People's Drug Store No. 12, North Capitol and H., Washington, D.C.,
Ilargi: You don't have to be a teacher of morals to know that some things are just plain wrong. And in our societies these days, a lot of things are plain wrong. Morally wrong, legally wrong, politically wrong, economically wrong.
The Royal Bank of Scotland this morning announced the biggest corporate loss in British history. Its stock, however, shot up 20-25%. The reason for that was another announcement, this one by the UK government, that RBS will be allowed to place over $1 trillion in toxic assets in government insured vehicles. What this means is that private shareholders have the opportunity to make a lot of money over the backs of taxpayers. The government is majority stockholder in RBS, but still allows speculation and profit taking with RBS shares. It's simply completely wrong, and an unforgivable piece of policy. RBS should have been placed in bankruptcy, the government should have taken over its assets, and shareholders and bondholders should have been wiped out 100%. All executives should have been fired without severance packages or pensions. Instead, former chief Sir Fred Goodwin, responsible for all losses, is set to receive a $925,000 pension per year.
In the US, Bank of America and Citigroup should have been taken over, wiping out share- and bondholders. It's not called risk capital for nothing. The taxpayer never accepted the risk willingly, but is burdened with it. Those who did accept it, can sell and walk away free. Wrong. Companies like AIG and RBS are still free to make multi-billion dollar decisions without consulting the governments without whose money they would have ceased to exist. Wrong.
The US government has started to perform a "stress test" on major banks that most experts agree is not even a genuine test, but a political tool aimed at fooling people into believing the banks are adequately capitalized. Which, no matter what the test results are, they are obviously not. How wrong can you be? The US refuses to do the only thing that's morally and legally right because it's too small to deal with the banks. Unwinding Lehman will take 10 years. Unwinding all the already failed banks in the US would cost centuries in the present circumstances. That should serve as a warning signal. Letting banks follow their natural cause would endanger the continued functioning of the government itself. However, the banks will fail anyway down the line. Washington may elect to throw your trillions into the back holes, but that will just delay the inevitable. And those trillions should have been used to take care of the people who will be hardest hit by the chaotic society they, and we, will all live in.
The same thing holds true for the UK and who knows how many other countries. The US may feel it is in a relatively good position to date, because it can borrow more money, i.e. put itself deeper in debt, easier and cheaper than other nations because of the status of the US dollar. But that will not go on forever. The amounts the US borrows are far higher than any of the other nations, its deficit is much higher. And no, China will not keep on buying ever more US debt, if only because it will be overwhelmed. The only way it could do that would be for US citizens to keep buying its products. But that will not happen. The consumer society is a thing of the past.
Our way of life is over, and it will unravel in a sea of chaos. Our governments right now are busy stealing the paddles that could have saved us. What lifeboats we might have had will be leaking. And yes, that is wrong. Our leaders should be helping us build the lifeboats, not make sure they are leaky, rusty and rudderless bathtubs.
Obama’s Proposes Up to $750 Billion More for Bank Aid
President Barack Obama’s first budget request would provide as much as $750 billion in new aid to the financial industry, as well as overhaul the U.S. health-care system and launch a program to cut carbon-dioxide emissions. The spending blueprint, being sent to Congress today, anticipates the government will run a deficit totaling $1.75 trillion in the year ending Sept. 30, equivalent to about 12 percent of the nation’s gross domestic product. Obama has promised to cut the shortfall -- the biggest since World War II - - in half by the end of his first term. "It’s only by restoring fiscal discipline" that the U.S. can produce growth and prosperity "over the long run," Obama said during remarks this morning. "That means cutting what we don’t need" to pay for necessary programs.
Obama pledged that his administration will "go through our books page by page, line by line" to cut wasteful or inefficient spending, and said officials have already found $2 trillion in deficit reduction. A senior administration official, in a briefing yesterday with reporters, declined to say how large the White House forecasts the fiscal year 2010 deficit will be or provide the total budget figure. The full budget document is set for release at 11 a.m. Washington time. The administration proposes to finance the budget in part by limiting tax deductions for couples earning more than $250,000 a year, raising taxes on hedge-fund managers, cutting defense spending and paring subsidies to insurance companies participating in the government’s Medicare health-care system.
More details will come in the 134-page overview the administration plans to release later outlining budget priorities for the 2010 fiscal year, which begins Oct. 1. The administration official, noting Obama has only been in office for little more than a month, said the White House doesn’t plan to release a full, detailed budget until April. The official, speaking on condition of anonymity, said the White House hasn’t decided whether the $750 billion in additional aid to the financial industry will be needed. He said it will be put in the budget as a "placeholder." The official said the aid would appear in the budget as about $250 billion because the rules require policy makers to record the plan’s net cost to taxpayers. The government anticipates it would eventually recoup some, though not all, of the money expended to help financial companies. The funds would come on top of the $700 billion rescue package approved last October by Congress.
The official said the White House is asking for a "down payment" of about $635 billion to begin overhauling the nation’s health-care system, which Obama has said is critical to expanding health-insurance coverage and getting the government’s fiscal house in order. The fund would be financed in part by the limits on tax deductions for those earning more than $250,000 a year and by requiring insurance companies participating in the Medicare Advantage program to enter into competitive bidding. The budget proposes raising taxes on hedge-fund managers by eliminating the so-called carried interest tax loophole that allows investment managers to pay 15 percent tax rates on their compensation rather than the usual income tax rates. The spending plan would also raise taxes on corporate income earned overseas and crack down on business transactions that are solely designed to reduce companies’ tax bills.
The budget would eliminate the Advance Earned Income Tax Credit, a tax break for low-income earners that government officials have said is poorly administrated. The spending plan assumes the government would begin taking in at least $75 billion in 2012 from a cap-and-trade system that requires companies to buy credits if they exceed greenhouse-gas limits. That money would be used to invest in clean-energy technology and also help offset higher energy costs for lower-and middle-income Americans, according to officials who spoke on condition of anonymity. On defense, the administration will request an additional $75 billion this year for Iraq and Afghanistan war costs, bringing the total annual spending on the conflicts to more than $140 billion. The budget assumes those costs will decline to about $130 billion in 2010 and $50 billion in subsequent years.
The administration official said Obama plans to pursue deficit reduction by cutting spending on defense, an area with "significant" opportunities for savings. Agriculture subsidies also are targeted for reductions, with the administration pushing to phase out payments to farmers earning more than $500,000 annually. While the federal government has taken over Fannie Mae and Freddie Mac, the Obama administration opted to exclude most of the costs of running the mortgage financiers in its budget plan. The blueprint includes the money the Treasury Department has injected into the companies so far, the official said.
US budget projects $1.75 trillion deficit
President Barack Obama is sending Congress a budget Thursday that projects the government's deficit for this year will soar to $1.75 trillion, reflecting efforts to pull the nation out of a deep recession and a severe financial crisis. A senior administration official told The Associated Press that Obama's $3 trillion-plus spending blueprint also asks Congress to raise taxes on the wealthy in 2011 and cut Medicare costs to provide health care for the uninsured. The president's first budget also holds out the possibility of spending $250 billion more for additional financial industry rescue efforts on top of the $700 billion that Congress has already authorized, according to this official, who spoke on condition of anonymity before the formal release of the budget. The official said the administration felt it would be prudent to ask for additional resources to deal with the financial crisis, the most severe to hit the country in seven decades. He called the request a "placeholder" in advance of a determination by the Treasury Department of what extra resources will actually be needed.
The spending blueprint Obama is sending Congress is a 140-page outline, with the complete details scheduled to come in mid- to late April, when the new administration sends up the massive budget books that will flesh out the plan. However, the submission of the bare budget outline was certain to set off fierce debate in Congress over Obama's spending and tax priorities. The budget document includes additional requests for the current year and Obama's proposals the 2010 budget year, which begins Oct. 1. The president wants Congress to extend the $400 annual tax cut due to start showing up in workers' paychecks in April, and it extends the tax cuts passed in 2001 and 2003 for couples earning less than $250,000 per year. Those tax cuts were due to expire at the end of 2010.
To pay for the middle-class tax relief and the effort to increase health coverage, Obama's budget makes significant cuts on the rate of growth in other areas of health care and seeks to trim a variety of other government programs, including subsidies earned by farmers with revenue of more than $500,000 a year. The budget would also seek savings in military weapons purchases. It would raise taxes on wealthy hedge fund managers and corporations, eliminating tax incentives U.S. companies now have to move jobs overseas, something Obama repeatedly mentioned during the presidential campaign. Even with all the savings, the cost of the $787 billion economic stimulus bill will push the deficit for this year to $1.75 trillion, a level -- as a percentage of the economy -- not seen since World War II. The deficit is expected to remain around $1 trillion for the next two years before starting to decline to $533 billion in 2013, according to budget projections.
Obama's plan proposes achieving $634 billion in savings on projected health care spending and diverting those resources to expanding coverage for uninsured Americans. The $634 billion represents a little more than half the money that would be needed to extend health insurance to all of the 48 million Americans now uninsured. Americans now spend a total of $2.4 trillion a year on health care. Obama also will ask for an additional $75 billion to cover the costs of wars in Iraq and Afghanistan through September, the end of the current budget year. That would be on top of the $40 billion already appropriated by Congress, the administration official said. The administration will also ask for $130 billion for Iraq and Afghanistan in 2010 and will budget the costs of operations in Iraq and Afghanistan at $50 billion annually over the next several years.
Obama's budget proposal would effectively raise income taxes and curb tax deductions on couples making more than $250,000 a year, beginning in 2011. By not extending former President George W. Bush's tax cuts for such wealthier filers, Obama would allow the marginal rate on household incomes above $250,000 to rise from 35 percent to 39.6 percent. The plan also contains a contentious proposal to raise hundreds of billions of dollars by auctioning off permits to exceed carbon emissions caps, which Obama wants to impose on users of fossil fuels to address global warming. Some of the revenues from the pollution permits would be used to extend the "Making Work Pay" tax credit of $400 for individuals and $800 for couples beyond 2010, as provided in the just-passed economic stimulus bill. About half of what officials characterized as a $634 billion "down payment" toward health care coverage for every American would come from cuts in Medicare. That is sure to incite battles with doctors, hospitals, health insurance companies and drug manufacturers.
Some of the Medicare savings would come from scaling back payments to private insurance plans that serve older Americans, which many analysts believe to be inflated. Other proposals include charging upper-income beneficiaries a higher premium for Medicare's prescription drug coverage. To raise the other half, Obama wants to reduce the rate by which wealthier people can cut their taxes through deductions for mortgage interest, charitable contributions, local taxes and other expenses to 28 cents on the dollar, rather than the 35 cents they can claim now. Even more money would be raised if the top rate reverts to 39.6 percent, as Obama wants. Sen. Max Baucus, D-Mont., chairman of the Senate Finance Committee, called Obama's proposal to tax the wealthy to finance health care reform a starting point. But he wants to also examine taxing some of health insurance benefits provided by employers -- an idea rejected by Obama in last year's presidential campaign.
Budget documents provided to The Associated Press show that Obama will not lay out a detailed blueprint for a health care overhaul, but a set of broad policy principles and some specific ideas for how to raise a big chunk of the money. Obama's promise to phase out direct payments to farming operations with revenues above $500,000 a year is sure to cause concerns among rural Democrats. Even after all those difficult choices, cutting about $2 trillion from the budget over 10 years, Obama's budget still would feature huge deficits. The $1.75 trillion deficit projected for this year would represent 12.3 percent of the gross domestic product, double the previous post-war record of 6 percent in 1983, when Ronald Reagan was president, and the highest level since the deficit totaled 21.5 percent of GDP in 1945, at the end of World War II. At $533 billion, the deficit in 2013 will be about 3 percent of the size of the economy, a level that administration officials said would be manageable.
Obama Delivers $3.6 Trillion Budget Blueprint
President Barack Obama delivered Congress a $3.6 trillion budget blueprint Thursday that hopes to "break from a troubled past" with a sharp shift toward expanded government activism, tax increases on affluent families and businesses, and spending cuts targeted at those he says profited from "an era of profound irresponsibility." The budget blueprint for fiscal year 2010 is one of the most ambitious policy prescriptions in decades, a reordering of the federal government to provide national health care, shift the energy economy away from oil and gas, and boost the federal commitment to education.
One war would end, as troops leave Iraq, while another would ramp up in Afghanistan. To fund it all, families earning over $250,000 and a variety of businesses will pay a steep price, but Mr. Obama implored Americans to own up to the mistakes of the past while accepting profound sacrifices. "We need to be honest with ourselves about what costs are being racked up, because that's how we'll come to grips with the hard choices that lie ahead," Mr. Obama said Thursday morning. "And there are some hard choices that lie ahead." The president blamed the nation's economic travails on the administration that preceded him and on a nation that lost its bearings. His budget plan projects a federal deficit of $1.75 trillion for 2009, or 12.3% of the gross domestic product, a level not seen since 1942 as the U.S. plunged into World War II.
"This crisis is neither the result of a normal turn of the business cycle nor an accident of history," the president states in an opening message of the 134-page document. "We arrived at this point as a result of an era of profound irresponsibility that engulfed both private and public institutions from some of our largest companies' executive suites to the seats of power in Washington, D.C." By 2013, the deficit would drop to $533 billion but begin to climb from there again as the heart of the Baby Boom begins drawing Social Security and Medicare benefits. The budget's introduction is likely to herald one of the fiercest political fights Washington has seen in years, waged on multiple fronts. Within minutes, Republicans were lambasting a document they called class warfare, designed to mire the nation in recession for years to come. Business lobbyists were girding for battle even before the budget's unveiling. Even Democrats are likely to blanch at cuts to agriculture and other programs that have been tried before – and have failed repeatedly.
The budget sets aside an additional $250 billion to complete the president's effort to rescue the financial markets and stabilize the banking sector. That would come on top of the $700 billion already allocated by Congress. And it is likely to grow. The budget makes clear that reserve would be used to leverage the purchase of toxic assets weighing down the banking sector's books, $750 billion in asset purchases overall. That could mean a doubling of the original bailout in the end. Mr. Obama proposes large increases in education funding, including indexing Pell Grants for higher education to inflation and converting the popular scholarship to an automatic "entitlement" program. High-speed rail would gain a $1 billion-a-year grant program, part of a larger effort to boost infrastructure spending even beyond the funds in his $787 billion stimulus plan.
The Defense Department would see a $20.4 billion boost in 2010, a 4% increase from this year, slowing its growth from the Bush years but securing personnel increases for the Army and Marine Corps. Mr. Obama will request an additional $75.5 billion for the wars in Iraq and Afghanistan for the rest of 2009 and another $130 billion for 2010, as he withdraws most combat troops from Iraq over 19 months but sends many of them to Afghanistan. In one of the budget's most ambitious proposals, the president plans to cap the emissions of greenhouse gases, forcing polluters to purchase permits for emissions that would be slowly brought down to 14% below 2005 levels by 2020 and 83% below 2005 levels by 2050. The sale of those permits, beginning in 2012, would reap $646 billion through 2019. Of those revenues, $525.7 billion would be devoted to extending Mr. Obama's signature "Making Work Pay" $800 tax credit for working couples. Another $120 billion would go to clean energy technology.
He acknowledged his $630 billion fund for a national health insurance program will not be enough to ensure access to health care for all Americans, but he said it will be a start. To finance his proposals, the president has clearly chosen winners and losers -- with the affluent heading the list of losers. In populist tones that reflect an anger he notably avoided on the campaign trail, Mr. Obama wrote, "Prudent investments in education, clean energy, health care, and infrastructure were sacrificed for huge tax cuts for the wealthy and well-connected. In the face of these trade-offs, Washington has ignored the squeeze on middle-class families that is making it harder for them to get ahead. There's nothing wrong with making money, but there is something wrong when we allow the playing field to be tilted so far in the favor of so few."
In that sense, the budget is payback. As expected, tax increases will rise for singles earning $200,000 and couples earning $250,000, beginning in 2011 -- for a total windfall of $656 billion over 10 years. Income tax hikes would raise $339 billion alone. Limits on personal exemptions and itemized deductions would bring in another $180 billion. Higher capital gains rates would bring in $118 billion. The estate tax, scheduled to be repealed next year, would instead be preserved forever, with the value of estates over $3.5 million -- $7 million for couples -- taxed at 45%. Businesses would be hit, too. The budget envisions reaping $210 billion over the next decade by limiting the ability of U.S.-based multinational companies to shield overseas profits from taxation.
Another $24 billion would come from hedge fund and private equity managers, whose income would be taxed at income tax rates, not capital gains rates. Oil and gas companies would be hit particularly hard, with the repeal of multiple tax credits and deductions. The federal government would take over most student lending. Managed care companies would lose their subsidies for offering Medicare plans. Farmers with operating incomes over $500,000 would see their farm subsidies phased out. And cotton storage would no longer be financed by the federal government. "There are times where you can afford to redecorate your house, and there are times where you need to focus on rebuilding its foundation," Mr. Obama said as he unveiled his plan. "Today we have to focus on foundations."
Government Offers Details of Bank Stress Test
The Obama administration ordered the nation’s 19 biggest banks on Wednesday to undergo stress tests to check whether they could hold up if the economy deteriorated further. But analysts say the administration’s worst projections, which it describes as unlikely, are not much more dire than what many private forecasters already expect. According to the new Treasury Department guidelines, the banks would have to assume that the economy contracts by 3.3 percent this year and remains almost flat in 2010. They would also have to assume that housing prices fall another 22 percent this year and that unemployment would shoot to 8.9 percent this year and hit 10.3 percent in 2010.
"I don’t think they are harsh enough," said David Hendler, an analyst at CreditSights, who said the dire projection was itself too optimistic about the growth that would be generated from President Obama’s stimulus program. "That would be a pleasant outcome, but you have to plan for the worst." The average outlook of private-sector forecasters envisions the economy shrinking by 2 percent this year and unemployment peaking just below 9 percent in 2010. The average forecast for housing prices is a decline of 14 percent this year and an additional 4 percent next year.
Recent forecasts by the Federal Reserve and most private forecasters have undershot the severity of the downturn. Big banks — those with more than $100 billion in assets — will have to carry out supervised analyses by the end of April of how much their capital would be depleted under the Treasury Department assumptions. If federal banking regulators conclude that a bank would not have enough capital under those circumstances, the bank would have to raise the extra money within six months or get it from the government in exchange for ceding a potentially big ownership stake.
The Treasury Department also laid out the terms on which it would offer banks additional capital, and the formula could make the government a major shareholder in banks like Citigroup with only a modest additional infusion of capital. The Treasury said that it would provide new capital in exchange for shares of preferred stock that could be converted to shares of common stock at a price slightly below the level at which the shares traded on Feb. 9. For many of the big banks, that price would be slightly higher than the quoted prices today, but still at rock-bottom levels compared with just one year ago.
In effect, analysts said, the administration’s offer of additional capital could set a floor on share prices of the major banks, which will now be able to raise more money at lower cost if the market value of their shares dropped below the levels on Feb. 9. Administration officials, insisting that they want to avoid full-fledged bank nationalizations, left themselves wide discretion on how to interpret the results of the stress tests. In a telephone conference call with reporters, officials from the Fed and Office of the Comptroller of the Currency said there would be no simple measure for "passing" or "failing" a test, and provided only vague descriptions of how they would interpret the results.
"It sure sounds to me like they are designing this to make it sound like the banking system is in great shape," said Paul J. Miller, an analyst at Friedman, Billings Ramsey, a brokerage firm that specializes in bank stocks. Administration officials said their intention was simply to make sure that the nation’s big banks would remain adequately capitalized even if the economic recession is substantially worse than expected. They said their goal was to increase confidence of investors and depositors in the big banks, providing tangible evidence that the institutions would have enough money, whether they had to raise it from private investors or get it from taxpayers.
Administration officials said there was no cap on how much money a single institution could obtain, and they declined to estimate how much money the government would end up injecting before the crisis was over. Banks and other "qualified financial institutions," which now includes investment banks and insurance companies that are part of bank holding companies, can start applying for more money immediately. The Treasury Department has already used or allocated the first $350 billion of the $700 billion financial rescue program that Congress approved last fall.
