Vis-O-Matic department store, the Canadian catalog store whose slide-projection system of displaying merchandise was like a Buck Rogers premonition of online shopping. The Vis-O-Matic phenomenon seems to have been short-lived, with hardly any documentation online aside from these photos in the Life archive, and no word of its fate.
Ilargi: Bernanke says the recession will be over in a few months. MarketWatch has a deadline that says "Evidence mounts that recession's worst is past”. The Dow is up 3.5% when I write this. Now I'm sure Bernanke would look just fine with a party hat on his skull, but by now words like his this morning have become irresponsible. You can't keep on lying to people and expect them to always come back for more. The high and mighty in the markets are understandably giddy at the prospect of hundreds of billions of additional taxpayer dollars being moved into their failed institutions.
This is the cover of the February 15, 1999, issue of TIME Magazine. Robert Rubin, Alan Greenspan and Larry Summers as the three wizards who will save the world. Ten years later, Rubin is the man behind the scenes of Obama's finance team, Greenspan is busy doing mea culpa's that leave him without blame, and Summers has his eyes on Greenspan's old throne. These guys have orchestrated the downfall of the American economy ten years ago, through the Glass-Steagall repeal, insanely low interest rates and lack of regulation for 'innovative' financial instruments. They are today still firmly in the seats of power. I can't think of anything more worrisome than that.
So what are the chances that the new bank bail-outs will accomplish what they are supposed to do? It may seem like a very complicated question, and one that many will claim no-one can foresee the answer to, but maybe it's actually pretty easy. A new version of the Case/Shiller S&P Housing Index was published today, and it shows another record fall in US home prices. 18.5% in one year, a 9th consecutive record.
Professor Robert Shiller, someone I’ve taken issue with for his overly rosy forecasts in the past, did an interview yesterday with Henry Blodget in which he makes three points with regards to the future of domestic real estate.
- House prices are still only halfway back down to fair value.
- Prices don't usually stop at fair value. (Shiller calls this overshoot, I have referred to it as oscillation, what goes up must come down harder)
- Obama's plan won't turn house prices around.
What this means is that prices have come down between 25% and 30% already, that they will drop another 30%, and that's before the overshoot. Shiller is getting very close to the prediction of 80% or more peak to trough I have been using for well over a year now, don’t you think?
How do we link housing prices to the bank bail-out? Like this. MoneyandMarkets has a cute little set of numbers.
Mike Larson adds a few comments:
Citigroup is on the list because of three factors: Its main banking unit has a C- financial strength rating. It has large exposure to the credit risk of derivatives. Plus, it has a big exposure to mortgages — $198 billion. Wachovia is in a similar situation: It made the fatal mistake of buying the nation’s largest and most aggressive mortgage lender — Great Western Financial — at the worst possible time. And it’s also got some serious exposure to derivatives. Washington Mutual, the nation’s largest thrift, has a D+ rating and is loaded with mortgage exposure. HSBC has a D+ rating. Plus, it has an exceptionally large 721% of its capital exposed to the credit risk of derivatives. In other words, for every single dollar in capital, HSBC is taking a credit risk of $7.21 with trading partners in derivatives, according to the U.S. Comptroller of the Currency.
Citi's market cap is around $12 billion. Its "assets" (wonder what is in that pot) are stated as over 100 times its cap, at $1,292 billion. If Citi indeed has all those assets, investors would be nuts not to buy in, wouldn't they? Its mortgage exposure is 16 times the market cap, while its derivatives risk is $2.79 per dollar in capital. (NB: total Citi derivatives positions were estimated at $38 trillion last year)
If housing prices keep falling in the way and to the extent that Shiller indicates, Citi will lose another $100 billion on its mortgage portfolio, while its mortgage backed securities and other derivatives will easily add a trillion here and there to the bleeding. Which in turn indicates that if home prices don't come back up, which Shiller says they will not, that Citi is way beyond salvation.
In 1999, mere months before the Glass-Steagall repeal was voted through, Robert Rubin handed the Treasury Secretary seat to Larry Summers, in order to move on to Citi and put to "good use" all the new financial powers he himself was responsible for writing.
In 2009, Rubin left Citi throuigh the revolving door that connects Wall Street to Washington, to team up again with Larry Summers and Tim Geithner, and make sure hundreds of billions are being poured into the bank he helped implode. None of Obama's initiatives will do anything to save the banking system, or restore economic growth, or benefit the taxpayer. We're witnessing the liquidation of the US as a going concern.
Major Meltdown Imminent!
The nation’s largest banks are so close to collapse and the world economy is coming unglued so rapidly, a major Wall Street meltdown is now imminent. Specifically, it’s now increasingly likely that virtually all of our forecasts of recent months could come to pass in a very short period of time, including …
- Stock market crash: A swift plunge in stocks to about 5000 on the Dow, 500 on the S&P 500 and 900 on the Nasdaq … or lower.
- Corporate bankruptcies: A chain reaction of Chapter 11 filings or federal takeovers, including not only General Motors and Chrysler, but also Ann Taylor, Best Buy, Jet Blue, Macy’s, Saks Fifth Avenue, Sears, Toys “R” Us, U.S. Airways and even giants like Ford or General Electric.
- Megabank failures: Bankruptcies or nationalization not only of Citigroup and Bank of America, but also JPMorgan Chase and HSBC.
- Nationwide epidemic of small and medium-sized bank failures: Outright FDIC takeovers, with little prospect of nationalization.
- Insurance failures: State takeovers of companies like Ambac Assurance, Bankers Life and Casualty, Conseco, FGIC, Medical Liability Mutual, Mortgage Guaranty Insurance, Nuclear Electric Insurance, PMI Mortgage, Standard Life of Indiana and many others.
- Cities and states: An epidemic of defaults by thousands of cities, states and other issuers of tax-exempt municipal bonds.
- Stock market shutdowns: Trading halts on major, big-cap stocks … plus on-again, off-again exchange shutdowns, making it increasingly difficult for investors to liquidate their holdings at any price.
- Credit market deep freeze: A virtual shutdown in all debt markets except U.S. Treasuries. An avalanche of selling — and virtually no buyers — for corporate bonds, commercial paper, asset-backed securities, municipal bonds and all forms of bank loans.
- Government bond collapse: A steep decline in the price of medium-and long-term government securities, as the U.S. Treasury bids aggressively for scarce funds to finance a ballooning budget deficit.
Shocking? Perhaps. Avoidable? No. Nor am I alone in anticipating this rapid unraveling of the economy and financial markets. This past Friday, at a Columbia University dinner, George Soros said the financial system has effectively disintegrated, with the turbulence more severe than during the Great Depression and with the decline comparable to the fall of the Soviet Union, while Paul Volcker said he could not remember any time, even in the Great Depression, when things went down so fast and quite so uniformly around the world. Both recognize that we’re in a new era of chaos.
US Home Prices Continue to Post Record Declines
Home prices continued their multiyear slide in December, according to the two closely-watched gauges. Separately, U.S. consumer confidence levels collapsed in February, as households painted a dire picture of the economy. The S&P/Case-Shiller home-price indexes showed both the 10-city and 20-city index posted record declines, making 2008 the second-straight full year of declining home prices. Nationally, home prices are at levels similar to late 2003, and the Sun Belt continues to be hit hardest. The U.S. National Home Price index, which covers all nine U.S. census divisions, fell 18% in the fourth quarter from a year earlier, the largest decline in the measure's 21-year history.
"There are very few, if any, pockets of turnaround that one can see in the data," said David M. Blitzer, chairman of S&P's index committee. "Most of the nation appears to remain on a downward path, with all of the 20 metro areas reporting annual declines, and eight of those [areas] now with negative rates exceeding 20%." Both composite indexes and 13 of the 20 metropolitan areas have reported consecutive record year-over-year declines since December 2007. As of December, average home prices are down 27% from their mid-2006 peak. The 10-city and 20-city indexes have fallen every month since August 2006, 29 straight.
Both the 10-city and 20-city indexes fell 19% in 2008. December's drop marks the 10-city index's 15th-straight monthly report of a record decline. The indexes showed prices in 10 major metropolitan areas fell 2.3% from November, while home prices in 20 major metropolitan areas fell 2.5% from November. Yet again, none of the regions could stave off a decline from November to December. Month-to-month decliners were led by Phoenix and Las Vegas, which fell 5.1% and 4.8%, respectively, and Minneapolis, which dropped 4.6%. And for the ninth straight month, no region was able to avoid a year-over-year decline. Phoenix and Las Vegas were again the worst performers, with drops of 34% and 33%, respectively, from a year earlier. San Francisco followed, with a decline of 31%. Phoenix is down 46% from its peak in June 2006.
Compared with a year earlier, Denver and Dallas again had the best relative performance, with annual declines of 4% and 4.3%, respectively. U.S. home prices fell a record 3.4% on a seasonally-adjusted basis during the fourth quarter of 2008, according to a separate government index released Tuesday. The drop surpassed the 2.0% decline reported for the third quarter and was the largest decrease in the index's 18-year history, the Federal Housing Finance Agency said. The FHFA's index is based only on loans backed by Fannie Mae and Freddie Mac, so it doesn't include subprime and jumbo loans. This can sometimes mute decline, especially as compared to the broader-based S&P/Case-Shiller home-price indexes. However, home prices rose by a seasonally-adjusted 0.1% in December, after a downward adjustment for November.
The index includes sales prices of home purchases only, not appraisals for refinancings. Those data are reflected in FHFA's broader "all-transactions" home price index, which posted a more modest 0.2% drop in the fourth quarter of last year. The Conference Board reported Tuesday that its February consumer confidence index fell to a historic low for the survey, at a reading of 25.0, from the previous low of 37.7 seen in December. Economists had expected a far more modest decline, predicting the February index would come in at 35.5. "Not only do consumers feel overall economic conditions have grown more dire, but just as disconcerting, they anticipate no improvement in conditions over the next six months," said Lynn Franco, who leads the private research group's Consumer Research Center.
The present situation index for February fell to 21.2 from January's 29.7, while the expectations index declined to 27.5, from the prior month's 42.5. The data suggested overall economic conditions have weakened even further in the first quarter of 2009, Franco said, while the future concerns about business conditions, employment and earnings "have further sapped confidence and driven expectations to their lowest levels ever." In the report, consumers became more disheartened about the state of the economy, with those calling business conditions as "bad" rising to 51.1% of the survey from 47.9% in January, while those calling conditions "good" edged up to 6.8%, from 6.4% the month before. The Conference Board found concerns about hiring have increased, with those calling jobs "hard to get" moving up to 47.8% of respondents, from 41.1% in January. Those who deemed jobs as "plentiful" fell to 4.4% of the survey, from 7.1% who had that view a month ago. The Conference Board's findings are based on a representative sample of 5,000 households. The cut off for responses was Feb. 18.
U.S. Consumer Confidence Collapsed to Record Low
Confidence among U.S. consumers plunged to a record low in February, signaling spending will slump further as unemployment soars. The Conference Board’s index declined more than forecast to 25 this month, the lowest level since data began in 1967, from a January reading of 37.4, the New York-based research group said today. Another report showed the drop in home values accelerated in December. Retailers such as Macy’s Inc. and J.C. Penney Co. are likely to keep hurting as foreclosures soar and job losses mount. President Barack Obama is trying to mend the breach in confidence with a stimulus plan that he says will save or create more than three million jobs, while Federal Reserve Chairman Ben S. Bernanke today said the economy is in a “severe” contraction.
“Just when you think confidence can’t go any lower, the bottom falls out of it, and you can be sure the rest of the economy is not far behind,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, which had the closest forecast at 26.7. “If consumers’ spending matches their flagging spirits, this recession is going longer and deeper.” Economists forecast confidence would fall to 35, from a previously reported 37.7 for January, according to the median of 72 projections in a Bloomberg News survey. Estimates ranged from 26.7 to 42. Home prices in 20 metropolitan areas fell 18.5 percent in December from a year earlier, the biggest drop since records began in 2001, according to S&P/Case-Shiller. All the regions were down during the period, led by a 34 percent slump in Phoenix and a 33 percent slide in Las Vegas.
“Strong government action” is critical to stabilize markets and financial firms, Bernanke said today during testimony before Congress. January forecasts by Fed officials suggest that “a full recovery of the economy from the current recession is likely to take more than two or three years,” Bernanke told lawmakers. Stocks trimmed gains following the chairman’s remarks and the report showing confidence sank, while Treasury securities climbed. The Standard & Poor’s 500 index was up 0.3 percent at 745.52 at 10:18 a.m. in New York. The yield on the benchmark 10- year note fell to 2.71 percent from 2.76 percent at yesterday’s close.
Today’s confidence survey showed the share of consumers who said jobs are plentiful slumped to 4.4 percent from 7.1 percent last month. The proportion of people who said jobs are hard to get increased to 47.8 percent, the highest level since 1992. Americans also viewed their financial well-being in future months with more pessimism. The Conference Board’s gauge of the outlook for the next six months decreased to 27.5, also the lowest on record, from 42.5 in January. The share of respondents expecting their incomes to rise over the next six months dropped to 7.6 percent from 10.3 percent. The measure of present conditions dropped to 21.2 from 29.7.
“Not only do consumers feel overall economic conditions have grown more dire, but just as disconcerting, they anticipate no improvement in conditions over the next six months,” Lynn Franco, director of the Conference Board’s consumer research center, said in a statement. The real-estate slump at the center of the U.S.-led global downturn shows no sign of letting up as lenders tighten borrowing rules during the worst credit crisis in seven decades. New-home sales continue to fall and builders are cutting additional projects. To cushion the downturn, Obama on Feb. 17 signed into law a $787 billion recovery bill that includes tax relief, infrastructure spending and aid to distressed states aimed at creating or saving 3.5 million jobs. A day later, he unveiled a $275 billion plan to curb foreclosures and halt the slide in home prices.
Even with lending rates near record lows and the government moving to prop up housing, foreclosures this year may reach about 3.1 million, surpassing last year’s record 2.7 million, Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania, said last week. The drop in home values is contributing to the decline in spending because home equity was a major source of cash for purchases of expensive items like autos during the housing and credit booms. U.S. sales of cars and light trucks plunged to a 9.6 million annual rate in January, the lowest level since 1982, according to industry data. General Motors Corp. said this month it will cut another 47,000 workers from payrolls worldwide.
Declining stock prices are also hurting household wealth and making Americans gloomy. The Standard & Poor’s 500 Index last week posted its biggest drop in three months on concern the government will have to nationalize banks. Through Feb. 20, the index was down 6.8 percent for the month, extending its losses since last May to 45 percent. Retailers are bracing for more bad news. Macy’s, the second- largest U.S. department-store company, this month said it was eliminating 7,000 jobs, while J.C. Penney, the third-largest, last week forecast its first quarterly loss in almost five years.
“The customer’s very tentative,” J.C. Penney’s Chief Executive Officer Myron Ullman said on a conference call with investors. “They’re buying what they need and they’re being very smart about how they spend their money.” After contracting for the last six months of 2008, consumer spending will keep shrinking for the first six months of this year, according to economists surveyed by Bloomberg this month. It would be the first 12-month drop in the postwar era. The recession that began in December 2007 will extend at least through the first half of 2009, with unemployment rising to 8.8 percent by year-end, according to the forecasts.
AIG's Plan to Bleed the Government Dry
Management at AIG has calculated exactly how much money the Treasury and Fed will have access to after all of the TARP, financial stimulus, and mortgage bailout projects have been funded. The insurance company then plans to ask for whatever is left to fund its deficits so that it can stay in business, effectively making the federal government insolvent. According to CNBC, AIG is about to post another huge loss. "Sources close to the company said the loss will be near $60 billion due to writedowns on a variety of assets including commercial real estate." The financial channel also reports that the need for capital may be so great that AIG might have to enter Chapter 11, something the government has spent over $130 billion trying to prevent.
Just like Detroit, Bank of America, and Citigroup, AIG is playing a game of chicken with Washington that the government does not feel it can afford to lose. Imagine what it would be like if all of these businesses failed at the same time. It is actually worth imagining. The government has so many balls in the air between the financial systems and deteriorating parts of the industrial sector that it may not have either the capital or intellectual capacity to go around. The Treasury has just appointed a prominent investment banker to help oversee the mess in Detroit, but it would take an army of financiers to first comprehend and then advise on what should happen to GM (GM) and Chrysler.
The period for comprehension is already in the past. The trouble in the auto industry has to be addressed in the next few weeks or its capacity to operate will go up in flames. The government made noises about taking a larger position in Citigroup. Based on the market's reaction, not may analysts and investors believe that the action will solve much. The poison of bad investments is in the blood of the financial system. Quarantining Citigroup will not solve that problem. The Treasury and Fed will have to take a holistic approach which involves healing the entire financial system. It is not clear that can even be done. How it would be done is an even more complicated matter.
The Little Dutch Boy is running out of fingers. The water that threatens to swamp the international financial system is getting closer to breaching the walls and pouring in. A month ago that seemed inconceivable. Now the odds that the government will have to allow large operations like AIG go into bankruptcy are fairly high. The trouble with that is not what will happen to AIG. As the market found out with the Lehman Brothers bankruptcy, many of the firms that are doing business with a very large financial institution when it becomes insolvent can have transactions worth billions of dollars wither voided or devalued. In the intricate global financial system, there is no such things as one big player going down in a vacuum.
U.S. pressed to add billions to bailouts
The government faced mounting pressure on Monday to put billions more in some of the nation's biggest banks, two of the biggest automakers and the biggest insurance company, despite the billions it has already committed to rescuing them. The government's boldest rescue to date, its $150 billion commitment for the insurance giant American International Group, is foundering. AIG indicated on Monday it was now negotiating for tens of billions of dollars in additional assistance as losses have mounted. Separately, the Obama administration confirmed it was in discussions to aid Citigroup, the recipient of $45 billion so far, that could raise the government's stake in the banking company to as much as 40 percent.
The Treasury Department named a special adviser to work with General Motors and Chrysler, two of Detroit's biggest automakers, which are seeking $22 billion on top of the $17 billion already granted to them. All these companies' mushrooming needs reflect just how hard it is to stanch the flow of losses as the economy deteriorates. Even though the government's finances are being stretched ? and still more aid might be needed in the future ? it is being forced to fill the growing holes in the finances of these companies out of fear that the demise of an important company could set off a chain reaction. The deepening global downturn is dragging down all kinds of businesses, and, with no bottom to the recession in sight, investors sent the Standard & Poor's 500-stock index down 3.5 percent on Monday to its lowest close since April 1997.
In an unexpectedly assertive joint statement after two weeks of bank stock declines, the Treasury Department, the Federal Reserve and U.S. government bank regulatory agencies announced that the government might demand a direct ownership stake in major banks that do not have enough capital to weather a deeper downturn. The government will begin conducting a test of the banks' financial health this week. Administration officials emphasized that nationalizing any of the major banks was their least favorite solution to the banking crisis, but they acknowledged that some banks might be both too big to fail and too fragile to endure another round of shocks without substantial help. The administration is debating how big a role to play in the auto businesses, what concessions the companies should make in return for aid and whether bankruptcy should be considered, though it prefers a private sector solution. On Monday, Steven Rattner, co-founder of the private equity firm Quadrangle Group, was named an adviser to the Treasury on restructuring the auto industry.
