Mission where Elsie Sigel met her slayer. The body of the 19-year-old missionary, granddaughter of Civil War hero Franz Sigel, was found in 1909 bound in a trunk in her lover Leon Ling's fourth-floor apartment at 782 Eighth Avenue in New York, next to the Chinese restaurant where he was a waiter. Ling disappeared, and the crime remains officially unsolved.
Verb. per·vert·ed, per·vert·ing, per·verts
- To cause to turn away from what is right, proper, or good; corrupt.
- To bring to a bad or worse condition; debase.
- To put to a wrong or improper use; misuse.
- To interpret incorrectly; misconstrue or distort.
Ben Bernanke says the Federal Reserve will release longer-term economic projections. The motivation behind this daring step?
The change "should provide the public a clearer picture of FOMC participants’ policy strategy for promoting maximum employment and price stability over time,"[..] The move also "should help to better stabilize the public’s inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low," he said. "We expect inflation to be quite low for some time,"
Ok, first of all, under Greenspan and Bernanke the Fed’s short term projections have been consistently off by so much that even the laughter has long subsided. Long term projections will be worse. But as long as there are enough people that are sufficiently gullible, the hope must be that they will forget the misery they're in, and willing to believe the undoubtedly much rosier figures Bernanke will project over the long term. This is the first of the long term projections, as presented by Bernanke this afternoon, ”The committee members said that the American economy was expected to grow by 2.5 to 2.7 percent annually over the next five to six years, and that unemployment rates would hover near 5 percent in the longer term.” What a clown. What a charade.
President Obama said in an interview with Canada’s CBC TV that the tar sands environmental troubles can be solved. Just add a pinch of — non existent— technology.
What we know is that oil sands creates a big carbon footprint. So the dilemma that Canada faces, the United States faces, and China and the entire world faces is how do we obtain the energy that we need to grow our economies in a way that is not rapidly accelerating climate change. That's one of the reasons why the stimulus bill that I'll be signing today contains billions of dollars towards clean energy development.
I think to the extent that Canada and the United States can collaborate on ways that we can sequester carbon, capture greenhouse gases before they're emitted into the atmosphere, that's going to be good for everybody. Because if we don't, then we're going to have a ceiling at some point in terms of our ability to expand our economies and maintain the standard of living that's so important...
What a clown. What a charade. Remarks like these are so far off the mark in so many ways that all that's left is utter despair for all of us.
Detroit wants more money. Billions of it. So GM, Chrysler and Ford can fire tens of thousands more workers. They'll get some of it, at least. So that charade can continue as well. The people who need to be fired in the car industry are the executives. The lot. Chrysler is a private company, and should not get a penny. GM and Ford should, under new leadership, be forced to merge and build a viable company with a production capacity of perhaps 7 million cars per year. That's all the US will need for years to come. It’ll be plenty hard to sell even that many. But GM's Wagoner and the sad clowns at Ford remain where they are, after having led their companies into insolvency. What is the world coming to?
The president's $275 billion plans to halt foreclosures are even more twisted. If you can afford your mortgage, or if you rent, you are now a sucker all of a sudden. The real suckers who are presently underwater or close to eviction are elevated to worthy of saving status. There is, however, not a word about what happens to the worthy former suckers when home values keep going down. And they will. What are we going to do, renegotiate every year?
The fact of the matter, of course, is that the $275 billion will not, and are not meant to, benefit the homeowners. They are provided for the benefit of the lenders, the banks. They are meant to guarantee an ongoing flow of funds towards the vaults replete with toxic debts based on the very homes the government now showers with cash. They are meant to artificially continue to prop up US real estate values, which, if they were allowed to simply follow the course of the markets, would bankrupt not only the owners, for which Washington cares preciously little, but also the banks, for which Washington will bend over backwards any time of day. The main problem is that it's way too late. The banks will drown, and everybody knows it. So the only real purpose served by these measures is to transfer ever more of the public's funds to the banking sector. It'll go on until the nation itself is completely broke and broken.
What would be in the real interest of the people is to let the banks fail, and use these funds to set up a new banking system. There are various ways to do this. Nationalizing the banks is not one of them, because it would transfer the toxic debts to the people. Who are already poor and getting much poorer even without those "assets". It can't be done. There is no way. Tim Geithner couldn't do it after 19 months of thinking, and nobody else can. The banks must be made to fail. But they won't be, because the main shareholders, who are among the richest people on the planet, would never allow it. At least not now. They prefer opening the public spigot more and more, until it breaks. Since they own Washington, that is what will happen.
Another hypothetical -since it won't be accepted- issue that would be in the public's interest is that Fannie and Freddie should be liquidated. Not made even bigger, as Obama is set to do. Fannie and Freddie are both perverted and perverting institutions. They keep home prices artificially high, which is good for banks, and banks only. All homes in foreclosure process that the two GSE's hold should be handed over to the communities they are located in. Nationalize those properties, not the banks. Under very strict regulations, which are necessary to prevent them from turning into objects of political power ploys, the homes, in which the former owners can stay, would be properly assessed and the rent the occupants will be forced to pay, if they choose to stay, can flow into the communities they live in. This is the proper and probably only way, not only to keep people in their homes, but also to prevent thousands upon thousands of US communities from going bankrupt.
But it will not come to pass. It would take money away from the owners of the chilled corpses called banks that guide the politics of the nation.
"Worst Is Yet to Come:" Americans' Standard of Living Permanently Changed
There's no question the American consumer is hurting in the face of a burst housing bubble, financial market meltdown and rising unemployment. But "the worst is yet to come," according to Howard Davidowitz, chairman of Davidowitz & Associates, who believes American's standard of living is undergoing a "permanent change" - and not for the better as a result of:
- An $8 trillion negative wealth effect from declining home values.
- A $10 trillion negative wealth effect from weakened capital markets.
- A $14 trillion consumer debt load amid "exploding unemployment", leading to "exploding bankruptcies."
"The average American used to be able to borrow to buy a home, send their kids to a good school [and] buy a car," Davidowitz says. "A lot of that is gone."
Going forward, the veteran retail industry consultant foresees higher savings rate and people trading down in both the goods and services they buy - as well as their aspirations. The end of rampant consumerism is ultimately a good thing, he says, but the unraveling of an economy built on debt-fueled spending will be painful for years to come.
America will never be the same
Michael Panzner Foresees Wealth Destruction, Rising Crime, Guns
Abandon hope, all ye who open this book. Michael J. Panzner, author of "Financial Armageddon," is back with a new jeremiad on our cracked and out-of-joint times. His outlook is grim. We stand on the cusp of what hedge- fund manager Barton Biggs would call "an episode of great wealth destruction," Panzner writes in "When Giants Fall: An Economic Roadmap for the End of the American Era." Things are already bad for Americans and they are going to get worse. Working hours will rise and pay will fall, forcing many people to take two or even three jobs, he asserts. We'll be traveling on foot -- or by bicycle or boat. More and more of us will live in extended-family households, three generations under one roof. We'll recycle rainwater, draw heat from the sun and eat food grown in our own gardens.
Tax revenue will slump, unraveling safety nets like Social Security and Medicare. Hospitals will shut. Police budgets will be slashed, crime will surge, more people will pack guns. The dollar and modern payment mechanisms may give way to "barter arrangements, alternative financial instruments and collective support networks," he says. "Like the other great spasms in our history, the one that now seems to be unfolding is unlikely to be narrow in scope, shallow in depth, or short-lived in duration," he writes. And so this book goes, with page after dystopian page outlining the decline of the U.S. and the splintering of the planet into brutish nation states fighting over dwindling stores of commodities, energy and water.
Panzner, a veteran trader who has worked for banks including HSBC Holdings Plc and JPMorgan Chase & Co., has read widely. The text bristles with references to historians such as Paul Kennedy and Niall Ferguson. He quotes Chalmers Johnson here, Richard Haass there. Pat Buchanan and Naomi Klein pop up in between. The result is a bleak collage of quotations describing a U.S. adrift in a dangerous world: Americans have overspent, lost their prestige and gone soft. Oil production may be peaking, poor populations are exploding, and the planet is being befouled. China's foreign reserves have surged to $1.95 trillion. The spectrum of books on America's shifting place in the world is now wide. At the bright end of the scale, Fareed Zakaria's "The Post-American World" stresses "the rise of the rest," not the decline of the U.S. George Friedman's new book, "The Next 100 Years," goes further. Far from fading, he says, the U.S. has "just begun its ascent.
Toward the middle of the doom-and-gloom gradation, we have sensible primers such as Charles R. Morris's "The Trillion Dollar Meltdown"; Robert J. Shiller's "The Subprime Solution"; and Mohamed El-Erian's "When Markets Collide." And then there are books like Panzner's. They argue that we're plunging into a new Dark Age. Now, I'm not one to ignore a wake-up call. I listened when Shiller began measuring the girth of the U.S. housing bubble. I paid heed when Morris predicted the bust would result in at least $1 trillion in bank write downs. What disturbs me about Panzner is his hectoring tone and the depth of his gloom. Even the Statue of Liberty is upside down on the cover, an image sure to make Osama bin Laden smirk. Yes, America's place in the world has changed, as Panzner says. Things are not as they were when the Berlin Wall fell two decades ago. That doesn't mean the U.S. is going the way of Rome.
As I read this apocalyptic book, I was reminded of a story about John Maynard Keynes that Liaquat Ahamed recounts in his superb history, "Lords of Finance." In the depths of the Great Depression, the economist turned to long-term investing, Ahamed writes. Convinced that Franklin D. Roosevelt would resuscitate the economy, Keynes put together a portfolio of U.K. and U.S. equities and leveraged it by as much as 2-to-1. "By 1936, his net worth was close to $2.5 million -- the equivalent today of $30 million," Ahamed notes. Though America's troubles weren't over, the country eventually pulled out of its funk and flourished once more.
Five Reasons for Japan's Leaders to Get Drunk
I don't know which cold medication Shoichi Nakagawa is taking, but I want some. Anyone who has seen the video of Japan's finance minister at last weekend's Group of Seven meeting in Rome may be having similar thoughts. Nakagawa resigned yesterday even after insisting he wasn't drunk. It was cold meds, he claimed. Few in the Japanese media bought his story. It didn't help that Asahi Television dug up a November 2006 video in which Nakagawa, then head of the Liberal Democratic Party's policy- making board, looked wasted giving a speech. The public's anger isn't about some red-faced man slurring his words and having difficulty fielding questions. It's that Taro Aso's government isn't up to the challenge of running Asia's biggest economy. It also reflects Japan's revolving-door politics; the next finance chief will be the fifth in two years. Of course, if I were in charge of this rapidly shrinking economy -- at an annual 12.7 percent pace last quarter alone -- I'd be tempted to hit the bar, too. The high won't last very long, mind you. Japanese data of late are way too sobering. Talk about an economic hangover. Here are five reasons why Japanese leaders might be excused for drinking in excess these days.
1. Things will get far worse. You know an export-driven economy is in trouble when exports plunged an unprecedented 13.9 percent last quarter. The collapse in demand for Corolla cars and Bravia televisions comes as the G-7 says the global slump will last for much of 2009. It's probably more like 2010, too. Big losses are forecast at Toyota Motor Corp., Sony Corp. and Hitachi Ltd., all of which are firing thousands of workers. That will accelerate the drop in household spending and deepen the recession. The current quarter could be even uglier. Bartender, another round please!
2. Leadership is nowhere to be found. Nakagawa's wobbly, droopy-eyed performance became an Internet hit and made Japan the butt of jokes. More importantly, though, his replacement, Economic and Fiscal Policy Minister Kaoru Yosano, recently cast doubts on whether Japan will get its act together by April, when the Group of 20 nations meets in London. Call it a two-month do- nothing binge. Aso's 9.7 percent approval rate -- according to a Nippon Television survey -- explains why U.S. Secretary of State Hillary Clinton met with opposition leader Ichiro Ozawa in Tokyo yesterday. Why bother with Aso when his days are numbered? And another question: Who will take Japan seriously if it has a new finance minister every few months? (Pub quiz: Name the last four Japanese finance chiefs?) Hey barman, got something stronger this time?
3. Even party bigwigs are turning on you. Media are in a tizzy over Junichiro Koizumi's public rebuke of Aso's bungling. A pro-reform prime minister who served from 2001 to 2006, Koizumi is credited with shaking up Japan's business world and privatizing the massive postal system, which also housed the nation's biggest savings bank. Koizumi recently spoke for many of Japan's 127 million people when he attacked Aso for what he called "appalling" and "laughable" blunders. He suggested that their party, the ruling LDP, may lose this year's election. Let's face it, the LDP deserves to lose badly. The party serves only itself, not Japan's people and certainly not the investors looking for opportunities in this $4.4 trillion economy. Yo barkeeper, just leave the bottle!
4. A woman is kicking your butt. In the annals of practicing what you preach, Yuko Obuchi deserves a mention. She is the minister responsible for increasing the nation's birthrate. And now, she's pregnant, expecting her second child in September. Obuchi clearly takes her role in stopping a decline in the population seriously; the National Institute of Population and Social Security Research says the number of Japanese may shrink 26 percent by 2050. Japanese leaders have rarely lifted a finger to empower women. Score one for Obuchi, who is also in charge of gender equality. Unlike the change-resistant men who run Japan, Obuchi is getting rave reviews for inspiring a national debate about whether more women can have a family and a career. Oh garcon, got something without alcohol?
5. The yen will rise no matter what happens. For 10 years now, Japan's ultra-low interest rates funded borrowings that were moved overseas into higher-yielding markets. Japanese companies and investors, hungry for fatter returns, ventured overseas. All that money is now coming back to Japan. The dollar's weakness is exacerbating the problem. That's a crisis for an economy that lives and dies by exchange rates. There's nothing the Finance Ministry or Bank of Japan can do about it. That's why Japan isn't intervening in currency markets to cap the yen. Whether Aso's LDP hangs on to power -- which is highly doubtful -- or Ozawa's Democratic Party of Japan grabs the reins, the yen will strengthen. A strong currency is normally a sign of confidence in an economy. In Japan's case, it's a contrarian indicator of growth prospects in a world fast losing altitude. Nightcap, anyone? It may help leaders in Tokyo deal with Japan's un-happy hour.
China Urges U.S., Europe to Protect Value of Debt in Reserves
China, whose $1.95 trillion in currency reserves are the world’s largest, called on the U.S. and Europe to protect the value of its overseas investments and said it plans to spend more foreign exchange on imports and acquisitions. "We hope countries whose currencies are the main holdings in our international reserves will take effective measures to cope with the financial crisis," Fang Shangpu, deputy director at the State Administration for Foreign Exchange, told a press conference in Beijing today. "They should work to maintain economic and financial stability, and protect the interests and confidence of investors."
China increased its purchases of U.S. Treasuries last year by 46 percent to $696.2 billion, data released by the U.S. Treasury Department yesterday showed. Premier Wen Jiabao said on Feb. 2 his government’s Treasury strategy would be aimed at maintaining the "value" of its foreign reserves. Benchmark 10-year Treasury yields climbed 44 basis points, or 0.44 percentage point, to 2.65 percent so far this year on speculation the government will step up borrowing to finance President Barack Obama’s $787 billion stimulus package. U.S. government bonds returned 14 percent last year including price gains and reinvested interest, the most since rallying 18.5 percent in 1995, according to indexes compiled by Merrill Lynch & Co. Concern that the flood of bonds would overwhelm demand caused Treasuries to lose 3.1 percent in January, the steepest monthly drop in almost five years.
The nation’s decision of "whether to buy and how much to buy" of U.S. Treasuries will depend on "China’s own needs and follow the principle of value preservation and safety," Fang said. SAFE will also facilitate foreign-exchange purchases for companies seeking expansion overseas and use more reserves for imports, it said today. The nation may set up an oil fund using part of the reserves to help companies buy fields abroad, according to a statement this week by the China National Petroleum Corp., the country’s biggest oil producer.
Stocks: A Painful New Phase
After more steep declines on Feb. 17, major indexes could be poised to hit their lowest levels of the financial crisis. The stock market could give a nasty surprise to those investors who thought equities were already as low as they could go. The broad Standard & Poor's 500-stock index fell below 800 on Feb. 17, dropping 4.6%, to 789.17. In the process, the market set off alarm bells on many Wall Street trading floors. For the past few months, amid plenty of bad news, buyers have stepped in to prevent stocks from falling to their extreme lows of last November. Now technical strategists, who watch such things closely, say the markets have a downward momentum that could be tough to slow. A close below 800 "would suggest a full test of the November lows is underway," warned Bruce Bittles, chief investment strategist at R.W. Baird. The level of 789 is particularly significant, says Uri Landesman of ING Investment Management (ING). "This is a very important battleground right here," he says.
It's not just technical traders who are worried. Long-term investors have been unnerved by a range of developments. Just a few weeks ago, many portfolio managers spoke confidently of a second-half rebound for the U.S. economy. Those hopes may not have faded entirely, but few appear willing to bet money on them anymore. "It continues to be a market that is rife with uncertainty," says Robert Siewert, a portfolio manager at Glenmede. Brian Reynolds, chief market strategist at WJB Capital Group, says stock investors are catching onto the economic pessimism that already dominates credit markets. "There is another year of economic pain ahead," he says. That pain is spreading fast. In fact, global developments are in many cases more alarming than those inside the U.S., says John Merrill of Tanglewood Wealth Management. The economic output of Japan fell by 12.7% last quarter, according to data released Feb. 16. By contrast, advance data for the U.S. gross domestic product showed a 3.8% decline in the fourth quarter.
To help stop the economy's slide, President Obama on Feb. 17 signed a $787 billion economic stimulus bill. Several days before, Treasury Secretary Timothy Geithner unveiled an effort to prop up the financial system. Both fell flat with many investors. "The financial markets were not impressed with either the fiscal stimulus deal reached by Congress or the announcement of the financial rescue plan," says Deutsche Bank (DB) chief economist Joseph LaVorgna. The stimulus bill won't provide a significant boost until next year, he said, while Geithner's plan lacked details. Markets were also rattled by parts of the stimulus bill that would limit bank executive pay, Landesman says. "A lot of people are willing to believe good stuff is coming" from the Obama administration, Merrill says. "But there is some disappointment on what's come down so far." Government, both in the U.S. and around the world, is a "powerful influence on equity markets," says Chad Deakins, portfolio manager of the RidgeWorth International Equity Fund (SCIIX). But investors get spooked when governments change laws and rewrite the rules. "If people are uncertain what government is going to do, people are going to try to protect their capital," Deakins says. "I don't think you can see the market rally decisively until we have a lot more certainty about what the government is going to do."
But whatever Washington does, investors seem resigned to a very difficult year. The troubled auto sector will be in the spotlight, with the Big Three carmakers required to present restructuring plans to the federal government by Feb. 17. Corporate earnings continue to tumble. With 385 of the companies in the S&P 500 having reported results, Thomson Reuters projects earnings for the index to drop 42.1% in the fourth quarter. On Jan. 1 analysts were expecting S&P 500 earnings to drop just 1.2%. Earnings for the financial sector dropped 751% from a year ago, from earnings of $5.2 billion in the last quarter of 2007 to a $33.9 billion loss last quarter. "We're clearly in a very difficult time," ING's Landesman says. After the past year's steep declines, stocks look cheap to many. But investors are unwilling to buy until they can see a turn in the economic and earnings picture. "That's a very difficult call to make," he says. Because of the uncertain outlook, "it's very difficult [for investors] to have a long-term perspective," Glenmede's Siewert says.