Many analysts say the administration will have to ask Congress to authorize additional spending, though administration officials have declined to make any predictions thus far. Christopher Whalen, managing director at Institutional Risk Analytics, said Citigroup and other major banks would almost certainly become insolvent once they absorb the full brunt of losses from the economic downturn. "The stress test is about politics," Mr. Whalen said. "The O.C.C. and the Fed already know the answer. The answer is that we’re going to have to come to a decision: are we going to put in more equity or are we going to resolve the banks through bankruptcy?"
Even as Treasury officials laid the ground rules for getting banks through the current crisis, President Obama met with lawmakers in Congress to begin discussions about a broader overhaul of how the financial regulatory system oversees risk in the future. Emerging from the meeting, Mr. Obama said the first principle of a new system should be that financial institutions "that pose serious risks to the markets should be subject to serious oversight by the government." He also said that the regulatory system should be strengthened to withstand major stresses and that the government should take steps to rebuild trust in markets by promoting transparency.
'Stress Test' for U.S. Bank Industry May Not Live Up to Name
The Obama administration’s much- anticipated stress test for the nation’s wounded banks may not live up to its name. "It’s not going to be onerous," said Nancy Bush, bank analyst and founder of Annandale, New Jersey-based NAB Research LLC. The government is trying "to quell the downward spiral that we’ve seen in some of these stocks to get the whole situation stabilized." By analyzing the health of the 19 largest U.S. banks, including Citigroup Inc., the recipient of $45 billion of federal money, regulators assume that the economy will shrink as much as 3.3 percent this year, followed by growth of 0.5 percent in 2010, and that unemployment will rise as high as 8.9 percent and 10.3 percent, respectively. That may not be pessimistic enough to truly test the banks, analysts and economists said.
Rather than checking the ability of banks to withstand losses, the tests outlined yesterday are designed to convince investors that the firms don’t need to be nationalized, said analysts including Bush and Richard Bove from Rochdale Securities. The 24-company KBW Bank Index has plunged 43 percent this year on concern the government may have to take over some of the largest financial firms, wiping out shareholders. "I’ve always thought that this stress-testing was a politically motivated approach to try to defuse the argument that the banks didn’t have enough capital," said Bove, in an interview from Lutz, Florida. "They’re trying to prove that the banks are well-funded."
Citigroup may be first in line for an infusion. The Wall Street Journal reported last night that an announcement may come as soon as today to boost the government’s stake in the Citigroup, the nation’s largest bank, to as much as 40 percent. The Journal cited unidentified people familiar with the matter. Citigroup spokesmen have declined to comment on more potential help from the government. The government’s plans don’t include nationalization, Federal Deposit Insurance Corp. Chairman Sheila Bair said last night. "That’s not the route we’re pursuing now," Bair told reporters last night after speaking at a dinner in New York, echoing remarks made earlier this week by Federal Reserve Chairman Ben Bernanke. "I think the markets need to calm down."
The most adverse jobless numbers in the government projections are in line with the most pessimistic analysts in surveys of economists conducted by Bloomberg. The Treasury is giving itself six weeks to complete the assessment. The rise in unemployment and drop in housing prices could be more dramatic than the worst-case expectations of the government, said Barry Eichengreen, professor of economics and political science at the University of California at Berkeley. "My hope had been that when they did a real stress test it would be the equivalent of turning up the treadmill beyond a trot," Eichengreen said in an interview. "There are now lots of people who accept the possibility that unemployment in 2010 could be in double digits. If we’re serious about doing a stress test we should be looking at 11 percent rather than 10 percent."
President Barack Obama’s administration is likely to seek more funds from Congress to buttress the Treasury’s $700 billion financial-bailout fund. The cash may be needed for more capital injections and for financing new efforts to thaw credit markets. The White House will today release budget projections that may include an outline of costs for stabilizing the financial system, White House press secretary Robert Gibbs signaled yesterday. The Treasury said it has until the end of April to identify how much extra capital is needed to protect banks with more than $100 billion in assets from losses on loans, securities and off- balance sheet commitments.
Regulators will test how well the banks can hold up in a "baseline scenario" with a 2 percent slide in the economy this year and unemployment at 8.4 percent, in addition to a "more adverse" situation. The test also assumes housing-price declines of 14 percent this year and 4 percent in 2010 as a baseline case. The more adverse possibility would see drops of 22 percent and 7 percent, respectively. Following the test, lenders will have six months to raise private capital or accept government funds in the form of convertible preferred securities, which would acquire voting rights if converted to stock. The Treasury has used about half the $700 billion allocated by Congress for rescuing the banking industry, and most of that was spent under former President George W. Bush.
Last month, Bush’s successor inherited an unemployment rate of 7.6 percent, the highest in 17 years, and an economy that shrank 3.8 percent in the fourth quarter, the most since 1982. Economists, on average, expect unemployment to reach 8.8 percent by the end of this year, with the economy contracting 2 percent in 2009, according to Bloomberg surveys. Given the surge in unemployment, the government isn’t testing for "an absolutely worst-case scenario," said Michael Feroli, an economist at JPMorgan Chase & Co. in New York, who used to work at the Federal Reserve.
Treasury Unveils New Bank Bailout Program — the CAP
The Treasury Department announced Wednesday afternoon a new Capital Assistance Program, which will include "stress tests" for some banks and is designed to shore up balance sheets of some of the country’s biggest financial institutions. Treasury plans to conduct stress tests on 19 major financial institutions that have received money from the Troubled Asset Relief Program and have assets in excess of $100 billion to see whether they need help from the CAP. Banks with assets of less than $100 billion are also able to obtain CAP capital, Treasury said. The firms that would receive the stress test include JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, State Street, Bank of New York Mellon, U.S. Bankcorp, Suntrust Banks, Capital One Financial, PNC, Regions Financial, BB&T, Fifth Third Bancorp, KeyCorp, MetLife, Goldman Sachs, Morgan Stanley, GMAC, American Express.
CAP is intended "to restore confidence throughout the financial system that the nation’s largest banking institutions have a sufficient capital cushion against larger-than-expected future losses," Treasury said in its press release. CAP capital will be provided in the form of preferred securities with a 9% dividend yield that are convertible to common equity at a 10% discount to the "price prevailing" prior to Feb. 9. They will be convertible "at the issuer’s option," subject to regulatory approval, and will automatically convert into common equity after seven years if not redeemed or converted before then. Banks can request capital from CAP in addition to existing preferred stock from another bailout program, and can apply to convert that existing preferred stock into CAP instruments instead.
Banks that receive CAP capital must comply with the executive-compensation provisions outline by Treasury for other bailout programs, must submit plans for how they intend to use the capital to strengthen lending capacity, and will have to comply with restrictions on common stock dividends, share repurchases and cash acquisitions. Treasury said taxpayers will be able to monitor the performance of banks that get money under CAP at the Web site FinancialStability.gov. The announcement comes with the backdrop of concerns about bank nationalization. Last week, Senate Banking Committee Chairman Chris Dodd (D-Conn.) said banks may need to be nationalized, sending shares of firms such as Citigroup and Bank of America plummeting. But the Obama Administration has generally played down such rumors -- and Fed Chairman Ben Bernanke on Tuesday, in his testimony to the Senate Banking Committee, spoke strongly against nationalization.
U.S. Sets a Six-Month Deadline for New Bank Capital
The government set a six-month deadline for the biggest 19 U.S. banks to raise any new capital deemed necessary after a mandatory review of their balance sheets. The regulators will oversee the so-called stress tests by the end of April, which will identify how much extra cushion each bank will need, the Treasury said today in Washington. Lenders will have six months to raise private capital or accept government funds and the conditions that come with it. "While the vast majority of U.S. banking organizations have capital in excess of the amounts required to be considered well capitalized, the uncertain economic environment has eroded confidence in the amount and quality of capital held by some," the Treasury said, announcing guidelines for new bank reviews.
Any new government money will come in the form of convertible preferred securities, which would acquire voting rights if converted into common stock. U.S. officials, speaking to reporters after the announcement, said there would be no limit on how much money the program could provide banks, raising questions about whether the Obama administration will need to ask Congress for more bailout funds. The banks themselves will analyze system-wide losses under two economic scenarios, along with forecasts for internal resources to absorb the losses. Supervisors will discuss the results with the companies and determine whether an additional capital buffer is needed, according to the Treasury.
Federal Reserve Chairman Ben S. Bernanke said today that not all of the 19 banks will likely need new injections of government funds. The Treasury has used about half the $700 billion allocated by Congress for the banking rescue, and most of that was spent under former President George W. Bush. Banks receiving the new money would be pressed to show how they will lend more, officials said. In their assessments, regulators will incorporate off- balance-sheet commitments, earnings projections, risks of the banks’ business activities and the composition and quality of their capital, the Treasury said.
"We wanted to bring a more consistent, more conservative, more forward-looking approach so that we help this cloud of uncertainty that’s hanging over our financial system that’s getting in the way of credit flowing again," Treasury Secretary Timothy Geithner said in an interview today with public television’s "The News Hour With Jim Lehrer." Geithner also said nationalization is "the wrong strategy for the country and I don’t think it’s the necessary strategy." Losses will be projected under two sets of projections. Under the "baseline," the U.S. economy will shrink 2 percent this year and expand 2.1 percent in 2010. The "alternative more adverse" set of projections has gross domestic product dropping by 3.3 percent this year, with a 0.5 percent expansion in 2010.
Any capital investments made by the Treasury will be placed in a separate trust to manage the government’s investments in financial companies. If it acquires voting rights, the Treasury said it would release guidelines on how it will handle the situation before completing any transactions. The shares would convert either at a bank’s request or at the end of a seven-year period. "U.S. government ownership is not an objective" of the program, the Treasury said. In cases of significant federal investment, "our goal will be to keep the period of government ownership as temporary as possible." While the biggest 19 banks will be required to undergo the stress tests and get more capital, smaller banks can also apply to participate in the Treasury initiative, known as the Capital Assistance Program.
Bernanke said today that while the U.S. government may take "substantial" stakes in Citigroup Inc. and other banks, it doesn’t plan a full-scale nationalization that wipes out stockholders. Nationalization is when the government "seizes" a company, "zeroes out the shareholders and begins to manage and run the bank, and we don’t plan anything like that," Bernanke told lawmakers in Washington. Today’s statement didn’t specify any potential limit on the amount of money involved. President Barack Obama late yesterday signaled that the administration will seek more money from Congress for the effort to break the back of the credit crisis.
RBS Posts Biggest Loss in U.K. Corporate History
Reporting the biggest annual loss in British corporate history, the Royal Bank of Scotland on Thursday became the first bank to sign up to the British government’s asset protection plan, designed to repair the economy and revive lending by helping banks to set aside illiquid assets. The bank, which is up to 70 percent owned by the British government, said it would insure assets worth 325 billion pounds, or $462 billion, with the government as it creates a separate division. In exchange, the bank will pay a fee of 6.5 billion pounds, or $9.23 billion, in preference shares to the government and commit to increase lending. Lloyds Banking Group and Barclays might also join the scheme.
Under the agreement, which is similar to a so-called bad bank, R.B.S. would bear the first loss on the insured assets of up to 19.5 billion pounds, or $27.69 billion. Any loss after that would be borne 90 percent by the taxpayer and 10 percent by R.B.S., the bank said in a statement. The Treasury will also buy 13 billion pounds, or $18.46 billion, of the preference shares. R.B.S. plans to run off or dispose the assets in the next three to five years. "This is the right way forward but it needs to be seen whether it’s large enough and how long it will take to implement," Howard Wheeldon, senior strategist at BGC Partners, said, referring to the asset protection plan.
R.B.S posted a net loss of 24.1 billion pounds, or $34.2 billion — 61 pence a share, or U.S. cents 86.6 for last year, mainly attributable to its ill-timed purchase of the Dutch bank ABN Amro. The bank had a profit of 7.3 billion pounds, or 75.7 pence a share, a year earlier. The loss was smaller than analysts expected, but stunned many Britons as a record-setting benchmark of corporate disaster. Many people registered bewilderment, too, that the former chief executive of the bank, Sir Fred Goodwin, was drawing a pension of 650,000 pounds a year — $923,000 — _ despite the bank’s collapse into partial government ownership.
Stephen Hester, R.B.S.’s chief executive, is cutting jobs and the scaling back operations abroad to return the bank to profitability and repay the British taxpayer. "We are charting a path to stand-alone strength and with it the goal of justifying the support of the U.K. government and all our shareholders," he said Thursday. The asset insurance plan is the latest attempt by the British government to revive lending without having to fully nationalize some banks, which continue to post record losses as the economy deteriorates. Under the plan, banks will be contractually bound to increase lending to cash-strapped companies and homebuyers. The government repeatedly said it wants to avoid full nationalization.
"The task for banks is to clean up their balance sheets and rebuild for the future," Alistair Darling, chancellor of the exchequer, wrote in The Financial Times on Wednesday. "We need to create the certainty that will enable the banks to lend to creditworthy people and businesses, which is essential if we are to see an economic recovery." Northern Rock, the mortgage lender that was fully nationalized a year ago, said earlier this month it will increase mortgage lending by up to 14 billion pounds, or $19.88 billion, over the next two years. British banks not only have to maintain lending but increase it to replace loans from American, Icelandic and other foreign banks that scaled down lending operations in Britain, the government said. But some analysts said nationalization might be unavoidable and the latest lending push can only have a limited affect on the British housing market because demand for mortgages is likely to remain low.
A tax payer rip-off of surprising boldness
by WIllem Buiter
The Treasury’s deal with RBS under the Asset Protection Scheme is even more disadvantageous to the tax payer than I had feared. The government will insure £325 bn of RBS toxic assets, with a first loss for RBS of only 6 percent (£19.5), and with RBS taking only 10 percent of any loss in excess of the first loss limit. The fee paid by RBS is just two percent of the amount insured (£ 6.5 bn), much lower than the market (and I) had anticipated, and it is paid in RBS B shares. This means that if and when RBS goes bust, an event that is not altogether unlikely, the cumulative value of the insurance fees already paid to the government will be zero. The government also agreed to to inject up to £25.5bn of additional capital into RBS. Of this, £13 bn has already been subscribed by the Treasury as preference shares. The Treasury is also committed to buy aan additional £6bn worth of (non-voting) B shares. For reasons that are hard to fathom, the Treasury has decided to cap its holding of RBS voting stock at 75 percent (it currently stands at 70 percent).
RBS reported the largest-ever British corporate loss for the year 2008, with an annual net loss of £8.13 bn before goodwill write-offs and a total net loss of £24.1 bn. I have used the Monty Python parrot sketch before in this blog, so I will not drag it out again, but there is no doubt that RBS is a dead bank. It isn’t even a dead bank walking any longer - more a dead bank stumbling and fumbling around. The government should stop playing ostrich, extract its head from the sand, observe that RBS is no longer viable and either nationalise it or make it the first bank to enjoy the rigours of the Special Resolution Regime for banks created earlier this month in the new Banking Act. Through the SRR it could even implement the ‘good bank’ solution for RBS. The penny hasn’t dropped yet for Lloyds, but that cannot be long in coming. The government should act courageously and decisively and put the non-viable banks out of their misery, in the process saving the tax payer some misery.
RBS taps UK Treasury for £25.5bn
Royal Bank of Scotland, already nearly 70 per cent state-owned, revealed on Thursday that the government has agreed to inject up to £25.5bn of additional capital into the beleaguered bank as it reported a record annual loss for a UK company. The bank said the Treasury had subscribed to £13bn of new preference shares as part of the UK government’s asset protection scheme at a price of 50p a RBS share. But as RBS reported an annual loss for 2008 of £8.13bn before goodwill write-offs, it revealed the Treasury had also committed to buying a further £6bn of B-shares at the option of RBS. These shares will attract dividends but only have voting rights in certain circumstances. RBS also said that it would pay a fee of £6.5bn, funded through the issue of B-shares, to cover the "first loss" of up to £19.5bn as part of the government’s asset guarantee scheme. As part of the scheme RBS has agreed waiver some UK tax allowances. In a deal agreed in the early hours of Thursday morning, the bank is putting £325bn of its assets into the scheme. Further losses would be split between the Treasury, taking 90 per cent, and RBS taking the remaining 10 per cent. Under the deal, which requires shareholder approval, the government’s voting stake would be capped at 75 per cent, but its economic interest could rise "significantly" above that, said new chief executive Stephen Hester.
Mr Hester, who took over from Sir Fred Goodwin in the autumn, said participation in the scheme would help assist the bank to reduce risk for shareholders and provide for increased lending to UK customers. The share issue would be dilutive to ordinary shareholders, but Mr Hester insisted it represented capital on terms that would not be available from private markets and would count towards the group’s core capital. "In all scenarios this is cheap insurance and the right thing for us to do," Mr Hester said of the government’s asset protection scheme. "But that is quite different from saying it is a shareholder bonanza – it is not." Rival Lloyds Banking Group – which is 43 per cent state-owned – confirmed on Thursday that it was in talks with the Treasury overtaking part in the scheme. "These discussions are ongoing and no terms have been agreed," it said. There can be no certainty that Lloyds’ participation would be on the same terms as those announced by RBS.’’ RBS promised to increase lending to UK homeowners and businesses by £25bn over the next 12 months, of which £9bn would be mortgage lending. It also agreed to lend a further £25bn the following year. These loans would be made on "arm’s-length" pricing and credit criteria.
Details of the fresh capital raising came as RBS reported pre-tax losses for 2008 on a statutory basis were £40.7bn. The net loss was £24.1bn, the biggest in UK corporate history. Goodwill write-offs were £16.2bn, due in large part due to its disastrous bid for Dutch lender ABN Amro. Shares in RBS jumped 21.2 per cent to 28p in lunchtime London trading. Alex Potter, banking analyst at Collins Stewart, said the bank was in effect conducting a £19.5bn rights issue, but at a price well above the stock market level, through the issue of shares to the government. However, Mr Potter said that while the asset protection scheme was larger and cheaper than had been expected, the bank’s asset quality trends were "appalling" and the recession was beginning to hit earnings. He predicted RBS would only break even this year, after further impairment charges, and there was "little chance of a dividend before 2012". Speaking of the possibility of future losses on insured assets, Mr Hester said: "All of us have our eyes open but we can’t foresee the future. I don’t think any of us have any ability to ascribe a sensible probability of where the loss will occur, or at what pace." The announcement of the results comes amid a growing political row over a £16m pension pot awarded to Sir Fred Goodwin, the former chief executive of RBS.
The pension, which was agreed with RBS’s board and approved by the government, allows Sir Fred to draw a £650,000 a year pension with immediate effect. The figure – double the amount previously reported – undermines the government’s claims that executives of failed banks would not be rewarded when they left. Under a strategic review led by Mr Hester, RBS plans to shrink its global banking and markets division, which was expanded under Sir Fred’s leadership, by taking out 45 per cent of the capital employed there. It aims to cut £2.5bn from its cost base and centre its business on the UK, and pledged to "drive major changes to management , processes and culture." Mr Hester said the move could involve 20,000 job cuts but no definitive figure had been set. The strategic plan would take three to five years to execute, he added. "We are not building on sand here," Mr Hester said. "We are building on rock. What we need to do is sweep away the sand that is covering that rock." Sir Philip Hampton, the newly-arrived chairman, said the bank had been through "an exceptionally difficult period" but he was "confident that we can, must and will restore RBS to standalone financial strength." The bank also announced the appointment of Nathan Bostock, chief financial officer of Abbey National, part of Santander bank, to be head of restructuring and risk. Gordon Pell, head of RBS’ regional markets division, is to be deputy chief executive.
RBS Insures $462 billion of Assets in UK Plan, Puts $700 Billion Worth in 'Bad Bank'
Royal Bank of Scotland Group Plc will put 325 billion pounds ($462 billion) of investments into a state insurance program and shift toxic assets to a new unit after posting the biggest loss in British history. Edinburgh-based RBS, the largest bank controlled by the U.K. government, plans to transfer 540 billion pounds of assets, including derivatives and loans on commercial and residential property, to the new division, mirroring the so-called bad bank created by Citigroup Inc. last month. RBS and Lloyds Banking Group Plc rose more than 25 percent in London trading as the government provided a bigger guarantee than analysts had estimated. Prime Minister Gordon Brown’s government agreed to insure the distressed assets of British banks to boost capital, spur lending and jumpstart the economy, which is facing its worst recession since the 1980s.
