization and question its viability. One of these new avenues of consideration is Complexity Theory.
Complexity Theory argues that societies become progressively more unstable and vulnerable as the network of interconnections within them increases -- not particularly good news for a globalizing system in which increasing complexity is precisely the thrust of economics, finance, manufacturing, technology and almost everything else we do. The sobering implications may explain why many proponents of Complexity Theory preface their comments with an apology. "We don't want to tell you this," goes the essence of their message, "but we think you should know."
When the New Scientist published two articles on Complexity Theory (Apr. 5/08), its editor anticipated some reader discomfort. "We are predisposed to pay attention to bad news," noted the editorial. "There is a good reason for this. We need to be warned of difficulty and danger so we can protect ourselves.... [But] if the warning is too scary or distressing, we attack the messenger as a doom monger."
Complexity Theory comes with its hint of doom, ominously reminding us that no civilization has ever survived the stresses of history, with the possible exception of China and Byzantium -- in a much reduced state for 450 years following the 15th century Arab invasions. But Sumer, Persia, Egypt, Greece, Maya and even Rome all collapsed, primarily because they succumbed to overwhelming complexities.
Joseph Tainter, writing in The Collapse of Complex Societies, explains why. "For the past 10,000 years, problem solving has produced increasing complexity in human societies" (Ibid.). Food production is a classical example. Each time people find the solution to a food shortage -- irrigation, fertilizer or plants with higher yields-- the population rises to meet the food supply and the next problem to solve is more complicated and challenging. Every solution adds extra levels of organization, complexity and interdependence, which adds inefficiency and diminishing returns for the total amount of energy expended.
Progress is a process of perpetual problem solving, with each new solution adding more specialists and more layers of peripheral tasks that don't directly address the problems being solved. A civilization finally peaks at its maximum level of complexity when all its efforts are being used just to maintain its equilibrium. Then an unusual adversity arises: invaders, crop failure, disease, climate change, depletion of a critical natural resource, or anything that stresses a structure already precariously balanced. Then the civilization collapses and reorganizes itself at a simpler level.
Civilization's simplest structure is the hunter-gatherer tribe, a hierarchy with one leader and a few followers. Feudal societies are based on the same linear model. This explains why the catastrophe of the Black Plague of 1348 could kill about a third of Europe's population without a discernible effect on the society's stability -- 80% of the people were peasant farmers so the system simply shrunk but held together. Tainter contrasts this with a similar plague and death rate that struck the Roman empire in 170 CE. Although also hierarchical, the Romans had huge urban populations that were wholly "depended on peasants for grain, taxes and soldiers" (Ibid.), and a complex infrastructure of administrators, builders, labourers and slaves. The weakening of these lateral connections compromised the empire's structure and set in motion an unstoppable and fatal decline.
Compared to the Roman empire, the networks of interdependence in our present global systems are orders of magnitude more complicated -- and comparably less resilient. Efficiency, the hallmark of modern economics, is precisely the fine tuning of higher levels of interdependence to minimize duplication and waste. Think of manufacturing with just-in-time delivery systems, or cities which typically store only a three-day supply of food, or hospitals which rely on the daily arrival of drugs, blood and oxygen -- Michael Osterholm of the University of Minnesota reminds us that "most medical equipment and 85% of US pharmaceuticals are made abroad" (Ibid.).
Now imagine the consequences if one link were removed from this network of interdependence. If truck drivers stopped delivering supplies to factories, cities and hospitals. If refineries did not make fuel for trucks. If tankers or pipelines could not send oil to refineries. Or if a highly infectious pandemic kept truck drivers from delivering anything anywhere. The same fear could ground all airplanes. A study by Warwick McKibben of the Lowry Institute for International Policy in Australia calculated that a pandemic equivalent to the Spanish flu of 1918 would kill 142 million people today and cause a 12.6% crash in global GDP -- the flu killed 3% of those infected compared to the 63% that could die from an H5N1 bird flu pandemic (Ibid.).
Or, to be less hypothetical about the failings of complexity, we are now learning what happens to the global economy when a few decisions to allow unsupported mortgages in the United States infects the entire international financial system. Complexity Theory is an uncomfortable subject, particularly given the unsettling stresses we are measuring in food production, climate change, resource depletion, ecosystem damage, pollution and population growth. But the theory has its saving graces. It does make us more aware of our vulnerabilities. And it does argue for simplification and local self-sufficiency, particularly for essentials such as food supply and energy production. The incentive to begin thinking and acting with foresight should compensate for the need to be apologetic.