If there is any hope for stocks, it may be hiding in an unlikely place, the housing sector. The National Association of Home Builders index rose one point in February, up from a record low reading of 8 last month. On Feb. 18, Geithner is slated to announce a new plan to revive the housing sector. If that plan is credible, says Miller Tabak strategist Tony Crescenzi, "the impact on financial markets could be significant." Siewert agrees that signs of a stabilization in the real estate crisis could be a catalyst for higher stock prices. "The largest asset and the largest liability on a U.S. citizen's balance sheet is their home," he says. Investors may be losing faith in a 2009 recovery, but eventually they may become optimistic for a rebound next year. WJB Capital's Reynolds is gloomy now, but, he says "2010 is going to be a good year." He adds: "If we can survive this year, we can begin to build on something." The problem, though, is that Reynolds' optimism rests on prices in financial markets dropping so low that they finally become attractive to skittish investors. And recent market action suggests stocks might have much farther to fall before wary investors will part with their money.
Obama Pledges $275 Billion to Stem U.S. Foreclosures
U.S. President Barack Obama pledged $275 billion to a program that will cut mortgage payments for as many as 9 million struggling homeowners and expand the role of Fannie Mae and Freddie Mac in curbing record foreclosures. The plan also will help as many as 5 million homeowners refinance loans owned or guaranteed by Fannie and Freddie, according to a White House fact sheet. Treasury will buy as much as $200 billion of preferred stock in the two mortgage companies, twice as much as previously promised, the announcement said. "It will give millions of families resigned to financial ruin a chance to rebuild," Obama said in remarks prepared for delivery at 10:15 a.m. in Mesa, Arizona. "By bringing down the foreclosure rate, it will help to shore up housing prices for everyone."
The program signals the Obama administration plans to take a more aggressive stance to halt foreclosures than the Bush administration, which backed voluntary industry efforts. Record foreclosures in the past year are swelling the glut of properties on the market, forcing down home values and undermining homebuilders’ efforts to revive demand and lighten inventory by cutting prices. U.S. builders broke ground in January on the fewest houses on record as a lack of credit and plunging sales exacerbated the worst real-estate slump in 75 years. Confidence among homebuilders barely rose in February from a record low, an industry index showed yesterday, signaling the slump continues.
Obama said he will support revamping U.S. bankruptcy rules to let judges reduce mortgages on primary residences to fair- market value as long as borrowers pay their debts under a court- ordered plan. The Obama plan will use $75 billion from the $700 billion financial bailout fund to match reductions lenders make in interest payments that lower borrowers’ payments to 31 percent of their monthly income. Under the program, a lender would be responsible for reducing monthly payments to no more than 38 percent of a borrower’s income, with government sharing the cost to further cut the rate to 31 percent. Treasury will share the cost when lenders reduce monthly payments by forgiving a portion of the borrower’s mortgage balance, the government said. The program may help as many as 4 million borrowers, the administration said. The average borrower’s home value could be stabilized against a price decline by up to $6,000, the White House fact sheet said.
"We think it is accurately aimed at homeowners at risk that are most likely to represent avoidable foreclosures, so it is likely to have a maximum impact where the dollar is committed," said Robert Davis, executive vice president of the American Bankers Association, in a telephone interview. Banks accepting help from the government must adopt loan modification plans, the government said. Companies that service mortgages will get $1,000 for each modified loan, and as much as $1,000 for three years when the borrower stays current, the government said. Homeowners also are eligible for $1,000 annually for five years for remaining current on their loans, according to the plan. Mortgage servicers will get $500 and loan holders $1,500 to modify agreements as an incentive for the industry to seek out borrowers at risk of falling behind on their payments.
"The Obama team is betting that if they can afford to stay in the home month-to-month, that borrower is not concerned about what today’s value of the home happens to be," Howard Glaser, former counsel to the secretary of the U.S. Department of Housing and Urban Development, said today in a telephone interview. "I think that’s the right bet." Focusing on reducing the mortgage principal would have been a "prohibitively expensive proposition," said Glaser, a Washington-based mortgage-industry analyst. Treasury will increase the size of Fannie and Freddie’s retained mortgage portfolios, to $900 billion, allowed under the preferred stock agreement included in the September federal takeover of the two mortgage-finance companies. "It is an indication they are not looking at shuttering them to move their responsibilities elsewhere. That has been a widely discussed option," said James Vogel, a debt analyst with FTN Financial in Memphis, Tennessee, in an e-mailed statement.
An administration official, speaking to reporters in Washington, said the Treasury’s pledge of support for Fannie and Freddie is intended to build confidence that the government stands fully behind the two mortgage-finance companies. The official said the two aren’t yet close to reaching the initial limit of $100 billion in government support. The additional $200 billion in funding will be made under a foreclosure-prevention law Congress enacted in July, the administration said. The White House also plans to improve Hope for Homeowners and other Federal Housing Administration programs to modify and refinance mortgages at risk of foreclosure. Banks including Citigroup Inc., JPMorgan Chase & Co., PNC Financial Services Group Inc. and Bank of America Corp. have agreed, at the request of lawmakers, to suspend foreclosure proceedings until the Obama plan is adopted. The Office of Thrift Supervision last week urged the lenders it oversees to suspend foreclosures
White House Unveils Housing Plan
Obama Administration to Increase Fannie, Freddie Portfolio Limits to $900 Billion Each
The Obama administration announced new plans Wednesday to make it easier for up to nine million people to rework or refinance their mortgages, as the White House began an aggressive effort to stabilize the housing market. A central element of the plan would allow up to five million people to refinance their mortgages into more affordable products through Fannie Mae and Freddie Mac, according to a summary of the plan. A total cost of the effort was not immediately clear, though it could eclipse more than $275 billion because of new commitments to the Fannie Mae and Freddie Mac.
The Obama administration's plan has three main elements: an effort to help homeowners refinance; another effort to help stabilize the housing market through a $75 billion initiative aimed at reaching up to four million at-risk homeowners; and a third element that aims to drive down mortgage rates. "The effects of this crisis have also reverberated across the financial markets," President Barack Obama was expected to say in a speech in Phoenix Wednesday, according to prepared remarks. "When the housing market collapsed, so did the availability of credit on which our economy depends." The administration pledges government money to separately entice homeowners, mortgage companies, and mortgage investors to rework loans. It would help a variety of homeowners, including those whose mortgage is more than the value of their home.
The housing plan is part of a broader effort by the government to address the volatile economy and it comes after Congress passed a major stimulus package and the Treasury Department released its plan to shore up the banking sector. Fannie Mae and Freddie Mac, which are privately held companies under government control, figure prominently in the housing plan. The companies generally are prevented from owning or guaranteeing mortgages that are more than 80% of a home's value, as those loans are seen as much riskier. But the Obama plan would allow them to buy or guarantee these riskier loans if they already own or guarantee them. This could be possible if a $80,000 loan was purchased by Fannie Mae last year for a $100,000 house, but the house is now worth just $75,000. "This will allow millions of families stuck with loans at a higher rate to refinance," Mr. Obama is expected to say. "And the estimated cost to taxpayers would be roughly zero; while Fannie and Freddie would receive less money in payments, this would be balanced out by a reduction in defaults and foreclosures."
The government said it would increase its limits on the size of Fannie Mae and Freddie Mac's portfolios to $900 billion each up from $850 billion. Treasury also said it would increase its funding commitment to both companies "to ensure the strength and security of the mortgage market and the help maintain mortgage affordability." Treasury also plans to increase its preferred stock purchase agreements with the companies to $200 billion each from $100 billion each. "The increased funding will provide forward-looking confidence in the mortgage market and enable Fannie Mae and Freddie Mac to carry out ambitious efforts to ensure mortgage affordability for responsible homeowners," Treasury Secretary Timothy Geithner said. The previous level was set when the companies were taken over by the Bush administration in September. Allowing the companies to buy or guarantee riskier loans could give them a bigger role in stabilizing the housing market but it could also expose them to heavier losses in the coming months.
The White House also called for a controversial provision to allow bankruptcy judges to rework the terms of mortgages in court. The banking industry has fought bitterly against such a law for years, though some banks have recently softened their stance. The White House summary says its plan would not help speculators, and instead would be aimed at keeping "hard pressed homeowners" in their homes. They also said they are working on "clear and consistent guidelines for loan modifications," which many have argued are necessary to speed up the process of making loans more affordable. Fannie Mae and Freddie Mac will use the new guidelines for the loans they own or guarantee.
All companies receiving government money "will be required to implement loan modification plans consistent with Treasury guidance," the summary said. The plan includes multiple incentives to prod servicers to modify loans. Servicers can receive an up-front payment of $1,000 for each eligible loan modification that meets certain criteria. The government said it would pay servicers $500 and mortgage investors $1,500 if at-risk loans are modified before borrowers fall behind. The government said it would also help pay down the principal of certain mortgages by up to $1,000 a year for up to five years if the borrower doesn't miss any payments. For a loan to qualify for modifications, lenders would need to bring the monthly mortgage payment down to 38% of a borrower's monthly income. The government would match further reductions in the interest rate down to 31%.
The housing plan contained many more details than a plan released last week to address the banking sector, which sent financial markets tumbling amid criticism that the effort was light on specifics. Mr. Obama is expected to say that the housing plan "could stop the slide in home prices due to neighboring foreclosures by up to $6,000 per home." The Obama administration met repeatedly with the banking industry, consumer groups, and academics as it worked to formulate its plan. The plan appears much more comprehensive than the voluntary measures attempted by the Bush administration, though the Obama administration would also count on the industry to mobilize behind these initiatives. One major difference is the bankruptcy court provision, which could be seen as a penalty for banks that don't go along with the government's plan. Some consumer groups had pushed for the government to directly buy mortgages from banks and rework them that way. It's unclear if that was in the final effort, though Fannie Mae and Freddie Mac could be playing a similar role.
How Foreclosures Help Banks Conceal Losses
It's going to be a big day for mortgage news today, so we thought we'd touch on a bit of background on the foreclosure issue. And shed some light on how foreclosures can lead to banks holding even more "toxic assets." People tend to speak in shorthand when talking about foreclosures—saying, for instance, that homeowners "hand the keys over to the bank." But that’s not really what happens. And once you understand why that isn’t what happens, you can begin to understand how foreclosures can help banks cover up losses.
Foreclosure Is An Auction. When a borrower defaults on his home loan, a bank can force him to sell it at auction. The auctions are typically open to all comers. In theory, the auction process would establish a market price for a home that would allow banks to know exactly the recovery value on the loan. If an outside party bought the house from the auction, the bank would receive the proceeds and could write down any losses—the difference between the full value of the mortgage and the price paid at the auction.
How Banks Use Foreclosures To Put A Floor On Losses. Typically a bank will put in a bid on a foreclosed property in order to limit the losses on the loans. In a market where housing prices are going up or are expected to go up soon, this move makes sense. It allows banks to avoid a big loss on a temporary housing downturn. But if you are in an environment when house prices are in free fall with no bottom ahead, this winds up creating an artificially high price—and therefore conceals the actual losses a bank may suffer from the mortgage default.
Marking to Model, Still. But it's far worse than banks just potentially overpaying for foreclosed homes. They may not only be overpaying. They may then be booking them at inflated prices. Let’s take an example. Suppose a bank forecloses on a home purchased for $250,000 with a $200,000 mortgage outstanding. At auction, let’s say other bidders offer just $125,000 for the house and the bank buys the house for $175,000, taking a loss of $25,000 or 12.5%. Keep in mind that no money really changes hands. Basically, the bank buys the house and immediately pays itself back with the proceeds from the sale.
The bank has an asset—the house--that it now needs to price. It needs to decide if the house is worth $250,000, $200,000, $175,000 or $125,000. Which value does the bank get to use? Since the asset was purchased in a distressed sale, the bank can use its financial models to figure out the worth of the house. These models are supposed to reflect outside markets but, as we’ve all learned, banks are very hesitant to truly book assets at market levels. One thing is almost certain, the bank won’t book it below the price they paid. In fact, it’s likely they will account for some additional recover—to say, $190,000—reducing their loss to just 5 percent. On the books, the loan has a recovery value of 95 percent.
Dropping Prices Mean Hidden Losses Mount. The bank’s purchase of the house may have put a floor on the immediate losses from the mortgage default but it doesn’t stop housing prices from dropping. If the housing market continues to deteriorate, the house now owned by the bank could be worth even less. The bank bought the house for $175K and booked it at $190K. But the market value of the house could be far less. If the value of the house drops to $150K, the bank is sitting on unrealized losses of 25% but has only booked a 5% loss.
How To Invent A Toxic Asset. Let’s conclude with the idea that this is exactly how a toxic asset is created. A bank buys something and books it at a value that winds up being far higher than the market value. It can’t sell the asset without realizing horrific losses. Investors and creditors of the bank know that it is holding these things at far above their real value, however, and discount the credit worthiness and profitability of the bank accordingly.
Dislocation Ideology. All of this is made possible by one thing: an ideological conviction that the national housing slump should have been impossible and therefore that housing prices are sure to recover shortly. That's what we call the "Dislocation Ideology"--the idea that housing markets are temporarily dislocated and will soon find themselves back on the old path onward and upward. If a long term downturn were acknowledged, a conservative bank would avoid buying foreclosed houses and prefer to take the losses up-front, letting the outside buyers pick up the home and the downside risk of further price slides. But banks are still long housing, so they keep buying houses and booking them at inflated values.
Republicans, analysts question Obama's foreclosure plan
Even before President Obama unveiled his home foreclosure plan Wednesday afternoon, some Republicans and political commentators questioned how exactly it would work to stave off a crisis plaguing the country. House Republican Whip Eric Cantor, R-Virginia, along with Minority Leader John Boehner, R-Ohio, sent a letter Wednesday to the president "seeking clarification on six important questions about [Obama's] broad housing proposal," according to a press release from Cantor's office. Obama unveiled his $75 billion multipronged plan in Phoenix, Arizona, that seeks to help up to 9 million borrowers suffering from falling home prices and unaffordable monthly payments. The long-awaited foreclosure fix marks a sharp departure from the Bush administration, which relied mainly on having servicers voluntarily modify troubled mortgages.
In the Phoenix area, median home prices have fallen 35 percent in the past year. Obama, according to the proposed plan, will make it easier for homeowners to afford their monthly payments either by refinancing the mortgages or having their loans modified. The president is vastly broadening the scope of the government rescue by focusing on homeowners who are still current in their payments but at risk of default But there could be fierce resistance among Republicans and some conservative Democrats on Capitol Hill. Already, top Republicans want several questions answered, an early sign that Obama may once again face stiff opposition to the plan when it comes before Congress. Last week, not one House Republican voted for his economic stimulus package, and only three GOP senators voted for the bill. The questions found in the letter from Cantor and Boehner to Obama include:
- What will your plan do for the over 90 percent of homeowners who are playing and paying by the rules?
- Does your plan compensate banks for bad mortgages they should have never made in the first place?
- Will individuals who misrepresented their income or assets on their original mortgage application be eligible to get the taxpayer funded assistance under your plan?
- Will you require mortgage servicers to verify income and other eligibility standards before modifying mortgages?
- What will you do to prevent the same mortgages that receive assistance and are modified from going into default three, six or eight months later?
- How do you intend to move forward in the drafting of the legislation and who will author it?
CNN political analyst David Gergen said some aspects of the proposed bill are not going to sit well with conservatives. "If the administration does move forward with forcing lenders to renegotiate mortgages downward, there are going to be a lot of conservatives who are going ... to say that [this] 'cram-down' is a terrible idea," he said. " What it means is, there will be risk premiums put on future sales of houses, because lenders will say, 'I have got to get a risk premium, in case the government does this to me again.'" Rep. Jeff Flake, R-Arizona, said Obama's plan "simply shifts the debt to taxpayers."
"How will borrowing more money to pay for bad loans solve the problem," Flake said in a press release Wednesday. "President Obama's talk of individual responsibility seems to be at odds with the details of the plan." Gergen also questioned the fairness of giving help to some mortgage holders that have been delinquent compared to those who are paying on time. "What do you do about the couple that has been paying their mortgage ... and next door there's another couple that's been delinquent, that's been out spending money, going to Las Vegas, having a lot of fun time," Gergen said. "Is it fair to the first couple when the second couple gets bailed out?"
David Walker, the former U.S. comptroller, echoed Gergen's thoughts.
"Well, we clearly have to do something on housing," Walker said. "I mean, we need to do something to try to be able to help those that are deserving help, but not to reward bad behavior. We have to end the spiraling down of prices." Obama's response to critics: The plan will not support irresponsible homeowners. "It will not rescue the unscrupulous or irresponsible by throwing good taxpayer money after bad loans. It will not help speculators who took risky bets on a rising market and bought homes not to live in but to sell," Obama said Wednesday. "It will not reward folks who bought homes they knew from the beginning they would never be able to afford."
US Treasury doubles aid to Fannie Mae, Freddie Mac
The US Treasury Department said Wednesday it was doubling its financial support to troubled mortgage finance giants Fannie Mae and Freddie Mac, to 200 billion dollars each, in an effort to stabilize the real estate sector. "The Treasury Department is increasing its funding commitment to Fannie Mae and Freddie Mac to ensure the strength and security of the mortgage market, to help maintain mortgage affordability, and to help keep interest rates low," Treasury Secretary Timothy Geithner said in a statement. "Using funds already authorized by Congress for this purpose, Treasury is amending the Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities designed to ensure that each company maintains a positive net worth, to 200 billion dollars each from their original level of 100 billion dollars each," Geithner said.
U.S. Housing Starts Fell to 50-Year Record Low in January
U.S. builders broke ground in January on the fewest houses on record as a lack of credit and plunging sales exacerbated the worst real-estate slump since the Great Depression. Housing starts plunged 17 percent last month to an annual rate of 466,000, lower than projected, according to figures from the Commerce Department today in Washington. A report from the Federal Reserve showed industrial output sank in January for the sixth time in seven months. Builders are struggling as record foreclosures swell the glut of homes on the market, undermining efforts to revive demand and lighten inventory by cutting prices. President Barack Obama today said his administration will use $75 billion to bring down mortgage rates and encourage loan modifications to stem repossessions.
"The problem with the build-up in inventory is coming from the increasing number of foreclosures," Nicolas Retsinas, director of Harvard University’s Joint Center for Housing Studies in Cambridge, Massachusetts, said in a Bloomberg Television interview. "It’s about time the government intervened so directly in the problem."
Stocks gained on speculation the president’s plan will help ameliorate the decline in housing. The Standard & Poor’s 500 Index advanced 0.7 percent to 794.7 as of 9:45 a.m. in New York. Treasury securities fell. Economists forecast starts would fall to a 529,000 rate, according to the median on 73 estimates in a Bloomberg News survey. Projections ranged from 480,000 to 578,000. The government revised December starts up to 560,000 from a previously reported 550,000 pace. Building permits, a sign of future construction, dropped 4.8 percent to 521,000. They were forecast to drop to a 525,000 pace. The government began keeping records on housing starts in 1959.
