The Ak-sar-ben toll bridge over the Missouri River between Iowa and Nebraska at Omaha.
Ilargi: Apart from Bernanke's admissions that the financial products division at AIG is holding the mother company hostage, and that the US should have taken the company into receivership a long time ago, -both of which are no small matters at all, they’re in fact stunning since he's known this all along-, I don't see much reason to watch Bernanke and Geithner's appearances in the House, nor Obama's press-op tonight. The reason is that I could write their speeches for them, not because I have intimate knowledge of the material at hand, but because they will avoid to address that material at any and all cost anyway. There are plenty smart writers who are starting to see what's going on, but they're only starting.
No Mish -and thousands with you-, Geithner and Bernanke don't get it all wrong all the time, in fact they get it remarkably right. What makes you think they get it wrong is that you fail to understand their objectives. Which have nothing to do with doing good for average Americans, at least not as a priority. The man in the street is an afterthought. The objective is to save the banks. Whether that is because they honestly feel that the banks need to be rescued at whatever cost to the public purse, or Armageddon will ensue, or whether they fear for their own little power lust comfort zones if they don't, it's hard to say, and in the end it doesn't matter either.
There may be all sorts of ideas of how another $1 trillion of taxpayer funds will free banks of their gambling losses to the point where they will start lending again, but whoever talks about that is just as stuck in their comfort zones as are Tim and Ben and Larry. It will not happen, it can't, America suffers a huge debt overload already, as a nation and individually, and that debt has to be repaid. Taking on more debt will bring no solution, least of all when it's used to bail out the very institutions that are most responsible for the majority of the debt.
And it's the system itself, it's not the institutions that are the core of the problem either, which by the way supplies a brilliantly solid reason to let them all fail tomorrow morning. That is, if as a government you have the best interests of the people in mind. Unfortunately, you're stuck with "leaders" that have either only the interests of the happy few in mind, or who have convinced themselves that to save what's left of the people's welfare, you need to save the happy few first. A very convenient worldview in which only one focus is needed: banks. It's the ultimate, and extremely perverted, version of trickle down economics.
Only, in this case, it’s as if you're watching a cartoon in which there's a pyramid filled with people, with the rich on top and the poor at the bottom, in which there's a mechanism to take away from the impoverished bottom whatever it has left, and reinject it at the top, while telling the poor that taking what's theirs is the only way to save them. Maybe someone with drawing skills can draw that picture for me.
The entire government is made up of people who either don't get it, or who don't care for the interests of the people. I’m sort of sure that Washington has both kinds of people working together, but we can't really tell the difference, because they all have the same priority. Those that don't get it steal from the people to give to the rich, because they see that as the only way to save the people. Those that don't care, steal from the people because they think that's some kind of inherent Darwinian right.
But there are no Robin Hoods out there. And that makes me think the game is pretty much set. The banks can't be saved, but they're the only party the government is attempting to save. There's only one possible outcome from here on in: an imploding society. This $1 trillion that Obama will talk about tonight can only be spent once, and it's being spent on the worst possible target. But that is not a mistake, it's a deliberate move made by the blind, the misguided and the cruel that are, all three of them, coincidentally, the only three categories of candidates who can get themselves elected to office. You need a substantial personality disorder to wind up in Washington, if only simply because you land in a pool of equally distorted minds. And that pool will lead us all into a world full of bitter misery. We're not on a road to nowhere. We will soon wish we were though.
Geithner plan will rob American taxpayers: Stiglitz
The U.S. government plan to rid banks of toxic assets will rob American taxpayers by exposing them to too much risk and is unlikely to work as long as the economy remains weak, Nobel Prize-winning economist Joseph Stiglitz said on Tuesday. "The Geithner plan is very badly flawed," Stiglitz told Reuters in an interview during a Credit Suisse Asian Investment Conference in Hong Kong. U.S. Treasury Secretary Timothy Geithner's plan to wipe up to US$1 trillion in bad debt off banks' balance sheets, unveiled on Monday, offered "perverse incentives," Stiglitz said. The U.S. government is basically using the taxpayer to guarantee against downside risk on the value of these assets, while giving the upside, or potential profits, to private investors, he said.