"It draws a line under the problems of what we know is a very weakened business," said Julian Chillingworth, chief investment officer at London-based Rathbone Brothers Plc, which manages $21 billion, including shares of RBS and Lloyds. "The asset protection scheme is more generous to the banking sector than was previously thought." In return for the insurance, RBS will pay a fee of 6.5 billion pounds over seven years in the form of preference shares. It will also increase lending to U.K. homeowners and businesses by 50 billion pounds over the next two years, the company said in a statement. The Treasury will buy 13 billion pounds of RBS preference shares, which pay 7 percent interest, and may purchase an additional 6 billion pounds worth at the bank’s discretion.
Lloyds is in talks with the Treasury about participating in the insurance program. No terms have been agreed and there is no certainty Lloyds will receive the same terms as RBS, the London- based lender said in a statement. "We’re going to rebuild confidence and provide certainty to enable banks to maintain and extend lending," Chancellor Alistair Darling said in an interview today. RBS rose 26 percent to 29 pence in London trading, with Lloyds gaining 31 percent to 75 pence. Barclays Plc advanced 7 percent to 113 pence. Shares of RBS have declined 41 percent this year, compared with a 24 percent drop in the five-member FTSE 350 Banks Index, amid concerns the bank may be fully nationalized. In the past month two analysts rated the stock a "buy," eight a "hold" and three a "sell," according to data compiled by Bloomberg.
The government currently owns 58 percent of RBS. The state’s stake in voting shares may rise to 75 percent and the "economic interest" may jump to as much as 95 percent, Chief Executive Officer Stephen Hester said on a conference call with reporters. RBS has already written down the value of the insured assets by 7.1 percent to 302 billion pounds. It will be responsible for the first 19.5 billion pounds of losses on that total, plus 10 percent of any additional drop. The Treasury will cover the rest, according to the statement. The highest-rated bonds secured against corporate loans are currently worth 20 to 25 percent less than their face value on the secondary market, according to Deutsche Bank AG prices. Top- rated commercial property-backed bonds trade for as much as 40 percent less than face value, and top-rated bonds secured against prime U.K. mortgages are trading at a 7 percent discount. RBS didn’t say what credit ratings the insured assets had.
The prices of shops, offices and warehouses in the U.K. are 37 percent lower than their mid-2007 peak, according to the Investment Property Databank Ltd. The government may be left liable for losses of more than 20 billion pounds as RBS places its most toxic assets in the program, said Sandy Chen, an analyst at Panmure Gordon & Co. in London who has a "sell" rating on the stock. It "raises the question of whether or not the Treasury is fully aware of the potential losses that it (read: we taxpayers) might have to bear," Chen said in a note to shareholders. RBS’s new "non-core" division will hold 240 billion pounds of third-party assets, 145 billion pounds of derivative balances and 155 billion pounds of "risky assets" the bank will wind down or sell over three to five years, the lender said. The bank will "significantly" reduce its presence in or withdraw from 36 of the 54 countries in which it operates. Risky assets will fall by 144 billion pounds, RBS said.
RBS will reduce costs by 2.5 billion pounds and remove 45 percent of capital deployed in its global banking and markets securities unit, the bank said in a statement. Job loses of 20,000 are "not irresponsible speculation," Hester said. "The asset protection scheme will give us a measure of stability in a hostile economic environment," he said. "The key building blocks for RBS’s recovery are in place. That doesn’t mean we will recover." RBS reported a net loss of 24.1 billion pounds, or 61 pence a share, compared with a profit of 7.3 billion pounds, or 75.7 pence, in the year-earlier period. The loss is the biggest ever reported by a U.K. company, surpassing the 22 billion pounds Vodafone Group Plc posted in 2006. The median estimate of eight analysts surveyed by Bloomberg News was 25.9 billion pounds.
Citigroup announced plans last month to split in two after the New York-based bank reported a record 2008 loss of $18.7 billion. CEO Vikram Pandit, undoing the legacy of former chief Sanford "Sandy" Weill, created Citicorp to house the company’s global bank; and Citi Holdings, for "non-core" assets, including $301 billion of mortgages, bonds, corporate loans and other assets that the U.S. government agreed to guarantee. Hester is selling international assets to focus on U.K. lending after the bank was damaged by acquisitions, including former Chief Executive Officer Fred Goodwin’s 14.3 billion-euro ($19 billion) takeover of ABN Amro Holding NV’s investment- banking assets in 2007. Goodwin was ousted in October after the government agreed to provide RBS with 20 billion pounds and take control the bank. Yesterday, the bank said it had sought legal advice on Goodwin’s 650,000-pound annual pension. "RBS is taking further legal advice in respect of certain aspects of Sir Fred Goodwin’s contractual arrangements," and continues to discuss the position with the U.K. Financial Investments Ltd., the agency that holds the government’s bank stakes, RBS spokesman Neil Moorhouse said.
US new home sales plunge 10.2% to record low
Supply of unsold homes rises to record-high 13.3 months
Despite a record drop in prices, sales of new homes fell 10.2% in January to a record-low seasonally adjusted annual rate of 309,000, the Commerce Department estimated Thursday. Sales were down 48.2% compared with a year earlier, the government reported, an indication that the downturn in the housing market was still accelerating as the recession headed into its second year. Sales were weaker than expected. Economists surveyed by MarketWatch were looking for a sales pace of about 320,000.
Builders cut their median sales prices by a record 9.9% in January compared with December in a bid to move unsold homes. Median sales prices are down 13.5% in the past year, the largest year-over-year decline in 38 years. The average sales price has fallen a record 17.6% in the past year. Builders are faced with intense competition from foreclosures and distressed sales of older homes. Buyers are faced with declining wealth and an uncertain labor market, offsetting lower mortgage rates that are improving affordability. Inventories of unsold homes fell by 3.1% to 342,000, the 13th consecutive decline. However, sales are falling even faster. The inventory at the end of January represented a record-high 13.3 month supply at the January sales pace. Nearly half the homes for sale have been completed.
The builders' overstock "will keep prices falling for the rest of this year at least," wrote Ian Shepherdson, chief domestic economist for High Frequency Economics. On Wednesday, the National Association of Realtors said sales of existing homes fell to a 12-year low in January. Government statisticians have low confidence in the monthly report, which is subject to large revisions and large sampling and other statistical errors. In most months, the government isn't sure whether sales rose or fell. The standard error in January, for instance, was plus or minus 15.4%. The government says it can take up to five months to establish a new trend in sales. Over the past five months, sales have been on a 374,000 annual pace, 42% slower than a year earlier.
In all of 2008, 483,000 homes were sold down, from 776,000 in 2007 and 1.05 million in 2006.
The release was the third economic report of the day that was weaker than expected. "It's getting uglier by the day," said Harm Bandholz, an economist for UniCredit Markets. In other reports, the Labor Department said initial jobless claims rose to a 27-year high of 667,000 while a record 5.1 million were collecting state unemployment checks. Also, the Commerce Department said orders for durable goods dropped 5.2% in January, a record sixth decline in a row as U.S. factories suffer from falling demand from consumers, businesses, and foreign markets.
Sales fell in three of four regions, led by a 28% decline in the West to a record low 59,000. Sales fell 6.5% in the South and fell 5.6% in the Midwest. Sales rose 12.5% in the Northeast, plus or minus 93%. Inventories fell 3.1% overall. Inventories of completed homes dropped 4%, inventories of homes under construction fell 5%, and inventories of homes yet to be started were flat. Completed homes represented 49% of all homes for sale, up from 40% a year ago.
U.S. Initial Jobless Claims Rose to 667,000 Last Week
First-time claims for U.S. unemployment benefits unexpectedly rose last week and total benefit rolls soared to a record high, a sign companies may keep shedding jobs as the recession worsens. First-time unemployment applications increased by 36,000 to 667,000, the highest since 1982, in the week that ended on Feb. 21 from a revised 631,000 the prior week, the Labor Department said today in Washington. The number of people staying on benefit rolls rose in the previous week by 114,000 to 5.112 million. Job losses are crippling the consumer spending that makes up about 70 percent of the economy, threatening to prolong what may be the worst recession in the postwar era.
President Barack Obama is counting on his $787 billion stimulus to help stop the slide by creating 3.5 million jobs, and on a separate plan to keep Americans struggling with mortgage costs from losing their homes. "The labor market weakness has not found a bottom," said Rudy Narvas, a senior economist at 4Cast Inc. in New York. "The payrolls report for February could be really bad." February payroll figures, due from Labor next week, may show job cuts exceeded half a million for a fourth consecutive month, according to a Bloomberg survey. The unemployment rate probably climbed to 7.9 percent, the highest level since 1984.
Already, the 3.6 million jobs lost since the U.S. recession began in December 2007 mark the biggest employment slump of any economic contraction in the postwar period. Another report today showed orders for U.S. durable goods fell for a record sixth consecutive month in January. The 5.2 percent drop was more than twice as large as projected and followed a 4.6 percent drop the prior month, the Commerce Department said in Washington. Comparable data began in 1992. Excluding transportation equipment, orders fell 2.5 percent. First-time jobless claims were estimated to have fallen to 625,000 from the 627,000 initially reported for the prior week, according to the median projection of 40 economists in a Bloomberg News survey. Estimates ranged from 600,000 to 700,000.
The four-week moving average of initial claims, a less volatile measure, rose to 639,000 from 620,000, today’s report showed. The number of people staying on benefit rolls rose more than expected. The unemployment rate among people eligible for benefits, which tends to track the jobless rate, increased to 3.8 percent, the highest since 1983, from 3.7 percent in the week ended Feb. 14. Six states and territories reported an increase in new claims for that same period, while 47 reported a decrease. Initial jobless claims reflect weekly firings and tend to rise as job growth, measured by the monthly non-farm payrolls report, slows.
Plummeting sales are prompting more firms to trim expenses. Group 1 Automotive Inc., the owner of 100 U.S. and U.K. car dealerships, reported a fourth-quarter loss and said it cut 1,450 jobs, reduced pay for employees, and suspended its dividend. "We got started early and were aggressive on cost cutting," Chief Executive Officer Earl Hesterberg said in an interview on Feb. 19. Others that announced job cuts in the past two weeks ranged from women’s clothing retailer Christopher & Banks Corp. to Brady Corp., a maker of identification cards, and Tokyo-based automaker Nissan Motor Co., which reported it would trim its U.S. planning team that creates cars and trucks for North America.
IMF sees 16 countries pushed into default
The International Monetary Fund says the financial crisis could push as many as 16 nations into default, and that it will need to double its lending capacity to mount an appropriate response. In a 31-page report released today in Washington, the fund argues that it will need the equivalent of about $500-billion (U.S.) to prop up governments that have been crushed by the collapse of the global economy. The report specifically noted that there's a high likelihood that more nations in Eastern Europe will come to the IMF for help.
"The institution's global membership, as well as its capacity to catalyze broader sources of financing, further reinforce the importance of it maintaining a central role in the provision of balance of payments support," the report said. "To play this role credibly, however, the fund must have resources commensurate to the magnitude of the problems at issue." The report serves as intellectual backing for the fund's managing director, Dominique Strauss-Kahn, who began pushing the world's richer countries for additional financial support earlier this month.
Japan was the first to respond, pledging an additional $100-billion to the IMF at a meeting of Group of Seven finance ministers and central bank governors in Rome on Feb. 14. The G7 as a group said they supported giving the IMF greater resources, but stopped short of endorsing an amount. Today's report advocates that the national governments that control the fund give Mr. Strauss-Kahn the authority to raise money by issuing bonds, suggesting the politics of getting countries to follow Japan's lead could take too long.
Ex-Bundesbank Chief Says Default Small Euro Nation Possible
Former Bundesbank President Karl Otto Poehl said smaller members of the euro region are more likely to default on their debt obligations and would probably be rescued by Germany or the International Monetary Fund. "The first will certainly be a small country, so that can be managed by the bigger countries or the IMF," he said in an interview with Sky News. "I think there are countries in Europe which are considering the possibility to leave the eurozone. But this is practically not possible. It would be very expensive." Poehl’s comments are the latest to suggest Germany’s economic establishment has become more willing to help rescue fellow members of the euro region facing bankruptcy. That marks a reversal from years in which German policy makers argued the Maastricht Treaty forbid bailouts and reflects growing concern that a default in one country would spark a region-wide crisis.
A deepening recession and bank bailouts are straining the budgets of some countries, sending bond spreads to records and prompting speculation among some investors that individual nations could leave. The spread between Italian and German bond yields today widened to the largest since 1997. The spreads on Irish, Portuguese and Greek bonds are close to the widest since before they adopted the euro, which was created a decade ago. Finance Minister Peer Steinbrueck heralded the shift in German thinking when he said last week that some euro nations are "getting into difficulties" and that Europe’s biggest economy would show its "ability to act."
Poehl, 79, said the high cost of leaving the euro region may help ensure its survival. He also said that one country’s departure doesn’t necessarily mean the bloc as a whole would crumble. "In the case that a country would leave the eurozone, the foreign exchange rate would go down significantly -- 50 or 60 percent," said Poehl, Bundesbank president between 1980 and 1991. "Interest rates would go sky high as the markets would lose confidence in the system" and "in the countries that can’t maintain their membership." European Central Bank President Jean-Claude Trichet last week tried to ease concerns about the euro region’s fiscal health, saying Feb. 20 there is no "weak link" in the bloc. "I consider that speaking of any particular country as a weak link in the euro area is an error of judgment," he said. Trichet said today in Dublin Ireland’s economy faces "severe challenges."
Not all German experts would back a bailout. Former ECB Chief Economist Otmar Issing told Frankfurt Allgemeine Zeitung last week that saving a profligate member would be "catastrophic" and undermine the monetary union framework. Current ECB Executive Board member Juergen Stark calls the no- bailout rule an "important pillar on which the European Union was founded." Former International Monetary Fund Chief Economist Kenneth Rogoff today predicted the default risk may rise once central banks start to raise borrowing costs from record lows. "Interest rates will rise in two to three years and countries like Italy may face rates of 11 percent again -- will they be able to pay?" he said in a speech near Reykjavik today. "I can well imagine that if we don’t have a large sovereign default, we will see some large sovereigns on the brink of it."
AIG's Uphill Battle
When sputtering insurance giant AIG next announces earnings, analysts expect more financial losses and further government intervention. American International Group (AIG) is starting to try a lot of people's patience. On Sept. 16, when the New York Federal Reserve gave the listing insurer its first emergency loan of $85 billion, it was the biggest government bailout in history. The size of the rescue was shocking, as was the speed with which it had become necessary. That was just the beginning. AIG has since gotten a total of $150 billion in government aid of one sort or another. And now analysts expect that when the company announces its next set of earnings, expected by Mar. 2, there will be tens of billions more in writedowns, financial losses, and further government intervention.
"AIG currently is just too big to fail," explains Sean Eagan, a founder of Eagan Jones Ratings, a credit and research firm. Recent trends will make it harder for AIG to repay the government. Employees are leaving and customers are fed up. Asset sales that were supposed to be the basis of repayment are slow and may be postponed further. And the company itself has few illusions about what an uphill road it confronts. "Those are all risks," says Nicholas Ashooh, an AIG senior vice-president. "Though we have five years to repay the government, no one wants to wait that long." Even some in the government are losing patience. On Jan. 30, Representative Spencer Bachus (R-Ala.), the ranking member on the House Financial Services Committee, and Representative Paul Kanjorski (D-Pa.), the chairman of the subcommittee on capital markets, insurance, & government sponsored enterprises, sent a letter to the U.S. Government Accountability Office seeking an investigation into the federal rescue package and its impact on the insurance market.
Among the things the representatives are looking for: a determination of whether the rescue package has "resulted in measurable progress." Employees seem to be voting no. A steady stream of AIG underwriters have handed in their resignations in the past few months, particularly bad news in a business built on relationships. The most high-profile departure: longtime executive Kevin Kelley, who had been running AIG's profitable Lexington Insurance reinsurance businesses. He left in December to become chief executive of Bermuda-based property insurer Ironshore. But he's just the tip of the iceberg, says insurance recruiter Gary Jacobson. With unemployment in the insurance industry at just 3.5%—and even lower levels for underwriters—there's plenty of opportunity for AIG staff to jump. "I think [AIG is] going to have a very difficult time executing [its] strategy because of the talent drain," says Jacobson.
Reports cropping up in the past two days that AIG may have a loss of as much as $60 billion this quarter have left customers tired of the bad surprises from the company, too. "In the last 48 hours, I think clients have lost their patience on the topic," says Neil Krauter, whose insurance brokerage, Krauter & Co., does business with AIG. "A lot of buyers said originally, 'Let's try to help them, be good partners.' I think that patience has really gone away." The government's bailout of AIG has taken a number of different forms. First is a five-year, interest-bearing $60 billion line of credit, of which AIG has currently drawn $36 billion, in return for which the government holds an 80% stake in the company. The government also used $40 billion of TARP money to buy preferred stock in AIG that earns a 10% dividend. The New York Federal Reserve Bank has also set up two limited partnerships called Maiden Lane II and Maiden Lane III that have taken on more than $100 billion in asset-backed securities once on the company's books. Even so, as of its most recent quarterly filing with the Securities & Exchange Commission last fall, AIG and its financial products business had $107.8 billion of commercial and residential mortgage-backed securities and collateralized debt obligations on the books. It also had a sizable securities lending business. Problems with this type of lending have contributed to AIG's financial pressures.
A big writedown of some of those assets could very well force the rating agencies to reconsider AIG's credit ratings, triggering more collateral calls and financial problems for the company. "That's too large to ignore if you're Standard & Poor's or Moody's," says Ernst Csiszar, insurance industry director for Bridge Strategy Group. "It's a real mess." From the beginning, AIG has argued that its core insurance businesses are healthy and just need to be broken off from their bad investments in order to thrive. But with employees and customers heading for the exits, that's now looking a lot less certain. And the money that was supposed to repay the government from other asset sales? That's not materializing, either. Though AIG has been actively trying to divest businesses to raise money to repay the government, with the help of restructuring advisers at Blackstone Capital and investment bankers, the company has completed only a handful of smaller deals to date. Selling off its Thai credit-card business, life insurance operations in Canada, a stake in a Brazilian financial firm, and Hartford Steam Boiler have raised a total of just $2.8 billion at this point. Ashooh blames AIG's slow asset sales on severe weakness in the broader economy.
The bigger businesses on the block—particularly the company's life insurance business and its Asian operations—have yet to attract an acceptable offer. Bids for the Asian business, AIA, are still expected, says David Monfried, an AIG spokesman. However, "if we don't get full and fair market value for the properties, we simply won't sell them at this time," Monfried says. "This is the worst possible environment in which to be selling these fine businesses." AIG received at least one offer for its life insurance business that was less than half the asking price, according to a person familiar with the bid. AIG, says Monfried, is in daily contact with the Federal Reserve, and the bank "understands the environment in which we're operating." But some in Washington have criticized the bailout as prolonging the time it takes AIG to sell off assets. "Private capital will wait on the sideline until the government comes up with some cohesive plan with an exit," says one critic. Unfortunately, that exit seems to be getting further away.
Why Is AIG Backing Fannie / Freddie 'Enhanced' Mortgages?
Bernanke laid it on the line today. I heard him say that the Fed and Treasury were going to provide debt and equity capital to many of the Nation's banks. Failure to do so was not an option. He pledged that the Risky Lending Standards of the past would be eliminated. He promised to ‘fix’ the errors that had been made by the misguided bankers. It sure sounded good. The market even liked it. It is bunk. The following is an example of how Lending Standards are set in DC. You decide. Are these good lending standards? Is this good business practice? The following is happening on a very regular basis. The numbers are big.
Fannie Mae (FNM) and Freddie Mac (FRE) have always had terms for a Conforming mortgage. A Conforming mortgage requires 20% equity from the buyer. That makes for a good borrower. That is a ‘good’ lending standard. Many years ago the Agencies and the insurance industry created a carve-out to the Conforming mortgage definition. If an 'approved’ insurance company was willing to take a first loss on the loan portion that was in excess of 80% then the Agencies would buy the mortgages. No more 20% down. This practice morphed. It started with 10% equity, 10% mortgage insurance. It ended with –3% equity, 23% insurance. These are terrible lending standards. The borrowers have no risk. Fannie Mae and Freddie Mac bought as much of this "enhanced" paper that they could. The yields were great and how could they lose if the likes of AIG were going to guarantee the first loss?
