Shacktown in Dubuque, Iowa. Many residents keep a cow or a few chickens
Ilargi: Now that the first death threats against AIG executives are a fact, you'd be inclined to believe the people who say we've passed the denial phase, and are now moving to anger. While that may be partially true, denial is by no means over. I would even make the point that the anger facilitates additional denial.
I said yesterday that the bonuses at AIG are not the problem, and people's anger shouldn't be directed at them. The problem is the entire system which exists as much in Washington as it does on Wall Street. This morning I saw that Eliot Spitzer wrote on the same topic at the same time.
Everybody is rushing to condemn AIG's bonuses, but this simple scandal is obscuring the real disgrace at the insurance giant: Why are AIG's counterparties getting paid back in full, to the tune of tens of billions of taxpayer dollars?
For the answer to this question, we need to go back to the very first decision to bail out AIG, made, we are told, by then-Treasury Secretary Henry Paulson, then-New York Fed official Timothy Geithner, Goldman Sachs CEO Lloyd Blankfein, and Fed Chairman Ben Bernanke last fall. Post-Lehman's collapse, they feared a systemic failure could be triggered by AIG's inability to pay the counterparties to all the sophisticated instruments AIG had sold.
And who were AIG's trading partners? No shock here: Goldman, Bank of America, Merrill Lynch, UBS, JPMorgan Chase, Morgan Stanley, Deutsche Bank, Barclays, and on it goes. So now we know for sure what we already surmised: The AIG bailout has been a way to hide an enormous second round of cash to the same group that had received TARP money already. It all appears, once again, to be the same insiders protecting themselves against sharing the pain and risk of their own bad adventure.
The payments to AIG's counterparties are justified with an appeal to the sanctity of contract. If AIG's contracts turned out to be shaky, the theory goes, then the whole edifice of the financial system would collapse. But wait a moment, aren't we in the midst of reopening contracts all over the place to share the burden of this crisis? From raising taxes—income taxes to sales taxes—to properly reopening labor contracts, we are all being asked to pitch in and carry our share of the burden.
Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won't be laid off. Why can't Wall Street royalty shoulder some of the burden? Why did Goldman have to get back 100 cents on the dollar? Didn't we already give Goldman a $25 billion capital infusion, and aren't they sitting on more than $100 billion in cash? Haven't we been told recently that they are beginning to come back to fiscal stability? If that is so, couldn't they have accepted a discount, and couldn't they have agreed to certain conditions before the AIG dollars—that is, our dollars—flowed?
The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation.
Even President Obama says it's not just the bonuses; it's the entire "culture" on Wall Street that's the problem. But what is the culture he talks about? When the government puts trillions of dollars into Wall Street financials without taking them over outright, it's safe to say the government becomes part of this culture. Washington always had and still has the ability to write laws and regulations for the way business is conducted anywhere in the economy, including Wall Street. It seems logical, then, to look at those politicians who today provide us, through the media, with the loudest outraged protests over the bonuses and see where they were when the whips came down.
Where were Barney Frank, Chris Dodd, Ben Bernanke, Tim Geithner and Barack Obama back in September, and where are they now?
Frank was, and still is, Chairman of the House Financial Services Committee. Kind of hard to feign complete innocence when you're that high up in the hierarchy. Frank has at the very least seen the AIG bail-outs, with all its terms, including retention pay and bonuses, pass by without protesting loud enough. His overall performance is so weak that he shouldn't these days cry blue murder over AIG's bonuses. Instead, Barney Frank should draw the conclusions that are an integral part of a functioning democracy, and resign.
Christopher Dodd is and was the Chairman of the Senate Committee on Banking, Housing, and Urban Affairs. Dodd's overall performance is far from convincing, but he did try to amend Geithner's third AIG bail-out a few weeks ago to include clear and even retroactive limits on fees and bonuses at the firm. Because of that, I'm torn here, and inclined towards giving him the benefit of the doubt. Still, people like him have been around fo a long time in Washington, for decades, and they should have acted much sooner. A few bail-out amendments are far outweighed by being an accomplice to secretly slushing public funds to Wall Street. Still torn. Note that Salon.com figured out that Dodd's protests were waved aside by Geithner and Larry Summers, and that both are now trying to blame him for his amendments not being included in the bail-out. That's professional spinning for you.
Ben Bernanke has been an active part of the entire three-part AIG bail-out history. Since the Federal reserve is not a government agency, it's hard to unseat him, but I'd be surprised if Bernanke is not made the fall guy for many things, as anger grows, before Christmas.
Timothy Geithner carries the main responsibility for all three phases of the AIG drama. As chairman of the New York Federal Reserve, it was his task to write the documents. It may well be possible that he had Wall Street people write them instead, but that would be even worse. And the revelations keep on coming: bonuses, billions for Wall Street banks and foreign banks, and now even billions for hedge funds, all in taxpayers' money. Geithner's days are numbered, no matter what.
Barack Obama was a senator in September, and is therefore responsible, no matter how many mitigating circumstances there may have been. Being too busy campaigning to halt laws that contradict what you want to do as president is no excuse. The demands made on a president should be higher than for anyone else in the nation. So far, nobody calls the president on these things, but that can change as his poll numbers go down. He gets the benefit of the doubt for now, but that's all.
Geithner Caves On AIG Bonuses, Defends Liddy
Tim Geithner is now completely on the defensive. In a long letter to Nancy Pelosi, he explained how and why he approved the AIG bonuses (troubling) and described a plan to "recoup" them. The letter will not likely stop the growing chorus of criticism that may well drive Geithner out of office. Geithner's new plan will not "recoup" the bonuses at all: It will merely reduce the amount of the next taxpayer handout to AIG from $30 billion to $29.835 billion. This is not likely to quell the outrage: What most people are angy about is that AIG paid $165 million of taxpayer money in "retention" bonuses to executives who blew up the firm (many of whom aren't at the company anymore).
The more troubling part of the letter, though, is Tim Geithner's description of his own approval of the bonuses. He says he registered "strong objections" and then asked for a written legal analysis of why the bonuses had to paid. This does not sound like the behavior a man who has the balls necessary to stand up to the many constituencies that want to roll right over him right now (which is the kind of man we need during this crisis). It sounds like the behavior of a man who is already thinking of how to defend a decision he knows is a bad one.
What Tim Geithner should have said, in our opinion, was "No." We're also not encouraged by Geithner's defense of AIG CEO Liddy in the penultimate paragraph (people are being unjustifiably mean to him, apparently). Edward Liddy is the CEO of a Fortune 500 company. By now, he should be able to look after himself. Our concern about Tim Geithner as Treasury Secretary during this crisis is that he's too close to Wall Street to make the kind of decisions that need to be made right now. This exchange bears that out.
Geithner faces critical test over bank plan
Tim Geithner, America’s beleaguered Treasury secretary, faces a critical test of his credibility when he unveils a much-awaited plan to take toxic assets off bank balance sheets – in an announcement expected in the coming days. Mr Geithner, whose initial announcement last month on the troubled asset purchase plan disappointed the market, has become the target of criticism in Washington and on Wall Street, with some questioning whether he can deliver. Speaking on condition of anonymity, senior Democratic figures questioned whether Mr Geithner has the credibility with the markets and Capitol Hill to push through a new request for funds. "The more time passes, the more convinced I am that Tim Geithner is becoming a liability for the administration," said one Democratic lawmaker.
Analysts say President Barack Obama would face steeper odds persuading Congress to authorise more money to recapitalise the banking sector if Mr Geithner was the one making the request. Mr Obama included a $250bn (€192bn) financial sector bail-out item in the budget he announced last month implying the administration will need up to $750bn more in troubled asset funds. "I don’t think Tim Geithner will last beyond June – he has no credibility with the markets," said Chris Whalen, managing director of Institutional Risk Analytics, a financial research group. "Given what we already know about the toxic asset purchase plan, I very much doubt he is going to turn this situation around." Mr Geithner, previously the head of the Federal Reserve Bank of New York, was initially hailed for his knowledge of the complex financial issues at the centre of the crisis – and for being a known quantity on Wall Street.
Treasury officials could not be reached for comment. But defenders of Mr Geithner, who remains the only official at the Treasury department to have been confirmed by the Senate, say he is being unfairly singled out as the lightning rod for the growing public anger on Wall Street’s misuse of emergency taxpayer funds. They say the Obama administration would have a difficult time requesting new bailout funds from Congress, whoever the Treasury secretary was. "I am quite certain that Tim Geithner has the full backing of the president and will continue to have it," said Roger Altman, a former senior Treasury official in the Clinton administration. "The main question is can anybody, including President Obama himself, persuade Congress to give new money in this climate?"
Mr Geithner is also attracting much of the blame for controversies over the misuse of funds that have already been disbursed – some of it under the Bush administration. On Tuesday, Richard Shelby, the ranking Republican member of the Senate banking committee, blamed Mr Geithner for the administration’s failure to prevent executives at AIG from paying out $165m in bonuses. On Monday, Mr Obama instructed Mr Geithner to explore every avenue to claw the bonuses back. AIG has received more than $170bn in public funds in the past four months. "What I want to ask, where was the secretary of the Treasury?" Mr Shelby told CBS News. "Why didn’t Treasury step in and let the American people know – just try to block it [the latest tranche of public money for AIG]?" On Tuesday night Mr Geithner said AIG would be forced to compensate taxpayers for the bonuses as a condition for receiving a further $30bn in government funds.
Ilargi: Eliot Spitzer says what I said yesterday: you're being played.
The Real AIG Scandal
by Eliot Spitzer
It's not the bonuses. It's that AIG's counterparties are getting paid back in full.
Everybody is rushing to condemn AIG's bonuses, but this simple scandal is obscuring the real disgrace at the insurance giant: Why are AIG's counterparties getting paid back in full, to the tune of tens of billions of taxpayer dollars? For the answer to this question, we need to go back to the very first decision to bail out AIG, made, we are told, by then-Treasury Secretary Henry Paulson, then-New York Fed official Timothy Geithner, Goldman Sachs CEO Lloyd Blankfein, and Fed Chairman Ben Bernanke last fall. Post-Lehman's collapse, they feared a systemic failure could be triggered by AIG's inability to pay the counterparties to all the sophisticated instruments AIG had sold.
And who were AIG's trading partners? No shock here: Goldman, Bank of America, Merrill Lynch, UBS, JPMorgan Chase, Morgan Stanley, Deutsche Bank, Barclays, and on it goes. So now we know for sure what we already surmised: The AIG bailout has been a way to hide an enormous second round of cash to the same group that had received TARP money already. It all appears, once again, to be the same insiders protecting themselves against sharing the pain and risk of their own bad adventure. The payments to AIG's counterparties are justified with an appeal to the sanctity of contract. If AIG's contracts turned out to be shaky, the theory goes, then the whole edifice of the financial system would collapse.
But wait a moment, aren't we in the midst of reopening contracts all over the place to share the burden of this crisis? From raising taxes—income taxes to sales taxes—to properly reopening labor contracts, we are all being asked to pitch in and carry our share of the burden. Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won't be laid off. Why can't Wall Street royalty shoulder some of the burden? Why did Goldman have to get back 100 cents on the dollar? Didn't we already give Goldman a $25 billion capital infusion, and aren't they sitting on more than $100 billion in cash? Haven't we been told recently that they are beginning to come back to fiscal stability? If that is so, couldn't they have accepted a discount, and couldn't they have agreed to certain conditions before the AIG dollars—that is, our dollars—flowed?
The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation.
So here are several questions that should be answered, in public, under oath, to clear the air:
- What was the precise conversation among Bernanke, Geithner, Paulson, and Blankfein that preceded the initial $80 billion grant?
- Was it already known who the counterparties were and what the exposure was for each of the counterparties?
- What did Goldman, and all the other counterparties, know about AIG's financial condition at the time they executed the swaps or other contracts? Had they done adequate due diligence to see whether they were buying real protection? And why shouldn't they bear a percentage of the risk of failure of their own counterparty?
- What is the deeper relationship between Goldman and AIG? Didn't they almost merge a few years ago but did not because Goldman couldn't get its arms around the black box that is AIG? If that is true, why should Goldman get bailed out? After all, they should have known as well as anybody that a big part of AIG's business model was not to pay on insurance it had issued.
- Why weren't the counterparties immediately and fully disclosed?
Failure to answer these questions will feed the populist rage that is metastasizing very quickly. And it will raise basic questions about the competence of those who are supposedly guiding this economic policy.
Hedge funds to America: Thanks for all that AIG money!
Billions of taxpayer dollars that the U.S. government gave to AIG to prop up the insurer could end up in the pockets of hedge funds that bet on a falling U.S. housing market, according to a story in the Wall Street Journal. No one knows how much will end up in the pockets of hedge funds or which hedge funds will benefit right now, but what is known is that $52 billion of taxpayer money has been spent to cover AIG's housing-related bets. Until AIG exited the market in 2006, "AIG was by far the single largest ultimate taker of risk in the [subprime mortgage] CDO space," a senior investment banker whose firm bought credit protection from AIG told the Journal. Essentially, the documents that the Journal has unearthed show that Wall Street banks were middlemen in trades with hedge funds. AIG insured those trades and was left holding the bag on billions of dollars of assets tied to souring mortgages.
AIG has already put money in escrow for Deutsche Bank (DB), whose hedge-fund clients made bets against the housing market. These funds will be paid off if mortgage defaults rise above a certain level. So while the U.S. is trying to prop up the housing market by limiting foreclosures, it's also paying out money to investors who bet housing prices would tumble and mortgage holders would default. "AIG's financial-products division went heavily into the business of speculation, and its gambling debts are what taxpayers are paying off right now." Martin Weiss, an investment consultant, told the Journal. Here's how the scheme worked: Hedge funds bet on mortgage defaults rising by buying financial instruments called credit default swaps from investment banks, such as Goldman Sachs and Deutsche Bank.
This is a form of insurance that pays out in the event of a debt default. It is unknown which hedge funds made these bets with specific banks, but it is known that these wagers were profitable for the hedge funds. The actual dollar profits and whose paying whom still needs to be exposed. The banks then wanted to protect themselves so they set up a complex set of financial instruments that were insured by AIG and other insurers. AIG was the biggest player in this gamble. The banks formed offshore companies known as collateralized debt obligations or CDOs. By doing this the banks neutralized hedge fund exposures, by buying swaps on the securities their clients were betting against. For example, in one deal cited by the Journal, AIG made less than $10 million annually on $1 billion worth of insurance. Now the U.S. taxpayer is paying for AIG's bad bets.