"Quite frankly, this amounts to robbery of the American people. I don't think it's going to work because I think there'll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer." Even if the plan clears banks of massive toxic debt, worries about the economic outlook mean banks could still be unwilling to make fresh loans, while the prospect of a higher tax burden to pay for various government stimulus plans could further undermine U.S. consumers, he said. Some Republican lawmakers have also expressed concern over the incentives offered by the government, which could end up providing private investors with more than 90 percent of the funds to buy the troubled assets. But President Barack Obama has said the plan was critical to a U.S. economic recovery.
Stiglitz, a professor at New York's Columbia University and a former World Bank chief economist, also urged G20 leaders at their London summit next month to commit to providing greater resources to developing countries and said China should be given bigger voting rights in the International Monetary Fund. "The voices of developing countries, and countries like China that will provide a lot of the money, are not heard." China would be hard pushed to reach its targeted 8 percent economic growth this year, but the important thing was that at least the Chinese economy was still growing, he said.
Stiglitz welcomed China's proposal on Monday for an overhaul of the world monetary system in which Zhou Xiaochuan, governor of the People's Bank of China, said the IMF's Special Drawing Right has the potential to become a super-sovereign reserve currency. Stiglitz has long called for the U.S. dollar to be replaced as the only reserve currency. Basing a reserve system on a single currency whose strength depends on confidence its own economy is not a good basis for a global system, he says. "We may be at the beginning of a loss of confidence (in the U.S. dollar reserve system)," he said. "I think there is support for some sort of global reserve system."
Fed and Treasury - Putting off Hard Choices with Easy Money (and Probable Chaos)
Brief remark - from early reports regarding the toxic assets plan, it appears that the Treasury envisions allowing private investors to bid for toxic mortgage securities, but only to put up about 7% of the purchase price, with the TARP matching that amount - the remainder being "non-recourse" financing from the Fed and FDIC. This essentially implies that the government would grant bidders a put option against 86% of whatever price is bid. This is not only an invitation for rampant moral hazard, as it would allow the financing of largely speculative and inefficently priced bids with the public bearing the cost of losses, but of much greater concern, it is a likely recipe for the insolvency of the Federal Deposit Insurance Corporation, and represents a major end-run around Congress by unelected bureaucrats.
Last week, the Federal Reserve announced its intention to purchase a trillion dollars worth of Treasury debt by creating the little pieces of paper in your pocket that have "Federal Reserve Note" inscribed at the top. In effect, the Fed intends to monetize the Treasury debt in an amount that exceeds the entire pre-2008 monetary base of the United States. Apparently, the Fed believes that absorbing part of the massively expanding government debt and maybe lowering long-term rates by a fraction of a percentage point will increase the capacity and incentive of the markets to purchase risky and toxic debt. Bernanke evidently believes that the choice between a default-free investment and one that is entirely open to principal loss comes down to a few basis points in interest. Even now, the expansion of federal spending as a fraction of GDP has clear inflationary implications looking a few years out, so any expectation that long-term Treasury yields will fall in response to the Fed's buying must be coupled with the belief that investors will ignore those inflation risks.
There is no doubt that the Fed also intends for the extra trillion in base money to end up as bank reserves. But think about what this move implies in equilibrium. The largest purchasers of U.S. Treasury bonds at present are foreign central banks. So what the Fed is really doing is printing enough money to crater the exchange value of the U.S. dollar, while leaving foreigners with a trillion dollars of savings that they would otherwise have invested in Treasury bonds, which they will now use, not to buy our lousy, toxic assets, but to acquire our productive assets, and at a steep discount thanks to the currency depreciation. So yes, the extra trillion in dollar bills will ultimately end up as bank reserves (and currency in circulation), but only by encouraging Beijing to go on a shopping spree to acquire a claim on our future production. Ultimately, funding the bailout of lousy assets comes at the cost of debasing our currency and selling our good assets to foreigners.