As the administration takes bigger stakes in companies, the value held by existing shareholders is being diluted, which could make it even harder to attract private money in the future. Timothy Geithner, the secretary of the Treasury, recently outlined a bank recovery plan that included a new program to attract a combination of public and private money to buy troubled mortgages and other assets. AIG serves as a cautionary note about the difficulty of luring private investors when the size of the losses is unknown. Each quarter since the government initially stepped in last fall to take an 80 percent stake in the insurer, the company has suffered deepening losses and has been forced to post more collateral with its trading partners. The company, according to a person close to the negotiations, is discussing the prospect of converting the government's $40 billion in preferred shares into common equity.
The prototype could turn out to be Citigroup, which is negotiating with regulators to replace the government's nonvoting preferred shares with shares that are convertible into common stock. "We absolutely believe that our private banking system is best off being in private hands and we are trying our best to keep it that way," said one senior administration official, who spoke on condition of anonymity. But, he continued, the government is already deeply involved in propping up the banking system and may have no choice. Officials said they were bracing for the possibility of new problems that might indeed require the government to take a more aggressive stance.
"Given our involvement at this particular stage, there is an element, a possibility over time, that we will end up with some ownership of these institutions," the official said. "This is really about aggressive anticipatory action. It is an acceptance that the future is uncertain, but that we can plan on a certain basis for it." Acquiring common stock would give the government more control, but expose it to more risk. Armed with voting shares, government officials would have more power to replace management and change company strategy. But the Treasury would lose its claim to dividend payments, which in Citigroup's case amount to more than $2.25 billion a year. AIG declined to provide details of its new financial problems, citing the "quiet period" just before it issues fourth-quarter results. But some people familiar with AIG's negotiations said it was on the brink of reporting one of the biggest year-end losses in American history.
Such losses lead to a bigger problem. A further credit rating downgrade would force the company to raise more capital, according to a person involved in the negotiations. The losses appeared to be across the board, unlike the insurer's giant losses of last September, which were confined mostly to the derivative contracts, called credit-default swaps, that AIG had written as insurance on other debts. AIG has not been writing new credit-default swap contracts, and had tried to put the swaps disaster behind it. In November the company worked out a relief package with the Federal Reserve Bank of New York, in which the most toxic of its swap contracts were put into a kind of quarantine, so they could no longer hurt its balance sheet. But AIG put only one type of credit-default swaps into the quarantine. It had written several other classes of credit-default swaps, which it has continued to carry on its books.
If the latest round of losses severely weaken AIG's capital and its creditworthiness, then its swap counterparties may be entitled to demand that AIG come up with a large amount of cash for collateral ? precisely the problem that brought the company to its knees last September. "They stand, unfortunately, to bring others down with them if they go down," said Donn Vickrey of Gradient Analytics, an independent research firm. Last fall, when AIG received its initial $85 billion from the Fed, he estimated that the total cost of bailing out AIG would eventually mount to $250 billion. "We are moving closer and closer to that prediction," he said Monday.
The difficulty of shoring up AIG must weigh on the administration at this moment. The administration's banking statement amounted to plan of action demonstrating a way to demand a major and possibly a controlling stake in systemically important banks like Citigroup and Bank of America. "They are desperate to not nationalize the banks," said Robert Barbera, chief economist at ITG. "They know what happened when they took Iraq and they would just as soon not take over the banks, because if you own it, you gotta fix it."
Bernanke: Strong Action Needed To End Recession
Federal Reserve Chairman Ben Bernanke warned Tuesday that unless government efforts succeed in restoring financial stability, the nation's recession may not end this year. Bernanke told lawmakers that the sharply shrinking economy was at further risk from mutually reinforcing weakening growth and financial market strain. "To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets," he said in testimony prepared for delivery to the Senate Banking Committee. "If actions taken by the administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability—and only if that is the case, in my view—there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery," he said.
Bernanke, delivering the Fed's semiannual report on monetary policy, further warned that another risk to his outlook was the global nature of the economic slowdown, which could sap U.S. exports and harm financial conditions to a greater degree than currently expected. A slump in U.S. exports as world growth chilled last year added to a deep pullback in consumer spending that steepened the country's economic downturn. Bernanke said the Fed—which has dropped rates to nearly zero—would keep borrowing costs exceptionally low for some time and pledged to use "all available tools" to stimulate the economy and heal financial markets. The Fed chairman made no mention of the possibility the central bank would purchase longer-term U.S. government debt in his prepared remarks. He noted that an ongoing Fed program to buy mortgage finance agency debt and mortgage-backed securities had helped move mortgage rates lower by nearly one percent.
Bernanke also said inflation pressures had receded dramatically as oil and commodity prices had fallen and slack had built up in the economy. Fed measures have helped restore some stability in areas of financial markets, the Fed chairman said, citing reduced strains in short-term funding markets, improved commercial paper market conditions, and declines in corporate risk spreads. "Nevertheless, despite these favorable developments, significant stresses persist in many markets," he said. "Notably, most securitization markets remain shut, other than for conforming mortgages, and some financial institutions remain under pressure." To revive the economy, the Fed has slashed a key interest rate to an all-time low and Obama recently signed a $787 billion stimulus package of increased government spending and tax cuts. In addition, Treasury Secretary Timothy Geithner has revamped a controversial $700 billion bank bailout program to include steps to partner with the private sector to buy rotten assets held by banks as well as expand government ownership stakes in them—all with the hopes of freeing up lending.
The Obama administration also will spend $75 billion to stem home foreclosures. Those and other bold steps—including a soon-to-be-operational Fed program to boost the availability of consumer loans—for autos, education, credit cards and other things -- should over time provide relief and promote an economic recovery, Bernanke said. Radical actions taken by the government since last fall when the financial crisis intensified have relieved some credit and financial strains, Bernanke said. "Nevertheless, despite these favorable developments significant stresses persist in many markets," he said. "Notably most securitization markets remain shut ... and some financial institutions remain under pressure." Although Bernanke didn't mention any such financial institutions by name, Citigroup —the industry's troubled titan— is apparently in line for additional government help. Critics worry the Fed's actions have the potential to put ever-more taxpayers' dollars at risk and encourage "moral hazard," where companies feel more comfortable making high-stakes gambles because the government will rescue them.
All the negative forces have battered consumers and businesses. "The economy is undergoing a severe contraction," Bernanke said. The nation's unemployment rate is now at 7.6 percent, the highest in more than 16 years. And it will climb higher—even in the best-case scenario that an economic recovery happens next year. The Fed expects the jobless rate to rise to close to 9 percent this year, and probably remain above normal levels of around 5 percent into 2011. The recession, which started in December 2007, already has killed a net total of 3.6 million jobs. To brace the economy, many analysts predict the Fed will leave its key rate at record lows through the rest of this year. The Fed has said repeatedly that it will explore expanding existing programs to provide loans or buy debt, or come up with new tools to fight the crises. The Fed is "committed to using all available tools to stimulate economic activity and to improve financial market functioning," Bernanke told lawmakers Tuesday.
Obama Gambles Tests for U.S. Banks Will Stem Investor Exodus
President Barack Obama is gambling he can dispel the cloud of uncertainty that has driven bank shares to a two-decade low by subjecting lenders to rigorous reviews and reviving the market for their toxic assets. Officials will begin so-called stress tests of about 20 of the nation’s largest banks tomorrow with the aim of ensuring they have sufficient capital to withstand the toughest of economic times. Institutions that cannot privately raise the added capital they need will get taxpayer money, regulators said yesterday. “What we need to clean out the system is for investors to know that there are not more crises to come,” said Raghuram Rajan, a former chief economist at the International Monetary Fund who’s now a professor at the University of Chicago. “The stress tests, if they are followed by action, can help do that.”
The administration’s strategy is not without its risks. By shining a light on banks’ potential problems, it may end up fanning investor fears, rather than quelling them. It may also highlight how little firepower the government has left for fixing the banks’ problems after spending more than half of the $700 billion bank bailout fund authorized by Congress last year. “With tests like these, you run the risk of further eroding the confidence of investors,” said Wayne Abernathy, an executive vice president at the American Bankers Association in Washington. “The jury is still out on whether receiving the government money will be a benefit or a harm.”
Policy makers are struggling with that issue as they try to decide how much more help they can provide Citigroup Inc. without diluting the value of shares held by investors too much, a person familiar with their deliberations said. The initial reaction yesterday showed some relief that shareholders won’t be wiped out by full nationalization of some lenders. Citigroup gained 10 percent to $2.14 after losing more than 40 percent of its value last week. The Standard & Poor’s 500 Banks Index advanced 2.1 percent to 59.41 even as the broader S&P 500 Stock Index tumbled 3.5 percent. The Treasury, Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and Office of Thrift Supervision vowed to preserve “the viability of systemically important financial institutions” and stated their “strong presumption” banks should remain in private hands and not be nationalized.
Fed Chairman Ben S. Bernanke may today be questioned about efforts to combat the credit crisis in a Senate Banking Committee hearing in Washington. Any fresh government funds injected into the banks would be in the form of mandatory convertible preferred shares that would be exchanged into equity “only as needed over time.” While the new injections could leave the government with majority ownership of several lenders, a Treasury official said on condition of anonymity that the stress tests aren’t intended to lay the groundwork for federal takeovers. Instead, they are aimed at getting a truer picture of the banks’ long-term health, the official said. That too is the goal of the Treasury’s effort to set up public-private partnerships to buy up the toxic assets clogging banks’ balance sheets.
By putting a market-determined price on the assets, Treasury Secretary Timothy Geithner hopes to address doubts about what the assets are worth and, in the process, provide investors with a clearer picture of banks’ balance sheets. “You have to remove the uncertainty about asset values, and Geithner’s plan is an efficient way of jump-starting private-sector price discovery of those values,” said Randal Quarles, a former Treasury undersecretary of domestic finance who is now a managing director at the Carlyle Group in Washington. Geithner is betting that lenders’ share prices have been so beaten down that investors have already discounted the distressed values that may result from the price-discovery process.
“Banks have lots of assets on their books that have not resulted in losses yet, that people think will result in losses at more than historical levels,” Quarles said. The philosophy behind both the public-private partnerships and the stress tests is that the more information investors have, the better the markets work. That’s in contrast to the stance taken by Japan in the 1990s, where executives regularly low-balled loan losses only to eventually have to come clean later. While U.S. regulators don’t intend to publish the details of their stress tests, the results will effectively become known once it is determined how much capital each bank is required to raise, either from investors or the government. The more capital needed, the worse off the bank.
“These examiners begin the stress test with already a deep understanding of the institution” because they are in effect residents at the firms they oversee, said Bob Bench, a former deputy comptroller of the currency. The stress tests may look at situations such as how much losses would climb if the unemployment rate climbs past 10 percent, he said. “In the normal course of business, bank regulators tend not to look over the horizon,” said Bench, a senior fellow at the Morin Center for Banking and Financial Law at Boston University. The new reviews will do so, he said. Gilbert Schwartz, a partner at Washington law firm Schwartz & Ballen LLP and a former Fed attorney, said the regulatory review would help “put a number” on the problem facing each individual bank. “Even though the hole may be large, it will clear up the uncertainty and provide assurance that the institution’s problems will be resolved -- either by the government putting capital in or taking some other measure,” he said.
The Stock Market's Frightful Slide
Last fall's fear-driven equity meltdown was scary. The latest drop in stock prices could be even scarier. The stock market on Feb. 23 replayed its November meltdown, dropping below last year's lows to a level not seen since April 1997. But though stocks are now back at levels not seen since 1997, February's orderly slide feels very different from the sharp declines seen last fall. And that's what's worrying investors: November's crisis sometimes felt like irrational panic, driven by fears of a financial meltdown. February's sell-off, by contrast, seems driven by reality. On Feb. 23, the broad Standard & Poor's 500-stock index closed at 742.33. That's almost exactly half the value of the stock market at the beginning of 2008. It's not just a recent bubble that has burst. If you bought into the overall stock market—represented by the S&P 500—at any point in the last 11 years, your shares are now worth less than you paid for them. On Nov. 20, the S&P 500 closed at 752.44. But that return to 1997 levels came after the collapse of Lehman Brothers and amid genuine fears the entire world's financial system was near collapse. When investors calmed down and some rational optimism returned, investors jumped back in the market, bidding the S&P 500 up 24% by Jan. 6.
But since then, a series of developments has punctured many illusions that had driven the stock market's rally. First, there was the technical analysts' argument that the November lows represented a floor below which the stock market would not fall. Technicians, who predict the market by studying market movements closely, repeatedly saw the market dip close to November lows but then recover. February's drop proves that the supports under that technical floor were very rickety. Second, conditions in the economy and in the stock market are worse than ever than before. Many investors were betting on a recovery for the economy in the second half of 2009. However, so far there is nothing in the economic data to justify those hopes. "We've had three months of worsening data," says independent stock analyst Doug Peta. "Where we are now [in terms of the economy] is worse than the market was anticipating in November." Moreover, the expectations for earnings by companies are now far worse. Analysts are cutting earnings estimates on a daily basis, undermining a key measure that investors use to determine the value of stocks. Even with the market down 49% in the last 14 months, "I don't think stocks are necessarily cheap," Peta says.
But the biggest disappointment for investors has come from Washington and the banking system. While the Bush Administration's main focus was on stopping the market panic, investors hoped the new Obama Administration would find ways to end the credit crisis. So far, investors haven't heard a coherent plan from Washington, says Quincy Krosby, chief investment strategist at the Hartford. "At this point, investors are just left waiting," she says. "The more you wait, the more you see deterioration of the overall economy." If any other sector of the stock market faced these problems, the rest of the market might be able to tread water. But the financial sector's troubles could turn into a deeper and more serious economic downturn. "As the financial sector goes, so goes the economy," Krosby says. As chief economist at Ibbotson Associates, a subsidiary of Morningstar (MORN), Michele Gambera tracks a wide variety of economic data. But, he says, the key data point these days is the state of the bond market. He likens the credit market to the economic motor's transmission. "If the transmission is jammed, there is nothing that can move," he says.
Both investors and the Obama Administration are caught in a Catch-22. If policymakers like Treasury Secretary Timothy Geithner hurry and implement a plan quickly, it might not work. "The risk is that the current conditions force Geithner's hand to put together a hurried and less than comprehensive approach," warns Daniel Clifton of Strategas, a Washington consulting firm. But as investors wait for a comprehensive solution, the economy and market conditions get worse. "There is no silver bullet," Peta says. "There isn't a nondisruptive way to fix everything." Many investors fear a drastic step like the nationalization of banks, which would wipe out some shareholders. But others, like Peta, worry the Administration hasn't been bold enough. For now, investors are stuck in an uncertain environment, where everything they scrutinize to make decisions — from earnings to economic measures to technical indicators — is deteriorating before their eyes. Stocks at these price levels could represent long-term bargains. But at a time like this, few investors are bold enough to challenge the bear.
Crafting a Bank Plan...No 'Lehman Weekends'
While markets appear to be waiting for the hammer of government to come crashing down on the nation’s two largest banks, several government officials in interviews with CNBC on Sunday described a process in the works that is far more deliberative. Some details will be made available this week Treasury confirmed, but parts of the plan will take weeks, months and even more than a year to play out as the Obama administration puts together a program that they hope will return banks to long-term health. What is clear is that they are specifically trying to avoid “Lehman Weekends,” referring to the furious efforts in September when Lehman Bros. went bankrupty and AIG was bailed out. Officials stressed that there were no separate meetings going on surrounding Bank of America or Citigroup specifically and that the two banks would be treated under the broad plan now in the works.
Neither bank has asked for increased government assistance and one official said such assistance is not needed at this time. Officials would not rule out increased or even outright government ownership of large banks at the end of the process, but they say their intent is to avoid that outcome and that it is anything but certain. They say the government does not want to be running these companies. If the banks end up in government hands, officials say, the intent would be to get them into private hands quickly and do so in a way that is not much different from how the Federal Deposit Insurance Corp. currently resolves bank insolvencies, which typically take place over the weekend. The extent of government ownership, they say, will depend on the size of the losses at the banks, the access of banks to private capital and how the recession plays out.
Said one high-level official, “I think the market is missing that the whole intent of this process is to show that the banks have enough capital for even worse outcomes than we currently envision and to show there’s a program in place to give banks access to that capital if they need it.” Several officials conceded that they have done a poor job in explaining the process to markets and that markets have, understandably, spun the darkest possible outcomes in the absence of information. New details on the so-called bank stress test could be made available as soon as tomorrow, officials say. This process will gauge bank capital levels under worst-case economic scenarios than are currently seen. Details on those scenarios are likely to be made public on Wednesday.
Officials say there will also be some information about the “capital-access program” that will explain how banks can obtain government capital in the event of worst-case economic scenarios. Separate details of the public-private partnership will also be made available soon, but the timing is less clear. The key misunderstanding in markets, officials believe, is how the public-private partnership will work and the way that new government capital, in the form of mandatory convertible preferred shares will become common equity. One official said the public-private partnership will be voluntary so there will not be no mandate that banks offload assets at a loss.
The official added that additional government capital will go into the banks as mandatory convertible preferred. Those shares remain preferred until realized losses and capital needs trigger conversion to common. As a result, the official said, the government may end up with a large stake in a given bank over a period of time, but it wont’ happen overnight. As Wall Street braced for the worst, Bank of America lost 32 percent last week, closing at $3.79, a more than 24-year low. Citigroup tumbled 46 percent last week to end at $1.95, an 18-year low.
The Problem With 'Nationalization'
The chorus for nationalizing America's struggling banks is growing louder, and support for the idea comes from strange sources. Alan Greenspan has said that he understands that "once in a hundred years" the government needs to take over the banks, and now is the time. Sen. Lindsey Graham, a Republican from South Carolina, has called for doing what works and "if nationalization is what works, then we should do it." That is the kind of pragmatism that leads to socialism. There is a great deal of imprecision in all the talk of nationalizing banks. The government, through the Federal Deposit Insurance Corp. (FDIC), temporarily takes over insolvent banks when it closes them. When it can, the FDIC sells a failed bank to another institution. Sometimes the purchaser does not want some or any of the failed bank's assets. The FDIC must either then pay the buyer to take the assets (subsidize expected losses) or take over those assets.
In a limited number of cases, there is no buyer for a failed bank. IndyMac Bank is a notable recent example. It has been operated since last year as an FDIC-owned institution (IndyMac Federal Bank) with the goal of finding a private buyer. Certainly, in the latter case, a government agency has taken ownership of a bank. The federal government, under the auspices of the FDIC, can be said to routinely nationalize failed banks. There is nothing new about that policy and it certainly occurs more than once every 100 years. There are some commentators, pursuing an ideological agenda, who want to use the current crisis to nationalize the entire financial system. That is nationalization in the style of a Latin American despot. It is presumably not what most advocates of bank nationalization have in mind, and certainly not what Mr. Greenspan or Mr. Graham are advocating. Those two advocate temporary nationalization of a limited number of institutions, until they can be restructured and put back into private hands.