According to the Journal, from mid-September through the end of last year, AIG and the U.S. taxpayer paid $5.4 billion to Deutsche and $8.1 billion to Goldman Sachs when assets dropped in value. Some of this money could end up in the hands of hedge funds. Should we as taxpayers have an obligation to pay for bad bets made by an insurer? Unfortunately, since the U.S. now owns such a large stake in the company, we do. Our only hope for keeping our tax dollars our of the hedge funds' hands is if mortgage defaults stop. Maybe it's time for Congress to take another look at how it's taxing hedge fund profits.
AIG's "Best and Brightest"
"We cannot attract and retain the best and brightest talent," AIG says, unless they pay those bonuses -- $165 million. Barney Frank had the best and brightest reply: on the Rachel Maddow Show Monday night, he said: "I don't want to retain them." He's talking about the people at AIG who brought down the company and then the financial institutions and then the rest of the world economy. "If you are trying to undo mistakes," Frank said, "it‘s very often not a good idea to keep the people who made the mistakes in there."
But that $165 million is only the latest in outrageous payments to "the best and brightest" talent at AIG. The disaster was rooted in AIG's Financial Products Group in London. In 2008, when the unit was collapsing, "they were still paying the head of the unit a consulting fee of $1 million a month," according to Gretchen Morgenson of the New York Times, interviewed Monday on "Fresh Air with Terry Gross." That man's name, for the record, is Joe Cassano. He left AIG a year ago, and these days he is not giving interviews; Morgenson said he is "lawyered up."
And the claim that AIG needs to pay bonuses to the people who brought the company down is only the latest in outrageous arguments. AIG was collapsing because it didn't have sufficient capital reserves to pay the insurance claims on the risky financial instruments it insured. Normally insurance companies are required to have sufficient reserves to pay claims, but the people AIG was insuring against loss -- Deutsche Bank, Barclays, BNP Paribas - did not require it to put aside any reserve for future potential losses, Morgenson reports.
That's because AIG had such a high credit rating from Moody's and Standard and Poor's. But when people have tried to sue the rating companies for incompetence, Morgenson told Terry Gross, the companies claimed their ratings are "opinions, just like a newspapers opinions," and "are therefore protected by the First Amendment." The courts thus far have accepted that argument. The Obama Treasury Department apparently has accepted AIG's argument that it is contractually obligated to pay the bonuses – because the government cannot order a private company to break its contracts. Barney Frank had a good idea: the government wouldn't have to order a private company to break its contracts; the owners of the company could do that. "I want the American government to assert its right of ownership in this company," Frank told Rachel Maddow. "We own 80 percent. We should run the company."
A.I.G.'s bailout priorities are in critics' cross hairs
Every day, insurance companies sell policies to homeowners to cover the cost of damage in the case of fire. Why would those companies agree to pay out in full to a policyholder even if a fire had not occurred? That is the type of question being asked about the U.S. government's bailout of American International Group in which the insurance company funneled $49.5 billion in taxpayer funds to financial institutions, including Deutsche Bank, Goldman Sachs and Merrill Lynch. The payments, which amount to almost 30 percent of the $170 billion in taxpayer commitments provided to A.I.G. since its near collapse last September, were disclosed by the company on Sunday. The company had resisted identifying the recipients of the taxpayers' money for months, citing confidentiality agreements.
But instead of quieting the controversy, the disclosure of the amounts paid to A.I.G.'s customers has created still more questions and unease over the insurer's rescue, arranged by the Federal Reserve Bank of New York and the United States Treasury. Critics argue that the government's decision to pay buyers of A.I.G. credit insurance in full and across the board was an inappropriate use of taxpayer money. In addition, these people say, options not pursued by the government could have allowed taxpayers to benefit from future gains or at least have done a better job of limiting the potential for losses. The criticism surrounds the action taken by the government on credit insurance that A.I.G. had written and sold to large and sophisticated investors, mostly financial institutions. The banks that did business with A.I.G. bought credit insurance to protect against possible defaults on debt securities they held or had underwritten.
But when A.I.G.'s credit rating was cut last year, the company was required to post collateral on these insurance contracts. The need to quickly deliver cash that it did not have created the downward spiral that brought it to the brink. What upsets some people is that the government paid the counterparties in full even though the underlying securities had not experienced widespread, or perhaps even any, defaults. "It is inappropriate to be giving money to A.I.G. for them to give it out to their counterparties equally," said Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Connecticut, and an expert in insurance. "If we decide that another bank will be in trouble because A.I.G. fails, then we should decide explicitly that the bank should be supported. We should not simply give everybody 100 cents on the dollar."
When the government bought the underlying securities to cancel the insurance, the taxpayer became the owner of these pools of debt issues. Because the government chose to pay par or 100 percent of the face value, the taxpayer has downside risk if the securities lose value but virtually no upside. Even if none of the debt securities in the pools experience a default, the taxpayer is likely to receive no more than par ? what the government paid ? when they mature. Had the government negotiated for a lower price, say 75 cents on the dollar, the taxpayer might have been able to reap gains down the road. The top three recipients of money from the government related to the credit insurance A.I.G. had written are Société Générale, a French bank, at $11 billion; Goldman Sachs, at $8.1 billion; and Deustche Bank, at $5.4 billion.
A.I.G.'s disclosure of payments to its counterparties did not provide any details of how the government arrived at the prices it paid for the underlying securities. If it overpaid, the taxpayer is at greater risk of loss and the recipients may have received more than they were due. Another troubling aspect to some is that so many of the counterparties are foreign institutions. Indeed, of the 22 institutions that have received either collateral from the government or cash payments to close out credit insurance deals, 16 are foreign. "I find it impossible to understand why we as taxpayers are bailing out foreign banks," said Thomas H. Patrick, a founder of new Vernon Capital and a former top executive at Merrill Lynch. "If the shoe was on the other foot and major U.S. institutions were exposed to those banks, would the U.K. or the E.U. tax their citizens to pay off JPMorgan? There has to be some explanation of why we decided to do that."
The decision to protect foreign institutions from losses in an A.I.G. collapse may reflect how interrelated the global financial markets have become. That is the view of Adam Glass, a partner at Linklaters in New York and co-head of the firm's structured finance and derivatives practice. "It is an interconnected world," Mr. Glass said. "If UBS or these French banks collapsed, it is not just their problem. It is our problem because world economic activity would have been further impaired." Even though A.I.G. finally disclosed the names of the institutions that received so much of the government money that was thought to be going to A.I.G., the idea that it took six months still rankles some market participants. "The system was undermined by asking the American people, under the veil of secrecy, to bail out one company when in fact they wanted to bail out someone else," said Sylvain R. Raynes, an authority in structured finance and a founder of R & R Consulting, a firm that helps investors gauge debt risks. "The prospectus for the bailout was not delivered to the people. And it was not delivered because if it had been, the deal would not have gone through."
Scolding the Bonus Babies
As the crowd began to file into the East Room yesterday to hear President Obama's thoughts on the AIG bonuses, the pianist in the Grand Foyer of the White House struck up the tune "Killing Me Softly." It was an apt selection. AIG, the insurance giant at the core of the financial meltdown, struck again over the weekend, disclosing that it would use some of its $170 billion in federal bailout money to reward its employees with $165 million in bonuses. And Obama was left looking like a pitiful giant as his aides explained that there was absolutely nothing they could do to stop the obscene payouts -- even though the government owns 80 percent of AIG. As the president read from his teleprompter yesterday about "this outrage to the taxpayers who are keeping the company afloat," he developed a tickle in his throat and tried to clear it. "Excuse me," he joked. "I'm choked up with anger here."
But not enough. As Obama appeals for patience, his plans to stabilize the economy are at risk of being overtaken by a populist fury over the greed at AIG and in the rest of the financial industry. The president and his aides, armed with little more than their jawbones, seem powerless to stop the outrage. A Pew Research Center poll out yesterday found that 87 percent of Americans are bothered by the bank bailout -- and that was before word got out about the bonuses at AIG, which was rescued by an earlier federal bailout. The rising anger helps to explain why Obama's towering support has slipped to mere mortal levels. The Pew poll put the president's support at 59 percent, down from 64 percent last month, while a CNN poll found Obama down 12 points from early February.
Obama has complained about "shameful" bonuses -- billions of dollars' worth -- for Wall Street bankers. He has admonished companies receiving the federal bailout that "you can't go take a trip to Las Vegas or go down to the Super Bowl on the taxpayer's dime." And yesterday, Treasury Secretary Tim Geithner used a podium at the White House to plead with banks: "You need -- you need -- you banks need to make the extra effort to make sure that good loans are getting to creditworthy small businesses, in order to serve the larger public good." But the administration's bully-pulpit strategy isn't keeping pace with the spreading anger. Lawmakers erupted over the AIG news yesterday with demands for repayment and even a breakup of the insurance group.
They were significantly more agitated than Obama's economic lieutenant, Larry Summers, who told ABC News on Sunday that the administration has "done everything it can do" to limit the AIG bonuses. Further, he told CBS, "we're not a country where contracts just get abrogated willy-nilly." The willy-nilly Summers position was obviously untenable -- so Obama and Geithner tried again at yesterday's event with small businesses in the East Room. They arrived 20 minutes late for the event, where several seats were empty. Obama flashed a quick smile as he took the stage but then adopted a suitably grim expression. Geithner clenched his jaw so tightly his cheeks became discolored.
Geithner, the warm-up act, delivered what he said would be "a clear message to our nation's banks." But it wasn't all that clear. The only teeth in Geithner's message -- if they could be called teeth -- was that he was "asking" regulators to propose quarterly reporting of small-business loans, and that he would require banks receiving bailout funds to provide small-business loan figures in their monthly reports. Otherwise, Geithner was just begging. "We need our nation's banks to go the extra mile in keeping credit lines in place," he pleaded, tossing in a bit of guilt: "Given the role that many banks played in causing this crisis, you bear a special responsibility for helping America get out of it."
Obama picked up with the shaming and cajoling, this time directed at AIG. "This is a corporation that finds itself in financial distress due to recklessness and greed," he said. "Under these circumstances, it's hard to understand how derivative traders at AIG warranted any bonuses, much less $165 million in extra pay." So what's he going to do about it? "I've asked Secretary Geithner to . . . pursue every single legal avenue to block these bonuses and make the American taxpayers whole." But didn't Summers already say the administration has "done everything it can do"? The riddle was left for White House press secretary Robert Gibbs to solve at his afternoon briefing. "You guys first found about these bonuses last week?" ABC News's Jake Tapper asked.
"I think that's true, based on what I read in the newspaper," Gibbs replied. "But you gave money to AIG" -- $30 billion more in taxpayer funds -- "two or three weeks ago?" "Mm-hmm," Gibbs replied. Why didn't Geithner find out about the bonuses before he gave AIG the money? "I'll ask the Treasury that," Gibbs offered. Does Obama worry that the bonuses will further erode public support for the bailouts? "Well," Gibbs answered, "I think the president shares the concerns of millions of Americans." But if the president wants to keep ahead of the public fury, he'll need to do more than share the concerns; he'll need to act on them.
The dishonest "Blame Dodd" scheme from Treasury officials
There is a major push underway -- engineered by Obama's Treasury officials, enabled by a mindless media, and amplified by the right-wing press -- to blame Chris Dodd for the AIG bonus payments. That would be perfectly fine if it were true. But it's completely false, and the scheme to heap the blame on him for the AIG bonus payments is based on demonstrable falsehoods.
Jane Hamsher has written the definitive post narrating and indisputably documenting what actually took place. The attempt to blame Dodd is based on a patently false claim that was first fed to The New York Times on Saturday by an "administration official" granted anonymity by Times reporters Edmund Andrew and Peter Baker (in violation, as usual, of the NYT anonymity policy, since all the official was doing was disseminating pro-administration spin). The accusation against Dodd is that there is nothing the Obama administration can do about the AIG bonus payments because Dodd inserted a clause into the stimulus bill which exempted executive compensation agreements entered into before February, 2009 from the compensation limits imposed on firms receiving bailout funds. Thus, this accusation asserts, it was Dodd's amendment which explicitly allowed firms like AIG to make bonus payments that were promised before the stimulus bill was enacted.
That is simply not what happened. What actually happened is the opposite. It was Dodd who did everything possible -- including writing and advocating for an amendment -- which would have applied the limitations on executive compensation to all bailout-receiving firms, including AIG, and applied it to all future bonus payments without regard to when those payments were promised. But it was Tim Geithner and Larry Summers who openly criticized Dodd's proposal at the time and insisted that those limitations should apply only to future compensation contracts, not ones that already existed. The exemption for already existing compensation agreements -- the exact provision that is now protecting the AIG bonus payments -- was inserted at the White House's insistence and over Dodd's objections. But now that a political scandal has erupted over these payments, the White House is trying to deflect blame from itself and heap it all on Chris Dodd by claiming that it was Dodd who was responsible for that exemption.
Jane's post documents this sequence of events without any possibility for doubt. The debate that took place over limits on executive compensation for bailout-receiving companies only occurred six weeks ago, and it is all documented in the public press. Dodd was the one fighting against the White House in order to apply the prohibition to all bonus payments, i.e., to make the compensation limits retroactive as well as prospective. As but one crystal-clear example that proves this, here is a February 14 article from the Wall St. Journal on the debate over executive compensation limits:
The most stringent pay restriction bars any company receiving funds from paying top earners bonuses equal to more than one-third of their total annual compensation. That could severely crimp pay packages at big banks, where top officials commonly get relatively modest salaries but often huge bonuses.
As word spread Friday about the new and retroactive limit -- inserted by Democratic Sen. Christopher Dodd of Connecticut -- so did consternation on Wall Street and in the Obama administration, which opposed it.
Can that be any clearer? It was Obama officials, not Dodd, who demanded that already-vested bonus payments be exempted. And it was Dodd, not Obama officials, who wanted the prohibition applied to all compensation agreements, past and future. The provision which shielded already-promised bonus payments from the executive compensation limits ended up being inserted at the insistence of Geithner. A spokesperson for Dodd, who is now consumed by these completely unfair attacks, finally confirmed today that these provisions were inserted at the direction of Treasury officials:Senator Dodd’s original executive compensation amendment adopted by the Senate did not include an exemption for existing contracts that provided for these types of bonuses. Because of negotiations with the Treasury Department and the bill Conferees, several modifications were made, including adding the exemption, to ensure that some bonus restrictions would be included in the final stimulus bill.
During the debate over these provisions, The Wall St. Journal article identified above reported explicitly that it was Geithner and Summers who were rejecting Dodd's limits on executive compensation as too broad and demanding that already-vested payments be exempted: exactly the exemption that protected the AIG bonuses and which they're now trying to blame on Dodd:The administration is concerned the rules will prompt a wave of banks to return the government's money and forgo future assistance, undermining the aid program's effectiveness. Both Treasury Secretary Timothy Geithner and Lawrence Summers, who heads the National Economic Council, had called Sen. Dodd and asked him to reconsider, these people said.
