Hanging around the saloon -at 5 p.m. in Chicopee Falls, Massachusetts
Ilargi: The longer the theater of the absurd continues in Washington, Connecticut and Manhattan, the more it becomes clear that America is not a nation where people are equal, no matter how many times anyone may quote the initial intentions to this end phrased by the founding fathers. There is a ruling class in what some still claim to be a democracy that gets away with breaking the laws of the country, including the constitution, on a daily basis.
In this, there is no difference with China, Myanmar or any other oligarchy, other than in the pictures painted by media and spin doctors, which in reality depict nothing but illusions. On Wall Street, the government's regulatory agencies, from Congress to the SEC, habitually look the other way or are implicitly complicit. One dollar one vote means that whoever has the money also has the power, political and military. If you're one of the boys, you can get away with anything. And I mean anything. I'll say it once again: this is not a financial crisis, this is a full-blown political crisis. And nobody recognizes it. There is no reason for anyone to go hungry or live on the street. Those are choices made by a society.
Boys keep swinging
Heaven loves ya
The clouds part for ya
Nothing stands in your way
When you're a boy
Clothes always fit ya
Life is a pop of the cherry
When you're a boy
When you're a boy
You can wear a uniform
When you're a boy
Other boys check you out
You get a girl
These are your favourite things
When you're a boy
Boys keep swinging
Boys always work it out
Uncage the colours
Unfurl the flag
Luck just kissed you hello
When you're a boy
They'll never clone ya
You're always first on the line
When you're a boy
When you're a boy
You can buy a home of your own
When you're a boy
Learn to drive and everything
You'll get your share
When you're a boy
Boys keep swinging
Boys always work it out
Hedge Funds and the Global Economic Meltdown
How long can this short-covering rally last?
Some of the recent rally in the market's most beaten-down stocks, such as financials, may be the result of investors covering short positions, raising questions about the long-term endurance of the move higher. "I think particularly with the big rally in financials, we're seeing a lot of short covering," said Ken Tower, market strategist at Quantitative Analysis Services. "Fundamentals haven't changed enough for financials to really generate that much enthusiasm." Investors who short a stock are essentially betting that its price will fall -- first borrowing the shares from to sell them, and then buying them back at a hoped-for lower price. When the shares are returned to the broker, the difference is the short seller's profit. But if the price rises, as has been the case with many financial stocks this month, they are forced to "cover" their positions by buying shares.
Financial stocks have outperformed the broad market during March, helped by some positive statements from Citigroup and Bank of America Corp. about their year-to-date performance. The Financial Sector SPDR Fund, an exchange-traded fund that tracks financial stocks in the S&P 500, has gained 14% this month, outpacing the 6.7% rise in the broader S&P. "It's safe to say at least 50% or more was due to short covering. But it's not 100% and that's the good news," said Charles Gradante, co-founder of the Hennessee Group, which manages $1 billion in assets and advises investors in hedge funds. "That positive news was the other half of the rally," he said. Gradante's firm has been advising clients start investing in the financial sector, saying banks should start to benefit from all the money the Federal Reserve is pushing into the economy by buying mortgage-backed securities and other bonds. They could also benefit if policymakers loosen mark-to-market accounting rules.
Some of the companies that have rallied the most in recent weeks also are the companies that topped the list of most-shorted stocks. Citigroup ranked third on the most-shorted roster among NYSE-listed companies at the end of February, according to the most recent data made available by New York Stock Exchange. American International Group was at No. 5, while the Financial Select SPDR Fund, Wells Fargo & Co. and Bank of America all were among the top 10 shorted stocks. Shares of Citi and E-Trade Financial have risen 46% and 56% each this week. On Thursday, the market failed to hold early gains. The S&P 500 finished down 10 points at 784. The Dow Jones Industrial Average fell 85 points to 7,400 and the Nasdaq Composite fell 7 points to 1,483. Stocks rallied sharply on Wednesday after the Federal Reserve surprised markets, saying it would buy $300 billion in Treasurys from the open market. Yet, the market was already on a winning streak since March 10, with the broad S&P 500 gaining over 16% in just eight sessions.
A short-covering rally, especially in a sector that's been beaten down such as financials, isn't normally given much credibility in terms of lasting power by investment professionals. "Certainly, financials saying that things were looking up at the start of this rally led to people that had been short [to cover their positions]," said Dan Greenhaus, market strategist at Miller Tabak. The roller-coaster ride in Citigroup's stock, meanwhile, has created havoc among investors betting its stock would plunge. Earlier this month, shares had dropped below $1 a share, or 86% off its Dec. 31 close, on the heels of a late February announcement that it would convert some preferred shares to common stock. That boosted the U.S. government's direct ownership in the banking company to 36% but signaled a dilution in the value of common stockholders' shares. Citi shares have more than doubled since then.
Citigroup CEO Vikram Pandit said the plan created a "large technical short" in its shares "that should be lifted once the conversion is completed." Its late-February plan calls for converting about $52.5 billion preferred shares into common stock. A few weeks ago, Citigroup and other bank stocks came under pressure after hedge funds bought the preferred shares of Citigroup, Bank of America, Wells Fargo & Co. while shorting their common stock. Fears that the U.S. government would have to take over some of the country's biggest banks, wiping out the value of their common stock, gave investors a window to short the common stock but buy the preferred shares. These tend to hold their value more in a liquidation. But now "that trade is unwinding, where hedge funds are covering their shorts, buying shorts back and selling the preferreds," Gradante said.
Citigroup shares Thursday jumped as much as 26% after saying it reached a definite agreement with private preferred shareholders to convert $12.5 billion of those securities into common shares and was seeking permission for a reverse stock split, before reversing lower on word of a big bond sale. Short selling has been rising, NYSE data show. Short interest rose to 14.624 billion in the two weeks ended Feb. 27, up 3% from the prior two weeks and the highest level since the week ended Nov. 28. Still, short-selling is probably not the end of the story for this recent rally in stocks.
Greenhaus, along with other strategists, believes sellers had also just exhausted themselves. The S&P 500 fell 25% since the start of the year through March 9, and by then sellers just weren't finding anyone to sell to anymore. "The news out of the financials sector was the fuel that many had been looking for anyways," he said. "There's only so much of a 10-day rally that you can attribute to short covering. There were some people that were just coming into buy." The S&P 500 has gained 4% this week. Some of those gains may stem from an uptick in sentiment that a recovery in the economy and in stocks is underway. "I think optimism is real and something that's starting to percolate up throughout lots of different contacts," from money managers to business executives, said James Hedges, president of LJH Global Investments, an investment advisory firm that focuses on alternative investments.
Banks warned on commercial property ‘black hole’
A "black hole" in the US commercial property market is set to put further pressure on troubled banks, the head of leading private equity firm Apollo Management has warned. Leon Black, founder of the firm, said the extra costs of cleaning up the US banking industry could total as much as $2,000bn, putting further strain on the economy. He said the woes of the commercial property had not yet been reflected fully on bank balance sheets. "You have the black hole of commercial real estate and that hasn’t happened yet," said Mr Black in a wide-ranging interview on FT.com. "There you are sitting with $4 trillion of debt and you know not all of it’s bad but a lot of it is diminished and that really hasn’t yet been addressed."
He warned it would be 12 to 18 months before there are lasting signs of US economic recovery. Apollo, a firm established in 1990 that combines buy-out activity with investing in the debt of troubled companies, is in better shape than many of its competitors. It has at least $13bn to invest at a time when it is almost impossible to raise new money. Largely because the banks are not providing financing and the capital markets are not open, Mr Black conceded that "conventional private equity right now doesn’t exist ... Conventional buy-outs are really not on the table right now". Mr Black warned in February that traditional buy-outs were "essentially dead for the time being" and claimed "the big public-to-privates are gone the way of the dodo".
During the boom years, which ended abruptly in 2007, Mr Black took advantage of cheap and flexible debt to buy companies, pay his investors dividends and then sell these acquisitions as he did with Intelsat. Now, as some of the companies he owns, such as Harrah’s Entertainment, have been hard hit by the recession, he is spending much of his time reducing their debt burdens. "The name of the game is survival, it is too live to play another day," said the veteran of now defunct Drexel Burnham Lambert, which pioneered the business of raising debt for less creditworthy firms. While many private equity firms are looking at investing in debt of troubled firms – an area that Apollo has long been involved with – Mr Black is exploring the market for non-performing loans in Europe.
Fed says let's Twist again after 48 years
The Federal Reserve on Wednesday flashed back almost 50 years to a campaign code-named "Operation Twist", as it announced the purchase of longer-dated Treasury securities to help end a deepening U.S. recession. In a decisive escalation in its campaign to restore growth, the Fed said it would buy up to $300 billion of longer-dated Treasuries over the next six months and buy another $850 billion of mortgage securities. Economists said the bold move was warranted by a worsening economic outlook, but also carried the risk of inflation in the future, unless the Fed was very careful.
Either way, the news got a very good bang for its buck. Benchmark Treasury yields notched the steepest one-day fall since the stock market crisis of 1987, while 30-year mortgage rates dropped to almost record lows of 5.0 percent. Economists said this added Japan-style quantitative easing to reinforce Fed support of specific private credit markets, after it had already lowered interest rates almost to zero. "The Fed has signaled the initiation of the third powerful leg of central bank policy: independent quantitative easing," said Marvin Goodfriend, a former senior economist at the Richmond Federal Reserve Bank.
Quantitative easing refers to the deliberate creation of money by a central bank to encourage spending. It was used as a tactic by Japan in the 1990s to confront a decade of stagnation, and by the Bank of England in recent weeks via the purchase of government debt. "Monetary policy at zero on interest rates plausibly needs to be more aggressive in the current moment," said Goodfriend, an economics professor at Carnegie Mellon University in Rochester, New York. The Fed also said on Wednesday that it would more than double an existing effort to boost the market for mortgage securities and debt, to the tune of $1.45 trillion. It has aggressively supported selected private credit markets since the global credit crisis flared last year, and this week launched a program to boost consumer and small business lending which could grow to $1 trillion in size.
The move to purchase longer-dated U.S. government debt, on top of regular purchases of short-term Treasury bills, marked the first time it has done so since Operation Twist, which ran from 1961 until 1965. But that is where the similarities end. In the 1960s, in an effort to flatten the yield curve to simultaneously tackle a recession and a lingering trade deficit, the Fed bought long-term bonds and sold short-term bills. As a result, the operation was sterilized in terms of its impact on the money supply and was not an expansion of monetary policy. This time, the intervention will not be sterilized and should help ease monetary conditions.
"We see this as equivalent to a 75 basis point cut in the (fed) funds rate," said Ethan Harris, co chief U.S. economist at Barclays Capital in New York. A basis point is one one-hundredth of a percentage point. "A combination of monetary, credit and fiscal easing will slow the recession in the second quarter and spark a modest recovery by year-end," he said. To reinforce aggressive Fed action, President Barack Obama has won $787 billion in emergency fiscal spending, and has drafted a multi-trillion dollar budget to aid the economy.
All this stimulus comes with risks. "It will raise inflation uncertainty," said Gregory Hess, an economics professor at Claremont McKenna College in Claremont, California. The Fed has deliberately pumped up the money supply to encourage spending and beat back the risk that deflation, or a prolonged, broad-based decline in prices, might set in. However, the money-supply surge could spark inflation when growth resumes, unless the Fed can bleed off the heavy support. "The risk is that the public misunderstands this as excessively inflationary; as policy that is premature; perhaps excessively concerned about the contraction and the possibility of deflation," said Goodfriend.
GM, Chrysler May Need 'Considerably' More Aid, Rattner Says
General Motors Corp. and Chrysler LLC may need "considerably" more government aid than their request for as much as $21.6 billion, said Steven Rattner, the U.S. Treasury’s chief auto adviser. "It could be considerably higher, I won’t deny that," Rattner said, when asked whether U.S. aid sought could rise to $30 billion or $40 billion. Rattner spoke in an interview on Bloomberg Television’s "Political Capital with Al Hunt," scheduled to air today. Rattner and President Barack Obama’s auto task force are assessing proposals from GM and Chrysler and deciding whether to recommend additional aid or tip the car companies into bankruptcy. Rattner said the task force will give its "sense of direction" before March 31. Chrysler and GM have received $17.4 billion since December and requested more last month.
"What they’ve asked for depends on them achieving plans that are somewhat ambitious," Rattner said. "Like all management teams they tend to take a reasonably, slightly perhaps, optimistic view of their business. So it could be more, I can’t rule that out." Rattner said he may set a deadline for parties including the United Auto Workers and GM bondholders to reach a deal on concessions. "Part of why there’s a lack of appearance of movement is nobody wants to go first," Rattner said. "You say here’s the deadline, everybody has to get there by this date or we’re going to do something else."
GM’s bondholders "are looking to the government to help them solve their problem," Rattner said. "The government cannot solve everybody’s problems, and we need for the bondholders to become part of this in a constructive way." Chrysler’s proposal to give Italian carmaker Fiat SpA a 35 percent stake is "a worthy idea to consider," Rattner said. Chrysler’s numbers show the company "just kind of barely making it" as a stand-alone entity and managing to "just kind of inch along."
"There’s no real uptick, no real sense that the company would generate meaningful amounts of cash flow on a stand-alone basis," Rattner said of Chrysler. "We have not made a determination on whether they could exist on a stand-alone basis, but we do find their idea of partnership with Fiat a worthy idea to consider." Rattner said any decision about GM and Chrysler management would be tied to the ultimate configuration of the companies "and I’m not in a position to comment on that today." GM Chief Executive Officer Rick Wagoner and Chrysler’s Robert Nardelli have been "exceptionally cooperative," "thoughtful," and "energetic," Rattner said. "They’re good guys really trying hard to run those companies," Rattner said. "I have nothing bad to say about them."
U.S. Debt Passes $11 Trillion
The government has two “bazookas” aimed directly at the economic crisis: fiscal and monetary policy. Kicking off what I hope to be a regular Thursday afternoon post, I will be tracking the amount of ammunition fired from each…
Under the Obama administration our fiscal policy is to borrow and spend in order to “stimulate” the economy. A good way to track the scale of fiscal policy is to watch total public debt outstanding. This figure is published daily by the Treasury Dept. at this website. The big news here is that the public debt just passed $11 trillion. At least $2 trillion worth of Treasurys are likely to be sold this year in order to fund the stimulus package, bank bailouts, as well as the government’s existing structural budget deficit. In other words, look for the line in the chart to continue its rapid ascent.
Under the Bernanke Fed our monetary policy is to print massive amounts of currency in order to head off asset price deflation. Falling asset prices, combined with way too much leverage, are the chief reasons the financial system is in such deep trouble. Over-leveraged banks have very little tangible common equity to absorb losses in the value of their assets. If asset values were allowed to fall to market clearing prices (say another 25% decline in home prices), this would mean banks’ remaining assets aren’t sufficient to pay off their liabilities.
Assets = Liabilities + Equity. As the left side of the equation falls, so must the right. Liabilities are ostensibly fixed, so a decline in assets must be matched by a decline in equity. Again, financials are ridiculously over-leveraged, which means they have very little equity cushion to absorb losses on assets. In other words, allowing asset prices to fall will bankrupt the financial sector, leading to systemic meltdown and worldwide bank runs. To fight the fall in asset prices, Bernanke has made clear the Fed will print money at a very rapid clip in order to buy assets like Treasurys, mortgage-backed securities, asset-backed securities, etc.
The best way to track how much money is being printed by the Fed is to watch the expansion of assets on its balance sheet. The balance sheet equation (A = L + E) applies to the Fed just like it applies to banks. The difference is the Fed has this magical machine called a printing press which means it can manufacture its own debt in order to finance purchases of assets. The debt it manufactures are simply electronic dollars that it puts in the accounts of those from whom it buys assets. This is not hard to grasp actually. The Fed said yesterday that it wants to buy $300 billion worth of long-term Treasurys (in addition to another $750 billion of MBS). As an example, pretend you owned some Treasury bonds that you want to sell. Since the Fed wants to buy them, it will conjure dollars out of thin air and put them in your bank account in exchange for the Treasury securites you’re selling.
As the Fed prints money to buy assets, look for total assets on its balance sheet to expand dramatically. An Economist article published today included an estimate from Capital Economics claiming the Fed’s assets are likely to expand to $4.5 trillion. That’s an awful lot of new dollars!
As I’ve argued before, this strategy is badly flawed. The Fed thinks the economy’s problem is falling asset prices. That is wrong; the economy’s problem is too much debt, which over-inflated asset prices to being with. The only “solution” is to let asset prices fall. Unfortunately, this will be very painful and will likely destroy a majority of the paper wealth that exists in the world.
Pumping more borrowed money into the economy via fiscal and monetary policy won’t actually stop that from happening, it will just delay the day of reckoning and make it far more painful when it arrives
Fed's TALF gets off to sluggish start
The debut of the Federal Reserve's long-awaited program to resuscitate consumer and small business lending got off to a stuttering start on Thursday, as investors largely stayed away. Big investors applied for only $4.7 billion in loans in the first round of the Fed's Term Asset-Backed Securities Loan Facility, known as TALF. That's far below the up to $200 billion the U.S. central bank had pledged to lend. The Fed has said eventually the program could grow to $1 trillion. TALF is part of the Fed's massive efforts to revive lending and help pull the economy out of a painful and deepening recession by lending money to investors who want to buy newly issued securities backed by assets such as credit card, small business, student and auto loans.
Political fury over retention bonuses paid out to executives at bailed-out insurer American International Group had been expected to dampen some demand, as investors worried that the government would get too involved in their day-to-day operations. "It's not looking like you're going to get anywhere near to filling to capacity," said Michael Feroli, economist at JPMorgan in New York. "What we are hearing is a lot of concern that there will be after-the-fact restrictions placed on people who use this facility." Investors requested $1.9 billion of loans to buy securities backed by auto loans and $2.8 billion for loans to buy credit card asset-backed securities, the New York Fed said.
There was no demand for loans for securities backed by student or small business loans in the March 17-19 subscription period for this first round. A lot is riding on the long-term success of TALF, which was welcomed when it was announced last fall as the Fed's premier rescue program for the economy. It is also seen as somewhat of a blueprint for the government's toxic asset program, known as the Public Private Investment Fund (PPIF), which has yet to be launched. "It's probably below what we'd been expecting, but it's not completely surprising because it's a test run," said Tony Crescenzi, chief bond market strategist at Miller Tabak. "It is a problem in the sense that the PPIF is based on a model similar to the TALF. And if you can't sell AAA, imagine how difficult it will be to sell all those distressed assets that people have been saying for a long time now are so difficult to value," he said referring to top-rated AAA bonds.
The Fed had tried to soothe some investor concerns late last week by limiting its ability to comb through their books -- given the importance investors, especially hedge funds, place on their privacy. The Fed also earlier this month dropped curbs on pay for executives at participating firms. But investors said this week they were worried about shifting government policy on the Troubled Asset Relief Program and on the bailout of AIG. Only three ABS deals eligible for TALF funding priced this week, and one has yet to price. Citigroup sold a $3 billion deal, Ford priced a $2.95 billion deal and Nissan sold a $1.3 billion bond on Thursday. On Wednesday, Huntington National Bank offered a $963 million TALF-eligible deal.