The real issue is what to do with a subset of the largest financial institutions, the financial behemoths headquartered in New York City and other money centers, which are feared to be headed toward insolvency. (Some think they are already insolvent.) Treasury Secretary Timothy Geithner's promise to "stress test" the major banks has fed the chorus of Cassandras. What if a major bank fails the test? There are no good options and certainly nothing resembling a free-market solution. The government has put the taxpayer on the hook in a myriad of ways. First, there is deposit insurance. Second, there have been guarantees issued to certain creditors. Third, and most notoriously, the Treasury has invested taxpayer funds in preferred shares of certain institutions. Fourth, the Fed has lent funds on many of the dodgy assets of these banks. The Fed's balance sheet should be consolidated with the Treasury's in any cost-benefit calculation of alternative resolution strategies.
Ideally, the administration would adopt the least-cost method for the taxpayer of resolving the failure of a large bank. In principle, temporary nationalization in some instances could be the least-cost approach. The example of the Swedish banking crisis of the early 1990s is most often cited by nationalization advocates. The conservative government of Prime Minister Carl Bildt took an aggressive approach to the banking crisis and is generally credited with having done a good job of resolving it. He acted quickly to guarantee all depositors and bank creditors. Asset values were aggressively written down. Public funds were used to recapitalize banks, for which the government received common shares to give any upside to the taxpayer. Two banks were nationalized entirely. The rest of the story is an important element of Mr. Bildt's success. His political opposition backed his government, at least in public. The bad assets, mostly real estate, were sold relatively quickly. The needed workouts brought cries that borrowers were being squeezed. In short, the resolution was handled professionally rather than politically.
The contrast with the current U.S. crisis could not be sharper. From the beginning, the handling of the U.S. crisis has been politicized. The partisanship is as toxic as the bad assets on bank balance sheets. Both parties are coming up with schemes to impede the process of foreclosing on homeowners who can't afford their homes, which would get those homes into the hands of new owners who can afford them. Does anyone believe that a government bad bank will squeeze homeowners? To ask the question is to answer it. Moreover, we know how the government runs financial institutions -- consider Fannie Mae and Freddie Mac. Or IndyMac, whose management by the FDIC has been criticized for inflating the rescue costs through its liberal loan-modification program. A money-center bank in government hands would become a conduit for politicized lending and grants disguised as loans. That's what's happened at Fannie and Freddie. The government would never let go of its political ATM. You might as well consolidate such an institution with the Fed from the outset.
Mr. Geithner wants a public-private partnership to buy toxic assets from banks. All that government has done thus far has only scared private money off. As bankers now realize, when you turn to the government for financial assistance you take on an untrustworthy partner. Outside money will not come in only to see its investment diluted later on when the government injects additional funds. Rather than focusing on ways in which we can further involve the government in the financial system, we need to find ways to extricate banks from government's deadly embrace. Banks, at least the behemoths, were public-private partnerships before the crisis. Deposit insurance, access to the Fed's lending, and the implicit (now explicit) government guarantee for banks "too big to fail" all constituted a system of financial corporatism. It must be ended not extended. If a bank is too big to fail, then it is simply too big. Those institutions need to be downsized until their failure would no longer constitute a systemic risk. Then we can discuss how to untangle the government and the major banks, and create a banking system of genuinely private institutions.
Bill Gross: Nationalization Would Fail
Bond king Bill Gross said in his latest monthly missive that any effort by the U.S. government to nationalize floundering banks wouldn't work, partly because of the number of banks involved. "We have 7,500, as well as many (savings and loans) and credit unions, which would have to be flushed into government hands," said Gross, managing director at Pacific Investment Management Co. "Regulators are overwhelmed as it is, and if you thought Lehman Brothers was a mistake, just stand by and see what nationalizing" Citigroup Inc. or Bank of America Corp. would do.
Fears that broken U.S. banks might be nationalized have roiled the stock market periodically in the last few months as the government made cash infusions to troubled financial institutions. Investors are worried that nationalizing banks would wipe out or severely dilute their stakes. Mr. Gross said Tuesday "The goal of future policy should be to recapitalize lending institutions while maintaining the basic infrastructure of credit markets. Outright nationalization and haircutting of creditors will do just the opposite." He also tackled the question of how bad the nation's financial crisis could get.
"If the government cannot substitute credit to the same extent that it is disappearing from the private system, then the U.S. and global economies will retreat," the bond maven said. "If the economy is viewed as a bathtub filled with water (credit) at two different times with two different levels, then draining it back down to the lower first level might reduce economic activity proportionately. Liquidate debt (credit) to 2003 totals and you just might reduce economic activity to 2003 numbers as well. Whoops! That would mean a 10%+ contraction in the economy with unemployment approaching the teens. Keep that bathtub full!"
Commercial property could sink banks further, says Fed's Lockhart
U.S. commercial real estate problems could derail the country's economic recovery later this year, a top Federal Reserve official said on Monday. "Many banks are pretty heavily exposed to commercial real estate. It is also a big part of the securitization market. So commercial real estate is one that concerns me," said Federal Reserve Bank of Atlanta President Dennis Lockhart. Lockhart, a voting member of the Fed's policy-setting committee this year, said that around $400 billion of commercial real estate refinancing was hanging over the market and he was monitoring its progress with care.
"If you think of 2007 and 2008, in a negative sense, as the year of...residential real estate issues, it is possible to think of 2009 as the year of commercial real estate. That is the one domestic factor that keeps me up at night," he told the Association for Financial Professionals after a speech. Lockhart said bold action by U.S. officials should restore growth in the second half of 2009, and he emphasized this meant that Fed rates would be hiked at some stage from their current near-zero levels to keep inflation at bay. "We see very little risk of hyper-inflation, or serious inflation, in the short term. If anything, we're somewhat more concerned about the opposite," Lockhart told a questioner.
"One of the requirements of the future, conceivably, as the economy recovers, will be the return to more conventional policy and shrinking of the Fed's balance sheet (and), conceivably, rate rises. You have to time that appropriately to ensure that we don't have a long-term inflation," Lockhart said. In his prepared remarks, Lockhart stressed that the U.S. central bank had undertaken to use all the tools at its disposal to aid the economy, and he endorsed government action to boost bank balance sheets. "By injecting capital into banks, I believe the U.S. Treasury has strengthened and will further strengthen bank balance sheets," The Treasury has already injected more than $200 billion into banks and was joined by the Fed and other agencies on Monday in a fresh assurance that the government would provide more capital as needed to keep large financial institutions viable.
In one brighter note, Lockhart said it was very hard to gauge the start and end of recessions, and cautioned there was a tendency to be too gloomy in predicting a recovery. "Economic forecasts will tend to be overly optimistic as the economy goes into a recession, but overly pessimistic as the economy comes out of recession and begins its expansion phase. Perhaps we should take some comfort from that," he said. But he warned there were significant risks to his outlook from a chilled international growth climate, in addition to the weakened state of the domestic housing and bank sectors.
"I'm also playing close attention to the trajectory of Japan. Last quarter the Japanese economy contracted by 13 percent and deflationary pressures have accelerated," he said. Asked after the speech if he was confident that China would be able to boost domestic demand speedily, Lockhart made plain that he was not holding his breath for quick results from stimulus measures announced by Beijing. "Whether that is going to be possible in the short-term is a very debatable question. Because shifting from a high savings, low consumption society to a lower savings, higher consumption society in a short period of time can't easily be done," he said.
Fed May Need to Recast TALF on Commercial Real Estate
The Federal Reserve may need to loosen the terms of a new $1 trillion credit initiative aimed at averting a meltdown in commercial mortgage-backed securities, analysts and industry representatives said. The Fed would prop up the CMBS market by lending against the securities for a five-year term rather than three years, and taking as collateral existing debt rather than just new bonds, they said. The Fed hasn’t said when the program, the Term Asset- Backed Securities Loan Facility, will begin accepting the debt. “If we don’t get credit flowing again to commercial real estate” through programs like the TALF, “we’ll probably see a very significant increase in defaults on commercial mortgages and further stress on the balance sheets of banks,” said Richard Parkus, an analyst at Deutsche Bank AG in New York.
Failure by the Fed and Treasury to rekindle private investment in the $760 billion CMBS market may worsen the longest U.S. recession since 1982. Fed Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner are promoting the TALF as a cornerstone of plans to revive credit, end a decline in home prices and cleanse toxic assets from banks’ balance sheets. The market for commercial mortgages bundled together and sold as bonds is souring, with the late payment rate for CMBS at 1.44 percent at the end of last year compared with 0.47 percent at the end of 2007, according to RBS Greenwich Capital data. The delinquency rate may rise to almost 6 percent by the end of the year and continue to increase into 2011, RBS said.
The Fed, through the TALF, could reduce the cost of financing commercial real estate by taking as collateral CMBS already traded in the secondary market rather just new bonds, said RBS analyst Lisa Pendergast in Greenwich, Connecticut. Accepting bonds from the secondary market would be a “big deal” for reviving credit, said Jan Sternin, a senior vice president at the Mortgage Bankers Association in Washington. The central bank also should make loans with at least a five-year term against CMBS, Pendergast said. The TALF is now geared to make loans of no more than three years against collateral, a misalignment with the typical five- or 10-year term of commercial mortgages. “Nobody would buy a 10-year asset with a three-year loan,” she said. The Fed initially proposed a one-year term for TALF loans it will make before revising to a three-year period in December.
Without TALF support, borrowers would have a tougher time refinancing maturing debt and avoiding delinquency or foreclosure, said Chip Rodgers, senior vice president at the Real Estate Roundtable, a trade group in Washington. Geithner has backed using the TALF to aid commercial real estate and proposed increasing the Treasury’s seed money for the program to $100 billion from $20 billion. The Fed would then expand its loans to $1 trillion from $200 billion. Bernanke said on Feb. 18 that the first phase of the TALF will begin “shortly.” That includes as much as $200 billion in loans for the auto, education, credit-card and small-business markets. The Fed has yet to provide details on the second phase, which would include CMBS and expand to $1 trillion. The Fed chief may provide more details on the TALF when he delivers semiannual testimony to Congress tomorrow and the next day.
Atlanta Fed President Dennis Lockhart said today that commercial real estate is “the one domestic factor that keeps me up at night.” “Many banks are pretty heavily exposed to commercial real estate,” he said in Orlando, Florida. Sales of CMBS plummeted to $12.2 billion last year, compared with a record $237 billion in 2007, according to estimates by JPMorgan Chase & Co. Top-rated commercial mortgage bonds are currently trading at about 10.82 percentage points more than benchmark interest rates, compared with 2.32 percentage points a year ago, Bank of America Corp. data show. In January 2007, the debt traded at 0.22 percentage point. Without the TALF, the high cost to sell the debt makes it unprofitable for investment banks to write new loans, choking off funding to commercial property owners. Banks can’t profitably originate new loans at attractive rates for refinancing because the cost to securitize the mortgages and sell the resulting bonds would be too high given the current trading price for the securities.
By accepting CMBS already trading on the secondary market, the central bank could revive demand, making it cheaper to sell the securities and enabling lenders to offer lower rates, Pendergast said. The Fed may compound the long-term burden on its balance sheet by taking on CMBS. The central bank has already doubled its assets to $1.92 trillion in the past year by creating other emergency credit programs. Buying assets with terms of five to 10 years “poses a problem for the Fed in monetary policy, because in the longer run at some point they’re going to have to reverse course,” said former Atlanta Fed research director Robert Eisenbeis, now chief monetary economist with Cumberland Advisors. The central bank may have to take losses on the assets or face higher costs of carrying them, he said. The Fed may expand the TALF to include residential mortgage- backed securities for loans bigger than $417,000 and assets collateralized by corporate debt, the Treasury said on Feb. 10.
AmEx shares fall to 12-year low amid worries about credit losses
American Express Co's shares fell to a 12-year low on Tuesday amid growing concerns about credit card losses, one day after news that the company was offering $300 to certain U.S. card holders who pay off their balances and close their accounts. "It means that they are concerned about their credit portfolio and are trying to think of ways to reduce that risk," said Stifel Nicolaus analyst Chris Brendler. "It is a little bit concerning on the surface. Why would you pay $300 to have someone close their accounts? It's an eyebrow raiser."
American Express, often seen as catering to relatively wealthy customers and companies, has been expanding its credit card business in recent years by reaching out to a wider range of clients. But that strategy has backfired. The company's earnings tumbled in the fourth quarter as credit losses jumped and debt-burdened consumers slashed spending. In addition, American Express reported last week that credit card delinquencies rose in January more than analysts expected, as U.S. unemployment increased and the global economy deteriorated. American Express shares fell 3.7 percent to $11.70 after touching a 12-year low of $11.44 in morning trading on the New York Stock Exchange. The shares have lost a third of their value this year.
Cities, States Grapple with Labor Market Free Fall
The United States is losing jobs at an alarming rate, with new waves of layoffs in the news almost every day. In some areas, local unemployment insurance funds are beginning to run out of money. Americans are now pinning their hopes on President Barack Obama's economic stimulus program. The line stretches halfway around the block. Many of the roughly 1,000 people have been camping out for days here, in downtown Miami, hoping to be among the first to apply the minute the doors open at City Hall. The City of Miami's fire department is hiring for 35 new positions. Available jobs have become a rarity in Florida, especially recession-proof jobs paying the kinds of salaries city workers earn. The job market is fraught with uncertainty, especially here in Miami, with its tropical cityscape of glittering high-rises, palm trees and the turquoise ocean. The Miami metropolitan area, with its population of 5.4 million, has lost 60,000 jobs in the last few months. This is the greatest per capita job loss among all 363 Metropolitan Statistical Areas (MSAs) in the United States. Not too long ago, Miami was considered a booming region, with fast-paced development and virtually full employment -- and a party mood. The construction cranes are idle today. The newly built skyscrapers are without tenants and unemployment has jumped to more than eight percent. Even the city's internationally renowned, and now financially strapped, ballet has had to lay off dancers.
The situation is almost as gloomy in the rest of the country, as the American economy slides downhill at an ever-increasing pace. Jobs are disappearing at a stunning rate -- much more quickly and drastically than even the most pessimistic prognoses had foreseen. The United States has already lost more than 3.6 million jobs since the recession began, with 1.8 million of those jobs having disappeared in the last three months alone. The current downturn marks the steepest plunge in the labor market since 1974, and the recession is not over by a long shot. Economic experts and the president are increasingly consternated. "The economy is collapsing at an alarming rate," says President Obama. "Only a few months ago, most economists would not have believed that this was possible." Meanwhile, hardly a day goes by without new announcements of major layoffs across all sectors. Aircraft manufacturer Boeing is laying off 10,000 workers. Photo giant Kodak is cutting its workforce by 4,000, while home improvement chain Home Depot is letting 6,000 people go. Retail electronics giant Circuit City has gone out of business, putting 30,000 people on the street, while department store chain Macy's has said goodbye to 7,000 employees. The list of horror reports in the job market just keeps on growing. One of worst days was "Black Monday" in late January, when the papers published page after page of stories about layoffs. Sixty-five thousands jobs were lost in a single day -- and that figure only included the layoffs at large companies typically reported in the media.
Companies in industries severely shaken by the crisis, like the auto and financial industries, are no longer the only ones laying off large numbers of employees. Companies that are still profitable have also begun letting workers go, apparently as a precautionary measure -- in preparation for a prolonged recession. Starbucks, for example, plans to lay off 7,000 employees, while pharmaceutical manufacturer Pfizer is letting 8,000 workers go. Even software giant Microsoft has announced layoffs -- the first time in the company's history -- of 5,000 employees. Within a year, the nationwide unemployment rate has risen from 4.9 to 7.6 percent. The president has been surprisingly open in showing his concern, admitting that it keeps him up at night. Obama's $790 billion (€632 billion) economic stimulus program, approved after a long fight with Congress, is intended to create or preserve up to 4 million jobs. But there is great skepticism. The plan doesn't provide enough funding to create a sufficient number of new jobs, say many economists. Meanwhile, the president's political rivals claim that too much money is being wasted on ineffective measures with no impact on the labor market. "Our problems certainly haven't been solved in Washington in the past," says David Pennington, the mayor of Dalton, Georgia. A small manufacturing city in the northwestern part of the state, Dalton prides itself on being the "Carpet Capital of the World." Dalton and the surrounding region is home to 80 percent of all carpet production in the United States. As long as the Americans were building houses at a steady rate, business in Dalton was booming. The streets are well-kept and the city boasts a carefully restored historic downtown.
But with the sharp downturn in new home construction in the United States, the demand for carpeting has plummeted. As a result, unemployment in Dalton has more than doubled in the last 12 months, from five to 11.2 percent. "It's actually a lot higher than that," says Brian Anderson, president of the local chamber of commerce, explaining that the figures only reflect those who file for unemployment benefits. All across the United States industrial jobs, including those at Dalton's carpet factories, are attracting immigrant workers. Most are Mexicans, and many are in the country illegally. Instead of filing for unemployment when they lose their jobs, they simply leave. In the somewhat run-down eastern part of Dalton, where supermarkets and restaurants have Spanish names, like La Providencia or El Taco, there are many empty storefronts and boarded-up windows. The economy is also struggling elsewhere in the city. Workers who have been laid off are less likely to go out to eat at the local pizzeria or shop for clothes at stores on Main Street. Two of the anchor stores at the local shopping mall have already closed. Even more people have been let go, adding to the ranks of local residents with no disposable income left for consumption. Two-thirds of the US economy depends on domestic demand. The less Americans consume, the worse the crisis will get. "We have to break this vicious cycle," says President Obama.
The unemployment office in Dalton is filled with tired faces, on both sides of the counters. Danny Cope, who manages the office, says it gets 500 calls a day. The waiting room is crowded with people, but few of them stand a chance of finding a new job. "If you've worked in a carpet factory for 20 years," says Cope, "you don't have many qualifications to do anything else." The United States has little in the way of retraining and continuing education programs. In Dalton, for example, the unemployment office pays employers to provide training programs, and sometimes courses are offered in conjunction with local colleges. There are no other programs. "Most of what we do is help people find jobs and set up job application workshops," says Cope. There is only $3 billion (€2.4 billion) in federal funding available for job retraining programs nationwide. When it comes to government spending on job training, the United States is in the bottom 20 percent of Organization for Economic Cooperation and Development (OECD) member nations. For the mayor of Dalton, even the current level of spending is too much. "What do you want retrain people to do?" he asks. The United States should finally start "producing things at home, instead of outsourcing everything," says Pennington. "Where did all of our factory jobs go?" Many Americans -- from factory workers in Dalton to construction workers in Miami and bank employees in New York -- lack the prospect of finding another job in their own industry or the necessary qualifications to find alternative work, and are thus dependent on unemployment assistance.