At the same time, The Hill reported that "President Obama and the chairman of the Senate Banking Committee [Dodd] are at odds on how to rein in the salaries of top executives whose companies are being propped up by the federal government" and that "most of the administration's concern stems from the Dodd's move to trump Obama's compensation provisions by seeking more aggressive restrictions." Let's repeat that: the Obama administration was complaining because the compensation restrictions Dodd wanted were too "aggressive."
Yet now, the Obama administration is feeding reporters the accusation that it was Dodd who was responsible for the exemptions that protected already-vested bonuses. The Times article from Saturday that started the Dodd scandal thus contains this outrageously misleading claim:The administration official said the Treasury Department did its own legal analysis and concluded that those contracts could not be broken. The official noted that even a provision recently pushed through Congress by Senator Christopher J. Dodd, a Connecticut Democrat, had an exemption for such bonus agreements already in place.
And yet another New York Times article from today ("Fingers Are Pointed Across Washington Over Bonuses") -- this one by David Herszenhorn -- contains this White-House-mimicking, misleading passage:But Mr. Reid mostly ducked a question about whether Democrats had missed an opportunity to prevent the bonuses because of a clause in the economic stimulus bill, part of an amendment by Senator Christopher J. Dodd, Democrat of Connecticut, that imposed limits on executive compensation and bonuses but made an exception for pre-existing employment contracts.
That was the exact provision that Geithner and Summers demanded and that Dodd opposed. And even after Dodd finally gave in to Treasury's demands, he continued to support an amendment from Ron Wyden and Olympia Snowe to impose fines on bailout-receiving companies which paid executive bonuses (which was stripped from the bill at the last minute). But now that Treasury officials are desperate to heap the blame on others for what they did, they're running to gullible, mindless journalists and feeding them the storyline that it was Dodd who was responsible for these provisions. And today, during his White House Press Conference, Robert Gibbs advanced this dishonest attack by repeatedly describing the offending provisions as the "the Dodd compensation requirements."
This is working because, as the White House well knows, Dodd is very politically vulnerable. He is a major target of the Right because of his genuinely questionable involvement with various banks, including his Countrywide mortgate, and this story (fueled by the fact that Dodd is a receipient of substantial AIG campaign donations), inflames those accusations. As predictable as can be, right-wing news outlets like Fox, Drudge and others have blown this Dodd story up today into a major scandal -- heaping blame for the AIG payments on Dodd -- and it was all started by Obama officials to ensure that no blame for these provisions was laid where it belongs: at the feet of Geithner and Summers.
I'm not defending Chris Dodd here. As I said, there are all sorts of legitimate (though still unresolved) ethical questions about Dodd's personal financial matters. And if he were responsible for these compensation exemptions, then he ought to be blamed. But he simply wasn't responsible. He opposed them vehemently (The Hill at the time even noted that "Dodd is not backing down" from his opposition to the exemption that Geithner/Summers were demanding, and Jane has much more evidence, including the legislative history, conclusively demonstrating what really happened here). Geithner and Summers obviously thought that the exemption was justified when they were running around protecting those past compensation agreements, and they simply ought to explain why, rather than trying to sink Chris Dodd's political career in order to protect themselves.
The only point here is that what the White House and many journalists are claiming simply did not happen. They're just inventing a false history in order to blame the politically hapless Dodd for what Geithner and Summers did. And they're being aided by a right-wing noise machine that knows Dodd is vulnerable and which views the opportunity to blame the AIG bonuses on him, probably accurately, as a final nail in his political coffin (Media Matters today details today the right-wing falsehoods in the attacks on Dodd by documenting that the claims against Dodd are inaccurate, but they don't say who was actually responsible for the exemption). The next reporter who writes a word about this or listens to anonymous White House officials blame Dodd for these provisions might want to spend a moment reading Jane's post and looking at the evidence showing what actually happened, rather than mindlessly writing down what
Rahm Emanuelthese anonymous White House officials are whispering in their ears.
* * * * *
Speaking of The New York Times, that paper asked six legal experts to opine for its online edition on whether AIG would be able to evade the bonus obligations in its employment contracts. My contribution to their forum can be read here and the others can be read here. Almost uniformly, the contributions demonstrate just how frivolous Summer's Sunday excuse was for the payment of these bonsues -- that the sanctity of contracts left no way out.
UPDATE: Just in case the point wasn't yet crystal clear, here is a Think Progress report from February 15, 2009, reporting on the White House/Dodd dispute over the executive compensation provisions. Is there any doubt which party was the one demanding weaker and narrower executive compensation limits? (hint: it wasn't Dodd):
UPDATE II: Rather oddly, the NYT article I quoted above, by David Herzsenhorn, has been moved on the NYT site and is now at this link (see here). Most importantly, it has been re-written to reflect that fact that it was not Dodd who inserted the exception for past contracts:
But Mr. Reid mostly ducked a question about whether Democrats had missed an opportunity to prevent the bonuses because of a clause in the stimulus bill, that imposed limits on executive compensation and bonuses but made an exception for pre-existing employment contracts.
Senator Christopher J. Dodd, Democrat of Connecticut, who initially proposed adding executive compensation and bonus limits to the stimulus bill, did not include the exception.
In the place of the Herzsenorn article is now this article by Jackie Calmes and Louise Story that also includes the Dodd version of events:
Mr. Geithner reiterated the Treasury position of that lawyers inside and out of government had agreed that “it would be legally difficult to prevent these contractually mandated payments.”
That position was being questioned at the Capitol. Congressional Republicans, eager to implicate Democrats, initially blamed Senator Christopher J. Dodd, the Connecticut Democrat who heads the banking committee, for adding to the economic recovery package an amendment that cracked down on bonuses at companies getting bailout money, but that exempted bonuses protected by contracts, like A.I.G.’s.
Mr. Dodd, in turn, responded Tuesday with a statement saying that the exemption actually had been inserted at the insistence of Treasury during Congress’s final legislative negotiations.
Something in the last couple of hours caused The New York Times to change the way it is reporting this matter so that it is no longer mindlessly reciting the false White House attempt to blame Dodd for the bonus exemption, but instead is at least including a version of the truth.
What Does AIG's Future Hold?
As AIG's chief heads to Congress, some of the thorny problems facing the insurer include its troubled asset sales and the billions paid to counterparties. American International Group's executive team shouldn't expect a warm welcome when it goes before Congress on Mar. 18. Americans are up in arms about the $165 million in bonuses paid to AIG (AIG) executives, and Congress has noticed. Rather than an information-gathering session, the executives should be ready to face a grilling worthy of Torquemada. "It's going to be a witch hunt," says Dory Wiley, chief executive of boutique investment banking firm Commerce Street Capital. American taxpayers own 80% of AIG at a cost of $173 billion in loans and guarantees. But the value of that investment is shrinking by the day.
"They're holding a deteriorating asset," says Adam Lerrick, a scholar at the American Enterprise Institute and a former investment banker. "They're losing clients, businesses, and good people, and the assets [soon] won't be worth much." There are important questions that should be asked, but probably won't be, about how taxpayers are going to recoup even a small portion of their investment. The focus should be on resolving the issues at AIG, not on righteous anger and revenge. In the current rage, Lerrick says, elected officials would be wise to start thinking like investors. To do that, they need to dig below the headlines. Start with the bonuses. It seems inconceivable that anyone working for a company that has cost taxpayers billions should get million-dollar payouts. But there are arguments for the pay. For starters, the skills these managers possess are still in demand. UBS (UBS) and Deutsche Bank (DB), among others, have been raiding U.S. financial firms for brokers and other financial professionals. Nor are there many incentives for employees to stay put.
AIG Financial Products employees are being paid to clean up the unit and wind it down. When they complete their task, they will be out of a job. "You don't punish the cleanup crew," says Rob Sloan, head of U.S. financial services at Egon Zehnder International. Congress may wonder why it was important to retain everyone who was rewarded with a bonus for staying on the job. After all, some of these same workers undoubtedly helped get AIG into the financial mess. And according to New York Attorney General Andrew Cuomo, 11 of the 73 AIG employees who received retention bonuses of more than $1 million no longer even work at AIG. They also need to ensure that the incentives are designed correctly to balance performance and retention. Lean too far to the retention side, and employees will be rewarded for keeping the unit going as long as possible, rather than liquidating it for the best value.
But if any payments are based on past agreements, rather than the new order, anger would be justified. "That would be troubling," says Sloan. AIG Chief Executive Officer Edward Liddy himself has been critical of the bonuses. "I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them," he wrote in a Mar. 14 letter to Treasury Secretary Timothy Geithner. If investors really want to get angry, they should take a look at how management of AIG has been handling its asset sales. A big part of AIG's restructuring plan involves selling profitable units to pay back the government. But these asset sales have been a disaster, despite the presence of veteran insurance CEO and dealmaker Paula Reynolds, who was brought into AIG to handle the restructuring. For instance, the sale of AIG's Asian businesses (AIA) was announced in October and financial details were supposed to be available to bidders by the end of that month.
Instead, the prospectus wasn't available until February, and it was a scant 65 pages long and contained information only through August 2008. Bidding, unsurprisingly, was light and the unit was taken off the market. "There is no coherent effort internally to sell the assets in an organized M&A process," says Steve Czech, head of hedge fund SJC Capital Partners. Congress needs to ask what went wrong. "The process to gauge market interest in AIA was very thoughtful and deliberate," says AIG spokesman David Monfried. "This is the most difficult market in years and years, and to date nobody has the ability to raise the capital that reflects the worth of this company." The asset sales are small change compared to the $100 billion plus paid to AIG's counterparties. This information, released by AIG on Mar. 15, confirmed what many suspected since October—that a large portion of the government's investment in AIG became a backdoor bailout to the world's banks.
Goldman Sachs got $13 billion, Société Générale (SOGN.PA) received $12 billion, and $12 billion went to Deutsche Bank, nearly 100% of what they were owed. That strikes some financial professionals as egregious. If AIG had filed for Chapter 11 bankruptcy in September, those same firms would have gotten in line with other creditors and received pennies on the dollar. There's no reason AIG couldn't have negotiated better terms, says Lerrick. "Everyone should have [been] marked down 20%." Most important, Congress needs to know how Liddy and his team plan to get taxpayers out of this mess. Some experts argue that AIG should have filed for Chapter 11 in September, and that bankruptcy remains the best option. "Dissolution would be painful," says Martin Weiss, chairman of the Weiss Group, a research group. "But it would not take a Herculean effort to rearrange things and shift responsibility to a receiver." AIG, however, continues to operate under its original plan to raise cash by selling off successful businesses, liquidate AIG Financial Products, and pay the government back. Legislators will likely demand specifics on how that's going to happen and when. And if Liddy can't do that, some in Congress may begin to demand someone who can.
Paying Workers More to Fix Their Own Mess
We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury.— Edward Liddy, chief executive, American International Group
Ah, retention pay. It has been one of the great rationales for showering money on chief executives and bankers regardless of how well they are doing their jobs. It’s just that the specific rationale keeps changing. In the booming 1990s, companies supposedly had to pay retention bonuses because executives had so many other job opportunities. There was a war raging — a war for talent, said McKinsey & Company, the consulting firm. Then came the aftermath of Enron, when new scrutiny and regulations apparently made some chief executives wonder if they still wanted their jobs. "I’m thinking of actually getting out," David D’Alessandro, the head of John Hancock Financial Services, reported hearing from one fellow chief executive. The antidote to such doubts? Retention pay, obviously.
Now comes Mr. Liddy, the government-appointed chief of A.I.G., defending multimillion-dollar bonus payments for the people who run the small division that brought down the company. If the government doesn’t let them have their money, they will walk away, Mr. Liddy says, and nobody else will know how to clean up their mess. We’ll get to the merits of his argument in a moment, but it’s first worth considering the damage that the current system of corporate pay has wrought. The potential windfalls were so large that executives and bankers had an incentive to create rules that would reward them no matter what. The country is now living with the consequences. So any attempt to build a new financial system, one that’s less susceptible to bubble, bust and bailout, will have to include a new approach to pay. Yes, the issue is thorny. Some past attempts to rein in pay have ended up being feckless or even counterproductive. But that is no reason to give up.
Nothing highlights the fiction of performance-based pay quite so well as retention bonuses. It turns out that, at least for chief executives, retention bonuses are almost entirely unnecessary. A few years ago, when the economy was still expanding, I looked into every large company that had changed chief executives over the previous six months. Not a single boss at any of them had left for another job. Such departures are so rare that Booz & Company’s annual study of executive turnover doesn’t even include a category for them. The benefits of the job — the pay, the perks, the gratification that comes from running a company well — are too good to leave, even for a similar job.
The situation is a little different for jobs below the top level, particularly on Wall Street. Surely, if the employees of A.I.G.’s notorious financial products division were to be denied their bonuses — a big chunk of their annual compensation — many might leave. The nub of Mr. Liddy’s argument is that these departures would be a terrible thing. But there are several weaknesses with this argument. The first is that the original explanation for these bonuses was rather different. When they were devised in early 2008, months before the first bailout, as Mr. Liddy’s letter to the government on Saturday explained, "A.I.G. Financial Products was expected to have a significant, ongoing role at A.I.G." The idea, he said, was to guarantee "a minimum level of pay for both 2008 and 2009." So the rationale for A.I.G.’s retention bonuses is as malleable as the rationale for chief executives’ bonuses.
Most amazingly, the A.I.G. bonuses haven’t even accomplished their stated goal. Andrew Cuomo, New York’s attorney general, said Tuesday that 52 employees who received bonuses had since left A.I.G. The second problem with Mr. Liddy’s argument has to do with Mr. Liddy himself. His defenders have noted that the government brought him out of retirement to fix A.I.G. and that he presumably puts a higher priority on doing a good job than pleasing A.I.G.’s employees. And he probably does. But he is also a product of the current, broken executive pay system. As the chairman of Allstate from 1999 to 2007, when the company’s stock underperformed those of its rivals, he made $137 million. Almost $14 million of that, according to the Corporate Library, came in the form of stock that the company called a "a tool for retaining executive talent." Which means Mr. Liddy may not be entirely objective about retention bonuses.
Finally, there is the question of how hard replacing those A.I.G. employees would be. Certainly, some of them must have particular insight into unwinding the toxic portfolio they built. But I doubt that anywhere near all 418 financial products employees — who have received bonuses worth $395,000 on average — are indispensable. Simon Johnson, a former chief economist at the International Monetary Fund, has pointed out that in financial crises, bankers often exaggerate the difficulty of cleaning up their mess. They do so partly to justify their own continued importance and also to fight off calls for a government takeover of banks. In reality, Mr. Johnson says, the mechanics of cleaning up hobbled banks turned out to be fairly straightforward during other recent crises, like the Asian one in the ’90s.