Output at factories, mines and utilities dropped 1.8 percent last month after decreasing 2.4 percent in December, the Fed said today. Car and truck assemblies fell to the lowest level on record. Construction of single-family homes decreased 12 percent to a 347,000 rate, today’s report showed. Work on multifamily homes, such as townhouses and apartment buildings, dropped 28 percent from the prior month to an annual rate of 119,000. Housing starts declined in all four regions, led by a 43 percent plunge in the Northeast and a 29 percent drop in the Midwest. Obama’s housing recovery plan is seeking to help as many as 9 million people restructure or refinance their mortgages to avoid foreclosure. The Treasury Department today also said it will double the amount of stock purchases of Fannie Mae and Freddie Mac to as much as $200 billion of each company.
The president yesterday signed into law a $787 billion stimulus package that provides tax breaks and government spending designed to resuscitate the U.S. economy. "No one program, no matter how well designed it is, is going to solve all the problems at one time," said Adam York, an economist at Wachovia Corp. in Charlotte, North Carolina. "We are going to have a long, agonizing road to recovery." While foreclosure-driven declines in prices have helped boost sales of existing homes, they are depressing new-home purchases as builders can’t compete. New-home sales dropped in December to a record low 331,000 annual pace, according to figures from the Commerce Department. At that pace, it would take a record 12.9 months to whittle down the number of new houses on the market, more than twice the five-to-six months supply the National Association of Realtors has said is consistent with a stable market. It also suggests that builders will continue to hold back on production in coming months.
The National Association of Home Builders/Wells Fargo sentiment index edged up to 9 in February from a record-low 8 last month, the group said yesterday. Readings less than 50 indicate the majority of those polled said conditions were poor. While the group’s gauge of buyer traffic increased, builders’ expectations for sales six months from now fell to a record low. Residential investment has been a drag on the U.S. economy since the first quarter of 2006. Economists surveyed by Bloomberg earlier this month projected the U.S. will remain in a recession through at least the first half of this year. "The past five months have been among the most difficult in U.S. economic history," Toll Brothers Inc. Chief Executive Officer Robert Toll said on a conference call Feb. 11. Homebuyers are worried they may lose their jobs and won’t be able to sell their existing homes, he said. Toll Brothers, the largest U.S. luxury homebuilder, last week said first-quarter revenue plunged 51 percen
Treasury Notes Fall on Speculation U.S. to Hold Record Auctions Next Week
Treasury notes fell amid speculation the U.S. will sell a record amount of debt next week, pushing investors toward longer-term debt.
Notes due in five years or less led the declines before the government announces tomorrow the size of next week’s auctions of two-, five- and seven-year debt. The likely total is $97 billion, according to Wrightson ICAP LLC. The difference in yield between two- and 10-year notes shrank to 1.76 percentage points, the smallest gap in three weeks, as investors favored longer-maturity debt ahead of the supply. "The front end has seen a back-up in rates," said Alex Li, an interest-rate strategist in New York at Credit Suisse Securities USA LLC, one of the 16 primary dealers that trade with the Federal Reserve. "The market is looking forward to the supply to be announced tomorrow, so it’s putting pressure on the front end of the yield curve."
Two-year note yields rose seven basis points, or 0.07 percentage point, to 0.92 percent at 11:07 a.m. in New York, according to BGCantor Market Data. The price of the 0.875 percent security due in January 2011 fell 1/8, or $1.25 per $1,000 face amount, to 99 29/32. Benchmark 10-year note yields increased three basis points to 2.68 percent. Yields on 30-year bonds decreased four basis points to 3.44 percent. President Barack Obama released his administration’s $75 billion housing program aimed at stemming home foreclosures. It will help as many as 5 million homeowners refinance conforming loans owned or guaranteed by Fannie and Freddie, according to a fact sheet released by the White House. Obama signed a $787 billion economic-stimulus bill yesterday, and Treasury Secretary Timothy Geithner last week outlined a plan to rescue the financial system.
"Obviously everyone will be watching the Obama-Geithner foreclosure plan," said Martin Mitchell, head of government bond trading at the Baltimore unit of Stifel Nicolaus & Co. Treasury notes remained lower after a Fed report showed U.S. industrial production fell in January for the sixth time in seven months. Builders broke ground last month on the fewest houses since records on the data began in 1959, a Commerce Department report showed. Treasuries lost 2.1 percent so far in 2009, according to Merrill Lynch & Co.’s U.S. Treasury Master index, on speculation investors will demand higher yields to lend to the government. Yields on the benchmark 10-year note dropped earlier to 2.61 percent, the lowest level since Jan. 28, after General Motors Corp. said it needs more money from the government, fueling concern the global economic slowdown is spreading. Ten-year yields slipped to a record 2.035 percent Dec. 18 and have averaged 4.55 percent this decade.
The Fibonacci series of numbers, a technical indicator some investors use to identify targets, indicates 10-year yields need to hold below 2.60 percent if they are to decline further. That level is a 50 percent retracement of the rise in yield from 2.14 percent on Jan. 15 to 3.05 percent on Feb. 9. A move past one level in the series indicates the rate may fall or rise to another level. The next target is 2.49 percent. "The long-end outperformance takes us to within a hair’s breadth of our target of 2.60% in the 10-year note," strategists at primary dealer UBS Securities LLC led by William O’Donnell wrote in a note this morning. "Technical momentum still looks supportive of higher prices."
The government will sell $41 billion in two-year notes, $31 billion in five-year notes and $25 billion in seven-year notes next week, Wrightson ICAP forecast. The Jersey City, New Jersey- based firm specializes in government finance. The Treasury sold a record $67 billion in notes and bonds last week, prompting Western Asset Management, the Pasadena, California-based investor with $513.3 billion in fixed-income assets, to say future debt sales will probably send long-term yields higher. "Supply is on people’s minds on a consistent basis," said Richard Bryant, a trader of 30-year bonds at Citigroup Global Markets Inc., another primary dealer. Today’s move is "positioning ahead of supply." Federal Reserve Bank of Cleveland President Sandra Pianalto said the central bank’s new $1 trillion program to prop up markets for auto loans and other debt will make a "big difference" in strengthening the U.S. economy. The Term Asset- Backed Securities Loan Facility, known as the TALF, is likely to start operating "within the next few weeks," Pianalto said in a speech today in Columbus, Ohio.
Fed Chairman Ben S. Bernanke is scheduled to speak today on central bank programs to spur the economy. The Fed is also scheduled to issue the minutes of its Jan. 28 meeting. Investors were more optimistic about government debt this week than last, according to a weekly poll of clients by JPMorgan Chase & Co. The number of investors betting on a rise in note prices jumped to 36 percent from 20 percent last week. Investors forecast rising prices over falling prices by the most since the week of Nov. 17. In the following month after that survey, the 10-year yield fell 1.70 percentage points. The difference between what banks and the Treasury pay to borrow for three months, the so-called TED spread, narrowed to 0.94 percentage point from 4.64 percentage points in October. The gap averaged 0.27 percentage point from 2002 through 2006, before the credit crisis began in 2007.
U.S. Bank CEO: TARP program is ‘lousy’
While government leaders were well intentioned in setting up the Troubled Asset Relief Program, it’s a "lousy program," U.S. Bancorp CEO Richard Davis said at a business leaders forum Tuesday. The U.S. Treasury told, not asked, U.S. Bank to participate in the program, which is a Darwinian attempt to "synthesize" weaker banks into stronger banks through consolidation, Davis said at the forum, held at Thrivent Financial for Lutherans in Minneapolis. U.S. Bank sold $6.6 billion in preferred stock with warrants to the U.S. Treasury in November through its capital purchase program.
"There’s no A, R or P in TARP," Davis said, adding that "troubled" is the only word in the phrase that’s accurate. "The ‘asset relief program’ has yet to occur." The problems with the U.S. Treasury Department’s program are that its goals and rules have changed since its inception last fall, it’s poorly defined and it’s caused collateral damage to healthy banks. Davis said he would be "darned" if Minneapolis-based U.S. Bank would suffer collateral damage from the government’s "sloppy attempt at nationalizing the [banking] industry." U.S. Bank is the largest bank in St. Louis with more than $10 billion in deposits and one of the largest area employers with nearly 3,300 employees.
There's Virtue In Geithner's Vague Bank Plan
On Jan. 27, Bank of America sold a whopping $6 billion of three-year notes at a yield of 2.2% -- a good 3.5% less than what its other bonds of similar maturity were trading for. How did it manage this feat? For a mere fee of 0.75%, BofA accessed the FDIC's Temporary Liquidity Guarantee Program, which backs all bank debt of less than three-year maturity with the full faith and credit of the U.S. government. In essence, they got to issue debt at government rates. Since the program started last Nov. 25, BofA has gone to the well 11 times for a total of $35.5 billion. Other banks have lined up 91 times for a staggering $168 billion. They include GE Capital ($27 billion), Citigroup ($24 billion), J.P. Morgan ($19 billion), Morgan Stanley ($19 billion), and Goldman Sachs ($15 billion).
Feelings about the liquidity guarantee program weren't always so rosy. On Oct. 31, 2008, the law firm Sullivan & Cromwell wrote the FDIC on behalf of nine banks, arguing that the government program to back the bonds of financial firms did not provide strong-enough guarantees. The letter asked that the guarantee cover principal and interest payment obligations as they became due, backed by the full faith and credit of the U.S. government. The guarantee was included three weeks later when the final rule was issued. No prize for guessing which banks signed the letter. The government's motivation for this program is to get banks back in the lending game. But in an economic and financial crisis, we want healthy banks to lend to creditworthy institutions and individuals, not for unhealthy banks to take another flyer on credit spreads.
There is, however, a remarkable coincidence between the banks with the largest writedowns -- one measure of sickness -- and those accessing the FDIC program. It's not as if we haven't seen this before. On Sept. 7, 2008, the government put Fannie Mae and Freddie Mac into conservatorship. They were bankrupt because of an accumulated portfolio of $1.5 trillion worth of mortgage-backed securities, of which $225 billion was subprime mortgages and the other $1.275 trillion were illiquid prime mortgages. While some of Fannie and Freddie's portfolios were hedged against interest rate movements using interest rate swaps, the subprime portion was an outright bet on default rates of low quality mortgages. How much cushion did they have? Only $1 of capital for every $25 of debt. What type of crazy creditor would lend to them? Almost anyone, because the debt had the implicit, now explicit, guarantee of the U.S. government.
With the economic dangers we now face, do we really want to go down this road again? We don't, and that's why, for all the criticism, Treasury Secretary Tim Geithner's plan -- call it Bailout 2.0 -- does have a silver lining. It stops the madness. Yes, Bailout 2.0 lacks details, but it is clear it won't propose more bank freebies -- no new loan guarantee programs or backstops of losses on their bad assets, or government capital infusions in the form of underpriced preferred shares. Now the banks will have to prove themselves via a "stress test" on their solvency to access new capital. It won't be a pretty picture. And by the way, if banks want Uncle Sam to buy all those "toxic" assets, the government is now going to do it alongside private capital. These investors aren't going to overpay, so that game is up as well.
Since Mr. Geithner's plan has been unveiled, the stock prices of the financial sector are off about 19%. This is not necessarily a bad thing. The banks were expecting another handout. While it was not his intention, the reality is that Mr. Geithner is going to confirm the insolvency of the financial system. Once we face this truth, there really isn't much left to do but nationalize. We are not talking about the government operating the banks for the long-term. But, as was done in Scandinavia in the early 1990s, we are talking about orderly clean up, then reselling the banks to private investors. The good news is that much of the risk will be borne by the banks' common and preferred shareholders and their long-term unsecured creditors -- as opposed to by taxpayers. This makes sense since shareholders and creditors were the ones who bet on banks in the first place. We'll also stop repeating the mistakes we made with Fannie and Freddie.
Fed to Release Longer-Term Economic Projections, Bernanke Says
The Federal Reserve today will begin releasing officials’ longer-term projections for inflation, economic growth and unemployment, aiming to anchor public expectations for prices, Chairman Ben S. Bernanke said. New projections for five or six years from now, in addition to the current three-year forecasts, will appear starting with minutes of the Jan. 27-28 Federal Open Market Committee meeting, Bernanke said in a speech today. The minutes are scheduled for release at 2 p.m. in Washington. Fed governors and district-bank presidents are trying to contain the risk of deflation, which would worsen the financial crisis and deepen the recession. The change brings the Fed closer to a formal inflation goal, something that central banks in the euro region, the U.K. and other countries are required to observe in designing interest rate policies.
The change "should provide the public a clearer picture of FOMC participants’ policy strategy for promoting maximum employment and price stability over time," Bernanke said in prepared remarks to the National Press Club in Washington. The move also "should help to better stabilize the public’s inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low," he said. "We expect inflation to be quite low for some time," Bernanke said in the speech, without mentioning the word deflation. The central bank, using emergency powers, is channeling money into the financial system and putting home loans and other assets on its balance sheet to unfreeze credit markets and end the longest recession since 1982. The Fed’s balance sheet during the past year has expanded to $1.8 trillion from $959 billion.
The Fed can scale back its balance sheet "relatively quickly" once it deems credit markets are returning to normal and "prospects for the economy" have improved, Bernanke said. A "substantial portion" of central bank assets are short-term in duration and can be allowed to run off, he said. "We will take all necessary actions to ensure that the unwinding of our programs is accomplished smoothly and in a timely way, consistent with meeting our obligation to foster maximum employment and price stability," he said. The Fed announced last week that it may expand a program aimed at supporting consumer loans to $1 trillion from $200 billion, aiding Treasury Secretary Timothy Geithner in the government’s revised financial-rescue plan.
The Fed is also buying $600 billion of debt sold by government-backed mortgage finance companies and mortgage-backed securities they guarantee. Under other emergency programs, the Fed is lending to bond dealers, financing the commercial paper market and supporting institutions such as insurer American International Group Inc. Bernanke sought to dispel concerns among some Fed watchers that the central bank will fuel inflation by expanding its balance sheet. Most banks are leaving the "great bulk" of excess reserves idle, primarily by keeping the funds on deposit with the Fed, he said. Not all Fed officials support the credit programs. Richmond Federal Reserve President Jeffrey Lacker dissented at the January meeting, preferring to boost the money supply through purchases of U.S. Treasury securities.
Fed Offers Bleak Economic Outlook
The Federal Reserve cut its economic outlook for 2009 on Wednesday and warned that the United States economy would face an “unusually gradual and prolonged” period of recovery as the country struggles to climb out of a deep global downturn. In gloomy economic projections released by the central bank, the Fed’s Open Market Committee said it expected that the economy would contract by 0.5 percent to 1.3 percent this year, that unemployment would soar to 8.5 to 8.8 percent, and that inflation would remain under greater pressure. Bleak economic data reflecting a sharpening slide in housing, trade, industrial production, spending and employment rates “more than offset” any potential impact from an economic stimulus plan, the Fed said, forcing it to cut its economic outlook.
“Financial markets continued to be strained over all, credit remained unusually tight for both households and businesses, and equity prices had fallen further,” the Open Market Committee said in the report, which reflected the minutes of its Jan. 27-28 meeting. On Tuesday, President Obama signed a $787 billion package of tax cuts and spending projects, saying it was necessary to stop the bleeding in the economy. He unveiled a $75 billion plan on Wednesday that seeks to help as many as nine million families refinance their mortgages or avoid foreclosure. The Fed released the minutes as its chairman, Ben S. Bernanke, defended the dramatic measures it had taken to try to revive frozen credit markets and restore confidence among borrowers and lenders. The Fed has expanded its balance sheet to $2 trillion, demonstrating a willingness to print money to try to fight the downturn.
“The Federal Reserve has done, and will continue to do, everything possible within the limits of its authority to assist in restoring our nation to financial stability and economic prosperity as quickly as possible,” Mr. Bernanke said in remarks at the National Press Club in Washington. Members of the Open Market Committee expect that the economy will ultimately rebound from a recession that began in December 2007, and will grow at a pace of 2.5 percent to 3.3 percent two years from now. But even as the economy heals, the Fed expects unemployment to remain near 8 percent. The unemployment rate rose to 7.6 percent last month as the faltering economy shed 598,000 jobs.
For the first time, the Fed also released projections of longer-term growth going beyond its normal one-to-three-year predictions. The committee members said that the American economy was expected to grow by 2.5 to 2.7 percent annually over the next five to six years, and that unemployment rates would hover near 5 percent in the longer term.
Fed's Evans: Economy shrinking at disturbing pace
The U.S. economy is still contracting at a "disturbing" pace, underlining the need for more stimulus even with interest rates already set near zero, a top Federal Reserve policy-maker said on Wednesday. "We likely are in for a protracted period of poor economic performance," Chicago Fed President Charles Evans said in a speech on the economic outlook to the Rockford Chamber of Commerce in Rockford, Illinois. "For the Fed, this means that the (Federal Open Market) Committee will have to focus on other ways to impart monetary stimulus to the economy."
The central bank's various new liquidity programs can still be expanded, and the purchase of longer-term Treasuries is still being mulled, Evans noted. Evans, a voting member of the central bank's policy-setting Federal Open Market Committee in 2009, said that the pessimistic outlook "has reduced everyone's confidence," making investors, households and businesses reluctant to take on longer-term investments or new spending, only adding to the economy's woes. Real GDP, the broadest measure of economic growth, "will fall markedly" in the first half of 2009 before potentially expanding later in the year and moving back to "the neighborhood" of its potential in 2010.
"However, I do not see growth as being strong enough to make much progress in closing resource gaps over this period. Indeed, the unemployment rate ... is likely to rise into 2010," he said. The impact the Obama administration's $787 billion economic stimulus would have on GDP was not yet clear, he added. "The new fiscal stimulus package will boost output ... Our forecast could need some recalibration as we gain knowledge of how the package is affecting the economy." Evans said inflation was likely to remain "a good deal below" the 2-percent level that is consistent with price stability in both 2009 and 2010, and reiterated support for a more explicit inflation target.
Discussing the Fed's initiatives to pump liquidity into various corners of the credit market, Evans said the programs reflected the current dysfunction and risk aversion rampant in financial markets. "Markets have become highly segmented .... as stressed markets improve, more normal functioning of the financial system as a whole can be achieved," he said. For now, the Fed's traditional and nontraditional policy actions "are beginning to help the functioning of credit markets," as shown by falling spreads on interest rates charged for interbank lending since October, Evans said.
Evans said some of the winding down of the Fed's nontraditional programs "will occur naturally as market conditions improve," allowing the central bank to return to its traditional focus on short-term lending rates. Financial markets currently do not fully price an increase in the federal funds rate to 0.50 percent from the current range of zero to 0.25 percent until December.
Fed Should Expand Supply of Money, Bullard Says
Federal Reserve Bank of St. Louis President James Bullard said the U.S. faces a risk of "sustained deflation" and called on the central bank to avert a decline in prices by expanding the money supply. The prospect of deflation is a "significant downside risk" and may increase home foreclosures, Bullard said in a speech today in New York. Adopting a target "rapid" growth rate for the monetary base, which includes money in circulation and banks' reserve deposits with the Fed, should "head off any incipient deflationary threat," he said. Bullard is one of a few Fed officials to advocate a new policy tool after the Federal Open Market Committee in December cut its main interest rate almost to zero. The central bank is using money-creation authority to put assets such as home loans on its balance sheet, aiming to unfreeze credit and end the longest recession since 1982.
