Workers installing fixtures and assemblies in the tail section of a B-17F bomber at the Douglas Aircraft Company plant in Long Beach, California
Ilargi: Lately I've been seeing a lot of people in the US and UK talking about the financial problems in Europe, especially in the former Soviet states. I think this is perhaps a bit myopic, or perhaps it's also partly wishful thinking. What I don't see much are analyses of the situation Stateside, and I find that a bit worrisome. I would suggest that the US is in such dire straits that Americans need all their energy to focus on the homefront, instead of wasting it on speculating on the pitfalls of Riga and Sofia.
The pending nationalization of the two largest US commercial banks, Citi and Bank of America, deserves far more serious scrutiny than it gets until now. I don't know what Chris Dodd was thinking yesterday morning when he brought up the topic. I don't know if he was thinking at all, for that matter. What I do know is that his comments sealed the fate of the two institutions. The token denial by the White House of any nationalization plans has a lot of folks fooled, but investors will not return to the shares. The genie has left the bottle. Those are his footprints over there.
The government cannot let these shares fall much further, since a bank run becomes more imminent with every penny lost. We already have the insane situation that Citi has received some $50 billion in public funds, but has a market cap of only slightly above $10 billion. It should be obvious by now that the issue should have been dealt with much sooner, and in a totally different fashion.
Be that as it may, we need to direct some thought to the consequences of this nationalization, whether it comes tomorrow or two months from now. For one thing, it would shatter most of the remaining confidence in the American banking system. A whole lot of people would wake up to the fact that keeping their money in bank accounts, any bank accounts, might not necessarily be the wisest move. Sure, the government will give guarantees from here to eternity, but it doesn’t take an Einstein to figure out that kind of promise is as empty as it is void.
It should also be obvious that potential additional losses at Citi and BofA are as enormous as they are unpredictable. When it comes to protecting your money, unpredictability does not rhyme with confidence and trust. I have seen no indication, other than a hollow vow to do an equally hollow stress test on banks, that nationalization will be preceded by a thorough inspection of toxic assets. And that very simply means that, government guarantee or not, your money is at risk. People will draw their conclusions. An added difficulty is, as I’ve pointed out before, that the government doesn't have nearly enough institutions or manpower to effectively execute these nationalizations. Not exactly a minor footnote. The FDIC shut down another bank last night in its usual Friday happy hour, but it is terribly under-equipped for handling the behemoths that CIti and BofA have foolishly been allowed to become.
And that constitutes a very big threat to US banking as a whole. It will take years if not decades to unravel the rotting corpses of all the banks that will fail in the next few years. The FDIC doesn't have the funds, the people nor the expertise to handle most of it. And there's no Plan B either. More funding for the FDIC would mean more debt issued by the government, on top of the $2 trillion or so that lies waiting on the shelves to be thrown into the bond markets. Allowing banks to grow bigger than governments is a death threat to entire nations and societies. To figure that one out, all you need to do is ask Iceland. And, going by population numbers, multiply that country's misery a thousand times to get to what the US is in for.
Going back for a moment to Eastern Europe, there's something else that caught my attention. Problems will be severe for Riga and Sofia, certainly, I'll be the last to play down that issue. But you need to remember that the Berlin Wall came down less than 20 years ago, which means the people stuck between Russia and Western Europe will fall back into a situation they knew well as little as 10 or 15 years ago. They have vivid memories of those days. They won't like it, but they do have ways to deal with it.
America and Britain face a change that is much more profound. They are set to revert to a level of wealth and social cohesion that was last seen 70 or 80 years ago (perhaps more). Nobody remembers it, and nobody is prepared for it. I know many will object to such an assessment, but one look at the above description of the potential consequences of bank nationalizations should make you think twice.
Eastern Europe will muddle on through, albeit with violent protests and political upheaval, in a world that its citizens are familiar with. The Anglo-Saxon part of the planet will wake up to a whole new day, and do so tragically unprepared. The chaos that must ensue makes predictions hard to deliver, but one thing is clear: the next decade will see preciously few quiet days.
In Latvia and Bulgaria, people will recognize the world they wake up to in the morning. In America, they will not.
There are ghosts in the eyes
Of all the boys you sent away
They haunt this dusty beach road
In the skeleton frames of burned out Chevrolets
They scream your name at night in the street
Your graduation gown lies in rags at their feet
And in the lonely cool before dawn
You hear their engines roaring on
But when you get to the porch they're gone
On the wind, so Mary climb in
It's a town full of losers
And I'm pulling out of here to win
Springsteen, Thunder Road
Growing Worry on Rescue Takes a Toll on Banks
Once again, investors are losing confidence in the nation’s beleaguered banks — and, this time, experts say, in Washington’s ever-changing plans to rescue the banks as well. Despite somber assurances from the White House that the industry is sound, shares of bank companies plunged to new lows Friday on fears that some of the nation’s largest banks, including Citigroup and Bank of America, eventually could be nationalized. Though both companies said that was not the case, investors pointed to a seemingly offhand remark by Senator Christopher J. Dodd — to the effect that the administration might assume ownership of certain banks for a short time — as cause for concern.
The decline, which had been building for days, underscored the growing anxiety on Wall Street about what the government would do next. The Obama administration has provided few details about its plans to shore up troubled lenders, sowing confusion in the markets and inside the banks about its intentions. With so much uncertainty, some investors are abandoning banking shares, fearing shareholders will be wiped out if the government seizes control. The worry, investors say, is that Washington is running out of time and options. "Banks live on confidence, and there is precious little coming from the new Treasury secretary," said Gary B. Townsend, a former federal banking regulator who runs his own investment firm, referring to Timothy F. Geithner. "We are getting only confusion."
Bank of America and Citigroup, both of which have received tens of billions of dollars in government aid, bore the brunt of the selling on Friday. Bank of America sank 14 cents, to $3.79, while Citigroup fell 56 cents, to $1.95, although both rallied in after-hours trading. The decline capped the stock market’s worst week since November, when Citigroup confronted a crisis of confidence that eventually compelled it to reach for a second financial lifeline from Washington. The Dow Jones industrial average fell 100.28 points, to 7,365.67 Friday. Bankers were hoping the government would clarify its intentions. But several said that senior administration officials with whom they had been in regular contact had not spoken to them in days.
Others fear a further, rapid market decline might force the government to act, although banking regulators insist the daily gyrations of the stock market will not force their hand. Instead, officials are focusing on whether bank customers are withdrawing money or lenders are struggling to finance themselves with short-term borrowing. So far, there have been no such warning signs. One piece of the administration’s plan — a new "stress test" for the nation’s banks — could become clearer next week. Regulators are preparing to apply the test to assess the health of 20 or so large banks, and are expected to provide more details about the process on Wednesday.
"The financial stability plan outlined last week ensures that there is capital available where it is needed, and that it is provided in a way that will facilitate the replacement of public support with private capital," said a spokeswoman for Mr. Geithner, Stephanie Cutter. Banking shares began to plunge Friday morning after Senator Dodd, the Connecticut Democrat who is chairman of the banking committee, said in an interview with Bloomberg Television that he was concerned the government might end up nationalizing some lenders "at least for a short time." Several other prominent policy makers — including Alan Greenspan, the former chairman of the Federal Reserve, and Senator Lindsey Graham of South Carolina — have echoed that view recently.
As the decline gathered speed Friday afternoon, the White House and several banks moved to allay concerns of investors. "This administration continues to strongly believe that a privately held banking system is the correct way to go," said Robert Gibbs, the White House spokesman. "That’s been our belief for quite some time, and we continue to have that." Kenneth D. Lewis, the chief executive of Bank of America, dismissed talk of nationalization as uninformed speculation. "We see no reason why a company that is profitable, with strong levels of capital and liquidity, and that continues to lend actively should be considered for nationalization," he said in a statement.
Jon Diat, a Citigroup spokesman, did not address whether the government would need to take a larger ownership stake but said that the bank was focused on improving its financial condition. Even so, investors worry that many banks will need big infusions of capital. Raising capital, however, would dilute existing shareholders. And the more bank shares fall, the more likely it is that the government will end up owning large stakes in banks. That fear, analysts say, is creating a vicious circle, in which investors keep selling more shares. "People are getting spooked," Mr. Townsend said. "When you have the government coming out and saying that they are not thinking about nationalization, I think it falls on deaf ears."
Get ready for a wave of bank failures
If it's Friday, there must be a bank failing somewhere across the country. For six consecutive weeks, industry regulators have seized control of a bank after the market closed on Friday, bringing the total number of failed banks so far this year to 14. To put that into perspective, 25 banks failed in 2008, suggesting that the rate of failures is quickening as the economic crisis deepens. "We'll have a banner year [of failures] this year," said Stuart Greenbaum, retired dean and professor emeritus at the Olin Business School at Washington University in St. Louis. At the current rate, nearly 100 institutions -- with a combined $50 billion in assets -- will collapse by year's end.
The latest is Oregon's Silver Falls Bank, which was closed by U.S. regulators Friday. With more consumers and businesses likely to default on loans as the recession drags on, some industry observers think the pace of bank failures could accelerate further. Gerard Cassidy, managing director of bank equity research at RBC Capital Markets, upped his expectations for bank failures earlier this month, warning that he anticipates 1000 institutions could fail over the next three to five years. "The sooner the bank regulators can shut down the troubled banks, the faster the industry will get back on its feet, in our view," he wrote.
Still, the current crop of bank failures hardly comes close to what happened during the savings & loan crisis two decades ago. More than 1,900 financial institutions went under during 1987-1991, peaking with the failure of 534 banks in 1989. And many experts are quick to draw distinctions between the two eras. During the last crisis, many savings and loans were coping with an inability to adapt to higher interest rates, while many banks were significantly undercapitalized to deal with losses. "That is not our problem here," noted Ann Graham, a professor of law at Texas Tech who spent part of her career as a litigator for the FDIC and Texas' Department of Banking during the 1980s.
Instead, she said the main problem now is that banks have been stuck with assets in their loan and investment portfolios that have quickly soured.
It's also worth remembering that when banks fail, they don't close down for good. The Federal Deposit Insurance Corp. guarantees deposits up to $250,000 in single accounts. Also, the FDIC often is able to find a willing buyer for the failed bank immediately, which means little, if any, disruption for the failed bank's customers. Still, regulators face a crisis of significantly larger proportions today that promises to keep the nation's banking industry strained for some time. Even though the overwhelming majority of the banks that have gone under since the beginning of 2008 are smaller community banks, there have been two notable big bank failures.
Last year, the California-based mortgage lender IndyMac failed. That was followed by the collapse of savings and loan Washington Mutual, the largest bank failure in history. The FDIC seized WaMu and immediately sold its banking operations to JPMorgan Chase. Several experts fear the potential for another large bank failure. While the U.S. government has repeatedly said it will not allow major institutions to fail, namely Citigroup and Bank of America, some embattled regional banking giants may be too far gone to save. "Conceivably, we'll see some larger names fail as we go forward," said Frank Barkocy, director of research with Mendon Capital Advisors, a money management firm that invests primarily in financial stocks.
Regulators have indicated they are gearing up for tougher times. In addition to requesting an increase in its borrowing authority from the Treasury, the FDIC has maintained that it expects its deposit insurance fund to suffer $40 billion in losses through 2013. Last summer's collapse of IndyMac wiped out $8.9 billion from the fund. Fearful of drawing down the fund any further, banking authorities may attempt to broker more assisted acquisitions like JPMorgan Chase's purchase of Washington Mutual, where the purchaser acquires the deposits and a portion of the failed bank's bad assets. "The [FDIC's] incentive is not to have a bank failure at all," said Jack Murphy, a long-time partner at the law firm Cleary Gottlieb Steen & Hamilton, who previously served as general counsel for the agency. "If it is possible to have a private market solution, that is ideal."