Make no mistake - we are selling off our future and the future of our children to prevent the bondholders of U.S. financial corporations from taking losses. We are using public funds to protect the bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own. All our policy makers have done to date has been to squander public funds to protect the full interests of corporate bondholders. Even Bear Stearns' bondholders can expect to get 100% of their money back, thanks to the generosity of Bernanke, Geithner and other bureaucrats eager to hand out the money of ordinary Americans. Though I believe that the consequences (via credit default swaps and the like) are overstated of letting bondholders take a haircut, and will ultimately be no worse than having the public take the losses, the fact is that we don't even need the bonds of major financial institutions to go into default. What we do need to do is offer those bondholders a choice:
1) The U.S. government takes receivership of the financial institution, changes the management, wipes out the stockholders and a chunk of the bondholders claims entirely, continues the operation of the institution in receivership, eventually reissues the company to private ownership, and leaves the bondholders with the residual. This is not "nationalization," but receivership – a form of "pre-packaged bankruptcy" that protects the customers and allows the institution to continue to operate, followed by re-privatization. As I've previously noted, this would fully protect all of the customers and depositors at no probable expense to the public. Alternatively;
2) The bondholders voluntarily agree to move a portion of their claims lower down in the capital structure, swapping debt for equity (preferred or common), allowing the bank to have a larger cushion of Tier-1 capital, avoiding insolvency, and hopefully allowing the bank to recover by its own bootstraps, preferably assisted by debt restructuring on the borrower side (via property appreciation rights and the like). Similar debt/equity swaps would be an appropriate strategy toward failing U.S. automakers as well.
This week, the Treasury is expected to take another shot at announcing a toxic assets plan, which regardless of short-term market response, is likely to be met with a terrific vote of no-confidence. Why? Because the only point in buying up a toxic mortgage security is if you can restructure it, which requires that you buy up every tranche having a claim to the underlying mortgages. These mortgage securities are a lot like a stack of sponges. If you pour water down, the top tranches absorb it first, and then the next, and so on. Banks don't want to let go of the better pieces (the tranches that pay out first), and nobody wants to buy the bottom ones because there's simply no point unless you can restructure the mortgage obligations so that there's a probable return of capital.
As I've said before, the U.S. currently has a private debt to GDP ratio of about 3.5, which is nearly double the historical norm, at a time when the underlying collateral is being marked down easily by 20-30%. That implies total collateral losses of 70-100% of GDP; a figure that includes not only mortgage debt in the banking system, but consumer credit, corporate debt and so on. The holders are not just banks, but insurance companies, pension funds, foreign lenders, and others. Even so, there is no way to prevent huge, ongoing losses, because the cash flows off of these assets are not sufficient to service the debt. The only question is whether the bondholders appropriately bear those losses, or whether the public bears them inappropriately. A continued policy of protecting all of these bondholders would eventually require U.S. citizens to be put on the hook for something on the order of $10-14 trillion. We are nowhere near the end of this process.
We simply cannot make these bad investments whole unless we are willing to hand the next 10-20 years of U.S. private savings over to the bondholders who financed reckless lending. Those bondholders should, and ultimately must, take a portion of these losses, and debt obligations will have to be restructured. Wall Street has become a bunch of Tooter Turtles crying "Help, Mr. Wizard!" because it got so used to Greenspan bailing everybody out. But that constant attempt to avoid inevitable private market losses is what allowed this problem to become so noxious. It will continue to do so until we collectively scream loud enough for Congress to say on our behalf, "Enough."
The sideshow about bonuses at AIG simply underscores how little these bailouts have altered the fundamental behavior of people throwing around other people's money with nothing at risk themselves. The bondholders of poorly run financial companies should lose because they deserve to lose. The American public does not. Speaking of "other people's money" and conflicts of interest, the first step toward better public policy is to bar the unelected bureaucrats conducting these bailouts from any future employment by companies that benefit from their actions. Call me cynical.
The Real AIG Scandal, Continued!
by Eliot Spitzer
The transfer of $12.9 billion from AIG to Goldman looks fishier and fishier.
The AIG scandal is getting ever-more disturbing. Goldman Sachs' public conference call explaining its trading relationship and exposure with AIG established, once again, that Goldman knows how to protect itself. According to Goldman, even if AIG had failed, Goldman's losses would have been minimal. How did Goldman protect itself? Sensing AIG's weakening capital position through 2006 and 2007, Goldman demanded more collateral from AIG and covered outstanding risk with instruments from other firms.
But this raises two critical questions. The first is why $12.9 billion of taxpayer money went from AIG to Goldman. What risk—systemic or otherwise—was being covered? If Goldman wasn't going to suffer severe losses, why are taxpayers paying them off at 100 cents on the dollar? As I wrote earlier in the week, the real AIG scandal is that the company's trading partners are getting fully paid rather than taking a haircut. Goldman's answer is that it was merely taking a commercial position—trying to avoid any losses at all on its AIG positions. I suppose we can hardly expect Goldman to reject government assistance in the form of pure cash that seems to have had no strings attached.