"You can argue that a chunk of that (credit card loan requests) came from a largely government-controlled institution, Citi," said Feroli. In a typical TALF deal, a fund manager would borrow $9 million from the Fed, and put up $1 million of its own money to buy $10 million in newly originated securities backed by credit card, auto, student and small business loans. TALF is intended to jump-start securitization markets that have collapsed since the bursting of the U.S. housing bubble forced a large number of mortgages into default. Perhaps teething problems are not surprising, given the complexities of the securitization market, said Neal Soss, economist at Credit Suisse. "I'm not surprised it's awkward for a relatively small and specialized institution like the central bank to try and step in an recreate a market from scratch."
Fed closes first round of TALF as Citi prices deal
The Federal Reserve Bank of New York said late Thursday it had received nearly $5 billion in requests from investors seeking to tap central-bank funds under its latest financial-rescue program, a $200 billon effort designed to generate new consumer and small-business loans by reawakening the dormant securitization market. The Fed said it had received $1.9 billion in loan requests linked to auto-loan securitizations and $2.8 billion in credit-card related loan requests under the Fed's Term Asset-Backed Securities Loan Facility, or TALF. It did not receive any requests for loans to buy student-loan or small-business securitizations.
The central bank is offering loans to institutional investors that buy new asset-backed securities, letting these traditional buyers of pooled credit-card and auto loans to get leverage at discount rates. It hopes luring members from the so-called shadow banking system -- the pension funds and hedge funds that underwrote this decade's credit boom -- will make it easier for financial firms that make credit-card and other consumer loans to lower their rates and get borrowing going again. "This is a good start for a program that we will continue to build on in the future," said New York Fed President William Dudley in a statement. Hedge funds, buyout shops and other investors interested in participating in the first round of TALF had until late Thursday to submit their funding requests to the New York Fed, which is administering the program. The central bank had not set a size on the amount of money it would extend in this first round of lending.
Wall Street also has high hopes that this latest financial-rescue program will do the trick turning around credit markets and the economy. "I'm a big believer in the impact that TALF can and should have," said Wes Edens, chief executive of Fortress Investment Group, a $26 billion private-equity and hedge fund that talked with the government as it set up the program, in comments to analysts Monday. Some firms already have started to test demand from institutional investors, who have shunned new securitizations since the autumn, when the collapse of Lehman Brothers caused a spike in counterparty risk fears. nCitigroup Inc. said late Thursday it had priced a $3 billion three-year bond issue, backed by its Citibank unit's credit-card receivables, that will be eligible for TALF. It carries a triple-A rating and an initial coupon of 2.55%.
Automaker Nissan Motors is planning a $1.5 billion sale of bonds backed by auto loans, according to media reports. A spokesman for Nissan North America declined to comment. Earlier Thursday, the Fed said it was expanding the types of collateral it would accept from investors seeking to borrow money under the TALF. It'll take securities backed by mortgage-servicing advances, loans relating to business equipment and leases of vehicle fleets, and may add more asset classes later. It's the latest of several tweaks to the program, which has faced delays after investors balked at rules governing their involvement. Analysts have been eager to see if these institutional investors would buy into the program, "There is little evidence that consumer credit is becoming more readily available -- however, there may be some reason for optimism if the details on the first TALF funding ... are positive," said Joseph Lavorgna, chief U.S. economist at Deutsche Bank, in a report Wednesday.
The Fed announced the program, which involves asset-backed securities, also known as ABS, in November, then unveiled an expansion last month, but the highly anticipated program was delayed. The deadline for applications was postponed from March 17 to March 19. Loans in this round will settle on March 25. Many hedge-fund and private-equity investors in consumer loans initially were apprehensive about participating because of a broad provision in the initial TALF rules that required participants to open up all their financial records to government auditors, said Conrad DeQuadros, economist at RDQ Economics in New York. On March 11, the Fed changed its requirements by restricting the extent of government audits of participant books to securities related to the TALF loans. Once the change was made, hedge funds and private-equity companies expanded their interest in participating, but needed some more time to prepare their requests, said DeQuadros.
Other potential TALF participants, such as financial institutions that have received capital from the $700 billion Troubled Asset Relief Program, or TARP, are already open to a high level of government oversight and may not have needed additional time, DeQuadros added. TALF was originally restricted to owners of assets backed by consumer loans, auto loans, student loans, credit-card receivables or small-business loans, but now has been expanded. Investors or companies holding these loans will be able to use them as collateral to obtain fresh funding from the government to extend credit to new customers worth up to $1 trillion. The Federal Reserve's program is designed to make a profit in the long run through interest and fees. To manage the growth in the balance sheet, the Fed and the Treasury will ask Congress for legislation to give the Fed additional powers. The program seeks to stimulate the economy by circumventing traditional credit channels that are now blocked up. With banks unable or unwilling to lend, even the most credit-worthy customers are finding it difficult to obtain credit.
Ratings Agencies See Windfall in TALF
Credit-rating companies, widely assailed for their role in fueling the financial crisis with overly rosy debt ratings, stand to make a billion-dollar windfall in the government's latest attempt to heal the credit markets. The new rescue effort, run by the Federal Reserve, kicked off Thursday with bond deals totaling more than $7 billion. Each bond issue will need to be blessed by at least two of the three big rating firms: Moody's Investors Service, Standard & Poor's Ratings Services and Fitch Ratings. These firms dominate the credit-ratings business, and their imprimatur is considered crucial for investors that buy bonds and asset-backed securities. They have been vilified in recent months because their ratings on mortgage securities were widely off base.
Now the government is in the uncomfortable position of rewarding these same firms through a new program that will result in numerous companies issuing securities. If the ratings companies are wrong this time around, the Federal Reserve and the Treasury -- and therefore taxpayers -- will be on the hook for some losses. A Federal Reserve spokesman declined to comment. At a Senate hearing in Washington earlier this month, Fed Chairman Ben Bernanke said the central bank has looked at the models of the major rating companies and is "comfortable" they can rate securities eligible for the new program "in an appropriate way." Under the so-called Term Asset-Backed Securities Loan Facility, or TALF, the Federal Reserve will lend money to investors who buy securities backed by such things as auto, student, small-business and credit-card loans. But the government, hoping to protect itself from losses, will allow its money only to be used to buy securities rated triple-A by the ratings services.
Rating services typically charge $40,000 to $120,000 for every $100 million in so-called structured-finance securities they rate. For the initial $200 billion portion of TALF, that translates to $80 million to $240 million. If the program is extended to $1 trillion as the government plans, those fees could skyrocket to anywhere between $400 million and $1.2 billion. The fees for individual firms are often subject to caps. Critics say Moody's, S&P, a unit of McGraw-Hill Cos., and Fimalac SA's Fitch have made few fundamental changes to the way they assess debt. Officials at all three firms say they have taken steps to avoid a repeat of past mistakes in assigning ratings. They are still paid for their ratings by the companies whose bonds they rate, a potential conflict of interest. And much-anticipated competition for the three companies has failed to materialize so far.
"Until the rating firms bite the bullet and develop forward-looking signals and methods, it's going to be same old, same old, and their models can be gamed," says Ann Rutledge, principal of New York structured-finance advisory firm R&R Consulting and a former credit-rating analyst. Last year, roughly 30,000 structured-finance securities had their ratings downgraded by credit-rating services. About 3,000 of them were originally rated triple-A. "This credit crunch started off as a structured-finance crisis, when the market lost confidence in credit ratings and realized that risk had been massively underpriced," says Ed Grebeck, chief executive of debt strategy firm Tempus Advisors. "Now the government is relying on rating models for structured-finance asset purchases even though some of those have demonstrably failed."
At Moody's Investors Service, a unit of Moody's Corp., committees that oversee policies and ratings of structured-finance securities -- so named because they are "structured" to earn specific credit ratings -- consist mostly of people who work in business units that generate revenue for the rating service. A Moody's spokesman says the firm's structured-finance credit committee "isn't the final arbiter" on ratings methodologies. The ratings firms acknowledge that their models still rely largely on historical data, though they say they have updated their assumptions and analyses to reflect current economic stresses. In the mortgage sector, historical loan performance trends proved to be all but useless in the past year amid the unprecedented market slide.
The first TALF deals include $1.3 billion in bonds backed by auto loans made by Nissan Motor Co., $3 billion from Ford Motor Co. and $3 billion in credit-card loans made by Citigroup Inc. The loans were pooled together and their risks allocated to different securities. Some carry little risk and pay low interest rates; others have greater risk, but promise higher yields. The ratings services bless the low-risk slices with their highest Triple-A ratings, just as they did with pools of mortgages during the housing boom. The possibility of a default on a Triple-A rated security is considered remote. But during the housing bust, billions of dollars worth of securities with these ratings defaulted soon after they were issued. A spokesman at S&P says that ratings for asset-backed securities that are not tied to mortgages have largely performed in line with its expectations, given current economic conditions.
A Fitch spokesman said its methods and criteria are "regularly reviewed, tested and updated." The fees from the new program could make a big difference to the bottom line of ratings firms as fees elsewhere tumble. Last year, structured-finance revenues at Moody's Investors Service slumped 53% to $411 million, according to its financial statements. Revenue from structured-finance securities once made up almost half of Moody's revenues, but its contribution has shrunk to about 34%. One of the biggest concerns surrounding TALF is the seemingly arbitrary nature of ratings decisions. Many of the ratings firms, for example, changed their view of one part of the auto-financing sector, deciding that loans made to auto dealers were far riskier than they previously thought. Their downgrades meant that bonds backed by loans to those dealers would be unlikely to get triple-A ratings, effectively shutting them out of the TALF.
Will TALF Soar? Or Fall Flat?
Spring is almost here, but hopes are riding on the Federal Reserve, not Mother Nature, to jump-start a much-needed thaw in the credit markets. After multiple delays and adjustments, the Fed's Term Asset-Backed Securities Loan Facility, or TALF, has arrived. The Fed began accepting applications for the low-interest, nonrecourse loans on Mar. 17 and will disperse the funds to the winning bidders on Mar. 25. The central bank has said it expects to create up to $200 billion in liquidity for credit markets under the TALF program. The U.S. government's ability to attract private capital from hedge funds and other investors through the TALF program is even more crucial now that public sentiment has turned so virulently against bank bailouts. Public anger about the $165 million in bonuses paid to American International Group (AIG) execs may have soured prospects for additional financial-sector bailouts and could threaten to scuttle further government liquidity measures.
"The Treasury and the Fed realize they've got to get private money involved. They don't have enough money left in the TARP program to do it on their own," says Scott Valentin, an analyst who covers consumer finance for Friedman, Billings, Ramsey (FBR) in Arlington, Va. The Fed has had to make adjustments to TALF after hearing from private investors who objected to having to open their books and records to broker-dealers who would be applying for the loans on behalf of investors. There was also opposition to the idea of turning nonrecourse loans into recourse loans—to the jeopardy of investors—if the assets pledged as collateral are determined to be ineligible after the fact by the Fed. Questions have also been raised about whether the program would restrict participating companies from replacing fired U.S. employees with foreign workers, since TALF comes under the stimulus package.
Not content to wait to see how TALF takes hold, the Fed on Mar. 18 announced plans to buy an additional $750 billion of government-guaranteed mortgage-backed securities (MBS), in addition to the $500 billion of MBS it is already in the process of buying. The Fed also said it would purchase up to $300 billion of longer-term Treasury bonds over the next six months in an effort to lower longer-term interest rates on a variety of loans. Some economists and analysts believe that resuscitating the market for securitized consumer loans won't be enough by itself to repair the all-but-disabled financial system, since mortgage-backed securities constitute the bulk of the debt clogging banks' balance sheets. That's why the success of TALF is critical. Early signs of strong investor participation would encourage the Fed to expand the program at some later date to include residential and commercial MBS.
The TALF program is essentially a way for investors to use eligible, triple-A, asset-backed securities—such as pools of prime auto loans, credit-card receivables, student loans, and small business loans—as collateral against loans from the Federal Reserve Bank of New York, which can then be used to buy additional asset-backed securities, or ABS. Only securities created since Jan. 1, 2009, are eligible for these loans. The key feature is something called the collateral haircut, or the minimum capital an investor has to put up to obtain the loan, expressed as a percentage of the loan's value. Generally, the longer the maturity of the ABS, the higher the haircut—to account for the greater risk the Fed is taking. The higher the haircut, the less leverage available to the investor.
For example, a one-year $100 credit-card bond with a 5% haircut would permit an investor to pledge collateral worth $5, leaving the remaining $95 available to buy other securities. That equates to employing 20 times leverage. "Nowhere else in the marketplace can you get that kind of leverage," says Valentin at FBR. "Right now, no one can lever up, so there's a lack of demand for debt assets." (ABS are typically purchased on margin.) The greater the leverage, the higher the return on invested capital an investor can earn—around 40% to 60% for 20 times leverage, vs. 10% to 15% for five times leverage, says Valentin. If the TALF loans are offered at the one-month London Interbank Offered Rate (Libor) plus 1%, and the investor uses the loan to buy ABS with a spread of 5% above Libor, his profit is the difference of 4%. That could result in a huge profit for the investor given the amount of leverage he can use. As demand for ABS rises, prices should go up, causing the spreads to come down.
"The Fed is trying to spur investor demand for these bonds, to get issuance going again," says Valentin. "But also, if you can lower the funding cost [for companies issuing debt], that savings should be passed on to consumers," who would end up paying a lower interest rate on an auto loan or a credit card. The expectation is that over time, as the ABS market improves, demand for the assets will rise—and that will lower the cost of issuing debt for such companies as automakers. They in turn could then lower the interest rates they charge their customers on auto financing, benefiting both consumers and the automaker. Besides allowing for more leverage, TALF also limits investors' downside risk in case the ABS is downgraded or defaults, since TALF loans are nonrecourse to the investor. So the most an investor can lose is the collateral he has put up. And investors won't be required to post more collateral if the assets' value falls.
A key question is how much demand for TALF loans will come from such private investors as hedge funds, many of which have suffered enormous cash outflows and may be risk-averse at the moment. Joe Davis, chief economist at the Vanguard Group outside Philadelphia, thinks the main reason more investors haven't expressed interest in TALF is questions about the requirements, which the Fed has been ironing out. "The private sector is very worried about downside risk. The recession is deepening, and there are going to be more consumer defaults and investment defaults," says Richard Marston, a finance professor at the Wharton School. "If they weren't worried, [private investors] would be purchasing these assets at their current prices. They've got to break this logjam we're in."
Douglas Elliott, a fellow at the Brookings Institution, says he expects TALF will ultimately succeed in reviving the ABS market, since it's "well-designed" and provides guarantees via nonrecourse loans, which will encourage private investors without incurring that high a risk for the Fed. Unlike securities issued last year, prices of the new securities are factoring in a severe recession and a really ugly scenario for consumer-loan defaults before the economy improves, says Elliott. The new securities have greater protections in place, so fewer consumers need to repay their loans for ABS investors to get repaid. The fact that credit spreads on the securities are much wider than a few years ago means investors will be better compensated for the higher risk they're taking. "That's where you want to buy," Elliott says.
So far, only prime auto-loan issuers have announced plans to tap into TALF. Nissan Motor's (NSANY) finance arm sold $1.3 billion of triple-A bonds on Mar. 19. Ford Motor (F) said it soon will issue $2.95 billion of TALF-eligible bonds, and Huntington Auto has also mentioned a debt offering. Valentin believes auto dealers will continue to be the biggest users of TALF. While private student-loan providers, such as Sallie Mae and First Marblehead, didn't apply for the first round of TALF, they are considering it for future rounds, according to Mark Kantrowitz, publisher of www.FinAid.org, a free Web site for advice and tools on student financial aid. Improved terms, such as lower interest rates, may make TALF loans attractive to private lenders, especially for consolidation loans, which many lenders have been unable to securitize because the margins are too thin, he says.
The main impediment to student-loan providers using TALF is the mismatch between the three-year term on TALF loans and the average 12-year life of private student loans, which can stretch out to 30 years. "I'm not entirely certain this is going to lead to an improved liquidity situation," says Kantrowitz. It may serve as an incentive for lenders who have considered securitization but remain undecided. The three-year term, however, means lenders would need to find an alternate source of liquidity after the three years are up, he says. Attracting credit-card securities may be tough, too. Currently, credit-card issuers are all bank holding companies, which are in no rush to securitize their receivables. That's partly because credit-card use is shrinking, not growing, and partly to consumers having other funding sources, including savings deposits and funds from the Federal Deposit Insurance Corp.'s Temporary Liquidity Guarantee Program (TLGP), says Valentin.
"Credit-card issuers are waiting to see what the price [of loans] will be," he says. "If the cost is low enough, and it's cheaper to issue debt than go through the TLGP, they'll use [TALF]." Elliott at Brookings thinks there will be interest among credit-card issuers. "If you're American Express (AXP) and you're not able to securitize your old [loans], the ability to fund new stuff with securitization through TALF is a godsend." To expand TALF to include commercial mortgage-backed securities will require a somewhat different structure, says Davis. Either the program will have to provide funding for longer than the current three years, or the securities that qualify for loans will have to be expanded to include longer maturities. Keefe Bruyette & Woods, in a Mar. 19 research note, said CMBS would require funding for seven years, while funding for nonagency residential mortgage-backed securities would need to run five years. For Davis, the real purpose of TALF is to break the pervasive negative psychology in the market, which has killed investor appetite for risk. Investor confidence often depends on leadership in policy. Contrary to 1931 and 1932, when little leadership was apparent and confidence evaporated as a result, the Fed has been very aggressive this time on the policy front. "The stakes haven't been this high for policy in a long time," Davis says.
European Industrial Output Plunges by Most on Record
European industrial production dropped by the most on record in January as the deepest global recession in more than six decades forced companies to cut output and curb investments. Production in the euro region fell 17.3 percent from the year-earlier month, the biggest decline since the data series began in 1986, the European Union’s statistics office in Luxembourg said today. The January plunge exceeded the 15.5 percent drop forecast by economists in a Bloomberg survey. From the previous month, output fell 3.5 percent. European manufacturers are cutting production, scrapping investments and firing workers as the worsening slump curtails orders for products from eyeglasses to automobiles. ThyssenKrupp AG, Germany’s largest steelmaker, yesterday said it may eliminate more than 3,000 jobs after demand for the metal plunged.
"The dreadful industrial-production figures for January confirm that the euro-zone recession is deepening rapidly," said Martin van Vliet, senior economist at ING Bank in Amsterdam. "Further macroeconomic stimulus is urgently required." EU leaders meeting in Brussels rejected charges that they aren’t doing enough to counter the worldwide recession. "Good progress" is being made in implementing stimulus plans already pledged, according to the draft of a communiqué to be issued after the summit ends this afternoon. The euro-area economy will contract 3.2 percent this year, the International Monetary Fund forecast yesterday, worse than the 2 percent slump it projected in January.
The euro moved lower against the dollar after the output data were released, trading at $1.3454 at 10:55 a.m. in London, down 0.8 percent. The Dow Jones Stoxx 600 Index of European stocks fell 1 percent. Industrial production in Germany, Europe’s largest economy, dropped 7.5 percent from December, the sharpest slide since data for a reunified Germany began in 1991. Output in France, the second-biggest economy in the euro area, dropped 3.1 percent. Carmakers in Europe are likely to build 25 percent fewer vehicles this year as the global slump erodes sales, the European Automobile Manufacturers Association estimated on March 5. Volkswagen AG, Europe’s largest automaker, is cutting 16,500 temporary jobs and Bayerische Motor Werke AG, the world’s biggest luxury-car manufacturer, eliminated 4,000 jobs last year and will cut 1,000 more in 2009.