Next week, regulators are expected to provide a better glimpse of the health of the banking sector, when the FDIC presents its quarterly banking profile for the fourth quarter of 2008. One highlight of the report will be the agency's so-called "problem bank" list. That number is expected to climb from 171, where it stood at the end of the third quarter. Some have charged that the list is hardly reliable, given that only a fraction of the banks that are included ever actually reach the point of collapse. Nevertheless, a big jump in the number of banks on the problem list could serve as an indicator that there will many more Friday failures to come this year.
Double Trouble: The hole in housing
How bad actors and good intentions are doing in the stock market.
The calamitous decline and fall of both the economy and the stock market has laid waste to markets of every asset (and we use that term loosely) traded by man except gold. We're quite aware that doesn't come under the heading of Stunning Revelation to even the least observant inhabitant of this blighted planet. But less widely recognized is the fact that the investment ice age now gripping us has had its beneficial effects as well. For it has spelled curtains to a kind of netherworld (but enormously vigorous) bull market. We're talking about the bull market in fraud.
Now, before you sneer that fraud is older than dirt and impervious to eradication, let us stress that we're referring to state-of-the-art skullduggery that puts to shame the traditional nickel-and-dime swindle. These are truly grand schemes devised by outsized imaginations that have a global reach and relieve the unwary of not just a few stray shekels but billions on billions. And the accused perpetrators are not your usual slick sleaze artists, but such fine upstanding gentlemen as Bernie Madoff and Robert Allen Stanford.
Without blinking the financial pain and emotional distress they've inflicted while shearing myriads of unsuspecting lambs, we submit that we owe such rascals some small measure of appreciation for their efforts, however misguided, to repair our chronically lopsided trade imbalance by going the extra mile (literally the extra thousands of miles) to sell their made-in-America wares to eager buyers as far from New York and Texas as Caracas and Madrid. On that score, we got to wondering: Just as big-league baseball is pondering the use of asterisks to distinguish home runs hit by players who achieved a certain statistical eminence with the aid of steroids, Uncle Sam might do something similar to adjust the relevant data on our international money flows to account for the impact of duping foreigners out of megabucks.
And since, thanks to UBS, the Swiss banks seem destined to break their centuries-old vow of silence that kept the identity of their depositors a deep, dark secret, it occurs to us that some similar adjustment might be warranted by the likely repatriation of a sizable chunk of that vast pile of dough squirreled away in the vaults of those banks by tax-phobic U.S. citizens intent on escaping the clutches of the Internal Revenue Service. In the end, what proved to be the undoing of Bernie, Robert Allen, et al was the epidemic of risk-aversion that spread faster than the speed of light, as the fallout from the credit implosion engulfed a big slice of what passes for the civilized world.
In the ensuing stampede to put as much daylight between themselves and such suddenly dangerous places as markets and banks and various other traditional repositories, investors and savers -- big, small and in-between -- clamored to turn stocks, bonds, commodities, you name it, into cash or its equivalent. Even the most talented fraudster couldn't withstand the tidal wave of liquidation (especially since the moola they desperately needed to keep their victims at least temporarily at bay was long gone). And ironically, disclosure of their noxious schemes touched off fresh bouts of anxiety and withdrawal among the populace, the very stuff that brought them down.
It's a pretty good bet, we're sorry to say, that we haven't exhausted the supply of roguish financial plots waiting to be exposed -- and to exert their malign influence on already jittery investors. The damage done by evil machinations pales before that done by good intentions, especially when the source of those good intentions is Washington. As we've remarked from time to time, when some well-meaning high official (who typically gets his high from an intoxicating sense of self-importance) proudly announced a big new measure to rescue the financial system or the economy as a whole from the morass they had sunk into, the principal effect has been to thicken the gloom enveloping the citizenry, reflected in the dismal reaction of the stock market.
When in December of 2007, the first measure to help troubled banks was unveiled -- the Term Auction Facility, or TAF, for short -- the Dow stood a bit shy of 13,500. Since then, we've had the proverbial steady stream of supposed remedies flowing out of Washington, each and every one designed to get the banks, other ailing sectors and the economy out of intensive care, so far, alas, without resounding success. That effort continues, and now encompasses two administrations; the Dow is around 7,300, or roughly 45% lower than when the TAF began.
With the much-heralded stimulus package signed into law, maybe it's time to try a different tack, like holding the hoopla and hurrahs until there's some slight evidence of progress. At the very least, it'd be a welcome -- to use one of President Barack Obama's cherished words -- change, and by not kiting expectations and courting the inevitable disappointment, it might even help. We sure hope something does. With the stock market hitting a new six-year low and hovering perilously above the nadir of 7,286.27, set in October 2002, in the aftermath of the dot-com collapse, the economy lurching ever deeper into recession, corporate earnings, consumer spending spiraling downward, and foreign markets in disarray, you don't have to be a Nostradamus to predict things will get worse, maybe much worse, before they get better. How much worse? Bad enough, we diffidently hazard, to send the Dow below 6,000 before the bear finally calls it quits.
Although we've always been a firm believer that a word is worth a thousand pictures, the two charts adorning this page, we're forced to admit, provide eloquent and graphic descriptions of why housing still isn't able to get out of its own way and why there's still plenty of room on the downside for prices. We lifted the charts from a recent commentary by our estimable friends at ISI Group. As their respective headlines nicely explain, one shows the ratio of house prices to rents; the other, the median house price divided by median family income.
At a glance, they both relate the same message: House prices are still too high, and not by a modest amount, either. Nor, ISI reckons, will reducing the number of foreclosures, desirable as that may be, halt the erosion in prices. While fewer foreclosures are likely to slow the rate of decline, they won't reverse the downtrend or determine "where home prices end up." And while the sharp contraction in residential construction of new houses is obviously a plus, the homebuilders, at last report, were still building appreciably more houses than they were selling, and inventories of unsold houses are huge.
But given the remorseless rise in unemployment, which, if anything, is destined to accelerate in the months ahead, the simple fact that so many people are too strapped to afford to buy a home, is, we believe, the most formidable barrier to even a tepid housing recovery. For that to happen (much less to get a sustained and reasonably robust rebound) will require home prices to suffer a further steep decline, in tandem with a radical improvement on the jobs front.
House prices, in our bloodshot view, have another 20% or so to fall before hitting bottom and, at the earliest, we're talking sometime next year. And, possibly more important, a meaningful brightening of the current, profoundly bleak jobs picture, isn't in the cards for certainly as long, if not longer. What we see, then, for housing to achieve a decent recovery, is a long road ahead with more than a few bumps -- not the least of the reasons why we're not exactly ecstatic about the outlook for either the economy or the stock market.
The good, the bad, and the ugly on the Obama mortgage plan
The Obama mortgage plan has been made public. The questions going forward are simple: Will this latest plan work? And what are its biggest flaws? Let's start with the "good":
First, mortgage lenders and investors appear to be taking the "first hit" on whatever modification would get a borrower's payment down to a 38% DTI ratio. Then the government shares the cost for the next seven percentage points. I like this "loss share" component. Second, the program is targeted at borrowers who may not already be delinquent on their loans, in addition to those who have already fallen behind. This eliminates the "My lender won't talk to me until I miss three payments" problem. Third, borrowers are going to get up to $5,000 in principal reduction payments from the government, spread out over a period of five years. The idea is to help incentivize borrowers who are upside down to stay put during the period they are upside down, but paying at the reduced rate.
And now, the "bad": First, the plan only applies to owner occupied homes with loans under the conforming loan limit. Some 40% of existing homes sold during the peak of the bubble -- 2005 -- were purchased as second homes or investment properties, according to the National Association of Realtors. Jumbo loan borrowers would also be excluded from the plan. These exclusions are understandable from a political standpoint. After all, officials don't want to be seen bailing out speculators or the rich. But they will also limit the plan's impact.
Second, the provision that would allow Fannie Mae and Freddie Mac to refinance borrowers into new loans with LTVs of up to 105% is somewhat troubling. Waiting and hoping for a home price rebound -- and refusing to just go ahead and foreclose on loans where borrowers have fallen behind and are upside down -- has proven to be a losing strategy. It's akin to kicking the can down the road, and it has resulted in billions and billions of dollars in industry losses. Now, rather than cut their losses short, Fannie and Freddie will be allowed to refinance these outstanding mortgages into new lower-rate loans that feature LTVs of 80% to 105%.
That means a portion of the new loans will effectively be unsecured. This exposes Fannie and Freddie to potentially larger losses down the road if home prices don't rebound and/or if borrowers just end up defaulting anyway. That, in turn, could result in some additional risk being priced into the GSEs' cost of funds. So what's the problem? Taxpayers could ultimately get soaked if home prices don't rise in the coming few years. Those losses would come on top of any possible losses stemming from the recent surge in FHA loan volume. FHA, unlike most private lenders these days, will still extend mortgage loans at LTVs as high as 97%. That's a significant risk in an environment of falling home prices and rising unemployment.
Third, the plan still doesn't attack the principal reduction issue head on. Lenders and servicers may voluntarily apply any government aid toward principal reductions. But it appears term extensions and rate reductions will be the main technique used to reduce payments to the 38% and 31% thresholds. The Obama administration is hoping that the threat of bankruptcy cramdowns will inspire lenders to act. But that remains to be seen.
Fourth, in many hard-hit markets -- the ones where foreclosure rates are the highest, including Florida and California -- home price declines have been extremely severe. Even a $5,000 principal reduction incentive payment likely won't be enough to incentive those borrowers to stick around should hardship strike. And the more generous 105% LTV standard on Fannie and Freddie refinances won't make much difference.
Consider the following example from my own backyard, Palm Beach County, FL: Let's say you bought a median priced home in the West Palm Beach market in December 2005, around the peak of the market. It would have cost you $408,200 at the time, according to Florida Association of Realtors figures. Let's be generous and assume you put 10% down, rather than finance with some 80/20 scheme. You would have had to cough up $40,820 and finance $367,380 -- leaving you with a mortgage with an initial LTV of 90%. Thirty-year fixed rates were around 6.3% at the time, so your payment (principal and interest only) would have been $2,273.98.
As of December 2008, just three years later, the median price of a West Palm Beach home is $246,000 (again, going from FAR data). That means your home would have lost $162,200 in value, or 39.7%. During that same three-year period, you would have only paid your mortgage principal down to $353,738.60 (about $13,600, or 3.7% of the original balance). You would have $54,461.40 in equity, or a 13.3% equity position, assuming the original home did not lose or gain any value in the interim. Stated another way, your LTV would have declined to just under 87%, and the new Fannie/Freddie 105% LTV break would give you some relief.
But as I said earlier, prices haven't stayed the same. They've plunged almost 40%. That means you now have a mortgage with an LTV ratio of 143.8% (!) As you can see, even a more generous 105% LTV limit doesn't help you refi in a market like this one. And a $5,000 subsidy over five years doesn't do much to offset a $162,000 decline in value, much less incentivize you to stay put. This is why principal cramdowns/reductions are all but inevitable in hard hit markets -- Florida, California, and so on.
And now let's talk about the "ugly" part of this plan, the possibility that it will incentivize bad behavior (moral hazard) and more importantly, that it might actually DELAY a rebound in the housing market ...As part of this program, the government could end up subsidizing mortgage borrowers, lenders, and servicers to the tune of more than $10,000. How is that fair to borrowers who played by the rules ... who didn't buy too much house ... and continue to pay their loans on time? Why are they left out in the cold? That's what many Americans are going to be asking, and what many politicians are going to be hearing from callers.
Moreover, market forces ARE working. Foreclosures are actually resulting in overpriced homes burdened with too much debt being moved into the hands of new buyers, who are paying drastically reduced prices. They can therefore purchase using a traditional mortgage. In markets where prices have fallen the most, home sales are currently rising smartly. Delaying and dragging out the downturn by artificially propping up home prices will arguably work against the market healing, even if it makes us all feel good for doing "something."