More terrible trade numbers from China
Yesterday while I was preparing for my presentation in Hong Kong on the impact of slowing trade on the Chinese economy, one of the participants in the conference passed on to me the January trade numbers, which had just been released. Although they were "surprisingly" bad, and fit perfectly within my very gloomy presentation, they were also not a surprise in the sense that they show what many of us had been expecting anyway. According to an article in today’s Xinhua:A sharp fall in imports and exports in January, which included a weeklong Spring Festival holiday, has both puzzled and alarmed economists. General Administration of Customs figures released yesterday showed exports plummeted 17.5 percent year-on-year, much sharper than the 2.8 percent fall in December. Imports fell even more dramatically, to 43.1 percent year-on-year. The combined foreign trade in January fell 29 percent year-on-year. Such a major decline in monthly foreign trade is rare in the 30 years of reform and opening up.
…Last month, however, was an exception because it had one full week of holiday from January 26. The Chinese Lunar New Year is the most important festival for Chinese but usually it falls in February. So this year, January had five fewer working days than those in many of the previous years. If that is considered, the Customs said, exports actually rose 6.8 percent year-on-year in January. And compared with December, they increased 4.6 percent.
As usual, the local press tried to put the best face possible on the decline by comparing numbers on a day-count basis ("exports actually rose 6.8 percent"). This only makes sense however if Chinese exporters and importers were unaware of the week-long Spring Festival holiday and made no attempts to accelerate late January transactions to fit into the January holiday schedule. Pretty unlikely, I would think. The reality is that both exports and imports continue to contract at a rapid pace, and indicate that both foreign consumption and local consumption are in sharp decline. What worries me even more is a number that the Xinhua report, for some reason, did not bother to publish in their article on the trade data. China’s trade surplus for January was a mind-blowing $39.1 billion, just a smidgen under November’s all-time high of $40.1 billion (or about 25% higher, if we want to play the day-count game), and edging out December’s $39.0 billion for second place. That puts the trade surplus over the past four months $153.4 billion, well over half of all of last year’s record-smashing $297.5 billion trade surplus.
I know I have written about this many times, but I want to say again what that means for the global imbalance. The world’s consumers are experiencing a sharp contraction in demand. That contraction has to be "shared out" among all of the world’s producers. The decline in Chinese exports means that Chinese producers are absorbing part of that contraction, but the bigger decline in its imports means that Chinese consumers are contributing an even greater amount to the contraction in demand. The result, with net Chinese consumption contracting by more than net Chinese production, is that non-Chinese producers must absorb more than 100% of the contraction in demand from non-Chinese consumers. It will be hard to convince them that this is fair. Although China has tremendous domestic problems and is very worried about the employment impact of the global slowdown, my fear is that those considerations are likely to have little value for other countries also suffering from awful employment prospects. For comparison, in December Taiwan’s exports fell 42%, South Korea’s by 17%, and Japan’s by 35%, compared to. China’s 2.8%, and Bloomberg earlier this week had this article:China said it was "seriously concerned" at Indian barriers to its exports, highlighting global trade tensions as the worst financial crisis since World War II sends demand plummeting. India’s use of sanctions may have "a serious impact on bilateral trade relations," Ministry of Commerce spokesman Yao Jian said in a statement on the ministry’s Web site today. India imposed a six-month ban on imports of Chinese toys last month.
…India has initiated 17 trade actions, including 10 anti- dumping probes, against Chinese imports such as penicillin, hot- rolled steel, vehicle axles and linen since October, the Chinese ministry said today. It also cited additional Indian restrictions on imports of products including steel, chemicals and textiles.
…"I believe China won’t implement a ‘Buy China’ policy," Vice Commerce Minister Jiang Zengwei said at a press conference in Beijing today. "We just need to boost consumption, whether it’s through domestically made goods or foreign-made goods. We will treat them equally without discrimination. Why in the current climate should we resort to protectionism?"
Why indeed? It never makes sense for the leading trade surplus country to resort to protectionism if there is any chance of a global backlash, as the US discovered to its chagrin in 1930. It may, however, make a lot more sense for countries with trade deficits to turn to protection, and there is now overwhelming evidence that this is exactly what they are doing or thinking about doing. At any rate whether recent Chinese moves to lower interest rates, to increase dramatically the provision of credit to manufacturing companies, to reduce export tax rebates, to reduce corporate taxes, and to stall the earlier discussions over increasing minimum wages, should be considered "resorting to protectionism" is something one can debate extensively, but the fact is that all of these moves are aimed at boosting manufacturing output and employment.
Matters are made worse by the fact that most of the stimulus package so far seems to consist of an explosion in bank lending (by the way last week’s rumors were confirmed – bank lending in January was up by RMB 1.62 trillion), and aside from the problems I discussed in my post earlier this week, bank lending is directed almost exclusively towards investment and manufacturing. Whatever effect it might have in increasing consumption could easily be exceeded by the impact it has on increasing output. Of course the government can point to consumption-boosting measures too, and there is a lot of discussion about providing Chinese consumers with coupons to be used to consume before some expiry date (although whether these create new consumption or simply substitute for old consumption would be a tricky issue), the fact is that the transmission from domestic demand enhancement to import demand is, for whatever reason, very weak. China is still exacerbating the global overcapacity problem.