"By expanding the monetary base at an appropriate rate, the FOMC can signal that it intends to avoid the risk of further deflation and the possibility of a deflation trap," Bullard said in prepared remarks to the New York Association for Business Economics. He didn't propose a specific figure for the target. The FOMC said in its Jan. 28 statement that there's "some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term." The FOMC at its December meeting discussed setting a target for growth in measures of money, such as the monetary base. While a "few" policy makers favored a numerical goal for money growth, most preferred a more open-ended "close cooperation and consultation" with the Fed board on how to expand assets and liabilities, according to minutes of the session.
Bullard's warning about deflation is stronger than comments by other central bank officials. Chicago Fed President Charles Evans said Feb. 11 that he's "not tremendously concerned about deflation." Bullard told reporters after the speech he supports the adoption of an inflation target to prevent expectations for prices from falling too far. A target for inflation "would be helpful at this time," he said. "You have to consult with all players, including Congress," he said. "If they don't want to do it, then we don't do it." The Fed announced last week that it may expand a program aimed at supporting consumer loans to $1 trillion from $200 billion, aiding Treasury Secretary Timothy Geithner in the government's revised financial-rescue plan. Separately, the Fed is buying $600 billion of debt sold by government-backed mortgage finance companies and mortgage-backed securities they guarantee.
Other emergency-lending programs that have swelled the Fed's balance sheet by more than $1 trillion since December 2007, including the Term Auction Facility and commercial-paper backstop, are "temporary" and would fail to meet a goal of combating deflation by increasing the monetary base, Bullard said. "These programs seem to be a thin reed on which to balance medium-term inflation objectives," he said. "Outright purchases of agency debt and MBS are likely to be more persistent, however, and it is these purchases that may provide enough expansion in the monetary base to offset the risk of further disinflation and possible deflation." Purchasing long-term Treasuries "is still on the table" as a policy option, Bullard said, answering an audience question. The debate over buying Treasuries has continued for two meetings of the FOMC and may continue through the spring, Bullard told reporters.
"For now we want to see how other" emergency Fed programs designed to increase credit "work out," he said. Targeting monetary growth isn't a sure thing. "One important disadvantage is that the linkages between the growth rate of the monetary base and key macroeconomic variables are not statistically tight," Bullard said. Bullard also said he wouldn't recommend the approach for "normal times," doing so now only because of near-zero interest rates and the "exceptionally weak state of the economy." Congress in the 1970s required the Fed to set monetary targets twice a year and explain any deviations. From 1979 to 1982 central bank officials used money growth targets more to influence the economy. For the remainder of the 1980s, the Fed shifted back to a focus on interest rates as the main policy tool. The FOMC stopped setting money supply targets after the legal requirements lapsed in 2000. Bullard, 47, took over as president from William Poole, who retired on March 31. While he won't vote on interest rates this year at the FOMC, his turn in the rotation among Fed bank presidents will be in 2010. Bullard was previously the St. Louis Fed's deputy director of research for monetary analysis.
Greenspan Says U.S. May Not Be Doing Enough to Promote Recovery
Former Federal Reserve Chairman Alan Greenspan said the U.S. may be doing too little to repair its financial system and promote an economic recovery. President Barack Obama today signed into law a $787 billion economic stimulus package of tax cuts and increased spending. He has also pledged to use the bulk of the roughly $315 billion left in the bank bailout fund approved by Congress last October to revive the battered financial industry. "The amount of money in both these pots may not be enough to solve the problem," Greenspan said in an interview before a speech prepared for today to the Economic Club of New York. The comments highlight the difficulties Obama faces in fighting the steepest recession in a generation. The economy contracted at an annual pace of 3.8 percent in the fourth quarter of last year, the most since 1982.
Greenspan, who now heads his own Washington-based consulting company, warned in his speech that the positive impact of the stimulus package on the economy will peter out if the U.S. fails to fix its financial system. "Given the Japanese experience of the 1990s, we need to assure that the repair of the financial system precedes the onset of any major fiscal stimulus," he said. U.S. bank stocks have been hammered as their loan losses have mounted. Citigroup Inc., the bank that received $45 billion from the government last year, fell 43 cents to $3.06. JPMorgan Chase & Co., the second-largest U.S. bank by assets, declined $3.04 to $21.65. Bank of America Corp. dropped 67 cents to $4.90. The Obama administration last week laid out a multipronged plan to aid the banks, drawing on the remaining money in the $700 billion Troubled Asset Relief Program. Greenspan said that wouldn't be enough.
"To stabilize the banking system and restore normal lending, additional TARP funds will be required," he said. He highlighted the importance of building up banks' capital. "Banks are not going to increase their lending until they feel comfortable with the amount of capital they hold," he said in the Feb. 16 interview. "That's not going to happen for a while." The 82-year-old economist also stressed the importance of halting the decline in house prices that is battering bank balance sheets. "Until we can stabilize the asset side of bank balance sheets, this crisis will not come to a close," he said. U.S. banks have sustained $758 billion in credit losses since the crisis began. Many of those losses stemmed from mortgage-related investments that declined with the collapse in the housing market.
Home prices in 20 U.S. cities were down 18.2 percent in November from a year earlier, the fastest drop on record, according to the S&P/Case-Shiller index. "Unfortunately, the prospect of stable home prices remains many months in the future," Greenspan said in his speech. "Many forecasters project a decline in home prices of 10 percent or more from current levels." Greenspan estimated the collapse in housing, coupled with the steep drop in equity prices worldwide, had wiped out more than $40 trillion of wealth, equivalent to two-thirds of last year's global gross domestic product. U.S. stocks tumbled to a three-month low today, extending a decline that began overseas. "Certainly, by any historical measure, world stock prices are cheap," Greenspan said. "But as history also counsels they could get a lot cheaper before they turn."
He said that investors were gripped by a degree of fear not seen since at least 1932. Those fears should dissipate once the rate of decline in the economy and the financial markets starts to slow, he added. "A rise in equity prices could help offset the impact of falling house prices" on the economy, he said in the interview. Yet he warned that a stock market recovery could be derailed if inflation fears resurface because of the money the government is channeling into the economy. "The recent rise of long-term interest rates appears to be signaling market concerns about inflationary pressures," he said. "It could turn out to be the canary in the coal mine." The yield on the 10-year Treasury note ended the day at 2.65 percent, down from 2.88 percent yesterday, yet still well above the 2.05 percent level set on Dec. 30.
Japan’s lessons for a world of balance-sheet deflation
What has Japan’s "lost decade" to teach us? Even a year ago, this seemed an absurd question. The general consensus of informed opinion was that the US, the UK and other heavily indebted western economies could not suffer as Japan had done. Now the question is changing to whether these countries will manage as well as Japan did. Welcome to the world of balance-sheet deflation. As I have noted before, the best analysis of what happened to Japan is by Richard Koo of the Nomura Research Institute.* His big point, though simple, is ignored by conventional economics: balance sheets matter.
Threatened with bankruptcy, the overborrowed will struggle to pay down their debts. A collapse in asset prices purchased through debt will have a far more devastating impact than the same collapse accompanied by little debt. Most of the decline in Japanese private spending and borrowing in the 1990s was, argues Mr Koo, due not to the state of the banks, but to that of their borrowers. This was a situation in which, in the words of John Maynard Keynes, low interest rates – and Japan’s were, for years, as low as could be – were "pushing on a string". Debtors kept paying down their loans. How far, then, does this viewpoint inform us of the plight we are now in? A great deal, is the answer.
First, comparisons between today and the deep recessions of the early 1980s are utterly misguided. In 1981, US private debt was 123 per cent of gross domestic product; by the third quarter of 2008, it was 290 per cent. In 1981, household debt was 48 per cent of GDP; in 2007, it was 100 per cent. In 1980, the Federal Reserve’s intervention rate reached 19–20 per cent. Today, it is nearly zero. When interest rates fell in the early 1980s, borrowing jumped (see chart below). The chances of igniting a surge in borrowing now are close to zero. A recession caused by the central bank’s determination to squeeze out inflation is quite different from one caused by excessive debt and collapsing net worth. In the former case, the central bank causes the recession. In the latter, it is trying hard to prevent it.
Second, those who argue that the Japanese government’s fiscal expansion failed are, again, mistaken. When the private sector tries to repay debt over many years, a country has three options: let the government do the borrowing; expand net exports; or let the economy collapse in a downward spiral of mass bankruptcy. Despite a loss in wealth of three times GDP and a shift of 20 per cent of GDP in the financial balance of the corporate sector, from deficits into surpluses, Japan did not suffer a depression. This was a triumph. The explanation was the big fiscal deficits. When, in 1997, the Hashimoto government tried to reduce the fiscal deficits, the economy collapsed and actual fiscal deficits rose.
Third, recognising losses and recapitalising the financial system are vital, even if, as Mr Koo argues, the unwillingness to borrow was even more important. The Japanese lived with zombie banks for nearly a decade. The explanation was a political stand-off: public hostility to bankers rendered it impossible to inject government money on a large scale, and the power of bankers made it impossible to nationalise insolvent institutions. For years, people pretended that the problem was downward overshooting of asset price. In the end, a financial implosion forced the Japanese government’s hand. The same was true in the US last autumn, but the opportunity for a full restructuring and recapitalisation of the system was lost.
In the US, the state of the financial sector may well be far more important than it was in Japan. The big US debt accumulations were not by non-financial corporations but by households and the financial sector. The gross debt of the financial sector rose from 22 per cent of GDP in 1981 to 117 per cent in the third quarter of 2008, while the debt of non-financial corporations rose only from 53 per cent to 76 per cent of GDP. Thus, the desire of financial institutions to shrink balance sheets may be an even bigger cause of recession in the US. How far, then, is Japan’s overall experience relevant to today?
The good news is that the asset price bubbles themselves were far smaller in the US than in Japan (see charts below). Furthermore, the US central bank has been swifter in recognising reality, cutting interest rates quickly to close to zero and moving towards "unconventional" monetary policy. The bad news is that the debate over fiscal policy in the US seems even more neanderthal than in Japan: it cannot be stressed too strongly that in a balance-sheet deflation, with zero official interest rates, fiscal policy is all we have. The big danger is that an attempt will be made to close the fiscal deficit prematurely, with dire results. Again, the US administration’s proposals for a public/private partnership , to purchase toxic assets, look hopeless. Even if it can be made to work operationally, the prices are likely to be too low to encourage banks to sell or to represent a big taxpayer subsidy to buyers, sellers, or both. Far more important, it is unlikely that modestly raising prices of a range of bad assets will recapitalise damaged institutions. In the end, reality will come out. But that may follow a lengthy pretence.
Yet what is happening inside the US is far from the worst news. That is the global reach of the crisis. Japan was able to rely on exports to a buoyant world economy. This crisis is global: the bubbles and associated spending booms spread across much of the western world, as did the financial mania and purchases of bad assets. Economies directly affected account for close to half of the world economy. Economies indirectly affected, via falling external demand and collapsing finance, account for the rest. The US, it is clear, remains the core of the world economy.
As a result, we confront a balance-sheet deflation that, albeit far shallower than that in Japan in the 1990s, has a far wider reach. It is, for this reason, fanciful to imagine a swift and strong return to global growth. Where is the demand to come from? From over-indebted western consumers? Hardly. From emerging country consumers? Unlikely. From fiscal expansion? Up to a point. But this still looks too weak and too unbalanced, with much coming from the US. China is helping, but the eurozone and Japan seem paralysed, while most emerging economies cannot now risk aggressive action. Last year marked the end of a hopeful era. Today, it is impossible to rule out a lost decade for the world economy. This has to be prevented. Posterity will not forgive leaders who fail to rise to this great challenge.
Californian dream turns into nightmare
In Contra Costa County, a few miles from San Francisco and the millionaires of Silicon Valley, widespread poverty has returned to California. Buffeted by a housing collapse and a slumping economy, the county of 1m is struggling to cope with a sharp rise in the number of residents seeking welfare assistance. Applications for food stamps – vouchers for low-income earners that can be used to buy food – have risen 65 per cent in the county in the past year. There has been a similar jump in the number of applications for Medi-Cal, which provides health services for the poor, and other welfare programmes. Like the rest of the Golden State, Contra Costa is fighting a battle on two fronts. Demand for welfare assistance is rising as the US recession tightens its grip. But the county’s ability to support its residents is being hindered by a spending freeze tied to California’s projected $42bn (€32bn, £29bn) budget deficit – the biggest in the US.
The state has slashed funding for social programmes and postponed thousands of infrastructure projects – such as school, hospital or highway developments – worth more than $21bn. The projects have been put on ice while legislators try to address the shortfall. Lawmakers have spent the past four days locked in the state’s capitol building in Sacramento to hammer out a budget deal that would raise about $14bn from new taxes and cut spending by a similar amount. A proposal backed by Arnold Schwarzenegger, California’s governor, and state Democrats is one vote shy of being passed. With the pressure for a new budget mounting, Mr Schwarzenegger on Tuesday began making good on a promise to cut 10,000 jobs from the state’s payroll in an attempt to preserve cash.
In Contra Costa the spending freeze could not have come at a worse moment. "We have had to cut 200 positions and at the same time there has been a huge increase in the number of people seeking help," says Joe Valentine, director of the employment and human services department in the county. Many of those seeking assistance are unused to the experience, he says. "We call them the ‘newly poor’. We had a man come in recently who had been a carpenter for 20 years. He had just been laid off and then lost his house." California has traditionally been the most prosperous state in the US, but the urgent need to address its budget deficit is exacerbating the impact of the recession on its 36m residents.
The state is in line for a federal bail-out and may receive up to $26bn from the economic stimulus package that passed last week. But the long delay in implementing a new budget has spooked Wall Street and seen California’s credit rating cut to the lowest of any US state. This has made it impossible to sell bonds that are supposed to finance billions of dollars of public works projects that have already been approved by voters. Some of those projects, such as the redevelopment of schools and prisons, have been put on ice until a budget can be agreed. "We have really slowed down and have probably let go 150 carpenters and labourers," says Terry Street, chief executive of Roebbelen Contracting, a Sacramento-based company that has worked on several public projects.
His company was ordered to stop work on a $20m mental health facility that was close to completion and also had to halt construction of a school east of Sacramento.
Postponing these projects is heaping more misery on California’s once-booming construction sector. Unemployment in the state is running at almost 10 per cent but among building workers it is nearer 20 per cent, according to Jim Earp, of the California Alliance for Jobs, which represents contractors and 80,000 workers. There are also doubts about the state’s ability to continue providing welfare assistance. In Los Angeles County, home to some 10m people, there was a near 25 per cent jump in applications for homeless assistance between June and September last year. "My members got into this business because they wanted to help people," says Cathy Senderling-McDonald, of the County Welfare Directors Association of California. "So many families need help ... but there is a big gap between what we can offer them and what they need."
California Senator Feels Heat
Gov. Arnold Schwarzenegger and California's legislative leaders, in a desperate effort to end a 15-week budget impasse, are turning principally to one man: State Sen. Abel Maldonado.The state senate began voting just before 1:00 a.m. Wednesday on a plan to close California's $42 billion deficit, after the plan's backers failed to find enough votes to pass it in sessions from Saturday through Tuesday. Mr. Maldonado, a broccoli and cauliflower farmer from Santa Maria, is considered the most likely Republican to cast the final "aye" vote needed to pass the plan.The assembly, expected to pass the budget with bipartisan support, is scheduled to convene later Wednesday.
Democratic Senate Majority Leader Darrell Steinberg started the after-midnight vote on the budget's key tax-proposal bill. He said he will leave the vote open and force senators to stay in the state house until the bill passes -- a scenario that could last for more than a day. "Our minor inconvenience pales in comparison to the pain and suffering that will be done to the people California" without immediate budget solutions, Mr. Steinberg said. "Grab the moment, members." Less than an hour earlier, the Republican state senate caucus broke down, as members ousted minority leader Dave Cogdill, who designed the budget proposal with three other legislative leaders and the governor. But the shakeup wasn't expected to affect the two senate GOP votes already committed to the budget, leaving the plan still lacking just one vote.
Before last week, the 41-year-old Mr. Maldonado was little known. But last week, he became the focus of intense attention, as the most likely swing vote. State leaders have been courting Mr. Maldonado, the son of a Mexican immigrant father, throughout a marathon budget session that began Saturday. Mr. Maldonado, like other state Republicans, objected to the tax increases in the proposed package and said it included too few spending cuts. He continued to hold out early Wednesday morning, casting an initial "no" vote that he can later change while the vote stays open. He might consider voting for the plan, he said in an interview, if certain provisions were worked into the bills that make up the plan. Among his demands: open primary elections and a pay cut for lawmakers if they fail to meet the budget deadline. Mr. Maldonado said the plan won't get his vote unless the budget proposal includes these overhauls, which he believes will help the state avert future fiscal emergencies.
With California set to run out of cash in weeks, state leaders have already shut off funding for $7 billion in construction projects and delayed $3 billion in tax refunds, welfare checks and other payments. The state controller warns that he may soon issue IOUs if no budget is passed. State lawmakers readied themselves Tuesday for an all-night budget session, their second in four days. They first convened Saturday evening and adjourned 24 hours later, aborting a budget vote after it became clear that the state Senate had only two of the three Republican votes needed to pass the budget. Democrats dominate the state legislature, but they need bipartisan support because California is one of three states that require budgets to be passed by a two-thirds majority. State leaders have been lobbying Mr. Maldonado and Dave Cox, another moderate Republican senator viewed as a potential swing vote. But Mr. Cox has blasted the budget in floor sessions, while Mr. Maldonado has appeared more receptive to compromise.
Mr. Maldonado considers himself a fiscal conservative, but said he differentiates himself from his Republican colleagues by championing public education and environmental protection. As an eight-year-old, he picked strawberries on his father's half-acre farm, which he helped turn into a 6,000-acre enterprise. His slender Senate district covers a quarter of the California coast, from Santa Cruz to Santa Barbara County. He travels the district by piloting his own Mooney single-engine airplane. Mr. Maldonado said, like his Republican colleagues, that he disliked a budget that proposes $14 billion in new taxes during a recession. He said he is working with Senate leaders to lessen the tax increases. But he said he also worried about the layoffs, possible IOUs and other consequences of the budget impasse dragging beyond its 15th week. "Those are valid warnings," he said.
He said an open primary system, in which the two candidates who receive the most votes face off in a runoff election regardless of party affiliation, will result in a statehouse with fewer extreme liberals or conservatives. "We would have elected officials voting for the people of California, instead of worrying about their next election and party bosses," he said. Such an overhaul would have to be approved by California voters. Mr. Maldonado said recent discussions with Mr. Schwarzenegger and Mr. Steinberg have been constructive, but still not enough. "If we don't put government reforms in, we'll be back at this next year again," he said. "We'll be sitting here till midnight, all night, not getting a budget out."
GM needs up to $30-billion
General Motors Corp. said on Tuesday it could need a total of up to $30-billion (U.S.) in U.S. government aid – more than doubling its original aid – and would run out of cash as soon as March without new federal funding. The request for additional aid from the top U.S. auto maker came in a restructuring plan GM submitted to U.S. officials on Tuesday. The GM restructuring plan of more than 100 pages was posted on the U.S. Treasury Web site. The request came on the same afternoon that No. 3 U.S. auto maker Chrysler LLC sought an additional $2-billion on top of $4-billion it has already received and $3-billion it is awaiting from the U.S. government, saying it expects the brutal downturn in the U.S. market to run another three years.