But unemployment benefits in the United States are meager compared with other industrialized nations, with the jobless in America receiving smaller benefits for a shorter amount of time. In Georgia, for example, laid off workers covered by unemployment insurance receive maximum benefits of $330 (€265) a week for no more than 26 weeks -- hardly enough to survive in major cities. Benefits are deliberately limited so as to motivate the unemployed to venture into the job market and find new work as quickly as possible. The system works well in a booming economy, but not in a prolonged recession, when there are no new jobs. To address this problem, the US Congress has approved extending unemployment benefits for up to one year. But the problem with this approach is that the entire unemployment insurance system is already burdened to capacity by the unexpected onslaught of new applicants. At the end of last year, close to 5 million applications for unemployment benefits were counted -- the highest number since records were first kept in 1967. "Unemployment offices are notoriously underfunded," laments Richard Hobbie, executive director of the National Association of State Workforce Agencies. According to Hobbie, government funding for unemployment has been steadily reduced since the 1990s. "We've become overly self-confident because we haven't had a severe recession in the last few decades," says Hobbie.
The consequences are now becoming clear. The lines in front of unemployment offices are growing longer, the telephone lines are busy for hours and the Internet servers are overloaded. The unemployment insurance funds in some states have already run out of money. In the United States, unlike in Germany -- where they are organized at the federal level -- unemployment insurance is paid for by the states. To fund the programs, the states collect taxes from employers and deposit the proceeds into funds. But many states opted to reduce these taxes in good years, so as to impose as little of a burden on their economies as possible, and now they are underfunded as a result. The state of New York, for example, has had to borrow $90 million (€72 million) from the federal government each week since the beginning of the year because its unemployment insurance fund is empty. Michigan, the home of America's ailing auto industry, has already accumulated a deficit of $1.2 billion (€960 million). Hobbie estimates that by mid-year 15 states could run out of money to pay for their unemployment insurance programs. "After years of neglect, it's time for a basic reform of the system," says Andrew Stettner, deputy director of the National Employment Law Project, the leading American advocate for the rights of the unemployed. In Congress, members like Jim McDermott are urging the government to act. "We cannot truly help the unemployed by simply pumping money into a system that isn't designed to handle the current crisis."
President Obama has included additional funds for unemployment insurance in his stimulus package. The benefit period will be extended by up to 20 additional weeks, and weekly benefits will be raised by $25 (€20). But this will hardly suffice to protect millions of Americans against sinking into welfare, especially since only 36 percent of the unemployed are even entitled to unemployment benefits. If the recession lasts a long time, the social consequences could be dramatic. Since the 1990s, there have also been drastic cuts in welfare programs. Cities like Miami expect the ranks of the homeless to grow. With the dimensions of the problem growing, Miami Mayor Manny Diaz recently traveled to Washington to apply political pressure. Diaz is also the chairman of the US Conference of Mayors. American cities want more money from the stimulus package to be made directly available to them, instead of the funds being allocated to them through the states. "All department managers in the city administration have already met, so that they'll be prepared when the money arrives," says Larry Spring, Miami's chief financial officer. The city hopes to receive funding for infrastructure projects, in particular. Government experts in Washington have calculated that the stimulus package will create 218,300 jobs in Florida in the next two years. Spring's mobile phone rings in the middle of the interview, and he spends the next 20 minutes in a hectic conversation about numbers -- numbers ranging into the two or three billions. "Sorry," Spring says after hanging up. "I had to take the call. It was the mayor, calling from Washington." The city wants to build a new baseball stadium for $515 million (€412 million), and possibly a tunnel from the city's downtown to the Port of Miami, at a cost of almost $1 billion (€800 million). "It would mean work for 17,000 people," says the chief financial officer. The construction industry in South Florida has been especially hard-hit in recent months. From his office high above downtown Miami, Spring has a view of many unfinished high-rise apartment and office buildings. But nothing is moving on the construction sites -- there is not a worker in sight.
Bringing Down House With Credit Swaps May Hit Yen Too
Six months ago, Lee Hardman didn’t care how much it cost to protect government bonds from losses. Now the Bank of Tokyo-Mitsubishi UFJ Ltd. strategist studies derivatives that provide such insurance to predict currency moves -- and he’s betting against the yen and the pound as a result. “We wouldn’t really have looked at sovereign credit-default swaps in any great detail before” the September bankruptcy of Lehman Brothers Holdings Inc. caused credit markets to freeze, said Hardman, who is based in London. “It’s an area which potentially is going to see increasing focus as a driver of currency rates.” Traders are starting to use the speculative contracts blamed for fueling Wall Street’s meltdown last year to measure currency strength as countries increase debt sales after pledging at least $2.4 trillion to kick-start their economies. Interest rates are becoming less useful for predicting foreign exchange as central banks slash borrowing costs to zero, narrowing differences between government debt yields.
“The credit-default swap market has taken a lot of bad press,” said Andrea Cicione, a credit strategist in London at BNP Paribas SA, in a Feb. 20 telephone interview. “The traders and the investors who have been involved in the CDS market understand that it’s operating just fine and there’s no need to throw it down a hole.” Originally conceived to protect against corporate defaults, credit-default swaps are now being used to predict the direction of everything from the Canadian to New Zealand dollars. The swaps pay buyers the face value of a bond in exchange for the underlying securities or the cash equivalent if borrowers fail to adhere to debt agreements. Prices of the contracts, increasingly used to speculate on government bonds, rise as the perception of an issuer’s ability to pay decreases. Since January, the correlation between the yen and the cost of protecting against a default on Japanese government bonds swung to negative 43 percent, showing investor concerns are increasing. The yen and cost of credit-default swaps moved in tandem 88 percent of the time last year.
Government reports show Japan is sinking deeper into recession, with fourth-quarter gross domestic product contracting at an annual rate of 12.7 percent, the most since the 1974 oil shock. The yen slumped 4.2 percent against the dollar this year to 94.69, and is headed for its worst month since April. The yen appreciated 23 percent in 2008. The pound traded at a negative correlation of 94 percent in the past year against U.K. debt swaps, showing the currency is weakening as credit perceptions worsen. Sterling dropped 26 percent in that period to 1.4589 per dollar. Ron Leven, an executive vice president and senior currency strategist at Morgan Stanley in New York, doesn’t buy the argument that swap prices influence currency movements. “If anything, the currencies are telling you what the swap spreads are going to do,” Leven said in a Feb. 9 interview. Still, every couple of days he updates his charts that show differences in prices of swaps on U.K. and U.S. debt and between New Zealand and U.S. bonds. A year ago he never looked at sovereign swaps.
Eric Lascelles, chief economics strategist at TD Securities Inc. in Toronto, said sovereign swaps don’t trade enough to make a good forecasting tool. Prices are often unavailable in the Canadian swap market, he said in a Feb. 9 interview. Government bond swaps are “in play and getting the attraction that a moving variable deserves” because the global recession and increasing bond sales boosted the default risks for many countries, Lascelles said. Credit-default swaps dealers are under pressure from governments and central banks to increase transparency in the unregulated $28 trillion market and to create a body that will arbitrate disputes. The firms agreed to process the derivatives transactions through a clearinghouse following the failure of Lehman, one of the largest dealers. Derivatives are financial contracts whose value is derived from interest rates, the outcome of specific events or the price of underlying assets such as debt, equities and commodities.
The cost of protecting against default by Lehman, Bear Stearns Cos. and American International Group Inc. rose as high as 7.07 percent before the companies collapsed. Richard Fuld, the former chief executive officer of Lehman, blamed speculation in the market for helping to speed the companies’ demise. While swaps don’t suggest Japan is close to default, the cost of protecting Japanese government bonds more than doubled to 1.21 percent of the face value on Feb. 17, from 0.49 percent on Jan. 30, according to CMA Datavision. A basis point, or 0.01 percentage point, on a credit-default swap contract protecting $10 million of debt for five years is equivalent to $1,000 a year, or $121,000 for the Japanese bond. The U.K.’s swap price increased to 1.75 percent, or $175,000, on Feb. 17, from 1.23 percent. The pound declined 0.8 percent since Jan. 30.
Before Lehman’s failure, neither country’s swap price exceeded 0.74 percent. Hardman said the ballooning costs signal further depreciation. He expects the pound to drop to 1.35 per dollar by the end of the first quarter and yen to weaken to 100 per dollar by the end of 2009. Japan’s Prime Minister Taro Aso announced plans in December to inject as much as 12 trillion yen ($127.6 billion) into the nation’s banks. The government cut its assessment of the economy for a fifth month last week, fanning speculation more fiscal stimulus will be needed. “Should these conditions continue, we could say that the Japanese economy is at risk of falling apart,” Finance Minister Kaoru Yosano said in the Diet in Tokyo on Feb. 18. The British currency fell to a two-week low that day after the Daily Telegraph said the country’s credit rating may be lowered by Standard & Poor’s as the government increases borrowing to bail out banks. U.K. policy makers voted 8-1 on Feb. 5 to cut the main interest rate by half a percentage point to 1 percent.
President Barack Obama enacted a $787 billion economic- stimulus package last week. China is rolling out 4 trillion yuan ($586 billion) to prop up domestic demand. European leaders pledged to spend a combined 200 billion euros ($257 billion) to haul their economies out of recession. Traders are looking at credit-default swaps in part because interest rates are losing their effectiveness as a tool for predicting currencies’ direction after central banks in 11 of the world’s largest economies lowered borrowing costs an average 2.2 percentage points last year, according to data compiled by Bloomberg. Rates are below 1 percent in the U.S., Japan and Switzerland. “You have nothing to distinguish any more in terms of monetary policy,” said Michael Hart, a London-based analyst at Citigroup Inc. “Several countries are at or near zero, so interest rates are reflecting credit concerns much more than anything else.”
The market for sovereign contracts had 132,200 outstanding contracts with an underlying value of $1.69 trillion as of Feb. 13, representing about 5.9 percent of the total market for credit default swaps, according to the Depository Trust and Clearing Corp.’s Web site. Swaps on financial institutions are the largest segment, with a notional value of $3.2 trillion. Swap prices have increased the most for the U.K., Sweden and Australia since Lehman’s collapse, according to Hart. Currencies of those countries were three of four worst performers since August, when measured in trade-weighted terms, Hart said in a Feb. 2 report. The New Zealand dollar was the other. “Default swaps will become increasingly important, given the issuance tsunami awaiting us,” Hart said in an interview. “The credit-default market is a better indicator of fiscal concerns with respect to each country.”
Japan considers share market support
The Japanese government is considering ways to prop up the ailing stock market, as tumbling share prices threaten to erode further Japanese banks’ capital and damage their ability to lend to cash-strapped businesses. Kaoru Yosano, who currently occupies the three key posts of finance minister, financial services minister and economics minister, on Tuesday said he had instructed government staff to look into measures to counter falling stock prices. “It is undesirable for share prices to fall, causing unnecessary consequences. I discussed with government staff last Friday what we could do generally to deal with [falling] share prices. We must consider this, keeping an eye on market moves,” he said. Mr Yosano’s comments come as the broad-based Topix index closed at its lowest level in 26 years, at 730.28. The benchmark Nikkei average also came dangerously close to a 26-year low before paring losses to close down 1.5 per cent at 7,268.56.
The stock market’s relentless decline ahead of the March year-end has alarmed business leaders as well as policymakers. Fujio Mitarai, chairman of the influential Keidanren business lobby, on Monday called on the government to set up a public body to buy shares in the market. After expressing appreciation for the government and Bank of Japan’s measures to assist companies to meet their borrowing needs, Mr Mitarai said: “In addition, if it is possible to support stock prices using public funds, we can expect a strengthening of the financial health of financial institutions and an increase in lending.” Japanese banks, which hold a high level of stocks as capital, have suffered from the sharp plunge in share prices. The Tokyo market is down about 18 per cent so far this year and analysts note that if share prices continue to slide, Japanese banks – which have already turned to investors for billions of dollars in additional capital – could be forced to raise further funds in order to meet capital adequacy requirements.
ECB's Trichet sounds alarm over Europe's credit contraction
The eurozone's financial system is under "severe strain" and risks setting off a downward spiral as the banking crisis and economic recession feed on each other, according to European Central Bank president Jean-Claude Trichet. "What has become increasingly clear since the intensification of the crisis in mid-September is that strains in the financial sector are spilling over into the real economy," he said. "This has set in motion a process of negative feedback." Mr Trichet said the bank was disturbed by signs of an fully-fledged credit crunch as banks shut off lending to healthy borrowers. Credit has contracted in absolute terms for the first time in recent weeks. "There are indications that falling credit flows reflect tight financing conditions associated with a phenomenon of deleveraging. If such behaviour became widespread across the banking system, it would undermine the raison d'etre of the system as a whole" he said. The ECB has been caught off guard by the ferocity of the recession, which is now ravaging Europe's steel, car, aeronautics and chemical industries. The bank's hard line has led to criticisms from trade unions and business leaders as the eurozone's economy contracted at an annual rate of 6pc in the fourth quarter of 2008.
Mr Trichet's warning is a clear sign that the ECB will cut interest rates below 2pc at its next meeting in March. It has stood aloof in recent weeks as central banks worldwide tore up rulebooks and explored extreme measures. In recent days a string of ECB governors have at some form of quantitative easing, although the ECB is constrained by EU law from buying bonds issued eurozone states. Mario Draghi, the Bank of Italy's governor, said the lesson of the 1930s was to take pre-emptive action to head off debt deflation early in a crisis, adding it was an error to resist cutting rates to zero should it be necessary. Professor Tim Congdon from the London School of Economcs said the contraction of eurozone credit was "extremely disturbing" but inevitable after moves in October to force banks to raise their capital ratios. "It was a catastrophic decision," he said.
German business confidence plunges
German business confidence has tumbled to the lowest level for at least 18 years in spite of the first signs emerging that emergency government action to save Europe’s largest economy is starting to work. The Munich-based Ifo institute reported its business climate indicator fell from 83.0 in January to 82.6 in February, the lowest level since the survey began in 1991 – more than reversing a small rise last month. The latest reading came as the precipitous collapse in European manufacturing late last year was confirmed by data showing eurozone industrial orders in December were 22.3 per cent lower than a year before. Germany saw a larger-than-average fall in orders of 27.5. per cent – but Spain saw a 30.3 per cent contraction, according to Eurostat, the European Union’s statistical office. The latest fall in the Ifo was due to a significantly more pessimistic assessment of current business conditions. In contrast, expectations about the next six months brightened for the second consecutive month. Ifo cited a rebound in confidence among car dealers, thanks to the special subsidies Berlin is offering to Germans who trade in older vehicles.
However, the improvement reflected domestic conditions rather than the outlook for the crucially-important export sector, which had previously powered Germany growth, said Thomas Köbel, economist at SEB bank in Frankfurt. Given the gloomy outlook for global growth, “German companies don’t have much to be confident about,” he warned. Germany is particularly exposed to eastern European economies, where the economic deterioration has gathered pace recently. German exports to the region, including to Russia, accounted for a higher proportion of the total than to the US, Mr Köbel said. Hans-Werner Sinn, Ifo’s president, added that, “overall the [Ifo] survey results do not point to a turnround in the economy”. Signs that relatively resilient consumers are helping to offset partially the dire situation in industrial sectors have emerged elsewhere in the 16-country eurozone. France reported consumer spending rose by 1.8 per cent in January compared with the previous month, far more than expected. Italy reported a surprise improvement in consumer sentiment in February. Research institute ISEA’s seasonally-adjusted index showed Italians’ confidence back at the pre-crisis levels of December 2007.
UK businesses slash investment as fastest rate in 18 years
The UK's slide into recession saw businesses slash investment at the fastest rate in 18 years during the final quarter of 2008, new figures showed on Tuesday. The Office for National Statistics (ONS) data revealed a 7.7pc slump in investment in the fourth quarter of 2008 against the same period the previous year - the steepest decline between two corresponding quarters since 1991. This reflected a 15.7pc year-on-year drop in manufacturing and an 8.1pc decline in construction and other production investment as industries tightened their belts in the face of the worsening economic climate. Analysts said the slump "reinforces suspicions" that the economy shrank more sharply than previously estimated in the fourth quarter. Hetal Mehta, Senior Economic Advisor to the Ernst & Young ITEM Club, said: "Today’s numbers indicate that firms are battening down the hatches amidst the economic misery by slashing investment.
"With credit conditions remaining tight, firms are finding it difficult to acquire external sources of finance. And with high input costs in the second half of 2008 squeezing profits, firms will have found it even harder to find the finances for investing." ONS figures in January showed the economy shrank by 1.5pc in the fourth quarter of last year - worse than the declines seen in the recession of the early 1990s and the biggest fall in more than 28 years. Howard Archer, of IHS Global Insight, said revised data for the period, due out tomorrow, could show the UK's slide into recession was steeper than first thought, with the quarter-on-quarter decline in gross domestic product (GDP) revised to 1.6pc. "Sustained sharp drops in business investment would have very serious negative repercussions for future UK productive capacity and productivity," he added. "Businesses are increasingly and substantially scaling back their investment in the face of sharply weakening demand, rising levels of spare capacity, worsening cash flows and very tight credit conditions, deteriorating profitability, and serious concerns and uncertainties about the potential length and depth of the recession."
Overall manufacturing saw a sharp fall from the previous quarter, of 11pc, with a decrease of £402m across the sector. Investment by the food, drink and tobacco industry plummeted 26.9pc in the quarter compared to the previous year, while chemicals and manmade fibres producers fell 15.1pc in the same period and textiles, clothing, leather and footwear declined 14.1pc. In the non-manufacturing industries, investment in financial intermediation dropped 17.3pc, while real estate, renting and business was 24.5pc down on the previous year. The ONS figures showed business investment dropped 3.9pc from the previous quarter, which was also revised down to a 2.1pc quarterly decline.
The Steep Decline of the British Economy
As the global economic crisis takes hold, hardly any other country has seen its fortunes wane as brutally as the United Kingdom. Once a model economy, the country has been overcome by a deep sense of uncertainty. It is a gloomy February in Great Britain, yet another month in which the economy is shrinking and the pound is faltering, and yet another month of record growth in unemployment. It is a month that has seen Ed Balls, the Secretary of State for Children, Schools and Families, refer to the current recession as the "worst in 100 years," and which has witnessed the heads of the country's largest banks appear on television to apologize to the nation for the harm they have caused. Meanwhile, Britons are asking themselves how things could have come to this.