This of course ended very badly. The insurers got crushed. It is not clear what their claims-paying abilities are any longer. Fannie and Freddie are big losers on the enhanced book of business as well. The losses on the enhanced mortgages far exceeded the 10–20% that was insured. The only ones who made out were the regional banks that originated and sold the risky loans to the Agencies. FNM recently reported that its default rate on enhanced loans was five times larger than on loans that had the traditional 20% down. Bad lending standards make for bad loans. These questionable standards are 'business as usual' today at Fannie and Freddie. They continue to buy pools of mortgages where the required equity of a borrower has been replaced with an insurance company's promise to pay. The incredible part is that one of those "approved’ insurers continues to be AIG.
Twenty-two percent of Fannie's 08 business was enhanced. AIG was one of the biggest providers of the PMI coverage. AIG owes its existence to the taxpayers. Yet they are writing first loss insurance on high risk mortgages. With this questionable promise to pay attached, the loans can be sold to another ward of the state, FNM. These are terrible lending standards and it is bad business practice. The taxpayers are at risk to both sides of this transaction. If history is a guide 'we' will ultimately suffer losses from both AIG and FNM on this business. The PMI/AIG/FNM connection is understood by Geithner. Lockhart and Bernanke. They are aware of the entire PMI time bomb within the Agencies. That they are allowing this to continue today does not evoke much confidence in Bernanke’s claim to end the Reckless Lending Standards of the past.
AIG Rescue May Include Credit-Default Swap Backstop
American International Group Inc. may get a backstop from the U.S. to protect against further losses on credit-default swaps, according to a person familiar with the matter. The federal guarantees may be included in New York-based AIG’s restructured bailout, which the company plans to disclose next week with fourth-quarter results, according to the person, who declined to be identified because the talks are private. Regulators who saved AIG in September feared that a collapse of the insurer, which sold swaps to banks including Goldman Sachs Group Inc., would spread losses throughout the global financial system. In November the U.S. committed $30 billion to retire some of the contracts tied to subprime mortgages, while not addressing other swaps tied to corporate loans and European debt.
"Counterparties around the world continue to have significant exposure to AIG, and market conditions continue to be fragile and sensitive to the potential disorderly failure of AIG," the Federal Reserve said in a report in November. AIG provided protection on more than $300 billion of assets through credit derivatives as of Sept. 30. Credit-default swaps pay the buyer face value on their debt holdings in exchange for the underlying securities if the borrower fails to meet its obligations. It wasn’t immediately clear how many of the swaps would be backed by the U.S., and talks are continuing, the person said. AIG has posted four straight quarterly losses on swaps tied to U.S. home loans. Michelle Smith, a spokesman for the Federal Reserve, declined to comment as did the Treasury’s Isaac Baker and Joseph Norton of AIG.
U.S. Thrifts Post Record $13.4 Billion Loss in 2008
U.S. savings and loans reported a record $13.4 billion loss last year as they set aside more funds for loan losses amid the recession and worsening financial crisis, the industry’s regulator said today. Thrifts lost $3 billion in the fourth quarter, down from $4.4 billion in the preceding three months, the Office of Thrift Supervision, the regulator of savings and loans, said today in a report on the industry’s health. "What started out to be a housing problem with a fairly limited sector of the housing market has expanded to the broader economy and affected virtually all businesses and most financial institutions," OTS Director John Reich, who is leaving the agency tomorrow, said today at a news briefing in Washington.
OTS-regulated lenders Downey Financial Corp. and PFF Bank and Trust, both based in California, were seized in the fourth quarter as home prices plunged and foreclosures soared in the worst housing crisis since the Great Depression. Five lenders regulated by OTS failed last year, including IndyMac Bancorp Inc. and Washington Mutual Inc., the biggest U.S. bank collapse. The OTS and three other regulators yesterday began conducting so-called stress tests to analyze the health of the 19 largest U.S. banks to determine how much additional capital they need to withstand losses. The stress tests are part of President Barack Obama’s plan to fortify financial institutions.
Problem thrifts increased to 26 from 23 at the end of the third quarter, the agency said without identifying companies on the list. The number of problem thrifts was the largest since 29 reported in the first quarter of 1997. Regulators typically require a lender with that designation to raise capital and improve earnings and liquidity. "Two-thirds of our institutions are still profitable," Reich said. The Federal Deposit Insurance Corp. will release its fourth- quarter report for the U.S. bank industry later today. The number of banks on the FDIC’s "problem" list will increase from the 171 reported in the third quarter, Bair said in an interview yesterday after speaking at a dinner in New York.
"It will not be an alarming number, but it’s clearly going up," Bair said. "It was a tough quarter. Banks are cleaning up their balance sheets." OTS-regulated lenders added a record $38.7 billion in provisions for loan losses last year and $8.7 billion in the fourth quarter, the agency said today. The OTS is expanding its regulatory efforts by creating a division to monitor and review the largest 25 thrifts with over $10 billion in assets, Reich said. The agency also is setting up new standards for reviewing and approving enforcement actions, he said. The OTS, an agency of the Treasury, supervised 810 thrifts, including Hudson City Savings Bank and Sovereign Bank, that had a combined $1.2 trillion in assets at the end of the fourth quarter.
The government’s planned overhaul of U.S. financial regulation is putting the agency’s future in doubt amid suggestions it was a light-touch regulator. Former Treasury Secretary Henry Paulson in March proposed eliminating the agency and merging its functions into the Office of the Comptroller of the Currency, the regulator of national banks. Reich, a Republican who is serving a five-year term that would have ended in August 2010, told OTS employees on Feb. 12 that he will resign as director effective tomorrow. Scott Polakoff, the agency’s chief operating officer, will become acting director until Obama, a Democrat, names a permanent successor
GM posts $9.6B 4Q loss, burns through $6.2B cash
General Motors Corp. posted a $9.6 billion fourth-quarter loss and said it burned through $6.2 billion of cash in the last three months of 2008 as it fought the worst U.S. auto sales climate since 1982 and sought government loans to keep the century-old company running. The biggest U.S. automaker said Thursday it lost $30.9 billion for the full year and expects an opinion from its auditors as to whether the company remains a "going concern" when its annual report is issued in March. That means the auditors will determine whether there is substantial doubt about the automaker's ability to continue operations.
Chief Financial Officer Ray Young said the determination will depend a lot on whether GM gets further government loans and whether it can accomplish its restructuring goals. The company has received $13.4 billion in federal loans since Dec. 31 and says it needs up to $30 billion to stay out of bankruptcy. Top GM executives were in Washington, D.C., Thursday to meet with the Obama administration's auto task force to talk about restructuring and additional loans. "2008 was an extremely difficult year for the U.S. and global auto markets, especially the second half," Chairman and CEO Rick Wagoner said in a statement. "These conditions created a very challenging environment for GM and other automakers and led us to take further aggressive and difficult measures to restructure our business."
GM reported a net loss of $15.71 per share for the fourth quarter, compared with a loss of $722 million, or $1.28 per share in the year-ago period. Quarterly revenue fell 39 percent to $30.8 billion from $46.8 billion, as credit availability froze across the globe, and a lack of consumer confidence and fears of job losses kept people from buying vehicles. Excluding special items, GM's fourth-quarter adjusted loss was $5.9 billion, or $9.65 per share. That was worse than Wall Street expected. Analysts surveyed by Thomson Reuters predicted a quarterly loss of $7.40 per share on sales of $35.1 billion. For the full year, the loss was $53.32 per share, the second-worst annual result in the company's history. The worst loss occurred in 2007, when GM lost $38.7 billion, or $68.45 per share, in 2007, due largely to charges for unused tax credits. GM shares fell 22 cents, or 8.6 percent, to $2.33 in premarket activity.
The flight of the long run
The "long run" used to be one of the most popular topics among investors, particularly institutional investors. In recent months, discussion of the long run has disappeared from view. Indeed, the possibility the long run has run away is one of the few pieces of good news I have been able to find in the financial and economic turmoil of recent months. The cold statistics have hardly been encouraging for the traditional view. On a total return basis, the Ibbotson data show that the S&P 500 has underperformed long-term Treasury bonds for the last five-year, 10-year, and 25-year periods, and by substantial amounts. These data are not to be taken lightly.
If the long-run expected return on bonds in the future were higher than the expected return on equities, the capitalist system would grind to a halt, because the reward system would be completely out of whack with the risks involved. After all, from the end of 1949 to the end of 2000, the S&P 500 provided a total annual return of 13.1 per cent, while long Treasuries could grind out only 5.8 per cent a year. But does this history really tell us anything about what lies ahead? Neither the awesome historical track record of equities nor the theoretical case is a promise of a realised equity risk premium. John Maynard Keynes, in an immortal observation about the future, expressed the matter in simple but obvious terms: "We simply do not know."
Relying on the long run for investment decisions is essentially relying on trend lines. But how certain can we be that trends are destiny? Trends bend. Trends break. Today, in fact, we have no idea where any trend lines might begin or end, or even whether any trend lines still exist. As Lord Keynes in one of his best known (and wisest) observations, reminded us: "The long run is a misleading guide to current affairs. Economists set themselves too easy, too useless a task if in the tempestuous seasons they only tell us that when the storm is past the ocean will be flat." To Lord Keynes, the tempestuous seas are the norm. We cannot escape the short run.
There is an even deeper reason to reject the long run as a guide to future investment policy. The long-run results we can discern in the data of stock market history are not a random set of numbers: each event was the result of a preceding event rather than an independent observation. This is a statement of the highest importance. Any starting conditions we select in the historical data cannot replicate the starting conditions at any other moment because the preceding events in the two cases are never identical. There is no predestined rate of return. There is only an expected return that may not be realised. Recent experience raises a different but perhaps an even more serious question relating to the long run. How do you frame a view of the long run from early 2009? The world has a ruptured financial system showing only fragile signs of recovery. The economic recession now encompasses the whole world. The speed of economic decline is without precedent.
Government intervention is also without precedent, in its magnitude, depth, and complexity. Fiscal deficits are reaching numbers no one dreamed about even 12 months ago, yet they will have to be financed. What kind of a long run is this mess going to produce? Was Bill Gross correct when he wrote for the December 2008 issue of Pimco’s Investment Outlook that "capitalism is and will remain a going concern, that risk-taking – over the long run – will be rewarded, but only from a starting price that correctly anticipates the economy’s growth and its share of after-tax corporate profits within it?" Can capitalism remain "a going concern" after an extended period characterised by massive government intervention into the economy – and bail-outs of firms that would otherwise have failed? To what extent will the "going" in Mr Gross’s vision be tied to government intervention in these forms and magnitude? Or is Mr Gross’s optimism justified? Will we be able to unwind the role of government in the capitalist system as we know it and go back to the status quo ante?
Will our economy and society emerge so risk-averse after these experiences that years will have to pass before we return to a system naturally generating vibrant economic growth and a renewed willingness to both borrow and lend? Or will we head in the opposite direction, where faith in ultimate bail-outs will justify the wildest kind of risk-taking? Or will the entire structure collapse from government debts and deficits that turn out to be so unmanageable that chaos is the ultimate result?
We can neither answer those questions nor can we claim they are a complete list of the possibilities. The unknown today seems more than usually unknown. Then my whole point remains the same. The long run is an impenetrable mystery. It always has been.
California’s Newly Poor Push Social Services Network to Brink
In California’s Contra Costa County, 40,000 families are applying for just 350 affordable-housing vouchers. Church-operated pantries are running out of food. Crisis calls have more than doubled in the city of Antioch, where the Family Stress Center occupies the site of a former bank.
The worst financial crisis in seven decades is forcing thousands of previously middle-income workers to seek social services, overwhelming local agencies, clinics and nonprofits. Each month 16,000 people, including many who were making $60,000 to $100,000 annually just a few years ago, fill four county offices requesting financial, medical or food assistance.
"Unless we do things differently, not only will we continue to be on life support, but the power to the machine is going to die," said county Supervisor Federal Glover, who represents Antioch and the cities of Pittsburg and Oakley about 50 miles (80.5 kilometers) east of San Francisco. Contra Costa, an East Bay suburban region of more than 1 million, turned thousands of farmland acres into housing in the past two decades, becoming an affordable alternative to San Francisco. Now, the area is being hit by a double whammy, as rising unemployment increases demand for social services, while plunging home values shrink tax revenue and squeeze agency budgets.
County officials made $90 million in cuts during the current fiscal year, and plan to reduce another $56 million, out of a $1.2 billion general-fund budget, in the coming year. County administrator David Twa said he doesn’t expect to see a "gradual recovery" in property taxes until 2012 or 2013. The social safety net is being stretched "all over the country," said Jacqueline Byers, research director for the National Association of Counties in Washington. "The formerly middle class who lost jobs, homes, or both suddenly are requesting assistance for the first time." Nationwide, demand for food stamps, one of the first benefits that new applicants for services qualify for, has mushroomed since the recession began in December 2007. About 31.1 million people received food stamps in November, an increase of 13 percent from the end of 2007, according to the U.S. Agriculture Department, which administers the program.
A record 4.99 million Americans were collecting unemployment benefits in the week ended Feb. 7. The jobless rate in Contra Costa, currently at 9.3 percent compared with a U.S. rate of 7.6 percent, is likely to reach as high as 12 percent, Twa said. Among local employers that have cut jobs or forced workers to take unpaid leave are USS-Posco Industries, a joint venture of U.S. Steel Corp. and Posco of South Korea, and newspaper publisher MediaNews Group Inc. "We are in a critical situation and it’s not likely to get better over the next several years," Twa said. Lines snake out the door of Contra Costa County’s employment and human services office in Antioch. At the Richmond office, the applicants’ stories of foreclosures and repossessed cars are "weighing" on staffers, who are offered therapy, said division manager Renee Giometti.
"People are physically going through a slow death," said Karen Stewart, an area real-estate agent who earned about $80,000 a year just three years ago and is now down to her last $700. "You don’t have any support and the support systems that were in place before aren’t in place anymore." Recently separated, Stewart, 45, said she has been without a steady income since 2006 and is living on a county-issued food- debit card. The five-bedroom house in Brentwood she and her husband had purchased for $500,000 went into foreclosure in January. She said she hasn’t ruled out moving into her Lexus sedan and sending her 12-year-old son to live with a relative on the East Coast.
Shelley Bowen, a 35-year-old stay-at-home mom from Antioch, said she and her husband Jason are "teetering on the edge," as they face slowing sales of his art work and a $2,500 monthly mortgage that will go up by $1,000 in April. Even though Jason makes $90,000 to $95,000 a year as an oil painter and instructor, "we’re kind of holding our breath, hoping nothing else happens," Bowen said. If necessary, the couple would turn to family and friends, then church-welfare services and government assistance, she said. "It’s a combination of a housing crisis and unemployment crisis like we’ve never seen before," said Antioch realtor Kay Trail, a former city-planning commissioner. "Instead of being a bedroom community where people could live a certain lifestyle for an affordable price, now there’s quiet dread."
The county’s median house price has plummeted 53 percent to $220,000 from $463,000 in a year, according to MDA Dataquick in San Diego. In the fourth quarter, 3,135 notices of default representing the first stage of foreclosure were filed against county homeowners, the firm said. That’s more than 10 times the number in San Francisco. In Antioch’s old-town district, the Peacock Expressions art gallery, More to Love clothing store, and Rivertown Cafe are gone, replaced by empty storefronts. About five miles away, signs reading "bank-owned home" are scattered throughout neighborhoods. Single-family properties built by KB Home are offered for less than $300,000. At the County East Mall, TJX Cos.’ Marshalls and Gottschalks Inc. stores were almost empty.
The county’s Housing Authority has a five-year wait for affordable-housing vouchers, said executive director Joseph Villarreal. Requests for homeless assistance statewide were up 26 percent in September over a year earlier, according to the California State Association of Counties in Sacramento. "There’s always a level of desperation" in applicants, Villarreal said. "But the degree and depth of it now I’ve never seen: I’m not used to getting calls from clients saying they’ll kill themselves if they don’t get on the wait list." California’s 58 counties are $1 billion short of the amount needed to administer social-service programs in the current fiscal year that ends in June, said Paul McIntosh, executive director of the statewide group of counties. The local-government crisis was aggravated by state Controller John Chiang’s move earlier this month to start delaying almost $270 million in payments to counties for social services.
Neither the California legislature’s new budget package approved on Feb. 19 nor President Barack Obama’s $787 billion federal stimulus plan signed into law two days earlier will be enough to completely or immediately help counties, said McIntosh and Glover. Counties will still fall short of what they need even if Chiang releases previously withheld funds, they said. "Contra Costa is near the front of the pack" among counties with the deepest financial woes, McIntosh said. "But the pack is tightly bunched and all headed in the same direction: off a cliff."
Ilargi: Note: the Caisse de Dépot holds "only" $13 billion in ABCP, so it's lost $27 billion on other gambling activities. Journalism in Canada remains at a questionable level. Today brings all sorts of rosy stories about revenues in the banks, but how real that is is very hard to say. An example: the Caisse reports a 22% writedown of real estate mark-to-market values. What are the banks who wrote the loans writing down?
No.1 Canada pension fund loses $40 billion, 25% of assets
They were chasing alpha; now they are eating crow. Caisse de dépôt et placement du Québec, Canada's largest pension fund, reported a record loss of $39.8-billion as of Dec. 31, 2008. As a result, total assets under allocation fell to $120.1-billion from $155.4-billion in 2007. The balance was made up for $4.6-billion in new deposits. The 25% haircut in total assets, which represents the biggest loss ever reported by a Canadian pension fund, has raised concerns about the security of Quebec pensioners. It also has people in the financial sector calling for a re-evaluation of risk models adopted by the Canadian institutions.
"It's clearly a staggering loss in absolute dollars," says Tawfik Hammoud, partner and managing director of The Boston Consulting Group in Toronto. "The government should mandate a bottom up review of their asset model, risk strategy and organization" he says. He adds: They also need a strong full-time CEO who can develop a credible path to recovery and deal with the various stakeholders." With its risk strategy under attack, it seems certain that the Caisse will take a more conservative approach in the future. Already, Quebec's Finance Minister has announced an overhaul of the organization, and has requested a National Assembly committee hold special hearings to examine the issue of losses.
All asset classes -- with the exception of the best government securities - recorded steep losses at the pension plan. In addition to a significant writedown due to hedging its foreign exchange risk on assets outside the country, the Caisse took a huge financial blow investing in asset-backed commercial paper (ABCP). The Caisse was forced to write down 43% ($5.6-billion) of its $12.8-billion investment in the toxic paper. In a statement to the press, Fernand Perreault, president and chief executive of the Caisse, did a mea culpa: "The risk management policy had not set overall limits on the amount of AAA-rated money market instruments that could be held. In hindsight, we placed too much confidence in these securities."
Speaking to the issue of the Caisse's ABCP loss, Finance Minister Jim Flaherty was quick to point out that had the government not come to the rescue, the losses "would have been much worse." But for pension watchers like Keith Ambachtsheer, director of the Rotman International Centre for Pension Management at the Rotman School of Management, the losses only speak to poor oversight. "These institutions need to do their own due diligence," he said. "Just because the agencies rate them as AAA doesn't mean they are," he says. Not all the Caisse's $40-billion losses were real. While the pension plan realized losses on the sale of its investments of $23.2-billion, over 56% of its losses were unrealized decreases in value, otherwise known as paper losses.
While the real estate portfolio generated more net rental income in 2008 than the previous year, the fund estimated that the mark-to-market value of real estate declined 22%. So far the Caisse's losses stand in dramatic relief to losses at the other pension funds and calls into question the performance of the managers. The Caisse had a benchmark portfolio of a 18.5% loss, but posted a 25% loss. That's 650 points below its benchmark and a shortfall that is considered disastrous by pension fund managers. By contrast, Ontario Municipal Employees Retirement System (OMERS) declared a negative 15.3% return for 2008 compared with a benchmark of negative 13.2% which represents 210 basis points below benchmark.