"Industrial orders have been declining for nearly a year and foreign demand for European products has fallen substantially," said Carsten Brzeski, an economist at ING Groep in Brussels. "The European Central Bank will certainly lower interest rates to 1 percent but will be very hesitant to go below that unless the economy doesn’t stabilize." The ECB is under pressure to outline a strategy for how it would help the euro-region economy once it runs out of room to cut interest rates. The Frankfurt-based central bank reduced the benchmark rate to a record low of 1.5 percent on March 5.
"Unlike other central banks, we have not completely exhausted our margin for maneuver on interest rates," ECB council member Guy Quaden said in an interview with Belgium’s Trend-Tendances magazine published yesterday, adding that a rate of 1.5 percent is not the lowest point. Economists had expected a 4 percent drop in January industrial production from the previous month, according to the medium of 38 estimates in a Bloomberg survey. The December drop in output was revised to 2.7 percent from the earlier estimate of 2.6 percent. The decline from the year-earlier month in December was revised to 11.8 percent from 12 percent estimated before.
US Rep Frank Demands Cancellation Of Fannie, Freddie Bonuses
U.S. House Rep. Barney Frank, D-Mass., on Friday called on the regulator for Fannie Mae (FNM) and Freddie Mac (FRE) to cancel bonuses paid to employees at the companies under a retention program. In a letter, Frank urged Federal Housing Finance Agency Director James B. Lockhart to rescind any bonuses already paid under the program and to prohibit any further payments. "The public, having provided significant support for the purpose of restoring trust and confidence in our country's financial system, rightfully insists that large bonuses such as these awarded by institutions receiving public funds at a time of a serious economic downturn cannot continue," Frank wrote in the letter.
The move comes after $165 million in bonuses paid to employees at American International Group Inc.'s (AIG) financial products division set off a political firestorm this week. The House on Thursday approved legislation to tax at 90% any bonuses earned by employees earning more than $250,000 at firms that have received at least $5 billion in aid from the government's financial rescue program. Fannie and Freddie, which together have received $60 billion in taxpayer funds under a separate government program, are covered under the legislation. A similar bill is gathering momentum in the Senate.
Fannie's and Freddie's regulator established a retention program when the companies were taken over by the government last fall. Under the program, a broad swath of employees at each firm were promised bonuses, to be delivered over three periods. Lockhart defended the bonuses this week, saying the program ensured the companies wouldn't lose key employees just as they play a central role in stabilizing the U.S. housing market. "As the previous senior management teams left, it would have been catastrophic to lose the next layers down and other highly experienced employees," Lockhart said in a statement earlier this week. "This retention program is pay for specific efforts underway now to meet national goals."
A test of will
A few days ago Ben Bernanke, chairman of the Federal Reserve, was asked to identify the biggest obstacle to economic recovery. That "we don’t have the political will," he replied. Mr Bernanke showed his own will on Wednesday March 18th, when the Fed’s policy panel said it would purchase $300 billion in Treasury debt, mostly maturing in two to ten years, starting next week. It will also boost its purchases of mortgage-backed securities to a total of $1.25 trillion from a previously announced $500 billion, and its purchases of debt issued by Fannie Mae and Freddie Mac, the mortgage agencies, to a total of $200 billion from $100 billion.
The Fed had already said it was considering Treasury purchases, but expectations had waned in recent weeks. The announcement electrified investors, sending the Dow Jones Industrial Average up by 91 points, or 1.2%, and the ten-year Treasury bond yield down a stunning 50 basis points to 2.51%. The plans are awe inspiring in their scale, but they are different only in degree rather than kind from the steps the Fed has already taken. In December, it exhausted its supply of conventional monetary ammunition when it lowered its short term-interest rate to between zero and 0.25%.
At that time it had already started unconventional operations: expanding loans to banks and other financial institutions; buying private commercial paper; making enormous and controversial loans and loan guarantees to AIG, Bear Stearns, Citigroup and Bank of America; and setting up a facility, capitalised by the Treasury, to buy securities backed by car, student and small-business loans, and mortgages. By the time its new steps are done, the Fed’s balance sheet will reach $4.5 trillion, or about a third of GDP, up from less than $1 trillion a year ago, Capital Economics estimates.
All these steps were aimed at reducing credit spreads on private loans and increasing the supply of private credit, currently constrained by fear of counterparty default, illiquidity and banks’ depleted capital. They have worked to some extent, as spreads on private debt have come down, though they remain well above pre-crisis levels. Taking the added step of buying Treasuries made some inside the Fed uncomfortable. It amounts to monetising government debt—in essence, allowing the government to finance its spending with newly printed money rather than by borrowing or through higher taxes. That raises two fears: that it would eventually lead to inflation, or even hyperinflation, and that it would compromise the Fed’s independence.
The fear of inflation is exaggerated. Inflation was just 0.2% year-on-year in February, the government said on Wednesday. While core inflation, which strips out food and energy, was a more normal 1.8%, that is probably headed lower as high unemployment and unused capacity put downward pressure on wages and prices. The Fed repeated in its announcement that it "sees some risk that inflation could persist for a time below [its preferred rate]". As for the Fed’s independence, Mr Bernanke has previously argued that should be more of a consideration in times of inflation, rather than deflation. In any case, the Federal Open Market Committee, which approved the decision unanimously, appears to agree such risks were an acceptable price for more forceful action against the recession.
Following a similar announcement by the Bank of England, the Fed’s action understandably suggests central banks, having approached the limits of conventional monetary easing, are now experimenting with more monetarist solutions. And the monetary base (currency plus commercial bank reserves) has grown sharply in America, Britain and the euro zone. The Bank of England describes its actions in monetary terms: by expanding the amount of money in the hands of the public, some people will shift to riskier assets such as stocks and bonds, raising wealth and spurring investment. Banks may use the reserves to make higher-returning loans. But an expanding monetary base will not create inflation if the money is not lent out. The Bank of Japan engaged in quantitative easing earlier this decade, buying government debt and raising commercial bank reserves. Banks did not expand their loans because their capital was constrained and loan demand was weak.
The Fed has explicitly described its goals as lowering the cost and improving the supply of private-sector credit; that this results in an expanded monetary base is secondary. Even Treasury purchases are meant to "improve conditions in private credit markets." In the short term at least, the Fed’s actions raise the odds that the economy, in recession since the end of 2007, will pull out by the end of this year. There have been signs the housing market has stabilised, albeit at deeply depressed levels, and lower mortgage rates will bolster demand. If share and home prices stabilise, that will mitigate the astonishing loss of wealth that is depressing consumer spending.
But the Fed cannot do the job by itself. For one thing, many borrowers are unable to take advantage of lower mortgage rates because of stiffer underwriting requirements. Many corporations are either unable to borrow because lenders are more skittish or unwilling to borrow because the business outlook is so weak. Barack Obama’s administration has tackled the first problem with plans to help homeowners refinance and avoid foreclosure. It is to announce within days how it will remove toxic assets from bank balance sheets and regulatory tests should soon disclose how much more capital the government must inject into the banks.
The problem is that the administration’s ability to get the extra funds needed for these schemes has been significantly injured by the outrage among voters and Congress over bonuses paid to recipients of bail-out money. That thirst for retribution could also deter banks, investors and others from participating in the schemes. "I don't want to quell anger, what I want us to do…is channel our anger in a constructive way," Mr Obama said on Wednesday. That will take political will from him and Congress. For now, Mr Bernanke has done his part.
Bernanke defends big bank bailouts
Federal Reserve Chairman Ben Bernanke responded to ongoing criticism of the government's efforts to keep alive institutions it has deemed "too big to fail," saying that this is an "enormous problem" that needs to be addressed. Speaking before a group of community bankers in Phoenix, the central bank chief argued that actions taken thus far to prop up the nation's largest banks have been extremely unpleasant, but necessary to preventing further harm across financial markets and the broader economy. "I do not think we have had a realistic alternative to preventing such failures," he said. Many smaller community banks avoided making too many subprime mortgages and also did not own the types of toxic securities backed by these loans that have plagued big banks.
These smaller banks, along with taxpayers, have become increasingly frustrated by the government's stance that major financial institutions like Citigroup (C, Fortune 500), Bank of America (BAC, Fortune 500) and American International Group (AIG, Fortune 500) continue to require billions of dollars in government support because they have been viewed as too big and important to the broader economy to fail. Those remarks were echoed by Sheila Bair, chairman of the Federal Deposit Insurance Corp., who addressed the same industry group Friday. In her prepared comments, Bair reiterated comments she made before the Senate Banking Committee Thursday, adding that ending the "too to big to fail" issue required a number of new tools including a systemic risk regulator and a program that would help resolve problems at a large financial institution, similar to how the FDIC handles other banks that fail. "I hope Congress acts soon," she said. "Nobody wants to go through another banking crisis like this one."
Bair also reiterated previously made remarks that she expected bank failures to cost about $65 billion over the next five years. The FDIC recently moved to raise assessments fees charged to banks to fund the industry's deposit insurance fund, which is used to cover deposits when a bank fails. She also repeated an earlier assertion that without "additional revenue beyond the regular assessments, current projections indicate that the fund balance will approach zero." With that in mind, Senate Banking Committee Chairman Chris Dodd, D-Conn. and Sen. Mike Crapo, R-Idaho have already proposed a bill that would allow the FDIC to borrow up to $500 billion from the government to shore up the fund.
Friday's comments by Bernanke and Bair cap what has been a particularly busy week for the Fed chief and other regulators. On Wednesday, Bernanke and fellow members of the Fed's Federal Open Market Committee, which sets interest rates, unveiled plans to purchase massive amounts of government debt over the next six months to help keep long-term rates low and get credit flowing again. In a televised interview with 60 Minutes last Sunday, Bernanke said that a "depression" can be avoided, but he acknowledged that a full economic recovery will take time and that the financial system must be fixed in order for the recession to end. Next week, Bernanke is slated to testify before Congress about the government's extensive efforts to rescue AIG and the controversy over the insurer's decision to pay $165 million in bonuses. Treasury Secretary Timothy Geithner will also appear at that hearing.
Bernanke says Fed has exit strategy from credit policy
Federal Reserve Chairman Ben Bernanke on Friday said the Fed's buying of longer-dated U.S. Treasuries would "taper off" when the economy no longer needed help, allowing the Fed to cease its emergency support. "The time will come when the economy will be growing, the housing market will be recovering, that support will no longer be needed. And we will of course at that point taper off that support," Bernanke told community bankers in Phoenix, Arizona. The U.S. central bank on Wednesday surprised investors with plans to buy up to $300 billion of longer-term U.S. Treasury securities and an additional $850 billion of agency mortgage debt to ease a deepening U.S. recession. It also confirmed it would hold interest rates near zero for "an extended period".
"We are very much aware that we don't want to be in the credit markets forever. We need to help them now, but we want to have an exit strategy, and allow those markets to recover and become again fully private sector," Bernanke said in response to an audience question after delivering a speech. It was the first time the Fed had bought longer-dated Treasuries since the 1960s. The news sent yields sharply lower, while on the foreign exchange markets it inflicted the biggest decline in the dollar in 25 years. Bernanke said the Fed had decided to expand its aid for the mortgage sector and buy Treasury securities to "support the housing market, the broader economy." Economists said the Fed was effectively printing money by buying debt issued by the U.S. government, and then recycling all proceeds from this investment back to the Treasury.
In terms of policy, it is equivalent to the quantitative easing strategies employed by Japan during the 1990s to end deflation and a decade of miserable economic performance. Quantitative easing was needed, with rates already at zero and deflation a genuine threat, Federal Reserve Bank of St Louis President James Bullard said in a presentation at a policy workshop at the Bank of France in Paris. "Moving to quantitative approaches to policy is feasible and is going on right now," Bullard told the workshop, according to his presentation on the St Louis Fed website. He also emphasized the risks of deflation, citing the experience of Japan, where widespread declining prices following the collapse of a property and stock market bubble made the economic downturn much worse. "Deflation is a real possibility in the current environment important near-term goal for monetary policy is to prevent this outcome," said Bullard, who is not a voting member of the Fed's policy-setting committee this year.
Was the Bailout Itself a Scam?
Professor Michael Hudson is correct that the orchestrated outrage over the $165 million AIG bonuses is a diversion from the thousand times greater theft from taxpayers of the approximately $200 billion "bailout" of AIG. Nevertheless, it is a diversion that serves an important purpose. It has taught an inattentive American public that the elites run the government in their own private interests. Americans are angry that AIG executives are paying themselves millions of dollars in bonuses after having cost the taxpayers an exorbitant sum. Senator Charles Grassley put a proper face on the anger when he suggested that the AIG executives "follow the Japanese example and resign or go commit suicide."
Yet, Obama’s White House economist, Larry Summers, on whose watch as Treasury Secretary in the Clinton administration financial deregulation got out of control, invoked the "sanctity of contracts" in defense of the AIG bonuses. But the Obama administration does not regard other contracts as sacred. Specifically: labor unions had to agree to give-backs in order for the auto companies to obtain federal help; CNN reports that "Veterans Affairs Secretary Eric Shinseki confirmed Tuesday March 10 that the Obama administration is considering a controversial plan to make veterans pay for treatment of service-related injuries with private insurance"; the Washington Post reports that the Obama team has set its sights on downsizing Social Security and Medicare. According to the Post, Obama said that "it is impossible to separate the country’s financial ills from the long-term need to rein in health-care costs, stabilize Social Security and prevent the Medicare program from bankrupting the government."
After Washington’s trillion dollar bank bailouts and trillion dollar gratuitous wars for the sake of the military industry’s profits and Israeli territorial expansion, there is no money for Social Security and Medicare. The US government breaks its contracts with US citizens on a daily basis, but AIG’s bonus contracts are sacrosanct. The Social Security contract was broken when the government decided to tax 85% of the benefits. It was broken again when the Clinton administration rigged the inflation measure in order to beat retirees out of their cost-of-living adjustments. To have any real Medicare coverage, a person has to give up part of his Social Security check to pay Medicare Part B premium and then take out a private supplemental policy. The true cost of Medicare to beneficiaries is about $6,000 annually in premiums, plus deductibles and the Medicare tax if the person is still earning.
Treasury Secretary Geithner, the fox in charge of the hen house, has resolved the problem for us. He is going to withhold $165 million (the amount of the AIG bonuses) from the next taxpayer payment to AIG of $30,000 million. If someone handed you $30,000 dollars, would you mind if they held back $165? PR flaks have rechristened the bonus payments "retention payments" necessary if AIG is to retain crucial employees. This lie was shot down by New York Attorney General Andrew Cuomo, who informed the House Committee on Financial Services that the payments went to members of AIG’s Financial Products subsidiary, "the unit of AIG that was principally responsible for the firm’s meltdown." As for retention, Cuomo pointed out that "numerous individuals who received large ‘retention’ bonuses are no longer at the firm" .
Eliot Spitzer, the former New York Governor who was set-up in a sex scandal to prevent him investigating Wall Street’s financial gangsterism, pointed out on March 17 that the real scandal is the billions of taxpayer dollars paid to the counter-parties of AIG’s financial deals. These payments, Spitzer writes, are "a way to hide an enormous second round of cash to the same group that had received TARP money already." Goldman Sachs, for example, had already received a taxpayer cash infusion of $25 billion and was sitting on more than $100 billion in cash when the Wall Street firm received another $13 billion via the AIG bailout.
Moreover, in my opinion, most of the billions of dollars in AIG counter-party payments were unnecessary. They represent gravy paid to firms that had made risk-free bets, the non-payment of which constituted no threat to financial solvency. Spitzer identifies a conflict of interest that could possibly be criminal self-dealing. According to reports, the AIG bailout decision involved Bush Treasury Secretary Henry Paulson, formerly of Goldman Sachs, Goldman Sachs CEO Lloyd Blankfein, Fed Chairman Ben Bernanke, and Timothy Geithner, former New York Federal Reserve president and currently Secretary of the Treasury. No doubt the incestuous relationships are the reason the original bailout deal had no oversight or transparency.
The Bush/Obama bailouts require serious investigation. Were these bailouts necessary, or were they a scam, like "weapons of mass destruction," used to advance a private agenda behind a wall of fear? Recently I heard Harvard Law professor Elizabeth Warren, a member of a congressional bailout oversight panel, say on NPR that the US has far too many banks. Out of the financial crisis, she said, should come consolidation with the financial sector consisting of a few mega-banks. Was the whole point of the bailout to supply taxpayer money for a program of financial concentration?
Goldman CFO feels no guilt over AIG payments
Goldman Sachs Group Inc insists it did nothing wrong when it accepted payments to close out trades with American International Group before and after the insurer was rescued by the U.S. government last September, Chief Financial Officer David Viniar told reporters on Friday. Goldman answered reporters' questions on a conference call seeking to clear up what it called "misperceptions" about its trading relationship with AIG. The insurer since mid-September received as much as $180 billion in government support to avoid collapse stemming from its exposure to crumbling debt markets. The bank has come under fire amid revelations that $90 billion of those funds were funneled quickly to AIG's trading counterparties, which were bought out at nearly face value.
"We don't think we did anything wrong," Viniar said. "We had commercial terms. It is our responsibility to our shareholders to make sure that we are protecting ourselves." Goldman was the largest single beneficiary, receiving $12.9 billion between mid-September and the end of December. Viniar told reporters these trades were "commercial contracts" and that AIG was obligated to make good. "That's why we enter into these contracts. That's why we have collateral terms in the first place, to make sure that we are protected. And all we did was call for the collateral that was due to us under the contracts," Viniar said. "I don't think there's any guilt whatsoever." Goldman reiterated it would not have been hurt by AIG's failure because its exposure was either fully collateralized or hedged. Viniar also stressed that Goldman had no direct exposure to AIG as a result, though he added that an AIG failure would have disrupted the world's financial markets and likely cause indirect harm.
Which Hedge Funds Are Collecting Under the AIG Bailout?
Hedge funds are the hidden recipients of the taxpayer dollars flowing through AIG. The unregulated and exclusive trading houses bet against the housing market, reaping billions as that market tanked. But because they did the deals through the banks, there is still almost no transparency about which funds were involved, or how much money they could receive. At the end of Wednesday’s House Financial Services subcommittee hearing into AIG’s bonuses, Rep. Marcy Kaptur, D-Ohio, asked AIG CEO Edward Liddy for information about the hedge funds – who they are and how much bailout money they got.
"They are not our customers," said Liddy. "What you are asking is ‘What did they [the banks] do? Who are their clients?’ I don’t have any answers to those questions." So far, those questions remain almost completely unanswered. When AIG released the names of "counterparties" – banks and states at the winning end of AIG’s bad deals – this weekend, not one hedge fund appeared on the list. The Wall Street Journal reported that Deutsche Bank is holding money in an escrow account for at least one hedge fund. But so far, that’s all the public knows about these shadowy deals. AIG owes the American taxpayer nearly $80 billion, part of up to $180 billion in bailout funds authorized so far. The company paid $100 billion to banks who were the counterparties to its credit default swaps and securities lending programs.