For some reason whenever I point this out there is always someone who accuses me of being "anti-China" (and weirdly enough the accuser is not always Chinese), so let me stress that I am not evaluating, I am only counting, and it doesn’t matter whether or not I point this out. The fact is that quite a lot of people have made or will make the same argument, and if that argument spreads, which it seems to be doing very quickly, China is going to have to deal with it whether or not it likes. The more noise those of us who want to see China succeed make about the growing perception, right or wrong, that China is exacerbating the global problem, the better it is for China. The thing to remember is that for the rest of the world it doesn’t really matter what explanation Chinese policymakers give for this high and rising trade surplus. They will consider the fact that with China’s export of overcapacity extremely high, and growing even further, anger within their political constituencies cannot help but rise.
Of course China needs to fight rapidly rising unemployment, but so does nearly every other country in the world. At all costs China must move quickly to defuse the threat of trade war, but unfortunately I see little evidence that Chinese policymakers are even beginning to understand China’s role in the Great Global Imbalance. And the problem is certainly not helped by actions like last week’s posting, on the website of the research institute associated with China’s Ministry of Finance, of a report arguing that China’s central bank should "actively guide" the exchange rate and devalue the RMB to about 6.93 against the dollar. The purpose of depreciating, the report said, was to help maintain economic growth and bolster employment. Wow. It is as if they have absolutely no understanding of how dangerous the global climate is. This is very scary. On a separate but related note, yesterday’s Financial Times had this story:China will continue to buy US Treasury bonds even though it knows the dollar will depreciate because such investments remain its "only option" in a perilous world, a senior Chinese banking regulator said on Wednesday. China has used the dollars it accumulates selling manufactured goods to US consumers to accumulate the world’s largest holding of Treasuries.
However, the increasing US budget deficit and its potential impact on the dollar have raised questions about the future Chinese appetite for US debt. Luo Ping, a director-general at the China Banking Regulatory Commission, said after a speech in New York on Wednesday that China would continue to buy Treasuries in spite of its misgivings about US finances. "Except for US Treasuries, what can you hold?" he asked. "Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option."
It is good that Mr. Luo is helping to dissipate the widespread but profoundly silly worry about whether or not China will choose to stop funding the US trade deficit. It can’t. As long as China keeps running these trade surpluses it has no choice but to recycle the money, and the only market large enough in which to recycle so much money is the US dollar market. Even if it tried to divert more of it into the euro, this would simply force a larger trade deficit onto Europe, which is not sustainable for any length of time. What still puzzles me, however, is how China "knows the dollar will depreciate." Against what? The euro? Why, because the US economy is slowing and fiscal debt is rising? Since Europe is slowing even more, and starts with a higher level of debt, I have trouble understanding why this would indicate that the euro must strengthen against the dollar. By the way the dollar has strengthened remarkably against the euro over the past six months, so perhaps the PBoC would only be forced to give back a part of its windfall? Or is it not a windfall?
Before closing this post I want to complain about one last, only vaguely related thing. On Tuesday when I arrived at the Hong Kong airport, among all the huge advertisements offering services to bankers and businesses, I saw one even larger advertisement for Credit Suisse concerning an exhibit they sponsored of "Emerging Asian Artists." I know this is going to sound unbearably snobbish, and I really apologize for sounding like this, but while the global financial crisis has many terrible aspects to it, there is no cloud without a sliver lining, and if the emerging artist investment class is one of the many markets that die as a consequence of this crisis (and if history is any guide at all, it will), then the global crisis can’t have been all bad, right?
Obama's Awful Financial Recovery Plan
Martin Wolf started off his Financial Times column for February 11 with the bold question: "Has Barack Obama’s presidency already failed?" The stock market had a similar opinion, plunging 382 points. Having promised "change," Mr. Obama is giving us more Clinton-Bush via Robert Rubin’s protégé, Tim Geithner. Tuesday’s $2.5 trillion Financial Stabilization Plan to re-inflate the Bubble Economy is basically an extension of the Bush-Paulson giveaway – yet more Rubinomics for financial insiders in the emerging Wall Street trusts. The financial system is to be concentrated into a cartel of just a few giant conglomerates to act as the economy’s central planners and resource allocators. This makes banks the big winners in the game of "chicken" they’ve been playing with Washington, a shakedown holding the economy hostage.
"Give us what we want or we’ll plunge the economy into financial crisis." Washington has given them $9 trillion so far, with promises now of another $2 trillion– and still counting. A true reform – one designed to undo the systemic market distortions that led to the real estate bubble – would have set out to reverse the Clinton-Rubin repeal of the Glass-Steagall Act so as to prevent the corrupting conflicts of interest that have resulted in vertical trusts such as Citibank and Bank of America/Countrywide/Merrill Lynch. By unleashing these conglomerate grupos (to use the term popularized under Pinochet with Chicago Boy direction – a dress rehearsal of the mass financial bankruptcies they caused in Chile by the end of the 1970s) the Clinton administration enabled banks to merge with junk mortgage companies, junk-money managers, fictitious property appraisal companies, and law-evasion firms all designed to package debts to investors who trusted them enough to let them rake off enough commissions and capital gains to make their managers the world’s highest-paid economic planners.