It’s entirely understandable, then, that the Obama administration, the Federal Reserve and Congress are looking for creative, legal ways to claw back some of the bonuses. That bonus money is really taxpayer money: absent a bailout, no A.I.G. would exist to pay bonuses. The larger question is how to change the rules on corporate pay to reduce the odds of future crises. Throughout this crisis, policy makers, starting with President George Bush and Ben Bernanke and now including President Obama, have been a bit too deferential to Wall Street. That deference has fed populist anger, which threatens the political viability of the necessary continuing bailout of the credit markets. The bonus scandal offers Mr. Obama and Mr. Bernanke a chance to get ahead of the curve — so long as they come up with changes that extend well beyond A.I.G. The starting point would be a rigorous analysis of whether the government can take specific steps to restrain pay. Some thoughtful management experts think any such efforts are doomed to fail.
Others are more optimistic. "There are ways to do it," says Lucian Bebchuk, a Harvard Law professor. Across-the-board caps on pay don’t make sense. But perhaps the government can prevent companies from claiming a corporate tax deduction on any pay above a certain threshold. The current limit, which is $1 million, applies only to base salaries and thus has little meaning. Or perhaps companies can be penalized if they pay bonuses based on short-term profits, as A.I.G., Lehman Brothers and just about every other company recently has. The Fed made a suggestion along these lines recently, but it didn’t do anything more than ask nicely. If no such ideas proved workable, there is still one more option. Today’s tax code makes no distinction between income above $373,000 and income above, say, $5 million. Both are taxed at 35 percent.
That is a legacy of the tax changes of the early 1990s, when far less of the nation’s income went to millionaires. Today, you can make a good argument for a new, higher tax bracket on the very largest incomes. In the past, the economist Thomas Piketty says, higher marginal tax rates tended to hold down salaries and bonuses, because executives had less incentive to angle for multimillion-dollar pay. Do these ideas stem in part from anger and bitterness? Of course they do. How can you not be a little angry and bitter about the role that huge, unjustified pay played in causing the worst recession in a generation? In fact, that’s sort of the point. Given the damage that’s been caused by our decidedly unmeritocratic system of paying executives, the most irrational course of all would be the status quo.
Cuomo Discovers All Kinds Of Outrageous AIG Bonus Facts
Andrew Cuomo is on the AIG bonus case. And he's loving it, and wrote a letter to Barney Frank. Some highlights:
AIG now claims that it had no choice but to pay these sums because of the unalterable terms of the plan. However, had the federal government not bailed out AIG with billions in taxpayer funds, the firm likely would have gone bankrupt, and surely no payments would have been made out of the plan. My Office has reviewed the legal opinion that AIG obtained from its own counsel, and it is not at all clear that these lawyers even considered the argument that it is only by the grace of American taxpayers that members of Financial Products even have jobs, let alone a pool of retention bonus money. I hope the Committee will take up this issue at its hearing tomorrow.
Furthermore, we know that AIG was able to bargain with its Financial Products employees since these employees have agreed to take salaries of $1 for 2009 in exchange for receiving their retention bonus packages. The fact that AIG engaged in this negotiation flies in the face of AIG's assertion that it had no choice but to make these lavish multi-million dollar bonus payments. It appears that AIG had far more leverage than they now claim. AIG also claims that retention of individuals at Financial Products was vital to unwinding the subsidiary's business. However, to date, AIG has been unwilling to disclose the names of those who received these retention payments making it impossible to test their claim. Moreover, as detailed below, numerous individuals who received large "retention" bonuses are no longer at the firm. Until we obtain the names of these individuals, it is impossible to determine when and why they left the firm and how it is that they received these payments.
If AIG were confident in its claim that those who received these large bonuses were so vital to the orderly unwinding of the unit, one would expect them to freely provide the names and positions of those who got these bonuses. My Office will continue to seek an explanation for why each one of these individuals was so crucial to keep aboard that they were paid handsomely despite the unit's disastrous performance... Already my Office has determined that some of these bonuses were staggering in size. For example:
• The top recipient received more than $6.4 million;
• The top seven bonus recipients received more than $4 million each;
• The top ten bonus recipients received a combined $42 million;
• 22 individuals received bonuses of $2 million or more, and combined they
received more than $72 million;
• 73 individuals received bonuses of $1 million or more; and
• Eleven of the individuals who received "retention" bonuses of $1 million or more are no longer working at AIG, including one who received $4.6 million;
Again, these payments were all made to individuals in the subsidiary whose performance led to crushing losses and the near failure of AIG. Thus, last week, AIG made more than 73 millionaires in the unit which lost so much money that it brought the firm to its knees, forcing ~
taxpayer bailout. Something is deeply wrong with this outcome. I hope the Committee will address it head on. We have also now obtained the contracts under which AIG decided to make these payments. The contracts shockingly contain a provision that required most individuals' bonuses to be 100% of their 2007 bonuses. Thus, in the Spring of last year, AIG chose to lock in bonuses for 2008 at 2007 levels despite obvious signs that 2008 performance would be disastrous in comparison to the year before. My Office has thus begun to closely examine the circumstances under which the plan was created.
U.S. Considers Expanding TALF to Distressed Assets
The Obama administration is considering using a new Federal Reserve program designed to spur consumer lending to help remove distressed assets from banks’ balance sheets, according to people familiar with the matter. Officials may meld the Treasury’s plan to set up private investment funds to buy frozen assets with the Fed program, known as the Term Asset-Backed Securities Loan Facility, the people said. The Federal Deposit Insurance Corp. may also get a wider role, the people said. Treasury Secretary Timothy Geithner may use an array of approaches to maximize the likelihood of cleansing banks’ balance sheets so they can start lending again. The next announcement, which may come as soon as this week, will be critical after Geithner’s first unveiling of the strategy caused a sell-off in financial stocks.
"The markets are just getting increasingly nervous, the longer they wait to announce the plan," said Stephen Myrow, a former Treasury official in the Bush administration who helped create the TALF. The TALF would provide loans to investors and agree to take illiquid debt as collateral, the people said. It would be used alongside the Treasury’s planned public-private investment funds. As it’s currently set up, the TALF may lend as much as $1 trillion to investors from hedge funds to pension funds and insurance companies to buy recently created securities backed by loans for car purchases, college education and real estate. Applications for its first loans are due tomorrow. Broadening the TALF to include older, illiquid and lower- rated securities could allow the participants in the public- private investment funds to potentially repackage assets and sell them on to a wider group.
The TALF is supported with money from the $700 billion bank- rescue fund passed by Congress in October. The Bush administration originally set aside $20 billion to seed $200 billion in loans; Geithner has proposed raising the government contribution to $100 billion. The facility could need additional money to address so-called legacy assets. The Fed’s policy-making committee, which met today in Washington, said in its statement that the range of eligible collateral for the TALF "is likely to be expanded to include other financial assets." The Federal Open Market Committee also announced about $1.1 trillion of extra measures to revive financial markets, including purchases of long-term Treasuries. The FDIC’s role may also expand to help finance the administration’s initiative, and perhaps to run an aggregator- type unit that would purchase whole loans -- those not packaged into other securities -- three people said. FDIC officials have extensive experience dealing with nonperforming loans from their role in taking over failed banks.
The rollout of details on the toxic-asset plan could slip into next week as the Treasury grapples with a growing furor over bonuses awarded by insurer American International Group Inc. AIG has been given more than $170 billion in government aid. President Barack Obama has ordered Geithner to "pursue every legal avenue" to recoup money distributed to employees in an AIG unit that sold credit-default swaps and whose bad bets helped touch off the financial crisis.
Geithner told reporters after meeting with international counterparts outside London last week that his plan was likely to emerge "in coming days." Details of the strategy could still change. The Treasury secretary disappointed markets and lawmakers when he didn’t provide many specifics about the distressed asset clean-up in his Feb. 10 unveiling of the administration’s approach.
Dealing with the illiquid securities also bedeviled former Treasury chief Henry Paulson, who ultimately decided to scrap his plans and instead spent almost half the bank-rescue funds injecting capital into financial institutions. To expand the program, the Treasury will need the agreement of the Fed. Opening the TALF to legacy assets "is the most effective and efficient way to purge troubled assets from the financial system while maximizing taxpayer protection," Myrow said. To guard against losses the Fed would take so-called haircuts, or discounts on the loans, for the collateral it accepts. The FDIC option, pushed by Chairman Sheila Bair, could be known as the Asset Disposition Facility, the people familiar with the matter said. Under one scenario being discussed, the FDIC may attach a government guarantee to the assets and then sell them to investors.
It’s not clear when Obama will need to ask Congress for more money to continue to fund the bank-rescue program. Most of the $700 billion has already been allocated to existing programs. "We’re talking about big numbers here," said Kevin Petrasic, a former official at the Office of Thrift Supervision, who is now a lawyer at the Paul, Hastings, Janofsky & Walker law firm in Washington, adding that Congress is still "smarting" from having to dole out $700 billion for saving Wall Street. "This is a difficult market right now, and there are lots and lots of challenges as far as Treasury and the Fed are concerned," he said. "The margin for error is very slim."
To TALF, or not to TALF
The long-awaited Federal Reserve program aimed at thawing the frozen credit markets got underway this week. Will it work? The government's efforts to tame the credit crisis faces one of its biggest tests yet as the Federal Reserve finally launches a $1 trillion program aimed at reviving lending for both consumers and business. Last November, the Fed announced the creation of the Term Asset-Backed Securities Loan Facility, or TALF. Under the plan, the Fed will effectively serve as a matchmaker, partnering buyers and sellers of newly issued, top-rated securities backed by a variety of loans including student, small business, auto and credit card loans. The TALF program was originally supposed to start in February, but an expansion of the program and several adjustments to it have pushed back its launch until now.
Now there are questions about whether the program will bring about the results regulators are hoping for. "That is the worry - is it going to be effective?" said Ken Alverson, managing director at the New York City-based financial services consultancy Novantas. As global financial markets remain under pressure, so has investor demand for securities backed by a variety of consumer and business loans. That makes it incredibly difficult for lenders that rely on securitization to make new loans. Last year, the volume of loan securitization worldwide plummeted by $2.4 trillion from where it stood in 2006, according to the American Securitization Forum. The industry group estimates nearly half of all consumer loans depend on securitization.
The Fed is hoping that TALF will push banks and other finance companies to keep making new loans. To help coax reluctant investors to buy the securities, the central bank is offering buyers cheap financing and only requiring them to pay a small portion of the purchase price up front. Many believe that the participation of private investors, such as hedge funds, private equity firms and mutual funds, could very well determine the success or failure of the program. There has been widespread speculation that investor interest may be relatively robust, but there are stumbling blocks. One hitch, experts said, is that the maturity dates of many of these securities don't match up with TALF loans, which last three years. An investor looking to snap up an asset-backed security that matures a year later, for example, could run into refinancing difficulties, be forced to sell the investment or have to give it back to the Fed.
Regulators may prove willing to make such changes, said Julie Spellman Sweet, a corporate partner at law firm Cravath, Swaine and Moore, much in the same way they have tinkered with the program after it was unveiled last fall. Since its inception, the Fed has increased the size of the program from $200 billion to $1 trillion, and widened the scope of TALF to include securities backed by commercial real estate mortgages. It is believed that the program could also, at some point, include corporate debt and mortgages not guaranteed by Fannie Mae and Freddie Mac. In addition, the Obama administration may also be considering expanding the TALF program to help banks remove toxic assets from their balance sheets, according to a report from Bloomberg on Wednesday.
Requests for comment from both the Treasury and the Fed about this report were not immediately returned. But the Fed's policymaking committee said in a statement Wednesday that it "anticipates that the range of eligible collateral [for TALF] is likely to be expanded to include other financial assets." Nonetheless, Tanya Beder, chairman of advisory firm SBCC Group, which focuses on the financial services industry, said there is still a lack of certainty about the value of the assets backing the securities that buyers are expected to purchase. "There is a terrific degree of uncertainty surrounding cash flows and what instruments are worth right now," said Beder. Top officials, including Neil Barofsky, special inspector general of the Treasury's Troubled Asset Relief Program, or TARP, have also warned in recent months that there is a risk that Fed could accept securities that have been overvalued.
Even a mild response from investors could go a long way to helping financial firms that rely heavily on asset-backed securities as a source of funding for new loans. But some experts wonder just how enthusiastically some lenders will reenter the securitization market. Traditional commercial banks for example, have been raising credit requirements lately to steel themselves against further loan losses. At the same time, the appetite for new consumer loans has waned as many Americans try to rein in their spending during the recession. But banks may also have more attractive alternatives when it comes to making new loans, according to experts. That could also impair the effectiveness of the TALF program.
Tanya Azarchs, credit analyst and managing director for Standard & Poor's, wrote in a note to clients earlier this month that traditional deposits or even the billions of dollars in capital that the industry has received through TARP could be a more inexpensive option for some banks. At the same time, some lenders may be reluctant to accept more government funding. Several banks that received TARP money have complained loudly about the growing number of rules that lawmakers have imposed on participants in the program. The Fed overturned original TALF rules that would have required lenders to abide by the same executive compensation restrictions that were folded into the TARP program. But with the Treasury pitching in to help fund the program, bankers worry that the government could impose demands as it sees fit. "Potential participants have seen that the rules have changed [with TARP]," said Alan Avery, a partner in the financial services group at the law firm Arnold & Porter. "There is some concern that it may happen in TALF as well."
Fannie, Freddie Retention Bonuses 'Reasonable,' Lockhart Says
Retention bonuses for executives at Fannie Mae and Freddie Mac, seized by federal regulators last year, are reasonable and protect taxpayer’s investment in the mortgage-finance companies, their regulator said today. "It’s a reasonable and well thought-out plan," James Lockhart, director of the Federal Housing Finance Agency, said today after a speech in Washington. Lockhart said the companies’ employees are among their most valuable assets and that retaining key personnel was critical for the regulator when the two were placed into conservatorship in September.
The retention plan was announced shortly after the government takeover, and the companies reported the bonuses in recent securities filings. Fannie’s filing says that Chief Operating Officer Michael Williams will receive a bonus of $611,000 this year, the Wall Street Journal reported today. Executive Vice President David Hisey is to be paid $517,000, and Executive Vice Presidents Thomas Lund and Kenneth Bacon are to receive $470,000 each, the Journal reported. "What we’re trying to do is protect and keep the government’s investment," Lockhart said after a luncheon hosted by Women in Housing & Finance.
Freddie Mac: The Government's Next Black Hole?
AIG is to date the most expensive corporate bailout in American history, requiring $180 billion of government funds. But it may soon have competition. Last week, mortgage giant Freddie Mac said that it had lost $50 billion in 2008 alone. A look at the company's books suggests the government will have to spend at least triple that much to save the financial firm from collapse. If the housing market worsens, the tab could even be larger. "Freddie's portfolio of [mortgage] insurance is more risky than the market was led to believe," says Paul Miller, an analysts at FBR Capital Markets. Sister company Fannie Mae lost even more last year, with $58.7 billion of red ink. But Fannie was better capitalized than Freddie going into the credit crunch. So even though Freddie by many measures is smaller than Fannie, the problems at Freddie will probably end up costing more.