Scorn Trails A.I.G. Executives, Even in Their Driveways
The A.I.G. executive who was nicknamed "Jackpot Jimmy" by a New York tabloid walked up the driveway toward his bay-windowed house in Fairfield, Conn., on Thursday afternoon. "How do I feel?" said the executive, James Haas, repeating the question he had just been asked. "I feel horrible. This has been a complete invasion of privacy." Mr. Haas walked on, his pink shirt a burst of color on a slate-gray afternoon. The words came haltingly. "You have to understand," he said, "there are kids involved, there have been death threats. ..." His voice trailed off. It looked as if he was fighting back tears. "I didn’t have anything to do with those credit problems," said Mr. Haas, 47. "I told Mr. Liddy" — Edward M. Liddy, the chief executive of A.I.G., the insurance giant — "I would rescind my retention contract." He ended the conversation with a request: "Leave my neighbors alone."
Too late. Jean Wieson, who has lived down the block for 24 years, had stopped her car in front of Mr. Haas’s house before he arrived home. She was angry about the millions of dollars in bonuses paid to its executives, the credit-default swaps that brought American International Group to its knees, the $170 billion the federal government has spent to prop it up. "It makes me absolutely sick," she said. "It’s despicable. It’s disgusting what these people have done. They should be forced to give every cent back." Those bonuses in years past helped make A.I.G. executives into prominent local citizens. They own big houses like Mr. Haas’s, with its three chimneys and its views of Southport Harbor and Long Island Sound in the distance. Some are well-known contributors to arts groups and private schools in Connecticut communities not far from the office park in Wilton that is the workplace of many of the employees in A.I.G.’s Financial Products division, which is at the center of the storm over bonus payments.
Now these executives are toxic, and those communities are rattled and divided. Private security guards have been stationed outside their houses, and sometimes the local police drive by. A.I.G. employees at the company’s office tower in Lower Manhattan were told to avoid leaving the building while a demonstration was going on outside. The memo also advised them to avoid displaying company-issued ID cards when they left the office and to abandon tote bags or other items with the A.I.G. logo. One A.I.G. executive, who spoke on the condition of anonymity because he feared the consequences of identifying himself, said many workers felt demonized and betrayed. "It is as bad if not worse than McCarthyism," he said. Everyone has sacrificed the employees of A.I.G.’s financial products division, he said, "for their own political agenda."
The public’s anger, he said, "is coming from bad facts as a result of someone else’s agenda — or just bad facts period." Instead, he said, the so-called bonuses were in fact just payments that had been promised long ago to workers, including technical and administrative assistants. A.I.G. employees are not the only ones seeking protection: An executive at Merrill Lynch, where bonuses have also come under fire, said that some employees had asked whether the firm would cover the cost of private security for them. Scott Silvestri, a spokesman for Bank of America, which bought Merrill in December, would not respond to that claim, but said in a statement, "The safety and security of our associates is paramount, and we will always take the appropriate steps."
And there may be more protests. The Connecticut Working Families party, which has support from organized labor, is planning a bus tour of A.I.G. executives’ homes on Saturday, with a stop at the company’s Wilton office. "We’re going to be peaceful and lawful in everything we do," said Jon Green, the director of Connecticut Working Families. "I know there’s a lot of anger and a lot of rage about what’s happened. We’re not looking to foment that unnecessarily, but what we want to do is give folks in Bridgeport and Hartford and other parts of Connecticut who are struggling and losing their homes and their jobs and their health insurance an opportunity to see what kinds of lifestyle billions of dollars in credit-default swaps can buy."
A.I.G. paid the $165 million in bonuses to 463 of its executives, but in the uproar that erupted when the payments were made public, Mr. Liddy asked the employees to return much of that money. He said that many of them have agreed to do so. The New York attorney general, Andrew M. Cuomo, said on Thursday that A.I.G. had handed over a list with the names of the bonus recipients. But he did not release the list. "We are aware of the security concerns of A.I.G. employees," Mr. Cuomo said in a statement, "and we will be sensitive to those issues by doing a risk assessment before releasing any individual’s name."
It was unclear exactly what measures the officials at A.I.G. have taken in the name of protecting the company’s executives. Officials at several police departments in Connecticut towns where A.I.G. executives live said they did not know about possible threats against the bonus recipients. "We haven’t heard of it," said Sgt. Carol Ogrinc of the New Canaan police. "There have been no complaints made to our department." But several security companies in New York credited the financial crisis with a noticeable increase in some areas of their business, from protecting executives to dispatching bomb-sniffing dogs to check for trouble. "There is certainly anger among people about the economy and fear among corporate executives themselves," said Patrick Timlin, the president of Michael Stapleton Associates, which provides bomb-dog teams.
And there is concern in places like Wilton that the scandal is tarring their town. "They’re blaming us," said Konstantinos Papanikolaou, a manager at Orem’s Diner in Wilton, about a mile from the A.I.G. office. Jay Fiedler of Trumbull, Conn., said his town was also a "victim," initially of a brutal economic downturn that had been fueled by problems at companies like A.I.G., and then of the outrage that has coalesced around the bonuses that A.I.G. paid. "It just so happened that it happened here," Mr. Fiedler said. "The community is the victim of the fact that it takes place here." Others in A.I.G.’s neighborhood were clearly angry. Tamara King, an immigration specialist at a health care company whose office is adjacent to the A.I.G. quarters, said she feels disgust each time she walks past it. "You don’t want to associate with them because it’s not a reflection on the state, it’s not a reflection on us," she said. But she added, "You have so many people out of a job, and these people think they can take the money and run."
The largest single bonus check, for $6.4 million, went to Douglas L. Poling, an executive vice president for energy and infrastructure investments. Mark Herr, an A.I.G. spokesman, said Mr. Poling had told him he was returning the bonus "because he thought it was the correct thing to do." Gerry Pasciucco, a former vice chairman of Morgan Stanley who was brought in by Mr. Liddy in November to wind down the financial products unit, said Mr. Poling had sold off roughly 80 percent of the unit’s assets. Mr. Pasciucco said the money from the sales would go to the government, which has handed more than $170 billion in bailout money to A.I.G. in the last six months. "He’s done an outstanding job in winding down his investment books," Mr. Pasciucco said. "He did it at the right time, and we’ve made money. We would be losing money today if we waited to sell some of these assets."
Mr. Poling’s father, Harold A. Poling, retired as the chief executive of Ford Motor Company in 1994. On Thursday, Cheryle Campbell answered the phone at Harold Poling’s house in Bloomfield, Mich., where she said she had worked as a housekeeper for 20 years. She said she was not surprised to hear that Douglas Poling had decided to give back his bonus. "You’d think, being in the kind of job he is, that he’d be one of those sharks," she said. "But he’s not at all." Douglas Poling has lived in the same house on a dead-end street in Fairfield for 11 years. The local papers say that he and his wife have given generously to a homeless shelter, to the Westport Country Playhouse and the Fairfield Country Day School, a boys’ prep school where tuition runs as high as $29,300 a year. But on Thursday, his house, like Mr. Haas’s, was being watched by private security guards.
Mass Hysteria Over AIG Obscures Simple Truths
Last September the U.S. government began to dole out the first of $173 billion to American International Group. A big chunk of it passed right through to banks that had bought insurance from AIG against mortgage and corporate defaults -- foreign banks such as Deutsche Bank and Societe Generale but also some domestic ones, such as Goldman Sachs and Bank of America. U.S. government officials then went to great lengths to disguise from the public exactly what they had done, and why, going so far as to declare the ultimate list of recipients of taxpayer funds off limits to the taxpayer. To its immense credit, the media -- or, rather, a handful of diligent reporters, the New York Times’ Gretchen Morgenson chief among them -- prevented the public officials from getting their way.
This incredible act triggered hardly any political backlash. In effect, the U.S. taxpayer had paid off AIG’s gambling debts. The end recipient of the money was not AIG, but Goldman Sachs, Deutsche Bank and the others. Some large portion of the billions obviously wound up, in one form or another, in the pockets of their employees and shareholders. A few people on Capitol Hill moan and groan but there is popular agreement on the wisdom of this transfer of ONE HUNDRED AND SEVENTY THREE BILLION dollars from the taxpayer to the financiers. But when AIG itself pays out $165 million in bonuses -- money it is contractually obliged to pay -- the entire political system goes insane. President Barack Obama says he’s going to find a way to abrogate the contracts and take the money back. A U.S. senator says that AIG employees should kill themselves.
Every recriminatory bone in the political body is aroused; the one thing you can do right now in Washington without getting an argument is to rail against the ethics of AIG’s bonus payment. Apart from Andrew Ross Sorkin at the New York Times, it occurs to no one to say that a) the vast majority of the employees at AIG had as little as you or I to do with its quasi- criminal risk taking and catastrophic losses; b) that the most- valuable of those employees can easily find work at AIG’s competitors; and c) that if the government insists on punishing those valuable employees they will understandably leave, and leave behind a company even less viable than it is, and less likely to give the taxpayer back his money. And also -- oh, yes -- that if the government can arbitrarily break contracts made by firms in which it has taken a stake no one in his right mind will ever again make a contract with one of those firms. And so all of the banks in which the government has investment will be damaged.
From this episode we can observe several general truths about the financial crisis, and the attempt to end it:
1) To the political process all big numbers look alike; above a certain number the money becomes purely symbolic. The general public has no ability to feel the relative weight of 173 billion and 165 million. You can generate as much political action and public anger over millions as you can over billions. Maybe more: the larger the number the more abstract it becomes and, therefore, the easier to ignore. (The trillions we owe foreigners, for example.)
2) As the financial crisis has evolved its moral has been simplified, grotesquely. In the beginning this crisis was messy. Wall Street financiers behaved horribly but so did ordinary Americans. Millions of people borrowed money they shouldn’t have borrowed and, not, typically, because they were duped or defrauded but because they were covetous and greedy: they wanted to own stuff they hadn’t earned the right to buy. But now that taxpayer money is on the line the story has changed: innocent taxpayers are now being exploited by horrible Wall Street financiers. The guy who defaulted on mortgages on his six spec houses in the Nevada desert has turned himself into the citizen enraged by the bonuses paid to the AIG employees trying to sort out the mess caused by his defaults.
3) The complexity of the issues at the heart of the crisis paralyzes the political processes’ ability to deal with them intelligently. I have no doubt that, by the time this saga ends, we will all know what happened to every penny of that $165 million in bonuses and each have our opinion of the morality of it. I doubt seriously we will ever understand the morality of the $173 billion payment that is the far more serious issue. For instance, Goldman Sachs, which received about 8 percent of the pile, or $13 billion, has claimed publicly that the money was, to them, a matter of indifference, as Goldman had hedged itself against a possible collapse of AIG -- by making bets against AIG.
This suggests that it was clear to at least one market player, before the collapse, that AAA-rated AIG was behaving in ways that might lead to its demise -- which is to say that there was really no responsible place to lay off these bets. (So why bail out those who made them?) It also suggests that it is a matter of indifference to Goldman Sachs whether AIG lived or died, as either way it was protected. (So why bail it out?) Since the beginning of the crisis I’ve wondered why the government has found neither the will nor the way to attack the root of the problem -- the people who borrowed money to buy homes they shouldn’t have bought. Now I think I understand. It would be too simple. People would understand a lot of small payments to the guy down the street who doesn’t deserve them, and become outraged. Far better to throw trillions at opaque corporations, the inner workings of which no one still really understands.
Many in Government Knew Weeks Ago About A.I.G. Bonuses
The question was direct and prescient. Representative Joseph Crowley, Democrat of New York, asked the Treasury secretary in an open hearing what could be done to stop American International Group from paying $165 million in bonuses to hundreds of employees in the very unit that had nearly destroyed the company. Timothy F. Geithner, the Treasury secretary, responded by saying that executive pay in the financial industry had gotten "out of whack" in recent years, and pledged to crack down on exorbitant pay at companies like A.I.G. that were being bailed out with billons of taxpayer dollars.
The exchange took place before the House Ways and Means Committee on March 3 — one week before Mr. Geithner claims he first learned that the failed insurance company was about to pay a round of bonuses that have since caused a political uproar. A Treasury spokesman, Isaac Baker, said in a statement on Thursday night, "Although Congressman Crowley raised the issue of the bonuses two weeks ago, Secretary Geithner was not aware of the timing or full extent of the contractual retention payments or the other bonus programs until his staff brought them to his attention on March 10." Mr. Baker said that after Mr. Geithner had been briefed on the bonuses, he called Edward M. Liddy, the chief executive of A.I.G., and "insisted that they be renegotiated and restructured, in light of the extraordinary assistance being provided by taxpayers." Mr. Baker added that Mr. Geithner "takes full responsibility for not being aware of these programs before last week."
Interviews with senior Federal Reserve and Treasury officials, as well as members of Congress, leave little doubt that the bonus program was a disaster hiding in plain sight. Mr. Geithner is not the only one who appears not to have understood the populist fury the bonuses would set off. Career staff officials at the Treasury, Fed and Federal Reserve Bank of New York exchanged e-mail messages about the A.I.G. bonus program as early as late February, according to a person familiar with the matter. A.I.G. itself revealed the bonus plan in regulatory filings last September. In November, when the bailout of A.I.G. was restructured, Treasury and Fed officials negotiated the terms under which A.I.G. could make the retention payments. And in December, Democratic lawmakers sought a hearing about the payments.
A.I.G., which incurred staggering losses through its sale of complex financial instruments tied to mortgage-backed securities, has received more than $170 billion in capital infusions, loans and credit lines from the federal government since last September, and is about to get $30 billion more. A.I.G. executives have insisted that they informed the New York Fed about the bonus plan, and that they assumed the New York Fed was informing the Treasury. Treasury officials have suggested that the New York Fed and the Federal Reserve Board in Washington failed to alert the Treasury staff until March 5. And Fed officials said that they not only alerted the Treasury staff weeks earlier, but discussed the issue with them via e-mail.
Despite the interagency discussions in February about A.I.G.’s ill-starred bonus plan, as well as Mr. Geithner’s exchange on the matter in a hearing, Mr. Geithner continued to insist on Thursday that he had not really understood the magnitude of the bonuses until one week ago. "I was informed by my staff of the full scale of these specific things on Tuesday, March 10," Mr. Geithner said in an interview with CNN on Thursday. "As soon as I heard about the full scale of these things, we moved very actively to explore every possible avenue — legal avenue — to address this problem."
As early as December, two Democratic lawmakers had vociferously and repeatedly complained about the bonuses, and one of them went so far as to demand the resignation of A.I.G.’s chief executive. But both Mr. Geithner, and the chairman of the Federal Reserve, Ben S. Bernanke, were preoccupied at the time with multiple crises. The nation’s banks were reeling from as much as $2 trillion in mortgage-related losses. The recession was deepening and unemployment was soaring. Mr. Bernanke’s team at the Fed and Mr. Geithner’s team at Treasury, moreover, were reluctant to impose what they viewed as "punitive" and possibly self-defeating pay restrictions on companies being bailed out.
In early February, Mr. Geithner opposed a provision in the economic stimulus bill that would have slapped a steep tax on the kind of bonuses that A.I.G. was about to pay. If A.I.G.’s plan to pay out an additional $165 million in bonuses came as a surprise to Mr. Geithner, it did not come as a surprise to staff at the Treasury, the Federal Reserve in Washington or the New York Fed. Staff at all three agencies had been in daily communication with each other about A.I.G. ever since the Fed agreed to lend the company $85 billion in September in exchange for almost 80 percent of the company. In late November, after A.I.G.’s plight became worse and the Treasury jumped in with a $40 billion capital infusion, the three agencies negotiated cuts in bonuses and salaries for many of the company’s top executives. Officials at the New York Fed carried out the most direct oversight of A.I.G., and they were well aware of the coming bonus payments, said a person familiar with the matter.
Probes of AIG Bonuses Started by New Jersey, 18 Other States
Nineteen states including New Jersey began an investigation of bonuses paid by American International Group Inc. as Connecticut subpoenaed the insurer and Congress took steps to recover the funds. New Jersey Attorney General Anne Milgram said she sent a letter to AIG Chief Executive Officer Edward Liddy demanding a list of employees in the AIG Financial Products unit who received bonuses since September and whether they were paid with federal money. New York Attorney General Andrew Cuomo said yesterday the insurer sent him such a list to comply with a subpoena. "At this moment, with emotions running high, it is important that we proceed diligently, with care, reflection, and sober judgment," Cuomo said in a statement.
New York-based AIG sparked a national furor by paying $165 million in bonuses last week after receiving $173 billion in federal bailout funds. The U.S. House responded to public outrage yesterday by voting to impose a 90 percent tax on employee bonuses at AIG and other companies that get at least $5 billion in taxpayer bailout funds. The measure, approved on a 328-93 vote, would cover companies receiving 75 percent of federal bailout funds, according to the House Ways and Means Committee. Milgram said yesterday in a statement that she asked AIG to send her the information about bonus recipients and copies of their employment contracts within five days. She was joined in the request by Arizona, Delaware, Illinois, Kentucky, Louisiana, Maine, Michigan, Mississippi, Montana, Nebraska, New Mexico, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Washington and West Virginia.
Separately, Connecticut subpoenaed AIG for information on the bonus recipients, amounts and contracts. Connecticut Attorney General Richard Blumenthal said in a statement that he will "take steps to enforce" the subpoena issued by the state’s Department of Consumer Protection if AIG doesn’t promptly provide the information. Blumenthal said in a March 18 letter to Liddy that he wants a list within three days of all bonuses paid in 2008 by AIG Financial Products, the unit that sold credit-default swaps blamed for crippling the company. The unit is based in Wilton, Connecticut. Blumenthal said AIG was "categorically wrong when it claimed that Connecticut state labor law compelled" the payments. Cuomo also said that he expected to receive information yesterday on $3.6 billion in bonuses paid to Merrill Lynch & Co. employees in December. Bank of America Corp., which bought Merrill Jan. 1, lost its court bid to prevent Cuomo from disclosing the recipients’ identities to the public.
London could be big winner from US war on Wall Street
US lawmakers have turned protectionism on its head. They seem hell-bent on cutting American bankers down to size. A punishing bonus tax on a large swathe of those working on Wall Street was approved by the House of Representatives on Thursday. That follows an earlier pay cap on the banking elite. The latest measure would impose a 90pc tax on some bonuses. The draconian rate would apply to employees who earned more than $250,000 (£173,000), from companies which took more than $5bn of government rescue money from the Troubled Asset Relief Plan. The tax would be retroactive to December 31, 2008, and would remain in effect until the company paid back the funds.
Even if that proposed tax, or a milder version under consideration in the Senate, doesn’t get signed into law, the best bankers at the likes of Goldman Sachs, Citigroup and JPMorgan Chase probably won’t be waiting to find out. The anti-protectionism works two ways. It will increase the inbound flow of applicants to foreign-owned banks unaffected by the legislation, and give the employees of those same institutions fewer places to flee. Inside Manhattan, Barclays, Credit Suisse, Deutsche Bank and Nomura must be among those rubbing their hands with glee. As yet, these ambitious firms have dodged the restraints of state ownership. But London might be an even greater beneficiary of Washington’s outrage. Alistair Darling, the UK Chancellor of the Exchequer, said the UK would not follow the US with a blanket cap on banker pay.