But what were the government officials possibly thinking? The only rationale for what we should call the "hidden conduit bailout" to AIG's trading partners is that the cascading effect of AIG's inability to pay would have been devastating. But Goldman has now said very clearly there would have been no cascade. Not even a ripple. Is the same true of AIG's other counterparties, including several foreign banks? What examination of the impact of an AIG failure did federal officials undertake before deciding to spend countless billions bailing out AIG and its trading partners?
The government decision to bail out AIG was made after the private parties, supposedly at risk, had declined to structure a private series of investments that might have avoided the need for use of public money. Perhaps they knew the impact of an AIG default would be small, or perhaps they knew that the federal officials in the room would blink and ante up. In a post-Lehman moment when panic, not reason, was dominating the discussion, perhaps they figured they could walk away with extra billions—and, indeed, they did.
This issue cries out for immediate government inquiry. Maybe one or two of the more than two dozen government entities now beating their chests about bonuses can redirect their energies to this much larger issue confronting us: Who signed off on this $80 billion bailout—now approaching $200 billion—and why? The second question, of course, is why Goldman was wise to AIG's declining position two years ago but nobody else appears to have known. There is always the operating premise that Goldman is better than the rest in the field, but where were the federal agencies that should have been taking a look at AIG's leverage situation and general financial health?
And were AIG's public statements accurate in revealing a decline? Or did Goldman, with its multiple trading relationships with AIG, get an early warning? This series of questions also demands immediate inquiry and resolution. What continues to be fundamentally disappointing is that the "too big to fail" institutions continue to absorb enormous sums of taxpayer support without either demonstrating the genuine need for such support or altering their behavior after receiving it. After getting $12.9 billion in what now seems to be a mere gift, has Goldman begun to lend in a way that will restore the credit markets? Were they asked to do so? It is time the government realizes it has two simple options: tightly regulate entities that are too big to fail or break them up so they aren't.
Treasury Preserves Bank Payday With AIG Rescue Cash
The U.S. Treasury Department preserved a payday for five banks that was worth almost 200 times the bonuses handed out at American International Group Inc. through a government rescue. As part of a bid to prevent the insurer’s failure, the U.S. settled derivatives and loan contracts worth $32.7 billion with Goldman Sachs Group Inc., Merrill Lynch & Co., Societe Generale, Deutsche Bank AG and UBS AG. That’s about half the $66.7 billion that those companies, the five biggest beneficiaries of loans and capital infusions for AIG, said they spent on pay and benefits last year for employees, some of whom created or traded toxic subprime assets that proved deadly for lenders.
The bonuses paid by AIG and the banks were allowed under a congressional exemption from compensation limits on companies getting government rescue funds. The Treasury staff requested the exception to avoid lawsuits over agreements signed before Feb. 11, Secretary Timothy Geithner said last week. "The issue of excessive compensation extends beyond AIG and requires reform of the system of incentives and compensation in the financial sector," Geithner said today in testimony prepared for the House Financial Services Committee. AIG’s bonus payments were "deeply troubling," Geithner said. The Treasury secretary said he demanded that the compensation contracts be renegotiated and was told by Chief Executive Edward Liddy that they were "legally binding."
The $165 million paid to employees of New York-based AIG represents 0.0014 percent of the $11.6 trillion committed by the government to combat the credit crisis, according to data compiled by Bloomberg. The $32.7 billion is 0.3 percent of the total federal loans, guarantees and cash. Nine out of the top 10 recipients of the insurer’s bonuses agreed to give the money back, New York State Attorney General Andrew Cuomo said yesterday. The AIG bonuses prompted the House of Representatives to approve a 90 percent tax on bonuses to workers at companies that received more than $5 billion in capital from the Troubled Asset Relief Program. Geithner said last week that the Treasury’s staff asked Senator Christopher Dodd, a Connecticut Democrat and chairman of the Senate Banking Committee, to change compensation limits that were part of this year’s economic-stimulus bill.
The law was approved by Congress Feb. 13 and signed by President Barack Obama the next week. AIG’s bonuses qualified under the provision exempting contractual arrangements that predated Feb. 11. Banks can pay bonuses without eroding capital if they were funded from profitable trades that were settled through financing provided by the government to AIG, said Sylvain Raynes, a derivative consultant in New York and author of "The Analysis of Structured Securities" The payments from AIG helped the banks offset losses in other operations. Goldman Sachs reported a fourth-quarter loss of $2.12 billion in the three months ended Nov. 28, its first since going public in 1999. The firm reported net income of $3.22 billion a year earlier.