GM also said it had not reached deals with bondholders and its major union to reduce some $47-billion in debt but would work to reach those agreements by the end of March. In response to signs of a prolonged slump in demand for new cars and trucks, the auto maker also said it would step up cost-cutting, reducing its global work force by 47,000 jobs this year and cutting five additional U.S. plants by 2012. In addition, GM said it would cut its U.S. work force by another 20,000 jobs by 2012 with most of those reductions coming earlier.
GM has been kept afloat since the start of the year with $13.4-billion in loans from the U.S. Treasury. Its expanded aid request for up to $30-billion includes a $7.5-billion credit line in the event that the autos market remains depressed. Critics of the bailout of GM and its smaller rival Chrysler have urged the government to consider financing a court-supervised restructuring for the two ailing auto makers in bankruptcy. GM said its own analysis of the costs and risks of a bankruptcy filing would require more than $100-billion in financing that could have to be provided by the U.S. government.
GM requested an unprecedented U.S. government bailout in December and had pegged its funding need then at up to $18-billion. But the auto maker has faced a deep slide in sales outside its long-slumping home market in the weeks since and GM said its revised restructuring plan would take aim at loss-making overseas units as well. GM also said it would plan to phase out its Saturn brand by the end of 2011 and make a decision on whether to sell or just wind down its Hummer SUV brand by the end of the current quarter.
GM Seeks $16.6 Billion More in U.S. Aid to Slash 47.000 Jobs
General Motors Corp. and Chrysler LLC told the federal government they may need up to $21.6 billion more combined in bailout loans to put them on the road to recovery, and outlined extensive bankruptcy contingency plans even while continuing to lobby against the option. The recovery plans submitted to the U.S. Treasury would cement GM's fall from the top of the global auto industry to a smaller, more flexible car company relying less on its core U.S. market for sales. Chrysler, meanwhile, appears to be steering itself toward being the North American arm of Fiat SpA. GM said it might need as much as $100 billion in financing from the government if it were to go through the traditional bankruptcy process. Rick Wagoner, GM's chairman and chief executive, said the bankruptcy scenarios are "risky" and "costly" and would only be pursued as a last resort.
Chrysler's plan said the company would likely have to file for Chapter 11 protection if it doesn't get additional loans from the government and concessions from unions, creditors and dealers. It said it would need $24 billion in financing if the company were to file for bankruptcy. But company officials said in a conference call that they believe a Chapter 11 filing is "not necessary" for Chrysler's survival. The submission of the recovery plans was required under terms of the U.S. loans the auto makers received in early January. GM said it now plans to phase out its Hummer brand this year and Saturn in 2011 if no alternatives arise. Earlier, it said it was trying to sell Hummer and was re-evaluating the future of Saturn. The company also is scaling back Pontiac and trying to sell Saab, its Swedish brand. GM also said it will shut five more factories on top of the closures it had already planned. In addition, it plans to eliminate thousands of dealerships and slash 47,000 jobs this year around the world, leaving it with a work force of about 200,000. Chrysler said it will trim production capacity by 100,000 vehicles, a modest reduction for a company that has several more plants than it needs.
A spokesman for President Barack Obama, Robert Gibbs, said in a statement that the administration appreciates the effort by the auto makers. But he added that "more will be required from everyone involved -- creditors, suppliers, dealers, labor and auto executives themselves -- to ensure the viability of these companies."
In particular, new opposition to further aid for Chrysler seemed to be building on Capitol Hill. In an interview Tuesday, Sen. Judd Gregg (R., N.H.) said no more taxpayer money should be given to Chrysler until its majority owner, private-equity firm Cerberus Capital Management LP, agrees to inject more funds into it. Cerberus said in a statement that it can't put additional investments into Chrysler because agreements with its investors limit how much it can commit to any single investment. It added Cerberus has agreed to forgo any Chrysler profits before the government loans are repaid.
So far, GM has received $13.4 billion in U.S. loans; its plan said the company needs a total of $30 billion in aid, or $16.6 billion more than it has now. GM also said it needs at least $7.7 billion in loans from the Department of Energy to develop fuel-efficient technology. Chrysler has received $4 billion in loans and said it needs $5 billion more. In one sign of progress, GM, Chrysler and Ford Motor Co. reached tentative agreements Tuesday with the United Auto Workers union on a range of labor cost reductions. Among them are changes in work rules and cuts in so-called substitute pay, which supplements laid-off workers' unemployment benefits, a person familiar with the matter said. Basic wage levels of auto workers, which are seen as generally equivalent to workers at foreign-owned auto plants in the U.S., remain unchanged, this person said.
But the union and the auto makers remained at odds over the largest sticking point: new terms for how the car companies will put billions of dollars into trust funds to cover the cost of health care for retired union workers. The auto makers want to pay a portion of their cash obligation to the funds with stock instead. The funds are known as VEBAs, or voluntary employee beneficiary associations. "The UAW is withholding the terms of the tentative understanding pending completion of the VEBA discussions and ratification of the agreements," the union said. Coming to agreement on revamping the VEBAs is a requirement of the U.S. loans. With the release of its updated viability plan, GM now must focus on the task of convincing key stakeholders to make considerable concessions. That process has been under way for several weeks but has not yielded substantive results.
On Sunday, GM received a letter from its bondholder committee outlining its framework for restructuring $29 billion in company debt by swapping debt for stock. "This framework is consistent with the government's objective in the U.S. Department of the Treasury's term loan of substantially de-leveraging GM but also provides that bondholders must receive fair and equitable treatment vis-a-vis other GM stakeholders," the letter said. Several bondholders, however, say they have not yet been contacted and many are reluctant to embrace a debt-for-equity swap. "I can assure you, we are not being represented," one bondholder said. Yet even if GM can reduce its public debt to $9 billion through an exchange, it will carry a far heavier burden, as much as $39 billion, than it currently does if it receives the additional federal loans it is seeking.
Tuesday's announcement signals GM's management has softened it view on a possible bankruptcy filing. In the past Mr. Wagoner has insisted bankruptcy was not an option for the company. But in the recovery plan the company described two alternative scenarios in addition to a traditional filing. The plan says a "pre-packaged" bankruptcy, in which new terms with unions, suppliers and creditors are hammered out in advance, might require only $30 billion in debtor-in-possession financing. In another scenario known as a "cram-down" bankruptcy, GM could try to restructure its debt over the objections of creditors. GM's loan request includes $4.6 billion it hopes to draw down in March and April. That would bring the loan total to $18 billion, which is the amount GM initially requested in December. Additionally, GM is asking for a $7.5 billion line of credit that could be drawn under a downside scenario and to defer repayment of a $4.5 credit line due in 2011. Under the plan submitted Tuesday, GM said it can break even once U.S. vehicle sales hit a seasonally adjusted rate of 11.5 million to 12 million car and truck sales. That compares with 9.5 million as of January.
Saturn dealers hope to spin off Saturn from GM into a new company, said Dan Januska, owner of Saturn of Scottsdale in Arizona. Mr. Januska, who is on the Saturn Dealer Council, said Saturn dealers would be open to selling vehicles made by Indian or Chinese makers that would be sold as Saturns. GM Saturn spokesman Steve Janisse declined to comment Chrysler's request for an additional $5 billion in loans is more than expected. In the past several weeks Chrysler had said it would seek $3 billion in additional aid. Its restructuring plan also said the company's two owners, Cerberus and Daimler AG, have agreed to convert $2 billion in loans to the company into stock to ease the auto maker's debt. But Chrysler outlined few other major restructuring measures. While it said it would reduce its manufacturing capacity by 100,000 vehicles a year, that wouldn't be significant in light of its production capacity of 2.5 million vehicles at its 12 assembly plants in North America. The projections imply it is on track to sell slightly more than one million vehicles in the U.S. this year.
Chrysler vowed to launch 24 new vehicles in the next 48 months, but it's unclear what new vehicles Chrysler has in its pipeline. Several engineers who have left the company said they departed because they were concerned about cutbacks in development of new models. Suppliers working with Chrysler have also said they have halted or significantly slowed work on future Chrysler vehicles. Some of the new models could come from Fiat SpA, the Italian auto maker that has a tentative alliance with Chrysler. Kimberly Rodriguez, an auto consultant at Grant Thornton LLP, said she found Chrysler's plan underwhelming. "There just has to be more. They really have to call out the final solution. They have bitten around the corners." The Fiat alliance, she added, "is not going to be enough" to ensure Chrysler's survival.
Douglas C. Bernstein, a bankruptcy attorney with Plunkett Cooney in Bloomfield Hills, Mich., described the GM viability plan as "a work-in-process."
He added that it was unclear from GM's submission how it intended to support its network of auto-parts suppliers, which are suffering from a liquidity crisis, and whether the government would inject funds into the supply base to keep it afloat. GM's recovery plan is the latest in a series of restructuring moves implemented by Mr. Wagoner since taking the company's helm in 2000. In his first year in office, he killed the Oldsmobile division. But Mr. Wagoner was able to avoid a deep overhaul until 2005, when a combination of escalating labor costs and a decline in sales of profitable sport-utility vehicles collided to bring the company to a $10.6 billion loss. In late 2005, Mr. Wagoner announced tens of thousands of job cuts.
Saab may go bust in 10 days, warns GM
Saab, the Swedish carmaker owned by America's General Motors (GM), could go bust within ten days without an immediate injection of state aid, the US company warned last night. GM said last night that as part of a sweeping restructuring of its global operations, it aimed to sell Saab along with other underperfoming businesses including its Hummer brand. However, GM said that Saab was losing so much money so quickly that, without government intervention to secure its future, the subsidiary could be forced to file for reorganisation by the end of this month. "Given the urgency of stemming sizeable cash demands associated with Saab operations, GM is requesting Swedish Government support prior to any sale," the Detroit-based group said.
"While GM hopes to reach agreement with the Swedish government, the Saab Automobile AB subsidiary could file for reorganization as early as this month," it said.
But this morning, the Swedish Government appeared to rule out the prospect of state support in the interim period. "The Swedish state and taxpayers in Sweden will not own car factories," Maud Olofsson, the industry minister, said. "Sometimes you get the impression that this is a small, small company but it is the world’s biggest automaker so we have a right to make demands." She said that talks with Saab were continuing and that the group had asked the Government for 5 billion Swedish kronor (£400 million) to keep it afloat until the start of next year.
"When I see that Saab has been running at a loss for so many years it would be irresponsible for me to stand here and say, sure, we are going to use the taxpayers' money in this way. I don't think I was elected to do that," she said. GM gave its stark warning over the future of Saab as part of a "viability plan" it revealed to the US Treasury last night which stated the car giant needed as much as $30 billion in funds to stave off bankruptcy. Chrysler is also seeking extra taxpayers’ cash to survive, according to restructuring plans filed with the US Treasury last night. Saab, which is based in Trollhaettan and was founded in 1947, employs over 4,300 people. It is one of Sweden’s best-known manufacturing brands.
GM, which last night also announced plans to slash 47,000 jobs out of its global workforce of 244,000, said that it had offered the Swedish Government a specific proposal that would cap its financial support for the business, with Saab effectively being spun off as an independent business from the start of next year. Including suppliers and other manufacturers such as Volvo, owned by Ford, the Swedish car industry employs 140,000 people in a country of just nine million. The car industry accounts for 15 per cent of exports. Saab has been wholly owned by GM, which is struggling to avoid bankruptcy, since 2000. GM said that it could run out of money by March without the money it has requested from the US Government. It said that it needs $2 billion next month and another $2.6 billion in April.
Chrysler Increases U.S. Aid Request to $9 Billion
Chrysler LLC, the third-largest U.S. automaker, said it would need $2 billion more in federal aid to successfully restructure, pushing its total request to $9 billion. Chrysler also said it needs to eliminate an additional 3,000 jobs after shedding 32,000 through the end of last year. The company had requested $7 billion before today, and had received $4 billion so far. The Chrysler proposal came before one due later today from General Motors Corp., which has received loan pledges for $13.4 billion. A final plan due March 31 will determine whether government backing continues or whether GM and Chrysler may need to be forced into bankruptcy to overhaul their operations.
The industry got a boost when the United Auto Workers said it reached tentative agreements with GM, Chrysler and Ford Motor Co. to amend U.S. labor contracts to help the companies survive. President Barack Obama’s chief spokesman said the administration can’t rule out a restructuring through bankruptcy for GM and Chrysler, while adding the industry is "tremendously important" to the economy. White House press secretary Robert Gibbs, speaking before GM and Chrysler submitted their progress reports, said the administration won’t "prejudge" the next steps.
"I wouldn’t preclude policy choices, particularly since we haven’t seen details," Gibbs told reporters traveling with the president to Colorado. The auto companies "represent a huge part of our manufacturing base, and to have a strong and viable auto industry is tremendously important for the future." Chrysler has agreed in principle to trade 35 percent of its equity to Turin, Italy-based Fiat SpA for small-car technology and access to global markets. The accord depends on Chrysler getting additional federal aid and approval by the U.S. government.
Sales last year at Chrysler tumbled 30 percent, the most of any major automaker. The company relies more than competitors on pickup trucks, sport-utility vehicles and vans, which lost sales last year as gasoline prices rose to a record high and consumers shifted to more fuel-efficient cars. GM fell 32 cents, or 13 percent, to $2.18 at 4:15 p.m. in New York Stock Exchange composite trading. The stock has dropped 92 percent in the past 12 months. Chrysler is controlled by Cerberus Capital Management LP. The automakers must show progress in getting creditors and the UAW to accept equity in place of billions of dollars in scheduled cash payments. GM and Chrysler must also ensure that future models will meet environmental rules that may require $100 billion in new technology.
"Everyone has a lot at risk," said Dennis Virag, president of Automotive Consulting Group in Ann Arbor, Michigan. "If the UAW doesn’t provide concessions, and the union forces GM’s hand and they go into bankruptcy, it will be the end of the UAW as we know it." The progress report will be evaluated by Treasury Secretary Tim Geithner, White House economic adviser Lawrence Summers and a new automotive task force. The Obama administration created the panel rather than use a single "car czar" to supervise the federal loans, which were authorized by then-President George W. Bush’s Treasury Department Dec. 19.
GM is to receive $4 billion today, as scheduled, said a person familiar with the matter. The administration may give more money to the automakers if they demonstrate they can repay the loans, Geithner said in a Feb. 10 CNBC interview. David Cole, chairman of the Center for Automotive Research in Ann Arbor, Michigan, said before today’s submissions that the GM and Chrysler reports probably would "lead into kind of a 4- way discussion between the government, the companies, the union and the bondholders."
The terms of the Dec. 19 loan agreements from the U.S. Treasury require GM and Auburn Hills, Michigan-based Chrysler to persuade the UAW to accept equity instead of cash for half of next year’s scheduled payments into a union-run retiree health- care fund. The UAW walked out on GM talks Feb. 13 in a dispute over the proposal. UAW President Ron Gettelfinger has said he’s willing to make additional concessions to help the automakers avoid bankruptcy if auto executives, debt holders and others also sacrifice.
GM said last week it will fire 10,000 of 73,000 salaried workers globally and cut the pay of many who remain. The automaker also is seeking to shed 1,700 of its 6,400 auto dealers. Chrysler is also seeking savings from dealers and suppliers. In separate talks, GM and its bondholders are working to craft a debt exchange that gives investors who participate greater security and more seniority so that enough take part, a person with direct knowledge of the talks said this weekend. GM needs to cut two-thirds of its $27.5 billion in unsecured public debt to $9.2 billion as required by the U.S. government.
Opel Bailout Poses Major Risks for Berlin
With a election looming in seven months, the German government is under mounting pressure to rescue automaker Opel. But a rescue would prompt an "avalanche" of demands for state aid from other manufacturers battling the global downturn. Some venerable German brands have already fallen victim to the financial crisis. In recent weeks, porcelain maker Rosenthal, underwear manufacturer Schiesser, model train maker Märklin and department store chain Hertie have all filed for bankruptcy. Now the future of auto company Opel is on the line, prompting mass circulation Bild to pose the anxious question that many Germans must be asking themselves: "Is 'Made in Germany' Going Kaputt?"
Politicians are scrambling to mount a rescue for Opel, which faces heavy redundancies and even plant closures in the course of a restructuring announced by its parent company General Motors overnight. Angela Merkel's government hasn't rule out going as far as nationalizing Opel to keep it afloat. Other options are providing billions of euros in state loan guarantees or direct subsidies similar to the bailouts Berlin has granted Germany's financial sector. GM added urgency to the debate overnight by announcing it plans to reduce its global workforce by 47,000 jobs this year and to cut five additional US plants by 2012. It also said it needed up to $30 billion in government aid and that it would run out of cash as soon as March unless it gets fresh state funds.
That has sparked fears of insolvency at Opel, which employs 26,000 workers at four German plants in Rüsselsheim, Bochum, Kaiserslautern and Eisenach. The potential impact of cuts is even greater if auto components suppliers are included. So far, GM appears not to have decided on the future of Opel. GM CEO Rick Wagoner said the group was talking to the German government and other parties and reviewing all options. He said the restructing involved the closure or sale of plants in Europe, but didn't give details whether and to what extent Opel and GM's other European units Vauxhall of Britain and Saab of Sweden would be affected. Now the German federal government, along with governments of those states home to Opel factories, are in a quandary.
There's a general election in September and it would be political suicide to refuse government assistance to car workers months after bailing out the financial sector with hundreds of billions of state aid. The problem, say German media commentators, is that helping out Opel will open a floodgate of demands for state aid from other German manufacturers struggling with the economic downturn. And the state can't afford to bail out the whole economy. Besides, some commentators say, Opel has made some key management mistakes in recent years, which partly explains why it is among the first big European auto manufacturers to get into trouble.
Center-left Süddeutsche Zeitung writes:
"It's doubtful that saving Opel with taxpayers' money would be in the public interest. The billions of euros of state aid will be applauded at Opel's sites in Bochum, Eisenach or Rüsselsheim -- but most Germans are unlikely to be prepared to pay higher taxes to rescue one industrial company after another. If you help Opel, you're also going to have to help Volkswagen, BMW or Daimler. And if you spend billions rescuing the carmakers, you're also going to have to bail out the big parts suppliers. And the engineering firms that deliver the production lines for the auto industry."
Conservative Die Welt writes:
"The debate shows the dilemma faced by the federal and regional governments in trying to rescue Opel. They're trying to portray Opel as a special case because a supposedly healthy company is being pulled down by its US parent company. But Opel is anything but a special case. If it's rescued there will immediately be questions about which other companies also deserves state aid. So far, virtually every politician has declined to answer those questions. That turns the rescue of individual companies -- which fundamentally isn't the job of the governments -- into a matter of gut feeling. If influential politicians believe they can win votes by paying out government aid, the chances of a company getting rescued improve. But that's got to be the worst criterion for apportioning state aid."