Today’s economic collapse is the direct result of their planning philosophy. It actually was taught as "wealth creation" and still is, as supposedly more productive than the public regulation and oversight so detested by Wall Street and its Chicago School aficionados. The financial powerhouses created by this "free market" philosophy span the entire FIRE sector – finance, insurance and real estate, "financializing" housing and commercial property markets in ways guaranteed to make money by creating and selling debt. Mr. Obama’s advisors are precisely those of the Clinton Administration who supported trustification of the FIRE sector. This is the broad deregulatory medium in which today’s bad-debt disaster has been able to spread so much more rapidly than at any time since the 1920s.
The commercial banks have used their credit-creating power not to expand the production of goods and services or raise living standards but simply to inflate prices for real estate (making fortunes for their brokerage, property appraisal and insurance affiliates), stocks and bonds (making more fortunes for their investment bank subsidiaries), fine arts (whose demand is now essentially for trophies, degrading the idea of art accordingly) and other assets already in place.
The resulting dot.com and real estate bubbles were not inevitable, not economically necessary. They were financially engineered by the political deregulatory power acquired by banks corrupting Congress through campaign contributions and public relations "think tanks" (more in the character of doublethink tanks) to promote the perverse fiction that Wall Street can be and indeed is automatically self-regulating -- a travesty of Adam Smith’s "Invisible Hand." This hand is better thought of as covert. The myth of "free markets" is now supposed to consist of governments withdrawing from planning and taxing wealth, so as to leave resource allocation and the economic surplus to bankers rather than elected public representatives. This is what classically is called oligarchy, not democracy.
This centralization of planning, debt creation and revenue-extracting power is defended as the alternative to Hayek’s road to serfdom. But it is itself the road to debt peonage, a.k.a. the post-industrial economy or "Information Economy." The latter term is another euphemistic travesty in view of the kind of information the banking system has promoted in the junk accounting crafted by their accounting firms and tax lawyers (off-balance-sheet entities registered on offshore tax-avoidance islands), the AAA applause provided as "information" to investors by the bond-rating cartel, and indeed the national income and product accounts that depict the FIRE sector as being part of the "real" economy, not as an institutional wrapping of special interests and government-sanctioned privilege acting in an extractive rather than a productive way.
"Thanks for the bonuses," bankers in the United States and England testified this week before Congress and Parliament. "We’ll keep the money, but rest assured that we are truly sorry for having to ask you for another few trillion dollars. At least you should remember our theme song: We are still better managers than the government, and the bulwark against government bureaucratic resource allocation." This is the ideological Big Lie sold by the Chicago School "free market" celebration of dismantling government power over finance, all defended by complex math rivaling that of nuclear physics that the financial sector is part of the "real" economy automatically producing a fair and equitable equilibrium.
This is not bad news for stockholders of more local and relatively healthy banks (healthy in the sense of avoiding negative equity). Their stocks soared and were by far the major gainers on Tuesday’s stock market, while Wall Street’s large Bad Banks plunged to new lows. Solvent local banks are the sort that were normal prior to repeal of Glass Steagall. They are to be bought by the large "troubled" banks, whose "toxic loans" reflect a basically toxic operating philosophy. In other words, small banks who have made loans carefully will be sucked into Citibank, Bank of America, JP Morgan Chase and Wells Fargo – the Big Four or Five where the junk mortgages, junk CDOs and junk derivatives are concentrated, and have used Treasury money from the past bailout to buy out smaller banks that were not infected with such reckless financial opportunism. Even the Wall Street Journal editorialized regarding the Obama Treasury’s new "Public-Private Investment Fund" to pump a trillion dollars into this mess: "Mr. Geithner would be wise to put someone strong and independent in charge of this fund – someone who can say no to Congress and has no ties to Citigroup, Robert Rubin or Wall Street."
None of this can solve today’s financial problem. The debt overhead far exceeds the economy’s ability to pay. If the banks would indeed do what Pres. Obama’s appointees are begging them to do and lend more, the debt burden would become even heavier and buying access to housing even more costly. When the banks look back fondly on what Alan Greenspan called "wealth creation," we can see today that the less euphemistic terminology would be "debt creation." This is the objective of the new bank giveaway. It threatens to spread the distortions that the large banks have introduced until the entire system presumably looks like Citibank, long the number-one offender of "stretching the envelope," its euphemism for breaking the law bit by bit and daring government regulators and prosecutors to try and stop it and thereby plunging the U.S. financial system into crisis. This is the shakedown that is being played out this week. And the Obama administration blinked – as these same regulators did when they were in charge of the Clinton administration’s bank policy. So much for the promised change!