Citigroup and other banks have also lost money, and will need more capital to survive. But in those cases it's not clear who will take the hit - shareholders, bondholders or the government. In the case of AIG, Freddie Mac and Fannie Mae, however, there is no question where the money will come from. Freddie and Fannie were taken over by the government and put into conservatorship last fall. AIG is now 80% owned by the government. The losses at those companies are now taxpayer losses. And like AIG, Freddie has had to come back to the government a number of times with cup in hand. The mortgage giant has already received $14 billion in government aid. After the fourth quarter loss of $24 billion, the company said it needs an additional $31 billion from the government to keep the lights on.
Freddie's business, which in part comes from a government mandate, is insuring mortgages. So when borrowers lose their jobs, as many now are, Freddie is going to lose money. But only a quarter of Freddie's red ink, or about $13 billion, comes from mortgage insurance woes. The firm took a larger hit from its investment in mortgage-backed securities tied to subprime, adjustable-rate or jumbo mortgages. By law, Freddie isn't allowed to insure against losses on those types of mortgages, in part because they are riskier. But it bought securities tied to those home loans anyway - which it is allowed to do - in order to capture the higher rates of return that those mortgage bonds offered. Unfortunately, the bets didn't pay off. Freddie lost $16 billion on those investments.
Another bet that didn't pay off for Freddie was on interest rates. The firm's managers bought derivatives that would pay out if interest rates rose. Instead, a global financial meltdown has caused interest rates to plummet. That resulted is a $15 billion loss for Freddie from its hedges. Freddie lost another $1 billion on bonds tied to short-term loans made to Lehman Brothers. Like Lehman, that investment went belly up. Then there are all the houses it now has to repossess as people stop paying their mortgages. The company now owns about 30,000 homes. Maintaining these houses cost about $3,300 a month each, and that comes on top of the loan loss, which is typically about one-third of the size of the mortgage. Wave goodbye to another billion. When will the red ink at Freddie stop? It's hard to say. In its most recent annual report, the company said that if it had to mark all of its assets to the price similar bonds are trading for in the market, the company's net worth would sink by another $65 billion. But Freddie's bottom line woes may run deeper even than that. Freddie has $38 billion in losses it has yet to acknowledge in its investment portfolio.
The firm also has additional $48 billion in non-performing loans that it either holds or has guaranteed against. In a painful stroke of irony, there is a $15.4 billion line item on the asset side of Freddie's balance sheet for deferred taxes. That means Freddie is still hoping to claim $15 billion in write-offs against future profits. But since Freddie continues to lose money, and because it is now part of the government, the likelihood that the company will have to pay taxes anytime soon is probably nil. Add all those items up, and it becomes apparent that the government will likely spend more than $100 billion in additional funds cleaning up the mess at Freddie. "The losses at Freddie show the pressure the banking system as a whole is under," says Fred Cannon, chief equity strategist at Keefe, Bruyette & Woods. "Freddie is going to need more capital, but they are not alone."
Morgan Stanley should scrap $3 billion bonuses: senator
Morgan Stanley should be barred from paying as much as $3 billion to entice brokers to stay when the company and Citigroup Inc merge their brokerage operations, U.S. Senator Robert Menendez said. In a Tuesday letter to U.S. Treasury Secretary Timothy Geithner, Menendez, a New Jersey Democrat, urged the government to use "every legal means available" to stop the payouts as long as Morgan Stanley receives support from taxpayers. "These payouts constitute misuse of taxpayer money," Menendez wrote. "Some on Wall Street don't understand that they, more than anyone, cannot be permitted to carry on with business as usual. These times demand shared sacrifice."
The senator said the payouts, like bonuses paid at troubled insurer American International Group Inc, are "essentially the same form of extra compensation" and are "not fully necessary to retain executives in this tough financial market." Morgan Stanley has taken $10 billion and Citigroup $45 billion from the government's Troubled Asset Relief Program (TARP). Christy Pollak, a Morgan Stanley spokeswoman, said each award is "not a bonus," but is a nine-year "forgivable loan" that must be paid back if a broker leaves sooner. "The program is necessary because our financial advisers are being poached by competitors," Pollak said. The cost is covered by operating revenue of the joint venture and not government TARP money."
About 6,500 of the venture's 20,000 brokers are expected to be eligible for awards, which would be made in 2010 and 2012. Retention awards are paid to keep brokers from defecting after a company is bought. Financial companies getting taxpayer money are facing heavy pressure from Congress and regulators to limit pay. "If you want this venture to succeed, then this type of award is necessary," said Danny Sarch, founder of recruiting firm Leitner Sarch Consultants Ltd in White Plains, New York. "If the awards are cut back, they will have dramatically more attrition than they would otherwise. The rest of the industry would have a field day in recruiting."
Under the payout plan, brokers who generate at least $1.75 million in revenue a year may get awards equal to 105 percent of their annual production, a person familiar with the plan said last month. The person was not authorized to publicly discuss details of the plan. Wells Fargo & Co (WFC.N), which bought Wachovia Corp at the end of 2008, said last month it will not issue retention awards to about 14,600 brokers from Wachovia's brokerage arm, Wachovia Securities. Morgan Stanley is paying Citigroup $2.7 billion for an initial 51 percent stake in their venture, and may take full control after five years. A closing is expected this summer.
General Motors Checkmates Obama In Two Moves
The wooden but plucky CEO of GM, Rick Wagoner, told the press that if his company is allowed to go into Chapter 11, it will end up being a simple liquidation. GM will be torn into pieces and sold off as scrap. He made one good point to support his point of view. If a bankruptcy of the No. 1 U.S. car company drags on for several months, potential auto buyers will purchase vehicles from competitors that they view as being "safe". No one wants to buy a car that won't be serviced. Wagoner has made this point before, but it is more compelling now that the deadline for the government to approve or disapprove GM's restructuring plan is only two weeks away.
GM has effectively taken a page out of the AIG playbook for gaming the Administration and Congress. Henry Paulson and his associates were led to believe, perhaps rightly, that if AIG failed it would cost other financial companies so significantly that the government would have to bailout almost every large financial firm in the country. GM's argument is even simpler. A liquidation of the car firm would probably cost tens of thousands of jobs at the company, and many times that at suppliers. That argument is also old, but with the chance of liquidation in the next few months becoming more likely, it refreshes the strength of the logic.
GM has been in the middle of quietly challenging the government's plan to close it down for three months now. The Administration has now sent its car experts to Detroit, and they have said that a bankruptcy of either GM or Chrysler is undesirable. They did not elaborate much on this analysis, but, from the standpoint of the car companies, they do not need to. It is enough that the blue chip analysts sent by the President to evaluate the car companies have a belief system that matches the one in The Motor City.
The financial and car industries have effectively ganged up on the government. They would seem to be weak because of their remarkable failures and reliance on outside help to keep them alive. The opposite is true. By being terribly crippled, they are sucking all of the money out of the U.S. Treasury because the Administration knows that if these parts of American business fail, replacing the jobs and capital will be insurmountable tasks. The recession would get much, much worse. Staying ahead of the job losses would become impossible.
AIG has led the way for GM. It has taken government money and made it clear that a great deal of the cash has been wasted. Even with the evidence of that completely uncovered, the Administration has so little power that it cannot let AIG go under, as a punishment for taking taxpayer money and using it for multimillion dollar bonuses. No one at GM is going to get a raise because the government will give it another $20 billion or $30 billion. The car industry embezzlement is more artful. With more than one million jobs at risk and unemployment rising at a pace rarely seen in American history, letting GM fail would completely compromise any chance of keeping the unemployment rate below 10%. If this figure rises above that number, it will make every American shudder.
GM to cut prices to lure back US buyers
General Motors is preparing a fresh barrage of discounts and other promotions to coax Americans into buying more cars after an upcoming US government decision on further financial aid to the Detroit motor industry. The incentives will be designed to counter a slump in sales and GM’s market share, amid signs on both sides of the Atlantic that its financial woes are beginning to drive away customers. GM and Chrysler have so far received $17.4bn in emergency loans from the government and are seeking billions more. However, they need to prove their viability to a government task force.
Steven Rattner, a former private equity investor who is a key member of the task force, told the Detroit Free Press yesterday that the group was committed to meeting the March 31 deadline. He added, however: "It’s more than likely that what you will see is not a single announcement...but rather a series of actions over perhaps a reasonably long period of time." While stressing that GM does not know what the group will recommend, a spokesman said on Monday that "the kind of positive news coming out of that is something we can build on". He added that "the biggest concern for us is the fundamental softness in the market. The level of sales is unsustainable."
GM’s share of US light vehicle sales sank to 18.3 per cent last month from 19.5 per cent in January and an average of 22.6 per cent in the final two months of 2008. The company’s viability plan is based on a 20 per cent share. In Europe, where GM is seeking a €3.3bn ($4.3bn) bail-out from governments led by Germany, the company’s market share was 8.6 per cent in January and February, down from 9.4 per cent a year ago. Jessica Caldwell, an analyst at Edmunds.com, an online car-pricing service, said that uncertainty about GM’s future was "definitely part of the reason" for its falling sales in the US. According to surveys by Oregon-based CNW Marketing Research, prospective buyers’ interest in GM and Chrysler vehicles is well below their recent market shares. The gap is especially wide for Saturn, Saab and Hummer, three GM brands threatened with extinction. In Europe, sales of Saab, which filed for bankruptcy last month, are down 55 per cent year on year.
Treasurys Are 'Disaster Waiting to Happen': Dr. Doom
The Federal Reserve has no option but to start buying Treasurys as the government's needs for financing are huge, but the government bond market is a disaster in the making, Marc Faber, editor and publisher of The Gloom, Boom & Doom Report, told CNBC. Federal Reserve policymakers start a two-day meeting on Tuesday, weighing options on how to spur lending to help cash-strapped consumers kickstart the economy. Economists expect them to leave rates at zero and look to other ways of boosting liquidity, such as buying government bonds – a measure which has already been taken by the Bank of England. "Well I think other central banks have done it already around the world but basically what it amounts to is money printing and in fact I don't think that it will help the bond market at all in the long run," Faber told CNBC's Martin Soong.
The yield on the 30-year Treasurys touched a low of 2.51 percent last year in December but now it is back up at 3.77 percent, he said. "Yields have already backed up pretty substantially and I tell you, I think the US government bond market is a disaster waiting to happen for the simple reason that the requirements of the government to cover its fiscal deficit will be very, very high," Faber said. "The Federal Reserve will have to buy Treasurys, otherwise yields will go up substantially," he said, adding that as their reserves were dwindling, foreign investors were likely to scale down their purchases.
But there will be a time when the Federal Reserve will have to increase interest rates to fight inflation, and it will be reluctant to do so because the cost of servicing government debt will rise substantially. "So we'll go into high inflation rates one day," Faber said. The stock market is likely to continue its bounce at least for a while, but the outlook is bleak, he added. "I think we may still have a rally (in the S&P) until about the end of April and probably then a total collapse in the second half of the year sometimes, when it becomes clear that the economy is a total disaster," Faber said.
U.S. Congress must tackle "too big to fail" problem
Congress should identify banks or other financial institutions that have become so large their failure poses a systemic risk and should put them under federal supervision, according to the Independent Community Bankers of America. "Excessive concentration has led to systemic risk and the banking crisis that we now face," C.R. Cloutier, president of MidSouth Bank in Louisiana, told the U.S. House of Representatives antitrust subcommittee on Tuesday. Cloutier, who represented the Independent Community Bankers of America, said the presidents of smaller institutions thought it unfair that large banks were bailed out, while community banks were shuttered when they ran out of funds. "Community banks are angry," he said.
He called for an interagency task force that would identify banks that were so embedded in the U.S. financial network that they had become too big to fail. These would be put under federal supervision, potentially the Federal Reserve. The large banks themselves would be required to fund this oversight. Albert Foer, head of the independent American Antitrust Institute, said antitrust challenges in the courts were unlikely to succeed and urged the creation of a new position in the Justice Department -- deputy assistant attorney general for emergency restructuring -- to argue for antitrust concerns while crucial decisions were being made.
"Congress should assure that a loud competition voice is heard," said Foer, who argued the government should stop mergers that could create "an unreasonable systemic risk." Over the past year, the top tier of the U.S. banking industry has changed drastically as venerable names disappeared, either into bankruptcy or absorbed into larger organizations. In March 2008, JPMorgan Chase & Co agreed to buy the investment bank Bear Stearns Cos. Following that, Lehman Brothers Holdings Inc sank into bankruptcy, JPMorgan has absorbed the failed Washington Mutual Inc, Bank of America Corp bought Countrywide Financial Corp and agreed to salvage Merrill Lynch & Co. Meanwhile, Wells Fargo & Co acquired Wachovia Corp.
Fed Delays Securities Limits to Boost Banks’ Capital
The Federal Reserve will delay by two years limits on capital held at bank-holding companies to help lenders maintain adequate funding as they weather the worst financial crisis since the Great Depression. "This action is being taken in light of continued stress in financial markets and the efforts of bank-holding companies to increase their overall capital levels," the Federal Reserve said in a news release today. The Fed action postpones implementation of rules initially set to take effect March 31. The requirements would have limited the amount of cumulative perpetual preferred stock, trust preferred securities and minority interests in the equity accounts included in banks’ Tier 1 capital.
U.S. regulators are moving to bolster the health of the nation’s banking industry, which posted its first quarterly loss in 18 years in the fourth quarter amid loan losses stemming from the collapse of the subprime mortgage market. The Fed rule, adopted in 2005, would create "a substantial burden" on lenders if implemented this month, the central bank said. "In the prevailing market conditions, it is especially important for bank-holding companies to expand efforts to increase their overall capital levels, although it is challenging to do so now through retention of earnings, the most typical means," the Fed said. The delay allows banks to hold higher levels of Tier 1 capital, a measure of financial strength and ability to absorb losses. Also known as core capital, it includes common stock, retained earnings and perpetual securities.
The change "provides much-needed flexibility to banks in strengthening their core capital," Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, said in an e-mailed statement. "The action demonstrates the Fed’s continuing effort to facilitate the ability of bank holding companies to raise capital at a time when investors are reluctant to commit resources without significant incentives," Gilbert Schwartz, a former Fed attorney and a partner at Washington law firm Schwartz & Ballen LLP, said in an e-mailed statement. The Fed move is "significant" because it will allow banks to continue issuing trust preferred securities at the 25 percent level compared with the new 15 percent level for purposes of Tier 1 capital, Schwartz said.