Business daily Handelsblatt writes:
"In this country there's a very broad coalition forming in favor of protecting jobs. It extends from left-wing trade unions to conservative regional governments. And with general elections in just seven months, Berlin too is unlikely to oppose moves to help the carmaker with billions of euros. What party would have the courage to enter an election campaign after having refused to protect jobs at (Opel) plants in Bochum and Rüsselsheim while having spent billions on bailing out ailing banks? But one should nevertheless warn Berlin and the rest of the country against helping out the company. That's because Opel is almost as sick as GM. It would be a miracle if Opel were to be resurrected from the ruins of the (GM) empire. Opel is synonymous with years of strategic errors and poor brand management, with a thinned-out distribution network and highly complicated corporate structures. That's why Opel has such a poor hand to deal in the European automaking game.
It's the worst player, and that's why it is rightly the first to be affected in the crisis. It was necessary for the state to shell out billions to rescue banks to prevent a collapse of the economic system. But rescuing Opel could cause an avalanche that could tear politicians down with it. Where and when should the state draw the line with life-saving measures? Germany and the world are in a deep recession and it doesn't look as if things will improve anytime soon. The bleak weeks ahead of us will pose a major challenge for governments. The market economic order will only remain able to function if it allows corporate collapses. It's a bitter message to the Opel employees. But it would be dishonest to keep silent on the truth. Billions here or there, Opel will find it hard to stay alive."
Germany may rescue debt-laden EU members
Germany has acknowledged for the first time that it may have to rescue eurozone states in acute difficulties, marking a radical shift in policy by the anchor nation of Europe's monetary union. Finance minister Peer Steinbruck said it would be intolerable to let fellow EMU members fall victim to the global financial crisis. "We have a number of countries in the eurozone that are clearly getting into trouble on their payments," he said. "Ireland is in a very difficult situation.
"The euro-region treaties don't foresee any help for insolvent states, but in reality the others would have to rescue those running into difficulty."
Credit default swaps (CDS) measuring risk on Irish debt rose to 386 basis points yesterday despite Berlin's show of support, suggesting that the markets remain sceptical over hard-line German financier's change of heart. The CDS on Austrian debt surged to 180 on fears of banking contagion from Eastern Europe, while Greece, Belgium, Italy and Spain have all seen a surge in default costs. However, it is clearly Ireland that is now in the eye of the storm as Dublin struggles to prevent the budget deficit spiralling up to 12pc or even 13pc of GDP as the economy contracts. Fears are mounting that Ireland may not be able to cover the massive liabilities of its banking system.
The Maastricht Treaty prohibits eurozone bail-outs by EU bodies but Article 100.2 allows for aid to countries facing "exceptional occurrences beyond its control". The European Investment Bank is already providing aid by steering project finance to regions in distress. This could be expanded subtly into short-term help. Ultimately, the European Central Bank could purchase bonds from vulnerable countries in the open market. That would amount to a full monetary bail-out, and the de facto creation of an EU debt union. Such proposals have been anathema to Germany in the past.
Switzerland threatened with bankruptcy
In an interview with Swiss daily Tagesanzeiger, a well-known economist has warned that Switzerland risks bankruptcy, if the recent market turmoil centering on Eastern Europe is not contained quickly. At issue are loans made in Swiss francs to Eastern European debtors. With many countries in the region falling into depression, currencies and asset prices are plunging. Therefore, debtors domiciled in Eastern Europe are increasingly expected to have difficulty with mounting foreign debt loads — and that spells trouble for Switzerland. Below is my translation of the Tagesanzeiger article.Switzerland threatened with bankruptcy
Swiss banks have given billions of credit to eastern europe - now the customers cannot pay back the money. Switzerland is threatened with the fate of Iceland, says economist Arthur P. Schmidt. In countries such as Poland, Hungary and Croatia, the Swiss franc has become an important currency. Thousands of households and small firms took out loans in Swiss francs, and not in the national currency zloty, forint, or kuna because of lower interest rates. In Hungary, 31 percent of all loans are in Swiss currency. Amongst household loans, they are almost 60 percent.
Now, the financial crisis has ended the era of cheap credit. As a result, Eastern European currencies are falling. At the end of September, one had to pay 46 francs for 100 Polish zlotys. Today it is 30 francs. That means more and more borrowers are having problems with interest payments and repayment. So the question is what effect this has on the Swiss financial marketplace. One who sees a dark future for Switzerland is economic expert Artur P. Schmidt. He believes that the Swiss franc is in danger because of the loans in Eastern Europe.
In Poland, Hungary and Croatia, the Swiss franc has become an important foreign currency - the dollar, so to speak, of Eastern Europe. Thousands of households and businesses have franc loans. Why?
The rapid growth in many countries of Eastern Europe was stimulated through loans in Swiss francs. Swiss banks and offshore institutions loaned the local banks francs, which passed the francs onto their customers. The loans were attractive because borrowers pay interest rates much lower than required for loans in local currency.
Now, this system has been shaken?
Yes, the system has only worked as long as the exchange rate between the franc and the currencies were reasonably stable. But that is not currently the case. For example, the Hungarian forint and Polish zloty have lost over a third of their value against the Swiss franc in recent weeks. Because of the devaluations of the national currencies, the debt to Switzerland has increased by more than one-third. Many of the Eastern European countries have serious payment difficulties, and are virtually bankrupt.
What does this mean for Switzerland?
It is likely that a significant proportion of the total 200 billion U.S. dollars of Eastern European loans were issued in Swiss francs. According to a report by the Bank for International Settlements worldwide franc loans equivalent to around 675 billion U.S. dollars are in circulation - which was about 150 billion directly from Switzerland, 80 billion of Great Britain and about 430 billion U.S. dollars through offshore financial centres. How many of these loans have gone bad is not known. But even if the failure rate is 20 percent, the banks would lose a lot of money.
Is the federal government going to intervene now?
If the banks require a massive writedown of such loans, above a certain magnitude, the government must intervene. This is already happening via the Swiss National Bank. In Poland, it has made several billion francs available to the local central bank so that Polish banks can cover the loans. At the same time, the Swiss National Bank inquired by the European Central Bank whether it could borrow money in an emergency. This is a clear warning sign that the Swiss franc could be under huge devaluation pressures in the near future.
Swiss banks were too careless in their lending in Eastern Europe?
Yes, indeed. Many bankers wanted to earn a lot and neglected the risks. The National Bank is also at fault as it did not intervene. In addition, the regulator and the politicians completely failed.
What must Switzerland do now?
Now, the possible losses caused by these loans must be made transparent. Above all, all of the Eastern European risks must be fully disclosed. Together with the loan losses from UBS and Credit Suisse, the entire writedown for Switzerland could exceed the Swiss gross domestic product.
That is to say?
Switzerland, like Iceland, is threatened with a potential national bankruptcy. One consequence would be that the Swiss currency could fall massively in value — possibly even crash. Another would be that Switzerland’s credit rating would be massively downgraded. That would be a trauma for the country: Switzerland was always as a stronghold of stability. The franc could become an unstable soft currency. Then Switzerland would perhaps be forced to abandon the franc and take on the euro.
This article fills in a lot of gaps for me. Two weeks ago, I happened to catch another post in the Swiss press about the Swiss government issuing debt in U.S. Dollars. In my post "Why are the Swiss now issuing debt in U.S. Dollars? I asked an open question as to why the Swiss were issuing debt in dollars. No one knew and I had yet to hear a satisfactory answer to this question. However, my post also pointed to central bank swap lines between Switzerland and a number of countries in Eastern Europe as a related event.
The Tagesanzeiger article makes clear that these swap lines are needed due to Eastern European exposure to loans in Swiss Francs. I expect the U.S. dollar swap lines and dollar debt issuance are related - as are the Euro swap lines with the ECB - for liquidity in case of emergency. These machinations are a testament to the continued fragility of the global financial system. The interconnectedness across currencies and countries is staggering. One domino falls and the whole global financial system is at risk. Welcome to the dark side of globalisation.
Banks Reel On Eastern Europe's Bad News
Fears of a full-blown economic crash in Eastern Europe shook the region's currencies and the share prices of Western banks doing big business there, helping to spur a new shock to financial confidence around the globe. Some market analysts warned of a regional economic collapse on the scale of the Asian crisis in the late 1990s, as a report by the Moody's ratings agency warned it may downgrade banks active in Eastern Europe. The cost of insuring government debt from Poland to Russia rose further, while currencies fell. The Hungarian forint slid to an all-time low Tuesday against the euro. Poland's zloty fell to a near-low against the euro, and is down by a third since August, prompting Warsaw to announce Tuesday it would intervene to prop up the currency if it fell further. The euro itself fell 1.33% against the U.S. dollar to $1.26.
The new evidence of enduring problems for Western banks -- and for the emerging markets they've invested in -- helped markets tumble around the globe, with financial stocks leading the way down. In the U.S. the Dow Jones Industrial Average fell 3.8% and the more financial-heavy Standard & Poor's 500-stock index dropped 4.6%, both nearing recent lows. The STOXX Europe (600) banking index shrunk more than 6%, and banks with heavy Eastern Europe investment dived as much as 10%. Asian shares slid Tuesday as well. Bad news among ex-communist nations came from as far afield as oil-rich Kazakhstan in Central Asia -- treated as part of the same emerging-market region as Eastern Europe -- where the country's biggest bank faced a run by depositors. Ukraine posted a 34% drop in industrial output for January compared with a year earlier, and a 16% drop from December, in part a result of the gas-pricing dispute with neighboring Russia. After years in which Eastern Europe attracted investment for its fast growth and increasing financial ties with Western counterparts, the region's fortunes have abruptly reversed -- largely the result of oversized dependence on foreign-currency loans that now are leading to rising defaults, and fast-dwindling demand by its Western neighbors for its exports amid the global slowdown.
"To us this looks like a market meltdown on the same scale as occurred during the Asian crisis of 1997" that began with the devaluation of the Thai baht, said Lars Christensen, chief analyst at Denmark's Danske Bank Group, in a research note Tuesday. Mr. Christensen wrote a paper in 2006 accurately predicting the eventual meltdown in Iceland. "Doubtless the markets have decided that the region is the subprime area of Europe and now everyone is running for the door," the note said. The volume of capital flowing into emerging European economies is expected to fall to just $30 billion in 2009, from $254 billion in 2008, according to Institute of International Finance, an association of the world's largest banks. The group called the swing "unprecedented in scale." It expects foreign bank lending to swing to the negative by $27.2 billion in 2009, meaning banks will collect more than they loan. Deep slides in currencies raise the prospect of widespread defaults on foreign-currency loans marketed by a growing roster of foreign-owned banks and taken out by businesses and individuals, who were attracted by better interest rates offered in euros and Swiss francs. Now those troubled loans are boomeranging on the Western banks that charged into the region in the past decade, competing heavily to buy up local banks and establish subsidiaries in what was Europe's biggest growth area.
Austria-based banks, for example, had some €278 billion in exposure to emerging Europe, according to September statistics from Bank for International Settlements. That equals nearly two-thirds of Austria's gross domestic product. A "special comment" published Tuesday by Moody's Investors Service Inc. warned that euro-zone banks -- notably in Austria, France, Italy, Belgium, Germany and Sweden -- with significant exposure to East European economies may be downgraded. The Moody's report said economies across Central and Eastern Europe, the Balkans and the ex-Soviet bloc "have now entered a deep and long economic downturn." The economic distress and currency tumbles in Eastern Europe will "trigger a write-down into the Western European banking system," says Hans-Guenter Redeker, a currency strategist at BNP Paribas in London. "The question is how much." He says a conservative estimate would be about 20% of the total invested by such banks in the region. Moody's estimated the total at $1.3 trillion at the start of 2008.
The Moody's report said parent banks might now reduce support for subsidiaries in Eastern Europe, a move that could further hit growth. But Italy's UniCredit SpA, which was down 7.4% at €1.12 a share on Tuesday, said fears of imminent disaster are overplayed. "We won't come short on our funding to Central and Eastern European subsidiaries," said Federico Ghizzoni, who runs UniCredit's emerging-markets division. UniCredit's 2008 profit in Central and Eastern Europe, to be released with group results next month, was above target, he said. Shares in Austria's Raiffeisen International Bank-Holding and Erste Group Bank AG fell 8.3% and 7.5% on Tuesday, respectively. Also hit were Belgium's KBC Group, whose shares slid 13%, and France's Société Générale SA, off 9.6%.
The Moody's report spilled over to the government bond markets, where investors already were demanding ever-higher yield premiums to hold debt issued by countries other than Germany. The yield premium for 10-year Austrian bonds widened to 1.27 percentage point, from 1.17 percentage point Monday, meaning the price rose to insure sovereign debt against default. The developments come as growth forecasts for 2009 across Europe already have been plummeting, along with exports and domestic demand. In Poland, where Finance Minister Jacek Rostowski in October called his country "immune" to the global financial crisis, the government has slashed its 2009 growth forecast to 1.7% from a range of 4.6% to 5%. Many economists believe its economy actually will contract in 2009. Polish Prime Minister Donald Tusk sought Tuesday to put a floor under the zloty, saying his government would use European Union funds to support the currency if it fell below five zloty to the euro. Poland is budgeted to receive €67 billion from 2007 to 2013 in EU aid.
Poland, like several other ex-communist bloc countries that joined the EU in recent years, is committed to adopting the euro. That expectation has helped fuel foreign investment, and also tends to make euro-denominated loans look less risky, as countries need to push their currencies into a band against the euro in the two years before joining. For Poland, that would start next year. But to join the common currency, countries also have to stay within a budget deficit limit of 3% of GDP -- a tall order for developing countries and even tougher as governments try to spend their way out of recession.
Gold hits record against euro on fear of Zimbabwean-style response to bank crisis
Gold has surged to an all-time high against the euro, sterling, and a string of Asian currencies on mounting concerns that global authorities are embarking on a "Zimbabwe-style" debasement of the international monetary system. "This gold rally is driven by safe-haven fears and has a very different feel from the bull market we've had for the last eight years," said John Reade, chief metals strategist at UBS. "Investors are seeing articles in the press saying governments should deliberately stoke inflation, and they are reacting to it." Gold jumped to multiple records on Tuesday, triggered by fears that East Europe's banking crisis could set off debt defaults and lead to contagion within the eurozone.
It touched €762 an ounce against the euro, £675 against sterling, and 47,783 against India's rupee. Jewellery demand – usually the mainstay of the industry – has almost entirely dried up and the price is now being driven by investors. They range from the billionaires stashing boxes of krugerrands under the floors of their Swiss chalets (as an emergency fund for total disorder) to the small savers buying the exchange traded funds (ETFs). SPDR Gold Trust has added 200 metric tonnes in the last six weeks. ETF Securities added 62,000 ounces last week alone.
In dollar terms, gold is at a seven-month high of $964. This is below last spring's peak of $1,030 but the circumstances today are radically different. The dollar itself has become a safe haven as the crisis goes from bad to worse – if only because it is the currency of a unified and powerful nation with institutions that have been tested over time. It is not yet clear how well the eurozone's 16-strong bloc of disparate states will respond to extreme stress. The euro dived two cents to $1.26 against the dollar, threatening to break below a 24-year upward trend line. Crucially, gold has decoupled from oil and base metals, finding once again its ancient role as a store of wealth in dangerous times.
"People can see that the only solution to the credit crisis is to devalue all fiat currencies," said Peter Hambro, chairman of the Anglo-Russian mining group Peter Hambro Gold. "The job of central bankers is to allow this to happen in an orderly fashion through inflation. I'm afraid it is the only way to avoid disaster, but naturally investors are turning to gold as a form of wealth insurance." One analyst said the spectacle of central banks slashing rates to zero across the world and buying government debt as if there was no tomorrow feels like the "beginning of the 'Zimbabwe-isation' of the global economy". Gold bugs have been emboldened by news that Russia has accumulated 90 tonnes over the last 15 months. "We are buying gold," said Alexei Ulyukayev, deputy head of Russia's central bank. The bank is under orders from the Kremlin to raise the gold share of foreign reserves to 10pc.
The trend by central banks and global wealth funds to shift reserves into euro bonds may have peaked as it becomes clear that the European region is tipping into a slump that is as deep – if not deeper – than the US downturn. Germany contracted at an 8.4pc annual rate in the fourth quarter. The severity of the crash in Britain, Ireland, Spain, the Baltics, Hungary, Ukraine and Russia has shifted the epicentre of this crisis across the Atlantic. The latest shock news is the 20pc fall in Russia's industrial production in January. The country is losing half a million jobs a month. Markets have been rattled this week by warnings from rating agency Moody's that Austrian, Swedish and Italian banks may face downgrades over their heavy exposure to the ex-Soviet bloc. The region has borrowed $1.7 trillion (£1.2 trillion) – mostly from European banks – and must roll over $400bn this year.
Austria's central bank governor, Ewald Nowotny, said the regional crisis had become "dangerous" and called for a pan-EU rescue strategy to prevent contagion. Bartosz Pawlowski, from TD Securities, said the recent plunge in currencies across Eastern Europe had come as a brutal shock. "The rout could potentially lead to substantial problems, if not an outright collapse of the financial system," he said, citing the rising real burden of debt taken out in euros and Swiss francs. Even Poland – a pillar of stability in the region – may ultimately need a bail-out by the International Monetary Fund. Latvia, Hungary, Ukraine and Belarus have already been rescued. Romania's premier, Emil Boc said his country would decide over the next two weeks whether to seek an IMF loan. Turkey is next.
Obama Says Canada Just Needs Technology To Fix Oil Sands Problems
President Barack Obama is heading up to Canada on Wednesday Thursday to chat with Prime Minister Stephen Harper, as David mentioned earlier. The two are slated to discuss, among other things, trade, climate change, and tar sands. Harper is expected to encourage Obama to support a partnership between the neighboring nations that protects Alberta's tar sands from greenhouse-gas regulation. A coalition of 15 environmental groups has launched a campaign urging Obama to reject Harper's proposals, noting that tar-sands operations emit massive amounts of greenhouse gases (not to mention the numerous other ways in which they despoil the environment).
In an interview with the Canadian Broadcasting Corporation (CBC) set to air tonight, Obama was asked specifically about the tar sands. While he acknowledged that tar-sands oil "creates a big carbon footprint," he didn't rule out the use. Instead, he compared it to the United States' problem with coal, suggesting that new technologies to capture and sequester carbon emissions could solve the problem. "Ultimately I think this can be solved by technology," said Obama. "I think that it is possible for us to create a set of clean energy mechanisms that allow us to use things not just like oil sands, but also coal. The United States is the Saudi Arabia of coal, but we have our own homegrown problems in terms of dealing with a cheap energy source that creates a big carbon footprint." Here's the relevant portion of the transcript:Q. Part of that trade involves the energy sector, a lot of oil and gas comes to the United States from Canada, and even more in the future with oil sands development. Now there are some in your Canada -- and Canada, as well -- who feel the oil sands is dirty oil because of the extraction process. What do you think; is it dirty oil?
THE PRESIDENT: What we know is that oil sands creates a big carbon footprint. So the dilemma that Canada faces, the United States faces, and China and the entire world faces is how do we obtain the energy that we need to grow our economies in a way that is not rapidly accelerating climate change. That's one of the reasons why the stimulus bill that I'll be signing today contains billions of dollars towards clean energy development.