Despite Wednesday's bad news, "the Caisse continues to have a strong liquidity position and they still have a massive amount of capital," said Huston Loke, co-president of DBRS Ltd. While the rating agency looks at how funds do in relation to their peers, Mr. Loke likes the fact that the Caisse appears to be recalibrating its risk models and focussing on assets that "are more understood." The Caisse announced it has suspended its "asset allocation operations" a risky portfolio (although non-transparent portfolio) that contributed to $2-billion in losses last year. At the end of the day, pension insiders don't think the province is going to throw the Caisse out with the bathwater. "The province is so proud of the Caisse," said one analyst. "They put them through the ringer in front of the General Assembly, but at the end of the day they will simply ask them to strengthen internal controls and make some changes," he said.
Canadian taxpayers face double pension peril
By the time Canada's public sector pension plans have finished reporting results for last year, they will be sitting in a sea of red ink, experts say. And because those pensions are typically guaranteed by the government, taxpayers will likely find themselves on the hook for much of the cost of fixing the damage.
The loss tally for last year "could easily exceed $100-billion," said Malcolm Hamilton, a principal at Mercer Human Resources. Wednesday The Caisse de dépôt et placement du Québec posted a $40-billion loss for 2008, the worst ever performance for any public sector pension plan in Canada, which was blamed on a currency hedging program that went wrong and a disastrous investment in asset-backed commercial paper.
Observers say that unless the markets stage a miraculous recovery taxpayers will end up facing a double whammy, because not only will they be forced to deal with declines in their own retirement plans ?- which mostly means RRSP savings - they must now put money into the retirement plans of public servants. "That's the irony of the system," said Mr. Hamilton. On Monday OMERS, which manages pensions for Ontario municipal employees, reported a loss of 15.3% or $8-billion for 2008. The Public Sector Pension Investment Board with more than $30-billion under management has yet to come forward but observers predict big losses there too. "These are big, scary numbers and it's going to create a crisis," said Kevin Gaudet, federal director of the Canadian Taxpayers Federation.
Mr. Gaudet predicted that governments across Canada will seek to raise taxes to deal with the wave of unprecedented losses at public sector pensions. But that might prove difficult, he warned, given that so many Canadians are already reeling from collapsing house prices and losses in their RRSPs. Since their peak last summer, stock markets in Canada, the U.S. and Europe have lost about half their value. "These are lavish plans where people can contribute for 25 years and draw an income for 35 years, all indexed to inflation," he said. Fewer than 40% of Canadians are part of employer-sponsored retirement plans, according to a recent report by the CD Howe Institute. The remainder are dependent on their own savings and the Canada Pension Plan.
The royalty of the pension world are those with so-called defined benefit plans - most common in the public sector. In years when the economy was doing well, most of these plans were able to rely on investment returns to meet their obligations. Players such as the Caisse de dépôt, the Ontario Teachers Pension Plan and OMERS moved into the markets aggressively, placing huge bets in hopes of a big payoff. But amid the financial turmoil, many of those bets have gone wrong and the plans are now facing staggering shortfalls. The plan managers are left with few options. They can hope that markets improve so the losses can be make back, which is considered unlikely for some time. In some cases they can ask plan members to increase contributions. But the easiest solution from the managers' perspective is to go to government, cap in hand.
Recently the Alberta government provided a top-up of several billion dollars for a public school teachers pension plan after it lost money, well in excess of the amount it was required to put in under the contract. "It was the easiest way for the government because they just wanted labour peace," said Mr. Gaudet. The government was concerned not only about possible labour action by the teachers but also about maintaining the appeal of working as a teacher at a time when many industries were experiencing worker shortages. Such behaviour is often the preferred route for governments because taxpayers rarely find out the truth, observers said. "We don't exactly have a transparent system when it comes to public sector pensions," Mr. Hamilton said.
One of the biggest concerns is figuring out the true level of actual losses. In recent years many big plans moved billions of dollars aggressively into credit derivatives, real estate and other private markets. Some of those markets have stopped trading, forcing investors to estimate the value of their assets. But often those estimates prove over-optimistic, said Mr. Hamilton. Give the current environment it may be some time before the level of real losses is known. It will likely take even longer before those numbers are made public. Experts say that this lack of transparency makes it almost impossible for taxpayers to find out the true cost of the public sector pension plans they pay for
Ilargi: Buiter gives a long but very good description of the consequences of the various ways of dealing with toxic assets.
Insuring toxic assets: throwing good tax payers’ money after bad private money
by Willem Buiter
The UK government has offered, under its asset protection scheme (APS), to guarantee (or insure) up to £600 bn worth of toxic assets held by British banks- up to £300 bn for RBS and up to £250 -£300 bn for the Lloyds Banking Group. Barclays may be waiting in the wings. The APS insures the banks (that is, their CEOs, shareholders, junior and senior unsecured creditors other than retail depositors - already covered by deposit guarantees up to £50.000 - and staff) against losses on these toxic assets over and above a certain deductible or ‘first loss’ for the bank. There is ample precedent for this kind of guarantee scheme. In the US, the Fed, the FDIC and the US Treasury have guaranteed a large chunk ($300 bn) of toxic assets of CItigroup. In the Netherlands, the Dutch state insured a portfolio of $39 bn (face value) worth of securitised US Alt-A mortgages held by ING.
Like its American and Dutch counterparts, this toxic asset insurance scheme is without redeeming social value: it is inefficient, unfair and expensive to the tax payer. Apart from that it is great. There also are superior alternatives available: full nationalisation and, best of breed, the ‘good bank’ solution. The proposed UK insurance scheme is in design rather like the Dutch guarantee for ING’s toxic assets. The Dutch assistance took the form of a back-up guarantee facility for ING, under which the state shares with ING any gains and losses on this portfolio relative to a benchmark value for the portfolio of $35.1 bn. The shares of the state and ING in any gains/losses relative to this benchmark are 80% and 20% respectively. Ignoring the sharing of the gains (the possibility that the portfolio will turn out to be worth more than $35.1 bn is remote), this amounts to a 10 percent or $3.9 bn first loss tranche for ING, with the state taking 80 percent of the losses in excess of $3.9 bn, and ING 20 percent. There is therefore 20 percent private co-insurance.
People familiar with the market believe the portfolio to be worth no more than 65 cents on the dollar, so a ten percent first loss seems generous to ING, and not really balanced by the 80 percent share of the state in the upside. So to determine how good a deal for the tax payer the UK government’s APS is, the magnitude of the first loss and of the subsequent co-insurance shares of the banks are key. In the Dutch case, the bank pays a guarantee fee to the state and the state pays ING a management and funding fee. Incredibly, with ING the combination management and funding fee exceed the guarantee fee, so the state is paying ING for the privilige of providing the bank with a guarantee. Since ING continues to own the assets (the same holds for the APS) and would have had to manage and fund them in any case, the payment by the state of a management and funding fee to ING is ludicrous. Again, Parliament in the UK has to scrutinise very carefully the magnitude of the guarantee fee paid by the British banks to the Treasury and the size of any other fee income (if any) going the other way. The 3-6 percent fee size rumoured by the Press would, cet. par. be a reasonable start, as long as there or no offsetting management and funding fees going towards the banks.
The upside for the tax payer in the UK comes through the payment of the guarantee fee in the form of convertible preference shares or warrants. This does indeed provided ex-ante upside, but also ex-ante downside. Only if the common stock of the banks is fundamentally undervalued when the preference shares are converted or the warrants exercised, will there be any real shareholder upside. ING is also to provide 25 bn euro of additional credit to Dutch businesses and Dutch households; there will be no bonuses for 2009 and until a new remuneration policy is adopted, and the CEO was told to leave. It is unclear whether the British scheme will have further bonus-bashing features, human sacrifices and forced lending attached to it. The new economic nationalism and financial protectionism that are inevitably associated with the bailing out of banks with tax payers’ money will no doubt be part of the UK plan for the banks as well: when the British tax payer bails you out, it isn’t politically acceptable to increase lending to households and enterprises in Zanzibar. Of course, the enforceability of even the most solemn pledge to increase lending is dubious.
Why guarantees rather than outright purchases by the state of toxic assets? A toxic asset is an asset whose fair value is highly uncertain. Its current market value, if a market price can be found at all, is likely to understate its fair value because the markets these assets used to be traded in have become illiquid and may have dried up completely. The hold-to-maturity value of a toxic asset, obtained by discounting its (risky) expected future cash flow using a discount rate that abstracts from illiquidity premia, is a highly subjective concept. The toxic assets may eventually turn out to be good assets (future sale price close to fair value or held-to-maturity value close to notional or face value) or bad assets (future sale price or held-to-maturity value well below face value). The banks argue that their toxic assets are bound to turn out to be good assets. "Well they would, wouldn’t they", if I may paraphrase that well-known appraiser of illiquid complex structured products, Mandy Rice-Davies. With the earlier destruction of asset values through the implosion of a brace of asset price bubbles and credit bubbles followed by a vicious downturn in the real economy that will feed back negatively on what’s left of the value of mortgages, credit card receivables, student loans, car loans and regular corporate lending, there is a strong likelihood that most toxic assets will turn out to be bad assets once the veil of uncertainty is lifted.
Instead of RBS and Lloyds retaining ownership of the toxic assets and the government providing insurance against losses, the state could have purchased the toxic assets outright from the banks. From an economic point of view, the two approaches are equivalent: there exists a price at which the government acquires a toxic asset outright that is equivalent to insuring the asset againts losses for a given first loss tranche for the banks (before the insurance would kick in) - likely to be less than 10 percent -, a given co-insurance share for the banks (the share of the additional losses beyond the first-loss tranche borne by the banks) - likely to be 10 percent -, a given net insurance premium, somewhere between three and six percent, and a given duration of the insurance. You need to be able to value and price the asset if you are willing to insure it.
But from a public sector accounting and government accountability point of view, transparency-dodging and accountability-avoiding governments much prefer insurance or guarantees to outright purchases. The reason is that insurance is off-balance sheet. It is a contingent liability, which is not entered at its fair value on the liability side of the government balance sheet under the uninformative government accounting practices followed in the UK and most other countries. It ought to be, if we take an informed, comprehensive approach to valuing all the government’s assets and liabilities, even the contingent one. I have been advocating such a comprehensive balance sheet approach for more than 25 years. Only in a few enlightened countries like New Zealand do we find governments that subject themselves to something approximating comprehensive asset, liability and net worth accounting. But in most of the world, including the US, the UK and the Netherlands, contingent liabilities don’t count towards public sector debt.
In a rational world (or even in a world that is merely not terminally stupid and/or bent on escaping accountability), the fair value of the contingent liability represented by the government’s insurance scheme would be entered as a liability on the comprehensive public sector balance sheet. The fair value of the future cash flow of the insurance or guarantee premia would be entered on the asset side. Should the government instead purchase the toxic assets outright and borrow funds to make the purchase, the government debt thus incurred would, both under real-world UK and US-style accounting and under economically sensible, comprehensive accounting methods à la New Zealand, add to the liabilities of the government. The fair value of the toxic assets would be on the asset side of the government’s comprehensive balance sheet.
If reason prevailed, the excess of the fair value of the contingent insurance liability over the fair value of the future insurance premia under the insurance scheme would be the same as the excess of the value of the public debt issued to finance the outright purchase of the toxic assets over the fair value of the toxic assets acquired by the government. Under current UK accounting conventions, the insurance scheme does not show any immediate increase in government liabilities, while the outright purchase scheme does. Under neither scheme would the assets be recorded as such in the government balance sheet. Guess which of the two schemes the UK, the US and the Dutch governments have chosen? You guessed right. With nothing showing up on the government balance sheet or in the government budget unless and until a loss materialises, the government does not, given the general economic illiteracy of its interlocutors in Parliament, the media and the public at large, have to subject itself to up-front accountability for the contingent exposure it has incurred.
Why should the government guarantee/insure or purchase the toxic assets at all? All the toxic assets insured by the government are already existing assets. They are the result of investment decisions made in the past. One of the oldest insights in economics is that bygones are bygones. You cannot undo past mistakes. We may not know yet the magnitude of the losses that have been incurred on the underlying assets (how bad the toxic assets will turn out to be), but there is little if anything the banks or anyone else can do, other than sensible macroeconomic management (monetary, credit and fiscal policy) to affect the eventual magnitude of these losses. By insuring losses that have already been incurred (although we may not know their magnitude as yet), the government simply redistributes these existing losses from the shareholders, creditors, management and employees of the banks to the tax payers. This is both unfair - those who break something should own it - and inefficient: it encourages future reckless lending and investment by the banks, that is, it creates serious moral hazard. As I will argue below, it creates this moral hazard quite unnecesarily.
There are two efficiency arguments for this ex-post insurance of losses that have already been incurred - losses on stocks of existing assets. The first argument is that the overhang of a stock of toxic assets on the balance sheet of a bank discourages new lending by that bank. The toxic assets require considerable capital to be held against them, and perhaps additional liquidity as well; they increase the funding costs of the bank. Toxic assets on a bank’s balance sheet act as a tax on new lending. It is true that toxic assets will act as a tax on new lending by the bank that holds them. Insuring the toxic assets (or purchasing them from the bank using public money (or a combination of public and private money as proposed in the US) is, however, likely to represent an inefficient use of public money, because the terms of the insurance offered to the banks or the price offered to purchase their toxic assets outright, are likely to be far too generous. Knowing that the government is desperate for a deal, because the government knows the banks will fail without either the insurance scheme or the removal of the toxic assets from their balance sheets, the government invariable gets pushed into terms that imply a massive subsidy to the shareholders and unsecured creditors of the troubled banks.
The second potentially sound economic reason for the government intervening in the market for toxic assets is that these assets are systemically important, liquid under normal circumstances but temporarily illiquid as a result of pervasive uncertainty, fear and loathing. In that case the state can act as a market maker of last resort, engaging in a price discovery process, through reverse auctions and similar mechanisms, to restore the market for toxic assets more quickly to its desirable liquid state. This argument for government intervention applies, at most, only to outright purchases of toxic assets by the government or the government in combination with the private sector. It does not apply to the UK insurance scheme, even though it is equivalent from an economic perspective, because most of the market cannot back out an implied market price from an insurance contract. Even if the government were to purchase the toxic assets outright, I believe that this argument is not relevant for most existing toxic assets. Far from being normally useful and systemically important securities, they tend to be complex, opaque and indeed incomprehesible structured products that should never have been created. No wider social purpose is served by the state making market in these assets.
The good bank solution: more efficient, cheaper and fairer There is a much simpler solution. Leave the bad assets with the banks that own them now (Old RBS, say). Create a new bank (New RBS, say), capitalised with government money or, if possible, with a combination of government money and new private money. Take away its banking license from Old RBS. Transfer the deposits of Old RBS to New RBS. Let new RBS purchase any of the good assets of Old RBS it is interested in at market value or fair value. Apart from some financial assets, the good assets purchased by New RBS from Old RBS will include most of the UK commercial banking franchise (the physical and organisational infrastructure of UK high-street banking and corporate lending). New RBS would also hire most of the staff of the UK retail banking and corporate lending franchises of Old RBS. The good assets are, of course, by definition, easy to value. Old RBS would not be allowed to make new loans or investments. It would fund its existing asset portfolio of toxic and bad assets, plus the money received from the sale of the good assets to New RBS, plus the excess of the value of the sale of the good assets over the value of deposit liabilities transferred out of Old RBS. This excess could take the form of government securities or (if negative) a debt to the government.
All present and future government financial support would go towards the capitalisation of the new good banks and towardx guaranteeing new lending and new borrowing by these new good banks. The old legacy banks would not get another penny of new government support. Should they go bust, as would be quite likely, their existing shareholders would lose what is left of their investment (not much in any case). The unsecured creditors, junior and senior, might also lose some or all of their investment. Partial or complete conversion of their debt into equity would be a possible next step in the after-life of Old RBS. Old RBS would manage the existing assets either by selling them or by holding them to maturity. When the last asset is sold or matures, Old RBS would effectively cease to exist as an economic actor. It may be possible to use the Special Resolution Regime of the new Banking Act of 2009 to implement the ‘good bank’ solution. Under the SRR, the Triparite authorities can (according to the Bank of England’s website):
- transfer all or part of a bank to a private sector purchaser
- transfer all or part of a bank to a bridge bank – a subsidiary of the Bank of England – pending a future sale
- place a bank into temporary public ownership (the Treasury’s decision)
- apply to put a bank into the Bank Insolvency Procedure (BIP) which is designed to allow for rapid payments to Financial Services Compensation Scheme (FSCS) insured depositors
- apply for the use of the Bank Administration Procedure (BAP) to deal with a part of a bank that is not transferred and is instead put into administration
Only the first of these powers would be necessary to implement the ‘good bank’ solution.
Why it does not pay to be a little bit pregnantThe Treasury is surprisingly reluctant to bite the bullet and nationalise the dead banks walking in the UK. This includes at least RBS (already 70 percent publicly owned) and Lloyds (43 percent publicly owned). As regards the other UK high street banks, we are likely to find out before the end of the year how they stand up under the battering the are taking because of their emerging market exposures in South America and the Far East, and under the common strain of a deep and long slowdown in their markets in the overdeveloped world. Partial public ownership (or the threat of future partial or complete public ownership) provides the banks with powerful incentives to do everything except lending to the (risky) real economy. First and foremost, the leadership (CEO plus minions and non-government-appointed Board members) of these partially state-owned banks and banks under threat of state ownership and control want to get rid of the state ownership stake or prevent the state from acquiring an ownership state.
They have this incentive whenever state ownership is financially costly or imposes constraints on the management to act in its best interest: constraints on dividend pay-outs and share repurchases; caps on bonuses and on executive and board remuneration in general; pressures to lend beyond what the banks consider commercially desirable, which even if they are resisted, are a pain in the neck for bank executives who have to come up with new excuses in front of the Treasury Committee ("we are very sorry"), and who have to put up with public chastisement by the Chancellor and the Prime Minister . These state-ejecting or state-evading banks pursue their strategies by building up capital and boosting liquidity rather than lending to the real economy. This hoarding of capital and liquidity can be observed in the US and in the UK and whereever else the state has partial ownership of banks or threatens to achieve (partial ownership), and this partial ownership cramps the style of the banks’ management.
The halfway-house of partial state ownership with costly conditionality is the worst of all possible worlds. There are two alternatives. The first is the solution preferred by the US regulators and the US Treasury. It is to make government support for the banks as cheap as possible - financially and in all other ways. Populist outrage and blood-lust in the Congress have compelled the imposition of banker-bashing measures like bonus caps and other ceilings on bankers’ remuneration, but it is clear that no-one in the US administration or regulatory agencies cares about moral hazard - the incentives created by current actions for future excessive risk taking - and that massive redistribution is taking place from the tax payer to the banks’ executives, shareholders and unsecured creditors. The second alternative to partial nationalisation is full nationalisation. It would reduce the incentives not to engage in new lending. It is not as cheap (in terms public funds required) as creating good banks - i.e. the (partial) nationalisation of new lending. That is because full nationalisation would involve the purchase of the toxic assets as well as the good assets. But is is better than the limbo of partial public ownership, which is the worst of all possible worlds from the perspective of incentivising new lending.
Why does the inefficient and inequitable guarantee scheme prevail over the superior ‘good bank’ solution? Why do governments invariably prefer insuring toxic assets or even the ‘bad bank’ solution, where the government (possibly jointly with the private sector) purchases the toxic assets outright, to the ‘good bank’ solution? The reason is explained in a famous book straddling economics and political science, by Mancur Olson, The Logic of Collective Action: Public Goods and the Theory of Groups, first published in 1965. In the book, Olson develops a theory of concentrated benefits versus diffuse costs. In a democratic society, a limited number of economic agents, each with much to gain from a policy or regulation that is socially inefficient, will generally prevail over a much large number of opponents, each of whom may not stand to lose very much individually, even though the aggregate loss of the losers exceeds the aggregate gain of the winners.
The reputation of the banks and of some of the other highly leveraged financial institutions has taken quite a battering as a result of the financial crisis and economic slump. Despite this, the powers of persuasion, lobbying prowess and influence of the established banks and other financial institutions and of their representatives exceeds that of the millions of tax payers who stand to lose as a result of this bail-out, compared to the economically more efficient and fairer alternative offered by the ‘good bank’ solution. No-one speaks for the legions of tax payers with the same ‘voice’, eloquence and powers of persuasion that the City establishment can turn on when it makes its case in the corridors of power.