Fed scopes out options with key rate near zero
With a key interest rate already near zero, Federal Reserve policymakers are weighing what other tools they can use to jolt the country out of recession. Fed Chairman Ben Bernanke and his colleagues resume their two-day meeting Wednesday, and at its conclusion they are all but certain to leave a key bank lending rate at a record low to try to bolster the economy, which has been stuck in a recession since December 2007. Economists predict the Fed will hold its lending rate between zero and 0.25 percent for the rest of this year and for most -- if not all of -- next year. The hope is that rock-bottom borrowing costs will spur Americans to step up spending, which would aid the economy. So far, though, hard-to-get credit, rising unemployment and other negative forces have forced consumers and businesses to retrench. Against that backdrop, Bernanke and his colleagues have pledged to use "all available tools" to battle the financial crisis and turn the economy around.
One option advanced at its last meeting in January is buying long-term Treasury securities. Doing so would help further drive down mortgage rates and help the crippled housing market, economists said. Another option put forward in January is expanding a Fed program aimed at bolstering the mortgage market. The Fed could boost its purchases of debt issued or guaranteed by mortgage giants Fannie Mae and Freddie Mac. Since that program was announced late last year, mortgage rates have fallen. "The main message the Fed will want to convey is that policymakers still have tools and options to support the economy," said Mike Feroli, economist at economist at JPMorgan Economics. Fallout from housing, credit and financial debacles -- the worst since the 1930s-- has thrown millions of Americans out of work, driven a growing number of banks out of business and forced the government to put up hundreds of billions of taxpayers' money to bail out troubled financial companies.
Much is riding on a new program, created by the Fed and the Treasury Department, to spur lending for auto, education, credit card and other consumer loans. The Fed later this month will start providing up to $200 billion in financing to investors to buy up such debt. The program could generate up to $1 trillion of lending for businesses and households, the government says. It will be expanded to include commercial real estate, though that component won't be part of the initial rollout. There are risks to pumping more money into the economy, bailing out financial institutions and leaving a key rate near zero for too long. Those steps could ignite inflation, put ever-more taxpayers' money in danger and encourage companies to make high-stake gambles, confident the government stands ready to rescue them. Fed officials meet as public outrage over government bailouts of financial institutions has swelled.
What has really touched a public nerve: The fact that American International Group Inc. -- bailed at four times by the U.S. government to the tune of more than $170 billion -- paid millions in bonuses to employees who worked in a division that has been blamed for the insurance company's near collapse last year. The bonuses came even as the company reported a stunning $62 billion loss, the biggest in U.S. corporate history. Fury expressed by the public as well as Democrats and Republicans on Capitol Hill over the AIG case could make it politically harder for the Obama administration and the Fed to sell new financial rescue efforts. Stabilizing the nation's financial system is key to turning around the economy, Bernanke has repeatedly said. If that can be done, then the recession might end this year, setting the stage for a recovery next year, he said. Even in this best-case scenario, though, the nation's unemployment rate now at quarter-century peak of 8.1 percent will keep climbing. Some economists think it will hit 10 percent by the end of this year.
Crisis having "major" impact on central bank reserve management
Global financial turmoil has had a "major" impact on the reserve management policies of two thirds of central banks and almost all are rethinking diversification tactics, a survey showed on Wednesday. The survey of 39 central banks who control reserve assets worth $3.2 trillion, just under 42 percent of the world's total, showed reserve managers were much more conservative and cautious last year than a year earlier. Reserve managers expressed "great concern" about credit and liquidity risks, with over two thirds of respondents saying they experienced bouts of illiquidity in even the major bond markets.
Over 90 percent of respondents to the survey conducted by Central Banking Publications said they have been forced to reassess counterparty risk and most said the hunt for diversity and yield in recent years has been severely curtailed. The majority of respondents in the survey, carried out late last year, also said they expect reserves to fall as the crisis unfolds before recovering to only "marginally" above current levels over the next four years. "The unprecedented changes to the financial landscape witnessed over the last (few) months have dramatically altered previous paradigms and beliefs," said a respondent from a central bank in the Americas.
"These events have increased risk aversion and central banks have not been an exception." This was in stark contrast to the findings in last year's survey, which showed reserve managers still inclined to seek yield and almost 60 percent of them saying derivatives were an attractive asset class in which to invest FX reserves. This year's survey showed that as the financial turmoil ebbed and flowed reserve managers, like most other investors, opted for safety. "Less credit and more 'plain vanilla' instruments are preferred," said one European reserve manager. Over two thirds said they had experienced illiquidity in important government bond markets, and the survey said reserve managers had expressed surprise that even these markets had frozen up as spreads widened and trades failed to settle.
Almost 80 percent of respondents said government bonds rated AA or higher were a more attractive investment than a year earlier, 61 percent said the same for agency paper and 57 percent said gold was a better investment. Between roughly two thirds and all the respondents said virtually every other asset class was a less attractive investment than a year ago: equities, mortgage-backed securities, derivatives, lower-rated government bonds, commodities and hedge funds, amongst others. "In view of the coming recession in the world economy, almost all the listed instruments are considered too risky for central bank investments," said an Asian reserve manager. The survey's findings also suggested there had been a loss of faith in credit rating agencies.
Just over half the respondents said they had altered the way they judge credit quality, with some of their comments noting a downgrading of agencies' assessments and an increasing recourse to other external indicators such as credit default swaps, share prices, and/or a strengthening of internal models. In terms of reserves' currency composition, 74 percent of respondents said there was no change over the year in the number of currencies they invested in, and 94 percent of them said they didn't even consider investing in other currencies. "Central banks have refrained from diversifying their reserves in terms of currencies," the survey noted. "Whereas previous surveys had revealed interest or active allocation in non-traditional reserve currencies, that was not the case in 2008."
Reserve managers believe overall reserve levels will fall this year as countries draw down the cash needed to fund the huge financial and economic rescue packages needed to fight recession. Most believe reserves will slowly accumulate again over the next four years but a significant minority -- almost a quarter -- believe the crisis will bring the build up in reserves over recent years to a shuddering halt.
Why saving the world economy should be affordable
by Martin Wolf
Can we afford this crisis? Will governments destroy their solvency, as they use their balance sheets to rescue over-indebted private sectors? The debate, as it has so often been, is between the US and Germany. Thus, in a speech last week, Tim Geithner, US Treasury secretary, noted that, "The IMF has called for countries to put in place fiscal stimulus of 2 per cent of aggregate GDP each year by 2009-10. This is a reasonable benchmark to guide each of our individual efforts. We think the G20 should ask the IMF to report on countries’ stimulus efforts scaled against the relative shortfall in growth rates." Needless to say, no such firm pledge was forthcoming, with Germany particularly resistant. Nevertheless, a great deal of fiscal stimulus has occurred. This is what readers of recent research on the aftermath of financial crises by Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard would expect. These authors concluded from studying 13 big financial crises that the average rise in real public debt in the three years following a banking crisis was 86 per cent. In some of these cases, the increase was more than 150 per cent*.
So, is there good reason to expect huge increases in public sector indebtedness across the globe, not least in triple A rated sovereign borrowers ? The answer is: yes. If so, does this guarantee defaults of some kind? The answer is: no. In a recent paper, the staff of the International Monetary Fund suggest why these are the right answers**. By 2012, suggests the IMF, the ratio of gross public debt to gross domestic product could be 117 per cent in Italy; 97 per cent in the US; 80 per cent in France; 79 per cent in Germany; and 75 per cent in the UK. In Japan, still scarred by the legacy of a huge bubble, the ratio could hit 224 per cent. Current forecasts are evidently much higher than those made before the crisis hit. Yet the jumps in indebtedness are not particularly onerous, provided the willingness of governments to avoid default is not in question. Assume, for example, that the real interest rate these highly rated countries pay is 1 percentage point higher than the long-term growth rate of their economies. Then the requirement for stabilising a ratio of public debt to GDP at 100 per cent is a primary budget surplus (surplus before interest) of just 1 per cent of GDP. Nevertheless, three counter-arguments can be advanced.
First, in some cases, primary fiscal deficits are very large. Among bigger advanced countries, this is particularly true for this year – in the US, forecast at minus 9.9 per cent of GDP; Japan and the UK, both forecast at minus 5.6 per cent; and Spain, forecast at minus 4.9 per cent. The primary deficits of France, Germany and Italy are far smaller, at minus 3.6 per cent; minus 1.1 per cent; and plus 1.1 per cent, respectively. So stabilising debt requires large fiscal adjustment in some countries. Second, the political willingness to curb deficits, by raising taxes or cutting spending, may come into question. This could become a self-fulfilling prophecy, with flight from debt raising interest rates, necessitating ever more costly (and so less plausible) fiscal tightening. Third, the ultimate rise in indebtedness could be far bigger than the IMF forecasts. This would be consistent with experience. The primary explanation would be that the world economy is embarked on a prolonged balance-sheet deflation, comparable to Japan’s in the 1990s.
I would argue against these points. First, markets are optimistic about the fiscal prospects: expected inflation remains well contained in the US and UK and interest rates on conventional 10-year US and UK government bonds are still below 3 per cent. Second, the cost of meeting the added burden of ageing is far higher than any plausible cost of the crisis. On IMF forecasts, the present value of the fiscal costs of ageing in the US is 15 times the cost of the crisis. Third, it makes no sense to avoid action that would greatly lower the real economic costs of the crisis now, to eliminate a hypothetical and avoidable fiscal crisis later on. This would be like committing suicide in order to stop worrying about death.
Nevertheless, it is wise to limit longer-term fiscal risks. The most important actions are to curb long-term age-related spending. But there is also a current agenda: rebalancing of world demand. Surplus countries subcontract to their trading partners the job of spending oneself into bankruptcy, while lecturing the latter on their profligacy. Thus the reason the US, the UK and Spain have huge fiscal deficits is that they are offsetting the collapse of private spending at home and the export of demand abroad. This is unsustainable, in the long run. The danger now is that the surplus countries expect recovery to come from enormous and sustained fiscal expansion in deficit countries. Some analysts argue that the US should have refused to take fiscal action at all, leaving it to surplus countries. Unfortunately, that would have meant a global depression. Nevertheless, without rebalancing there can be no healthy recovery. On this point, the US is right and Germany is wrong.
*The Aftermath of Financial Crises, January 2009, www.nber.org
**The State of Public Finances, March 2009, www.imf.org
Buffett Is Unusually Silent on Rating Agencies
In his annual Berkshire Hathaway letter, Warren E. Buffett recently urged investors to pose tough questions at the shareholders meeting in May. Here is one on the mind of some Buffett watchers: When are you going to fix Moody’s? Mr. Buffett, known as the Oracle of Omaha, owns a stake of roughly 20 percent in the Moody’s Corporation, parent of one of the three rating agencies that grade debt issued by corporations and banks looking to raise money. In recent months, Moody’s Investors Service and its rivals, Standard & Poor’s and Fitch Ratings, have been prominent in virtually every account of the What Went Wrong horror story that is the financial crisis.
The agencies put their seals of approval on countless subprime mortgage-related securities now commonly described as toxic. The problem, critics contend, is that the agencies were paid by the corporations whose debt they were rating, earning billions in fees and giving the agencies a financial incentive to slap high marks on securities that did not deserve them. At least 10 of the big companies that failed or were bailed out in the last year had investment-grade ratings when they went belly up — like deathly ill patients bearing clean bills of health. Moody’s rated Lehman Brothers’ debt A2, putting it squarely in the investment-grade range, days before the company filed for bankruptcy. And Moody’s gave the senior unsecured debt of the American International Group, the insurance behemoth, an Aa3 rating — which is even stronger than A2 — the week before the government had to step in and take over the company in September as part of what has become a $170 billion bailout.
Mr. Buffett, 78, one of the world’s richest men, is known for piquant and unsparing criticism of his own performance, as well as the institutional flaws of Wall Street. But on the subject of the conflict of interest built into the rating agencies’ business model, Mr. Buffett has been uncharacteristically silent — even though that conflict is especially glaring in his case because one of the companies that Moody’s rates is Berkshire. (Its Aaa rating, for the record, is the same as the one from Standard & Poor’s. Fitch downgraded Berkshire for the first time last week.) Mr. Buffett also seems to have said nothing about a problem that some contend is just as serious and endemic: because ratings are required in so many transactions, the agencies’ inaccurate ratings have no effect on their own bottom lines. And a company that is paid regardless of its performance is a company that will eventually underperform, says Frank Partnoy, a professor of law at the University of San Diego.
"Imagine if you had a rabbi and said, ‘All the laws of kosher depend on whether this rabbi decides if food is kosher or not,’ " says Mr. Partnoy, a former derivatives trader. "If the rules say ‘You have to use this rabbi,’ he could be totally wrong and it won’t affect the value of his franchise." The rating agencies have been mislabeling the goods for a long time. "A lot of investors have been eating pork recently," Mr. Partnoy says, "and they’re not too happy about it." Mr. Buffett declined to be interviewed for this article. Of course, he has bigger problems on his mind than a company that makes up less than $2 billion of his $127 billion empire. Berkshire Hathaway, the conglomerate he has run for decades, recently reported its worst year ever: in the fourth quarter, net income fell 96 percent to $117 million.
Short-selling Berkshire Hathaway has recently become a popular strategy, according to a report in Bloomberg News. But betting against Mr. Buffett has never been a profitable strategy in the long term, and the company’s class A shares, which now trade at about $82,000, way off the 52-week high of $147,000, look tempting to many analysts. Justin Fuller, a partner at Midway Capital Research and Management and author of the blog Buffetologist, says that anyone buying shares of Berkshire now is essentially buying the company at its 2004 price and getting everything that Mr. Buffett acquired since then gratis. "During the dot-com boom everyone said the old man had lost his touch, because he said he wouldn’t invest in technology companies," Mr. Fuller says. "When all the brick-and-mortar stock valuations improved, he was lauded as a genius again. He’s able to recognize these manias and waits for the world to go crazy, then comes in as lender of last resort and scoops up assets on the cheap."
Mr. Buffett has been scooping. In the last year, he dipped into his multibillion-dollar war chest and also sold some shares in a variety of companies to add to his holdings, which now include preferred shares of Goldman Sachs and General Electric, each of which pays Berkshire 10 percent annually on its investment. But he has also made an ill-timed deal to buy shares of ConocoPhillips and he acquired two Irish banks that have fared poorly, decisions he describes in his annual letter as a few of the "dumb things" he did in 2008. He does not say much about his stake in Moody’s, and close readers of his letters say he has a history of highlighting some errors in order to obscure subjects he would rather not discuss. "Warren deserves credit for his candor in admitting mistakes," says Alice Schroeder, author of "The Snowball," a biography of Mr. Buffett. "But he chooses which mistakes to discuss. It also pays to listen for the ‘dog that didn’t bark.’ " One of those nonbarking dogs, she says, is Moody’s. "He hasn’t discussed publicly what he might be doing to influence the management at this time of crisis," she says. "Last spring, he knew the rating agencies were deeply involved with the financial crisis. Since he didn’t sell Moody’s then, he should explain what he’s doing to influence the management."