'Dow Theory' Says Worst Isn’t Over for U.S. Stocks
A 125-year-old method for forecasting the market is telling investors the worst isn’t over for stocks. Dow Theory, which holds that simultaneous moves in industrial and transportation shares foreshadow economic activity, indicates the Dow Jones Industrial Average’s drop to a six-year low yesterday may presage more losses. The Dow industrials slumped to 7,365.67 on concern the deepening recession will force the U.S. government to bail out banks. Adherents of Dow Theory say the 30-stock gauge will fall farther because the Dow Jones Transportation Average has slipped to the worst level since September 2003. "When you have that confirmation in both legs, that’s clearly negative," said Ryan Detrick, senior technical analyst at Schaeffer’s Investment Research in Cincinnati. "There’s some validity to Dow Theory."
This week’s retreat left the Standard & Poor’s 500 Index, the benchmark for U.S. stocks, within 2.3 percent of breaking through its Nov. 20 low to the worst level since 1997. Citigroup Inc. and Bank of America Corp. declined the most in the Dow this week, losing more than 31 percent, on concern shareholders will be wiped out through nationalization. General Motors Corp. had the third-biggest slump, losing 29 percent on concern about its solvency. General Electric Co. dropped 18 percent to $9.38, becoming the fifth stock in the average since last year to sink below $10. "The direction of the market is clearly down," said Richard Moroney, who manages $150 million at Hammond, Indiana- based Horizon Investment Services and edits the Dow Theory Forecasts newsletter. "We’re holding a lot more cash than we normally do."
Dow Theory, created by Wall Street Journal co-founder Charles Dow in 1884, argues that transportation companies are harbingers of economic activity. The transportation gauge slipped below its November nadir in January and has kept retreating. YRC Worldwide Inc. and JetBlue Airways Corp. fell the most this week, losing more than 27 percent. Dow Theory is showing that "the bear market is in force," said Philip Roth, the New York-based chief technical analyst at Miller Tabak & Co. "It doesn’t tell you whether it’s going to last another year or another day. It isn’t a forecaster of magnitude, just direction." In November 2007, one month after the Dow industrials and S&P 500 surged to record highs, Dow Theory suggested the rally was over. The S&P 500 went on to tumble 38 percent in 2008, the most since 1937.
The Dow Theory signal goes against all 10 Wall Street strategists tracked by Bloomberg, who on average project the S&P 500 will end the year at 1,059, a 38 percent gain from yesterday’s close of 770.05. Almost $800 billion in federal spending and the cheapest valuations in two decades will spur the rally, the strategists say. The S&P 500 is a better indicator of the market’s direction because it has almost 17 times more companies than the Dow average and uses market value, not share prices, to determine company weightings, said Roger Volz, New York-based senior vice president at Hampton Securities Ltd. and a technical analyst since 1982. The index would probably plunge to 681 should it fall below the 11-year-low of 752.44 reached in November, according to Volz. His chart-based techniques include Fibonacci analysis. "I don’t think we get out of the woods for 14 months," he said. "The destruction is severe."
Soros sees no bottom for world financial "collapse"
Renowned investor George Soros said on Friday the world financial system has effectively disintegrated, adding that there is yet no prospect of a near-term resolution to the crisis. Soros said the turbulence is actually more severe than during the Great Depression, comparing the current situation to the demise of the Soviet Union. He said the bankruptcy of Lehman Brothers in September marked a turning point in the functioning of the market system. "We witnessed the collapse of the financial system," Soros said at a Columbia University dinner. "It was placed on life support, and it's still on life support. There's no sign that we are anywhere near a bottom."
His comments echoed those made earlier at the same conference by Paul Volcker, a former Federal Reserve chairman who is now a top adviser to President Barack Obama. Volcker said industrial production around the world was declining even more rapidly than in the United States, which is itself under severe strain. "I don't remember any time, maybe even in the Great Depression, when things went down quite so fast, quite so uniformly around the world," Volcker said.
U.S. Lawmakers Clash Over Nationalizing Banks to Stem Declines
U.S. Senate and House Democrats who steer financial-industry legislation clashed over having the government take over some banks as a way to help lenders that have been hammered by the worst economic slump in 75 years. Senate Banking Committee Chairman Christopher Dodd said yesterday some banks may have to be taken over for “a short time,” and his House counterpart, Financial Services Committee Chairman Barney Frank, along with Republican Senator Jon Kyl rejected having the government step in to run banks. “I don’t welcome that at all, but I could see how it’s possible it may happen,” Dodd, a Connecticut Democrat, said on Bloomberg Television’s “Political Capital with Al Hunt,” broadcast this weekend. “I’m concerned that we may end up having to do that, at least for a short time.”
Citigroup Inc. and Bank of America Corp., which received $90 billion in U.S. aid in four months, tumbled as much as 36 percent yesterday on concern the U.S. may take over the banks. The Obama administration in response said a “privately held” banking system is the “correct way to go.” Dodd, a Connecticut Democrat, also said Treasury Secretary Timothy Geithner has “an awful lot of leeway” in interpreting how the executive compensation restrictions he wrote into the economic stimulus legislation will be applied for banks that take federal aid. Dodd’s statement gives Geithner the flexibility to say the rules don’t apply to firms that participate in the public-private partnership Treasury announced Feb. 10 to buy banks’ toxic assets, but only to companies that get cash injections under the Troubled Asset Relief Program.
“That’s one the Treasury has to respond to,” Dodd said. “That’s the kind of question that really ought to be reserved for them.” Dodd softened his Feb. 5 opposition to nationalizing U.S. banks, when he told reporters he didn’t think it was time for the government to take over Bank of America, which had fallen to the lowest level in New York trading since 1984. A possible government takeover has gained support. Former Federal Reserve Chairman Alan Greenspan told the Financial Times this week that the U.S. may have to temporarily nationalize some banks until the industry is restructured. Republican Senator Lindsey Graham, a member of the Budget Committee, said on ABC’s “This Week” Feb. 15 he wouldn’t reject the idea of nationalizing the banks.
The Obama administration turned aside questions about a U.S. takeover of banks, saying a “privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government,” White House spokesman Robert Gibbs said yesterday at a briefing. “That’s been our belief for quite some time and we continue to have that.” Frank, a Massachusetts Democrat who heads the House panel that crafts banking legislation and often collaborates with Dodd, said he didn’t see the likelihood U.S. banks would be nationalized, and Geithner’s bank bailout plan should be given time to take effect. “If that works, then we don’t have to go beyond it,” Frank said in a telephone interview yesterday.
Senator Jon Kyl, the second-ranking Republican and a member of the Finance Committee, agreed with Frank, saying nationalizing U.S. banks is “out of the question” and isn’t going to happen. “I don’t think it’s something the market has to worry about,” Kyl, an Arizona Republican, said yesterday in a telephone interview, after Dodd spoke. “There are plenty of tools that we have short of that to deal with the crisis.” Citigroup tumbled 22 percent yesterday, to $1.95, the lowest in 18 years. Bank of America, the biggest bank by assets with $883 billion in deposits, recouped most of a 36 percent loss after Chief Executive Officer Kenneth Lewis said the bank can survive “on our own.” The KBW Bank Index of 26 companies fell for a sixth day, extending its decline this year to 51 percent.
Dodd said the executive-pay restrictions on banks that get TARP funds are necessary to draw taxpayer support for more government action.
“As long as they think their money is being squandered on bonuses or super salaries at a point like this, the job of getting people to support what we need to do is going to be that much more difficult,” Dodd said. Dodd wrote a provision into the $787 billion stimulus bill that restricts bonuses for senior executives and the next top 20 employees at companies getting more than $500 million from the government rescue package. Limits on bonuses apply to other companies on a sliding scale based on how much aid they received. Dodd said additional aid to the automobile industry should come from TARP, as there is “zero” tolerance in Congress to offer more funding for the government aid program. General Motors Corp., the biggest U.S. carmaker, or Chrysler LLC could end up being forced into a merger, or a prepackaged bankruptcy filing, Dodd said. “I’m fearful it might turn into just a liquidation,” he said.
What is nationalization?
What does it mean to nationalize a bank, anyway? That question has weighed on the minds of investors in the two weeks since the Obama administration's comprehensive financial industry stability plan fell flat. And it came to a head Friday. Nationalization fears helped drag down shares of Citigroup and Bank of America as much as 36% at one point Friday. BofA recovered most of its losses to finish Friday down just 3.6%. But Cit's stock closed Friday with a 22% loss. The term nationalization has been used to cover a range of very different outcomes. Most obviously, it refers to the outright takeover of troubled firms, such as when the Treasury Department put mortgage giants Fannie Mae and Freddie Mac into conservatorship.
But it has also been used by some people to cover sizable investments that give government officials considerable say in a firm's activities -- such as the loan guarantees extended in recent months to Citi and BofA. The Obama administration has said it wants to keep the banking system in private hands, which seems to suggest it isn't aiming to run the likes of Citi and BofA. "We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system," Treasury Secretary Tim Geithner said two weeks ago. But the White House hasn't completely ruled out taking over troubled firms, either - if with a very different intent.
Senate Banking Committee Chairman Chris Dodd, D-Conn., unsettled the market Friday morning when he told Bloomberg Television that he could see regulators briefly taking over Citi or BofA in the name of stabilizing the nation's two biggest banks. "I don't welcome that at all, but I could see how it's possible it may happen," he said. "I'm concerned that we may end up having to do that, at least for a short time." The White House moved later Friday to ease fears of a takeover, with spokesman Robert Gibbs telling reporters at an afternoon briefing that the administration wants to keep the nation's banks in private hands.
"The president believes that ... a privately held banking system regulated by the government is -- is what this country should have," Gibbs said.
But Gibbs' statement, while echoing the one Geithner made on Feb. 6, leaves open the question of whether the administration is considering what observers of the financial industry have termed an intervention -- a takeover of a troubled bank for the purpose of breaking it up, bringing in new capital and finding new owners and management. Many economists say the Obama administration will have to take this tack before the financial crisis is resolved.
"We have no problem in this country shutting down small banks," Simon Johnson, a finance professor at MIT and a former chief economist at the International Monetary Fund, said last week on "Bill Moyers' Journal" on PBS. "In fact, the FDIC is world class at shutting down and managing the handover of deposits, for example, from small banks." But with the big banks, which employ hundreds of thousands of people and make millions of dollars of campaign contributions, it may be a different story. "Nobody has the political will to do it," Johnson said. "So you need to take an FDIC-type process. You scale it up. You say, 'You haven't raised the capital privately. The government is taking over your bank. You guys are out of business. Your bonuses are wiped out. Your golden parachutes are gone.'"
There are multiple advantages to this approach, proponents say. They say recapitalizing the banks is necessary, but it will be costly -- and the more current investors share in those costs, the less that burden must be borne by taxpayers. And any form of nationalization would probably mean the removal of current executives. So it would not reward bad behavior and mismanagement. That's exactly what many observers believe previous bailouts, namely the Bush administration's Troubled Asset Relief Program, have done. But shareholders clearly believe they would be severely diluted in any government action, which explains, in part, why bank stocks have plunged in recent days.
What's more, the Obama administration's insistence that it won't nationalize a bank reminds some of how former Treasury Secretary Henry Paulson repeatedly pledged to stand behind Fannie and Freddie last summer - before he suddenly changed course Sept. 7 and took them over. Regardless of how the government handles the problems at Citi, BofA and other too-big-to-fail banks, economists say the tab for the financial cleanup will come due -- it's only a matter of who gets stuck with it. "There seems to be some sort of ideological bias against the government taking over banks," said Paola Sapienza, a finance professor at Northwestern University in Evanston, Ill. "But eventually we're going to pay for this, one way or another."