The three-pronged Treasury program seems to be only Stage One of a two-stage "dream recovery plan" for Wall Street. Enough hints have trickled out for the past three months in Wall Street Journal op-eds to tip the hand for what may be in store. Watch for the magic phrase "equity kicker," first heard in the S&L mortgage crisis of the 1980s. It refers to the banker’s share of capital gains, that is, asset price inflation in Bubble #2 that the Recovery Program hopes to sponsor. The first question to ask about any Recovery Program is, "Recovery for whom?" The answer given on Tuesday is, "For the people who design the Program and their constituency" – in this case, the bank lobby. The second question is, "Just what is it they want to ‘recover’?" The answer is, the Bubble Economy. For the financial sector it was a golden age. Having enjoyed the Greenspan Bubble that made them so rich, its managers would love to create yet more wealth for themselves by indebting the "real" economy yet further while inflating prices all over again to make new capital gains.
The problem for today’s financial elites is that it is not possible to inflate another bubble from today’s debt levels, widespread negative equity, and still-high level of real estate, stock and bond prices. No amount of new capital will induce banks to provide credit to real estate already over-mortgaged or to individuals and corporations already over-indebted. Moody’s and other leading professional observers have forecast property prices to keep on plunging for at least the next year, which is as far as the eye can see in today’s unstable conditions. So the smartest money is still waiting like vultures in the wings – waiting for government guarantees that toxic loans will pay off. Another no-risk private profit to be subsidized by public-sector losses.
While the Obama administration’s financial planners wring their hands in public and say "We feel your pain" to debtors at large, they know that the past ten years have been a golden age for the banking system and the rest of Wall Street. Like feudal lords claiming the economic surplus for themselves while administering austerity for the population at large, the wealthiest 1 per cent of the population has raised their appropriation of the nationwide returns to wealth – dividends, interest, rent and capital gains – from 37 per cent of the total ten years ago to 57 per cent five years ago and it seems nearly 70 per cent today. This is the highest proportion since records have been kept. We are approaching Russian kleptocratic levels.
The officials drawn from Wall Street who now control of the Treasury and Federal Reserve repeat the right-wing Big Lie: Poor "subprime families" have brought the system down, exploiting the rich by trying to ape their betters and live beyond their means. Taking out subprime loans and not revealing their actual ability to pay, the NINJA poor (no income, no job, no audit) signed up to obtain "liars’ loans" as no-documentation Alt-A loans are called in the financial junk-paper trade. I learned the reality a few years ago in London, talking to a commercial banker. "We’ve had an intellectual breakthrough," he said. "It’s changed our credit philosophy."
"What is it?" I asked, imagining that he was about to come out with yet a new magical mathematics formula? "The poor are honest," he said, accompanying his words with his jaw dropping open as if to say, "Who would have guessed?" The meaning was clear enough. The poor pay their debts as a matter of honor, even at great personal sacrifice and what today’s neoliberal Chicago School language would call uneconomic behavior. Unlike Donald Trump, they are less likely to walk away from their homes when market prices sink below the mortgage level. This sociological gullibility does not make economic sense, but reflects a group morality that has made them rich pickings for predatory lenders such as Countrywide, Wachovia and Citibank. So it’s not the "lying poor." It’s the banksters’ fault after all!
For this elite the Bubble Economy was a deliberate policy they would love to recover. The problem is how to start a new bubble to make yet another fortune? The alternative is not so bad – to keep the bonuses, capital gains and golden parachutes they have given themselves, and run. But perhaps they can improve in Bubble Economy #2. The Treasury’s newest Financial Stability Plan (Bailout 2.0) is only the first step. It aims at putting in place enough new bank-lending capacity to start inflating prices on credit all over again. But a new bubble can’t be started from today’s asset-price levels. How can the $10 to $20 trillion capital-gain run-up of the Greenspan years been repeated in an economy that is "all loaned up"? One thing Wall Street knows is that in order to make money, asset prices not only need to rise, they have to go down again. Without going down, after all, how can they rise up? Without a crucifixion for the economy, how can there be a resurrection? The more frenetic the price fibrillation, the easier it is for computerized buy-and-sell programs to make money on options and derivatives.
So here’s the situation as I see it. The first objective is to preserve the wealth of the creditor class – Wall Street, the banks and the other financial vehicles that enrich the wealthiest 1 per cent and, to be fair within America’s emerging new financial oligarchy, the richest 10 per cent of the population. Stage One involves buying out their bad loans at a price that saves them from taking a loss. The money will be depicted to voters as a "loan," to be repaid by banks extracting enough new debt charges in the new rigged game the Treasury is setting up. The current loss will be shifted the onto "taxpayers" and made up by new debtors – in both cases labor, onto whose shoulders the tax burden has been shifted steadily, step by step since 1980.