The government cash paid out by AIG may have prevented the banks from defaulting on their own trades with investors and other lenders. Federal Reserve Chairman Ben S. Bernanke and Geithner’s predecessor, Henry Paulson, said in September that had the insurer gone bust, the financial industry would have seen a cascade of bankruptcies. "Absent this money, it wouldn’t have been sufficient to allow the banks to pay bonuses or anything else," said Lynn Turner, chief accountant for the Securities and Exchange Commission from 1998 to 2001. "It’s safe to draw the conclusion that the money was necessary to pay bonuses." Dodd said he would support an amendment to rescind the exemption last week. The House of Representatives has passed legislation to tax bonuses at a 90 percent rate and the Senate is considering its own measure.
"There’s a hose hooked up between the American taxpayers’ pocketbook and the bank accounts of some people getting bonuses," Senator Byron Dorgan, a North Dakota Democrat, said in an interview. "There is obviously something dreadfully wrong and I want it to be investigated." Treasury spokesman Isaac Baker said in an e-mail that there were conversations between Treasury and Dodd’s staff about the exemption from pay restrictions. "Treasury staff raised a general concern about broad legal challenges to the retroactivity of the amendment, including constitutional claims, but did not insist on any changes or receive any resistance from the Senator’s staff," Baker said. House Financial Services Committee Chairman Barney Frank said March 22 that the government should "assert our rights" as AIG’s owner and sue to recover the $165 million. Frank, a Massachusetts Democrat, made the comments on CBS television’s "Face the Nation."
The exemption pursued by the Treasury included signed bonus contracts for carmakers, AIG and banks that receive more than $5 billion from TARP. Of the five biggest recipients of U.S. funds paid to the government-owned insurer through Dec. 31, only New York-based Goldman Sachs and Merrill Lynch, now part of Bank of America Corp. in Charlotte, North Carolina, also got TARP funds. Each received $10 billion. A second group led by Calyon, the Paris-based investment bank of Credit Agricole SA; Frankfurt’s DZ Bank AG; and Barclays Plc in London, received payments from AIG totaling $17.2 billion, according to the company. No legislation has been submitted to recover bonuses at foreign companies that received money in the insurer’s rescue. Lenders owed money from AIG’s derivative contracts were led by Paris-based Societe Generale with $11 billion, followed by Goldman Sachs with $8.1 billion; Frankfurt’s Deutsche Bank, with $5.4 billion; Merrill Lynch, at $4.9 billion; and Zurich-based UBS, which received $3.3 billion. The totals exclude amounts from securities-lending programs.
Of the biggest U.S. banks, JPMorgan Chase & Co. received $400 million from AIG, and Morgan Stanley got $200 million. Both are based in New York. Bank of America was given $700 million. SocGen spokeswoman Laura Schalk declined to comment last week, although the bank said March 22 that senior executives would hand back stock options in response to public "indignation" over bonus awards. The bank’s 8.6 billion euros ($12 billion as of Dec. 31) of total compensation and benefits included 1.17 billion euros of bonuses, according to the 2008 annual report. UBS spokesman Mark Arena said bonus pools were "significantly" reduced last year. UBS’s 16.3 billion Swiss francs ($15.5 billion) in total 2008 compensation included 2.1 billion francs in bonuses, down 80 percent from a year earlier, the bank said in filings.
Goldman Sachs and Deutsche Bank don’t disclose bonus figures. The New York bank said the payments in 2008 fell 65 percent across the firm and dropped about 80 percent for more senior employees. Deutsche Bank, Merrill Lynch and Goldman Sachs all have said the AIG payments weren’t related to employee pay. "Absolutely not at all," David Viniar, Goldman Sachs’s chief financial officer, said on a conference call with journalists March 20. "It really didn’t affect the bottom line of Goldman Sachs." "I am not saying that we would have been unaffected," Viniar said. "I don’t think there is any company in the world that would have been unaffected by a failure of AIG because all of the world’s financial markets would have been affected." For Goldman Sachs’s 30,067 employees, the $8.1 billion that came from the U.S. government via AIG was equivalent to about three-quarters of the firm’s $10.9 billion in compensation for last year. Pay and benefits were down 46 percent from 2007, the bank said. Goldman Sachs employees averaged $363,654 in compensation during 2008.