Fannie Mae Rescue Hindered as Asians Seek Guarantee
Asian investors won’t buy debt and mortgage-backed securities from Fannie Mae and Freddie Mac until they carry explicit U.S. guarantees, similar to those given on bonds issued by Bank of America Corp. or Citigroup Inc. The risks are too great without a pledge that the U.S. will repay the debt no matter what, according to Hideo Shimomura, chief fund investor in Tokyo for Mitsubishi UFJ Asset Management Co., and other bondholders and analysts in Japan, China and South Korea interviewed by Bloomberg. Overseas resistance may hamper U.S. efforts to hold down home-loan rates and shore up the nation’s largest mortgage-finance companies.
Even after President Barack Obama vowed on Feb. 18 to sink as much as $400 billion of capital into Fannie Mae and Freddie Mac, double the original commitment, "there is still a concern that there is no guarantee" from the government, said Shimomura, who oversees $4 billion in non-yen bonds for the arm of Japan’s largest bank. "Looking at the risk, they’re not so attractive," he said. "We need a guarantee before we’ll buy." Foreign investors sold $170 billion of agency debt and securities in the second half of 2008, the largest amount since the Treasury began tracking sales in 1977, according to the most recent data. Asians, the biggest non-U.S. block of owners in the category, unloaded $70 billion worth from July through December, after scooping up $55 billion in the second quarter and being net buyers during much of the last decade.
The sell-off and calls for a guarantee reflect a continuing lack of confidence among foreign investors five months after the U.S. seized control of Fannie Mae and Freddie Mac. The takeovers followed the biggest surge in mortgage defaults in three decades. Without restoring foreign demand, Federal Reserve Chairman Ben S. Bernanke will find it more difficult to cut rates on housing loans, which depend on the ability of the finance companies to attract investors for their securities at the lowest possible yield. Fannie and Freddie sell debt to fund their purchases of mortgage assets and also guarantee home-loan bonds sold by lenders.
The Fed, which promised to buy as much as $100 billion of Fannie Mae, Freddie Mac and Federal Home Loan Bank corporate debt, may need to spend more, according to Margaret Kerins, an agency-debt strategist at RBS Greenwich Capital in Greenwich, Connecticut. The central bank last month indicated that it may increase this buying program as well as a second $500 billion one for mortgage-bond purchases. The Treasury has bought $94.2 billion worth of mortgage bonds under its own continuing program.
"You’d be back to the situation that prompted them to act" if the purchases of Fannie and Freddie debt were discontinued before foreign investors return, Kerins said. The agency-debt market has recently improved as the "crowding out effect" from sales of government-guaranteed bank debt has proven less than expected, something that may lessen the need for government buying, she added. The Fed’s buying program resulted in a yield of 2.06 percent on Fannie Mae notes maturing May 2012 at the close of trading Feb. 18 -- 0.15 percentage point less than government-guaranteed Bank of America bonds maturing a month later and 0.12 percentage point less than similar Goldman Sachs Group Inc. debt, according to RBS Greenwich data.
Yield gaps between Fannie Mae’s 10-year debt and Treasuries have narrowed from the record of 1.75 percentage point set in November, after countries worldwide announced plans to back bank bonds and offer buyers more federal guarantees. At 0.64 percentage point, it is now 0.27 percentage point above what the spread averaged in 2006, according to data compiled by Bloomberg. The average 30-year fixed mortgage rate fell to a record low of 4.96 percent last month from 6.47 percent in the last week of October, according to Freddie Mac surveys. It rose to 5.04 percent during the week ended yesterday.
Fannie Mae, based in Washington, and Freddie Mac, in McLean, Virginia, have about $1.7 trillion of corporate debt outstanding and $3.7 trillion of their guaranteed mortgage-backed securities held by other investors. The two mortgage companies finance almost half of the $12 trillion of residential loans outstanding. The government-run conservatorship won’t end until the mortgage market recovers and the companies regain profitability, Federal Housing Finance Agency Director James Lockhart said yesterday on Bloomberg Television. He took charge of Fannie and Freddie last September and describes the companies’ U.S. backing as "effective," though not "explicit."
That’s not enough for foreign investors these days, said Laurie Goodman, a senior managing director at Austin, Texas-based Amherst Securities Group LP. Goodman was a former head of fixed- income research at UBS AG. "Overseas investors are looking for the full-faith-and- credit clarification," Goodman said. Such a pledge would essentially about double the U.S.’s debt, potentially boosting the country’s own borrowing costs. "The U.S. government is worried about the agency market, and market participants feel the same way," said Kei Katayama, head of the foreign fixed-income group in Tokyo at Daiwa SB Investments Ltd., who oversees $1.6 billion of non-yen bonds for the arm of Japan’s second-biggest brokerage.
Katayama sold all of his agency debt on Sept. 16, the day after Lehman Brothers Holdings Inc. filed the biggest bankruptcy ever, taking it as a sign to get out of riskier assets, he said. The bonds also have been difficult to sell after credit markets froze last year, according to Jaemin Cheong, who trades U.S. securities in Seoul at Industrial Bank of Korea, South Korea’s biggest lender to small and mid-size companies. He said he won’t touch them. Sellers in the fourth quarter included Caribbean-based investors, often hedge funds, which dumped a net $35.8 billion of the agency debt and securities after buying $15.7 billion in September. China sold $10.4 billion in the period after unloading $8 billion in September, while South Korea got rid of $10.5 billion.
"China’s demand for U.S. agency bonds will gradually decrease because China has drawn lessons from the credit crisis and learned to invest smarter," said Yi Xianrong, a researcher at the Beijing-based financial research institute of the Chinese Academy of Social Sciences, which advises the government. "We will try to stay away from these types of bonds." Freddie Mac Treasurer Peter Federico connects the sales to certain institutions and doesn’t think it is part of "a broader liquidation," although "it kind of felt like that for a couple of weeks or months later in the year. "There are a couple of institutions who continue to sell agency debt," he said in a Feb. 18 telephone interview. "I think their reasoning for doing that is not related to their comfort with our credit. It’s their own monetary-management and currency-related issues. Apart from those institutions, I don’t believe there is a lot of demand to sell going forward."
Federico spoke after the company completed a record $10 billion, three-year note sale at yields of 2.24 percent, or 0.02 percent more than JPMorgan Chase & Co. offered in a sale of government-guaranteed, three-year debt of the same size. Asian investors bought 12 percent of this week’s sale, and North American investors purchased 72 percent, according to the company. The U.S. share was high in comparison to recent years, "but it’s very consistent with what we’ve seen over the last six months, where the U.S. domestic investor who probably understands the conservatorship status better than foreign investors has really been supporting the market in a big way," said Drew Ertman, head of financial-institutions debt coverage at Morgan Stanley, one of the underwriters.
Sales of agency debt and securities may be more closely tied to the availability of better returns in corporate bonds than a lack of faith among investors, according to Andrew Harding, chief investment officer for fixed income at Allegiant Asset Management in Cleveland. Those include bank debt with explicit U.S. guarantees offering higher yields, he said. "I don’t think the credit quality or housing market has precluded people from buying agency debt right now," said Harding, who helps manage $20 billion for Allegiant. "There are just more attractive alternatives." Fukoku Mutual Life Insurance Co. spent last year trimming "risky assets," and it sold all agency holdings in the third quarter, said Satoshi Okumoto, general manager at the company in Tokyo, which has $63.5 billion in assets. "It’s not really the same credit" as government debt, Okumoto said. "It’s one step below."
Did Ben Bernanke Pull the TARP Over Eyes?
The Facts: The week that Lehman Brothers went under and AIG collapsed, Treasury Secretary Henry Paulson and Federal Reserve Board Chairman Ben Bernacke wne to Congress and told the leadership that the financial system was collapsing and that Congress had to take immediate action to avert economic collapse. That weekend, Secretary Paulson put in a request for $700 billion for a bailout program with no strings attached. Over the next two weeks Congress debated the bill, adding some provisions that were ostensibly designed to constrain Treasury for example by limiting executive compensation at the banks getting public funds and also limiting the extent to which banks could profit off these funds.
Many members of Congress, and millions of people across the country, objected that the restrictions were inadequate. Congress ended up approving the bill, based on the claim that the need for the money was urgent and there was insufficient time to produce a better bill. One of the important factors behind the urgency was the claim that even healthy non-financial companies (e.g. Verizon or Boeing) could not borrow in commercial paper markets to get the credit they needed to meet their payrolls and pay their other bills. Ben Bernanke contributed to this view when he answered a question at a press conference: "I see the financial markets as already quite fragile. The credit markets aren't working. Corporations aren't able to finance themselves through commercial paper." The weekend after Congress passed the TARP, Bernanke announced that the Fed would begin to directly buy the commercial paper of non-financial corporations.
The Conspiracy Theory:Bernanke was working with Paulson and the Bush administration to promote a climate of panic. This climate was necessary in order to push Congress to hastily pass the TARP without serious restrictions on executive compensation, dividends, or measures that would ensure a fair return for the public's investment. Bernanke did not start buying commercial paper until after the TARP was approved by Congress because he did not want to take the pressure off, thereby leading Congress to believe that it had time to develop a better rescue package.
New Evidence for the Conspiracy Theory. At a speech at the Press Club this week, Bernanke was asked why he waited until after the TARP was approved before he began buying up commercial paper of non-financial corporations. He responded:"Well, look at the calendar. The financial crisis intensified in mid-September and got worse to the point where there was a huge global financial crisis in early October. During that interim, Congress passed the Emergency Economic Stabilization Act, which includes the TARP. And that TARP, the money there was very useful in helping to stabilize the banking system in early October. There was this critical moment. I think it was about the 14th of October, following a G7 meeting here in Washington, where not The United States but countries around the world took very strong actions in terms of capital, in terms of guarantees and other actions to try to stabilize the world banking system.
It was during this period that the commercial paper market and the money markets, money market mutual funds showed the worst stress. It was in those 18 weeks that that stress appeared and those markets began to dysfunction. And we can't set these programs up immediately. It takes a bit of time to get them structured legally and to arrange for the market terms and to work with market participants and so on. But we got it going actually quite quickly. It's been now more than three months since the commercial paper facility has been functioning. And it seems to have had notable impact on both commercial paper rates and on the terms of finance available."
This statement, that the commercial paper market first seized up in October would seem to contradict Mr. Bernanke's statement of September 24th: "Corporations aren't able to finance themselves through commercial paper." The question here: why aren't any reporters asking questions about this?
Treasuries Climb as Stocks Tumble Amid Bank-Takeover Concern
Treasuries rose for a second week as concern the U.S. may need to take over struggling banks sent stocks tumbling and investors fleeing to the relative safety of government debt. U.S. securities climbed today, snapping two days of losses, as Citigroup Inc. and Bank of America Corp. slid on concern nationalization would wipe out shareholders. A government report showed the consumer price index failed to rise over the past 12 months for the first time since 1955. The Treasury will sell a record $94 billion in notes next week.
"It’s all stocks and the doom and gloom mood that everyone is in," said Hicham Hajhamou, a Treasury trader in New York at BNP Paribas Securities Corp., one of 16 primary dealers that trade with the Federal Reserve. "It’s tough to find good news or anything that is going to bring back some sort of confidence." The yield on the 10-year note dropped six basis points, or 0.06 percentage point, to 2.79 percent at 4:38 p.m. in New York, according to BGCantor Market Data. The price of the 2.75 percent security due February 2019 rose 1/2, or $5 per $1,000 face amount, to 99 21/32. Thirty-year bond yields decreased 10 basis points to 3.57 percent.