Ash Akhtiar, who works for an employment agency in a Birmingham suburb, says he wants to see someone pay for all of this. David L., a banker who, fearing for his job does not wish to see his name in print, is considering buying a gun to protect his family. Philip Augar, a financial expert, tries to explain how his country could have become so dependent on banks and loans, while bestselling author Tony Parsons says that the upheaval the United Kingdom is experiencing is as serious as the fall of the Berlin Wall. The current mood in Great Britain is gloomy. Long Europe's most successful economy, Britain's fortunes have since plunged more than those of almost any other European country. Unemployment is rising twice as fast as the European average. Two million people have already lost their jobs, a number that could rise to 3 million by the end of the year. According to the International Monetary Fund (IMF), the British economy will shrink by 2.8 percent in 2009, the greatest projected decline among the seven largest industrialized nations. Ironically, for a long time it seemed as if Great Britain had done everything right. Didn't former Prime Ministers Margaret Thatcher and Tony Blair bring deep-seated reforms to the country? The British experienced a 16-year economic boom and it seemed as if they had successfully transitioned into a post-industrial, globalized service economy driven by a rapidly growing financial sector.
And now it is precisely those investment bankers who practiced their modern alchemy in the glass towers of the City of London who have plunged the country and the world into the biggest economic crisis since the 1930s. Great Britain was at the root of this worldwide economic downturn and is now especially hard-hit by it. What began 18 months ago as a financial crisis in London and other cities has now taken hold of the entire country. It began when the British real estate bubble burst, first for residential and then for commercial property. The investment banking sector fell apart at the same time. The country has been in a deep recession since the fourth quarter of last year. Consumption and industrial production are in serious decline, while the value of the British pound has fallen against the euro. Ash Akhtiar is one of the few people working overtime these days in Washwood Heath, a run-down suburb of Birmingham. Akhtiar is standing outside, smoking a cigarette, in front of a two-story brick building that houses the offices of Jobcentre Plus, the modern British employment agency founded by former Prime Minister Tony Blair. He is waiting for his clients, the workers at LDV, a manufacturer of small trucks. The LDV plant, only a kilometer down the road, stopped producing trucks in mid-December. There are no buyers anymore for the brand-new fleet of white panel vans parked outside. LDV has already laid off 95 workers. With the plant idle, hundreds more are waiting at home, still collecting their wages.
Akhtiar, 31, wears his hair slicked back with gel, has dark rings under his eyes. Part of his job is to make sure that the jobless receive their unemployment checks. The situation in Washwood Heath has been so bad for the last three months that Akhtiar and his colleagues have been working on cases every day until 7 p.m., and they recently began coming in on Saturdays. More and more people are losing their jobs, and more and more are coming to see Akhtiar. "You can see the desperation in their eyes," he says. "They realize that things are different now, and that they won't get new jobs after only a few weeks." In the West Midlands region, home of the British automobile industry, unemployment is rising rapidly -- by 20 percent between October and December of last year alone. Few carmakers with plants in the region -- Aston Martin, Jaguar, Land Rover, Honda -- are operating at full capacity these days, and hardly any are still in British hands. Thousands of jobs have been cut, and tens of thousands of workers are working reduced hours or have been furloughed temporarily. The British welfare state, its reach narrowed by a succession of reforms, only offers about £60 ($85) a week in unemployment benefits to those who have been laid off. The unemployed are often forced to give up their apartments or homes because many are deeply in debt and can no longer afford to make their monthly mortgage payments. Someone in Great Britain loses his home once every seven minutes.
Akhtiar says he is furious over the economic crisis. The bankers who drove the country to economic ruin, he says, were able to have their companies nationalized and yet they received bonuses of millions of pounds in taxpayer money. He says that many of his clients are also furious with the bankers, and that someone needs to take responsibility and pay for what has happened. But he doesn't know who that should be. Akhtiar raises an important point: Whose fault is it, exactly? A shabby pizzeria in London's Mayfair neighborhood, where only a few tourists might have been seen a few months ago, is filled with bankers today. Their Blackberries are on the tables in front of them, just as they used to be when they served as status symbols, as evidence that these bankers were having lunch at the center of the world. But there is one difference: Their conversations, once loud and pretentious, are now whispered. David L. speaks quietly, even when he asks for a glass of tap water with his pizza. He still has a job, he says, because he took his customers' £200 million ($284 million) out of the market just in time, in the summer of 2007, when the first tremors began to make their way through the global financial system. The fact that he still has his job is the one bit of good news David L. has to report. The other is that World War III hasn't broken out yet. Otherwise, he says, he has nothing but bad news.
His real job is to spread confidence. An astute investor, he was long considered one of the stars in the private banking department of a powerful British financial institution. But nowadays fear has taken hold within the bank, where 20 percent of David L.'s colleagues have already been let go. If the bank continues to do this poorly, he says, another 30 percent will probably lose their jobs soon. "When that happens," he says, "I'll be gone, too." Ten years in the financial industry have made him a wealthy man, with a house in the exclusive Kensington neighborhood, four children in private schools and a wife who wears handmade Manolo Blahnik shoes. Nowadays, says David L., he sometimes feels nauseous with panic. He imagines a future in which many people are poor and angry, people who could even break down his door in Kensington and enter the house. He has even been thinking about ways to protect his family. In good times, investment bankers were treated like celebrities in Great Britain, and dubbed, like their counterparts in the United States, "masters of the universe." Children dreamed of working at Goldman Sachs, and the London City, the world's largest financial center, was the shining center of the British economy, the capital of excess. It looked as though Great Britain had created an economy of the future, but in reality it had become dependent on an increasingly bloated financial sector. Even though it generated only 8 percent of gross domestic product (GDP) in the best of times, the financial sector provided the government with a quarter of all corporate taxes. The number of Britons working in the financial sector grew from 4.4 to 6.5 million in the good years.
The papers were filled with tales of excess, like the account of a banker who, after having completed a successful deal, handed his American Express "Black Card" to the bartender at the Baglioni Hotel and paid for everyone in the bar, for the entire evening. The bill included 851 cocktails and six magnum bottles of Dom Perignon. At the end of the night, the man readily paid the £36,000 ($51,000/€40,709) tab and even handed a waitress a £3,000 tip. The year was 2005, and in those days the banker's magnanimous gesture was considered cool. But the country's once-powerful bankers sounded significantly more subdued as they ate humble pie before the Parliament's Treasury Select Committee in London at the beginning of February. Lord Dennis Stevenson, the former chairman of the HBOS banking and insurance group, told the committee: "Our shareholders, all of us, have lost a great deal of money," and "We are profoundly, and I think I would say unreservedly, sorry at the turn of events." The current widespread loathing of bankers has reached levels reminiscent of the year 1720. That was when the South Sea Bubble, one of the first speculative bubbles in history, burst, and a parliamentary inquiry suggested sewing the guilty into sacks filled with poisonous snakes and tossing them into the Thames River. But how could the banking sector in Great Britain have grown at such a dizzying pace in the first place?
Philip Augar is a financial expert who worked in investment banking for 20 years and made a lot of money in the process. A former head of the global securities division at NatWest and a former managing director at the Schroders investment bank, he left the industry in 2000. Since then, he has written books warning against the excesses of the industry and possible collapse of the markets. As the River Cam flows past the lattice windows of his large house in Cambridge, Augar says that the British financial sector, built on an extremely shaky foundation, has developed into a monster over time. More than 20 years ago, then Prime Minister Margaret Thatcher broke apart or privatized ailing traditional industries like shipping, mining and automobile manufacturing. Thatcher made it clear that the future, in her eyes, lay in a deregulated financial industry that would emulate the United States, which she considered Britain's role model. US investment giants like Goldman Sachs, Merrill Lynch and Morgan Stanley set up shop in the British capital, and major continental European financial institutions like Deutsche Bank and Credit Suisse made London a center of their investment banking businesses. When Tony Blair came into power in 1997, his Labour government did not reverse any of Thatcher's neoliberal reforms. On the contrary, Labour even loosened the reins on the financial caste a little further.
Its approach was one of "light-touch regulation," which removed onerous restrictions and reduced taxes on capital gains. London became the private equity and hedge fund capital of the world. According to Augar, bonus payments jumped from £1.7 billion ($2.4 billion) to £8.5 billion ($12.1 billion) over 10 years of Labour government. "The effect the financial industry had on the economy was like a big stone thrown into the water," says Augar. The waves of artificial affluence spread to include lawyers, consultants, shop owners and restaurants. Most of all, however, they drove up the real estate market, where prices almost tripled in only 10 years, making people feel rich. "Rising house prices," says Augar, "gave the consumers confidence to spend money, to borrow money. Actually, the whole boom was based on debt." This conclusion helps to explain why the British economy is now in so much trouble. Now owing more than 1.5 trillion ($2.1 trillion), the Brits lead Europe in private household debt. In addition to the impact it has had on the economy, the process has also changed British society. "Great Britain developed from a nation of savers into a society of borrowers," says Augar, "and from a nation of investors into one of traders, no longer oriented toward long-term profits but interested only in short-term gains." The words of Prime Minister Gordon Brown, who only last year insisted that the United Kingdom was better prepared for the global crisis than most other countries, sound like a mockery today. Few Britons still believe that Brown is the right person to lead the country through the crisis. According to recent surveys, only 28 percent of citizens would vote for Labour in a new election, while 48 percent say they would choose the Conservatives and their leader, David Cameron.
Mervyn King, the governor of the Bank of England, has warned his fellow Britons of difficult times ahead and what may be "the worst recession" since World War II. Many countries have entered into long recessions in the wake of a banking crisis. Japan, for one, never quite recovered from its crisis in the 1990s, and now it finds itself plunging into yet another deep recession. The situation in Britain is exacerbated by the fact that the country's real estate bubble has burst. British taxpayers have already had to bail out two banks, the Royal Bank of Scotland and HBOS. Two mortgage lenders have also been nationalized, and the government, like other governments around the world, is considering a plan to guarantee all toxic securities. In Great Britain, new borrowing will comprise 9 percent of GDP in the coming year. According to the Institute for Fiscal Studies, it will take the United Kingdom until 2030 to bring its national debt back to pre-crisis levels. Some are already referring to London as "Reykjavík on the Thames." The negative numbers have also weighed heavily on the British pound, which has lost 17 percent of its value as a result of the recession, the currency's sharpest decline since 1992. Major US investor Jim Rogers warns: "I don't like to say it, but I wouldn't invest any more money in Great Britain." Instead of being the "sick man of Europe" it was in the 1970s, Great Britain, as the Times of London predicted, is fast becoming the "sick man of the world." The country is firmly in the grip of deep uncertainty. "We have become a 'fear nation,'" says author Tony Parsons. "Everyone is afraid: the people, the banks, everyone."
Parsons, 55, is sitting in the Café Rouge in London's exclusive Hampstead neighborhood, home to the rich and bohemian alike. More millionaires live in Hampstead than in any other community in the country. Parsons, the author of the bestseller "Man and Boy" and one of these affluent residents, writes about Britain's prosperous middle class. He is familiar with its soul and is an avid consumer himself, as evidenced by the Prada windbreaker hanging on the back of his chair. But, as he points out, this is the first year he has decided not to buy a new BMW X5. "What is happening now is like the fall of the Berlin Wall," says Parsons. "People look at this ideology and realize that it hasn't worked. We cannot have unregulated capitalism. We cannot tell these people to do as they wish, and hope that a lot of money comes out in the process." But it's too late now. Parsons says that he has never known of so many people in his social circle who have lost their jobs. "Thatcher had riots in the streets with 3 million unemployed. Gordon Brown, or David Cameron, will experience the same thing." And those who do have money, like Parsons himself, will soon be pleased about the security guards they have in front of their houses. "We have a Gurkha in our neighborhood, a former elite soldier. Perhaps it'll be like South Africa here soon."
Parsons, who comes from a working-class background, is familiar with poverty. Perhaps this perspective is what makes his vision of the future seem so dark. The picture he paints is one of a country returning, as a result of the crisis, to social divisions that have always been deeper in Britain than elsewhere in Europe. "We have always had two nations in this country, that of the haves and that of the have-nots. Some live like Roman emperors, and they will continue to do so. Others, at some point, got used to the fact that they could go on holiday twice a year. Those days are now gone. I believe that we will soon return to a kind of 21st century Dickensian society." Parsons believes that there are people in prison who have caused far less harm than the bank directors who recently apologized on television. He characterizes the bankers' public mea culpa as a highly unsatisfactory charade, one without true remorse. "I know, of course, that it won't change anything if we put their heads on a stick in front of the Bank of England. But we should do it anyway. Maybe it would make us feel better." Clarification: The editors have changed one sentence in this story: "Two million people have already lost their jobs, a number that could rise to 3 million by the end of the year" to "2 million people are already on the jobless rolls" in order to clarify that those jobs have not necessarily been eliminated as a result of the current financial crisis."
Central Europe acts to bolster currencies
Central Europe’s battered currencies rallied on Monday after four of the region’s central banks issued co-ordinated statements calling recent currency weakness unjustified and raising the possibility of intervention on foreign exchange markets. It was the first time that banks from the region’s four ex-communist countries with floating currencies had co-ordinated policies, a testament to the seriousness with which falls in Poland’s zloty, Hungary’s forint, Czech Republic’s koruna and the Romania’s leu are being treated. Depreciating currencies are raising fears about the stability of local banks, something that could send shockwaves through countries such as Austria, and Italy, where many parent banks are based. “In the assessment of the National Bank of Poland, the macroeconomic situation in Poland does not justify the scale of the weakening of the zloty. The NBP may undertake actions aimed at avoiding the unfavourable consequences of currency volatility on the economy,” said Slawomir Skrzypek, Poland’s central bank governor.
Mugur Isarescu, governor of the central bank of Romania, said his institution would be prepared to use a range of instruments to support the leu, including interest rate policy, moral suasion and minimum reserve requirements. He said: “There are regional risks, but reports are presenting this area as Europe’s subprime, even though we can prove this is not the case.” The zloty’s uptick in the last few days is also a result of the government’s campaign to see Poland admitted into the European Exchange Rate Mechanism by May or June, a necessary precondition for joining the euro. The government is still holding out for Poland to adopt the common currency by 2012, in spite of a lack of enthusiasm from the opposition and Lech Kaczynski, Poland’s president. The other three central European countries are less advanced in their quest to join the euro. Sagging local currencies have made central banks increasingly reluctant to continue with interest rate cuts aimed at reviving sharply decelerating economies. By midday in New York on Monday, the Polish zloty rose 2.2 per cent to 4.6390 zlotys against the euro, the Hungarian forint climbed 2.8 per cent to Ft295.28 and the Czech koruna gained 2.1 per cent to Kc28.2048. The leu was little changed.
Swiss banks deposits plummet in 2008
The amount of money deposited in Swiss banks shrank by more than a quarter last year as the global financial crisis hit asset values and customers withdrew large sums amid concerns about probes into the offshore banking industry. Figures released by the Swiss National Bank on Monday show total deposits fell 27 percent, or 1.41 trillion Swiss francs ($1.21 trillion), to 3.82 trillion francs -- their lowest since August 2005. Deposits from foreign customers shrank by 882 billion francs, while Swiss customers had 531 billion francs deposited in their country's banks, according to the SNB's monthly statistical bulletin. Foreign private customers saw the highest proportional drop in assets -- 36 percent or 371 billion francs -- leaving only 671 billion francs worth of deposits in Swiss vaults. That is the lowest deposit amount from foreign private customers since the end of 1998. Deposits by foreign institutional customers dropped 23 percent, or about 417 billion francs, to 1,386 billion francs. Domestic private customers had 417 billion francs deposited by the end of the year, 28 percent less than in 2007. The report didn't break the figures down by institution, but Switzerland's two flagship banks have both suffered heavy losses and reported billions in asset writedowns and customer withdrawals last year.
Earlier this month, Credit Suisse Group reported full-year withdrawals of billions of francs, and net losses of 8.2 billion francs. UBS AG said net withdrawals reached 226 billion francs in 2008, compared with inflows of 140.6 billion francs the previous year. The bank posted a full-year loss of 19.7 billion francs earlier this month, the biggest in Swiss corporate history. A high-profile court battle in the United States over UBS's cross-border business also has harmed its image in the eyes of foreign customers. The case has become the focus of U.S. Senate hearings on offshore tax evasion. "People aren't sure where UBS is going," said Axel Merk, chief investment officer at California-based Merk Mutual Funds. UBS shares dropped 9.1 percent Monday to reach an all-time low of 10 francs. Merk cautioned against attributing all of the deposit losses to withdrawals, noting that falling asset values on the global markets would also have played a role. "Still, it could have been worse," he said, noting that Switzerland's traditional role as safe haven for money may have brought in additional deposits during a year of financial turmoil.
The Collapse of Manufacturing
$0.00, not counting fuel and handling: that is the cheapest quote right now if you want to ship a container from southern China to Europe. Back in the summer of 2007 the shipper would have charged $1,400. Half-empty freighters are just one sign of a worldwide collapse in manufacturing. In Germany December's machine-tool orders were 40 percent lower than a year earlier. Half of China's 9,000 or so toy exporters have gone bust. Taiwan's shipments of notebook computers fell by a third in the month of January. The number of cars being assembled in America was 60 percent below January 2008. The destructive global power of the financial crisis became clear last year. The immensity of the manufacturing crisis is still sinking in, largely because it is seen in national terms-indeed, often nationalistic ones. In fact manufacturing is also caught up in a global whirlwind.
Industrial production fell in the latest three months by 3.6 percent and 4.4 percent respectively in America and Britain (equivalent to annual declines of 13.8 percent and 16.4 percent). Some locals blame that on Wall Street and the City. But the collapse is much worse in countries more dependent on manufacturing exports, which have come to rely on consumers in debtor countries. Germany's industrial production in the fourth quarter fell by 6.8 percent; Taiwan's by 21.7 percent; Japan's by 12 percent-which helps to explain why GDP is falling even faster there than it did in the early 1990s (see article). Industrial production is volatile, but the world has not seen a contraction like this since the first oil shock in the 1970s-and even that was not so widespread. Industry is collapsing in eastern Europe, as it is in Brazil, Malaysia and Turkey. Thousands of factories in southern China are now abandoned. Their workers went home to the countryside for the new year in January. Millions never came back.
Having bailed out the financial system, governments are now being called on to save industry, too. Next to scheming bankers, factory workers look positively deserving. Manufacturing is still a big employer and it tends to be a very visible one, concentrated in places like Detroit, Stuttgart and Guangzhou. The failure of a famous manufacturer like General Motors (GM) would be a severe blow to people's faith in their own prospects when a lack of confidence is already dragging down the economy. So surely it is right to give industry special support? Despite manufacturing's woes, the answer is no. There are no painless choices, but industrial aid suffers from two big drawbacks. One is that government programmes, which are slow to design and amend, are too cumbersome to deal with the varied, constantly changing difficulties of the world's manufacturing industries. Part of the problem has been a drying-up of trade finance. Nobody knows how long that will last. Another part has come as firms have run down their inventories (in China some of these were stockpiles amassed before the Beijing Olympics).
The inventory effect should be temporary, but, again, nobody knows how big or lasting it will be. The other drawback is that sectoral aid does not address the underlying cause of the crisis-a fall in demand, not just for manufactured goods, but for everything. Because there is too much capacity (far too much in the car industry), some businesses must close however much aid the government pumps in. How can governments know which firms to save or the "right" size of any industry? That is for consumers to decide. Giving money to the industries with the loudest voices and cleverest lobbyists would be unjust and wasteful. Shifting demand to the fortunate sector that has won aid from the unfortunate one that has not will only exacerbate the upheaval. One country's preference for a given industry risks provoking a protectionist backlash abroad and will slow the long-run growth rate at home by locking up resources in inefficient firms.