I think to the extent that Canada and the United States can collaborate on ways that we can sequester carbon, capture greenhouse gases before they're emitted into the atmosphere, that's going to be good for everybody. Because if we don't, then we're going to have a ceiling at some point in terms of our ability to expand our economies and maintain the standard of living that's so important, particularly when you've got countries like China and India that are obviously interested in catching up.
Q. So are you drawing a link, then, in terms of the future of tar sands oil coming into the U.S. contingent on a sense of a continental environment policy on cap and trade?
THE PRESIDENT: Well, I think what I'm suggesting is, is that no country in isolation is going to be able to solve this problem. So Canada, the United States, China, India, the European Union, all of us are going to have to work together in an effective way to figure out how do we balance the imperatives of economic growth with very real concerns about the effect we're having on our planet. And ultimately I think this can be solved by technology.
I think that it is possible for us to create a set of clean energy mechanisms that allow us to use things not just like oil sands, but also coal. The United States is the Saudi Arabia of coal, but we have our own homegrown problems in terms of dealing with a cheap energy source that creates a big carbon footprint. And so we're not going to be able to deal with any of these issues in isolation. The more that we can develop technologies that tap alternative sources of energy but also contain the environmental damage of fossil fuels, the better off we're going to be.
Q. I know you're looking at it as a global situation, in terms of global partners, but there are some who do argue that this is the time; if there was ever going to be a continental energy policy and a continental environmental policy, this would be it. Would you agree with that thinking?
THE PRESIDENT: Well, you know, I think one of the -- one of the promising areas for not just for bilateral but also trilateral cooperation is around this issue. I met with President Calderón here in the United States, and Mexico actually has taken some of the boldest steps around the issues of alternative energy and carbon reductions of any country out there. And it's very rare for a country that's still involved in developing and trying to raise its standard of living to stay as focused on this issue as President Calderón's administration has.
What I think that offers is the possibility of a template that we can create between Canada, the United States and Mexico that is moving forcefully around these issues. But as I said, it's going to be important for us to make sure that countries like China and India, with enormous populations and huge energy needs, that they are brought into this process, as well.
Bank of Canada Governor worried over Canadians' debt
Bank of Canada Governor Mark Carney is expressing worry about the level of Canadians' household debt. In a television interview Tuesday, Mr. Carney said that after the global recession and the turmoil in global finance – which he called "issue No. 1 and issue No. 2" – the other thing that causes him some worry is the double-digit growth in Canadian household borrowing.
"When you look at the structure of the Canadian economy, the issues over which we have concern would include the level of household debt and household finances," Mr. Carney said when asked about the biggest risks facing the economy. The ratio of household debt to disposable income has bulged to 130 per cent, a higher level than in the United States, according to a recent report by consultancy Deloitte & Touch LLP. Outstanding credit card balances in Canada are $80-billion, a 40 per cent increase from 2004, according to Deloitte.
Mr. Carney said he expects that growth of household debt to slow as the recession reduces demand for purchases and makes credit more expensive. The Bank of Canada chief also emphasized that Canada's households were in better shape than those in many other richer countries. "As a whole in the Canadian economy, we do not have the imbalances, the excesses that a number of our G7 partners have," Mr. Carney said in the interview, which was taped in Ottawa. "There are issues from our perspective in terms of the trend of household debt and we are expecting it, as I say, to come off. But in absolute terms, or in relative terms, it is not as severe."
Canadian Manufacturing’s Steepest Tumble on Record
For the fifth straight month, in what is the worst time for the energy and automotive sectors, with worse to come, Canadian manufacturers' sales have taken their steepest tumble in 17-years. Benoit Durocher, and economist with the Desjardins Group comments: 'The bad news just keeps on coming for Canada 's economy, with another record decline being beaten'. According to Statistics Canada, December saw large shifts in international investment, as Canadians pulled $6.4-billion worth of foreign securities from abroad, a reflection of global instability, as they returned funds to the Canadian economy, even while, foreigners rid their holdings of an 'unprecedented' $2.8-billion of Canadian bonds.
December also saw a tally of 129,000 jobs lost, pushing unemployment to a four-year high of 7.2%, a rate one anticipates will swell, causing Jock Finlayson, executive vice-president of the Business Council of British Columbia to say: 'This is going to be a nasty recession. It's not going to be shallow or short. It looks like it's going to be deep. The only question is how protracted it is going to be.' Neither does Finance Minister Jim Flaherty expect things to improve any time soon, as he told a meeting of Group of Seven finance ministers in Rome over the weekend, he expects 'numbers of all kinds to continue getting worse month after month this year'.
While it is not yet official, the Canadian economy likely entered a recession in the final three months of last year, with no region in Canada insulated from weakening demand caused by the year-old U. S. recession. 'It's coast-to-coast,' says economist Marc Pinsonneault of National Bank Financial. 'This reveals how the U. S. recession, and the global economy, is taking its toll on Canadian manufacturing.' However, he does believe a recovery should emerge in the second half of the year, around the same time he expects the long U. S. recession to end.
Canada's Dollar Depreciates for Second Day on 'Doom and Gloom' Forecasts
Canada’s currency weakened for a second day, touching the lowest in almost a month as worries eastern European banking losses will drive the global economy deeper into recession increased the appeal of relatively safe assets like the U.S. dollar and Japanese yen. "The Canadian dollar is weaker because of the same risk aversion we’ve seen everywhere," said Firas Askari, head currency trader in Toronto at BMO Nesbitt Burns, a unit of Bank of Montreal. "It’s the market’s general sense of uncertainty that’s hurting it. As long as that’s present, it’s going to adversely affect the Canada dollar."
The Canadian currency declined 1.8 percent to C$1.2650 per U.S. dollar at 4:40 p.m. in Toronto, from C$1.2425 yesterday. It touched C$1.2674, the weakest since Jan. 22, when it reached C$1.2740. One Canadian dollar buys 79.05 U.S. cents. Equity markets worldwide plunged after Moody’s Investors Service said some of Europe’s largest banks may be downgraded because of loans to Eastern Europe. Canada’s dollar sank a record 18 percent last year as a global recession devastated demand for raw materials, which account for about half the country’s export revenue. The currency has extended that loss by 3.3 percent this year as stocks worldwide tumble, suggesting investors are still spooked.
"The C$1.30 resistance zone is on the radar once again," Shaun Osborne, Toronto-based chief foreign-exchange strategist at TD Securities Inc., wrote in a note to clients today, referring to the upper boundary of a technical trading range. The loonie, as Canada’s dollar is known, reached a four-year low of C$1.3017 on Oct. 28, and has since touched the C$1.30 level twice before rebounding. Osborne predicts the currency will weaken to the mid- to upper C$1.27 level in the "short-term." BMO’s Askari forecasts the loonie will weaken past C$1.28 in the next few days.
Canada’s currency will trade at C$1.26 against the U.S. dollar until the end of June before rebounding to C$1.20 by year- end, according to the median forecast in a Bloomberg News survey of 43 economists. "Longer term, you still have to look to sell U.S. dollars," Askari said. "They’re printing money like drunken sailors." The yield on the two-year government bond dropped five basis points, or 0.05 percentage point, to 1.15 percent. The price of the 2.75 percent security due in December 2010 climbed 8 cents to C$102.81.
Iceland at the brink of failure
Iceland's economic meltdown, fueled by its exposure to foreign debt, could bring the country to the brink of failure, according to research from Hennessee Group LLC. "Iceland had one of the highest standards of living in the world just a few months ago," said Charles Gradante, co-founder of the New York-based hedge fund advisory firm. "Now after experiencing the fastest economic collapse in history, Iceland is suffering from soaring unemployment, as well as double-digit interest rates and inflation." According to Hennessee's research, the primary contributor to the rise and fall of Iceland's economy was its growth as an international lender.
After privatizing the banking sector in 2000, the country's banks went from being largely domestic lenders to major international financial intermediaries with foreign assets worth nearly 10 times Iceland's gross domestic product. This was up from two times GDP in 2003, according to Mr. Gradante. As the markets seized up, Iceland's banks started to collapse under the heap of foreign debt they took on over the years, he said. "Now after experiencing the fastest economic collapse in history, Iceland is suffering from soaring unemployment, as well as double-digit interest rates and inflation," Mr. Gradante said. A study of the external debt in relation to GDP in several countries suggests the risk is not limited to Iceland, according to Hennessee's research.
Like Iceland, Ireland's external debt, at $1.8 trillion, equals 900% of the country's $200 billion GDP. The United Kingdom's external debt of $10.5 trillion equals 456% of its $2.3 trillion GDP. Switzerland's external debt of $1.3 trillion equals 433% of its $300 billion GDP. Even though it might not feel like it right now, the United States is in better shape with $12.3 trillion worth of external debt and a $14.6 trillion GDP for an 84% debt-to-GDP ratio. Mr. Gradante said if more countries start suffering fates similar to that of Iceland, there could be a move toward more protectionist policies where countries favor their own industries at the expense of foreigners.
Britain's AAA credit rating threatened by scale of bank bail-out
Britain could be stripped of its prized AAA credit rating as a result of the Government's latest bank bail-out, potentially jeopardising any economic recovery, according to rating agency Standard & Poor's. S&P only last month confirmed its "stable outlook" for the country's sovereign debt but may now be forced to review the top-notch rating. The change has been prompted by the Government's asset protection scheme – insurance for toxic debt – which will leave the taxpayer exposed to losses on billions of pounds of bad loans made by the banks. A downgrade would be calamitous for the country, which is on course to borrow an extra £500bn over five years, taking the national debt above £1 trillion for the first time.
Should the UK lose its AAA rating or even be put on "negative watch", the country's interest bill would soar – putting further strain on the economy. S&P indicated it might have to revisit the rating in evidence before the Treasury Select Committee last month. Under questioning, Barry Hancock, head of European corporate ratings, said S&P had confirmed the UK's status on the assumption that "up to approximately 20pc of GDP in the form of bank assets could be problematic in the future". With annual economic output running at £1,400bn, 20pc would equate to £280bn. However, it has since emerged that the Treasury is preparing to ring-fence about £400bn of "toxic" bank debt – or 29pc of GDP – to draw a line under the financial crisis. Royal Bank of Scotland is said to want to use the scheme for £200bn alone.
A ratings downgrade or a shift to "negative watch" could be devastating for the Government's planned economic stimulus package. As recently as last November, Frank Gill, S&P's director of European sovereign ratings, raised concerns about the Government's spending plans, warning that net debt above 60pc of GDP could undermine the AAA rating. Economists have forecast debt to reach 70pc of GDP by 2011. S&P has already downgraded the sovereign ratings of Spain and Greece this year. Questioned about the UK, Mr Hancock told MPs: "We are looking at the ratings on an ongoing basis.
If there were major shocks or changes we would look at the rating again." Credit default swaps (CDS) on UK sovereign debt, which act as insurance for borrowers, have risen sharply this year, from 106.9 to 158.6, indicating the market's dwindling faith in the security of UK gilts. Tellingly, the UK has tracked Spain, where CDS have risen from 100.7 to 156.8 this year. George Buckley, chief UK economist at Deutsche Bank, said: "While there is an increased risk of a downgrade it seems very unlikely the UK Government will ever default on its debt commitments." S&P declined to comment further. The Treasury also declined to comment.
Gordon Brown calls for 'grand bargain' to solve global economic crisis
Gordon Brown, the British prime minister, has called for world leaders to strike a "grand bargain" to deal with the economic downturn. He called for co-operation on banking reform and fiscal stimulus packages as he outlined his hopes for the G20 summit of world leaders in London in April. "From the discussions I have had and am about to have... I think we are fashioning for the future a global deal, a grand bargain, where each continent accepts its responsibilities and its obligations to act to deal with what is a global problem that can only be solved with a global solution," he told reporters in London. The Prime Minister was speaking at his regular Downing Street press conference shortly after talks with International Monetary Fund managing director Dominique Strauss-Kahn and World Bank president Robert Zoellick. He will meet European leaders in the coming days.
Mr Brown, who published a document setting out the Government's blueprint for the "Road To The London Summit", said: "America has just announced the biggest fiscal and monetary stimulus in the history of its country. "Every part of the world must be part of the stimulus to the economy, giving support into the economy with investment, getting interest rates down as much as possible, and I believe one of the features of our discussions at the G20 summit on April 2 is how all countries can come together to do that. "Some may have to do more on interest rates; some may have to do more fiscal stimulus. The whole point of the G20 is that the world must take action to deal with a global problem." Co-operation would be required on a "regulatory transformation" of the banking system, including an end to tax havens, he said.
Mr Brown said he believed a "global new deal" was possible. He said: "The old orthodoxies will not serve us well in the future. We've got to think the previously unthinkable, we've got to do what was previously undoable. "The co-operation that's needed around the world is not something that has been achieved before - but I believe it can be achieved to meet the needs of our times." The Prime Minister brushed aside the suggestion that he was tempted to become the "world's financial regulator". He said: "There is no possibility anyway of a job called Global Financial Regulator. I want get on with the job I'm doing. "My priority is to help people in this country who are facing problems with their mortgages, problems with their jobs and problems with small business finance."
Bank of England seeks power to inject more money into economy to fight recession
The Bank of England's Monetary Policy Committee has voted unanimously to seek Goverment permission to increase the amount of money in the economy as interest rate cuts lose their power to fight recession. The 9-0 vote by the MPC was revealed in the minutes of the meeting held on February 5. The Bank's Governor Mervyn King will now write to Alistair Darling, the Chancellor, to ask for approval to introduce measures aimed at raising the supply of money in the economy – known as quantitative easing. The Bank hopes that by increasing the quantity of money in the economy it can encourage banks to increase lending and consumers to start spending.
"The lack of supply credit is the biggest problem facing the UK economy and increasing the supply of central bank money via purchases of government securities should help to loosen these restrictions," said Andrew Goodwin, Senior Economic Adviser to the Ernst & Young Item Club. At the meeting, the MPC voted 8-1 to cut the main lending rate by half a point to 1pc, the lowest since the Bank was founded in 1694. David Blanchflower, who has long argued the UK faces a deep recession, wanted a full point cut. However, other members feared that cutting rates further would stop banks and building societies lending with "potentially adverse consequences for the rest of the economy". Lenders keep a spread between their deposits and lending rates to cover costs and to make a return. The minutes said: "Once those deposit rates were at zero ... banks might decide not to pass on cuts ... in order to mitigate the impact on their profitability."
Ross Walker, UK economist at RBS, said: "The news is the unanimous approval for moving to quantitative easing and seeking the Chancellor's approval." He said while not quite ruling out further cuts, the minutes suggested any further action will be more modest. Vickey Redwood, UK economist at Capital Economics, said: "The minutes of February's MPC meeting reinforce the message from last week's Inflation Report that a significant further policy easing is required and that quantitative easing is imminent." The MPC said it was likely that it would want to consider a range of asset purchases in due course and George Buckley, chief UK economist at Deutsche Bank, said he expected to measures to be in place by the March meeting.
UK companies warned that pensions must come before dividends
The pensions watchdog is warning Britain's major employers to maintain payments to their guaranteed retirement schemes despite concerns that the widening deficits in the funds will lead to steep cuts in dividend payments to shareholders. In a statement to be issued today, the regulator said the trustees of occupational final salary schemes should not bow to pressure from cash-strapped employers to take pension holidays. It said employers might seek to maintain dividend payments at the expense of pension contributions, but this should be resisted.
It said: "When the sponsor company is under pressure there is potential to renegotiate previously agreed plans to repair pension deficits (recovery plans). There is no reason why a pension scheme deficit should push an otherwise viable employer into insolvency. But the pension recovery plan should not suffer, for example, in order to enable companies to continue paying dividends to shareholders." The timing of the warning is likely to dismay investors already concerned that falling profits will have a knock on effect on dividend payments this year. Steep falls in stockmarkets around the world have knocked billions of the value of UK employer retirement schemes. In its latest survey the regulator revealed the deficit had soared to more than £200bn.
The CBI and other employer groups have pleaded with the regulator for a more lenient attitude to pension fund deficits to allow employers to maintain profits and dividend payments. In a review last month the CBI said companies should be given a longer timescale to make up shortfalls in their funds. Today's statement from the regulator is expected to be seen as an opening salvo in an intensely fought war with employers that are currently finalising their year-end accounts and taking a decision on dividend payment levels.
All employers have committed to reduce the deficits in their funds over a maximum of 10 years following discussions with the regulator. Employers have already poured billions of pounds into their retirement schemes in recent years to boost funding levels, but they fear they will be asked to give even more just as the economy is turning sour. The regulator believes that finance directors are preparing to confront pension scheme trustees to argue that the sponsoring company will be placed in jeopardy unless it is granted a payment holiday. Trustees should tell the company to raise money from other sources to fund dividend payments, the regulator said, before seeking to cut their contributions to a scheme in deficit.
Berlin Paves the Way for HRE Mortgage Bank Expropriation
German mortgage bank Hypo Real Estate has already taken on €102 billion of state aid. Now, Chancellor Merkel's cabinet has agreed on a draft law that would give Berlin the option of seizing control of the wobbling bank. Chancellor Angela Merkel's cabinet agreed on Wednesday morning to changes in the country's bank bailout law that would allow the country to expropriate shareholders of the crisis-ridden Munich-based mortgage lender Hypo Real Estate. The news comes just a week after total government aid to HRE -- in the form of bailouts and guarantees -- topped €102 billion. The draft law would allow the federal government to initiate expropriation proceedings until June 30. "The deadline makes it clear that the option of nationalization as a step toward stability is one which will not be available in the long term and is only conceived as a contribution to meeting the challenges presented by the financial crisis," the bill reads.
Sources within the Social Democrats -- junior partner in Merkel's governing coalition -- were more direct in their assessment of the bill. "For us it was clear," an SPD official told SPIEGEL ONLINE. "Expropriations must be possible so that one isn't open to blackmail by the locusts," he said, using SPD zoological shorthand for financial speculators. The agreement makes it clear that expropriation remains a step of last resort, an effort to silence critics worried about what may become Germany's first forced bank nationalization since the 1930s. Berlin seeks to gain control of 95 percent of HRE stock in an effort to prevent the lender from failing -- a collapse that would be comparable to the bankruptcy of Lehman Brothers in the US.
The draft law would most directly affect the New York-based private equity group JC Flowers & Co., which owns 24 percent of HRE's shares. HRE was among the first of Germany's financial institutions to be dragged down by the financial crisis as liquidity problems leapt across the Atlantic Ocean from the US. As early as Jan. 2008, the bank had to write down €390 million. The situation only got worse from there, with leading German banks together with the federal government agreeing to a €50 billion bailout package for the bank last October. Once Germany's €500 billion bank bailout bill was passed later that month, HRE was the first to take advantage, to the tune of an additional €15 billion.
As state help has risen, the value of HRE stock has plunged. Since the end of September, share prices have dropped by 92 percent and on Tuesday stood at a paltry €1.13 per share. JC Flowers bought its 24 percent stake in the bank last April for €1.1 billion -- when shares were going for €22.50. Senior Berlin officials spent last week meeting with JC Flowers representatives about a buyout, but the two sides could not agree on a share price. Now, opponents of the expropriation bill are weighing a constitutional challenge should it become law. DSW, a German shareholders advocacy group, said it was already looking into filing a complaint. The expropriation bill, DSW's Klaus Nieding told Reuters on Wednesday, "is a fatal signal for investors in Germany and worldwide." Critical voices have also come from the business-friendly Free Democratic Party and from German industry, both agreeing with Nieding that Germany's image will suffer. "That is complete nonsense," said Merkel of the critique on Tuesday. Her government, she pledged, will not allow HRE to fail.