The benchmark 10-year note’s yield, which touched a record low of 2.04 percent on Dec. 18, averaged 4.65 percent over the past decade. It fell 10 basis points this week after dropping 10 basis points last week from a yield of 2.99 percent. Thirty-year bond yields slid 11 basis points this week and two last week. Treasuries pared gains as stocks’ declines eased following a CNBC report that the Treasury Department will release some details next week of its plan to rescue the financial system. White House spokesman Robert Gibbs said President Barack Obama’s administration wants a "privately held banking system."
The Dow Jones Industrial Average dipped below its lowest close since 1997 before finishing the day down 1.3 percent. Gold topped $1,000 an ounce in New York for the first time in almost a year as investors sought to protect their wealth. On a monthly basis, consumer prices rose 0.3 percent in January after dropping 0.8 percent in December, Labor Department figures showed. They were unchanged over the past year. "People know we are in a deflationary environment," said Theodore Ake, New York-based head of U.S. Treasury trading at Mizuho Securities USA Inc., another primary dealer. "Just because we get one number that is an up number doesn’t mean the deflationary forces that are taking hold are over." Macy’s Inc., the second-largest U.S. department-store company, is eliminating 7,000 jobs after discounts of 60 percent failed to stem revenue declines during the worst holiday season in four decades.
The difference between two- and 10-year yields narrowed to 1.84 percentage points from 1.99 percentage points two weeks ago as investors favored longer-maturity debt. The so-called real yield, or what investors get from 10-year notes after inflation, was 2.70 percentage points, after holding below zero from November 2007 through September 2008. It averaged 1.84 percent over the past decade. Real yields increase amid rising inflation expectations as investors demand higher rates to compensate for the erosion of fixed payments. Except for one month in 2005, the previous time real yields were negative was 1980, when the Fed raised interest rates to 20 percent to fight inflation that exceeded 14 percent.
"You are having trouble rallying in Treasuries a whole heck of a lot because the inflation numbers have not been promising," said Andrew Harding, who helps manage $20 billion as chief investment officer for fixed income at Allegiant Asset Management in Cleveland. "A large part of our Treasury position is in TIPS." The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook for consumer price gains, was 1.15 percentage points, versus the average since February 2004 of 2.29 percentage points. "They have done well over the last couple of weeks, but they still look cheap to us," Harding said.
Treasuries fell yesterday amid speculation investors will demand higher yields as the U.S. sells $94 billion of two-, five- and seven-year securities Feb. 24-26. The government is borrowing unprecedented amounts to fund an economic stimulus program, a bank rescue package and other obligations. "Rates are trapped in a vise, with supply pressures putting a floor under rates and the steady stream of nasty economic releases providing the cap to bond yields," strategists at UBS Securities LLC led by William O’Donnell wrote in a note to clients today.
Corporate bond trading in the U.S. is rising to the highest in two years, adding to evidence that credit markets are thawing. An average $17.1 billion of corporate bonds traded daily this month, compared with $9.4 billion in August 2008, according to the Financial Industry Regulatory Authority. The difference between what banks and the Treasury pay to borrow for three months, the so-called TED spread, narrowed to 0.98 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.
Auction-Rate Bonds Claim Victims Year After Collapse
Mike Stelzer expected to retire after selling his cattle ranch south of Bakersfield, California. Instead, the 73-year-old is raising Holsteins on leased land, unable to quit because a chunk of his $2 million nest egg is stuck in auction-rate securities paying next to nothing. "I have lost all faith in bankers and Wall Street," said Stelzer, who invested the proceeds from the sale of his ranch in the securities through San Francisco-based Wells Fargo & Co. A year after collapsing, the one-time $330 billion market for debt with rates typically set every 7, 28 or 35 days is still claiming victims. Investors are stuck with as much as $176 billion of the securities even after regulators forced banks to buy back more than $50 billion of auction-rate debt that was marketed as safe, cash-like instruments.
The market’s meltdown, the result of the seizure in credit markets, initially left investors with bonds they couldn’t sell, though the securities paid interest at rates as high as 20 percent. Now, rates on securities auctioned every seven days pay an average 1.36 percent, according to an index from the Securities Industry and Financial Markets Association, after central banks slashed borrowing costs. Investors are stuck because interest on auction-rate securities is lower than what issuers would have to pay on new borrowings, giving them little incentive to refinance. Other options for investors are hoping that an auction succeeds or selling their securities at a loss on the secondary market. Of the 739 auctions reported the week ended yesterday, 82 percent failed, according to the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access web site.
Stelzer, whose old ranch was in Corona, earns an annual interest rate of less than 1 percent on $675,000 in so-called auction-rate preferred securities issued by New York-based money manager BlackRock Inc. He sold $675,000 of his holdings in October at a loss of $103,000 and got all his money back on $650,000 of debt that was refinanced by the borrower. Kathleen Golden, a Wells Fargo spokeswoman in San Francisco, said the company doesn’t comment on individual clients. UBS AG and nine of the 10 other biggest underwriters of municipal auction-rate debt reached agreements with state and federal regulators last year to redeem at par the bonds they sold to individual investors and some institutions; Lehman Brothers Holdings Inc. declared bankruptcy before settling.
The last resolution occurred in October, when the Financial Industry Regulatory Authority said City National Securities of Beverly Hills, California, BNY Capital Markets LLC of New York and Harris Investor Services of Chicago would redeem $60 million of the debt. Regulators, including officials in Massachusetts and Illinois, are now focused on banks and brokerages that resold the securities, said Denise Voigt Crawford, the Texas Securities Commissioner. Those companies didn’t underwrite the securities or run auctions, so proving they knew the market might fail may be more difficult, she said. A resolution can’t come soon enough for Brad Dickson of Los Angeles, whose holdings of BlackRock Inc. and Van Kampen Investments Inc. securities purchased through Oppenheimer Holdings Inc. pay less than 1 percent. "I’m getting paid virtually nothing," Dickson said. "This is money that’s frozen, that basically has a zero return, and I’m stuck with it indefinitely."
States, student-loan agencies and closed-end mutual funds sold auction-rate securities to raise money for 20 years or more. Yields on the bonds were reset at weekly or monthly auctions run by the underwriters, providing the borrowers with money-market rates. The market unraveled in February 2008 as dealers who supported auctions for two decades with their own money suddenly pulled back to preserve capital amid the mortgage slump that led to $1.1 trillion of credit losses and writedowns at the world’s largest financial institutions. Individual investors hold at least $20 billion of the debt, with companies and institutions owning the remainder, according to America’s Watchdog, a Washington-based adviser on securities litigation. An arbitration panel ruled Feb. 13 that Zurich-based Credit Suisse Group AG must pay STMicroelectronics NV of Geneva more than $400 million to resolve claims that it misled the semiconductor maker into buying auction-rate securities. "We respectfully disagree" with the award, Credit Suisse spokesman David Walker said. The bank is "reviewing our legal options."
About $85.2 billion in municipal securities remain outstanding, down from $211 billion a year ago, according to data compiled by Bloomberg. About $33 billion in auction preferred shares remain, according to Thomas J. Herzfeld Advisors Inc. in Miami. The $176 billion of auction-rate debt that issuers haven’t reclaimed includes $57.7 billion tied to student loans, corporations and mortgages, Bloomberg data show. Yesterday, Moody’s Investors Service cut the credit ratings on $5 billion of Brazos Student Finance Corp. bonds backed by student loans because most are funded with auction-rate securities. The interest Brazos collects on loans financed by auction-rate securities failed to keep up with the cost of borrowing, Moody’s said in a statement. "Most of the trusts are expected to generate slightly negative to zero gross excess spread," Moody’s wrote in its report, and said it was "unlikely" that some subordinate bonds that lack collateral will "be paid off in full by the legal maturity."
Brazos Student Finance Corp. is part of Waco, Texas-based Brazos Group Inc., the largest municipal borrower in the auction-rate market. The ratings on the bonds were cut to as low as Ba3, or three levels below investment grade. Some banks say they can’t buy bonds they sold because of the dislocation in credit markets. Thomas James, the chief executive officer of Raymond James Financial Inc., said in January that his company doesn’t have federal bailout money for such an effort. Clients of the St. Petersburg, Florida-based brokerage hold $1 billion of the debt. The brokerage unit of St. Louis-based Stifel Financial Corp. said on Feb. 11 it intends to buy back an estimated $40 million of the $183 million held by its clients. Missouri Secretary of State Robin Carnahan, who is investigating the company, called the offer "inadequate." State regulators in Washington filed a complaint on Nov. 20 against Wells Fargo that said the company failed to disclose enough information to investors about the risk of failing auctions. The bank requested a hearing, which may occur in six months, said Michael Stevenson, the state’s securities director.
Fed Assets Rise to $1.92 Trillion After Mortgage Bond Purchases
The Federal Reserve’s loans, securities and other assets expanded by 3.9 percent to $1.92 trillion over the past week as the central bank completed some of its planned $500 billion in purchases of mortgage bonds. The Fed added $57.9 billion of mortgage-backed securities to its balance sheet for a total of $65.3 billion, the Fed said today in a weekly release. The total value of assets on the Fed’s consolidated balance sheet rose by $72.2 billion from Feb. 11 until Feb. 18. Fed Chairman Ben S. Bernanke and fellow policy makers have indicated they’re ready to build on the $1 trillion increase in the central bank’s total assets over the past year to revive the economy and stem the risk of deflation. In December, the Fed switched to using emergency credit programs as the primary tool of monetary policy rather than changes in the main interest rate.
Holdings of federal agency and mortgage-backed securities rose as the central bank conducted outright purchases of debt to support housing markets. The Fed reported a $1.43 billion increase in federal agency securities to $33.6 billion. While acquisitions of mortgage bonds have totaled $134.8 billion, the majority of the purchases have yet to close and appear on the Fed’s balance sheet. Short-term debt held by the Fed in its Commercial Paper Funding Facility fell in value by $2.67 billion to $247.9 billion. The Fed’s foreign-currency swaps with other central banks fell by $15.8 billion to $375 billion over the past week. The Fed set up the swap lines with central banks in Europe, the U.K. and other countries to lend dollar funds to banks in those areas.
Discount-window lending to commercial banks was little changed at $65.1 billion as of yesterday from $65.2 billion a week earlier, the central bank said. Wall Street bond dealers pared their borrowings from the Fed to $25.3 billion yesterday from $26.1 billion last week. The central bank plans to purchase, by June, as much as $500 billion of mortgage-backed securities and $100 billion of debt from housing-finance companies Fannie Mae, Freddie Mac and Ginnie Mae. Credit to American International Group Inc., the insurer rescued by the government in September, was little changed at $80.5 billion, while the Fed’s loans to a program providing liquidity to the asset-backed commercial paper market and money- market funds fell to $12.7 billion from $14.2 billion. The report doesn’t reflect the Fed’s Term Asset-Backed Securities Loan Facility, a new program to prop up loan markets for autos, credit cards, education and small businesses.
The $200 billion program, backed with Treasury funds, will start "shortly," Bernanke said yesterday. It may expand to $1 trillion and include other assets such as commercial mortgage- backed securities. Fed emergency-lending programs, 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, St. Louis Fed President James Bullard said this week. "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," Bullard said Feb. 17.
The Fed said the M2 money supply increased by $11.2 billion in the week ended Feb. 9. That left M2 growing at an annual rate of 9.6 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target. The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds. During the latest reporting week, M1 rose by $1.4 billion. Over the past 52 weeks, M1 rose 14.9 percent. The Fed no longer publishes figures for M3.
GM's Opel Unit May Be Next 'Domino' After Saab
General Motors Corp.’s decision to push its Saab unit into bankruptcy protection puts pressure on Germany, the U.K. and Spain to come up with funding that the U.S. company says is needed to save the rest of its European business. Saab filed for creditor protection yesterday after GM said it would cut ties with the Swedish carmaker following two decades of losses. Hours later, Opel supervisory-board member Armin Schild said the Ruesselsheim, Germany-based unit needs a rescue package that may exceed 3.3 billion euros ($4.23 billion). "The Saab filing creates fear of a domino effect," said Ferdinand Dudenhoeffer, director of automotive research at the University of Duisburg-Essen. "It increases pressure on Opel because GM has shown it cannot absorb its units’ debts."