The Conservative party plans to campaign on a pledge to raise the tax rate on top earners, but to 45pc. In comparison to what’s rolling through the US Congress, that rate sounds appealing. American citizens won’t be able to escape any new tax by moving, since they have to pay US taxes wherever they live. Non-Americans, even at the affected firms, probably wouldn’t be subject to the proposed 90pc surtax. Still, with London house prices down, and no "Keep Out" signs for foreigners – think Tarp-related visa restrictions in the US – many of those who can choose their continents might soon be thinking the City is something of a safe haven with better job opportunities. As long as the UK doesn’t wind up succumbing to mob rule too.
Half of U.S. auto suppliers face bankruptcy
More than half of the top U.S. auto parts suppliers could file for bankruptcy protection in 2009 with at least one million job losses, according to a study by global consultants A.T. Kearney. Those suppliers, which ship parts directly to automakers, are pressured from above by production cuts by the automakers and from below by increasingly fragile companies that supply them with components, the study found. The survey encompassed 60 top North American auto parts suppliers, but did not name any of the suppliers. It was compiled through interviews with senior executives at suppliers in the United States.
The U.S. government has pledged up to $5 billion to aid financially stressed auto parts makers that are crucial to General Motors Corp and Chrysler. Chrysler, about 80 percent controlled by Cerberus Capital Management, and GM have accepted $17.4 billion of emergency government loans and are looking for an additional $22 billion. Ford Motor Co, which has not sought emergency government assistance, said on Thursday that it was not participating in the supplier relief program at this time. "Absent significant financial assistance from the government, we are headed toward a scenario that is going to be 50 percent or more of the supply base going through bankruptcy," Doug Harvey, an A.T. Kearney partner in its automotive practice in Detroit, told Reuters in an interview.
A.T. Kearney looked at three scenarios for the supply base. The other two scenarios include a "soft landing" resulting in 35 percent of the companies restructuring in bankruptcy and a "pessimistic" reading pushing that to 70 percent or more with many liquidations. The "soft-landing scenario" looks more like "wishful thinking" at this point, with the industry heading more toward the middle ground and leaning toward pessimistic, Harvey said. "To whatever extent the government provides relief to prevent them from going into bankruptcy, that number goes down," Harvey said. In each scenario, the study found that suppliers faced increased risk of bankruptcy through 2010.
U.S. auto parts makers have come under increasing financial pressure in recent months with steep production cuts by their customers starting toward the end of 2008 that have severely constrained revenue from the beginning of the year. Auto sales have slumped for more than three years, but the declines accelerated as the recession deepened last year and monthly rates have plunged to the lowest levels in 27 years. The study found that the larger suppliers expect up to 23 percent of the smaller companies that supply them with parts to face financial distress within a year. Most of those smaller companies are privately held and do not disclose their finances publicly, making it difficult to probe the depths of the stresses in the vast supply base.
However, data from Sageworks, which compiles information on private companies, highlighted the stress on these smaller suppliers. Double-digit sales growth in the 2004 to 2005 period had all but disappeared by 2008, and a $15,600 profit per employee in 2005 turned to a $13,600 loss, according to Sageworks. Harvey sees the administration's announcement of support for suppliers, coming even before it makes recommendations on GM and Chrysler, as reinforcing the immediate needs of the supply sector to avoid mass bankruptcies. "This is the lifeline to keep that from happening until a broader solution can emerge," Harvey said. "I don't expect we would see that until the complete analysis of the GM and Chrysler applications are complete."
Auto Suppliers to Get $5 Billion Government Bailout
The auto-supplier industry will receive up to $5 billion in financing under a new program by the Treasury Department that’s part of a large effort to save the entire automotive sector amid a major downturn. The Auto Supplier Support Program is meant to give "suppliers the confidence they need to continue shipping parts, pay their employees and continue their operations," Treasury said in a press release. On a conference call, a member of the Obama Administration’s automotive task force said that this was to help auto suppliers that were at risk of "literally ceasing operations."
The program gives suppliers access to government-backed protection that they will be paid the money owed to them for products they ship, regardless of what happens to the car company that receives the parts. As FOX Business’s Peter Barnes reported some weeks ago, auto makers owe parts companies around $13 billion. Suppliers will have to pay a premium on each shipment they want guaranteed by the program – the premium will be two percentage points to get the shipment guaranteed, and another percentage point if the company wants the ability to convert the facility into cash quickly. The money for the program is coming from the Troubled Asset Relief Program, or TARP.
The program is not available to foreign auto makers with operations in U.S., a task-force member said on the conference call. There’s a requirement that eligible parts being shipped must be sold by a domestic company and come from domestic operations of that company, and the part must be manufactured or assembled at a domestic facility. This guarantee takes on added significance because there has been talk in recent weeks about General Motors entering bankruptcy -- and some talk of Chrysler doing the same. Chrysler is owned by private-equity firm Cerberus Capital Management. Thus far, Ford Motor appears to have avoided the same dire situation, but would likely be able to tap government bailout money if it needs it.
Ford issued a statement about the plan, saying it "appreciates the efforts by the U.S. government to support the auto supply base. This is a good step forward for the near term, and we look forward to continue working with our government leaders on the long-term restructuring of the industry. These actions support all automakers that are reliant on a healthy U.S. supply chain. Ford does not need to participate in the program, as we remain viable and expect no issue with continued payments to our suppliers." Chrysler LLC Senior Vice President and Chief Procurement Officer Scott Garberding said, "This decision by the U.S. Treasury is viewed as a vote of confidence for the U.S. auto industry and the future of our Company... Chrysler supported the supplier loan request from the beginning. We will work tirelessly around the clock to get this program up and running."
And GM put out a statement saying, "This U.S. Treasury program recognizes how critical the domestic supply chain is in keeping America's auto industry running. GM appreciates the Treasury and President's Task Force on Autos taking quick action that will improve suppliers ability to access much needed liquidity during these very difficult economic times. This action can help reduce the risk of vehicle production disruptions that would occur if auto suppliers were unable to produce due to lack of access to working capital liquidity." The auto industry is confronting a March 31 deadline by which time President Barack Obama wants to have a plan put together about its future. "We do expect to have something to say before March 31 about the overall situation, at least to give people an overall sense of direction," a task-force member said on the conference call. However, he added, "I would not expect that whatever we say by March 31 would by any means be the final word" on the issue.
Next Round of Bank-Based Appeasement
On Tuesday the FASB released two exposure drafts that tinker with the edges of fair value reporting. While the Board had planned several fair value improvements projects that encompassed one of them (guidance on determining whether a market for a security is active), the timing of these two projects is in direct response to the Congressional pressure brought to bear on the FASB last week when Congressman Kanjorski held an investigative hearing into mark-to-market accounting.
Talk about misplaced investigations: what needs to be investigated is why Congress listens so well to bankers and their lobby. Consider the bill sponsored by Representative Ed Perlmutter of Colorado - the "Federal Accounting Oversight Board Act of 2009." It fairly bristles with the kind of rewards the banking industry would love: better than bonuses, it could give them the kind of regulation they want. The bill would transfer the SEC's oversight of the FASB to the new "Federal Accounting Oversight Board." Look at its mission - it's a banker's dream come true:(1) APPROVAL OF ACCOUNTING POLICY- The FAOB shall approve and oversee accounting principles and standards for purposes of the Federal financial regulatory agencies and reporting requirements required by such agencies. In approving and overseeing such accounting principles and standards, the FAOB shall consider--
(A) the extent to which accounting principles and standards create systemic risk exposure for--
(i) the United States public;
(ii) the United States financial markets; and
(iii) global financial markets;
(B) the extent to which various accounting principles and standards resolve questions concerning liquid and illiquid instruments;
(C) whether certain accounting principles and standards should apply to distressed markets differently than well-functioning markets;
(D) the balance between investors' need to know a value of a company or financial institution's balance sheet at any given time versus financial regulators' responsibility to examine a company or financial institution's capital and value on both a liquidation and going concern basis;
(E) the accuracy and transparency of financial statements;
(F) the ability of investors and regulators to accurately judge the current and long term financial condition of companies and financial institutions from their financial statements;
(G) the need for accounting principles and standards to take into account the need for financial institutions to maintain adequate reserves to cover expected losses from assets held by such institution
(H) the extent to which accounting principles and standards can improve the usefulness of financial reporting by focusing on the characteristics of relevance and reliability and on the qualities of comparability and consistency;
(I) the extent to which such principles and standards can be kept current to reflect changes in methods of doing business and changes in the economic environment; and
(J) any other factors that the FAOB considers appropriate.
It's downright Orwellian: to protect the public, this "oversight body" would blind them from the mistakes made by financial institutions by making accounting less transparent. The body has right to determine "the balance between investors' need to know a value of a company's balance sheet ... versus regulators responsibility to examine capital?" Doesn't that mean that the actual owners of an institution take a back seat to the regulators' decision to keep them in the dark about its true condition?
Truly incredible stuff. This bill wouldn't just turn the asylum over to the inmates; it would arm them with pistols and napalm, too. The banking lobby deserves to be proud of itself for making lemons out of lemonade: though financial institutions have covered themselves with muck through incredibly bad underwriting, they've managed to convince some folks that bad underwriting can be cured by bad accounting. Speaking of curing bad underwriting with bad accounting, let's move on to the two exposure drafts. Both have a 15-day comment period ending April 1. (Which is incredibly ironic.) Both will be effective on a prospective basis for interim and annual periods ending after March 15.
First up: FSP FAS 157-e, "Determining Whether a Market Is Not Active and a Transaction Is Not Distressed," which is intended to help preparers and auditors determine when a financial asset's trading price is affected by illiquid markets or a distressed transaction. It provides a list of indicators of illiquid markets; upon reviewing, if the preparer judges the securities in question to be trading in an illiquid market, it must take a second step. That second step is a presumption that the price is associated with a distressed transaction; it's a presumption that can only be overcome by evidence that sufficient, usual and normal marketing activities occurred for the asset before measurement date, and that multiple bidders existed for the asset. If those conditions aren't met, then the asset must be valued using a valuation technique other than one that uses the quoted price without significant adjustment. Bottom line, this will grease the skids for the expansion of "Level 3" valuations.
Next: FSP FAS 115-a, FAS 124-a, and EITF 99-20-b, "Recognition and Presentation of Other-Than-Temporary Impairments." This tweak will create a broad class of new long-term corporate investors in both debt and equity securities. Why? Because a firm will not recognize an other-than-temporary [OTT] impairment charge through earnings if it does not intend to sell an impaired security, and it is more likely than not that the firm will not have to sell it before the recovery of its cost basis. Therefore, we will likely witness an outbreak of "patient capital."
If those two criteria are not met (for either debt or equity securities, by the way), then only the part of the impairment charge attributable to credit losses is to be recognized in earnings. The remainder is to be recognized in a new bucket in other comprehensive income. For debt securities, the non-credit loss charges are to be pulled out of accumulated other comprehensive income and recognized in earnings over the remaining life of the debt securities in a prospective manner based on the amount and timing of future estimated cash flows.
Net result: if OTT impairments ever do occur, the hit to earnings will be less than they are now, all else equal. Accumulated other comprehensive income will take a blow for the non-credit loss charges - but financial institutions won't mind because it won't affect regulatory capital. Charges through the income statement definitely affect regulatory capital, and they'll decrease. And earnings will be so smooth, they'll make a baby's bottom look like 20 grit sandpaper.
Nothing in these two proposals betters the lot of investors, except for the ones in "the sky is falling, we gotta save the market from accountants" crowd. It'll at least make them feel like they've been heard.
The link between financial accounting and regulatory accounting needs to broken for good. Because regulatory capital is in part driven by GAAP, firms apply pressure to the FASB - who is essentially friendless in Washington, so pressure can be applied to it with favorable results. Bonus: if GAAP looks good, so do GAAP-based compensation targets. Would the financial institutions lobby their regulators so hard if there were no connection to GAAP? It would certainly be open to more scrutiny in the public eye if they did - and it might be harder for them to have their way.
Why the Turner report is a watershed for finance
by Martin Wolf
Lord Turner is the UK’s man for all seasons. A few years ago, he fixed pensions. Today, it is finance. The report by the new chairman of the UK’s Financial Services Authority is a turning point. The authorities of a country that used to boast of its light financial regulation have changed their minds: the UK has lost confidence in its financial sector. "Over the last 18 months, and with increasing intensity over the last six, the world’s financial system has gone through its greatest crisis for at least half a century, indeed arguably the greatest crisis in the history of finance capitalism." This is the report’s starting point. It advances two explanations for this disaster: exceptional macroeconomic conditions – particularly the emergence of excess savings in large parts of the world – and reliance on "the theory of efficient and rational markets". As the report notes, "the predominant assumption behind financial market regulation – in the US, the UK and increasingly across the world – has been that financial markets are capable of being both efficient and rational". So regulators were expected to stay out of the way. In the report’s new view, they should be in the way, instead. The financial sector no longer enjoys the benefit of the doubt: it may burn up the world.
The most important analytical points are that individual rationality does not ensure collective rationality, that individual behaviour is frequently less than rational and that, in consequence, markets can overshoot, in both directions. Above all, such failings create systemic risks: if everybody believes in the same (faulty) risk models, the system will become far more dangerous than any individual player appreciates; and if everybody relies on their ability to get out of the door before anybody else, many will die in the inferno. To these points must be added the vulnerability inherent in borrowing "short and safe", in order to lend "long and risky". If we were not so familiar with banking, we would surely treat it as fraudulent. Moreover, far from reducing the frailty, securitisation enhanced it by spreading "toxic assets" everywhere.
The recommendations include: increased quality and quantity of capital, particularly against trading activities; a strongly countercyclical capital adequacy regime; a maximum gross leverage ratio; enhanced regulation and supervision of liquidity; coverage of all significant institutions; enhanced supervision of rating agencies; codes covering remuneration in systemically significant institutions; and centralised clearance of the majority of trades in credit defaults swaps. Also recommended are enhanced "macro-prudential" analysis by the FSA, the Bank of England and global bodies; a big shift in regulation by the FSA towards high impact businesses, by focusing on business models, strategies, risks and outcomes in the supervised companies; greater international co-ordination of supervision; an independent European regulator; and an end to the "untenable present arrangements" for cross-border activities of European banks – the "Iceland problem".
In short, the stable doors are to be locked tight, though only after a herd of horses has already bolted. Nevertheless, even Lord Turner’s radicalism is limited: the report rejects division of the financial system into utilities and a casino. The arguments against are that the casino would still need to be regulated, that such a distinction could not be introduced by one country on its own, particularly in the European Union, and that global companies need "large complex banking institutions providing financial risk management products". So securities underwriting by banks is still needed, though "large-scale proprietary trading through in-house hedge funds is not". In all, this report offers radical tightening of regulation and supervision of a financial system that would remain broadly the same as today’s. The most regulated businesses would be less profitable and so would shrink. That would be no loss, suggests the report: the profits they reported were illusory, but the dangers they created all too real. This judgment is surely right.
Yet even this report leaves important questions unaddressed. First, it does not explain why we can hope to contain the behaviour of companies too important to fail. Second, it does not demonstrate that regulators can contain regulatory arbitrage by profit-seeking financiers. Third, it does not deal with risks posed by institutions that may be too big to rescue by some host countries. Fourth, it does not explore the room for charging heavily for guarantees. Finally, it does not consider the incentives towards excessive leverage inherent in the tax system. Nevertheless, this report is a milestone. It should help catalyse the needed global discussion of regulatory reform. Other countries – and, above all, the US – should commission comparable analyses of their own regulatory failures. I would also wish to see equally searching analysis of mistakes in monetary policy, both in the UK and elsewhere. Humans learn far more from failure than success. The failures this time are big enough to make learning the lessons essential. The Turner report is a start. More learning must follow.
*Turner Review, www.fsa.gov.uk
Norway's krone: the new safe haven currency?
The Swiss National Bank's decision to intervene to weaken the franc has left currency investors with one less haven from the financial crisis. Its move comes at a time when there are also questions surrounding the future haven status of two other leading currencies: the dollar and the yen. While the dollar has enjoyed a liquidity premium amid the current financial turmoil, many investors expect it to lose its allure as the full impact of large-scale US fiscal and monetary loosening filters through. Simon Derrick at Bank of New York Mellon says: "The dollar has clearly been supported by haven flows during the current crisis. "But, in the longer-term, the sheer scale of US fiscal spending and the lack of international capital available to support it represents a direct threat to the dollar's strength."
The other main beneficiaries during the current crisis, the Swiss franc and the yen, have both lost their haven status in recent weeks. The Swiss franc has been driven lower by the SNB, which last week intervened to sell the currency, saying its recent appreciation represented an unwelcome tightening in monetary conditions. Meanwhile, the yen has been undermined by a series of data showing a steep downturn in Japan's export-driven economy. This has helped stoke expectations that the Bank of Japan will follow the SNB and intervene to weaken its currency.
So where do currency investors turn now? One answer could be Norway. David Bloom at HSBC says "The ultimate haven currency in our view is the Norwegian krone. "It's probably the best currency in the world." This might seem surprising. Only last December the krone dropped to a record low against the euro, as falling oil prices took their toll on the currency. But, as crude prices have stabilised, the oil producer's currency has fought back strongly. Indeed, the krone is one of the few currencies that has outperformed the dollar so far this year, rising more than 3 per cent to NKr6.694. It has soared 11 per cent to NKr10.925 against the euro. Mr Bloom says: "The Norwegian krone is our preferred major currency and we expect a sustained appreciation over the next 18 months."
Analysts say on a number of measures, the krone is near or at the top of the league among the world's 10 most traded currencies. Norway's economy grew 1.3 per cent in the fourth quarter of last year and is not forecast to experience as big a downturn as most other leading economies this year. Monetary policy is also supportive of the krone, with the Norges Bank, Norway's central bank, like those in other commodity-producing countries such as Australia and New Zealand, not expected to resort to quantitative monetary easing to boost inflation expectations. The country also has a large current account surplus. The cost of insuring against sovereign default in Norway through credit default swaps is the lowest among the countries with the ten most traded currencies.
Mr Bloom says that if the stock of assets Norway has salted away from its oil revenues in the Government Pension Fund of Norway is added to the mix, the bullish story for the krone is complete. But some analysts are less glowing about the krone's prospects. Gavin Friend at NAB Capital agrees the krone appears one of the best of a bad lot, with a healthy current account balance and interest rates likely to lend it support. But he says: "You are trying to win the least ugly currency contest at the moment. I can't disagree that it might move higher, but I can't get too enthusiastic." His main concerns are the lack of liquidity in the market and the krone's long-held correlation with oil prices. "I struggle to see how the Norwegian krone can outperform for a sustained period if oil prices remain low," he says.
Ashraf Laidi at CMC Markets says the fact that the krone fell against both the dollar and the euro during the turbulence following the collapse of Lehman Brothers in September means it cannot really be called a haven currency. But he believes that the krone, along with the Australian dollar, is ideally positioned for prolonged gains as risk appetite improves. He says the Australian dollar represents an economy with a superior growth outlook. The country's budget surplus is expected to hover at 1 per cent of gross domestic product – which compares with the deepening deficits of the US, Europe and Japan. He says: "The krone has the upper hand as its structural situation is boosted by a hefty current account surplus standing at 5 per cent of GDP – the biggest in the industrialised world".