Moody’s, meanwhile, believes the ratings system may need tinkering but it is not broken. Michael Adler, a Moody’s spokesman, said the company’s role was simply to assess the odds that a given bond issuer will default — in some cases, taking into account the possibility of government intervention. He said anyone who makes assumptions about the stock price of those issuers based on Moody’s findings about its bonds is misusing the data. (A lot of investors are misusing the data, in that case.) Mr. Adler also stated in an e-mail message that there were potential conflicts of interest with any ratings system, whether issuers, government or investors pay. "Moody’s, for its part, has implemented a series of changes and procedural safeguards to help mitigate potential conflicts and increase the transparency of our analysis," Mr. Adler wrote. "That said, we believe that a healthy dialogue with regulators and other capital market participants is beneficial."
But not all models for paying rating agencies are equally risky, says a former Moody’s managing director, Jerome S. Fons — and none is more vulnerable to conflicts of interest than the issuer-pays model. Mr. Fons, who left the company in 2007 as part of a reorganization, says that Mr. Buffett has long found his connection to Moody’s a little awkward. Mr. Buffett never attended any board meetings, he says, and Berkshire has never bought any additional shares after it acquired its stake in 2000 as part of a deal with Dun & Bradstreet, then its parent company. It is widely assumed that Mr. Buffett does not use rating agencies at Berkshire: like many leading investors, he employs his own researchers. "I think he’d love to sell his stake in the company, but he can’t," Mr. Fons says. "As soon as it was known that he was selling, the value of the company would plunge." It is hard to expect any capitalist to push for change that squeezes profits. Then again, Mr. Buffett is not just any capitalist. He is the closest thing that the United States economy has to a life coach.
Typically, chief executives who show up on television after announcing their worst year ever offer some variation of "Don’t worry, America, I’ll do better soon." When Mr. Buffett appeared on CNBC last week, the subtext was more like, "Don’t worry, America, you’ll do better soon." (He said that though the economy had "fallen off a cliff," he was, as ever, bullish about the country’s long-term prospects.) Mr. Buffett is more than just our reassurer in chief. He also has a history of speaking out against parts of the financial system he considers broken or unfair, even if those parts benefit him. He is one of the few superrich people in favor of steeper estate taxes, for instance. Given how hard it would be to revamp the rating agencies, and given his credibility and the impact that reform would have on his portfolio, Mr. Buffett may be ideal for a job that no other executive or public official could do: rating agency reform. "Nobody is better positioned than Buffett," Mr. Fons says. "If he comes up with a good plan, people would pile on immediately. And if he really is a high-minded idealist, if he wants to leave a meaningful legacy, this would be it."
Financial Journalists Fail Upward
"Listen, you knew what the banks were doing and yet were touting it for months and months," said "Daily Show" host Jon Stewart to CNBC superstar Jim Cramer in their much-discussed confrontation last week. "The entire network was, and so now to pretend that this was some sort of crazy, once-in-a-lifetime tsunami that nobody could have seen coming is disingenuous at best and criminal at worst." The applause Mr. Stewart has received for his j'accuse is the sound of the old order cracking. We have turned on the financial CEOs, inducting them one by one into the Predator Hall of Fame. We have gone deaf to the seductive rhythms of the culture wars. We have tossed out the politicians whose antigovernment rhetoric seemed invincible for so long.
And now comes the turn of the bubble-blowers of pop culture, the army of fake populists who have prospered for years by depicting the stock market as an expression of the general will, as the trustworthy friend of the little guy buffeted by a globalizing economy. We know -- or we think we know -- about the roles played by other culprits in the debacle. The government regulators, for example: How could they have ignored the coming disaster? Well, they were incapacitated by decades of deregulation. What about the market's own watchdogs? Well, from appraisers to ratings agencies the whole tough-minded system was apparently undermined by conflicts of interest. But what about the syndicated columnists and the beloved stock pickers and the authors of personal finance best-sellers, the industry for which CNBC is the perfect symbol? How did they manage to miss the volcano under their feet?
Mr. Cramer, for his part, had the forthrightness to confess his errors and admit his limitations. "I'm not Eric Sevareid. I'm not Edward R. Murrow," he pleaded. "I'm a guy trying to do an entertainment show about business for people to watch." But the larger problem won't go away. And it's not just a matter of people missing the biggest economic story of the last 20 years. It's a matter of those who minimized it and those who blew it off because it didn't fit their worldview continuing in their plum positions of authority. Mr. Stewart wasn't rude enough to ask it, but over all his inquiries there hung the obvious question: Why do you still have a job, Mr. Cramer? If the world of financial infotainment can itself be described as a "market," it is a market where accountability does not seem to exist, where the heaviest of incentives seems to carry no weight, and where consumers, to judge by what they get, seem constantly to choose the lousy over the good. The old order discredits itself, but the old order persists nevertheless.
This needs to be repeated every time someone pleads, "Who could have known?" Plenty of people did see the disaster coming. Most of them were marginalized, however, laboring at out-of-the-way econ departments, blogs and B-list think tanks. They were excluded and even ridiculed because their larger understanding of the economy was not one that fit well with the sort of Wall Street worship preached by the likes of CNBC. Nor is this a particularly liberal line of inquiry, despite Jon Stewart's well-known fondness for tormenting Republicans. It was a question that interested Milton Friedman, among others, who could be seen musing on the subject in a 1994 TV interview that C-Span chose to rebroadcast on Sunday. The occasion was the 50th anniversary of the publication of Friedrich Hayek's "The Road to Serfdom." As he looked around him, Friedman marveled at the world's perverse refusal to learn certain lessons, even when history itself drove them home. Everyone had by then learned that government was too large, he said, but countries kept on growing government anyway.
Friedman may have misread the direction in which the world was moving in 1994, but the question he raised is still a good one. Bad ideas and clueless pundits often do get on top, and they stay there -- sometimes hailing incentives and accountability, even -- despite all manner of rebukes handed down by history itself. The reasons the financial-entertainment biz failed us are many and complex, but they ultimately come down to this: In the marketplace to describe the marketplace itself, there is precious little competition. There is a single, standard product that comes in packaging that is alternately sultry, energetic or fun -- bitter, brainy or Cramer "crazy" -- but which rarely strays beyond certain ideological boundaries. Adversarial voices are few. Criticism is sacrificed for access. Advice sometimes shades over into simple propaganda. Even the worst prognosticators sometimes go on to jobs with presidential campaigns or prominent think tanks. And the small investors whom the personal-financial industry claims so much to adore remain bystanders in a drama they neither understand nor control.
Citigroup's top economist tapped for Treasury post
Citigroup's chief economist is being tapped for a job at the short-staffed Treasury Department, which is at the center of the Obama administration's efforts to battle the financial crisis. Lewis Alexander will become a counselor to Treasury Secretary Timothy Geithner, according to a government official who spoke on condition of anonymity because a formal announcement has not been made. Alexander will work on domestic finance matters, the official said. Alexander had worked at the Federal Reserve and also served as the Commerce Department's chief economist in the 1990s. Geithner so far has battled the crisis with no key deputies in place. That's made for a rocky start for the man President Barack Obama put on the front lines of the financial crisis.
Treasury's handling of a $700 billion financial bailout fund has drawn fierce criticism from Congress and the American public. The government has put up hundreds of billions of taxpayers' dollars to rescue troubled financial companies, including American International Group, Bank of America and Lewis Alexander's own Citigroup Inc. In late February, the government said it will exchange up to $25 billion in emergency bailout money it provided Citigroup for as much as a 36 percent ownership stake in the struggling bank, a move that could put taxpayers at greater risk. The deal represented the third rescue attempt for Citigroup in the past five months. It's contingent on private investors agreeing to a similar swap.
As a Wall Street insider from a bank that has been one of the largest recipients of government rescue funds, Alexander's appointment could raise some eyebrows. In December 2007, he was quoted as saying that while he believed the housing market would remain weak well into 2008, it was more likely that the economy would keep growing than head into recession, adding that the housing bubble was "correcting on its own."
Ilargi: Three quarters of all US mortgage applications are now refi's. That's a lot of people losing the non-recourse status on their loans. As prices keep plunging, many will come to regret this. No more walking away for them.
U.S. mortgage applications spike on refinance demand
U.S. mortgage applications surged in the latest week, driven by a spike in demand for refinancing as the average rate on 30-year fixed-rate home loans fell, the Mortgage Bankers Association said on Wednesday. Refinancing applications jumped 30 percent in the week ended March 13 as the borrowing rate dipped 0.07 percentage point to 4.89 percent, tying the record low reached in early January in a survey that dates to 1990. The MBA's market index, which includes both purchase and refinance loans, jumped 21.2 percent to 876.9, the highest since mid-January.
But purchase applications rose just 1.5 percent last week to 257.1, a one-month high. The Mortgage Bankers Association said its seasonally adjusted refinancing applications index jumped 29.6 percent in the week ended March 13 to 4,497.6, also the highest level since mid-January. Home loan rates have fallen as the government has purchased more than $250 billion of mortgage-related assets and announced unprecedented steps to stabilize the deepest housing slump since the Great Depression. A year ago, the average rate on a 30-year mortgage was closer to 6 percent.
The Federal Reserve purchases of mortgage-related assets is nearing the half-way mark targeted by the end of June to help cut mortgage costs and revive housing. The programs are widely expected to be expanded to bring borrowing costs down, stimulate purchases and help struggling homeowners to refinance and avert foreclosure. Demand for purchases has been lagging refinancing applications. While homeowners are often compelled to cut current costs, worries about job loss or hopes that prices will cheapen further have keep many potential buyers at bay. Refinancings requests represented about 73 percent of all mortgage applications last week.
Owners skulking away from "underwater" U.S. homes
Ron Barnard is throwing in the towel. Like a growing number of the 8.3 million American homeowners who owe more on mortgages than their homes are worth, he's ready to just walk away. Barnard and others like him are starting to worry market experts and economists, who fret that the growing trend may deal a blow to an economy on its knees while swelling an already ample pool of bad loans. While others persist in draining savings and running up credit card debt in a last-ditch bid to save their homes, a growing number see no point in making boom-level mortgage payments in a bust market -- with no bottom in sight. "People are hurting," said Barnard, who includes himself in that group. "They're scared or they're angry,"
In California's Inland Empire east of Los Angeles, where Barnard lives and sells real estate, median home values have plunged more than 40 percent in the last year as formerly sidelined buyers snapped up foreclosed properties. Those bank-owned homes moved at fire-sale prices that decimated the value of neighboring homes -- many of which are owned by people who have limited "skin in the game" because they put little or no money down at purchase. Deflating home prices thus threaten to accelerate a negative feedback loop that has sent prices lower, said economist Ed Leamer, director of the UCLA Anderson Forecast. "Should the downward spiral in home prices, neighborhood condition and equity deterioration continue, more and more mainstream borrowers are likely to walk away from their homes," Credit Suisse said in a December report.
Barnard, who already has stopped making payments on five investment properties purchased in 2005, is on the verge of giving up on his own home that is now worth roughly half its $800,000 purchase price. Others weigh the predictable and relatively short-term foreclosure-related hit to their credit ratings against the diminishing likelihood of breaking even on their investments or even making monthly payments on such severely "underwater" homes. Market experts say that, while lenders have the right to sue such borrowers for breach of contract, most will not pursue charges against "indigent" individuals unless they abandon mortgage payments for business interests. Barnard and some financial planners say that, in certain cases, giving up is the only option.
It can take a year or longer for a bank to seize a home once the owner ceases payments. While a foreclosure hurts credit, owners do not have to make mortgage payments as the process unfolds and can use that saved money to start over. The prolonged U.S. housing slump prompted President Barack Obama to unveil a $275 billion housing rescue plan that aims to arrest a devastating fall in U.S. home prices and help as many as 9 million families stay in their homes, by reducing mortgage payments via refinancing or loan modifications. As lawmakers battle over legislation to help homeowners, the finance arm of Barnard's Home Center Realty is testing a short-pay "refi" program, or short payoff refinance, which seeks to keep people in their homes by writing down mortgage principal and then refinancing the smaller outstanding debt.
But some can't afford to wait. Take working mother Jullisa Kalish, 39. As a realtor in the Phoenix area, she rode high on the property boom. But when the market crumbled over the past three years, she wound up her business, went through a divorce and walked away from her five-bedroom home. Her home value peaked at $674,000 but was recently revalued at $395,000. Saddled with hundreds of thousands of dollars in negative equity, she found a two-bedroom apartment to rent for herself and her two daughters. "It's heartbreaking to lose $300,000 worth of equity, over $300,000 of my most valuable asset," she said. "It will be 10 years before it even gets back to its $600,000 value." "It will just take too long to recoup," she said.
She's not alone. More than half of Nevada's mortgage holders now owe more on their mortgages than their homes are worth. Arizona holds second place with 32 percent of homeowners have negative equity, and Florida and California follow with 30 percent each, according to First American CoreLogic, an affiliate of property services firm First American Corp. The total value of U.S. residential properties fell to $19.1 trillion in December 2008 from $21.5 trillion a year earlier. California's losses came to more $1.2 trillion -- roughly half the nationwide decline, the firm said. "I'm able to keep my head just above water right now," said Russ Sweet, 61, who is now living with his son and renting out his underwater home in Temecula, California, at a loss after an injury ended his career as an electrical lineman in San Diego.
While he fights to stay afloat, Sweet says some of his neighbors in Temecula -- a haven for commuters who work in more expensive coastal cities -- already have walked away. In Arizona, Phoenix electrician Alvaro Palacios, 34, called it quits on the dream home he bought at the top of the market in late 2006 for $172,000. Palacios stopped making payments after he was laid off in December. He took a part-time job as a supermarket delivery driver to make ends meet and has been waiting for his lender, Countrywide, to foreclose. His two-bedroom home with a large yard recently was revalued at $124,000 by the city. Until he hears from the bank, Palacios is staying put. "It is a difficult decision, but I don't really see any other alternative," the father of two said. "The house is worth much less than I paid for it, and it is too much of a struggle."
Mexico Puts Tariffs on U.S. Goods Over Truck Dispute
Mexico will apply tariffs of 10 percent to 45 percent on at least 90 products from the U.S. in retaliation for the U.S. scrapping a test program allowing Mexican trucks to deliver goods beyond a U.S. border zone. The products include some fruit and vegetables, wine, juices and sunglasses, according to the online version of the State Gazette. Most tariffs are 10 percent to 20 percent, with unspecified fresh products subject to a 45 percent tariff. The tariffs, which will apply to $2.4 billion of goods, take effect tomorrow, Economy Minister Gerardo Ruiz Mateos said yesterday.