Lithuania presses EU to tackle crisis
Eastern Europe is being plunged deeper into recession by western Europe’s banking crisis and needs co-ordinated help from the European Union, according to Andrius Kubilius, the Lithuanian prime minister. "It would be good to see a more co-ordinated approach from the EU authorities," Mr Kubilius told the Financial Times during a visit to Stockholm. "We are all suffering in a similar way from the credit crunch and the recession." He also warned that financial sector turmoil in Ukraine and Russia could worsen the region’s plight. "We are worried about what can happen in Ukraine and Russia," Mr Kubilius said.
"The collapse of one of these big markets would have a very negative impact on the whole region."Most of east Europe is now expected to follow west Europe into recession this year as export markets contract and foreign banks cut lending to their local subsidiaries. This will ricochet back onto western European banks and economies. This week equity and currency markets plunged after a warning from Moody’s that several banks risked rating downgrades because of looming problems at their eastern European subsidiaries. Some west European banks have already appealed to Brussels to support lending in eastern Europe and EU leaders will discuss the region’s problems at a summit on March 1.
Mr Kubilius said Baltic companies were complaining that foreign banks were tightening lending conditions, preventing them getting credits to pursue export opportunities. "Sometimes we would like to see a more positive attitude, especially when business is not in a bad shape," he said. The Baltic states entered recession last year after a consumption and real estate bubble burst and are expected to contract by up to 10 per cent this year. Mr Kubilius pointed out that the Baltic states were in an especially difficult position because, to defend their fixed exchange rates, they had to tighten rather than loosen fiscal policy and their exports had become less competitive compared to countries with depreciating currencies.
Nevertheless Mr Kubilius said Lithuania did not yet need to follow neighbouring Latvia and seek help from the International Monetary Fund. "We don’t have any real need for IMF lending," Mr Kubilius said. "We are controlling our budget deficit and we don’t have any real problems at the moment with local banks." Last week Reinoldijus Sarkinas, governor of the central bank, told parliament that it would be helpful if the government had a prior agreement with the IMF that it would provide funding if needed. However, Mr Kubilius said this could be counter-productive: "There is a stigma [in seeking IMF help] that we want to avoid," he said. "We can still borrow in the private market and we hope that in the second half of the year there will be a more positive international market."
Fall in eastern Europe currencies prompts policy rethink
Central European central banks looked set to at least verbally support their weakening currencies following a statement by the hawkish deputy government of the Czech central bank that the current cycle of interest rate cuts had ended. "Cutting interest rates is absolutely out of the question now given the going exchange rate," Miroslav Singer said in an interview with the E15 daily published on Wednesday. "The question is to raise and by how much." The Czech koruna closed Tuesday at Kc29.68 to the euro, its lowest rate in three years, but was up slightly on Wednesday morning. The Polish government has also broken from its past reluctance to comment on the value of the zloty, one of the region's worst performing currencies against the euro and the dollar. Donald Tusk, prime minister, said on Tuesday that the government may begin to purchase zlotys with the €3.2bn it holds in European funds if the rate drops to 5 zloty to the euro. On Tuesday, the zloty closed at 4.88 to the euro and 3.89 to the dollar, rates last seen five years ago.
The zloty's weakness has prompted members of the central bank's interest rate setting monetary policy council to say that rate cuts this month are increasingly unlikely. Markets had been expecting a cut of up to 50 basis points. The council has cut the rate by 1.75 points to 4.25 per cent since November in a bid to support the rapidly slowing economy. "Even radical options have to be considered," Andrzej Wojtyna, a council member, told Bloomberg. "It is possible that some sort of an interest rate increase may have to be discussed." The zloty has also fallen on worries about currency options bought by many companies last year when the zloty was strengthening against the euro. The Financial Supervision Authority, the markets regulator, estimates that companies could face losses of up to 15bn zlotys (€3.1bn) due to ill-timed hedges. The government had mooted the idea of allowing companies to back out of their contracts, but abandoned the idea after it raised concerns about Poland's international credibility. The Czech central bank last cut interest rates earlier this month by half a point, and the rate now stands at 1.75 per cent, the lowest since 2005.
Downgrades Loom for Hungary, Poland, Bond Yields Show
Hungarian, Polish and Czech government debt, among the highest rated in emerging markets, has already been downgraded by bondholders.
Investors are demanding 20 basis points more yield to own Hungary’s bonds than similar-maturity Brazilian debt, which is rated four levels lower by Moody’s Investors Service, JPMorgan Chase & Co. indexes show. The risk of Poland defaulting is about the same as Serbia, ranked six levels lower by Standard & Poor’s, based on credit-default swap prices. Czech 10-year bonds yield the most compared with German bunds since 2001. "Everybody is running for the door," said Lars Christensen, head of emerging-market strategy at Danske Bank A/S in Copenhagen. "The markets have decided the central and eastern European region is the subprime area of Europe."
Investors who lost more than 18 percent on emerging-market sovereign and corporate bonds last year based on Merrill Lynch & Co. indexes now face steeper declines in Eastern Europe, said Christensen. While the region’s integration with the European Union spurred foreign investment earlier this decade, Poland’s currency weakened 35 percent against the euro since August, the Czech economy cooled to the slowest pace in almost 10 years in the fourth quarter and Hungary required a bailout from the International Monetary Fund. "Hungary is the one that we are monitoring very closely," Dietmar Hornung, senior analyst in Frankfurt, said in a phone interview today. "The ratings as they are reflect to a certain degree the assumption that it is rating positive to be a European Union country."
Hungary’s bonds lost nearly 12 percent last year after returning 9.4 percent in 2007 and returns on Poland’s bonds shrank to 1.3 percent from 9.1 percent in the same period, Merrill indexes show. Investors in Romania’s bonds, which are yielding nearly double those of Egyptian debt rated one level lower in non-investment grade, lost more than 12 percent last year, the indexes show. Emerging Europe will post an average current account deficit of 4.1 percent of gross domestic product this year, more than double the 1.7 percent deficit in Latin America and trailing surpluses in Asia, Africa and the Middle East, according to Citigroup Inc. data on Czech, Poland, Hungary and five other economies the region.
The region’s economies are set to shrink 0.4 percent this year as demand for their exports and commodities falters, from an average 3.2 percent growth in 2008, according to the International Monetary Fund. The IMF granted more than $35 billion in aid to Hungary, Ukraine, Latvia, Serbia and Belarus to avert defaults. "There is no doubt the countries are struggling with large imbalances and significant currency mismatches," Christensen said. "The only way for this to go is weaker currencies and a significant slowdown in domestic demand, leading to more balanced economies." East European stocks slumped to the lowest level in more than five years after Moody’s said yesterday that banks with subsidiaries in the region face rating cuts. The MSCI EM Eastern Europe Index was 6 percent lower at 10:30 a.m. in London. Poland’s WIG20 index declined 3 percent to the lowest in more than five years, after dropping 7.5 percent yesterday.
The Hungarian forint, which weakened to the lowest ever against the euro yesterday, climbed 0.6 percent today. The Polish zloty held near a five-year low and the Czech koruna strengthened 0.7 percent after touching the lowest since 2005 yesterday. The currencies are among the world’s 10 worst- performers this year against the euro. As recently as June 2007, Czech 10-year bonds yielded less than German bunds of similar maturity. The securities now yield 1.63 percentage points more, the highest since 2001, according to data compiled by Bloomberg. The cost of protecting payment on Poland’s debt has risen more than six times in the past six months to 405 basis points, credit-default swaps show. The cost is about the same as on contracts linked to Serbia, which is rated three levels below investment grade at BB- by S&P, Bloomberg data show.
Prices for the contracts rise as perceptions of credit quality deteriorate. A basis point is equivalent to $1,000 on a contract protecting $10 million of debt.
The extra yield investors demand to own Hungarian sovereign or quasi-sovereign bonds instead of U.S. Treasuries has risen almost three-fold in the past six months to 4.71 percentage points, more than the 4.51 percentage point spread for Brazilian debt, JPMorgan data show. "Hungary is the most vulnerable." Frankfurt-based Standard & Poor’s analyst Kai Stukenbrock said in a phone interview. "External leveraging is not as high in Poland. The Czech Republic is the least exposed."
S&P and Moody’s cut Hungary’s credit ratings in November, after the country struggled to service its short-term debt amid the global financial crisis. Hungary’s rating was downgraded to A3 from A2 by Moody’s and to BBB from BBB+ by S&P. Both ratings companies have "negative" outlooks on Hungary, meaning the country’s grade is more likely to be cut again than raised or left unchanged. Poland has an A2 rating from Moody’s and an A- rating from S&P. The Czech Republic has an A1 rating from Moody’s and an A rating from S&P. Both ratings have "stable" outlooks. "The fear of crisis is increasing," said Ralph Sueppel, chief economist and strategist at London hedge fund BlueCrest Capital Management Ltd., which manages about $2 billion in emerging-market assets.
Taiwan’s GDP plunges more than 8%
Taiwan has entered the island’s worst recorded contraction, officials said on Wednesday as a steep slowdown in global electronics sales slammed the export-reliant economy. Asia's sixth-largest economy saw its gross domestic product shrink by 8.36 per cent in the last three months of 2008 compared to a year before, a bigger drop than analysts expected and overshadowing the poor figures reported earlier by export rivals Japan, South Korea and Singapore. For the whole of 2008 the island eked out growth of 0.12 per cent despite the fourth quarter debacle.
Coupled with China’s deceleration, the spreading gloom underlines how this financial crisis that originated in the west is hitting Asia harder than even the region’s own banking and financial crisis of a decade ago. Taiwan's woes spell further gloom for other economies in the region, particularly China, where Taiwanese manufacturers have shifted much of their production and assembly in recent years. Officials forecast that the economic situation would further deteriorate through the first half of the year, projecting that the economy would contract by nearly 3 per cent this year after earlier forecasting growth of more than 2 per cent. The contraction would be Taiwan’s worst annual result.
Exports are now expected to drop by a fifth this year and deflation to return with the consumer price index seen to fall by a record 0.82 per cent over the year. "There is little hope of returning to positive economic growth until the fourth quarter of this year," said Tsai Hung-kun of the national statistics agency. The dire economic performance prompted Taiwan's central bank to make an unscheduled, 25 basis point rate cut on Wednesday, bringing the island's key interest rate to a record low of 1.25 per cent. Yen Tzung-ta, the bank's top economist, told reporters that "by cutting rates, we want to send a signal: the central bank will maintain a loose money policy". The new figures will put further pressure on President Ma Ying-jeou, who was elected on a platform of economic growth last year and has seen his popularity fall to new lows in recent months.
The government has already announced a T$500bn, two-year stimulus package, which includes infrastructure projects, employment-boosting measures and handing out T$85bn in consumer vouchers. Mr Tsai said such government spending would provide a 2.77 percentage point boost to GDP this year. But economists doubted the extent to which the measures would help the economy and said Taiwan still remains at the mercy of the vagaries of global demand. "[The measures] will help but not significantly because they are not of a big enough scale," said Cheng Cheng-mount, chief economist at Citibank in Taipei. "There is still a lot of room for further government spending, as Taiwan's debt-to-GDP ratio is only around 30 per cent".
Goodyear Posts $330 Million Loss, to Trim 5,000 Jobs
Goodyear Tire & Rubber Co., the largest U.S. tiremaker, posted a fourth-quarter net loss of $330 million and said it plans to cut almost 5,000 jobs and continue a salary freeze. The loss, its first in almost two years, was $1.37 a share and compares with net income of $52 million, or 23 cents, a year earlier, the Akron, Ohio-based company said today in a statement. Sales fell 20 percent to $4.14 billion. Goodyear said the loss resulted from lower sales and higher raw material costs, which increased 28 percent. The company said it will curtail expenses by about $700 million and capital expenditures by as much as $800 million this year, while trimming production capacity by as much as 25 million units through 2010. The job cuts will reduce a workforce that stood at about 75,000 employees at the end of last year.
"These actions address the new economic realities," Chief Executive Officer Robert Keegan said in the statement. Goodyear rose 19 cents, or 3.2 percent, to $6.21 at 1:13 p.m. in New York Stock Exchange composite trading. The shares declined 78 percent in the 12 months through yesterday. The loss excluding one-time costs such as expenses related to hurricanes in North America was $1.18 a share, spokesman Keith Price said in an e-mail. That was wider than the $1.14 average of 6 analyst estimates compiled by Bloomberg. Goodyear said it eliminated 4,000 jobs and imposed a salary freeze in the second half of last year. The tiremaker will cut 12 million units of tire production in the first quarter, Chief Financial Officer Darren Wells said on a conference call today with analysts. The company expects raw material prices in the first half to increase as much as 18 percent, Wells said.
The drop in fourth-quarter sales reflected a 19 percent decline in tire volume and a $375 million negative impact of foreign currency translation, according to the statement. North America "was a big disappointment," Himanshu Patel, a JPMorgan Chase & Co. analyst, wrote in a note to investors today. The loss before interest and taxes of $193 million was wider than the $95 million loss that the New York-based analyst projected. He has a "neutral" rating on Goodyear shares. Demand for replacement tires in the U.S. fell an average of 13 percent in the last three months of 2008, Rod Lache, a New York-based analyst at Deutsche Bank, said in a Feb. 12 research note. About 80 percent of Goodyear’s sales come from replacement tires, with the rest from automaker purchases, Price said. About 62 percent of 2007 revenue came from outside the U.S.
Goodyear said it raised a four-year cost cutting target to $2.5 billion from $2 billion. The tiremaker achieved $1.8 billion in savings from 2006 through 2008, according to the statement. The company sold 16.9 million tires in North America last quarter, down 18 percent from a year earlier, and 15.1 million units in Europe, the Middle East and Africa, a drop of 21 percent. Volume declined 27 percent to 4.1 million tires in Latin America and 10 percent to 4.4 million in the Asia-Pacific region. For the full year, Goodyear had a net loss of $77 million as sales declined less than 1 percent to $19.5 billion. In 2007, the tiremaker had net income of $602 million.
Former Morgan Stanley VP accused of embezzlement
A former Morgan Stanley vice president has been indicted on charges of embezzling more than $2.5 million from the investment bank and spending it on high-end cars, expensive vacations and other personal luxuries. Richard Garaventa Jr. of Manalapan, N.J., pleaded not guilty Tuesday at his arraignment in Manhattan's state Supreme Court on 43 counts that include grand larceny, possession of stolen property and falsifying business records. Garaventa stole the money and used it to buy Mercedes and Lexus cars, purchase expensive jewelry, renovate his home, dine at fancy restaurants and take luxury vacations to Florida, Aruba and other places between Sept. 5, 2001, and last Dec. 24, Assistant District Attorney Jeremy Glickman said.
He said Garaventa, 36, was authorized to approve checks for corporate payments from the company's in-house accounts. Garaventa created a company called the New York Transfer Corp. and sent it 50 separate checks in amounts ranging from $8,670 to $74,812, the prosecutor said. The company had no apparent function except to receive the checks, Glickman said. Garaventa "spent this money almost as quickly as it came in," Glickman said. Morgan Stanley called Garaventa "a former rogue employee" and said the allegations represented "direct violation" of the firm's values and policies. "We reported this matter to the authorities and have provided every assistance to their investigation," the firm said in a statement. It declined to provide further information about Garaventa.
The prosecutor said Garaventa's 2008 salary was $125,000, plus a $50,000 bonus. Morgan Stanley fired him on Jan. 7. Defense lawyer Lawrence Fredella says Garaventa maintains his innocence. "There's more to this case than meets the eye," Fredella said. "One might wonder how this might go on for such a long time without being detected by the watchful eye of Morgan Stanley." Garaventa's bail was set at $1 million, and Fredella said he was still in jail Tuesday night. Garaventa faces up to 25 years in prison if convicted.
New York to Spend $45 Million to Retrain Laid-Off Wall Streeters
Just as Michigan is scrambling to retrain laid-off auto workers, New York City officials have come up with a plan to find new work for the unemployed of its core industry: investment banking. Under a program Mayor Michael R. Bloomberg unveiled on Wednesday, the city wants to invest $45 million in government money to retrain investment bankers, traders and others who have lost jobs on Wall Street, as well as provide seed capital and office space for new businesses those laid-off bankers might create. The plan is intended to stem the exodus of talent from the rapidly collapsing financial services industry, which has been the city’s economic engine for decades, and speed the industry’s recovery, which may take years, officials said.
City officials also plan to try to lure big banks and financial companies from Asia and other parts of the world to set up operations in New York, filling some of the void created by the implosion of large American firms like Lehman Brothers and Bear Stearns. They hope to receive permission from the federal and state governments to use $30 million of federal money to attract those companies and other financial firms to Lower Manhattan. Mr. Bloomberg said in a statement that he could not predict how the financial services sector would bounce back, but he said he was confident that it would. “When it does, cities around the world will compete to capture the jobs it brings,” he said. “In New York City, we’re not waiting for that day to come. Instead, we are taking aggressive steps to put the city in the best position to capture growth, and we’re doing it by promoting one thing more than any other: innovation.”
It is unclear how much of the damage to Wall Street can be repaired with such a small investment by the city. Mr. Bloomberg’s own company, Bloomberg L.P., may be a model of the type of business the program could spawn, but he started out with $10 million of severance he had received when he was dismissed from his job at Salomon Brothers. The mayor was scheduled to announce the 11-part program at a building in SoHo that will house an incubator for startup companies that might employ laid-off professionals. A second business incubator is scheduled to open in the spring in Lower Manhattan, according to Seth W. Pinsky, the president of the city’s Economic Development Corporation.
The Economic Development Corporation plans to put $3 million into funds that would make small investments in startup companies, Mr. Pinsky said. He said that he hoped to attract twice as much money from private investors and that $9 million would be enough to help start hundreds of new businesses. All told, city officials plan to spend about $15 million on the program, in addition to the $30 million of federal money. They estimate that over 10 years, it could stimulate the creation of at least 25,000 jobs and contribute $750 million to the local economy. The plan underscores the Bloomberg administration’s acceptance that Wall Street will play a much smaller role in the city’s economy for years to come, and perhaps forever. City officials now expect that the city will lose 65,000 jobs in financial services during this recession and that it will take several years to recover a significant portion of them.
One of the biggest concerns is the shrinkage of the capital markets subsector, which contributed much of the profits the big banks reported during the last boom. Capital markets, which New York dominated, includes the selling and trading of stocks and debt, like the subprime mortgages that fueled the housing bubble. City officials expect the number of jobs in capital markets to fall to about 100,000 this year from 131,000 in 2007. More important, they expect the city to gain back only about 4,000 of those high-paying jobs over the next five years. “We have a substantial number of very talented people coming out of Wall Street,” Mr. Pinsky said. “Where do these people go? Do they stay in New York or go elsewhere?” City officials admit that those people may feel less of a need to be in New York after this crisis. To counteract that notion, city officials are concentrating on retaining and developing New York’s financial infrastructure, like the New York Mercantile Exchange, and trying to rally the financial community around the idea of New York as a hothouse for entrepreneurs.