Some say that manufacturing is special, because the rest of the economy depends on it. In fact, the economy is more like a network in which everything is connected to everything else, and in which every producer is also a consumer. The important distinction is not between manufacturing and services, but between productive and unproductive jobs. Some manufacturers accept that, but proceed immediately to another argument: that the current crisis is needlessly endangering productive, highly skilled manufacturing jobs. Nowadays each link in the supply chain depends on all the others. Carmakers cite GM's new Camaro, threatened after a firm that makes moulded-plastic parts went bankrupt. The car industry argues that the loss of GM itself would permanently wreck the North American supply chain (see article). Aid, they say, can save good firms to fight another day.
Although some supply chains have choke points, that is a weak general argument for sectoral aid. As a rule, suppliers with several customers, and customers with several suppliers, should be more resilient than if they were a dependent captive of a large group. The evidence from China is that today's lack of demand creates the spare capacity that allows customers to find a new supplier quickly if theirs goes out of business. When that is hard, because a parts supplier is highly specialised, say, good management is likely to be more effective than state aid. The best firms monitor their vital suppliers closely and buy parts from more than one source, even if it costs money. In the extreme, firms can support vulnerable suppliers by helping them raise cash or by investing in them.
If sectoral aid is wasteful, why then save the banking system? Not for the sake of the bankers, certainly; nor because state aid will create an efficient financial industry. Even flawed bank rescues and stimulus plans, like the one Barack Obama signed into law this week, are aimed at the roots of the economy's problems: saving the banks, no matter how undeserving they are, is supposed to keep finance flowing to all firms; fiscal stimulus is supposed to lift demand across the board. As manufacturing collapses, governments should not fiddle with sectoral plans. Their proper task is broader but no less urgent: to get on with spending and with freeing up finance.
Canadian Retail Sales Record Biggest Drop Since 1991
Canadian retail sales fell twice as fast as expected in December, the biggest drop since January 1991, as consumers curtailed spending on cars, building supplies and clothes. Retail sales tumbled 5.4 percent from December, the third straight drop, to C$33 billion ($26.5 billion), Statistics Canada said today in Ottawa. Sales fell 2.4 percent in November. Economists expected a 2.7 percent drop, based on the median of 17 estimates. The drop in retail sales follows reports of the country’s first trade deficit since 1976 in December and record job losses in January, as Canada suffers its first recession since 1992. The central bank’s monetary policy panel, led by Governor Mark Carney, lowered its benchmark interest rate to a record-low 1 percent on Jan. 20, and said more rate cuts may be needed to jolt the economy.
“The consumer is definitely showing signs of strain,” said Krishen Rangasamy, an economist with CIBC World Markets in Toronto, who estimates the economy shrank 3.3 percent in the fourth quarter. “Those are very bad numbers, and the concern is that unless we see a turnaround in job numbers and incomes, we won’t see any improvement for retailers.” The central bank projected last month that the economy would contract by 2.3 per cent in the fourth quarter. Bank of Canada Senior Deputy Governor Paul Jenkins said today that 2009 will be a difficult year for Canada and reiterated the central bank’s prediction that the economy will shrink 1.2 percent this year.
The bank’s next rate decision is March 3. CIBC’s Rangasamy predicts the central bank will cut its key rate by half a percentage point to 0.5 percent. Canada’s dollar rose to C$1.2508 against the U.S. dollar at 4:49 p.m. in Toronto, from C$1.2520 late on Friday. The yield on the bankers’ acceptance contract due in June fell 4 basis points to 0.66 percent today on the Montreal Exchange, indicating investors expect borrowing costs to drop. There are 100 basis points in a percentage point. All eight major retail categories declined in December as sales fell the most since Statistics Canada changed the way it categorizes sales, which coincided with the introduction of the Goods and Services Tax in 1991.
Finance Minister Jim Flaherty told reporters in Ottawa today he anticipated “a lot of bad news” in his January budget, which included a stimulus package. He said he “hopes” the budget will be passed next month. “I expect the numbers are going to continue to deteriorate for the time being,” he said. December’s drop surpassed the 4.5 percent tumble in January 1998 that was caused by an ice storm that crippled much of Ontario and Quebec. “It seems that it didn’t matter whether you were naughty or nice this Christmas, there were simply fewer presents under the tree,” Chairmaine Buskas, an economist with TD Securities in Toronto, said in a note to clients. Buskas said December’s sales drop “all but seal the deal” for the central bank to cut rates by 50 basis points next week.
New car sales fell 15 percent, bringing that industry’s decline over the past 12 months to 23 percent, Statistics Canada said. Excluding the automotive sector, retail sales fell 3.2 percent, more than the 2 percent decrease anticipated by economists. Stores selling building and outdoor home supplies recorded a 5.6 percent drop and clothing outlets posted a 3.7 percent decline, the government agency said. Sales of furniture, home furnishings and electronics fell 2.6 percent, while sales at food and beverage stores dropped 1 percent. Gasoline station sales fell 12 percent from November, due mainly to lower prices. December’s decline extended across the country, with Alberta recording the largest provincial drop at 6.2 percent. Retail sales in Ontario fell 6 percent.
The shocking truth about the value of your Canadian home
There are still people out there who don’t believe Canada is about to be hit by a devastating housing crisis, but Riaz Kassam isn’t one of them. For him, the crisis has already arrived. Last July, he made an $80,000 pre-sale payment on a $1.5-million penthouse condominium in Vancouver’s tony H&H Yaletown building, just a few blocks away from where he lives. Kassam, a 42-year-old computer analyst, who’s married with no kids, expected to move in by the end of 2008. But when he put his current apartment on the market, he didn’t get a single offer.
He thought maybe he had priced it a little high, so he knocked a bit off. Still, no offers. He lowered it again, and again, until eventually he was offering his apartment for a full $120,000 less than his initial asking price. That’s when he realized he was in trouble. “We reached the point where we couldn’t drop the price any more,” he says, “or we wouldn’t have enough for the down payment on the new property.” He was caught between a rock and a hard place. Nobody would buy his condo, and therefore he didn’t have enough money for the down payment on the condo he’d already agreed to buy. “We told them that we can’t complete, we can’t sell our place, and we’d just have to forfeit our $80,000.”
Painful enough, but it was only the beginning. Kassam discovered that even if he had sold his old apartment, his bank “wouldn’t even consider” giving him a $1.5-million mortgage for his new place. Prices in Vancouver had been plummeting, and in just a few months, the assessed value of his new place had fallen to roughly $1.2 million—and his bank wouldn’t issue a mortgage for more than the property was worth. Meanwhile, the condo developer was finding that it couldn’t sell its units either, at least not for anything close to the $1.5 million Kassam had agreed to pay. So it held a “blow-out sale,” offering units for as much as 40 per cent off the original listed price.
Kassam’s unit wasn’t one of them, but the sale made it clear that his penthouse was worth even less than $1.2 million. Shortly after Christmas, the developer told him he was liable for the difference. He had signed a pre-sale agreement saying he would buy that condo for $1.5 million, they reminded him, and they reserved the right to pursue him for the drop in that condo’s value. Which means they’re probably not just going to keep his $80,000 deposit. They’re probably going to come after him for more than $300,000. Kassam thought he’d be settled into his gorgeous new penthouse by now, but instead he’s still at his old place, facing a long and expensive court battle with the Bowra Group, owner of the H&H Yaletown.
He’s planning to strike first, with a lawsuit alleging that the developer didn’t deliver his unit on time, but he’s not sure he’s going to win. If he doesn’t, “our nightmare begins,” he says. “It’s going to be devastating if we have a judgment against us.” Kassam is just one of thousands of people getting buried in the rubble of Vancouver’s collapsing prices; a dream market has turned into a nightmare, faster than anyone thought possible. For over a decade, the real estate industry has pumped out glowing reports, detailing the latest surges in prices and transactions, and predicting nothing but blue skies ahead. The heady combination of a strong economy, urban renewal and low interest rates triggered a stampede into houses and condos. Now the boom is shifting into reverse, and economists are warily backing away from their sunny predictions, and grappling with a question no one has posed for 20 years: how bad is it going to get? It’s becoming increasingly likely that the answer to that question will be “even worse than you imagined.”
The H&H Yaletown has now sent out several warning letters to buyers in retreat. Another developer, the Onni Group, is actively suing at least 20 purchasers of its Aria 2 development in Port Moody for backing out of their pre-sale agreements. Real estate developer Amacon is suing seven purchasers of its Morgan Heights development in Surrey for the same. Condo fire sales are raging—the Onni group has been taking out full-page ads in the local papers trumpeting “Vancouver’s largest real estate liquidation event”—and John White, a Vancouver lawyer representing several retreating buyers, says he now gets about “two or three calls a day” from people who have issues with their contracts.
“No one even came close to realizing the impact of this crisis,” Kassam says. Back when he signed the pre-sale agreement, he was following the news, and “they said the real estate market was slowing down, but they were only predicting maybe a one or two per cent drop in property values—nothing to this extent.” But Kassam has learned that you shouldn’t always believe what you read in the papers and what the economists say on TV. Especially now, because despite the carnage in Vancouver, many economists and real estate groups are still predicting that we’ll have just a little stumble—maybe a drop of three to eight per cent in prices—and then the market will roar back to life by the end of the year. But new data on the plunging housing market suggests that those relatively upbeat assessments are wrong, and Canada could see a 20 per cent drop in average house prices between now and late 2011. If sophisticated investors are correct, it might be close to a decade before we once again see prices as high as they were last summer.
A bout a year ago, Simon Côté, managing director of property derivatives at National Bank, had a bright idea. He noticed that the market let investors bet their money on oil futures, bond futures, even canola futures, but there wasn’t a way to bet on the future prices of Canadian houses. So he decided to launch a whole new market, one that, among other things, would allow investors who think they know where the housing market is going to put money on it. If they thought house prices would go up by five per cent in a year, while others thought prices would go down, they could buy a contract saying so, and if they were right, they could rake in huge profits. The market would also be useful for investors who wanted to hedge against falling house prices. By buying contracts that paid out if house prices declined, they could help to recoup any money they lost in the housing market.
In conjunction with the forward market (like a futures market, but with contracts sold over the counter), National Bank also launched the Teranet-National Bank House Price Index, which tells us where house prices are at right now. The index uses data from Teranet, a respected but little-known company that manages the land registry database for the government of Ontario. Because every house sale in the province must be entered in the database by law, and Teranet has agreements with other provinces to access their data, Côté says the company’s numbers are much more “robust” than the house price data economists currently use. Because much of that current data comes from the real estate industry itself, the Teranet data can boast of coming from a more unbiased source as well.
When the Teranet market started up in December, it immediately predicted a shocking drop of 20 per cent, followed by an excruciatingly slow recovery that might not see prices return to last year’s high for seven years, or longer. It’s still young and thinly traded, but the Teranet market outlook is startlingly different from what most economists see. Last week, for instance, the Canadian Real Estate Association (CREA) predicted a drop of just eight per cent in 2009, followed by a speedy recovery that would see prices starting to edge up again in 2010. Most banks and investment firms (with the exception of Merrill Lynch Canada, which predicted a more significant drop followed by a slow recovery) fell into line with similar predictions of drops between eight and 12 per cent.
Just six months ago, the Canada Mortgage and Housing Corporation (CMHC), the government agency that insures billions of dollars worth of Canadian mortgages, predicted that we would actually see an increase in house prices of almost three per cent in 2009. It has since backtracked dramatically, issuing a new forecast three months later predicting an increase of just 0.1 per cent. Another revision was scheduled for last week, but the agency cancelled the release at the last minute, saying that the data needed more analysis than expected. They set a new date for the release, but they missed that date too. “Conditions in the housing markets really have been changing,” CMHC’s chief economist Bob Dugan says. “So we’ve been doing a series of revisions to our forecasts.” He says their latest figures now show that housing prices will go down in 2009. But that doesn’t mean he sees any real cause for concern, despite January’s largest-ever single-month job loss figures and our faltering GDP.
“When I look at the economy as a whole,” he says, “I don’t really see the smoking gun.” He’s been scanning the numbers and just can’t see “the big scary indicators that say things are going south really terribly.” So he also predicts just a little dip followed by a quick recovery. “We think that house price growth is going to catch again during the year,” he says. “So year over year, you’ll see a decrease when you compare 2009 to 2008, but we think that during the year, prices will start to increase again.” The sunniest forecast of all comes from Royal LePage, a national real estate company. In a recent release entitled “Correction, not crash for Canadian real estate market in 2009,” Royal says there will be a minor slip of three per cent, then “consumer confidence is anticipated to recover, prompting real estate activity to pick up once again in the latter half of 2009.”
Phil Soper, the CEO of Royal LePage, says when you look at both prices and the volume of houses being sold each month, the market has already been declining since the end of 2007, so we’re due for a recovery soon. “We’ll hit bottom in about mid-year,” he says. “We believe that things will flatten out in the third quarter, and the recovery will begin for housing towards the end of the year.” He rejects the idea that the industry burnishes its predictions. “I can say absolutely that it does no one in the real estate industry any good to forecast home prices higher than the reality.”
So who’s right? The economists predicting a brief setback, or the futures market investors who see years of decline? Robert Shiller is an economics professor at Yale University and an internationally acclaimed expert on housing markets. He is one of the creators of the S&P/Case Shiller Home Price Index in the U.S.—one of the world’s most closely watched measures of real estate values. He says it looks like we’re in for the long decline. “I’d go with the futures market,” he says. “That’s called putting your money where your mouth is.”
Shiller says that when the U.S. market peaked in 2006, he saw the exact same situation we’re now seeing in Canada. Like us, the U.S. had just launched a futures market, and it was telling a drastically different story from the one the economists were pushing. “At first our market specialist thought the market would go up, but he immediately lost a lot of money,” says Shiller, “because the people trading on the market kept predicting declines. And ever since then, they have continued to predict declines.” Meanwhile, the economists were still talking of increases, or at worst, a minor correction. “The National Association of Realtors had economists that were boosting the market all the time, and doing everything they could to get people in,” says Shiller. “Their chief economist, David Lereah, even wrote this dreadful book called Are You Missing the Real Estate Boom? He wrote that in 2005, just before the peak.”
Shiller says that futures markets are better predictors because while the predictions made by CMHC, for instance, represent the opinions of one or two economists, the predictions made by a futures market represent the combined best guesses of many investors who are so convinced of their forecast, they’re willing to literally bet money on it. As New Yorker writer James Surowiecki detailed in his bestselling book The Wisdom of Crowds, such prediction markets tend to be more accurate than individual predictions, both because they are less biased and because the collective wisdom they draw upon is more powerful than any one economist’s best guess.
Even when you look at the quality of the underlying data itself, the Teranet numbers come out ahead of what the economists are working with. The National Bank’s Côté says he originally didn’t want to produce a housing index at all. If there had been a reliable source for Canadian housing data already, he says he would have likely just used that. But it turned out that the only comprehensive data for resale home prices in Canada came from CREA, the national organization supporting the real estate industry. Unfortunately, the CREA numbers had problems. “There was a lot of cleaning on their data to be done,” he says. “Their data is actually physically inputted by real estate agents as they sell the houses. And obviously, as a real estate agent, it’s in your best interest to show that prices are not falling too much because that’s how you make your living.” He was also nervous about the fact that CREA depends on the co-operation of real estate boards across the country to gather the data, and some weren’t thrilled about taking part.
So, he went with the Teranet data instead, and then he one-upped CREA, which did not respond to interview requests from Maclean’s, by adopting a more rigorous number-crunching methodology too. Like the Case Shiller index, the Teranet data tracks the resale prices of individual single-family houses in selected metropolitan areas, while CREA uses Canada’s Multiple Listing Service (MLS) to add up all the money spent on houses in a given area, then divides it by the number of houses sold. Côté says the real estate industry’s data can be misleading because cities that have a higher level of sales activity have a disproportionately large influence on the national average. In other words, if there’s more sales activity in Calgary than there is in Ottawa one month, then the higher prices in Calgary will tilt the numbers up, even though there are roughly the same number of homes in each city.
Beyond the quality of the data, Shiller says there’s another, more common-sense reason why you should trust the futures market over what the real estate economists tell you: the Teranet investors aren’t trying to sell you houses, and the real estate agents are. “The predictions from those guys are very biased,” he says. “They know that in a declining market, the volume of sales falls dramatically and real estate agents lose their jobs. So they don’t want to say anything that could be seen as contributing to a falling market. If their economist predicted a decline in the market—and then it happens—that’s deadly. The guy would have to watch out for his life.”
That’s part of the reason why David Lereah, the chief economist for the U.S. National Association of Realtors (NAR), kept pumping out the optimistic outlooks. He has since complained publicly about the pressure he was put under by his bosses at the NAR to toe the line. Now the U.S. is mired in the worst housing crash the country has ever seen, and Lereah has been discredited. He’s left his job at the NAR, lost millions in his own real estate portfolio, and he has been largely ostracized by his former colleagues.
We shouldn’t smugly assume that the same couldn’t happen here. One of Canada’s top economists, who spoke on condition of anonymity, says that he questions a lot of the numbers coming out of the real estate sector in Canada. “There’s clearly a lot of spin,” he says. Even the CMHC, which promotes home ownership and depends on home sales to sell mortgage insurance, has an interest in seeing the market prosper. “There is quite a lot of uncertainty regarding the market in general right now, and there are too few uninterested parties who are giving any sort of reasonable analysis on that outlook.” That leaves just one question: if the Teranet futures market is right, and house prices are about to embark upon a long, slow decline followed by an anemic recovery, what will that mean for Canada? On the positive side, it will mean thousands of families who can’t currently afford houses may gradually see them fall within reach.
But the negative fallout will be painful, long-lasting and will touch us all. It will mean more lawsuits against people like Riaz Kassam, who get trapped by tumbling prices. It will mean a huge drop in the wealth of millions of Canadians, as their biggest investment slowly sinks in value. It will mean consumers clamping down on their spending because they feel poorer, contributing to the general economic decline. Shiller says it’s the inevitable end to a truly wild ride. “We’ve never before had this all-pervading belief that I can buy a house in any city and prices will just keep going up,” he says. “This cultural change helped to bring on the world’s largest housing bubble, and that outlook has invaded Canada, just as it has other countries.” It’s time to brace yourself, he says, because that bubble has popped. Over the coming years, houses will cease to be speculative investments, and will simply become places to live again. Shiller says it’s a necessary correction, but that doesn’t mean the process will be a pleasant one. “We may be in for a bad recession,” he says, “and we may not see the markets perform well for a long time.”