Opel employs 50,000 people across Europe, more than 10 times the number at Saab. About half the workforce is in Germany, where Finance Minister Peer Steinbrueck said yesterday he’s opposed to taking a stake in order to save the division. GM says it needs $6 billion from foreign governments and must reach an agreement to shave $1.2 billion from European labor costs by March 31. Detroit-based GM said Jan. 11 that, in addition to talks with Germany, it’s also in touch with governments in Spain, where it employs more than 7,200 people, and the U.K., headquarters to Opel’s Vauxhall brand, with a workforce of almost 5,000.
GM has set March 31 for deciding on all its European divisions’ future as the carmaker seeks as much as $16.6 billion in new U.S. federal loans. The U.S. company will end financial support for Saab by Jan. 1. Opel division and Luton, England- based Vauxhall are integral to operations, GM has said. Opel plants in Bochum and Eisenach, Germany, face the greatest threat, together with another in Antwerp, Belgium, where the division employs another 3,700 people, a person familiar with the situation told Bloomberg this past week. Saab’s move to seek protection from creditors "creates a sense of urgency" at Opel, said Laurenz Meyer, a lawmaker and economics spokesman with Chancellor Angela Merkel’s ruling Christian Democrats.
GM must specify its plans for Opel before Germany can tailor a rescue package, said Birgit Diezel, finance minister for the state of Thuringia, where Eisenach is located. Germany’s federal government and four states where Opel has factories are looking at options including loan guarantees, direct investment and the recruitment of foreign partners to support the unit, she said. "We’re in concrete negotiations with all parties involved," said Diezel, also a Christian Democrat, adding that Thuringia "will use all options" to secure the future of the Eisenach factory and its 1,900 workers.
Opel may be unable to pay its bill by as early as May if no bank provides the carmaker with the necessary loans, the newspaper Bild Zeitung said today, citing estimates of the committee for guarantees, a body that contains members of the federal and state governments. The committee expects Opel will need 1.1 billion euros of additional capital because of likely losses through 2011, Bild reported. Some members of Merkel’s Christian Democrats oppose government guarantees for Opel. Kurt Lauk, head of a pro- business group in Merkel’s party, told the Tagesspiegel newspaper that Opel won’t operate profitably in the long term because it lacks an effective business model. His fellow party member Michael Fuchs told the newspaper Berliner Zeitung there is the risk of aid going directly to the U.S.
"The Saab filing very clearly shows how dramatic the situation is," said Christoph Stuermer, an analyst at IHS Global Insight research company in Frankfurt. Opel may also lose out because it had planned to build the new Saab 9-5 sedan, Stuermer said. Still, should Trollhaettan- based Saab survive a three-month "reconstruction" under court supervision, the Swedish company may play a role in a more independent Opel, he said. As GM’s only European brand with market recognition in the U.S., Saab could offer Opel a chance to "re-skin" its products for the world’s biggest auto market. The Swedish government, too, is keeping GM at arms length, reiterating yesterday that it doesn’t plan to risk taxpayers’ money on Saab. Prime Minister Fredrik Reinfeldt said Feb. 18 the U.S. company’s demands amounted to a "trap" set to pressure the government into granting aid.
UBS client details sent to US despite court order
Banking details of eight American clients of Switzerland's largest bank have been sent to US authorities, despite a Swiss court order blocking the move, a newspaper said Saturday. The court's ruling Friday apparently came too late, with the information on the eight having been sent along with the names of more than 240 other American clients of UBS, the Tribune de Geneve daily reported. "The information has already arrived in Washington," Alain Bischel, spokesman for Swiss bank regulator FINMA, told the newspaper. The tribunal's order forbade Swiss bank regulator FINMA from giving the plaintiffs' "banking documents to third parties, particularly US authorities," or risk legal proceedings.
The tribunal's decision came amid US Justice Department efforts to break through Switzerland's banking secrecy to go after tax cheats hiding their money in the European country. UBS, Switzerland's biggest bank, reached a settlement with US authorities on Wednesday in which it admitted to US tax fraud and agreed to pay 780 million dollars. The bank was also ordered to hand over details of 250 to 300 US clients. But Wednesday, eight of the clients filed a complaint against having their banking information sent to Washington on grounds it might prejudice possible legal proceedings against them, the newspaper said. UBS rejected a new US government lawsuit filed Thursday asking that the bank disclose the identities of some 52,000 US customers who allegedly evaded taxes.
Dollar Posts Biggest Two-Day Decline Versus Euro Since December
The dollar posted its biggest two- day drop against the euro since December as traders withdrew bets on the greenback. The U.S. dollar also slid versus the Swiss franc, the yen and the Australian currency as the sell-off versus the euro triggered preset orders. The dollar earlier increased as much as 0.9 percent versus the euro as Citigroup Inc. and Bank of America Corp. tumbled on speculation the U.S. government may take over the banks, encouraging demand for a haven. "It looks to be a Friday squeeze," said Brian Dolan, chief currency strategist at FOREX.com, a unit of online currency trading firm Gain Capital in Bedminster, New Jersey. "Stops were at $1.2650 to $1.2660 per euro, and they were taken out while the market dozed. Fast money is dumping dollars."
The dollar lost 1.3 percent to $1.2846 per euro at 4:26 p.m. in New York, from $1.2674 yesterday, when it decreased 1.1 percent. The two-day drop was the biggest since Dec. 17. The dollar touched $1.2513 on Feb. 18, the strongest since Nov. 21. Japan’s currency gained 1.1 percent to 93.16 per dollar from 94.20, declining yesterday beyond 94 for the first time since Jan. 7. The yen depreciated 0.2 percent to 119.63 per euro from 119.37. The ICE’s Dollar Index, which tracks the U.S. currency versus the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, fell for a second day, dropping 1.1 percent to 86.488. It touched 88.254 on Feb. 18, the strongest level since Nov. 21, when it reached a 2 1/2-year high. The dollar appreciated earlier versus most of its major counterparts as a drop in global stocks encouraged investors to take refuge in the world’s reserve currency. The greenback erased its gains at about 11:45 a.m. New York time as traders took off bets.
"Clearly the market was caught long on the dollar on the equity sell-off in financials," said Steven Butler, director of foreign-exchange trading in Toronto at Scotia Capital, a unit of Canada’s third-largest bank. A long position is a bet an asset will appreciate. The dollar fell 1.8 percent to 1.1530 francs, erasing an earlier gain of 1.3 percent. The dollar lost 0.4 percent to 64.63 U.S. cents against the Aussie after rising 1.3 percent. Mexico’s peso dropped as much as 1.5 percent to 14.9855 versus the dollar, its weakest level ever, as the central bank cut the target rate by a quarter-percentage point to 7.50 percent. The median forecast of 24 economists surveyed by Bloomberg News was for a reduction to 7.25 percent. The yen recorded a fourth straight weekly decline versus the dollar, dropping 1.3 percent, and was down 1.2 percent versus the euro. The greenback was little changed against the single currency this week.
Stocks declined today, with the MSCI World Index falling for a ninth day, retreating 1.6 percent, and the Standard & Poor’s 500 Index dropping 1.1 percent. Citigroup and Bank of America lost more than 16 percent. Senate Banking Committee Chairman Christopher Dodd said it may be necessary to nationalize some banks for a short time. He spoke in an interview on Bloomberg Television’s "Political Capital with Al Hunt." "This crisis has many surprises," said Matthew Strauss, a senior currency strategist in Toronto at RBC Capital Markets Inc., a unit of Canada’s biggest bank by assets. "The market thought it had discounted enough negative news, and now people have to admit things are worse than we thought."
The global credit crisis poses a "serious challenge" to the financial system, European Central Bank President Jean- Claude Trichet said today in a speech in Paris. The bank may lower borrowing costs again at its next meeting on March 5, he said. Policy makers will reduce the 2 percent target by a half- percentage point, according to the median forecast of 30 economists surveyed by Bloomberg News. Europe’s manufacturing and service industries unexpectedly contracted at a record pace in February, an index based on a survey of purchasing managers by Markit Economics showed. A composite index of both industries fell to 36.2, a record low. The median forecast of 13 economists surveyed by Bloomberg News was for an increase to 38.5.
The euro touched a three-month low against the dollar on Feb. 18 on concern financial turmoil in eastern Europe may slow growth in the countries that use the common currency. Europe’s currency dropped 1.7 percent a day earlier after Moody’s Investors Service said it may cut the ratings of several banks with units in eastern Europe. The euro is down 8 percent against the dollar this year. Germany’s Finance Ministry said today in an e-mail statement that it has "no doubts" about the cohesion of the region using the euro, while its member countries need to carry out "structural reforms" to improve competitiveness. A report in Germany’s Der Spiegel magazine saying the ministry is examining ways to bail out distressed countries "doesn’t correspond with the facts," according to the statement.
Central Bank Governor Says Record Australian Rate Cuts Add Powerful Stimulus
Australia’s lowest interest rates in 45 years and government spending will stoke the economy, central bank Governor Glenn Stevens said, fueling speculation he will slow the nation’s most aggressive round of rate cuts. The stimulus "will have a very powerful impact on the economy," Stevens told parliament’s economics committee today in Canberra. "The effects of the policy adjustments are only just beginning." Traders pared bets on the size of further reductions to the benchmark interest rate, which the Reserve Bank of Australia has cut by four percentage points to 3.25 percent since early September. Stevens said policy makers have room to move again if needed to stoke an economy that almost stagnated in the third quarter of 2008.
"He’s encouraged the idea that further cuts in rates in Australia will be smaller and less frequent" in coming months, said Rory Robertson, a Sydney-based economist at Macquarie Group Ltd. "We’ve seen the most aggressive monetary policy moves in Australia’s history to cope with a very weak period ahead." The yield on the two-year government bond rose 4 basis points, or 0.04 percentage point, to 2.75 percent after Stevens’ comments. Australia’s dollar traded at 64.20 U.S. cents at 2:07 p.m. in Sydney from 64.46 cents. The S&P/ASX 200 stock index fell 1.3 percent to 3,402.8. Stevens said market participants are "currently toying" with an expectation the central bank will cut the overnight cash rate target by another 125 basis points to 2 percent.
"I have no desire to encourage or disabuse them" of that view today, the governor said. "If there is a need to use more interest-rate stimulus, and that’s prudent, then we can." Investors pared rate-cut bets following Stevens’ testimony, according to a Credit Suisse Group index based on swaps trading. They forecast a 100 percent chance of a 50 basis point reduction, according to the index at 12:46 p.m. in Sydney. By contrast, they had a 34 percent expectation for a 75 basis point adjustment late yesterday. "There was a degree of bravado in today’s message," said Su-Lin Ong, an economist at RBC Capital Markets Ltd. in Sydney. "The testimony hinted at a reluctance to cut rates much further." Stevens reiterated the central bank’s view that the economy will outperform its global peers because Australia’s financial system is in better shape and monetary policy is working as lenders pass on official rate cuts to households with mortgages.
The nation’s four largest lenders, including Commonwealth Bank of Australia, have reduced home-loan interest rates by an average of 378 basis points since early September, compared with the central bank’s 400 basis points of adjustments. Those cuts have saved borrowers with an average A$250,000 ($160,000) home loan more than A$650 a month. Countries including the U.S. and U.K. face the prospect of zero interest rates because "they’re pushing on their accelerator, but their linkage to the motor is broken," Stevens said. "We haven’t got that problem and I don’t think we will have, so I’m not sure we’ll need to go that low." A report this month showed home-loan approvals jumped in December by the most in almost nine years, helped by demand from first-time buyers after the government tripled a grant for new homes to A$21,000. Low rates and the government’s A$42 billion in extra spending, approved by the Senate last week, "will work to support demand, increasingly so, as the year goes on," Stevens said.