Report Calls for New EU Financial Oversight Bodies
A new report presented to the European Commission on Wednesday calls for two new bodies to boost financial oversight in the EU. Leaders are set to discuss the watchdog agencies next month. The European Union wants to get serious about both financial oversight and monitoring risks to the economy. A new report presented to the European Commission on Wednesday recommends the establishment of two new watchdog groups in an effort to prevent a repeat of the financial meltdown that has European Union economies reeling. The report was written by a group chaired by Jacques de Larosiere, former governor of the Bank of France, and commissioned by the EU back in October as the extent of the financial crisis was just beginning to become clear. "In essence, we have two alternatives," de Larosiere wrote in the report.
"The first "chacun pour soi" beggar-thy-neighbor solutions or the second, enhanced, pragmatic, sensible European cooperation for the benefit of all to preserve an open world economy." A number of high-level economists from across Europe joined de Larosiere in drafting the report. The document will be used as a basis for a European Union discussion on financial supervision scheduled for next month and could also inform Europe's negotiating position at the G-20 summit in London at the beginning of April. Running to 68 pages, the report is chock full of recommendations and ends with the warning: "Work must begin immediately." The report is careful to avoid proposing a single, all-powerful EU regulatory body -- an idea that many member states find unpalatable -- but does include some ideas that would require countries to delegate oversight powers to the EU. "A key lesson to be drawn from the crisis," the report says, "is the urgent need to upgrade macro-prudential supervision in the EU for all financial activities."
Central to the improvements proposed by the report are two bodies designed to improve both risk assessment and supervision. One of the new groups proposed is called the "European Systemic Risk Council" (ESRC), which would be chaired by the European Central Bank. The report calls for the group to work closely with central banks in EU countries to establish an appropriate response to risks identified. The second measure would be the establishment of a European System of Financial Supervision (ESFS) to coordinate the transfer of information and supervision throughout the 27-member bloc. "The group believes that the world's monetary authorities and its regulatory and supervisory financial authorities can and must do much better in the future to reduce the chances of events like these happening again," the report states.
Also on Wednesday, the European Commission warned Italy, Portugal and Luxembourg to control public spending as part of an annual review of member state finances. The Commission noted that Italy, which holds the highest public debt of any of the 16 countries belonging to Europe's common currency, the euro, needs to aggressively cut debt where it can. It recommended the reform of jobless benefits and warned that the costs to Italy of borrowing money on the bond markets was rising as a result of investor concern that the country could default. Officials say this remains unlikely. The report also urged Lithuania, which is not part of the euro zone, to cut public sector wages in order to remain on track to join the euro. "Correction of previously high wage growth is warranted," the report said.
Debt markets take fright at 'EU bond'
The capital markets have become increasingly uneasy over proposals to use the European Investment Bank as an all-purpose fireman to prop up weaker regions of the eurozone or come to the rescue of Eastern Europe. The borrowing cost on the EIB's 10-year bonds has risen to 90 basis points above the benchmark German Bunds. The yield is now closer to the borrowing costs of Spain and even Italy, suggesting that investors already suspect the bank will be used to issue "EU bonds" for rescue purposes – whatever its original mandate.
The EIB, the world's biggest multilateral lender, was able to borrow for years at rates that were almost the same as the German government – or even lower – enabling the entire EU to take advantage of the Germany's credit-rating for project finance. The change has been abrupt. The bank said this week that yields had been pushed up by the avalanche of sovereign bond supply as governments around the world tap investors for $3 trillion (£2.1 trillion) of fresh money. But EIB debt has been hit surprisingly hard. Among the plans rattling the bond markets is a proposal by Centre for European Policy Studies in Brussels to convert the EIB into a vast stability fund to shore up European banks and prevent the crisis in the ex-Soviet bloc from mushrooming out of control.
Daniel Gros, the group's director and an influential figure in EU circles, said EIB borrowing should be "massively" increased. "With a gearing of 4:1, the EIB could expand its loan portfolio up to €1 trillion (£890bn). It could triple its activities without any additional capital increase," he said. Michael Klawitter, a currency strategist at Dresdner Kleinwort in Frankfurt, said enthusiasts for such plans are up against the ever attentive bond vigilantes. "This idea is never going to fly. The yields on EIB bonds could rise above the average cost of borrowing for the member states," he said. This may in fact be happening.
The EIB is already a powerful – if little-known – arm of EU economic policy. Its mandate is to provide co-finance for projects that "further EU objectives". In the past this has meant anything from fish farms to airports and high-tech ventures. It uses its AAA credit rating to access cheap capital on the global bond markets, just like the World Bank. Much to the unease of its own officials in Luxembourg, the EIB is already being asked to take on an ever-greater role in Europe's rescue programmes. EU leaders agreed to beef up its capital by €67bn to €232bn in December. Lending is to rise by 30pc to over €60bn this year with extra spending on green vehicles – which some say is a disguised bail-out for the car industry – as well as energy projects and small businesses.
The Maastricht Treaty forbids any direct rescue of eurozone states by the European Central Bank. There is no treaty mechanism for the sort of "EU bond" proposed by Italy's finance minister Giulio Tremonti, but the EIB could take on the role quite easily with a tweak to its mandate and little creativity by EU lawyers. Phillipe Maystadt, the EIB's president, played down talk this week that the bank was being pushed into galloping mission-creep. "What we can do is provide finance as intensely and rapidly as possible for investment. That's what we're doing and we aim to do more, better and faster," he told Reuters. Marc Ostwald, a bond expert at Monument Securities, said the EIB has been a major casualty of state guarantees for bank debt. "There has been a massive repricing. Why buy EIB debt if you can get a government guarantee on the banks?" he said.
Fight the crisis with eurozone bond market
by Romano Prodi
Last Sunday in Berlin the governments of the most important European countries agreed to promote a new transparency in international financial markets. This is a very important decision to avoid future crises. It is also an urgent one, because a concrete plan of action must be defined in the next Group of 20 nations summit in London, at the beginning of April. This will not be an easy project, because those who have interests in tax havens will attempt to block the creation of a transparent regime for the enormous flows of international money. The recent tension between the US and Switzerland on bank secrecy is just one of the first signs of the likely conflicts that will be triggered when this difficult but needed project is fully implemented. This is why the European decision to act is not only appropriate, but shows courage and wisdom.
While it is crucial to look ahead and plan for future reforms, we also need to tackle the immediate crisis that threatens Europe. Indeed, in the past weeks individual countries, even in the eurozone, have been left alone in the defence of their economies and their banks during the financial storm. Irish, Greek and Portuguese Treasury bonds, and to a lesser extent Spanish and Italian ones, have shown widening yield spreads, especially compared with those of Germany. In addition, the economic difficulties and related weakness of many banks of the European Union states outside the eurozone are shaking the banking and financial system as a whole. In order to avoid European countries being forced to confront the crisis on their own and relying only on their own resources, we must provide the EU with a common defence system.
Here European solidarity should not just be seen as an abstract ethical value that we talk about, but it is the best tool to avoid the deepening of the crisis. In other words, a euro spent to defend the EU as a whole has much more value then a euro spent to defend one individual country. To that end, two decisions must now urgently be taken at the European level. The first concerns the EU budget, which is today lower than 1 per cent of the European gross domestic product. This budget should be increased to 1.25 per cent when the 2008-09 budget is revised, targeting and binding the extra 0.25 per cent to extraordinary interventions aimed to reduce the tensions in the EU countries. This measure will greatly help in stabilising European financial markets. The second decision concerns the issuance of European public debt notes in addition to, rather than as a substitute for, the Treasury bills of the member states. How to issue, control and use these notes should be the sole responsibility of the finance ministers of the eurozone, in strict agreement with the European Central Bank.
These two tools should be used by Europe to ensure it is proactive and does not end up the passive victim of the financial storms afflicting individual countries. Finally, we must remember that while the euro has become one of the reference and reserve currencies in the global market, there is not yet a specific European note to invest in. I am aware of the fact that these proposals may raise some concern in the governments of those countries that should carry the heaviest burden, such as Germany, where the issue has been deeply and strongly debated. I understand, too, that I am touching on one of the pillars of the euro’s foundations – the view that while the currency is common, the debts of the individual states must remain separate. However, we face such a critical moment that it is in the interest of everyone – Germany in particular – that Europe unites to face the common threat. The German finance minister, Peer Steinbrück, recently agreed that there is a need to step in, if there is a risk of default by one country. The best way to do this is being proactive by creating a market for eurobonds at the European level. Although these decisions are critical, there is also a need to offer Germany, and the other virtuous countries, credible guarantees about the use of these common financial sources. I do believe that a spirit of solidarity is not only an essential of the EU, but must be the foundation on which Europe builds to defeat the fear that is fuelling the global crisis.
Euro-Zone Outlook Darkens as Job Fears Hit Consumer Confidence
The outlook for the euro-zone economy continues to darken, with rising unemployment and falling bank lending undermining consumer confidence despite the declining inflation rate. The euro zone's annual rate of inflation slowed to 1.1% in January and early reports from members of the 16-country currency bloc indicate another slowdown in February. Lower energy prices are driving that process, and should underpin confidence by increasing disposable income. But workers are now more fearful of losing their jobs than at any time since the European Commission, the European Union's executive arm, started its monthly survey of sentiment in January 1985. The commission said Thursday that its headline measure of consumer confidence fell to a record low of -33 in February from -31 in January.
More confirmation of the scale of job losses came from France and Germany Thursday. Some 90,200 additional French workers lost their jobs in January, the largest monthly jump ever. "Undoubtedly, the situation on the French labor market has turned dramatically in recent months," said Maryse Pogodzinski, an economist at J.P. Morgan. "This development does not augur well for household consumption." The number of jobless workers rose less rapidly than expected in Germany, with 63,000 becoming unemployed in February. In Germany, companies that are in trouble can apply for reduced working hours and compensation. Federal Labor Minister Olaf Scholz in January launched a campaign in a bid to mitigate the impact of the financial crisis on the jobs market. While workers suffer cutbacks in their salaries, the government partially compensates them for the reduction.
Even with government help of that sort, job cuts are likely to continue as companies find it increasingly difficult to generate new business. In the commission's survey, the measure for new industrial orders fell to a record low of -57 in February from -49 in January, as did its measure for export orders. The commission's overall measure of confidence in industry fell to a record low of -36 from -33 in January. Given that gloomy outlook, it's not surprising that industrial companies plan to cut their payrolls, although not yet at the record pace seen in 1993, during Europe's last major recession. The commission's survey also found that confidence in the services, retail and construction sectors fell, and its overall Economic Sentiment Indicator dropped to 65.4 from 67.2. That was a record low, as were the national measures for Belgium, Germany, Italy, Cyprus, Malta, the Netherlands, Austria, Portugal, Slovenia and Slovakia.
The European Central Bank has indicated that it will cut its key interest rate to 1.5% from 2% when its governing council meets March 5. However, the continuing decline in confidence suggests it may have to do more to turn the economy around. "The ECB will almost certainly deliver the signaled ... interest rate cut next week and we still see rates eventually falling more or less to zero," said Jennifer McKeown, an economist at Capital Economics. The ECB's own figures released Thursday indicate that banks in the euro zone continued to cut lending to households in January, although by a much smaller amount than in December. But the central bank may take some encouragement from the fact that lending to companies increased by €30 billion ($38.14 billion) in January from December, having declined by €13 billion in the final month of 2008.
Meanwhile, in the U.K., the Nationwide Building Society said Thursday that house prices dropped by their sharpest annual rate on record in February, adding that the recession means it is too early to say whether they have bottomed out. The mortgage lender said prices were 18% lower than they were in February last year after dropping 17% in January, marking the biggest drop from a year earlier since it began collecting comparable data in 1991. Nationwide said interest rate cuts by the Bank of England hadn't affected housing market confidence sufficiently to boost sales or slow the pace of house-price declines. The latest Nationwide data reinforce our belief that house prices are likely to fall by a further 15% in 2009," Howard Archer, chief U.K. and European economist at IHS Global Insight, said in a note.
UK house prices fall record 18% for year
House prices tracked by Nationwide, the UK's largest building society, fell by 1.8 per cent in February, and 17.6 per cent since the same time last year, figures published this morning show. The mortgage lender said that the average cost of a UK home is now £147,746, and indicated that the UK housing market has still further to fall. The annual house price fall of 17.6 per cent – or £31,612 - is a record drop since the survey started in 1952. Compared with data reported by rival lender Halifax for January, showing that house prices rose by 1.9 per cent over the month, the Nationwide figures paint a gloomy picture for the short-term.
In recent weeks, there has been some evidence from estate agents and housebuilders that new buyer inquiries have picked up slightly as prices fall and interest rates are cut. This does not seem to have affected prices for the better. Fionnuala Earley, chief economist at Nationwide, said: "Sharp cuts in interest rates have helped affordability but have not yet affected housing market confidence sufficiently to boost the levels of new transaction activity or slow the pace of house price falls. "Early signs of increased interest in housing, as reported by the pick-up in new buyer inquiries, have yet to filter into sales but do suggest that falling prices and interest rates are raising curiosity now, which could flow through quickly once confidence returns."
Miss Earley added that buyers were likely to put off buying a property while they thought prices still had further to fall. Nationwide predicted that the Bank of England’s Monetary Policy Committee, which has already cut the base rate to 1 per cent, will reduce them again. Quantitative easing, under which the supply of money in the economy is increased, is now being discussed by the MPC to ward off deflation. Howard Archer, chief UK and European economist at IHS Global Insight, said: "This reinforces our belief that house prices still have substantially further to drop. "While latest mortgage approvals data suggest that housing market activity may have bottomed out and survey evidence indicates that buyer inquiries have picked up significantly recently as people are attracted by lower house prices and the Bank of England slashing interest rates, we are sceptical that sales will pick up substantially anytime soon and put a floor under prices."
Bank of England: 'Impossible to say' how much capital needed to shore up banking system
Mervyn King, the Governor of the Bank of England, has said it is "impossible to say" how much capital will be required to shore up the British banking system. Mr King said it would take "many months" to establish the scale of toxic assets held by banks, and the scale of problems would change depending on the international economic outlook. Giving evidence to the Treasury Select Committee, Mr King said it was vital to "find out what is really on the balance sheets of our major banks". "That is not something that is easy to do or can be done quickly," he told the MPs. "It will require a much longer and more detailed assessment contract by contract." He went on: "It will certainly take many months in my view." Mr King said the state of the global economy would have a huge impact on the situation of struggling UK financial institutions.
"How much capital banks will need in the end is impossible to tell," he added. Mr King dismissed as "wild exaggeration" any suggestion that the country would have to be taken into administration because of the level of liabilities it had taken on from the banks. But he also suggested public borrowing was too high as the UK entered the crisis and that had affected the Government's response to it. "I do think public debt matters. We get to this crisis with levels of public borrowing which were too high and that made it difficult," he said. But, he added, that was a "million miles" away from the idea that Britain in any way resembled somewhere like Zimbabwe. Mr King also claimed that financial regulators were unable to stop City banks taking huge risks because they did not get support from the Government and MPs, echoing Lord Turner, the head of the Financial Services Authority at a hearing on Wednesday.
Regulators who had criticised banks lending in 2006 or 07 would have had "a massively difficult task" persuading politicians to back them. "They would have been seen to be arguing against success," said Mr King. Suggesting that politicians were in thrall to powerful banks, Mr King said any regulator who challenged the banks would have been left isolated and "lonely. " But, commenting on revelations about the £650,000-a-year for life pension of Fred Goodwin, the former boss of Royal Bank of Scotland, he said: "I'm not going to jump on the bandwagon of a rather unappealing vengeance. "The real question is why anyone thought it was a good idea for executives to be rewarded in this way. You cannot blame one individual for the failure of a system." Mr King promised that he and the Monetary Policy Committee would not allow a surge in inflation, amid fears about the fallout from current measures to bolster the economy.
He said he was concerned the current crisis was leading people to suggest it was time to alter the focus of the Bank of England. He went on: "Our clear and unique responsibility is for monetary policy and we must never, ever forget that. "And I can give my personal assurance and that of every member of the Monetary Policy Committee that we are totally focused on that and we are not going to allow a great inflationary surge. "The problem at present is not that the amount of money in the economy is growing too rapidly, threatening a big inflationary surge. "It is that the amount of money in the economy is growing too slowly and that's why we have asked the Chancellor for powers to engage in asset purchasing in order to increase the amount of money in the economy and we would expect that to happen over the next few months."
The Governor urged MPs not to try to hold the Bank accountable for things that it did not have powers over, saying: "We are still limited, in the end, to writing reports." Pressed as to what new powers the Bank might like, he said it ought to have the power to request information from banks. Mr King said there should be a detailed "asset by asset" audit of the major banks' balance sheets - but also warned the MPs not to expect too much from regulators. He said: "For a limited number of major banks we should have a detailed asset by asset audit of the balance sheet. Only then can the Government work out what price should be paid for the asset, how much the taxpayer should pay." Mr King said there had been different regulatory regimes in the UK, US and Europe. "Every single one of these failed to spot the seriousness of the risk-taking that was going on. The lesson I would draw from this is not to expect too much from regulators."
The Governor said if a regulator had spoken up about the risk-taking "they would have been seen to be arguing against success". Institutions would have said "'who are you to be saying we are taking big risks? How dare you tell us we should stop taking such risks, can you prove to us that the risks we are taking will necessarily end in tears' - and of course they couldn't". He added: "The same was true of employees inside institutions." The answer was not to create more regulatory committees but to have an independent voice prepared to speak out. Mr King went on: "It's very hard to say to someone who appears to be very successful that what you are doing is potentially damaging to the rest of the economy." He called for "very simple mechanisms to put some sand in the wheels in the expansion of the financial system". The Governor stressed: "The most important lesson is, think big, stick to first principles. "You have got to be willing to say, 'what's going on in the City is not in the national interest'."
London's Commercial Real Estate Freeze
With the lingering downturn and dearth of credit, many of London's office building projects have been delayed or put on hold. Some expect that the construction sector will fall a further 9 percent in 2009, the biggest drop in three decades. This was the year London's skyline was supposed to be transformed by the construction of yet more signature skyscrapers. But with funding increasingly hard to come by and fears that demand for office space will continue to drop, many such projects have now been delayed or shelved. Commercial property values fell by 3.5 percent in January, on top of a 27 percent decline in 2008, according to global property advisers CB Richard Ellis.
"The British commercial property market has been the first and fastest to react to the financial crisis," says Peter Damesick, CB Richard Ellis' head of research in Britain. Witness the number of high-profile projects that have fallen victim to the downturn. Plans for a tower called St. Alphage's in London's financial district-known as the City of London-were canceled after the intended tenant, JPMorgan Chase, withdrew. And Dutch bank ING pulled the plug on Frank Gehry's first British project, a $433 million waterfront development in Brighton. "There's been a sharp downturn in new development activity over the last 12 months," Damesick says. "A lot of projects that were in the pipeline are being reassessed."
Take British Land's skyscraper in the City. The 47-story-tall, Richard Rodgers-designed Leadenhall Building, popularly dubbed the Cheesegrater due to its resemblance to a certain kitchen accessory, was supposed to be completed in 2011. Instead, British Land put the project on hold in August. At the time, then-CEO Stephen Hester-who now heads another troubled company, the Royal Bank of Scotland conceded the economic environment had changed. "Today you would never start such a big project without a tenant already lined up," he said. "The economics are not attractive enough." Britain's property firms face many of the same problems as those of its beleaguered banks: a dearth of credit, rapidly declining asset values, massive writedowns, and mounting job losses. In February alone, the country's three biggest property companies, British Land, Hammerson, and Land Securities tapped investors for a total of $2.9 billion in cash in a series of rights issues to repair badly damaged balance sheets.
"This is what I would call an exceptional cyclical downturn," Land Securities CEO Francis Salway said in a conference call on Feb. 19 to announce the company's $1.1 billion rights issue. Finding tenants for commercial property in London is proving tough. London's West End still has the world's most expensive office space, at around $248 a square foot, compared with $98 per square foot in midtown Manhattan, according to CB Richard Ellis. Little wonder that the amount of vacant office space in central London has risen by 36.5 percent in the past 12 months as tenants shed staff or relocate, says global real estate firm Cushman Wakefield. Hoping to attract occupiers, some landlords are even offering two years rent-free on leases of 10 years or more, the firm says. The big property firms aren't the only ones suffering.