China prepares to buy up foreign oil companies
China is preparing to open a new phase in its race for the world's resources by using its huge currency reserves to buy foreign oil and gas companies. This proposal may risk a backlash from countries who fear that China is using the world's economic crisis to tilt the balance of trade and diplomacy in its favour. A conference of officials from the National Energy Administration has agreed to consider establishing a special fund for China's state-owned companies to buy oil and gas firms overseas. The beneficiaries would be the Beijing's three giant energy companies - Petrochina, Sinopec and CNOOC.
"Firms will be able to benefit from low-interest loans and, in some cases, direct capital injections," according to China Petroleum Daily. This state money would be used to fund takeovers or mergers with resource companies abroad. Which foreign firms, if any, have been identified for takeover has not been disclosed. But the dramatic fall in oil prices since last summer, and the strains caused by recession, have driven down the share prices of many energy companies, making them more affordable targets for predatory competitors.
Jiang Jemin, the chairman of Petrochina, recently remarked that the "low share prices of some global resource companies provide us with fresh opportunities". The possibility of a Chinese state subsidy for overseas acquisitions may ring alarm bells in Western economies. Four years ago, CNOOC tried to buy an American oil company, Unocal, and succeeded in outbidding its main US rival. But the Chinese firm eventually withdrew its offer amid opposition from American Congressmen. They opposed the idea of a private US firm falling into the lap of a state-owned company, bankrolled by the Chinese Communist Party.
This time, China may calculate that Western governments are in a weaker position to object. They are, after all, spending billions on taking over their own companies, notably the banking sector. Chinese leaders have now concluded a new raft of long-term oil supply deals. In the last week alone, Beijing has signed agreements worth more than £28 billion with countries as diverse as Russia, Venezuela and Brazil. Vice-President Xi Jinping last week toured major oil producers in Latin America. He signed one agreement worth £7 billion with Petrobras in Brazil, and another to invest £5.6 billion in expanding Venezuela's oil production.
The latter deal aims to increase Venezuela's oil sales to China from 350,000 barrels a day to 1 million barrels by 2015. With his customary flourish, President Hugo Chavez went further, claiming: "All the oil China needs for the next 200 years - it's here. It's in Venezuela." A separate deal with Russia will exchange £17 billion of Chinese loans to two major Russian companies - Rosneft, its biggest oil firm, and the pipeline operator Transneft - in return for for 15 million tons of oil ever year for the next two decades. Hillary Clinton finished her visit to Asia, her first tour as US secretary of state, in Beijing yesterday. Her travels took in the world's two largest holders of American debt, Japan and China.
She called on Beijing to continue to buy American Treasury bills to fund President Barack Obama's stimulus package. "By continuing to support American Treasury instruments the Chinese are recognising our interconnection. We are truly going to rise or fall together," she said. Mrs Clinton may be concerned by China's latest energy ties with Venezuela, a stridently anti-American country, and Russia, one of Washington's strategic competitors. But Dong Xiucheng, from the China University of Petroleum, said that Beijing's motives were solely commercial and there was no intention to strain relations with America. "From the Chinese government's point of view, perhaps a third country's relations with USA are taken into consideration, but they will not be a big issue," she said.
China cites risk of deflation, overcapacity
China is facing deflationary risks due to overcapacity in many industries amid a sharp downturn in demand, the central bank said in a report issued late Monday. "Against the backdrop of shrinking general demand, the power to push up prices is weak and that for driving down prices is strong," the People's Bank of China said in its report on fourth quarter 2008 monetary policy. "There exists a big risk of deflation," said the report posted on the central bank's Web site. While falling prices might seem a welcome trend, a long spell of deflation can lead to destructive declines in wages, stocks and property prices, sapping corporate profits and prompting businesses to cut jobs and investment. China's consumer price index, which had spiked last year to 12-year high of 8.7 percent, has eased to 1 percent in January.
Meanwhile, wholesale prices fell 3.3 percent, the second straight month of decline, as costs for oil and other raw materials eased. Such a fall in wholesale prices, which measures the cost of goods as they leave the factory, can indicate an impending decline in consumer prices. The central bank's comments underscore China's challenge in balancing policy to suit fast-changing global and domestic pressures. Until July, it noted, the prevailing concern was with surging inflation. But a sharp decline in demand for many products that began in the autumn has left many industries with excess inventory and too much production capacity -- a chronic problem even before the downturn. China's torrid economic growth slowed to a seven-year low of 9 percent in 2008. But the central bank also warned of potential longer-term risks from inflation due to the worldwide effort to expand credit and increase liquidity in the global financial system.
Beijing's Olympic building boom becomes a bust
"Empty," says Jack Rodman, an expert in distressed real estate, as he points from the window of his 40th-floor office toward a silver-skinned prism rising out of the Beijing skyline. "Beautiful building, but not a single tenant. "Completely empty. "Empty." So goes the refrain as his finger skips from building to building, each flashier than the next, and few of them more than barely occupied. Beijing went through a building boom before the 2008 Summer Olympics that filled a staid communist capital with angular architectural feats that grace the covers of glossy design magazines.
Now, six months after the Games ended, the city continues to dazzle by night, with neon and floodlights dancing across the skyline. By day, though, it is obvious that many are "see-through" buildings, to use the term coined during the Texas real estate bust of the 1980s. By Rodman's calculations, 500 million square feet of commercial real estate has been developed in Beijing since 2006, more than all the office space in Manhattan. And that doesn't include huge projects developed by the government. He says 100 million square feet of office space is vacant -- a 14-year supply if it filled up at the same rate as in the best years, 2004 through '06, when about 7 million square feet a year was leased.
"The scale of development was unprecedented anywhere in the world," said Rodman, a Los Angeles native who lives in Beijing, running a firm called Global Distressed Solutions. "It defied logic. It just doesn't make sense." Construction cranes jut into the skyline, but increasingly they are fixed in place, awaiting fresh financing before work resumes. Boarded fences advertise coming attractions -- "an iconic landmark" or "international wonderland" -- that are in varying states of half-completion. A retail strip in one development advertised as "La Vibrant shopping street" is empty. In a country where protests are rare, migrant workers stand in front of several construction projects, voicing their grievances.
"Our boss ran away with the money and he is nowhere to be found," said Li Zirong, a migrant worker from Shaanxi province, who was a supervisor on a stunning building with windows shaped like portholes. What makes this boom-and-bust cycle different from those in the West is that there is no private ownership of land in China, making local governments de facto partners in the real estate industry, which earn huge fees from leasing and transferring land. Huang Yasheng, an economist at the Massachusetts Institute of Technology, traces the blame for the bust to the Chinese Communist Party and its reluctance to allow a true market economy.
"The lack of land reform fed into the real estate bubble and now it's coming back to haunt them," said Huang, author of "Capitalism With Chinese Characteristics," published last year. "There should have been more checks and balances on the ability of the government to acquire land." The government spent $43 billion for the Olympics, nearly three times as much as any other host city. But many of the venues proved too big, too expensive and more photogenic than practical. The National Stadium, known as the Bird's Nest, has only one event scheduled for this year: a performance of the opera "Turandot" on Aug. 8, the one-year anniversary of the Olympic opening ceremony. China's leading soccer club backed out of a deal to play there, saying it would be an embarrassment to use a 91,000-seat stadium for games that ordinarily attract only 10,000 spectators.
The venue, which costs $9 million a year to maintain, is expected to be turned into a shopping mall in several years, its owners announced last month. A baseball stadium that opened last spring with an exhibition game between the Dodgers and the San Diego Padres, is being demolished. Its owner says it also will use the land for a shopping mall. Among the major Olympic venues, only the National Aquatics Center, nicknamed the Water Cube, has had a productive afterlife. It's used for sound-and-light shows, with dancing fountains in the swimming lanes where Michael Phelps won his gold medals. All around the Olympic complex, there are cavernous empty buildings, such as the main press center for the Games, that still await tenants.
A shopping arcade that stretches for a quarter of a mile across the street from the complex is empty, the storefronts papered over with signs reading "famous stores corridor." "They wanted to build 'the world's biggest this' and 'the world's biggest that,' but these buildings have almost zero long-term economic benefit," economist Huang said. Moreover, the makeover of Beijing for the Olympics led to an estimated 1.5 million residents being evicted from their homes, according to the Geneva-based Center on Housing Rights and Evictions. In this vibrant capital city of 17 million, there is an insatiable demand for housing, yet prices remain far out of reach of most residents. American-style free-standing homes are being advertised for more than $1 million in gated communities with names like Versailles, Provence, Arcadia and Riviera. Within the Fourth Ring Road, a beltway that defines the central part of the city, two- and three-bedroom apartments are offered for $800,000 in compounds named Central Park and Riverside.
"These are like New York prices, but we are Chinese. We don't have that kind of money," said Zhang Huizhan, a 55-year-old businessman who owns a Chinese furniture factory. He has been looking for five years for an apartment for him and his wife within their budget of $150,000. The average salary in Beijing is less than $6,000 a year. Louis Kuijs, a senior economist at the World Bank in Beijing, said a lack of government supervision of the real estate industry tempted developers to build only for the luxury market and to ignore the mass market. "If you think demand is endless for anything you build and you have just 200 square meters of land, you will build high-end apartments to make the highest profit," Kuijs said.
To its credit, the government recognized in 2007 that the real estate market was headed toward a bubble, economists say. In an attempt to make real estate more affordable, restrictions were introduced on ownership of second homes and on foreign home buyers. But the measures came too late, accelerating the crash of an already weakening market. The Beijing Municipal Bureau of Statistics reported this month that housing sales in the city dropped 40% last year. Chinese economists have predicted that housing prices will drop 15% to 20% in Beijing this year. Shanghai has experienced a similar decline. "You can look at this perhaps as a healthy correction in the market," Kuijs said.
In the longer term, he said, "China's urbanization and overall development is going to lead to a very large additional demand for housing in the city." Before that happens, the situation could get worse. Most of the real estate has been financed by Chinese banks, which have avoided writing down the loans. Eventually, they will be forced to, and that probably will have a ripple effect throughout the economy. "At the end, somebody is going to have to pay the piper," real estate expert Rodman said.
Congress, Obama missed key opportunity to reform health care
They had a chance and they didn't take it. The $787 billion stimulus package President Barack Obama signed last week gave Congress and the administration the chance to take a small step toward rebuilding a health care system that is illogical, inefficient and inhumane. Instead, Republicans cried socialism, Democrats buckled and Obama surrendered. Staying healthy has always been a crapshoot in the United States. There is nothing new about illness and disease visiting victims with a cruel randomness. The woman who has never smoked develops lung cancer. Her next-door neighbor, a former smoker, does not. Children come down with rare and mysterious ailments that leave us all heartbroken.
But increasingly, getting healthy again or preventing the diseases that can be prevented have developed their own cruel randomness. In the end, the final stimulus package only underscores how arbitrary our health care system has become. Initially House Democrats proposed temporarily extending Medicaid to those who lose their jobs in this horrendous economic downturn. The bill also called for helping the unemployed extend their employer-sponsored health insurance through COBRA, provided they had that insurance when they were laid off. The final bill dropped the provision to extend Medicaid to workers whose employers didn't provide health benefits in the first place. It kept the subsidy for COBRA, but also set up a potentially life-or-death lottery in which those who lost their jobs before Sept. 1 get no COBRA help while those who lost their jobs on or after Sept. 1 will have part of their health insurance bill paid by the government for nine months.
Why Sept. 1? Who knows? This stuff doesn't have to make sense. Does it make sense to tie access to decent health care to the ability to land a decent job? What was the thinking on killing the Medicaid extension? No need to help the unemployed who didn't have health coverage in the first place because, hey, they're used to it? Of course the original proposal was far from perfect. Nothing is easy, or cheap, when it comes to health care coverage. But as I argued in a recent column, the initial plan was a move in the right direction — the direction of universal, government-sponsored health care. And the Medicaid proposal was temporary, which means it was a chance to try something new on a small scale to see how it worked.
The idea of government-sponsored health care scares conservatives to death. A few responded to my column with howls of protest. The general themes? Government doesn't get anything right. Universal health care will lead to the rich getting the help they need by paying out of pocket. The poor will suffer long delays for needed care. Government bureaucrats will interfere with health decisions. As I wrote back to one such reader: The description sounds pretty much like the system we have today — although it's insurance companies that can't get anything right, and it's their bureaucrats interfering with medical treatment.
There can be no doubt that our current system is unworkable. About 45 million Americans are uninsured. The number in Silicon Valley is growing, according to the 2009 Index of Silicon Valley, issued by Joint Venture: Silicon Valley and the Silicon Valley Community Foundation. So is the number of valley residents buying their own policies, the index says. Premiums for private insurance can easily reach $1,000 or more a month. It's a crushing cost for some who are working and simply out of reach for most who aren't. The stimulus bill gave the nation's leaders a rare chance to do something about that. And they failed. They'll have to live with that — while the rest of us live with the consequences.
Health care costs to top $8,000 per person
A new government report on medical costs paints a stark picture for President Barack Obama, who is expected to call for a health care overhaul in a speech Tuesday night to a joint session of Congress. Even before lawmakers start debating how care is delivered to the American people, the report shows the economy is making the job of reform harder. Health care costs will top $8,000 per person this year, consuming an ever-bigger slice of a shrinking economic pie, says the report by the Department of Health and Human Services, due out Tuesday. As the recession cuts into tax receipts, Medicare's giant hospital trust fund is running out of cash more rapidly, and could become insolvent as early as 2016, the report said. That's three years sooner than previously forecast. At the same time, the government's already large share of the nation's health care bill will keep growing.
Programs such as Medicaid are expanding to take up some of the slack as more people lose job-based coverage. And baby boomers will soon start reaching 65 and signing up for Medicare. Those trends together mean that taxpayers will be responsible for more than half of the nation's health care bill by 2016 -- just seven years from now. "The outlook for health spending during these difficult economic times is laden with formidable challenges," said the report by statisticians at HHS. It appears in the journal Health Affairs. The health care cost forecast did not take into account recent legislation that expanded medical coverage for children of low income working parents, and added to the government's obligations. The report "accelerates the day of reckoning," said economist John Palmer of the Maxwell School at Syracuse University.
"It is bringing home more immediately the problematic dimensions of what we face," added Palmer, who has served as a trustee overseeing Social Security and Medicare finances. "The picture was bad enough ten years from now, but the fact that everything is accelerating gives greater impetus to be concerned about health reform." The report found health care costs will average $8,160 this year for every man, woman and child, an increase of $356 per person from last year. Meanwhile, the number of uninsured has risen to about 48 million, according to a new estimate by the Kaiser Family Foundation. The government statisticians estimated that health costs will reach $13,100 per person in 2018, accounting for $1 out of every $5 spent in the economy.
Policy makers would like to slow the rate of increase in spending, but that has proven difficult, because American-style medicine care relies on intensive use of costly high-tech tests and procedures. In a separate report, also due out Tuesday, private researchers looked at spending on medical conditions and found that the most costly were mental disorders -- including Alzheimer's -- and heart problems. The White House says Obama believes that out-of-control costs are the main obstacle to securing coverage for all. "Health care costs are crushing middle class families and the small businesses that fuel job growth in this country," said White House spokesman Reid Cherlin. "President Obama believes that if we're going to get our economy back on track, we have to act quickly to address this pressing issue."
Health Outlays May Hit $2.5 Trillion in 2009
The recession is shifting health-care costs from the private to the public sector, but it isn't making medical spending any less burdensome. Federal economists project that total U.S. health-care spending will reach $2.5 trillion this year, $1 billion more than last year. The health share of the gross domestic product is expected to rise to 17.6% from 16.6% in 2008, its largest single-year increase ever, mainly because the GDP is expected to shrink this year for the first time since 1949. The annual study, published in the journal Health Affairs by researchers at the Centers for Medicare & Medicaid Services, estimates that health spending will grow an average of 6.2% each year between 2008 and 2018. That's 2.1 percentage points higher than the average annual growth in the overall GDP. By 2018, national health-care spending is projected to nearly double, to $4.4 trillion, consuming 20.3% of GDP. And this is without calculating the impact of any health-care reforms, which are sure to raise costs over the near term. President Barack Obama is expected to outline his plans for health-care reform on Feb. 24.
The U.S. already spends more than twice the share of its GDP on health care than any other industrialized country, with no better outcomes, a state of affairs that most economists and company officials complain weighs mightily on the nation's global competitiveness. Consequently, there is a growing consensus among politicians and the health-care industry that some level of health-care reform is a must. Obama said during his campaign that he wants to decrease the number of uninsured, both by penalizing large employers who do not offer insurance and by setting up a new public insurer, a plan the Congressional Budget Office estimated could cost up to $65 billion to implement. Economists agree, however, that ultimately efforts to cover the uninsured and lower costs, though expensive in the short term, are critical to bringing long-term health-care inflation under control.
The government's economists say the projected growth in the overall economy and a decline in private health insurance coverage due to layoffs should dampen private-sector health-care spending, bringing the increase to a 15-year low of 3.9% this year. Public health spending will make up the difference, however, with spending accelerating by 7.4% this year. All of this, though, is just the lull before the storm that will hit in the next decade. Health-care spending will rapidly accelerate in 2011 as the economy improves and the first wave of the Baby Boom becomes eligible for Medicare. By 2018, annual health-care inflation should reach 7.2%, and government payers such as Medicare, Medicaid, and public health agencies are expected to pay for more than half of all national health spending, up from about 40% now.
The researchers caution that there are many uncertainties in their projections, such as the length of the economic downturn and potential health-care reforms that could extend coverage to the uninsured. For example, the researchers based their estimates on the assumption that physician payments would be cut 21% as required by a federal statute called the Sustainable Growth Rate. But Congress has overturned that pay cut every year since it went into effect in 2003. The biggest contributors to health-care inflation over the next 10 years will probably be hospitals and physician charges, the researchers note. Prescription-drug spending growth slowed from 4.9% in 2007 to 3.5% last year as patients switched to generics, but the researchers expect new specialty drugs to be approved in the coming years, causing prescription spending to almost double, to $453.7 billion by 2010.
The Three Marketeers
Economist heroes? It sounds silly unless you understand how close the world came to economic meltdown last year
The phone rings. You are on vacation in the Virgin Islands. You have been dreaming about the fishing for the better part of two months, and you are about to head out to chase the Christmastime bonefish running offshore and to spend a day on the water, with the sun leaching six months of Washington baloney from your brain. The phone rings, and because you are Secretary of the Treasury, you answer. "This is the Treasury operator," says the voice. "Please stand by for a conference call."
The phone rings. You are at home, but getting ready to head out to your weekly tennis game in the Virginia suburbs. You are thinking perhaps about your spin serve, a wicked slice that moves left to right so fast that you have left some of Washington's biggest names tripping over their feet and cursing. Sure, you can leave the stock market wheezing with one word about higher interest rates, but ... if only they could see what you can do to anyone foolish enough to line up inside against that serve! You are 72 years old, and your tennis game is still one of your great pleasures, and surely you have been looking forward to this match all week. But the phone is ringing, and because you are chairman of the Federal Reserve Board, you answer. "This is the Treasury operator," says the voice. "Please stand by."