Still, "we cannot realistically expect anything other than weak conditions in the early part of 2009." The central bank predicts the economy will expand 0.5 percent in 2009. By contrast, many of Australia’s major trading partners, including Japan and the U.S., are forecast to stay in recession. Australia will "come through this very difficult period, certainly not unscathed, but well placed to benefit from a renewed expansion," Stevens said. The nation’s long-run prospects haven’t "deteriorated by a much as we may all be feeling just now." The task of policy makers in coming months will be to distinguish between information that confirms anticipated trends "to which we have already responded, and that which tells us something genuinely new about the prospects for demand and prices over the medium term," the governor said. "We have the luxury of having more ammunition to use than most and we still have more if needed."
Gold Tops $1,000, Highest Since March, as Global Equities Slide
Gold surpassed $1,000 an ounce in New York for the first time in almost a year as investors, hurt by plunging stocks and a deepening recession, sought to protect their wealth. Gold futures for April delivery rose $25.70, or 2.6 percent, to $1,002.20 an ounce on the New York Mercantile Exchange’s Comex division. Earlier the price touched $1,007.70, the highest since March 18. Gold, the only metal to advance in 2008, has rallied annually since 2000 and is up 13 percent this year. Global stocks extended an eight-session slide, erasing 54 percent of their market value since the start of last year on concern that the economic slump may worsen and wipe out corporate earnings. Governments are lowering interest rates and spending trillions of dollars to combat the recession, spurring investors to buy bullion as a hedge against inflation. Demand has pushed gold holdings in exchange-traded funds to records.
"There’s a general fear of chaos in the financial system that’s weighing on markets across the globe," said William O’Neill, partner at Logic Advisors in Upper Saddle River, New Jersey. "This is a perfect storm for gold and its flight-to- quality characteristic is coming through." Gold last topped $1,000 in March as interest-rate cuts by the Federal Reserve propelled the dollar to an all-time low against the euro in July. The metal reached a record $1,033.90 on March 17 before retreating to as low as $681 by October. Analysts say the rally may continue as investors lose confidence in financial assets. Stocks and bonds have trailed gold this year. The Standard & Poor’s 500 Index of equities has declined 15 percent and the benchmark 10-year U.S. Treasury has returned 0.23 percent.
"The financial situation remains extremely fragile and gold seems to be the only safe haven," said Ron Goodis, retail trading director at Equidex Brokerage Group Inc. in Closter, New Jersey. "Currencies are losing value and holders of currencies are losing confidence. Gold may break through $1,000 and not look back." "One camp of investors is buying gold because of fear the fiscal stimulus packages are insufficient to bring the economy out of recession," said Peter Fertig, owner of Quantitative Commodity Research Ltd. in Hainburg, Germany. "The other camp fears the stimulus packages will lead to inflation." The U.S. government has committed more than $9.7 trillion to resolve the economic crisis. Benchmark interest rates in Japan and the U.S. are near zero while the Bank of England has slashed its main lending rate to 1 percent, the lowest ever.
"Given the zero interest-rate policy being pursued by central banks around the world, the incentive to hold national currency has been taken away," said James Turk, founder of GoldMoney.com. The company had $548 million of gold and silver in storage for investors at the end of January. Gold above $1,000 may attract more investors seeking to take advantage of the longest streak of annual advances in the metal’s price in 60 years. Assets in some of the industry’s largest exchange-traded funds are at all-time highs. Holdings in ETF Securities Ltd.’s gold exchange-traded commodities rose to a record 7 million ounces as of Feb. 13. The SPDR Gold Trust, the biggest ETF backed by the metal, expanded to 1,029 metric tons yesterday. Investment demand for bullion, including coins and bars, almost tripled to 399 tons in the fourth quarter, as total demand climbed 26 percent to 1,036.5 tons, the London-based World Gold Council said on Feb. 18.
Retail and professional investors will continue to seek gold’s stability, said Aram Shishmanian, the council’s chief executive officer. Silver futures for March delivery climbed 55.5 cents, or 4 percent, to $14.49 an ounce in New York. The metal has surged 28 percent this year, the best performance among the 26 contracts on the UBS Bloomberg Constant Maturity Commodity Index. The metal fell 24 percent in 2008. Investment in Barclays Plc’s IShares Silver Trust, the biggest ETF backed by silver, also rose to a record yesterday, topping 7,892.2 metric tons. The highest prices in a year may encourage some investors to sell for profit, analysts said. Still, investors are boosting bets that gold may not fall below $800, options trading shows.
The most-active options on gold futures were contracts that give the right to sell the metal at $805 an ounce by April. Those contracts rose 10 percent to $2.20. They accounted for two-thirds of today’s 3,983 put trades, with about 84 percent of the contracts trading at the bid price, indicating that sellers initiated the transactions. "Investors selling out-of-the-money puts expiring in April think there’s a slim chance gold will decline back to $800 an ounce," said Andrew Wilkinson, the senior market analyst at Greenwich, Connecticut-based Interactive Brokers Group Inc. Gold’s all-time inflation adjusted record is $2,224 an ounce on Jan. 21, 1980, according to a calculator on the Web site of the Federal Reserve Bank of Minneapolis. "From an inflation-weighted basis, gold is still pretty cheap," O’Neill of Logic Advisors said.
The return of capital controls
by Willem Buiter
It looks like capital controls for central and eastern European countries as well as emerging markets everywhere. This column argues that imposing capital outflow controls – while sometimes unavoidable – discourages future capital inflows and creates rents. This is why they should be explicitly made temporary.
When Iceland’s banking system and currency collapsed last September, a key component of the emergency package that was introduced under the auspices of the IMF was controls on capital outflows, implemented through rigorous foreign exchange controls. This made sense. The currency was in free fall. The foreign exchange markets had seized up. There was no level of domestic interest rates the Central Bank of Iceland (which had zero credibility at this stage) could set that would induce domestic and foreign investors to hold on to their Icelandic kroner rather than converting them into euro, US dollars, sterling or any other serious convertible currency.
Iceland is about to have company. The most likely candidates for the imminent imposition of capital controls are in Central and Eastern Europe (CEE) and among the CIS countries. We can expect to see capital controls imposed even by some of the EU members from Eastern Europe that have not yet adopted the euro as their currency (the Baltics, Bulgaria, the Czech Republic, Hungary, Poland, and Romania). All these countries have banking sectors that are overwhelmingly foreign-owned. With the de-globalisation and repatriation of the cross-border banking sector that is underway, parent banks (mainly in Western Europe) have become progressively less able and/or less willing to finance their subsidiaries in Central and Eastern Europe. The resulting financial stresses in the host countries have led the ECB to take the extremely unusual step of making swap facilities available to the central banks of two non-Eurozone EU members, Hungary and Poland. Hungary, which suffers from long-standing fiscal incontinence, has an IMF program as well.
The financial support from the ECB (and from the EC) is probably not unrelated to the fact that a number of Eurozone commercial banks are heavily exposed in CEE and the CIS. Austrian banks, in particular, have a massive exposure to the former Austro-Hungarian empire, as does Unicredit (an Italian bank) and several Nordic banks are at risk throughout the region, from the Baltics to Ukraine. In most CEE countries, households and non-financial corporations played the reverse carry trade by borrowing in the foreign currencies with the lowest interest rates, oblivious to the exchange risk this involved. These CEE counterparts of Mrs Watanabe did so without having any natural foreign exchange hedges (foreign currency assets or income) and without taking out any synthetic hedges. Households throughout CEE have Swiss-franc-denominated residential mortgages. I am surprised there weren’t more yen-denominated residential mortgages taken out! With the sharp decline in the external value of their currencies (the Polish zloty has declined against the euro by more than 35% since its peak in mid-2008, the Hungarian forint by 26% and the Czech koruny by 22%), the real value of their debt and debt service has increased sharply. Fortunately, most of these mortgages have long remaining maturities.
The same does not hold for the foreign currency debt taken on by the non-financial corporate sector in CEE. Much of this has a short maturity. In addition, during the period prior to the middle of 2008, when their currencies were appreciating, many CEE corporates bet on further appreciation of their currencies by writing puts on them. With their currencies way down, these corporates find themselves having to buy zloty, say, from the buyers of these puts, in exchange for euro at a much higher price for the zloty in terms of the euro than the current spot exchange rate, let alone the exchange rate anticipated when these CEE corporates wrote the puts. A further collapse of the currency would raise the likelihood and incidence of defaults among corporate borrowers. The banks in CEE may have both assets and liabilities denominated to a large extent in foreign currency. Because their clients are not currency-matched, the banks have replaced currency risk on their balance sheets with credit risk.
Some of the CEE countries were the victims of wild domestic credit and asset market booms and bubbles even before they were hit by the global credit crunch (through the drying up of funding for the local subsidiaries by the parent banks). Latvia is the most extreme example, but Estonia and, to a lesser degree Lithuania, were also caught up in classic, post-reform unsustainable emerging-market booms, with out-of-control construction industries and epic current account deficits. Bulgaria, which like the Baltics has a currency board vis-à-vis the euro, Romania and Poland (both with floating exchange rates) also ran growing current account deficits that had unsustainability warning lights flashing. All CEE countries, including those that had unsustainable domestic credit and asset market booms, are being hit hard by the domestic impact of the global credit crunch and by the collapse of world trade. The Czech Republic and Poland are the two CEE non-Eurozone members least likely to impose capital controls. The rest ranges from possible to quite likely.
The imposition of capital controls on a temporary basis to deal with a foreign exchange crisis/balance of payments emergency is compatible with the EU Treaties. Indeed, de-facto informal foreign exchange rationing has been taken place for quite a while in some countries. When I was in Latvia a year ago, local commercial bankers told me that if someone wished to borrow lat (the local currency), they would not lend it to him if the bank thought he was likely to use it to speculate against the currency peg of the lat with the euro. This is against the rules - indeed against the law — but it happened. Where could the frustrated would-be short seller of the lat go to complain? To the Latvian central bank?
Of course, an EU country that imposes capital controls could forget about joining the Eurozone in the foreseeable future, unless the Maastricht criteria for EMU membership were waved or scrapped. Although the unconditional offer of immediate full EMU membership to all EU members would be a wise and wonderful contribution to the stabilisation of the region, I consider it unlikely that such wisdom will indeed be found in Frankfurt, Brussels and the national capitals of the EU - inhabited as these locations are by bears of very little brain. With Eurozone membership years away, the cost of imposing capital controls, in terms of further delays in EMU accession, would be minor. Some of the non-EU countries in the Balkans (Albania, Bosnia-Herzegovina, Croatia, Macedonia, Serbia) are also likely to have recourse to capital controls before long. Montenegro already has the euro as its currency, despite not being a member of the Eurozone. Among the CIS countries that are likely candidates for the imposition of capital controls are Ukraine, Russia and Kazakhstan.
Ukraine is in an economic and political mess. Its banking system is a triumph of hope over fair value. Its currency is weakening rapidly. Its export-oriented heavy industry and its agricultural sector have been hit hard by declining prices and world demand. It has an IMF program. Russia has gone from Himmelhoch jauchzend to zum Tode betrübt in the space of less than a year. With oil at $140 a barrel and $460 billion of foreign exchange reserves, Russia felt and acted like a would-be super power. With oil at $40 a barrel and reserves draining fast in an unsuccessful attempt to stabilise the Rouble without raising interest rates, Russia looks increasingly like Venezuela with nukes. Industrial production has collapsed and the public finances are under severe strain. Russia’s industry has borrowed heavily abroad, in foreign currency, and on a short-term basis. Its banking system can no longer fund itself in the international wholesale markets. Russia 2009 looks more and more like Russia 1998.