Talks to diffuse the first trade spat of President Barack Obama’s administration can’t begin until the U.S. has a Commerce Secretary, Ruiz Mateos said. Discussions to resolve the dispute will start once his counterpart is ratified, he said. Ruiz Mateos said that the trade dispute with the U.S. is hurting the region and giving an advantage to other parts of the world. "We’re waiting to begin work," Ruiz Mateos said. "Unfortunately, the U.S. Senate hasn’t designated our counterparts yet." The dispute erupted in 1995 after the U.S. refused to implement a cross-border plan agreed to under the North American Free Trade Agreement because of safety concerns. The rules would have allowed Mexican trucks to haul goods to a U.S. destination and pick up cargo to return to Mexico.
Also among the 90 products on Mexico’s list are potatoes, cherries, mineral water, photocopy and toilet paper, as well as wireless phones, tickets for public events and the lottery. The list doesn’t include corn. A pilot program that allowed as many as 100 Mexican trucking companies to haul cargo into the U.S. after meeting safety requirements was implemented in September 2007 and renewed in August for two more years. "From our point of view it was very successful," Ruiz Mateos said of the program. "They show that they were equal or better than the U.S. trucks." Obama, who criticized NAFTA during his presidential campaign, signed a budget approved by Congress that cut the program’s funding.
Mexico was notified on March 11 that the pilot program, in which 26 Mexican trucking companies were participating, would be scrapped. "Congress has spoken and now Mexico has spoken and so it’s going to be up to us to develop a program that meets very high safety standards," U.S. Transportation Secretary Ray LaHood said in an interview yesterday. Ruiz Mateos said the move will undercut the efficiency of North American trade and give the advantage to Asia and Europe. The current system, in which a cargo trailer at the border is pulled by three different trucks, is not viable, Ruiz said. "This is the antithesis of competitiveness," he said.
UK unemployment jumps at fastest pace on record
UK unemployment last month jumped at the fastest pace since records began, driving the number of Britons without work to above 2 million for the first time since the Labour Government came to power in 1997. Figures from the Office of National Statistics released today show 138,400 people joined the dole last month, pushing the number of unemployed to 2.03 million. In a blizzard of terrible data, the number of people who began claiming jobless benefits in January was revised higher to 93,500 from 73,800. City economists had expected a jump of 84,800 for February and the month's increase is the fastest since records began in 1971, and leaves the unemployment rate at 6.5pc. "Horrendous," George Buckley, an economist at Deutsche Bank, said of the numbers. "This is probably going to persist for a while as long as that kind of growth continues."
The news sent sterling tumbling more than a cent against the dollar to to below $1.39 and left it weaker against the euro, down more than a penny at 94p. The FTSE, which has staged a rally over the past week, shrugged off the data and was little changed at 3840.3. The cuts that began in the crippled financial services industry have rapidly spread beyond the Square Mile to construction, retail and manufacturing. Broadcaster ITV, engineering group Renishaw and manufacturer Meggitt have this month joined the ranks of those cutting positions as consumer and business spending evaporates. "Sharply rising unemployment, along with slowing income growth, seems highly likely to increasingly depress consumer spending over the coming months," said Howard Archer, chief UK economist at Global Insight.
The UK is likely to lose more than a million more jobs over the next 12 months, according to a report from consultancy company Oxford Economics, with the north and the Midlands hit hard. Economists are worried that rising unemployment will sharpen the recession as those still in work cut their spending. The Bank of England's David Blanchflower, the most prominent economist to deliver an early warning about the threat of recession, said last month that unemployment could top 3 million, or 10pc in 2010. He recommends the government spends billions of pounds on public works to create jobs. UK Treasury Minister Stephen Timms admitted earlier this week that Britons face the prospect of much higher unemployment as the combination of an ailing banking system and sliding house prices depress the economy. Rising unemployment is being mirrored across the world's major economies, with an unemployment rate of 7.9pc in France, 7.2pc in Germany, 6.7pc in Italy and 7.6pc in the United States.
UK recession will be longer and deeper, says IMF
Britain will take longer to recover from the recession than any other major economy, according to a leaked International Monetary Fund report. The country will have one of the most severe downturns this year, and will be the only major economic area still shrinking next year, the fund has forecast. In figures to be published this week, it will warn that the world economy will contract for the first time since the Second World War. The fund forecasts that Britain’s economy will also suffer its worst post-war decline, shrinking by 3.8 per cent this year, and a further 0.2 per cent in 2010. The contraction will be among the worst of any major country, underlining the extent to which Britain has seen its stability shattered by the financial and economic crisis. By contrast, the US will contract by 2.6 per cent this year and will grow 0.2 per cent in 2010, while the world economy will shrink by 0.6 per cent this year but will rebound by 2.3 per cent in 2010.
George Osborne, the shadow chancellor said: "These IMF forecasts show that Britain is set to have the longest recession of all the major economies. It is further evidence that Gordon Brown’s economic model is fundamentally broken and his policies on the recession aren’t working." The IMF statistics coincided with a speech by Mervyn King, Governor of the Bank of England, in which he warned that the world faced the prospect of mass unemployment, and signalled an overhaul of financial regulation. Lord Turner, the chairman of the Financial Services Authority, will today raise the possibility of a ban on instruments like collateralised debt obligations (CDOs) – complex packages of debts from many sources. In a report, he will declare that some financial instruments are simply too complicated to be used without unacceptable risks. The report will also signal much tighter rules on mortgage lending, suggesting a new regulatory regime where the state sets limits, and asking whether the FSA should ban some types of mortgage. Lord Turner has previously signalled a preference for limits based on salary multiples.
For Many Young Irish, First Taste of Hard Times
Niall O'Donoghue grew up in a rich country. He got an architecture degree, a top-paying job with a pay raise every year and a bonus at Christmas. O'Donoghue and his wife bought a house in the city and another in the country. They have two cars, two mortgages and two children under age 2. Then a month ago, O'Donoghue, 33, was laid off, jobless for the first time in his life, another well-dressed victim of one of the world's fastest and deepest economic reversals. "It's a bit of a shock to the system, especially for my generation," O'Donoghue said one recent morning, waiting in the cold with dozens of other people in line outside the Limerick unemployment office. "I don't think things will ever be as good as they were in the last five, six or seven years. That's the bitter truth of it."
Young Irish people accustomed to economic boom times have suddenly found themselves living a bleak page out of Irish history. Many in their 20s and 30s -- a generation raised on the assumption of jobs and prosperity at home -- have had their expectations crushed by the global economic crisis. On the gloomiest St. Patrick's Day in years, the national jobless rate stands at 10.4 percent, more than twice the rate at this time last year. More than 354,000 people signed up last month for unemployment benefits, an 87 percent increase over the previous year. After 20 years of roaring growth during Ireland's "Celtic Tiger" economy, the government is bailing out teetering banks; the construction industry, which had driven the boom, is at a standstill. Property prices have crashed and stores and factories are closing.
Young professionals who bought houses -- and often second homes as far away as Spain and Bulgaria -- are stuck with mortgages worth more than the properties. Well-educated young workers are losing jobs they assumed were safe, and finding it hard to adjust to problems they thought belonged to their parents and grandparents. "This was the last thing I expected," said Joanne Martin, 24, who pulled up to the unemployment office in a sporty two-seater Mazda. Martin said she graduated from college with degrees in bioengineering and biotechnology and interned with NASA in Florida. But she is still out of work after applying for at least 100 positions in at least 20 different companies. "I never thought it would be like this."
Older Irish people remember recessions of the past when the most reliable route to a job was to emigrate to Britain, the United States and beyond. "It's part of our experience as a nation, successive generations have done that," Prime Minister Brian Cowen said in an interview in Limerick last week. "The fact that the recession is global means those gateways aren't available at the moment." Even though Irish citizens can move and work freely in any European Union nation, there are few jobs anywhere. During Ireland's boom, people from Eastern Europe came to work in construction, farming and other industries. Many of them have left; others are collecting unemployment here.
Cowen, who is visiting the White House on Tuesday, said he would urge President Obama to considering granting Irish workers visas doubling the time they could remain in the United States to two years. To increase the flow of people and trade between the two countries, Cowen also said he would propose changes in Irish law to allow more Irish Americans to claim Irish citizenship. Cowen noted that young Irish people have "lived in a different Ireland" from their parents, and "their fortunes have changed very quickly."
Outside the unemployment office, Eamonn Aherne, 48, said he was collecting "the dole," as unemployment benefits are called, for the first time in 20 years. Aherne, a laid-off electrician, said he is divorced with grown children and lives in a small trailer in the countryside. He said he'll budget his $265-a-week unemployment payment the way he did during the recession of the 1980s: on cheap clothes, groceries, a little gas for his motorcycle and not much else. "We got through that, we'll get though this, too," he said. "I pity the young people who have never seen this. They have no idea what they are going to go through." Aherne said many young professionals are in for a jarring drop in their standard of living. "The young people, going out four nights a week to the restaurants and the clubs -- that's over," he said.
Limerick Mayor John Gilligan said he had heard of young lawyers driving taxis, and that the number of people waiting for public housing had swelled to 2,000. "These young people are genuinely scared because they do not have the skills on how to survive," Gilligan said. "They're going to have to change the type of food they eat, and how they cook it. Every single cent is going to have to be accounted for, and they have never had that before." Gilligan said young professionals had become accustomed to getting mortgage loans worth 120 percent of the value of their homes, which he said was an extremely reckless practice.
Limerick, on the River Shannon in southwestern Ireland, was recently rocked by the news that U.S. computer giant Dell will cut 1,900 local jobs starting in April. Dell, which is Ireland's biggest exporter, second-largest company and accounts for about 5 percent of GDP, said it will move its European manufacturing hub from Limerick to Poland, where wages are lower. The company will keep 1,000 or so jobs in Limerick, but Gilligan said the city would be "devastated" by the Dell job losses. He estimated that the "knock on" effect would mean a loss of perhaps 10,000 jobs dependent on Dell, from caterers to bus drivers to pizza delivery drivers. "Unemployment in Limerick is 10 percent now, and a year from now it will be 20 percent," Gilligan said. "You're looking at a disaster."
A new McDonald's restaurant near Limerick hung up a "Now Hiring" banner last month, and within 10 days, 500 people applied for 50 jobs. A Limerick hotel advertised to fill 45 positions, and 2,500 people applied. At 8:30 a.m. one recent weekday, O'Donoghue stood outside Limerick's unemployment office on Dominic Street. He was second in a line of more than 30 people waiting for the office to open at 9:30. He said he has come to believe that the boom times were the exception in Ireland, not the rule. "It was just a peak -- a complete abnormality -- even though it wouldn't have felt like that for my generation," he said.
O'Donoghue said he and his wife, a teacher, are adjusting as they try to live on her salary and his unemployment benefits. He said he is trying to sell his Jeep, which he bought for about $17,000 two years ago, for $6,500, but no one has called. He said they also want to sell their home, and move into their smaller second home. But in the current market, he said, there is virtually no chance of selling his house. "If we didn't have my wife's job, we'd have to leave Ireland," he said. "But there's no work anywhere else, either."
Bank of Japan ramps up purchase of government bonds
The Bank of Japan is to increase its purchases of Japanese government bonds by nearly a third, the latest in a series of increasingly assertive measures by the central bank to respond to the pressures created by the global financial crisis and a fierce domestic recession. The BoJ said its decision to raise buying of JGBs from Y1,400bn a month to Y1,800bn was intended to ensure there was enough liquidity in the financial system to ensure its stability. However, the move will also help to hold down bond yields and smooth financing for Japan’s government just as it prepares to start drawing up a new package of fiscal measures to stimulate the world’s second largest economy. The BoJ has been widely criticised by Japanese politicians and officials for what they see as its overly-conservative response to the current downturn, the country’s sharpest in decades.
Masaaki Shirakawa, BoJ governor, is deeply reluctant to return to the policy of "quantitative easing" that the bank used to try to boost growth from 2001 to 2006 and the bank’s policy board unanimously voted to maintain its current 0.1 policy interest rate. However, the BoJ has become gradually more bold in its efforts to boost financial system liquidity and support financial institutions, this week unveiling a draft plan that would see it provide up to Y1,000bn in subordinated loans to large commercial banks. The loan scheme is intended as a safeguard to be used if conditions worsen for local lenders that have so far been much less affected by the global financial turmoil that US or European counterparts but have seen their capital bases hit by falls in the value of their equity holdings. By supporting banks, the BoJ hopes to encourage lending to the country’s corporate sector. The bank, which is already buying corporate debt itself to help ensure companies can access credit, said on Wednesday that fundraising for the crucial financial year-end period through this month had "mostly been completed".
However, the bank added markets could remain under stress, with economic conditions "likely to continue deteriorating for the time being". By increasing its JGB purchases and buying corporate debt, the BoJ is mirroring in a more cautious way the balance sheet expansions being undertaken by counterparts in the US and UK. However, the BoJ has avoided describing its actions as marking a return to quantitative easing, which it defines as providing excess liquidity to the financial system by targeting the level of reserves held by banks along with a commitment to long-term low or zero interest rates. Some analysts say the distinction is increasingly irrelevant. "The Bank’s actions are boosting the monetary base and ramping up its balance sheet, which is QE in all but name," wrote Julian Jessop chief international economist at Capital Economics in a research note. The increased purchase of government bonds will be welcomed within the administration of Taro Aso, Japan’s prime minister, who is currently preparing the ground for a new package of stimulus measures likely to be sent to the Diet early in the fiscal year that begins in April.
World Bank cuts China 2009 growth forecast to 6.5%
The World Bank on Wednesday lowered its forecast for China’s GDP growth this year to 6.5 per cent, down from 7.5 per cent it predicted at the end of November last year, following a huge drop in exports and shrinking private sector investment. The downgrade widens the gap between domestic estimates, which overwhelmingly predict that the country will hit its official target of 8 per cent growth this year, and more pessimistic forecasts from international economists. In a survey of 73 Chinese economists published last month by the National Statistics Bureau, fewer than one-third said they expected GDP to grow less than 8 per cent this year.
The average forecast was exactly 8 per cent, according to the survey. Few economists outside of China or working for international organisations expect growth to be that high and some believe the government’s emphasis of the 8 per cent figure could have adverse effects on the quality of China’s growth. They say the constant repetition of the government’s target could lead officials at lower levels to falsify statistics or, more worryingly, to do whatever it takes to meet growth targets through wasteful and redundant infrastructure projects. The World Bank praised China on Wednesday for its efforts to date to stimulate the economy but warned that exports were likely to shrink this year and government spending would not be able to take up the slack from falling market-based investment.