Related industries from construction to engineering and architecture are feeling the pinch. Recent data from Britain's Office for National Statistics revealed an 8 percent decline in construction investment. And the Construction Products Assn. predicts the British construction sector will fall a further 9 percent in 2009, the biggest drop in three decades. Uxbridge-based Galliford Try, one of Britain's biggest construction firms and homebuilders, has had to axe 400 staff and move to a four-day week to cope with the slowdown. On Feb. 19 the company conceded it tumbled from a $48.4 million profit to a $54 million pretax loss for the six months ended Dec. 31, 2008, compared with the same period last year. CEO Greg Fitzgerald says current conditions in the homebuilding market are "the worst in generations."
British architects would certainly agree. With the collapse in the commercial, residential, and retail property markets, architectural firms are suffering, and the slowdown is fast translating into layoffs. New data from the Office for National Statistics reveal architects are joining the ranks of the unemployed at a faster rate than any other occupation in Britain. Some 870 architects signed on to unemployment benefits in the last quarter of 2008, compared with just 135 in the same period the year before, an increase of 544 percent. Even some of the profession's biggest names have had to lay off staff. On Feb. 13, Norman Foster's Foster & Partners announced plans to let go around a quarter of its 1,300-strong workforce and close two of its 17 offices around the globe. Jo Wright, managing partner at Bath- and London-based design firm FCB Studios, which won last year's prestigious Stirling Prize, says her firm had to reduce its staff by 10 percent, to 135, in November.
"As recently as August, I was using a headhunter, but the market turned so quickly," she says. "All of our core work sectors are suffering." Few expect conditions to improve significantly until 2012. True, some projects such as Renzo Piano's "Shard"-set to be Britain's tallest building-are still going ahead. And for potential buyers and tenants, there's one bright spot in the real estate crunch: "If you combine the fall in asset prices with the decline in the value of sterling, some properties are as much as 55 percent cheaper than they were just 18 months ago," says Richard Barkham, group research director at Grosvenor Group, an international property firm privately owned by the Duke of Westminster. The only problem is finding investors with the cash on hand to take advantage.
British Charity warns of 'lifetime debts'
A typical householder seeking help has no realistic hope of paying off debts in their lifetime, according to Citizens Advice (CAB). The charity said that people turning to advisers for assistance owed an average of £16,971 that would typically take them 93 years to pay off. The most common reasons for debt were low incomes, over-commitment, illness or disability and job loss, it said. A new alternative to bankruptcy comes into force in April.
These Debt Relief Orders are aimed at people with debts of less than £15,000 but without much surplus income or assets to their name. The CAB said that a third of its debt cases would be eligible for the new relief, but called for fair treatment by lenders and creditors, as well as for more government schemes to help those in debt without them having to go to court. The CAB report studied the finances of 1,407 people in England and Wales who visited the charity for help with debt problems in July 2008. Similar studies were carried out in 2001 and 2004, and the charity claimed that the latest figures - published on Thursday - revealed a "deepening debt crisis".
The study found that the average CAB client with debt issues owed two-thirds more than seven years earlier. More than half had debts on priority bills such as mortgage repayments, rent, fuel bills or council tax. One in 10 had more than 10 credit debts, such as plastic cards, overdrafts or personal loans. "Low income, combined with irresponsible lending, unreasonable debt collection practices and badly-informed financial decisions are at the root of many of our clients' debt problems," said CAB chief executive David Harker.
"For many, there is little prospect of their income increasing or their circumstances changing. The reality is that they are condemned to a lifetime of poverty overshadowed by an inescapable burden of unpayable debt." He added that the majority of these people were poorer than the average householder. With the data taken in July, he said that further job losses across the country since then were only adding to debt problems. The findings suggested there were also distinct problems with housing cost, poverty caused by fuel and water bills, and growing numbers of householders with mortgage or secured loan arrears.
The latest figures from the Insolvency Service highlight the toll that has been taken on by companies by the rapid lurch into recession. The latest figures showed the number of corporate insolvencies rose by 220% in the last three months of 2008, compared with the same period the year before. But the number of individuals who were declared insolvent stood at 106,544 in England and Wales in 2008, which was roughly the same as in 2007. A separate survey by credit reference agency Experian's CreditExpert service, published on Thursday, suggested that one in five people were keeping their money worries secret from their partners. One in 10 of the 2,000 people asked said they had a secret bank account.
'If One Major Bank Collapsed, Others Would Fall Like Dominoes'
German regional bank HSH Nordbank has been saved from collapse through a bailout by the states of Schleswig-Holstein and Hamburg. Observers warn, though, that the states may be entering into an unknown risk they are ill-equipped to handle. Schleswig-Holstein Governor Peter Harry Carstensen and Hamburg Mayor Ole von Beust looked relaxed and confident Tuesday when they announced their states' joint rescue package for the troubled regional lender HSH Nordbank. But many observers are asking if the duo really knew what they were getting into. The €13 billion ($16.7 billion) bailout poses huge risks for the two states, especially Schleswig-Holstein which is already heavily in debt. Many are asking how two states which have annual budgets of €12 billion (Schleswig-Holstein) and €10 billion (Hamburg) can afford the massive rescue package. Some are going as far as to warn that Schleswig-Holstein may even go bankrupt.
"The problem is not just that this rescue package greatly exceeds the economic capacity of Schleswig-Holstein," Hans-Peter Burghof, a banking expert at Hohenheim University, told SPIEGEL ONLINE. "There is also no convincing future plan for the bank." He also fears that the bank's capital needs will continue to increase in the coming months, meaning that even more money will have to be spent propping up the bank. Under the rescue plan, HSH Nordbank is to receive a capital injection of €3 billion from the state of Schleswig-Holstein and the city-state of Hamburg, which each hold about 30 percent of the Hamburg-based bank. The bank will also receive a credit guarantee worth €10 billion. HSH Nordbank, which specializes in financing the shipbuilding industry, had posted a pre-tax loss of €2.8 billion in 2008 as a result of the global financial crisis.
As part of a major restructuring, the bank now plans to focus on its core business activities, such as ship financing and corporate clients, and spin other businesses and toxic assets off into a so-called "bad bank." It is also planning to cut around 1,100 jobs from its staff of over 4,000. Experts agree that there was no alternative to the bailout. The collapse of US-based bank Lehman Brothers showed the domino effect that can be caused if a financial institution fails, Burghof said. "The stock market turbulence which was triggered by that collapse wiped out 30 percent of global equity capital. We can't risk that again." Opposition politicians demanded a change of course for Germany's Landesbanken, as the country's state-backed regional banks are known. "It can't just be a question of carrying on with business as usual," Green Party deputy floor leader Christine Scheel told the newspaper Frankfurter Rundschau. "Risky deals in the US, like those which were also carried out at HSH, must be ruled out in the future."
Otto Fricke from the business-friendly Free Democratic Party said that the current dire position of HSH and other banks was partly a result of the conviction on the part of state governments that they "absolutely wanted to play with the big boys." Fricke said regional banks should now concentrate on their traditional role of promoting regional business, rather than speculating in risky assets. HSH Nordbank is merely the latest in a series of German regional banks that has had to be bailed out by state governments. Bavaria had to provide a cash injection of €10 billion for its regional bank BayernLB, while North Rhine-Westphalia and Baden-Württemberg each had to provide €5 billion for WestLB and LBBW respectively. Commentators writing in Germany's main newspapers Wednesday mostly agree that there was no alternative to the bailout but warn of the huge risk the states are taking.
The center-right Frankfurter Allgemeine Zeitung writes:
"Schleswig-Holstein and Hamburg are not bankrupt yet -- unlike their regional bank HSH. To rescue their bank, the two states must make a capital injection of €3 billion euros and provide a guarantee worth another €10 billion. Is there no end to the banking debacle? Not in the near future. More rescue missions will be needed ... Perhaps in the case of HSH, one should let a bank fail for once, instead of claiming that every institution is absolutely essential to stop the system from collapsing. After all, everyone knows that many of Germany's regional banks are superfluous. Of course, it's the taxpayer who foots the bill in the end."
The Financial Times Deutschland writes:
"It cannot be ruled out that the states' plan will work and that the €13 billion in capital and guarantees, which they are spending on HSH Nordbank via a new special purpose entity, does not end up burdening their budgets. The prerequisite is, however, that the bank once again manages to pay out dividends by 2011 or 2012, or that investors can be found for parts of the business. Politically, the only advantage of the model chosen by the states is that there will not be any costs imposed on the states' budgets in the short term. However it is not possible to eliminate risk entirely with their daring gamble. The risk is merely postponed until the future -- despite the fact that Germany's states have recently committed themselves to following sound fiscal policy and refrain from new borrowing. While it is premature to call Schleswig-Holstein's solvency into doubt, as many a politician in (Schleswig-Holstein state capital) Kiel is now doing, because the bank bailout could overwhelm the weak state, it can not be ruled out that precisely this problem will arise in a few years' time."
The center-left Süddeutsche Zeitung writes:
"The states are playing for time (with the bailout). With the new cash injection, the states are buying the luxury of being allowed to have hope. Hope that the core businesses of shipping, transportation and small- and medium-sized companies, which HSH now plans to focus on, will not collapse. Hope that the global economic climate improves. And hope that the additional €70 million in interest, which Schleswig-Holstein alone will have to pay annually for the debt-financed bailout, will be covered by HSH's new business model by 2011 at the latest. The government in Schleswig-Holstein no longer has any other options except for crossing their fingers. They were already heavily in debt before the HSH crash. … With €1.5 billion, the state could pay for all its schools, teachers and police for one year. … The state's citizens should help by crossing their fingers too."
The left-leaning Die Tageszeitung writes:
"With their rescue plan for HSH Nordbank, Hamburg and Schleswig-Holstein are taking a big risk: They are shouldering a package that they cannot afford. But there is no alternative to the high-risk rescue plan. The collapse of Lehman Brothers showed the kind of chain reaction that can be unleashed when a bank goes under. Such a domino effect would be unavoidable in the event of a total collapse of HSH Nordbank, at least on the regional level. The consequences for the economy, and for the budgets of Schleswig-Holstein and Hamburg, would be incalculable."
The conservative Die Welt writes:
"In recent weeks, politicians often liked to see themselves as the saviors of the German financial sector. People lost sight of one important fact, however: As the owners of the public banks, the elected representatives bore at least as much of the responsibility for the debacle of the German banking sector during the financial crisis as their private competitors. The costly rescue of HSH Nordbank demonstrates the failures of the country's politicians even more clearly. Due to a lack of viable business ideas, the states got their banks to play Monopoly (i.e. by speculating on risky assets). The taxpayer now has to foot the bill -- because if just one of the major banks was allowed to go bankrupt, others would fall like dominoes. The financial system -- and not just in Germany -- would finally collapse."
China Taxes Reveal Spending Slowdown, Goldman Says
China investors should be "defensively positioned" as a decline in the nation’s tax receipts signals a steeper slowdown in spending than retail sales figures show, according to Goldman Sachs Group Inc. "Tax data show much sharper deceleration in income and consumption in the past few months than suggested by official retail sales or income growth figures," Goldman Sachs analysts Joshua Lu, Caroline Li and Fiona Lau wrote in a note today. Value-added tax has "de-linked sharply" from retail sales figures, the analysts wrote. VAT rose 1 percent in the fourth quarter from a year earlier, while retail sales gained 21 percent, according to the note.
China is trying to boost domestic spending to shore up its economy as recessions in the U.S. and Europe smother demand for its exports. The nation’s growth has slowed for six straight quarters, while outbound shipments slumped 17.5 percent in January, the most in almost 13 years, customs bureau data showed this month. Growth in China’s individual income-tax receipts "slowed down significantly" in the second half and shrank in December and January, the Goldman Sachs analysts wrote. This compares with nominal wage growth of 21 percent in the third quarter, the report said. "We think the government’s fiscal stimulus package announced so far may help create jobs, but may not necessarily help boost wages which, in our view, is the key driver of consumption growth," the note said. "As such we are not hopeful that China’s consumption slowdown will bottom out soon."
The Politburo, the Communist Party’s top decision making body, said Feb. 23 that the government will focus on boosting consumption this year to reverse the slide in the world’s third- biggest economy. China’s growth will be the weakest in almost two decades as the world economy nears a standstill, according to the International Monetary Fund. "Domestic consumption has become the big hope for investors because everyone is banking on it to prop up the economy, but I’m not so sure," said Roger Groebli, head of financial market analysis at LGT Capital Management, which oversees $12 billion in Asia. "You can’t push people to spend if they’re scared and in uncertain times, people save more."
The Shanghai Composite Index has rallied 29 percent since reaching a two-year low on Nov. 4, compared with a 16 percent decline on the MSCI Asia Pacific Index, on speculation the government stimulus plans will help the country weather the global recession. Initiatives to spur spending include subsidies for farmers to buy home appliances, expanded by the government on Feb. 1 to cover computers, heaters and air conditioners, as well as televisions, refrigerators, washing machines and mobile phones. The central bank urged tax cuts in its latest quarterly monetary report and central bank Governor Zhou Xiaochuan said Feb. 10 that the nation needs to cut its savings rate to spur spending.
"We need to emphasize internal demand, that is, domestic consumption, especially in rural areas," Zhou said. "We need to change the consumption pattern." China has made little progress toward rebalancing its economy by reducing reliance on industry and investment and increasing the role of services and consumption, the World Bank said this month. China’s economic slide has already cost the jobs of 20 million migrant workers. The IMF forecasts a 6.7 percent economic expansion this year, the least since 1990. Goldman Sachs’s top China consumer stock recommendations are Want Want China Holdings Ltd., the country’s largest rice cracker maker, Tsingtao Brewery Co., the biggest Chinese beer company by sales, and China Mengniu Dairy Co., the largest milk producer.
American taste for soft toilet roll 'worse than driving Hummers'
The tenderness of the delicate American buttock is causing more environmental devastation than the country's love of gas-guzzling cars, fast food or McMansions, according to green campaigners. At fault, they say, is the US public's insistence on extra-soft, quilted and multi-ply products when they use the bathroom. "This is a product that we use for less than three seconds and the ecological consequences of manufacturing it from trees is enormous," said Allen Hershkowitz, a senior scientist at the Natural Resources Defence Council.
"Future generations are going to look at the way we make toilet paper as one of the greatest excesses of our age. Making toilet paper from virgin wood is a lot worse than driving Hummers in terms of global warming pollution." Making toilet paper has a significant impact because of chemicals used in pulp manufacture and cutting down forests. A campaign by Greenpeace seeks to raise consciousness among Americans about the environmental costs of their toilet habits and counter an aggressive new push by the paper industry giants to market so-called luxury brands.
More than 98% of the toilet roll sold in America comes from virgin forests, said Hershkowitz. In Europe and Latin America, up to 40% of toilet paper comes from recycled products. Greenpeace this week launched a cut-out-and-keep ecological ranking of toilet paper products. "We have this myth in the US that recycled is just so low quality, it's like cardboard and is impossible to use," said Lindsey Allen, the forestry campaigner of Greenpeace. The campaigning group says it produced the guide to counter an aggressive marketing push by the big paper product makers in which celebrities talk about the comforts of luxury brands of toilet paper and tissue.
Those brands, which put quilting and pockets of air between several layers of paper, are especially damaging to the environment. Paper manufacturers such as Kimberly-Clark have identified luxury brands such as three-ply tissues or tissues infused with hand lotion as the fastest-growing market share in a highly competitive industry. Its latest television advertisements show a woman caressing tissue infused with hand lotion. The New York Times reported a 40% in sales of luxury brands of toilet paper in 2008. Paper companies are anxious to keep those percentages up, even as the recession bites. And Reuters reported that Kimberly-Clark spent $25m in its third quarter on advertising to persuade Americans against trusting their bottoms to cheaper brands.
But Kimberly-Clark, which touts its green credentials on its website, rejects the idea that it is pushing destructive products on an unwitting American public. Dave Dixon, a company spokesman, said toilet paper and tissue from recycled fibre had been on the market for years. If Americans wanted to buy them, they could. "For bath tissue Americans in particular like the softness and strength that virgin fibres provides," Dixon said. "It's the quality and softness the consumers in America have come to expect."
Longer fibres in virgin wood are easier to lay out and fluff up for a softer tissue. Dixon said the company used products from sustainbly farmed forests in Canada. Americans already consume vastly more paper than any other country — about three times more per person than the average European, and 100 times more than the average person in China. Barely a third of the paper products sold in America are from recycled sources — most of it comes from virgin forests. "I really do think it is overwhelmingly an American phenomenom," said Hershkowitz. "People just don't understand that softness equals ecological destruction."
'Long-term it looks quite scary in Canada'
Katrin Meissner is determined to be on the forefront of understanding the climate change affecting everything from permafrost to bird migrations.
The celebrated young scientist at the University of Victoria had planned to build her career in Canada. But Meissner is packing up her young family and heading for Australia. The University of New South Wales made her an offer she couldn't refuse — a position as a senior lecturer, research opportunities and guaranteed daycare for her one-year-old son, which was the perk that sealed the deal. "I didn't really want to leave," says Meissner, who is walking away from a coveted tenure-track position in Victoria. But she says the opportunities in Australia seem much more promising. "Long-term it looks quite scary in Canada," says Meissner.
It is a refrain heard across Canada as funding dries up at the Canadian Foundation for Climate and Atmospheric Sciences (CFCAS), a prime source of funding for university-based projects underway from the Arctic to B.C. mountaintops. Projects involving hundreds of scientists have entered their final phase and will shut down by March 2010. "They're dead as of next spring," says atmospheric physicist Richard Peltier of University of Toronto, noting that there is no new federal money in sight for new projects or to build on existing ones. "It's a shame to see it go down the tubes," says Richard Lawford, at the University of Manitoba, who manages the four-year-old Drought Research Initiative funded by the foundation. The project is aimed at preparing for the country's next water crisis. The last drought, from 1999 to 2004, cost an estimated $6 billion and 41,000 jobs.
Lawford says the team is keen to build on the project in a bid to ensure there is enough water for farmers and cities. But with CFCAS running out of cash, so is the project. Young scientists and technical staff will be hardest hit. "That's were the real pain comes in," says Lawford, who fears many highly educated young scientists working on the drought project will head to the U.S. where science is expected to undergo a renaissance under President Barack Obama. "We may have just trained them for the U.S.," says Lawford. And expertise, which Canada will need to prevent rivers and reservoirs from running dry when the next drought hits, will be lost with them, he says. Scientists across the country echo the concern and say there are signs the exodus has begun.
"In my lab, I have three going to Australia," says Andrew Weaver, who leads a climate modelling team at the University of Victoria. Meissner, along with a PhD student and master students with newly minted Canadian degrees, is heading for a new climate change research centre in Australia. Young scientists have always tended to move between labs. But with the foundation projects all coming to an end, senior researchers say Canada will have trouble attracting bright young climate scientists and keeping the ones it now has. Atmospheric scientist James Drummond, who directs a remote polar lab on Ellesmere Island that is fast running out of money, says he has already lost a post-doctoral student to a NASA contractor in the U.S. He fears more will follow given Obama's plan to spend more than $400 million on climate change research at NASA and the National Oceanic and Atmospheric Administration.
Drummond notes that Obama's approach to science stands in sharp contrast to Prime Minister Stephen Harper's. His stimulus package disappointed many in Canada's research community. It provided no funding increases for key science funding agencies and did not renew funding for others. The Canadian Foundation for Climate and Atmospheric Sciences, which got nothing in the budget, had been looking for a $25-million-a-year lifeline. The foundation was set up by the federal government in 2000 and took over funding of climate and atmospheric research at Canadian universities from several federal programs that were phased out. The foundation, which received $60 million in 2000 and another $50 million in 2004, has financed 160 projects and 24 research networks.
"We've built up a number of very powerful research groups which are doing the country proud," says Peltier, at the University of Toronto. He heads the Polar Climate Stability Network, which received just over $5 million. The scientists have been assessing different components in the climate system — from the glaciers in Western Canada to the frigid waters flowing out of the Arctic. "It really is a huge concern that the country's investment in climate science is diminishing just at the time when we need it more than ever," says Peltier, noting how climate change will impact everything from permafrost to extreme weather events.