The other investment instrument that tends to have strong haven properties is gold – even though gold has weakened somewhat from its recent peak above $1,000 an ounce. Gold's appeal has been highlighted this week by Paulson & Co, the hedge fund. It took a $1.28bn stake in gold miner AngloGold Ashanti on Tuesday as part of a bet that gold would benefit as paper currencies were debased by global central banks turning on the printing presses to tackle the financial crisis. Indeed, with quantitative easing and the possibility of printing money being expanded across the world, gold's defensive properties are set to become more desirable, analysts say. "In a world where central banks are expected to increasingly turn to quantitative easing, there are less and less havens in currency terms. Gold should look increasingly attractive," says Mr Derrick.
U.N. panel says world should ditch dollar
A U.N. panel will next week recommend that the world ditch the dollar as its reserve currency in favor of a shared basket of currencies, a member of the panel said on Wednesday, adding to pressure on the dollar. Currency specialist Avinash Persaud, a member of the panel of experts, told a Reuters Funds Summit in Luxembourg that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket. Persaud, chairman of consultants Intelligence Capital and a former currency chief at JPMorgan, said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform. "It is a good moment to move to a shared reserve currency," he said.
Central banks hold their reserves in a variety of currencies and gold, but the dollar has dominated as the most convincing store of value -- though its rate has wavered in recent years as the United States ran up huge twin budget and external deficits. Some analysts said news of the U.N. panel's recommendation extended dollar losses because it fed into concerns about the future of the greenback as the main global reserve currency, raising the chances of central bank sales of dollar holdings. "Speculation that major central banks would begin rebalancing their FX reserves has risen since the intensification of the dollar's slide between 2002 and mid-2008," CMC Markets said in a note.
Russia is also planning to propose the creation of a new reserve currency, to be issued by international financial institutions, at the April G20 meeting, according to the text of its proposals published on Monday. It has significantly reduced the dollar's share in its own reserves in recent years. Persaud said that the United States was concerned that holding the reserve currency made it impossible to run policy, while the rest of world was also unhappy with the generally declining dollar. "There is a moment that can be grasped for change," he said. "Today the Americans complain that when the world wants to save, it means a deficit. A shared (reserve) would reduce the possibility of global imbalances." Persaud said the panel had been looking at using something like an expanded Special Drawing Right, originally created by the International Monetary Fund in 1969 but now used mainly as an accounting unit within similar organizations.
The SDR and the old Ecu are essentially combinations of currencies, weighted to a constituent's economic clout, which can be valued against other currencies and indeed against those inside the basket. Persaud said there were two main reasons why policymakers might consider such a move, one being the current desire for a change from the dollar. The other reason, he said, was the success of the euro, which incorporated a number of currencies but roughly speaking held on to the stability of the old German deutschemark compared with, say, the Greek drachma. Persaud has long argued that the dollar would give way to the Chinese yuan as a global reserve currency within decades. A shared reserve currency might negate this move, he said, but he believed that China would still like to take on the role.
Financial Crisis Caused by a 'Culture of Complicity'
While the world talks about new ways to save struggling banks, there are a handful of economists who think some banks shouldn't be saved at all. American economist James Galbraith told Manager Magazin that it might make more sense to break them up and start over.
Manager Magazin: Professor Galbraith, you suggest that banks that suffer from bad assets should simply be declared insolvent, instead of rescuing them with taxpayers' money. Why?
James Galbraith: We need a correct assessment of the degree of losses suffered by a bank which is functionally insolvent. But as long as the old management is in place, there are no incentives to cooperate in the evaluation you need to make. That's the first problem. The second problem is: When a bank is insolvent, the incentives for normal banking practice disappear. They become perverse. The incumbent management has good reason to gamble excessively and to make capital losses. This is because it appears that the regulators could soon close down the bank. Beyond that, if the situation for the bank is truly hopeless or if the management is truly corrupt, then the incentive is to loot the institution, to take as much money out of it -- e.g. in the shape of bonuses and dividends -- before the true state of the books is discovered.
Manager Magazin: Is this something we are witnessing right now?
Galbraith: Certainly those incentives are in place. In a situation when a bank has suffered losses sufficient to impair its capital, you need to have regulatory supervision in place. This does not mean that you necessarily close the bank. The way it usually works in the USA is that a bank is closed on Friday and re-opened on Monday under a new name, with a new leadership and with a team of examiners who are going through the books, trying to sort the good business loans and personal loans from those which are hopeless. Then you isolate the hopeless stuff, you force a write down of the equity and the subordinated debts of the people who put in risk capital -- so they have to take their losses as they should. And then you break up the bank into pieces which have a better prospect to gain viability soon. That's a process of re-organization and re-capitalization.
Manager Magazin: The change of management is probably the most important step.
Galbraith: A change of management is essential, because firstly, the incumbents are responsible, whether they were culpable or not, and secondly, you need new people who are in line with the public purpose of this re-organization. It's the same principle in the navy: When a ship runs aground, the captain is removed, no matter if he caused the accident or not. No one would think it's a good idea to have the subsequent investigation headed by the ones who are to be investigated.
Manager Magazin: What you suggest is hard for two groups of people: for the management in place and for the shareholders of the bank.
Galbraith: Why worry? The shareholders have already lost most of their capital. In the case of Citigroup, it was traded at $55 (€41) per share a year ago and it's now at $3.58. That's approximately a 95 percent loss. And the remaining 5 percent exists in the books only because of the expectation that the government would bail them out. So, even this poor market capitalization is only nominal. Everybody understands that the bank in fact is insolvent. Another question is: Who are the shareholders? Who holds shares at that price? A good deal of them could be people who bought their Citi shares at $5 or $4. Clearly, they are gambling on the bailout. There's nothing wrong with them doing this. But they have no claim on public support.
Manager Magazin: What about the management?
Galbraith: The managers are in their positions on behalf of the shareholders who gave them great powers and, of course, like to see them perform well. When they do, they are very well off. Most of them have been in place for a couple of years, and they have earned very much in recent years, in some cases bonuses of $20 million. Again: When the bank runs aground, there have to be consequences. The management has no claim on sympathy. They won't be poor. They have enough to send their kids to college. Some of them may have to sell some houses or boats. This is not a sad thing -- this is called the capitalist system. Well, it used to be called the capitalist system. Do we still have a capitalist system somewhere? China, maybe? (laughs) It's certainly a life change for them, but there's no human tragedy involved in changing the management of an insolvent bank.
Manager Magazin: In your scenario, the deposits must be guaranteed by the state.
Galbraith: Yes, that's absolutely essential. The standard practice in this case is to establish a deep insolvency insurance fund. This follows the principle that the ordinary depositor is not responsible for the problems of the bank because it's unreasonable to expect ordinary depositors to be monitoring the performance of the management. It's that simple: If the depositors feel that there's something wrong with the way the bank is run, they just leave, and that causes a systemic problem very quickly. And that's also the reason why you try as hard as possible to keep this ordinary business going after declaring a bank insolvent.
Manager Magazin: The most prominent example of a German bank facing a possible breakdown is an institution named Hypo Real Estate ...
Galbraith: (laughs) Why am I not surprised to hear that?
Manager Magazin: Yes, their core business is rather obvious... Their main problems stem from asset backed securities from the US. The government has already put some €100 billion into preventing the bank from collapsing. What's your recommendation for the future of such a bank?
Galbraith: I sincerely hope the bank management conducted some due diligence with the products they bought. And if they relied on agency ratings, they should have asked whether the agencies were working on their behalf. But I am very sure that, again, the answer is 'no'. The rating agencies made a mess by rating asset backed securities with AAA, so we're seeing a failure of due diligence at every stage. And a deep fraudulence at every stage. When a rating agency certifies that a security is AAA, it is making a claim about the quality of that security. It cannot make this claim unless it has closely looked at this security...
Manager Magazin: One would think.
Galbraith: One would think. The representation of such a quality of this security without examination is fraud. Perhaps Hypo Real Estate has legal recourse to these rating agencies for having relied on their fraudulent ratings.
Actually I doubt that, as there was some hidden understanding between such banks and rating agencies. The language they used reveals a different story than the one bank managers are selling to the public these days. "Liars' loans," "toxic waste," or my favorite: "neutron loans" -- loans that destroy the people but leave the buildings intact. These were the words to describe these loans and they were used by the people who were working in this industry. They reveal a culture of fraudulence on a massive scale. And of course governments now have to come to recognize that these are things they have to deal with.
Manager Magazin: So in your view, the talk about systemic failures is aiming to hide the real crimes that are actually involved?
Galbraith: There was clearly a systemic failure. But that does not mean there was no criminal energy around. The language one uses to describe these things is very important. I tend to stay away from neutral terms like "systemic failure" or "bubble," because these terms imply the innocence of the people involved -- and I can't see that.
Manager Magazin: What was it, then?
Galbraith: The reality of the financial crisis is that it was caused by a culture of complicity. That makes it so difficult for people to come to grips with it, especially for people who were involved, who were denying it themselves and who were partially aware of the extent of the damage. Probably many of them thought they would get away with it and now they realize that they have created an enormous slump.
Manager Magazin: Back to the consequences you suggest, declaring the banks insolvent and just saving the loans. What about the domino effect that could result, damaging systemically relevant banks?
Galbraith: The domino effect will happen anyway. The question politicians have to deal with is: Do they want to have the effect now or do they want to have to deal with these problems for another decade? They should be warned: The longer this goes on, the bigger the losses are. That's the lesson to be learned from the Japanese experience. There are moments where the state has to assert its autonomy. If, in the case of Hypo Real Estate, one assumes that the functioning of this bank for the entire system is necessary, then it's about time to make these bankers work for the public rather than having the public work for the bankers.
NY pension advisers charged in kickback scheme
The former New York state comptroller's top fund-raiser and pension investment chief on Thursday were arrested and charged with taking millions of dollars in kickbacks from money manager firms. More than 20 investment deals made by the state's $122 billion pension fund were "tainted" by the kickbacks, and five of the investments involved The Carlyle Group, one of the world's largest private equity funds, New York Attorney General Andrew Cuomo said. Henry Morris, who was the fund-raiser for former comptroller Alan Hevesi, and David Loglisci, who was the state pension fund's top investment officer, were charged with securities fraud, bribery, money laundering and other crimes in a 123-count indictment.
The two men were also charged in a civil complaint by the U.S. Securities and Exchange Commission. "Morris used the fund as his own piggy bank and took approximately $30 million in fees for himself and his business partners on investments which Morris himself had a role in approving," Cuomo said. Morris and an unidentified partner received more than $13 million in "sham placement fees" from five investments totaling $730 million that involved The Carlyle Group, Cuomo said. Morris's lawyer, William Schwartz, said in a statement that Morris was innocent. The pension deals that Morris recommended earned "hundreds of millions, if not billions, of dollars," he said. "There was no fraud and no corruption."
Loglisci's lawyer, Irving Seidman, also said his client is innocent, adding that his client's investments benefited the pension fund and that the deals were vetted by outside fiduciaries, including bankers, lawyers and attorneys. Chris Ullman, a spokesman for Washington, D.C.-based Carlyle Group, said the firm "has fully cooperated with the New York Attorney General's Office and is not a target of the investigation." New York puts its pension fund under the control of the comptroller, which, when coupled with lax campaign finance laws, "breeds corruption," Cuomo said. Morris helped pick Loglisci as the pension fund's top investment officer. If convicted on all the criminal charges, Morris would face up to 340 years in prison and Loglisci would face up to 193 years in prison, Cuomo said.
Under a forfeiture order won permitting the seizure of assets, Cuomo said his office had frozen approximately $11 million of Morris's assets, including banks accounts and property. Morris was released after posting a $1 million cash bail. Loglisci's bail was set at $350,000 and both men's travel was restricted. Companies controlled by Morris were also indicted. Cuomo and Securities and Exchange Commission Chairman Mary Shapiro told reporters that their probes were continuing, and said they would rule out the possibility that more individuals or companies could be charged. Former state Comptroller Alan Hevesi, who was not charged by the Cuomo or the SEC, resigned in December 2006 after pleading guilty to a felony charge of defrauding the government over his use of state drivers to chauffeur his ailing wife.
Current comptroller Thomas DiNapoli said the pension reforms he has proposed include public campaign financing. "The reforms we've instituted would have stopped the transgressions committed during the Hevesi administration." Cuomo said that Hevesi's senior staffers took "hundreds of thousands of dollars worth of gifts and bribes for themselves and their families and friends." "The charges entail a web of corrupt acts for both political and personal gain," he said. Cuomo charged that Loglisci accepted sham "investments" for the production by his brother of a low-budget movie, "Chooch," and said an unnamed high-ranking official in the comptroller's office got cash from Morris and rent payments for his girlfriend's luxury apartment. The indictment also listed other investment firms involved in deals allegedly tainted by kickbacks: Access/NY European Fund, Aldus New York Emerging fund, GKM/NY Venture Capital Fund, Olympia John Street Fund LP, Paladin Homeland Security Fund and Strategic Co-Investment Partners.
'Serious Delinquencies' May Cause RMBS Downgrades
Moody’s Investor Services announced Thursday it had revised its loss projections for residential mortgage-backed securities (RMBS) backed by prime jumbo loans. The vintage of RMBS in question was issued from 2005 to 2008; Moody’s said it expects the 2005 vintage securitization to lose 1.7 percent, the 2006 vintage to lose 3.55 percent and the 2007 vintage to lose .505 percent. The 2008 securitization is projected to shed 6.2 percent. In light of the projections, Moody’s said it has placed nearly 5,000 tranches of jumbo RMBS with an outstanding balance of $173.3 billion on review for various downgrades.
About 70 percent of 2005 senior securities are expected to retain investment-grade ratings, while the rest likely will reach Ba or B ratings. Moody’s said the majority of 2006 senior securities are likely to reach Baa1 to B3 ratings, while the majority of 2007 senior securities will likely migrate below B3. "[D]uring the last six months, jumbo mortgage loans backing 2005 to 2008 securitizations have shown substantial increases in serious delinquencies and decreases in prepayment rates — levels that are unprecedented for this asset class," Moody’s said. "…The quickly deteriorating performance, along with concerns about the continuing drop in housing prices nationwide and the rising unemployment rate has prompted" the revision.
Continued housing market weakness, job loss and economic hardship is driving borrower delinquency elsewhere. A massive wave of recent foreclosures has led to various foreclosure halts, moratoriums and increased efforts for borrower workouts. With increased efforts by lenders and servicers — now made mandatory for TARP fund recipients by President Barack Obama’s "Making Home Affordable" plan, launched March 4 — came an influx of homeowner hotlines to help navigate the confusing array of options. The Homeownership Preservation Foundation (HPF), which operates the Homeowner’s HOPE Hotline, announced Tuesday that on average, 13,500 homeowners have reached out to the Hotline each day since March 4, about three times the average number of daily calls the Hotline received prior to the release of the president’s program.
The Treasury Department on Thursday announced another homeowner assistance portal designed to help borrowers attempting to attain a more affordable mortgage payment. MakingHomeAffordable.gov features self-assessment tools that will help borrowers to determine if they’re eligible to participate and calculate the monthly mortgage payment reductions under the program. With these efforts in place, the volume of borrowers defaulting on payments is hoped to lessen somewhat in coming months. It’s still unclear what effect, if any, the mortgage plan will ultimately have on the securitizations being considered for downgrades at Moody’s.
San Francisco Bay Area Home Prices Down 46% In One Year
The median home price in San Francisco Bay Area last month dropped below $300,000 for the first time in almost a decade, spurring an increase in sales, MDA DataQuick said today. The median price fell to $295,000, down a record 46 percent from $548,000 a year earlier and reaching the lowest level since 1999, the San Diego-based real estate research company said in a statement. A total of 5,032 new and existing houses and condominiums sold last month in the nine-county region, up 26 percent from a year earlier.
Northern California prices are being driven down by a rise in foreclosures, with properties in default typically selling at a discount. Stricter lending standards for more expensive properties are affecting the market as well, MDA DataQuick said. Less than 18 percent of Bay Area homes were purchased with loans of more than $417,000 last month, down from 62 percent before credit tightening began in August 2007. "A lot of Bay Area activity is basically on hold, waiting for the jumbo-mortgage spigot to reopen," MDA DataQuick President John Walsh said in the statement. Prices fell in all nine Northern California counties. The biggest drop was in Contra Costa County, where the median fell 52 percent to $216,500.
More than 65 percent of all previously owned homes sold in Contra Costa last month had been foreclosed upon at some point in the past year. For the nine-county region, foreclosures accounted for 52 percent of February resales, up from 22 percent a year earlier. MDA DataQuick is a unit of Richmond, British Columbia-based MacDonald, Dettwiler and Associates Ltd. It compiles surveys using county records and supplies real estate information to customers including public agencies, lenders and title companies. In Southern California, house and condominium sales increased 41 percent in February as buyers took advantage of prices that fell 39 percent from a year earlier, MDA DataQuick said earlier this week. The median home price in the six-county region fell to $250,000 from $408,000 a year earlier.
More Americans are just a paycheck or two away from ruin
Americans are in a collective state of financial depression as many admit they could only cover their bills for two months at most if they found themselves suddenly jobless, a nightmare more and more worry may come true. The results of a bevy of surveys found a growing number of consumers are only a couple paychecks away from a household collapse even as many scramble to shore up savings. Rainy-day funds appear to be a distant memory as households burn cash to cover food and energy bills as well as mortgage and car payments. A large number of households say that even one missed paycheck would spell financial ruin. And even in households that remain well off, the surveys show a festering fear that financial problems are lurking.
"This is flashing so bright red," said Paul Ballew, senior vice president of Nationwide Insurance Co. "Roughly 60% of the population was ill-prepared (financially) before the meltdown." A MetLife study released last week found that 50% of Americans said they have only a one-month cushion -- roughly two paychecks -- or less before they would be unable to fully meet their financial obligations if they were to lose their jobs. More disturbing is that 28% said they could not make ends meet for longer than two weeks without their jobs. And it's not just low-income earners who would find themselves financially challenged. Twenty-nine percent of those making $100,000 or more a year said they would have trouble paying the bills after more than a month of unemployment.
Meanwhile, more than four in 10 respondents told pollsters in a recent Pew Research Center study that job-related issues were the nation's most important economic problem. "Since October, mentions of other major economic issues have declined, as the public is increasingly focused on the job situation," according to the Pew study.
Since July, the study noted, there was been a striking spike in the numbers of families making $100,000 or more who said it was difficult to find local jobs -- 73% compared with 40% eight months ago. A Discover U.S. Spending Monitor monthly study found that consumers were becoming more despondent as each month passed. For example, the number of people reporting that they had money left over after paying their bills in February fell to 47% from 51% in January. Those thinking they would come up short in finances in the following 30 days rose to 39% from 34%, while those who said they had six months or more of reserves on hand should the paychecks stop coming dropped to 20% from 22%.