An "aggregator" bank (sounds like "alligator," from the swamps of toxic waste) will buy the bad debts and put them in a public agency. The government calls this the "bad" bank. (This is Geithner’s first point.) But it does good for Wall Street – by buying loans that have gone bad, along with loans and derivative guarantees and swaps that never were good in the first place. If the private sector refuses to buy these bad loans at prices the banks are asking for, why should the government pretend that these debt claims are worth more. Vulture funds are said to be offering about what they were when Lehman Brothers went bankrupt: about 22 cents on the dollar. The banks are asking for 75 cents on the dollar. What will the government offer?
Perhaps the worst alternative is that is now being promoted by the banks and vulture investors in tandem: the government will guarantee the price at which private investors buy toxic financial waste from the banks. A vulture fund would be happy enough to pay 75 cents on the dollar for worthless junk if the government were to provide a guarantee. The Treasury and Federal Reserve pretend that they simply would be "providing liquidity" to "frozen markets." But the problem is not liquidity and it is not subjective "market psychology." It is "solvency," that is, a realistic awareness that toxic waste and bad derivatives gambles are junk. Mr. Geithner has not been able to come to terms with how to value this – without bringing the Obama administration down in a wave of populist protest – any more than Mr. Paulson was able to carry out his original Tarp proposal along these lines.
The hardest task for today’s banksters is to revive opportunities for creditors to make a new killing. (It’s the economy that’s being killed, of course.) This seems to be the aim of the Public/Private investment company that Mr. Geithner is establishing as the second element in his plan. The easiest free lunch is to ride the wave of a new bubble – a fresh wave of asset-price inflation to be introduced to "cure" the problem of debt deflation. Here’s how I imagine the ploy might work. Suppose a hapless family has bought a home for $500,000, with a full 100 per cent $500,000 adjustable-rate mortgage scheduled to reset this year at 8 per cent. Suppose too that the current market price will fall to $250,000, a loss of 50 per cent by yearend 2009. Sometime in mid 2010 would seem to be long enough for prices to decline by enough to make "recovery" possible – Bubble Economy 2.0. Without such a plunge, there will be no economy to "rescue," no opportunity for Tim Geithner and Laurence Summers to "feel your pain" and pull out of their pocket the following package – a variant on the "cash for trash" swap, a public agency to acquire the $500,000 mortgage that is going bad, heading toward only a $250,000 market price.
The "bad bank" was not quite ready to be created this week, but the embryo is there. It will take the form of a public/private partnership (PPP) of the sort that Tony Blair made so notorious in Britain. And speaking of Mr. Blair, I am writing this from England, where almost every America-watcher I talk to has expressed amazement at Obama’s performance last week idealizing England’s counterpart to George Bush when it comes to unpopularity contests. Blair’s tenure in office was a horror story, not something to be congratulated for. He entered into the disastrous public/private partnership that doubled, tripled or quadrupled the cost of public projects by adding on a heavy financial overhead. If Obama does not realize how he shocked Britain and much of Europe with his praise, then he is in danger of foisting a similar public/private financialized "partnership" on the United States.
The new public/private institution will be financed with private funds – in fact, with the money now being given to re-capitalize America’s banks (headed by the Wall St. banks that have done so badly). Banks will use the Treasury money they have received by "borrowing" against their junk mortgages at or near par to buy shares in a new $5 trillion institution created along the lines of the unfortunate Fanny Mae and Freddie Mac. Its bonds will be guaranteed. (That’s the "public" part – "socializing" the risk.) The PPP institution will have the power to buy and renegotiate the mortgages that have passed into the hands of the government and other holders. This "Homeowner Rescue Trust" will use its private funding for the "socially responsible" purpose of "saving the taxpayer" and middle class homeowners by renegotiating the mortgage down from its original $500,000 to the new $250,000 market price.
Here’s the patter talk you can expect, with the usual euphemisms. The Homeowners Rescue PPP will appear as a veritable Savior Bank resurrected from the wreckage of Bubble #1. Its clients will be families strapped by their mortgage debt and feeling more and more desperate as the price of their major asset plummets more deeply into Negative Equity territory. To them, the new PPP will say: "We’ve got a deal to save you. We’ll renegotiate your mortgage down to the current market price, $250,000, and we’ll also lower your interest rate to just 5.50 per cent, the new rate. This will cut your monthly debt charges by nearly two thirds. Not only can you afford to stay in your home, you will escape from your negative equity."
The family probably will say, "Great." But they will have to make a concession. That’s where the new public/private partnership makes its killing. Funded with private money that will take the "risk" (and also reap the rewards), the Savior Bank will say to the family that agrees to renegotiate its mortgage: "Now that the government has absorbed a loss (in today’s travesty of "socializing" the financial system) while letting let you stay in your home, we need to recover the money that’s been lost. If we make you whole, we want to be made whole too. So when the time comes for you to sell your home or renegotiate your mortgage, our Homeowners Rescue PPP will receive the capital gain up to the original amount written off."