He and his colleagues say a smooth and efficient transition to the next phase of climate projects would have required new funding in last month's budget. The foundation asked the Harper government for $250 million over 10 years in 2007 and pleaded its case with several parliamentary committees last year. Foundation Chair Gordon McBean met with new Environment Minister Jim Prentice late last fall and walked away hopeful the minister would fight for foundation funding at the budget table. Prentice's press officer Frederic Basil told Canwest News Service that "the government has not received a formal proposal for additional funding from the foundation."
CFCAS executive director Dawn Conway describes that as a "little bit ingenuous" given the repeated requests put forward through various channels. But if Prentice wants another proposal, she and her colleagues say they are happy to provide one. "We are already working it," she says. The minister's office also says the foundation has been funded until 2011. This is correct in that the foundation office, which has six full-time staff, must keep the lights on until all research reports are in before closing its books in 2011, says Conway. But there is no new money for science projects and hasn't been since 2008, when the last round of grants were given out. "Money is drying up without new money coming after," says Meissner, who was one of the young scientists funded by the Canadian foundation.
Las Vegas Running Out of Water Means Dimming Los Angeles Lights
On a cloudless December day in the Nevada desert, workers in white hard hats descend into a 30- foot-wide shaft next to Lake Mead. As they’ve been doing since June, they’ll blast and dig straight down into the limestone surrounding the reservoir that supplies 90 percent of Las Vegas’s water. In September, when they hit 600 feet, they’ll turn and burrow for 3 miles, laying a new pipe as they go. The crew is in a hurry. They’re battling the worst 10-year drought in recorded history along the Colorado River, which feeds the 110-mile-long reservoir. Since 1999, Lake Mead has dropped about 1 percent a year. By 2012, the lake’s surface could fall below the existing pipe that delivers 40 percent of the city’s water.
As Las Vegas’s economy worsens, the workers are also racing against a recession that threatens the ability to sell $500 million in bonds so they can complete the job. Patricia Mulroy, manager of the Southern Nevada Water Authority, is the general in this region’s war to stem a water emergency that’s playing out worldwide. It’s the biggest battle of her 31-year career. "We’ve tried everything," says Mulroy, 56, who made no secret of her desire to become secretary of the U.S. Interior Department before President Barack Obama picked U.S. Senator Ken Salazar of Colorado in December. "The way you look at water has to fundamentally change," adds Mulroy, who, after 20 years of running the authority, said in January she’s ready to start thinking about looking for a new job, declining to say where.
Across the planet, people like Mulroy are struggling to solve the next global crisis. From 2500 B.C., when King Urlama of Lagash diverted water in the Tigris and Euphrates Valley in a border dispute with nearby Umma, to 1924, when Owens Valley, California, farmers blew up part of the aqueduct that served a parched Los Angeles, societies have bargained, fought and rearranged geographies to get the water they need. Mulroy started her push with conservation. She’s paying homeowners $1.50 a square foot (0.09 square meter) to replace lawns with gravel and asking golf courses to dig up turf. That helped cut Las Vegas’s water use by 19.4 percent in the seven years ended in 2008, even as the metropolitan area added 482,000 people, bringing the total to 2 million. It wasn’t enough.
So she’s planning a $3.5 billion, 327-mile (525-kilometer) underground pipeline to tap aquifers beneath cattle-raising valleys northeast of the city. She’s even suggested refashioning the plumbing of the entire continent, Paul Bunyan style, by diverting floodwaters from the Mississippi River west toward the Rocky Mountains. If Mulroy’s ideas are extreme, one reason is that the planet’s most essential resource doesn’t work like other commodities. There’s no global marketplace for water. Deals for property, wells and water rights, such as the ones Mulroy must negotiate to build the pipeline, are done piecemeal. As the world grows needier, neither governments nor companies nor investors have figured out an effective and sustainable response. "We have 19th-century ways of utilizing water and 21st- century needs," says Brad Udall, director of Western Water Assessment at the University of Colorado at Boulder.
Water upheavals are intensifying because the population is growing fastest in places where fresh water is either scarce or polluted. Dry areas are becoming drier and wet areas wetter as the oceans and atmosphere warm. Economic roadblocks, such as the global credit crunch and its effects on Mulroy’s attempts to sell bonds, multiply during a recession. Yet local governments that control water face unyielding pressure from constituents to keep the price low, regardless of cost. Agricultural interests, commercial developers and the housing industry clash over dwindling supplies. Companies, burdened by slowing profits, will be forced to move from dry areas such as the American Southwest, Udall says. "Water is going to be more important than oil in the next 20 years," says Dipak Jain, dean of the Kellogg School of Management at Northwestern University in Evanston, Illinois, who studies why corporations locate where they do.
Even before the now decade-long drought began punishing Las Vegas, people used more than 75 percent of the water in northern Africa and western Asia that they could get their hands on in 2000, according to the United Nations. In 2002, 8 percent of the world suffered chronic shortages. By 2050, 40 percent of the projected world population, or about 4 billion people, will lack adequate water as entire regions turn dry, the UN predicts. "We can no longer assume that cheap water is available," says Peter Gleick, editor of The World’s Water 2008-2009 (Island Press, 2009). "We have to start living within our means." Over the Sierra Mountains from Las Vegas, Shasta Lake, California’s biggest reservoir, is less than a third full because melting snow that fed it for six decades is dwindling. A winter as dry as the previous two may mean rationing for 18 million people in Southern California this year, says Jeffrey Kightlinger, general manager of the Metropolitan Water District.
Across the Pacific Ocean, wildfires fueled by a 10-year drought and fanned by 60-mile-per-hour winds around Melbourne killed more than 200 people in February. In Asia, developing giants are battling pollution as their populations grow. China, home to 21 percent of the world’s people last year, has just 7 percent of the water. Nine in 10 Chinese-city groundwater systems are fouled by industrial toxins, pesticides and human waste, says Maude Barlow, the first senior adviser on water to the UN and author of "Blue Covenant" (New Press, 2007). In India, with 1.2 billion people, three-quarters of the surface water is contaminated, that country’s government said in September. In the Mideast, where the Dead Sea is dropping 3 feet (1 meter) a year, Israel, Jordan and Syria are diverting water upstream from the Jordan River. That’s adding another source of discord to an already volatile region. "There’s a growing risk of conflict over water shared by nations, ethnic groups or economic interests," Gleick says.
Las Vegas, an adult-entertainment haven carved into the Mojave Desert, may not draw much sympathy as a poster child for water emergencies. For decades, new residents imported their cravings for lawns, sprinklers, pools and golf courses to a region that receives 4 inches (10 centimeters) of rain a year, about 1/10 of what Chicago enjoys. Casinos and hotels with water slides and river rides sucked up limited groundwater. Until the real estate meltdown, Nevada was the fastest- growing U.S. market, with a 33 percent surge in new homes from 2000 to ‘07. Now the city is getting a dose of reality, says Cecil Garland, a rancher in neighboring Utah who opposes Mulroy’s groundwater pipeline. "Las Vegas is a place of gambling, gluttony and girls," Garland, 83, says. He says there’s no extra water along the proposed route, which travels through valleys green with 3-foot-tall shrubs called greasewood. If pumping kills the greasewood, dust storms that plague his town of Callao would soar 5,000 feet into the sky, he says.
"We live in one of the driest areas of the driest part of the U.S.," Garland says. "How in the world can anybody with reason or common sense think they can pump water in the amount they’re talking about and leave the integrity of the valley in place?" Mulroy says Nevada’s resorts use 3 percent of the state’s water compared with 90 percent going for farms and ranches. For the past two decades, Mulroy, a lifelong government employee whose business attire tends toward pantsuits with the collar of her blouses pointed up behind her neck, has wrestled with the competing truths that dog all water managers: There’s only so much to go around, somebody has already claimed most of it, and citizens and companies keep demanding more. "People view water as a human right and expect it to be virtually free," says Michael LoCascio at Boston-based Lux Research Inc., which analyzes water issues. "Governments respond to that, and you end up with inefficiency."
Without price-setting markets, water that cost 33 cents a cubic meter for the first 15 cubic meters delivered to homes in Memphis, Tennessee, in June 2007 was $3.01 in Atlanta and 57 cents in Las Vegas. That’s cheap compared with Copenhagen, where the same amount that month was $7.71 per cubic meter, Gleick says. Robert Glennon, a University of Arizona law professor, says governments must provide enough water for human survival. Beyond that, only freely functioning markets can allot it to people who need it most, he says. Fast-growing cities should buy from farmers who use water on marginal land, says Glennon, author of "Unquenchable" (Island Press, 2009). That would cut inefficiency caused by irrigating deserts, such as those around Las Vegas, to raise alfalfa or beef, he says. Worldwide, about 60 percent of fresh water goes to irrigate crops through flooding, losing 70 percent of the moisture to evaporation, Lux Research says.
The rudiments of water markets are cropping up across the American West. In 2005, after 19 years of negotiations, Los Angeles’s Metropolitan Water District signed a 35-year "dry year option" with the Palo Verde Irrigation District south of Las Vegas in California. Los Angeles pays 7,000 farmers to leave land fallow during droughts and ship their water to city residents. The city gives a one-time payment of $3,170 an acre (0.4 hectare) to farmers who sign up and then $630 per year for every acre not farmed. Companies and investors that see moneymaking opportunities in strategies to quench the world’s thirst may draw lessons from corporations that have tried. In October, General Electric Co. named the third head of its water unit in three years. GE had paid $3.8 billion to buy several treatment and filtration companies, including Watertown, Massachusetts-based Ionics Inc., which makes reverse-osmosis membranes for purifying salt water.
Last year, GE opened a $250 million desalination plant, Africa’s largest, with state-owned Algerian Energy Co. GE had hoped to profit from its newly acquired water technologies with the backing of its General Electric Capital Corp. financing arm, says Jeffrey Fulgham, chief marketing officer for the Trevose, Pennsylvania-based unit. Instead, GE wound up footing a lot of the building work for the plant, he says. "At the end of these big hardware deals, there isn’t much profit," says Fulgham, who adds that GE now focuses on water technology and avoids construction. Pure Cycle Corp., which buys and transports water for housing developments near Denver, seemed to have scored a windfall. Starting in 1976, it paid $110 million for water rights valued at $4 billion last year, Chief Executive Officer Mark Harding says. Yet shares in the Thornton, Colorado, company tumbled by 47 percent during the six months ended on Feb. 25. to trade at $3.25 apiece. The real estate slowdown convinced investors that profits from water rights may be years away, Harding says. Just financing water for municipal use is getting harder in the global recession.
The southern Nevada authority is about halfway through a 30-year, $8.3 billion construction campaign. Last year, 57 percent of the money for it came from a $6,310 fee to hook up new homes. The Las Vegas real estate slump is so severe that total hookup collections dropped to $61.5 million last year from $188.4 million in 2006. Mulroy says the authority actually lost money on hookups in January because of refunds to developers who abandoned construction projects. As a result, reserves in the construction fund dropped 6 percent in the first six weeks of 2009, to $480 million. Without those reserves, Mulroy says, she couldn’t assure investors the authority would be able to repay the $500 million in bonds she plans to start selling by early fall to complete the Lake Mead project. The authority had $3.9 billion in liabilities on June 30. The authority also gets money from water deliveries, property taxes and fees from federal land sales. If she has to protect the reserves, Mulroy says, she’ll raise water rates, which total about $21 a month for a single-family home.
She’s asked fellow Nevadan Harry Reid, the U.S. Senate majority leader, for a federal guarantee on the bonds. Reid is exploring how to help big municipal water systems, including Mulroy’s, get easier access to credit, spokesman Jon Summers says. In February, Mulroy presented such a dire description of the authority’s finances to the Nevada legislature that Jerry Claborn, chairman of the Natural Resources Committee, told her, "You’ll have to do like you did years ago: rub two sticks together." Mulroy said afterward she wanted to quash any notion that cash-strapped legislators could appropriate her reserves for some other purpose. To Richard Bunker, who hired her as an administrative assistant when he managed Clark County, Nevada, in 1978, Mulroy’s hardball tactics are a delight. "She walks into a room with guys who’ve been on the river 50 and 60 years and they just cringe," he says with a smile.
One thing Mulroy has ruled out, even in the economic meltdown, is using water as an excuse to limit Las Vegas’s growth. "During the next 50 years, this country’s population is expected to explode by another 140 million," she says, citing U.S. Census projections. "I always ask, ‘Where do you want the people to go?’" Mulroy also opposes the idea of privatizing water, or giving investors power to set prices. "You’d be telling people, ‘Pay me enough or I withhold it,’" she says, her voice rising, in the cafeteria of Clark County’s terra cotta-colored municipal headquarters. "It’s like you’re telling me I can live." Mulroy’s unflagging commitment to keeping Las Vegas green and growing gets the blessing of casino owner Stephen Wynn. "Pat is the best public servant I’ve met in my 40 years on the Strip," says Wynn, who credits her with teaching him to save money by using treated groundwater for the lagoons surrounding the artificial volcano at the Mirage hotel, now owned by MGM Mirage.
Finding the water for casinos is one reason crews are working around the clock at Lake Mead. In 2002 alone, lack of rainfall lowered the deep-blue waters by 24.6 feet, leaving white bathtub-ring-like marks on the brown cliffs and stranding docks half a mile from shore. Today, the lake is 1,112 feet above sea level. Should it fall to 1,075 feet, the federal government would cut the water to seven states that depend on the Colorado River, according to an agreement they all signed in 2007. If that happens, the states would likely renegotiate a 1922 pact that divided up the river’s water rights in the first place, Mulroy says. Mexico’s allocation under a 1944 treaty could also change. If the drought persists and more water is diverted from the Colorado, the lake could drop to 1,050 feet. That would prevent water from flowing into the intake pipe and cut 40 percent of Las Vegas’s supply -- the disaster Mulroy is trying to head off. Hoover Dam, completed in 1935 to regulate the river and form Lake Mead, wouldn’t be able to produce electricity for the 750,000 people it supplies in Los Angeles.
At 1,000 feet, the remaining intakes and the rest of the Lake Mead water would go. Because of climate change and population growth, chances of this are as great as 50 percent by 2026, the University of Colorado’s Udall says. When Mulroy, a daughter of a civilian employee of the U.S. Air Force, arrived in Las Vegas in 1974, the city had yet to be consumed by a water quest. Until the 1940s, parts of downtown had freely flowing springs. Mulroy, a native of Germany, studied German literature; got her master’s degree from the University of Nevada, Las Vegas; and went to work for Bunker at Clark County. A Mormon bishop, he later ran the state’s Gaming Control Board and the Nevada Resort Association. Bunker supported her promotion to administrator for the county justice court, which was storing records in shoeboxes when she took over. In 1989, he backed her as general manager of the Las Vegas Valley Water District, which the state legislature had formed four decades earlier. Mulroy helped create the seven- community Southern Nevada Water Authority two years later. "Absent her being here, I don’t know where we’d be," Bunker says.
Around the time Mulroy became water czar, Wynn unleashed the era of Wall Street-financed megaresorts with his 30-story Mirage. He tinted the hotel’s windows with real gold. Mulroy raced to boost water deliveries throughout the city by as much as 20 percent a year. With Bunker’s help, she started planning the pipeline to tap melting snow under Wheeler Peak, Nevada’s second-highest mountain. The pipeline’s planned path runs northeast out of Las Vegas, enters Lincoln County and passes through the Pahranagat National Wildlife Refuge, where, in December, gold leaves of cottonwoods shimmer and migratory birds swoop onto lakes fed by artesian springs. Farther north, hilltops are dotted with abandoned mining towns and bands of wild horses.
As Mulroy marched north to secure land and permits, she ran headfirst into what Gleick says is a fundamental truth about water across the U.S. and other parts of the world. "Nearly every drop is already spoken for, often more than once," he says. Determined to get what she required, Mulroy went into horse-trading mode. "You need a large amount of money and some very powerful people to make water projects happen," says Greg James, a California water rights attorney and a consultant for pipeline opponents. She struck a deal with Harvey Whittemore, then Nevada’s top gambling lobbyist. Members of Whittemore’s law firm include Rory Reid, Harry Reid’s son. The younger Reid later served as the water authority’s vice chairman, from 2003 to ‘08.
Whittemore, 56, is also a developer who’s planning a new suburb called Coyote Springs, 55 miles north of the Las Vegas Strip. Even with the real estate crash, Coyote Springs will have 120,000 homes and a dozen golf courses when it’s finished in four or five decades, he says. Whittemore’s land included one of the most productive wells ever drilled in southern Nevada. He sold 9,000 acre-feet of groundwater that he wasn’t using to Mulroy for $30.1 million. (One acre-foot equals about 326,000 gallons, or 1,240 kiloliters, enough for two average U.S. homes for a year.) That led to what Mulroy describes as a partnership in which Whittemore will help pay for the pipeline and use it to ship water to Coyote Springs. In 2003, Mulroy bargained with reluctant officials in neighboring Lincoln County, persuading them to drop opposition to the project by ceding back to them some of the water rights that she held.
In 2006, farther up the route, she learned how tough the water business can be. She paid $22 million for a ranch that had cost $4.5 million six years earlier. The seller, Carson City, Nevada-based Vidler Water Co., a unit of PICO Holdings Inc., based the price on similar purchases Whittemore had made, Vidler President Dorothy Timian-Palmer says. Last year, Mulroy got into a fight over greasewood with Tim Durbin, a hydrologist who’d once been a consultant for her. Durbin disputed Mulroy’s assessment that the pipeline would avoid major damage to the shrub. In his rebuttal, Durbin described a scene that still touches an open wound in the psyche of the American West. In 1913, William Mulholland built a 223-mile aqueduct from Owens Valley in California’s Sierras to Los Angeles, where he was water superintendent. The aqueduct drained a 40-foot-deep lake, exposing the valley floor and unleashing dust storms that plagued Los Angeles throughout the 20th century. The aqueduct also inspired the 1974 movie "Chinatown." In 1970, Los Angeles built a second aqueduct.
Today, the valley’s 75-mile-long expanse looks like it did a millennium ago. The water diverted to Los Angeles makes economic development in the valley impossible. "Because of groundwater pumping, vegetation was disappearing in the Owens Valley," says Durbin, who was chief hydrologist for the U.S. Geological Survey in California and Nevada before becoming a private consultant in 1984. "It’s a model for what one would expect in eastern Nevada." Because of such memories, Mulroy hasn’t won many friends among eastern Nevada’s old-timers. Rancher Dean Baker fears Mulroy’s pipeline would drain the water that’s let him survive in Snake Valley, in the shadow of Wheeler Peak, for more than half a century. Baker, 69, remembers when people staked uranium claims only to realize their Geiger counters were clicking because of residue from atomic tests outside Las Vegas. He recalls flying solo in a Piper J-3 Cub before he could drive.
Most of all, Baker remembers water. He rose at dawn to deliver it to cattle 50 miles away. He culled his herd and watched greasewood wither during droughts. It took 20 years for him to afford a backhoe with a jackhammer that could break rocks that covered a spring on his ranch. Legacy of Dust "Water is the limiting factor in everything we do," Baker says. "The legacy of this pipeline will be dust." Baker says people who want to move to Las Vegas should look instead to Mississippi and Louisiana. "People should go where there’s water," he says. Mulroy says her job is to bring water to the people. Last year, she said she thought the proposed pipeline could begin transporting water in 2015. Now, because of the recession, she doesn’t know when she’ll have the money to build it. She says she’ll wait for the economy to recover to decide -- unless Lake Mead drops even more and forces her to act.
Mulroy’s struggle to get water to a growing desert population wouldn’t have surprised John Wesley Powell, the first known explorer to pass through the entire Grand Canyon 130 miles east of Las Vegas. "You are piling up a heritage of conflict and litigation over the water rights," he told the International Irrigation Congress in Los Angeles in 1893. "There is no sufficient water to supply the land." Four generations later, Mulroy is a veteran of these age- old conflicts. She says the region’s water emergency is becoming more dangerous because of climate change and population growth. The crisis is too big to be solved one river or one continent at a time, she says. "We’ve managed water in such small, incremental units," she says. "We won’t be able to survive in our little bubbles." Even people who agree with Mulroy’s warning won’t have an easy time acting on it. As she has, they’ll discover the effort it will take to quench the world’s thirst and realize that the time and money to do so -- like water itself -- are running short.