Not surprisingly, spending and savings patterns have shifted dramatically and across nearly all income levels. The Pew Center study found that, on average, 86% of consumers at all income levels have cut back spending, though the changes differ by wage level. For example, lower-income Americans are likely to have cut back on vacations or put off big-ticket expenses, such as home improvements or purchasing a car. Meanwhile, higher-income earners are more likely to have tweaked their retirement plans, according to the Pew Center. The same is true even in eating behaviors, according to a recent Janney Montgomery Scott report. Consumers across the income spectrum are seeking more values, with lower income households most likely to move to private-label brands and use coupons, while wealthier consumers were deciding to eat at home and not out, analyst Jonathan Feeney wrote in the report.
Most families, however, are paring spending because they're worried about the future rather than the present, according to the Discover study. While only 30% said they're cutting back on dining out, vacations, cars or home goods because their financial situation has become worse, 56% said they are making those changes because they're anxious that their financial health will weaken considerably. That sentiment has held since December, the study found. "Consumers don't seem to be making any changes month to month," said Matt Towson, a spokesman for Discover. "The numbers indicate that people are being frugal and still planning to cut spending." America's Research Group found that nearly 57% of the consumers it polled said they would spend less this year while virtually no one plans to spend more. But this is not just a one-year thing, according to consumers surveyed by BIGresearch. Nearly 91% said they see this crisis bearing down on their spending decisions -- in effect, their lifestyles -- over the next five years.
Fifty-five percent said they will think carefully before they make a purchase and 51% said they expect to be more price-conscious when buying clothing and food.
"American consumers are hunkered down, bracing for a depression," said Britt Beemer, chief executive of America's Research Group. "The dramatic drops in shopping levels have no match in our database in the last 30 years." If there is a silver lining, it could be this: The recent stock market rallies and a slowdown in the numbers of mass layoff announcements are encouraging signs to consumers that could bring some sense of economic stabilization. Gallup's Consumer Mood Index, based on a daily tracking poll, increased over the last week to minus103 from minus 116 the week before. "The sharp improvement in consumers' mood over the past week should not be surprising," said Dennis Jacobe, chief economist for Gallup. He credited the market's surge coupled with a "concerted effort to create a positive spin on the economic outlook" by the White House and the Federal Reserve. "Given the results, these efforts seem to be working and appear to have brought the downward plunge in consumer psychology of the previous several weeks to at least a temporary end," he said. But it might not be enough to overcome what's already happened to millions of Americans.
California unemployment hits 10.5% in February
California's unemployment rate rose for the 11th straight month in February, hitting 10.5% as a recession-wracked economy shed 116,000 jobs across all professions and industries, the state reported today. The number is up from 10.1% in January and is the highest since April 1983. Los Angeles County's unemployment rate reached 10.9% in February, rising from 10.5% in January. (An earlier version of the story said the county unemployment rate reached 11% in February, but the seasonally adjusted number is 10.9%.)
Construction, which continues to weaken, suffered the most: 30,900 jobs lost for the month. All other industries reported declines, with the exception of information, which includes television and movie production. Even the once dependable government employment contracted, and those conditions could worsen between now and June as thousands of budget-cut-related pink slips go out to teachers and school employees. Though economists this week detected some first signs that the housing and stock market bust might be bottoming out, labor experts predicted that the unemployment rate would continue to climb the rest of this year and well into 2010.
California "tent city" for homeless to be closed
The mayor of California's state capital unveiled plans on Thursday to shut down a sprawling "tent city" of the homeless that has drawn worldwide media attention as a symbol of U.S. economic decline. Sacramento Mayor Kevin Johnson promised to first make alternative shelter space available for the estimated 150 men and women who inhabit the squalid encampment near the American River, at the edge of the city's downtown. Johnson, who toured the area with California Governor Arnold Schwarzenegger a day earlier, said he hoped to have the ramshackle settlement cleared of tents and debris in the next two to three weeks.
"We want to move as quickly as we can," he told a news conference, insisting the city was determined to treat the tent dwellers with compassion. "They are people out there. We have to do whatever we can do," he said. "We as a city are not going to shy away from it. We're going to tackle it head-on." Advocates for the homeless applauded the mayor's action. Municipal authorities in Sacramento have been debating the fate of the tent city for weeks. Sacramento has one of the highest mortgage foreclosure rates in the United States, and the homeless total in the city and surrounding county is estimated to have jumped nearly 10 percent last year to nearly 2,700. About half are believed to be living outdoors, according to a local survey.
The tent city site, near an almond-processing plant beside a railroad freight line, made global headlines after it was featured last month on "The Oprah Winfrey Show." Local shelter organizers helped fuel media excitement by suggesting the tent city mushroomed with the arrival of newly homeless men and women, formerly from the middle class and forced by sudden economic hardship to take up residence in tents along the river. One activist for the homeless estimated that 10 percent of the tent inhabitants fit that profile. A closer examination of the site, including interviews with camp residents and police officers who patrol the area, turned up little if any evidence that true "recession refugees" were living among the chronically homeless there.
Tent city residents and police say the camp had existed for at least a year and had expanded after several smaller clusters of homeless settlements were shut down. Johnson said his plan included enlarging existing shelters, opening a short-term tented shelter area at a fairground, and creating "permanent housing opportunities" for an additional 40 homeless individuals. He said city officials would meet individually with each of the tent dwellers to discuss options, and a special task force would finish devising a long-term strategy for all the city's known homeless. The plan, which will be financed from various public funds, will be submitted to the City Council for approval next week.
Obama targets foreclosures in California
President Barack Obama on Thursday announced that California will receive $145 million to help communities hard-hit by the foreclosure crisis. The president, speaking to about 1,000 people at a town hall-style event in downtown, said the Department of Housing and Urban Development funds will be used to purchase and rehabilitate vacant, foreclosed homes and resell them with affordable mortgages. The president says the funds will also provide mortgage assistance and rehabilitation loans for low-income and middle-income families. "We'll start transforming abandoned streets lined with empty houses back into thriving neighborhoods," the president said.
The money is part of $731 million destined for 48 states to counter the impact of high foreclosure rates and plummeting home values. "Our goal is to help communities throughout California turn these houses into homes again," HUD Secretary Shaun Donovan said in a statement. "California is clearly struggling with a brutal foreclosure crisis and we must make every effort to help communities prevent these foreclosed properties from becoming a source of neighborhood blight." The program was created as part of the Housing and Economic Recovery Act of 2008, which permits state and local governments to purchase foreclosed homes at a discount and rehabilitate or redevelop them. Additional funds will come from the massive stimulus package. The agency plans to issue application requirements no later than May 3.
HUD will review applications and make awards. The agency said in a statement governments can use the grants to buy land or property, demolish or rehabilitate abandoned properties, and offer downpayment and closing-cost aid to low- to moderate-income buyers. They can also create "land banks," which would temporarily manage and sell vacant land. Meanwhile Thursday, a tracking firm said the median home price in California plunged 40 percent in February from a year ago, as low-priced foreclosure sales kept dominating the market. The statewide median price dropped to $224,000 last month, compared to $373,000 in February of 2008, San Diego-based MDA DataQuick said. However, last month's figure was unchanged from January, raising hopes among some that the housing market might be stabilizing. The median home price for the state peaked at $484,000 in mid-2007.
Sarkozy Urges ECB to Broaden Collateral, Buy Commercial Paper
French President Nicolas Sarkozy urged the European Central Bank to boost the euro-area economy by broadening the collateral it accepts when making loans and buying commercial paper. "The central bank must widen the quality of paper it accepts," Sarkozy told reporters after a meeting of European Union leaders in Brussels. While the ECB has already revised its collateral rules since the financial crisis began, it has yet to follow the Federal Reserve and other major central banks by buying assets such as corporate securities or government bonds in a bid to reduce long-term interest rates. ECB President Jean-Claude Trichet said in an interview with Europe 1 radio on March 18 that although his central bank is studying whether to take more unconventional monetary policies, "they won’t necessarily be the same as our counterparts."
EU to Double Aid for Stressed States in Boost to East
European Union leaders agreed to double a credit line for countries in financial distress, trying to shore up ex-communist economies hit by the worst slump in 60 years. The EU will increase to 50 billion euros ($68 billion) a limit on emergency lending to 11 EU countries not using the euro, eight of which are in eastern Europe. Hungary has already drawn 6.5 billion euros and Latvia 3.1 billion euros. Leaders also agreed to boost funds to the International Monetary Fund by 75 billion euros "We have matched our words with action," European Commission President Jose Barroso told reporters after an EU summit in Brussels today. "Our message is one of confidence and solidarity."
The offer by the richer western European countries calmed tensions triggered by a March 1 veto of a broad-based bailout for eastern Europe, which sent stock markets in the region to the lowest level in 5 1/2 years. After spearheading opposition to an eastern rescue fund at the March 1 summit, German Chancellor Angela Merkel consented to lift the aid limit today as the deepening recession hammers eastern European finances. The borrowing facility wouldn’t be available to countries using the euro such as Spain, which is reeling from a downgrade in its credit rating by Standard & Poor’s in January.
Romania last week became the third eastern country to request aid, with Prime Minister Emil Boc saying yesterday that the country may need 20 billion euros from the EU and IMF. The credit line authorizes the European Commission to sell bonds to finance loans to EU countries outside the euro region that run into balance-of-payments difficulties. It was raised to 25 billion euros from 12 billion euros in December. The leaders today left final decisions on implementing the increased aid ceiling to the bloc’s finance ministers. The pledges came as EU leaders defended efforts to counter the economic crisis, rejecting criticism that they haven’t done enough. The economy of the 16-nation euro region will shrink 3.2 percent in 2009, the IMF said yesterday, worse than the 2 percent slump it forecast in January.
Goldman Sachs Group Inc. yesterday urged bolder European action, saying governments should inject 1 trillion euros into the economy this year and next and accelerate their cleansing of banks’ toxic assets. Along with the bloc’s increased in funding for the IMF, leaders announced spending of 5 billion euros on energy and telecommunications projects by the end of 2010 as part of a stimulus plan to combat the recession. Strained by loans of $55 billion in the past six months to countries such as Hungary, Ukraine and Pakistan, the IMF had lobbied for a doubling of its pool of bailout funds to $500 billion. The IMF contributions will come from individual EU governments and the size remains to be decided, possibly by the time Group of 20 leaders meet in London on April 2.
Merkel cleared the way for a separate deal on a 5 billion- euro package of energy and telecommunications projects, the final part of an EU stimulus plan to combat the recession. Germany backed the EU-funded package as long as "substantial parts" of the projects get off the ground by the money is spent by the end of 2010, Merkel said. The subsidies will go for energy and telecommunications networks, potentially including the Nabucco pipeline project to import natural gas from the Caspian Sea. The sum is part of the 30 billion euros from the EU’s central budgets that will be used to fight the recession. Steps by national governments will bring total EU spending to more than 400 billion euros.
The emergency spending will balloon the EU-wide deficit to 4.4 percent of GDP in 2009 from 2 percent last year, the EU forecasts. Under German and Dutch pressure, the leaders pledged to refocus on fiscal rectitude once the economy gets back on track. Governments should return "to positions consistent with sustainable public finances as soon as possible," according to a draft communiqué to be issued later today. The text set no deadline for erasing deficits.
Priests Become Bankers as Italy's Needy Turn to God
Father Vincenzo Federico usually offers prayers when times are tough. As Italy lurches deeper into an economic crisis, the Roman Catholic priest is turning into a financial, rather than spiritual, adviser. After he guaranteed a loan of 10,000 euros ($12,700) to a family of four earlier this year, his mornings are back-to-back appointments with churchgoers seeking similar aid. "These days I feel like a banker," Federico, 40, said by telephone from his parish in the medieval village of Padula in southern Italy. "In 15 years of priesthood, I never thought that this is what I would wind up doing."
As Europe’s most indebted country faces its worst recession since 1975, the church is stepping in to help cash-strapped Italians, who receive the lowest unemployment benefits in the 30-member Organization for Economic Cooperation and Development. The smallest of Italy’s 325 dioceses have earmarked a minimum of 15,000 euros to support bank loans for parishioners. The archdiocese of Milan, the country’s second-largest city, has created a fund now totaling 3.2 million euros to which people may contribute over the Internet. Church officials will meet in Rome March 23-26 at the Italian Bishops Conference to commit more cash, according to Andrea La Regina, head of social projects at Caritas, a Catholic charity based in the capital.
"We are putting more money in the pot to meet the demand of families that, until a few months ago, wouldn’t have dreamed to ask for help," La Regina said. "The state is not doing what it should to cushion the effects of unemployment." Italy’s jobless rate climbed in the fourth quarter to 6.9 percent, its highest in more than two years, the national statistics office Istat said today. Demand for unemployment benefits soared 46 percent in the first two months of 2009 from a year earlier, the country’s welfare and pension agency INPS said this week in its annual report. Caritas serves as the intermediary between parishes and Banca Etica, or Bank with Ethics, a lender started 10 years ago in Padua, west of Venice, by a group of nonprofit organizations.
To obtain credit, Catholics must first make their case to their parish priest, who presents the appeal to a three-member council of the local branch of Caritas. If the charity decides with Banca Etica that there are grounds for a loan, the church acts as a guarantor. "We examine case by case to ensure that people aren’t too indebted," said Claudio Gasponi, who screens loan requests at the bank. About a third of applicants receive the funds, he said. The current interest rate is 3 percent a year. That compares with personal-loan rates of between 8.9 percent and 9.3 percent at Intesa Sanpaolo SpA, Italy’s second-biggest bank. Simone Martinez, married with an eight-year-old daughter, is averse to bank loans but trusts his church and is considering applying for help. He has been unemployed for two years since returning to Italy in 2003 from Venezuela.
In Caracas, he worked as a taxi driver and a waiter. In Italy, he can’t find a job and shops for groceries with a prepaid card at Emporio, a Caritas-funded supermarket. "Where is the state?" said Martinez, 48. "If it weren’t for the church, I would be begging." Italy’s unemployment benefits are a fraction of what neighboring France pays. Former workers get a maximum of 40 percent of their wages, capped at 1,000 euros a month, for a maximum of six months, according to labor law. In France, benefits last for almost two years and equal a minimum of 57 percent of the person’s last paycheck. Prime Minister Silvio Berlusconi turned down a proposal by the opposition Democratic Party to extend unemployment payments to former temporary workers, who now account for 10 percent of Italy’s workforce as the country introduced more flexible labor contracts to encourage companies to hire. On March 1, he told reporters in Brussels the cost would be "unsustainable."
Italy is hemmed in by debt 1.1 times its gross domestic product, which costs 81.5 billion euros a year in interest payments. The country also has a European Union obligation to keep its deficit within 3 percent of GDP. "We would like to do more, but unfortunately we live in Europe and with its rules," Berlusconi said. Italy’s $1.8 trillion economy will contract 2.6 percent this year after shrinking 1 percent in 2008, the most in three decades, Bank of Italy’s deputy director general, Ignazio Visco, said on March 4. So Italians are turning to God. "Our door is always open," said Father Matteo Zuppi, who organizes soup kitchens and food deliveries to the poor, elderly and homeless in Rome for the Community of Sant’Egidio, Italy’s leading Christian charity. While Pope Benedict XVI said on Oct. 7 that the economic meltdown shows money "is nothing," Father Federico reckoned a lack of cash is all his parishioners in Padula think about. "They call me at all times, even late at night on my mobile," he said. "They have no one else."
British car production drops 59%, biggest fall in nearly 40 years
Car production has suffered its biggest fall since 1970 as Lord Mandelson, the Business Secretary, insisted the industry in Britain can still thrive. The latest figures produced by the Society of Motor Manufacturers and Traders showed that there is no end in sight to the gloom that has engulfed the industry since last Autumn. Months of lay-offs, factory shutdowns and shift cuts have led to a 59 per cent fall in February compared to the same time last year. The figures were announced within 24 hours of the cancellation of next year's British Motor Show – the first time this has happened since the war. They come as unemployment passes two million, intensifying pressure on the Government to act to protect the motor industry on which more than 800,000 jobs depend.
"The large fall in February's vehicle production is a direct result of weak demand and the need to protect the highly-skilled workforce and valuable industrial capability in the industry," said Paul Everitt, SMMT chief executive. In late January the Government announced a £2.3 billion aid package for the stricken industry, with much of the money earmarked for new "green technology." However none of the cash has been distributed yet, partly because of the need to get EU state aid clearance. In addition the money has been allocated for longer term investment at a time when the industry believes that short term support is vital to prevent more jobs being lost. The industry is looking to the Government to set up a scrappage scheme. This would see motorists given £2,000 to subsidise the purchase of a new – or nearly new – car, in return for getting rid of a vehicle which is nine years old or more. Critics have suggested that the scheme would not benefit British industry, because it would be illegal to limit subsidies to cars made in the UK.
But according to motor manufacturers, even foreign-made cars have to be sold, serviced and maintained in Britain. Lord Mandelson tried to sound an optimistic note ahead of a visit to the Nissan plant in Sunderland, where 1,200 jobs were axed earlier in the year. "The car manufacturers, their huge supply chain, are a cornerstone of our manufacturing sector. "They employ very, very many people, so their survival is important, and they will survive, they will thrive in the future, as long as they make the right decisions now." He defended the Government's plans for the industry. "Both through their access to European Investment Bank loans, which the Government here is prepared to guarantee, as well as the loans and guarantees that we are prepared to offer to the industry, domestically, we are going to make sure that where these companies are viable going concerns – and in the overwhelming majority of them that is the case – they do have a future."
Britain's public borrowing soars as recession bites hard
Britain will borrow more than any other nation in 2010
The Government will borrow more than any other major economy next year, according to the latest predictions by the IMF and trends indicated in data released by the Office for National Statistics (ONS). Economists say the UK seems set to borrow close to £300bn this year and next – £6,000 for every British citizen. That will propel the UK to the top of the international league table for budget deficits and help take the national debt beyond £1trillion (£1,000,000,000,000). It places the Chancellor, Alistair Darling, in an exceptionally difficult position as he frames his next Budget, to be unveiled on 22 April.
The IMF forecast the UK's borrowing will reach about £165bn next year, or 11 per cent of gross domestic product (GDP), the highest seen since the Second World War. Many independent economists say it could go as high as £200bn as the recession bites. In any case it will be by far the largest sum among the G20 group of advanced and fast-growing economies, whose leaders are set to meet at a summit hosted by Gordon Brown on 2 April. Although the borrowing will undoubtedly help to boost the economy in the short run, critics say it will load huge debts on to future generations of taxpayers and will severely limit the scope for public spending and tax reductions in the run-up to the next election and for years ahead.
David Cameron said yesterday that plans to cut taxes would be put on the backburner by an incoming Conservative government because of Britain's debt crisis. The Tory leader signalled an onslaught on public spending in an effort to tackle "the most red-inked, ruined public accounts in modern British history". He said the moves would have to take priority over previous commitments to reduce taxes. A Cameron administration would guarantee above-inflation increases for the NHS and foreign aid but budgets for other Whitehall departments would be scrutinised for savings. Yvette Cooper, the Chief Secretary to the Treasury, claimed the Tories were proposing cuts to apprenticeships, housing and transport in the middle of a recession. She said the moves were "economic madness that would cost us all more in the long run".