Capital controls would be an obvious tool to regain control of the Rouble without having to engage in immediate heroic monetary and fiscal policy tightening. Even if the anti-capital controls faction in the Russian leadership wins the ongoing argument with the pro-capital controls faction, events may well force the hand of the authorities. Kazakhstan may have enough financial resources and gas/oil revenues (despite the decline in oil prices) to get through the financial storm and the global slump without being forced to impose capital controls. It already had one major bail-out of its banks, however, and if Russia and Ukraine were to impose capital controls, Kazakhstan may well follow.
For countries with a minor-league currency (every currency except for the US dollar, the euro and the yen), an open capital account will always be a mixed blessing. The joys of an open capital account - the undoubted benefits from decoupling domestic capital formation from national saving and from unrestricted international portfolio diversification and risk trading - cannot be enjoyed without the pain; the risk of its domestic financial institutions, capital markets, non-financial enterprises, consumers and public finances becoming the flotsam and jetsam on massive and mindless killer waves propelled by an out-of-control global financial storm. Capital controls permit monetary and fiscal policy to be directed to the stabilisation of economic activity without having to worry about a collapse of the currency and its deleterious effects on the sectoral and national balance sheets. Of course capital controls will leak. They always leak. But provided they are enforced aggressively, say, with transgressors stoned to death in public after a fair trial, they can be made to work well enough to regain control of monetary and fiscal policy. And capital controls will leak progressively more copiously, the longer they are in place. This is why their imposition should be viewed as temporary, with a gradual relaxation as economic conditions improve and global financial stability returns.
Capital controls create rents whose allocation is at the discretion of public officials. They therefore encourage bribery, graft and corruption, which is again why they should only be temporary. The emerging markets of CEE and the CIS (and indeed emerging markets everywhere) have been progressively cut off from new external funding as the crisis deepened. At this stage, imposing capital controls (only controls on capital outflows really matter, at this stage; controls on capital inflows should have been imposed earlier) would not bring with it a heavy cost in terms of a sudden stop on capital inflows. That stop has happened already. Imposing capital outflow controls may discourage future capital inflows. The example of Malaysia, which imposed capital controls during the Asian crisis of 1997 suggests that foreign capital either has a short memory or can be convinced. I predict that at least some of the emerging market countries of CEE and the CIS will impose capital controls before long. I recommend that emerging markets everywhere consider this option seriously.
Thailand May Urge Banks to Lend Money to GM, Foreign Automakers
Thai Prime Minister Abhisit Vejjajiva said his government may help foreign automakers including General Motors Corp. by nudging commercial banks that are reluctant to lend as a global recession deepens. "What might be helpful is some kind of credit facilities which would be done through a commercial bank system," Abhisit said in an interview late yesterday in Jakarta, where he is on a two-day visit. "The government is not in a position to provide" cheap loans, he said. GM is seeking as much as $16.6 billion in new loans from the U.S. and another $6 billion from Canada, Germany, the U.K., Sweden and Thailand to sustain operations. Earlier this month Thailand recapitalized a state agency that shares credit risk with commercial banks in an effort to spur 100 billion baht ($2.8 billion) in lending to small businesses.
GM’s Thailand unit needs the money to move forward with a 15-billion-baht diesel-engine plant announced last year. The plant and another pickup truck line are "no longer feasible" without government help and are "suspended indefinitely," the company said on Feb. 18. "The reason we’ve worked with the government is that commercial banks on their own are pretty cautious these days," Steve Carlisle, the company’s head of Southeast Asia operations, said in a telephone interview yesterday. "We all need to get together and make a good assessment of what the future holds and what’s the right thing to do in supporting industry."
Detroit-based GM has received $13.4 billion in loans since December. Conditions attached to the funds have constrained the company’s ability to manage cash globally as it had done in the past, forcing its foreign units to restructure or seek help from their host governments, GM said in a Feb. 18 filing. "The discussion is not quite as far along in Thailand as it is in other places," Carlisle said. "What we are encouraging is demand stimulus on one hand and on the other hand some assistance with loans to fund future product programs." The company will make a decision on whether to proceed with its diesel-engine plant by the end of the third quarter, Carlisle said. The factory’s opening has been pushed back to May 2011. "If we can’t fund it then we’re going to have to look into other alternatives," Carlisle said.
GM’s Thai unit cut 790 jobs this year and slashed production by 56 percent to just under 50,000 units. The company may see sales drop "a bit more" than the 15 percent decline estimated for Thailand’s auto industry, Carlisle said. Thailand’s government plans to meet with automakers to design a rescue package for the industry, Abhisit said. The private sector has proposed excise tax cuts that would reduce vehicle prices by as much as 50,000 baht and help for consumers to access car loans, Carlisle said. "I don’t think an excise tax reduction is going to have a dramatic impact on demand," said John Bonnell, director of forecasting for JD Power & Associates’ Asia-Pacific operations. "It may stimulate demand somewhat, but any way we look at it, it will be a tough year." Vehicle sales amounted to about 8 percent of Thailand’s exports last year, according to the Finance Ministry. Thailand is the world’s fourth-largest maker of light commercial vehicles.
Warning for the West as crisis spills onto streets
The slump that has swept through developed nations like the UK, the eurozone and the United States is hitting the world's emerging economies with a speed and ferocity that has shocked even the most pessimistic analysts. Until recently, many investors and economists thought such countries could provide a bulwark against the collapse in growth elsewhere. Instead, the latest data suggests that emerging economies as a group actually contracted late last year, and will likely shrink further in 2009. The pace of the turnaround has caught policymakers and investors off guard. In a matter of months, key gauges of growth in trade and industrial production in a number of countries went from acceptable to alarming - even domestic demand is suffering.
Asia's economies have posted the starkest drops in economic activity, but the slide is evident from Latin America to Eastern Europe. Economists are particularly concerned about conditions in the Baltic countries, Eastern Europe and Russia, which still has a formidable nuclear arsenal. In all three areas of the former Soviet empire, deteriorating economic conditions, marked by steep falls in the value of national currencies and gross domestic product, has led to weeks of civil unrest. Analysts are worried that problems in Eastern Europe and Russia could have a negative impact upon western currencies and banks, which are big lenders and investors in the area.
They point to a sharp fall in the euro last Tuesday. The value of the 17-nation currency plunged after reports that Russian banks were seeking to reschedule as much as $400bn of foreign debts. Russian banks had $198bn in outstanding foreign debt as of October 1 and non-financial institutions had $300bn, according to the latest data available from the central bank in Moscow. Reports of rescheduling plans were denied by Moscow but this failed to help the single currency recoup all its losses. Analysts said the episode illustrated just how vulnerable the euro remains to the problems of Central and Eastern Europe. The Russian rouble and the Hungarian forint have also weakened against the dollar. In an ominous development, Russian companies, the biggest emerging-market borrowers during the last three years, have been shut out of the international bond market after yields jumped sixfold since August amid plunging energy prices and a weakening rouble.
The credit squeeze will force companies to rely on government bailouts to refinance their debt or face default, according to MDM Bank, VTB Group and Commerzbank. In a move to restore confidence in the Russian economy, President Dmitry Medvedev last week pledged more than $200bn in emergency funds to support banks and companies as the 60% drop in oil prices since August and the rouble's 35% tumble against the dollar push the world's biggest energy supplier into its worst economic crisis since the government defaulted on $40bn of domestic debt in 1998. Street clashes have broken out in Moscow and other cities and the government is clearly worried about further outbreaks of violence. Fitch recently downgraded Russia's sovereign rating, citing a wave of corporate refinancings and the government's macroeconomic policy. Standard & Poor's made similar moves late last year and many observers expect Moody's to do the same soon.
Downgrades make it more expensive for companies and the government to obtain new debt. The situation is little better in the Baltic states of Latvia, Lithuania and Estonia, where governments have had to cut spending on key programmes. Some experts are concerned that economic difficulties in the Baltic states will spill over into Sweden, Denmark and Norway. There are also worries about larger economies such as Slovakia, Bulgaria, Romania and Ukraine. If they weaken further, it will put banks in Germany and Austria in even deeper trouble. Austrian banks have run up huge debts in neighbouring countries. Last month saw the biggest demonstrations in Latvia and Lithuania for nearly 20 years. In Vilnius, the capital of Lithuania, a mass protest against austerity measures ended up in a riot as protesters hurled eggs, rocks and snowballs at the police.
In Latvia's capital Riga, people dug up cobblestones from the street, smashed storefronts and trashed police cars. The protests followed the government's decision to push through massive cuts in social security payments. Angry demonstrations have broken out elsewhere in Eastern Europe. The centre of the Bulgarian capital Sofia was brought to a standstill by protesters who surrounded the country's parliament building. In Romania, thousands of workers walked out of factories and marched against government plans for more privatisation and budget cuts. Tension is rising in Hungary, where unemployment has jumped to above 8%, according to analysts in Budapest. Last year, the government was forced to turn to the International Monetary Fund to avert a debt default, and the economy is forecast to contract as much as 3% this year.
Meanwhile, some of the strongest emerging economies outside of Europe are also in trouble. Taiwan said last week that exports in January plunged a record 44% from the same month last year, pushing them down to a level unseen since 2005. Last week, Brazil posted industrial production numbers for December that showed a historic tumble of 12.4% from the previous month, shocking the country and forcing its president to calm nerves. In South Korea, the December fall in industrial output over a year earlier was the largest since the country began keeping records. The South Korean won has shed nearly 10% of its value against the dollar. Malaysia announced last week that its factory output fell at its steepest pace in 15 years in December from a year ago, reinforcing expectations the government will step up spending to fend off a recession. It was the fourth straight month of decline in output in the South-east Asian country, which is grappling with collapsing demand for electronic goods, the biggest export revenue earner for the country.
"The magnitude of the deterioration (in emerging economies) is nothing short of dramatic," said Amer Bisat, an analyst at US investment firm Traxis Partners. "We're continually catching up with the data, and with continuing downward revisions, at a pace which to my mind is unprecedented." Bleak economic figures have prevented some stock markets in developing countries from making gains this year. Benchmark indices in Brazil and China are up about 10% this year, but India's is down slightly and Russia's has fallen sharply. The Russian equity market is one of the worst-performing bourses in the world. Analysts said a number of emerging markets are grappling with a series of blows such as declining trade, shrinking capital flows and slumping commodity prices. Domestic demand also is going into reverse.
JP Morgan forecasts that at least 11 emerging economies - among them South Korea, Taiwan, Russia, Turkey, and Mexico - will shrink in 2009, with another four posting no growth. Brazil is the latest example of the swift reversal of fortune in emerging markets. Just last month, the country's finance minister predicted "good economic results" and gross domestic product growth of 4% in 2009 for South America's largest economy. But forecasts by private economists are in freefall, and many now predict no growth or very little this year. JP Morgan economists predict that China, the giant of the emerging world, will grow 7.2% this year, a major deceleration compared to 2008 and 2007. Chinese imports and exports are falling at their worst rates in a decade, a sign not only of weak global demand, but of a retrenchment by Chinese companies and consumers.
The Chinese government has responded with an aggressive stimulus package and interest-rate cuts. A gauge of manufacturing posted a slight rebound for January, but is still signaling a contraction in activity. In South Korea, the economy began spinning backwards late last year. Surging exports from its ports stalled and then fell more than 30% in January over a year earlier, a reversal that has outpaced declines the country experienced during the Asian financial crisis of 1997-98. In 2009, Taiwan, Indonesia, and the Philippines are expected to see a fall in exports that will outstrip what they experienced during the Asian financial crisis of 1998, according to Credit Suisse. During that debacle, emerging nations were able to recover relatively quickly by relying on export markets like the United States to keep buying their goods - something they may not be able to count on this time around.