The phone rings. "Whoopee!" you think. "The phone is ringing!" O.K., you really should calm down about this phone-ringing stuff, but you are the Deputy Secretary of the Treasury, and this past year, for all its chaos and tumult, has been about the most exciting you could imagine. It's the holiday season, and you are eager to get to your family and all that, but boy, this holding the world economy by the hand is even better than advertised. The phone rings. Maybe it will be like this summer, when your mom picked up in your house on Cape Cod and found Fed Chairman Alan Greenspan on one line and worried Russian reformer Anatoli Chubais on the other. Oh, how she thrilled over that! The phone rings, and because you are the Deputy Secretary (and happen to be one of the few rocket-scientist economists not trying to create a black box to make deviously complex trades on Wall Street), you pick up the receiver. "This is the Treasury operator," the woman on the line says, and though she doesn't say it, what she could say now that she has you all connected is: "The committee to save the world is now in session."
Just ask the folks in Russia, who saw their economy strangled last August by an outflow of confidence that was as fast as it was lethal. Ask Latin American countries, whose economies were concussed by the Russian shock waves even though the two regions have few direct economic links. Or ask the thousands of ethnic Chinese who fled Indonesia last year after impoverished locals concluded that Chinese businessmen had magnified their misery by shipping cash out of the country in search of stability. Although the U.S. economy has been nothing but sunshine, it has been a terrifying year in world markets: famed financier George Soros lost $2 billion in Russia last year; a hedge fund blessed with two Nobel prizewinners blew up in an afternoon, nearly taking Wall Street with it; and Brazil's currency, the real, sambaed and swayed and then swooned. In the past 18 months 40% of the world's economies have been tugged from robust growth into recession or depression.
So far, the U.S. has dodged these bullets, but the danger to its economy is far from over. The tremendous appetite of American consumers for imports--an appetite whetted by stock-market wealth--has provided some support for Asia and Latin America. Yet the tiniest perturbation could send the whole economy tumbling, and there are perturbations all over the place. Brazil is just hanging on, which means so is the rest of Latin America. Europe, which suffers from high unemployment, is slowing. And Asia's comeback is predicated on Japan's getting its troubled economy into gear. In late-night phone calls, in marathon meetings and over bagels, orange juice and quiche, these three men--Robert Rubin, Alan Greenspan and Larry Summers--are working to stop what has become a plague of economic panic. Their biggest shield is an astonishingly robust U.S. economy. Growth at year's end was north of 5%--double what economists had expected--and unemployment is at a 28-year low. By fighting off one collapse after another--and defending their economic policy from political meddling--the three men have so far protected American growth, making investors deliriously, perhaps delusionally, happy in the process.
It has meant some very difficult decisions. In some of the nations devastated by the crisis, there is a growing anti-U.S. backlash, and politicians such as Malaysian Prime Minister Mahathir Mohamad complain that Rubin, Greenspan and Summers--and their henchmen at the International Monetary Fund--have turned nations like Malaysia and Russia into leper colonies by isolating them from global capital and making life hellish in order to protect U.S. growth. The three admit they've made hard choices--and they'll even cop to some mistakes--but they still believe that a strong U.S. economy is the last, best hope for the world.
And awful as the Asian correction is, it was, in a sense, inevitable because those economies had trundled billions of dollars into useless real estate and industrial development. "In general," said Summers, 44, as he sat in the Frankfurt airport last September recovering from a hectic trip to Moscow, "we start with the idea that you can't repeal the laws of economics. Even if they are inconvenient." Over dinner recently someone congratulated Rubin on the booming U.S. economy and pointed out that one international magazine had been uniformly wrong in its predictions of a global collapse. The Secretary wasn't biting: "Everything is probabilistic," he said. The battle continues.
The conventional wisdom is that the economic anxiety now gripping much of the world has its roots in the collapse of Thailand's currency, the baht, in July 1997, after investors discovered that Thailand's economic boom was built on a base as solid as a bowl of pad Thai noodles. But the roots actually reach back further, to Black Monday, Oct. 19, 1987, when the Dow Jones industrial average shed 22.6% of its value in a single day. The market, of course, rebounded--and how. But at the time, professional investors thought U.S. stocks were due for a decade of slow-to-sluggish performance. Their eyes--and wallets--quickly alighted on the world's so-called emerging markets. These nations, allegedly "emerging" from centuries of economic backwardness, were posting phenomenal growth rates: Malaysia grew 9.5% in one year, Thailand 13%. Investors--especially young portfolio managers entranced by Malaysian food and Thai night life--rushed to get in.
Between 1987 and 1997, half a trillion dollars flowed in from international investors. Initially the money was a godsend. It gave companies access to world-class technology and know-how. But in cities such as Jakarta or Kuala Lumpur or Bangkok, there aren't a whole lot of world-class companies. And as share prices of those rare firms rose, investors poured money into other, less well-run companies. At the height of the boom, in 1996, office space in Bangkok was commanding First World rents; in Jakarta supermodels Claudia Schiffer and Naomi Campbell inaugurated a Fashion Cafe, and in Kuala Lumpur the world's tallest building opened for business. Of course it couldn't last. In late 1996 the warp-speed growth in many of these nations began to slow--an inevitable turn in the business cycle. But the stutter was enough to panic a few investors, who headed for the exits. That set off a rapid spiral of defaults that became known as the Asian Contagion. Thailand's problems quickly became Indonesia's, then Korea's, in a dangerous daisy chain that is still looping together--witness last month's shuddering devaluation of the Brazilian real.
The initial downturn didn't surprise the Fed or the Treasury too much. For the better part of two years, Greenspan and Rubin had been quietly fretting about the narrowing "spread"--the difference in interest rates--between U.S. bonds and emerging-market bonds. By 1996 banks were lending money to countries such as Malaysia at interest rates just a few percentage points above what the U.S. Treasuries commanded. The implication: Malaysia was not a much riskier bet than the U.S. This was nonsense, and the committee knew some correction was in order. But the speed of the collapse, when it came, was breathtaking, and proof that world markets had entered a new and much more volatile phase. Summers has a favorite analogy: "Global capital markets pose the same kinds of problems that jet planes do. They are faster, more comfortable, and they get you where you are going better. But the crashes are much more spectacular."
The three men trying to cope with these mid-ether collisions of dollars and expectations are an unlikely team. Greenspan, the data-loving analyst with government roots sunk back into the financial and moral chaos of the Nixon Administration, and a shaman-like power over global markets. Rubin, the Goldman Sachs wonder boy who ran the firm's complex and dangerous arbitrage operations and then led it to rocket-ship international growth. And Summers, the Harvard-trained academic who is invariably called the Kissinger of economics: a total pragmatist whose ambition sometimes grates but whose intellect never fails to dazzle. What holds them together is a passion for thinking and an inextinguishable curiosity about a new economic order that is unfolding before them like an Alice in Wonderland world. The sheer fascination of inventing a 21st century financial system motivates them more than the usual Washington drugs of power and money. In the past six years the three men have merged into a kind of brotherhood, with an easy rapport.
Spending time with them is like sitting in on a meeting of the M.I.T. economics faculty, a kind of miniature world in which everyone has his own idiosyncrasies and idea-wrestling is the pastime. The conversation is by turns uproarious and serious. They may not finish one another's sentences, but they clearly can finish one another's thoughts. And there is tremendous camaraderie. "Let me tell you this about Alan's tennis game," jokes Summers, an occasional opponent on the court. "He is very good [pause] for his age." Says Greenspan, with a broad grin designed to mask what is either sarcasm or a psych job: "Larry is really almost as good as a professional player."
Greenspan has a theory about what holds them together: "In analytical people self-esteem relies on the analysis and not on the conclusions." That must be it. The three men have a mania for analysis that has bred a rigorous, unique intellectual honesty. In the Reagan Administration economic policymaking was guided not by analysis but by conclusions--specifically a belief in so-called supply-side economics. No matter what the data showed, the results among Reagan-era economists like Arthur Laffer were always the same: tax cuts and less regulation were the solution. Rubin, Greenspan and Summers have outgrown ideology. Their faith is in the markets and in their own ability to analyze them. "It's unusual," Greenspan says. "In Washington usually you come to the table, and everyone meets, and no one changes their mind. But with us, you have something else."
This pragmatism is a faith that recalls nothing so much as the objectivist philosophy of the novelist and social critic Ayn Rand (The Fountainhead, Atlas Shrugged), which Greenspan has studied intently. During long nights at Rand's apartment and through her articles and letters, Greenspan found in objectivism a sense that markets are an expression of the deepest truths about human nature and that, as a result, they will ultimately be correct. Greenspan jokes that Rubin, with his background in arbitrage, may be slightly more skeptical because of his experiences with market imperfections. But they all agree that trying to defy global market forces is in the end futile. That imposes a limit on how much they will permit ideology to intrude on their actions. So despite different political backgrounds, they have the ability, rare in Washington these days, to preclude partisan considerations from their discussions. In the same way that the threat of mutually assured destruction helped Kissinger replace Washington ideology with Realpolitik, the shadow of a massive economic meltdown has helped the committee sell a market-driven policy that could be labeled Realeconomik.
Yet in places like Malaysia, where one of those market imperfections led to a collapse that has impoverished millions, the intellectual beauty of Realeconomik is less appreciated. And the committee's fire brigade, the IMF, has been harshly accused of pumping gasoline on the flames. Faced with currency runs in many nations last year, the IMF pushed governments to raise interest rates (to persuade investors to hold on to their currencies) and slash deficit spending. But the IMF now says the formula may have been too harsh. The worsening of the crisis, explains critic Jeffrey Sachs, from Harvard's Institute for International Development, was "a predictable consequence of draconian measures that increase panic rather than reduce panic." The IMF has taken particular heat because even as these nations suffer, the U.S. and Europe continue to grow. The committee believes that the IMF remains a key international tool, especially as it works to clean up the abuses that led to the current mess and makes it easier for investors to get back into those developing markets.
That means trying to reduce volatility where possible. Many countries are at the mercy of international lenders who can decide, if they feel nervous, to jerk billions of dollars from country to country. This would be like having your bank pull your mortgage because your banker heard you'd had a bad day. The solution to the problem, the men believe, is more honesty on the part of borrowers--so banks know what they are getting into--and more caution on the part of banks. While some economic thinkers--notably Soros and Malaysia's Mahathir--have lobbied for more dramatic controls, Rubin warns that simply locking capital in place can often become a substitute for much needed reform, delaying an inevitable correction. As for the impact of speculators, who have been torched by politicians around the world, Rubin says they are a part of the crisis but a much less important factor than the real economic problems of the countries they hit.
To operate effectively in this new world, Rubin has remade the Treasury into an organization that is "more like an investment bank," says Tim Geithner, the 37-year-old Under Secretary for International Affairs. Unlike past Secretaries, who wanted decisions presented as thumbs-up, thumbs-down recommendations, Rubin wants debate. "He is a master at eliciting opinions," says David Lipton, a former Treasury official. The emblematic Treasury encounter is what Rubin calls a "rolling meeting," which cruises from one corner of the globe to the other as aides sprint in and out of the room. Says Lipton: "Often in meetings Rubin will cut right through the hierarchy, reach down to one of the youngsters at the table and ask what that person thinks. It creates a whole lot of energy--and an awful lot of fresh thinking."
And fresh thinking has been crucial in the new economic order. One legacy of 1998 has been the destruction of some of academe's and Wall Street's most cherished models of the world. More data and faster markets, says Greenspan, mean more opportunities to make money. They also mean more chances to lose your shirt, something he calls "the increased productivity of mistakes." Computers make it possible to push a button and destroy a billion dollars of wealth. The chairman was warning about the problem long before Long-Term Capital Management vaporized $4 billion, but that debacle silenced any skeptics of the new risks.
Summers, who was the youngest tenured professor in Harvard history, was every bit as much a rocket scientist as the economists at LTCM. But Greenspan says one of the keys to Summers' success in Washington is his ability to unlearn much of what he once taught. "Larry has one overriding virtue: he is very smart," Greenspan explained one afternoon last week, as a springlike day cooled into night outside his Washington office. "And unlike people who are smart and believe they are smart, he is open to the recognition that a lot of what he thinks is true is not. That is a very rare characteristic. The academic model is far too simplistic a structure to explain how this whole thing works. Larry had the intelligence to very rapidly grasp that."
In private, Greenspan is full of insights like this. He is as much an observer of people as of markets. Rubin, among others, says the joy of working with Greenspan lies in both the power of his intellect and the sweetness of his soul. Though the world has come to know him through his opaque congressional testimony, friends know him as the Juilliard-trained saxophone player who spent two years touring with a swing band before taking up economics. The quiet romance of the man has always been present if you looked hard enough. Ayn Rand told friends, "What I like about A.G. is that basically he has his feet on the ground. I love his love for life on earth. He really is a passionate person in his own quiet way." Greenspan, who ran his own consulting firm on Wall Street for nearly 30 years, could have returned to the private sector and racked up a fortune. But his interest is elsewhere. Says Rubin: "Like all of us, Alan just has a driving interest to see how this will develop."
Rubin has had his star turns as well. In late 1997 he probably single-handedly stopped a panic about Korean debt from avalanching into a U.S. market crash by working the phones, convincing international bankers that they should cut Korea a break. It was not a welcome pitch. "This is a hell of a Christmas present," one banker moaned to Rubin on Christmas Eve. But Rubin's scheme saved the banks billions because if Korea had crashed, the banks could have lost everything. "It was Bob who actually got the banks to see how it worked to their benefit," Greenspan explains. Was there any element of a threat in the calls, a suggestion that if the banks didn't play, perhaps Treasury would let Korea blow up to set an example? "There was no stick," Rubin says. "It was kind of a carrot," Summers explains with a giggle. "A variable carrot."
But why did these three men need a carrot at all? If markets work so well, why were they burning their vacations on the phone trying to convince central bankers 16,000 km away that the world depended on a little self-restraint? The problem, the men say, is that the markets are encumbered by all kinds of imperfections. Even tiny flaws create problems. A Thai banker who breaks the rules by passing $100,000 to his brother-in-law puts the whole system at risk. To help resolve the riddle of imperfect markets, the committee has spent six years working on an experiment. It's called the U.S. economy. The current boom is as much a part of the committee's legacy as is its battle to stem global turmoil. It was Rubin--via the 1993 deficit-reduction plan--who navigated the Clinton Administration into budgetary agreements that helped create the first surplus in 29 years. This fiscal responsibility helped lower interest rates, which kicked off a surge in business spending. Greenspan, who dovetailed his own monetary policy with those goals, let the economy build up its present head of steam. The men don't get all the credit for the boom--they're the first to say all they did was let the markets work--but on both Wall Street and Pennsylvania Avenue, they get the bulk of it.
Their success has turned them into a kind of free-market Politburo on economic matters. Clinton relies on the men to a level that drives other Cabinet members nuts. One weekend last year, when both Summers and Rubin were on vacation, Clinton began to panic about Russia's weakness. "Where's Bob?" the President kept asking nervously in a morning meeting. Turning to White House staff members, he told them to pull together a plan. The team spent a weekend crashing a strategy, only to be shut out again when Rubin arrived back in town. An aide to Secretary of State Madeleine Albright regularly worked the phones during last July's Russian collapse, insisting that reporters were missing the story--Albright's involvement in economic policy. No one spent an ounce of ink on it. But other Administration officials say they are comfortable with the power balance. Says Gene Sperling, head of the National Economic Council: "You are often in a situation where other people far less experienced are coming in with very simple solutions, sure things that are going to work. And here are Rubin and Greenspan and Summers, with all their knowledge and expertise, showing the most humility. That is very reassuring."
Clinton doesn't bestow his trust blindly. He has immersed himself in economic details over the past six years. Rubin recalls a fishing vacation he took last year as the President was trying to formulate his response to the Russian crisis. As Rubin stood streamside near Homer, Alaska, his Secret Service agent's phone rang with call after call from the White House. Rod in hand, Rubin helped Clinton develop a clear understanding of the options. "He doesn't just sit by and sign off on policy," Rubin explains. And, Rubin says, Clinton has been willing to make politically tough decisions when necessary to assure U.S. growth--bailing out Mexico in 1995, for instance. "I really don't know what would have happened with this global climate if we hadn't had a President who had within him the framework to do what was best for the global economy," Rubin says.
Clinton's grasp of Realeconomik includes the tenet that short-term political gains are never worth long-term economic risks. Even though this year he had plenty of incentives to pump up his role in Asia and Russia, he has remained mum. In particular, that meant resisting the temptation to "talk up" the dollar or the stock market or bash the Fed for interest-rate moves. And Clinton has, in typical style, been an aggressive autodidact. Aides recall the time late last year when, nursing an aching back, Clinton spent an afternoon stretched out on a White House couch with one eye on the TV and the other on George Soros' complex new book on the risks of capitalism. He finished it in a day and quickly passed the underlined, dog-eared copy to his aides as required reading. The White House has also played a role in averting crises before they appeared on the radar screens. There were times in the past year when countries including Egypt, South Africa and Ukraine were possibly just days away from becoming the next victims of Asian Contagion. But patient and highly secret intervention by Vice President Al Gore helped change policy and avert collapses that would surely have shaken global confidence again.
The contagion has been a kind of object lesson in the risks of the new economics, and many developing nations are paying more attention to their policies. Says a Treasury official: "It was awfully hard to tell the Thais they had something to worry about when they were growing at 8% a year. They're a lot more attentive now." Greenspan and Rubin hope they can turn that attention into the kind of reforms that will make these emerging markets closer to ideal. Among the top priorities: cleaner international banking systems, transparent lending practices and more open markets. As soon as they can ram those changes through, they expect growth to pick up again--possibly just in time to help a flagging U.S. economy.
There are many challenges to face between now and then. Japan, which, as a banker and buyer, is crucial to any plans for a recovery in Asia, continues to struggle with economic reform. And in the U.S., growth is more dependent than ever on the stock market--which has been powered to new highs on the back of Greenspan's interest-rate cuts during the fall. The link between the Dow and the GDP means that a major correction in the stock market could send the trio's fondest hopes into the dustbin. "They have done a masterful job so far," says Stephen Roach, a Morgan Stanley economist. "Unfortunately, in financial markets you are only as good as your last move. If Greenspan's legacy is a stock-market bubble, he will not be treated kindly by history." None of the three men will talk about life after government, though Rubin says of Summers, "Larry is one of the few people smart enough to be either chairman of the Federal Reserve or Secretary of the Treasury." Few who know Summers doubt that he will someday hold one of those jobs.
But the men don't seem in a rush to move anywhere. Partly this is their engagement in the process. It is also something else. When the three talk about their "special" relationship, they are hinting at how fortunate it is that they can work together instead of apart. Says Robert Hormats, vice chairman of Goldman Sachs International: "There have been moments in the past year when it has been, as Churchill said, a very near thing. These guys kept a near thing from becoming a disaster." That has happened because the men feel that being at the right place at the right time also means doing the right thing, putting their egos aside and, in an almost antique sense of civic duty, answering the phone when it rings.