In other words, if the homeowner sells the property for $400,000, the Homeowners Rescue PPP will get $150,000 of the capital gain. If the home sells for $500,000, the bank will get $250,000. And if it sells for more, thanks to some new clone of Alan Greenspan acting as bubblemeister, the capital gain will be split in some way. If the split is 50/50 and the home sells for $600,000, the owner will split the $100,000 further capital gain with the Homeowners Rescue PPP. It thus will make much more through its appropriation of capital gains (the new debt-fueled asset-price inflation being put in place) than it extracts in interest! This would make Bubble 2.0 even richer for Wall Street than the Greenspan bubble! Last time around, it was the middle class that got the gains – even if new buyers had to enter a lifetime of debt peonage to buy higher-priced homes. It really was the bank that got the gains, of course, because mortgage interest charges absorbed the entire rental value and even the hoped-for price gain.
But homeowners at least had a chance at the free ride, if they didn’t squander their money in refinancing their mortgages to "cash out" on their equity to support their living standards in a generation whose wage levels had stagnated since 1979. As Mr. Greenspan observed in testimony before Congress, a major reason why wages have not risen is that workers are afraid to strike or even to complain about being worked harder and harder for longer and longer hours ("raising productivity"), because they are one paycheck away from missing their mortgage payment – or, if renters, one paycheck or two away from homelessness.
This is the happy condition of normalcy that Wall Street’s financial planners would like to recover. This time around, they may not be obliged to make their gains in a way that also makes middle class homeowners rich. In the wake of Bubble Economy #1, today’s debt-strapped homeowners are willing to settle merely for a plan that leaves them in their homes! The Homeowners Rescue PPP can appropriate for its stockholder banks and other large investors the capital gains that have been the driving force of U.S. "wealth creation," bubble-style. That is what the term "equity kicker" means.
This situation confronts the economy with a dilemma. The only policies deemed politically correct these days are those that make the situation worse: yet more government money in the hope that banks will create yet more credit/debt to raise house prices and make them even more unaffordable; credit/debt to inflate a new Bubble Economy #2.
Lobbyists for Wall Street’s enormous Bad Bank conglomerates are screaming that all real solutions to today’s debt problem and tax shift onto labor are politically incorrect, above all the time-honored debt write-downs to bring the debt burden within the ability to pay. That is what the market is supposed to do, after all, by bankruptcy in an anarchic collapse if not by more deliberate and targeted government policy. The Bad Banks, having demanded "free markets" all these years, fear a really free market when it threatens their bonuses and other takings. For Wall Street, free markets are "free" of public regulation against predatory lending; "free" of taxing the wealthy so as to shift the burden onto labor; "free" for the financial sector to wrap itself around the "real" economy like parasitic ivy around a tree to extract the surplus.
This is a travesty of freedom. As the premature neoliberal Adam Smith explained, "The government of an exclusive company of merchants, is, perhaps, the worst of all governments." But worst of all is the "freedom" of today’s economic discussion from the wisdom of classical political economy and from historical experience regarding how societies through the ages have coped with the debt overhead.
How to save the economy from Wall Street
There is an alternative to ward all this off, and it is the classic definition of freedom from debt peonage and predatory credit. The only real solution to today’s debt overhang is a debt write-down. Until this occurs, debt service will crowd out spending on goods and services and there will be no recovery. Debt deflation will drag the economy down while assets are transferred further into the hands of the wealthiest 10 percent of the population, operating via the financial sector. If Obama means what he says, he would use his office as a bully pulpit to urge repeal the present harsh creditor-oriented bankruptcy law sponsored by the banks and credit-card companies [and pushed through by then-Senator Joe Biden. Editors]. He would campaign to restore the long-term trend of laws favoring debtors rather than creditors, and introduce legislation to restore the practice of writing down debts to reflect the debtor’s ability to pay, imposing market reality to debts that are far in excess of realistic valuations.
A second policy would be to restore the power of state attorneys general to bring financial fraud charges against the most egregious mortgage lenders – the prosecutions that the Bush Administration got thrown out of court by claiming that under an 1864 National Bank Act clause, the federal government had the right to override state prosecutions of national banks – and then appointing a non-prosecutor to this enforcement position. On the basis of reinstated fraud charges, the government might claw back the bank bonuses, salaries and bank earnings that represented the profits from America’s greatest financial and real estate fraud in history. And to prevent repetition of the past decade’s experience, the Obama Administration might help popularize a new psychology of debt. The government could encourage "the poor" to act as "economically" as Donald Trumps or Angelo Mozilos would do, making it clear that debt write-downs are a right.