City economists say that the widening budget deficit is already limiting the scope Mr Darling has. Jonathan Loynes, from Capital Economics, said: "With public borrowing set to soar towards £200bn next year, there are growing signs too of a structural black hole in the public finances, perhaps reflecting permanently lower levels of profits and income in the financial and housing sectors. It would seem to place some limit on the size of any further stimulus Mr Darling might implement in next month's Budget and underlines the need for a major fiscal consolidation in the future." The ONS reported that the Government had to borrow £9bn in February alone, bringing its total borrowing in the year to date to £75.2bn – more than £50bn higher than last year.
The Government is on course to borrow £100bn over 2008-09, say analysts, more than double what the Chancellor forecast in last year's Budget (£43bn).
Gemma Tetlow, a senior research economist at the Institute for Fiscal Studies, said: "The deterioration in the outlook for borrowing is mainly down to weaker-than-anticipated tax receipts, in particular VAT. Receipts of corporation tax have also been weaker." Bad as this year's borrowing figures are, the intensity of the recession will push the public finances even further into the red. The IMF said this week the UK economy would shrink by 3.8 per cent over 2009, compared to a Treasury prediction of a 1 per cent fall. That would add tens of billions to borrowing which is already set to rise to £118bn, a post-Second World War record. Adding in the liabilities of the Royal Bank of Scotland and other nationalised and semi-nationalised banks could see a surge in national debt from about 49 per cent of GDP today to 400 per cent or more, way ahead of the previous peak of 262 per cent of GDP it stood at in 1946. Then as now that could usher in decades of slower growth.
2 million UK homeowners to fall into negative equity
More than two million homeowners face falling into negative equity this year, the City regulator has warned. The Financial Services Authority (FSA) said that if property prices fall by 30 per cent from their peak - as is likely - two million homeowners and 500,000 buy-to-let investors will be in negative equity. This would mean that one in four homeowners with mortgages and half of buy-to-let borrowers may be unable to sell their properties or remortgage until property prices rise. The warning is contained in the FSA's financial risk outlook report for 2009. The regulator believes that negative equity, which blighted Britain in the early 1990s, could have damaging effects for the wider economy. "Households in, or close to, negative equity are more likely to reduce consumption, resulting in lower economic activity," the report says. "According to Council of Mortgage Lender estimates, around one quarter of possessions during the early 1990s recession was the result of borrowers voluntarily handing back their keys.
This behaviour is more likely if people are in negative equity. "From the lenders' perspective, negative equity could give rise to further losses and write downs. Lenders could therefore have an incentive to possess homes before property prices fall further below the value of the mortgage, potentially leading to consumers being treated unfairly." The Government has been criticised after it emerged that a flagship scheme for borrowers facing financial difficulty announced last year has not yet been introduced. The Prime Minister has insisted it will be available from next month. Grant Shapps, the shadow housing minister, said last night: "I hope these forecasts turn out not to be correct. I am shocked by the shear number of families now facing the prospect of negative equity. "Gordon Brown is in a state of denial and is failing to listen to the alarm bells being rung by his own financial watchdog."
Paris in the spring
Well over 1m protesters took to the streets across France on Thursday March 19th as part of a day of action in defence of jobs and salaries. All eight of France’s big unions joined the protests, which drew more support than a similar day of action in January. Train drivers, postmen, teachers, university lecturers, town-hall employees, carmakers, oil workers, supermarket cashiers took part. Among the unions’ demands were an end to public-sector job cuts, a boost to the minimum wage and a reversal of tax cuts for the rich. The government of Nicolas Sarkozy is worried not just by crowd numbers. With Mr Sarkozy’s popularity low, public opinion seems to be shifting. For a time voters were turning against strikers, but now they may be swinging behind them. Fully 74% said they supported this week’s protests, according to BVA, a pollster, up from 69% in January.
Union resistance, too, seems to be hardening. Last week Serge Foucher, the boss of Sony France, was kidnapped and held overnight by workers angry about the closure of a factory. The boss of a Continental tyre factory was pelted with eggs by employees dismayed by its closure—despite a promise to keep the factory going after workers agreed, unFrench-like, to shift up to a 40-hour week. French governments, haunted by May 1968, are wary of the street. Troublemakers can disrupt orderly protests. Blockades of factories and university campuses are common. A debate at the Sorbonne on the crisis of capitalism was cancelled because of a strike by students. Lecturers have abandoned the lecture halls. The University of Toulouse-Mirail closed for a day after students staged a sit-in. Laurent Fabius, a former Socialist prime minister, talks darkly of "revolts" in the spring.
The recession explains part of the discontent. It is little consolation for voters to learn that their economy is shrinking less than others: GDP is forecast to fall by 1.9% this year, compared with drops of 2.8% in Britain and 2.5% in Germany. The fear of job losses still weighs heavily. Every day sees more redundancies and factory closures. Even Total, the oil giant that has just reported big profits, has announced job cuts in France. Although most of those taking part in the one-day protests are from the public sector, with few of their jobs at risk, their actions draw extra legitimacy from general anxiety about the recession.
The militant tinge to the protests is new. As the Socialists fail to convince, the hard left is reviving, and with it class warfare. It has a new champion in Olivier Besancenot, a postman—himself on strike—and leader of the New Anti-Capitalist Party. One poll now suggests that he is the most credible alternative to Mr Sarkozy, ahead of any Socialist. Mr Besancenot does not miss a chance to side with strikers. He talks of workers’ "exploitation", denounces Mr Sarkozy for pandering to the rich, urges "revolt" and calls on the French to copy the rolling strikes in Guadeloupe. Hard-left politics and union activity are linked. Mr Besancenot is a member of SUD, a radical union bent on maximum disruption.
This month, many firms hold elections to works councils, whose statutory role gives the unions their power. At SNCF, the state railway, SUD grabbed 14.9% of the vote last time, and is set to improve on that. It is the second-biggest union at La Poste, the post office. The better SUD does, the more it drags all unions leftwards. Faced with discontent, the government is torn. It can try to act tough. Mr Sarkozy insists that nothing new will be put on the table after this week’s strike. But the unions are betting they can force his hand. After all, he has given ground before. After January’s one-day strike, and talks with unions, he announced new welfare measures, better unemployment protection and tax cuts for the low-paid—to the tune of €2.6 billion ($3.4 billion).
Bank Expropriation Bill Clears German Parliament
The German Bundestag on Friday passed a law that gives Chancellor Merkel the power to expropriate shareholders in the ailing real-estate lender HRE. It could become the first such expropriation in Germany since the 1930s. When it comes to financial problem children, the mortgage lender Hypo Real Estate has in recent months proven a particularly difficult case. Already, Berlin has provided the bank over €100 billion in aid, in the form of bailouts and guarantees. A further, and far more controversial, step was taken on Friday. Germany's parliament passed a law that would allow Berlin to expropriate HRE shareholders as a way to nationalize the bank. The law, passed by a vote of 379 to 107 with 46 abstentions, allows Chancellor Angela Merkel's government to initiate expropriation proceedings only until June 30.
Berlin is seeking to obtain over 90 percent of HRE shares as part of its plan to prevent the collapse of the bank, but has been hampered by the unwillingness of US private equity investor J.C. Flowers to sell its 25 percent stake in the ailing lender. Negotiations with J.C. Flowers will continue, but little progress has been made recently. Despite widespread support for the bill from the Social Democrats, and reluctant support from much of Merkel's Christian Democrats, the bill is a controversial one. The Federation of German Industries has blasted the bill, calling it "completely wrong." And the opposition Free Democrats (FDP) are also opposed to the measure. Indeed, the FDP has even managed to attract some conservatives away from the CDU lately, partially as a result of its opposition to the expropriation measure and other state-heavy reactions to the financial crisis by the Merkel government.
Some have even said the law represents the breaking of a taboo in Germany given the country's experience with expropriations under the Nazis and, in East Germany, under the communists. Were Berlin to carry out an expropriation of HRE, it would be the first such move since the 1930s. Still, the law is narrowly formulated in an effort to limit Berlin's reach. Furthermore, it expires at the end of June. HRE was among the first of Germany's banks to be hit by the financial crisis. In early 2008, the bank wrote down €390 million before needing a €50 billion bailout last October. When Germany passed a €500 billion bank bailout bill later that same month, HRE was the first bank to take advantage. The bank has now tapped Berlin for €102 billion in aid and there has been speculation recently that more will be necessary.
Asia Declines New 'E-Z' IMF Loans
Asian economies targeted for a sweetened credit backstop from the International Monetary Fund declined the offer, highlighting the stigma attached in the region to any suggestion of taking money from the IMF. Officials in South Korea, Taiwan and Singapore Friday said their governments don't need to participate in the revised $100 billion flexible credit line, a program announced in October that didn't attract a single borrower. "South Koreans tremble and financial markets turn sensitive whenever they hear the word 'IMF,' so it's not easy for us to participate in the program," said Lee Hyoung-ryoul, the head of the IMF team at the Korean Finance Ministry. He said Seoul has no need for such loans as the nation has sufficient foreign-currency liquidity.
Similarly, Taiwan has abundant liquidity and doesn't need to borrow from global organizations like the IMF, said Finance Minister Lee Sush-Der. The Monetary Authority of Singapore welcomed "the IMF's efforts to revise the lending facility as a precautionary crisis prevention instrument." But added that there was no need for Singapore to access the IMF facility. The IMF introduced the loan program, informally dubbed E-Z loans, after the September collapse of Lehman Brothers Holdings Inc. caused the global credit crunch to worsen dramatically. The idea is to support countries with policies the IMF believes are generally sound but which face sharp slowdowns in economic growth.
To shed an image -- prevalent in Latin America and Asia -- of the IMF as making heavy-handed demands on countries in crisis, the fund offers to preapprove countries for the E-Z loans and not require borrowers to make significant changes in economic policy. Finding no takers, the IMF now plans to offer the loans as lines of credit: countries would tap them only if needed and wouldn't pay interest unless they used the money. The plan would remove any formal cap on the amount countries can borrow and make the credit line renewable indefinitely. Senior IMF officials are targeting Mexico, Peru, Chile, Brazil, Singapore, Korea, Taiwan and perhaps Poland for the program.
But Asian countries, at least, don't appear impressed. The specter of being forced to undertake draconian economic policies to get IMF handouts during the worst of the 1997-1998 regional financial crisis remains stark for many Asian governments. Since then, governments have strengthened their finances and bolstered their banking systems while building huge foreign-exchange stockpiles to protect themselves. Taiwan's foreign-exchange reserves, at $294.2 billion at the end of February, are the fourth-largest in the world. South Korea's reserves totaled $201.5 billion and Singapore's foreign reserves as of January stood at $167 billion.
Russian Economy to Contract 7% in First Quarter, Ministry Says
Russia’s economy will probably contract by 7 percent in the first quarter of this year, according to the Economy Ministry. Gross domestic product shrank by 8 percent in the first two months of this year, the ministry said in a report posted on its Web site today. Exports declined by almost 50 percent in the first two months compared with the same period in 2008, the ministry said.
China Inc. On Huge Foreign Buying Spree
China’s companies are fast finding ways to spend, snapping up raw materials across the globe while those assets are cheap. Chinese companies have been have been gulping down tens of billions of dollars worth of key assets in countries as varied as Iran, Brazil, Russia, Venezuela, Australia and France, the Washington Post reports. Chinese companies poured $16.3 billion into foreign assets during January and February. If that pace continues, total overseas acquisitions could almost double last year’s total of $52 billion.
The assets are available at bargain-basement prices thanks to the financial crisis. As a result, China has garnered oil, minerals, metals, and other strategic natural resources necessary to sustain its economic expansion. "That China started investing or acquiring some overseas mineral resources companies with relatively low prices during the global economic crisis is quite a normal practice," Xu Xiangchun, consulting director for research firm Mysteel.com, tells The Post. "Japan did the same thing in its prime development period too."
It’s an early sign that China Inc. is gearing up for the next big surge of growth. Chinese demand for iron ore, food, and oil drove up the costs of those commodities at the tail end of the last boom. As the U.S. and Europe continue to slide commodities should fall, but Chinese buying is buoying commodities instead, creating global stagflation. Western consumers have less money, but prices rise anyway. The massive size of China’s purchases has swayed energy markets. It also has sparked concern that China will hoard commodities, lifting their prices and making them unavailable to other countries, including the United States. Investment guru Marc Faber says China’s strength makes its stock market a buy, despite its economic slowdown. "I would use weakness in Chinese equities to buy," he told Bloomberg TV.
Bank of Japan Says Economy Worsening 'Significantly'
The Bank of Japan said the world’s second-largest economy is worsening "significantly," maintaining its evaluation for a second month. "Japan’s economic conditions have deteriorated significantly" and are likely to keep worsening, the central bank said in a report in Tokyo today, keeping the most pessimistic language since 1998. The Bank of Japan this week decided to increase its purchases of government bonds from banks and offer subordinated loans to lenders in an effort to revive the economy. The central bank forecasts the sharpest economic contraction in more than 60 years as an unprecedented decline in exports forces companies to cut production and fire workers.
"Exports are expected to continue to decrease due to the deterioration in overseas economic conditions and the appreciation of the yen," the central bank said. Japan’s currency has gained 12 percent against the dollar in the past six months, eroding the value of exporters’ overseas sales. Spending by businesses and consumers is likely to weaken as profits worsen, funding remains difficult and the job market "becomes increasingly severe," the bank said. Declines in industrial output will "moderate gradually" as companies replace stockpiles they managed to offload when they left factories idle, the report said. The bank said corporate borrowing costs have eased since the end of last year, though companies with low credit ratings are still struggling to find investors willing to buy their bonds. Having cut the benchmark overnight lending rate to 0.1 percent in December, the central bank is trying to ease funding for businesses by buying corporate debt and other securities from banks.
Mexican Peso Becomes World's Weakest Currency on 'Cautious' Rate Cuts
Guillermo Ortiz, the longest-serving central bank governor in the Americas, is reducing interest rates slower than all his counterparts, and Mexico is paying for it in the currency market. Ortiz, whose second six-year term at Banco de Mexico ends Dec. 31, will lower the benchmark rate to 7.25 percent today from 7.5 percent, according to the median forecast of 23 analysts surveyed by Bloomberg. When the central bank cut borrowing costs on Feb. 20 by a smaller-than-forecast quarter-point, the peso plunged to a record low within 30 minutes.
While central bank chiefs around the world slash interest rates toward zero to revive growth, Ortiz, 61, is sticking to policies that have defined his career and helped him stabilize the currency after the 1994 devaluation and bring down inflation to a three-decade low. Now investors say the Stanford University- educated economist is too focused on controlling consumer price increases at the expense of growth in an economy that shrank in the fourth quarter for the first time since 2003. Ortiz and his board "sometimes just get too bogged down in their orthodox stance," said Joel Martinez, general director of Mexico City-based economic consulting firm Visor Financiero. The February cut, following January’s half-point reduction, "was very mediocre, very small and not aggressive enough," he said.
The peso tumbled 24 percent against the dollar in the past six months. It’s posted the worst performance against the dollar of the 16 most-traded currencies even after strengthening 10.4 percent since March 10. Chile’s peso is the biggest gainer in Latin America this year, advancing 9.4 percent, as its central bank pushed down the benchmark lending rate 6 percentage points to a four-year low of 2.25 percent. Brazil’s real is the second-best performer, rising 2.9 percent, after rate reductions of 1 point in January and 1.5 points last week. The Federal Reserve lowered the benchmark U.S. overnight rate to a range between zero and 0.25 percent in December from 4.25 percent a year earlier. Declines in exports, migrant remittances, tourism inflows and oil production swelled Mexico’s current account deficit to $6.1 billion in the fourth quarter, the widest trade gap since 2000. The slide in the peso drove annual inflation to 6.2 percent in February from 3.7 percent a year earlier.
"It’s a very difficult balancing act," said Neil Dougall, head of emerging-market research at Dresdner Kleinwort in London. "Inflation is a significant concern. Ortiz has done a very good job over a long period of time in terms of bringing a very steady hand to the tiller." To try to stem the peso’s decline, Banco de Mexico has spent $20 billion in the currency market since October, driving down the country’s foreign reserves by 5 percent. Mexico’s peso weakened as much as 1.5 percent on Feb. 20 after Ortiz lowered the rate less than the half-point median estimate in a Bloomberg survey of economists. The peso traded today at 14.0989 per dollar. It touched a record low of 15.5892 on March 9. Mexico’s Bolsa stock index declined 12.4 percent this year, the worst performance in Latin America. Yields on the government’s benchmark peso bonds due in 2024 have risen 36 basis points, or 0.36 percentage point, to 8.62 percent, according to Banco Santander SA.
"The market is not giving the Mexican central bank the benefit of the doubt," said Alberto Ramos, a Latin America economist with Goldman Sachs Group Inc. in New York. Investors are "looking more favorably on central banks that are looking to protect the economy," he said. Goldman says the peso will weaken to 14.25 per dollar by June. Societe Generale revised its mid-year estimate March 9 to 16.5 from 11. Rogelio Ramirez de la O, the Mexico City-based economist who predicted the 1994 devaluation, forecasts the peso will fall to 18.2 by year-end. The peso will drop to 14.5 per dollar, according to the median mid-year forecast in a Bloomberg survey of 24 economists.
Ortiz has "always erred on cautious side" even when "the best thing to do is to give the market what it wants," said Nick Chamie, global head of emerging-markets research at RBC Capital Markets in Toronto. In his four-decade career, Ortiz, a native of Mexico City, served as head of research at Banco de Mexico, executive director at the International Monetary Fund and undersecretary of the Finance Ministry before President Ernesto Zedillo tapped him as finance minister in December 1994. Days earlier, Zedillo had abandoned a currency peg that kept the peso near 3.4 per dollar. The currency plunged 53 percent before Ortiz managed to stabilize it in March 1995. The jump in inflation to a seven-year high of 52 percent in 1995 prompted Ortiz to rein in spending and then limit money supply growth after Zedillo named him central bank governor in January 1998.
Inflation dropped to 9 percent by 2000, helping the country win investment-grade credit ratings from Moody’s Investors Service that year and Standard & Poor’s in 2002. Inflation fell to 2.9 percent in 2005, the lowest since at least 1974. Ortiz turned Banco de Mexico into a "staunch inflation fighter," Federal Reserve Bank of Dallas President Richard Fisher said in a February 2006 speech. He dubbed Ortiz and then- Finance Minister Francisco Gil Diaz "Batman and Robin" -- an economic dynamic duo. "He has to take a good amount of the credit," said Lawrence Krohn, a professor of international economics at Tufts University in Boston. "He’s simply managed the money supply very astutely." Ortiz may have underestimated how investors would react to the February rate cut, according to Pablo Cisilino, who manages $8 billion in emerging-market assets at Stone Harbor Asset Management in New York.
"They didn’t communicate what they were doing," Cisilino said. "They never explained why" and "that scared the market," he said. President Felipe Calderon probably won’t reappoint Ortiz when his terms ends in December, Visor Financiero’s Martinez said. A decade ago, Calderon, then president of the opposition National Action Party, unsuccessfully pressured Zedillo to fire Ortiz as central bank governor, saying he had implemented a $61 billion banking industry bailout without proper congressional authorization. Maximiliano Cortazar, a spokesman for Calderon, said he didn’t know whether the president plans to reappoint Ortiz. "He knows this is his last year," said Martinez, who writes a weekly opinion column on financial markets in Reforma newspaper. It’s "been very difficult for Ortiz," he said.