Also to ward off repetition of the Bubble Economy, the Treasury could impose the "Tobin tax" of 1 per cent on purchases and options for stocks, bonds and foreign currency. Critics of this tax point out that it can be evaded by speculators trading offshore in the rights to securities held in U.S. accounts. But the government could simply refuse to provide deposit insurance and other support to institutions trading offshore, or simply could announce that trades in such "deposit receipts" for shares would not have legal standing. As for trades in derivatives, depository institutions – including conglomerates owning such banks – can simply be banned as inherently unsafe. If foreigners wish to speculate on financial horse races, let them.
Financial policy ultimately rests on tax policy. It is the ability to levy taxes, after all, that gives value to Treasury money (just as it is the inability to collect on debts that has depreciated the value of commercial bank deposits). It is easy enough for fiscal policy to prevent a new real estate bubble. Simply shift the tax system back to where it originally was, on the land’s site-rental value. The "free lunch" (what John Stuart Mill called the "unearned increment" of rising land prices, a gain that landlords made "in their sleep") would serve as the tax base instead of burdening labor and industry with income taxes and sales taxes. This would achieve the kind of free market that Adam Smith, John Stuart Mill and Alfred Marshall described, and which the Progressive Era aimed to achieve with America’s first income tax in 1913. It would be a market free of the free lunch that Chicago Boys insist does not exist. But the recent Bubble Economy and today’s Bailout Sequel have been all about getting a free lunch.
A land tax would prevent housing prices from rising again. It is the most hated tax in America today, largely because of the disinformation campaign that has been mounted by the real estate interests and amplified by the banks that stand behind them. The reality is that taxing land appreciation rather than wages or corporate profits would save homeowners from having to take on so much debt in order to obtain housing. It would save the economy from seeing "wealth creation" take the form of the "unearned increment" being capitalized into higher bank loans with their associated carrying charges (interest and amortization). The wealth tax originally fell mainly on real estate. The most immediate and politically feasible priority of the Obama Administration thus should be to repeal the Bush Administration’s drastic tax cuts for the top brackets and its moratorium on the estate tax. The aim should be to bring down the polarization between creditors and debtors that has concentrated over two-thirds of the returns to wealth in the richest 1 per cent of the population.
If alternatives to the Bubble Economy such as these are not promoted, we will know that promises of change were mere rhetoric, Tony Blair style. Mr. Geithner may have given the game away in his February 10 statement that "Access to public support is a privilege, not a right." The literal meaning of "privilege" is "private law" (Lat. leges), a law to benefit individuals as a special interest separate from the public interest. The problem is that Mr. Geithner is seeking to save a system that creates no real jobs products. The debt that banks sell is not really a "product." Extracting interest and receiving public bailouts to make financial gamblers whole is extractive, not productive.
The banking system often has been characterized as parasitic. The metaphor is appropriate on more than one plane. Most people think of parasites simply as leeches, draining nourishment from the host. But biological nature is more complex. In order for parasites to succeed they must first numb the host’s pain-warning system so that they can get a foothold. They then take control of the host’s brain. The trick the host into believing that the parasite is part of its own body, and indeed even its child, to be nurtured, protected and given preference. They turn the host into a zombie. So the problem we are facing is not "zombie banks," but the ability of Wall Street to create a zombie economy.
This is what the financial sector has done vis-à-vis the economy at large. It depicts itself and the rest of the symbiotic FIRE sector as part of the "real" economy, so that its extraction of interest, economic rent and monopoly prices is payment for providing a "service": the privilege of credit creation, landlordship and "corporate management. Like his predecessor Hank Paulson, Mr. Geithner claims that recovery cannot occur until the banking system is put back on its feet in sufficiently solvent and indeed, prosperous condition to "get credit flowing again," he said. "Without credit, economies cannot grow at their potential." But is the solution really to create yet more debt for the already debt-ridden U.S. economy? It was the Greenspan debt bubble that brought it to a halt! Interest and amortization charges on new debt will eats into the ability of consumers and companies to spend and invest. Claiming that economic recovery must be led by renewed debt creation threatens only to deepen debt dependency and further erode discretionary consumer spending power.
When it comes to cleaning up the Greenspan Bubble legacy by writing down homeowner mortgage debt, the Treasury proposal offers homeowners $50 billion – just 5 percent of the $10 trillion Wall Street bailout to date, and less than half the amount given to AIG to pay its hedge fund speculators on their derivative gambles. The Treasury has handed out $25 billion to each and every big bank, so just two of these banks alone got as much as the reported one-quarter of all homeowners in America suffering from Negative Equity on their homes and in need of mortgage renegotiation. Yet today’s economic shrinkage cannot be reversed without a recovery in consumer demand. The economy has lost the "virtual wealth" in higher-priced homes and the stock market, and must rely on after-tax earnings. But I see little concern for wage earners in the Treasury plan. Without debt relief, consumer spending and business investment will not recover. This debt dimension is what the Treasury’s "recovery" plan leaves out of account. It seeks to recover the debt-bubble economy, not the real economy of production and consumption.