"Congress’s outrage over $165 million in bonuses is simply a smoke-and-mirrors attempt to distract the American people from the fact that they used taxpayer money to bail out these companies in the first place," Representative Scott Garrett, a New Jersey Republican, said in an interview. "Where was the outrage when $40 billion in TARP money was pumped into AIG for the benefit of its counterparties?" he said. Congress may not have yet focused on the bonus issues for the banks because lawmakers "probably haven’t thought of it yet," he said. Merrill Lynch bonuses of $3.6 billion prompted New York’s Cuomo to subpoena company executives because they were paid days before its sale to Bank of America on Jan 2. The company lost a court bid to prevent Cuomo from revealing the recipients. The bonuses included $13 million to David Sobotka, who ran fixed income, including mortgages and structured finance, for the investment bank and now leads its proprietary trading unit.
"There have been 694 people who have gotten more than $1 million each at Merrill," said Senator Dorgan, who is seeking to form a select committee to investigate the causes of the crisis. He recommended that the U.S. attorney general create a task force to investigate financial crimes. The biggest Merrill bonus, $33.8 million, was received by Andrea Orcel, who advised Royal Bank of Scotland Group Plc to buy ABN Amro Holding NV, a transaction that ended with the largest loss in U.K. corporate history, at $34 billion. The U.K. government injected 20 billion pounds ($29 billion) into the bank and took control. Orcel and Sobotka were identified as being among the biggest Merrill Lynch bonus recipients by the Wall Street Journal earlier this month. Sobotka didn’t reply to a call to his office and Orcel didn’t reply to a message left for him with Tim Cobb, a London-based spokesman for Merrill.
According to documents obtained by Connecticut Attorney General Richard Blumenthal, 418 AIG employees received bonuses ranging from $1,000 to $6.4 million. At least 73 people made $1 million or more, and seven got $4 million or more, Blumenthal said. Blumenthal said the documents show $218 million in payouts, not $165 million. He couldn’t account for the difference. The House bill taxing bonuses would affect employees whose household income is more than $250,000 at companies that received more than $5 billion. JPMorgan took $25 billion as part of the first round of infusions. Citigroup Inc. got $45 billion and agreed to allow the government to become its biggest shareholder. Bank of America, including Merrill Lynch, has received $45 billion in cash and a backstop on $118 billion in assets. Some members of Congress say they’ll find a way to rein in compensation for employees of bailed-out companies. "The one law that seems to have no exceptions is that Wall Street always wins, and everyone else always loses," said Representative Alan Grayson, a Florida Democrat and a member of the House Financial Services Committee.
The Great Government Induced Bubble, part 2
The high leverage, low cost loans provided to buy the dead assets from the resultant bubble stemming from offering high leverage, low cost loans (just a year or two ago) will create another bubble that is destined to pop. The optimal solution is to let this current bubble pop. It appears that the powers that be really don't want the bubble to pop and fully deflate. The problem is that bubbles cannot be inflated in perpetuity. I think that's why they call them bubbles! Pray tell, what happens to the toxic assets prices after the private sector overbids for them using excessive, low cost government leverage (or collusion, which is possible when the bank can turn around and sell a swap to the buyer to cover losses on the miniscule equity at risk) when those purchasers then attempt to resell them to normal buyers who don't have access to 6:1, sub 2% leverage on a non-recourse basis (or the cooperation of the bank to cover their equity losses)? No banks or brokerages that I can think of are offering terms anywhere near this level. Will our government continue to play Global Prime Broker ad infinitum by supplying margin to everyone who asks for it, forever? Highly doubtful!
Well, just like with the subprime crisis, once reality hits the fan, and that cheap and easy credit is no longer available, asset prices will fall - and they will fall hard - just like they did last time. Just like they will do every time. It is the the nature of a bubble. They get popped! The market can rally all it wants on the news of this latest bailout, natural market price discovery has yet to take place, and when it does, downward pricing pressure will rear its ugly head again. Only this time, the assets will fall in price after the government would have spent $100 billion to $1 trillion to buy them, and eat up tax payer monies directly. Natural market price discovery is the endgame, and the only way the bear market turns to a real, full-fledged bull market. I can't give you timing on this, but I can give you the parameters.
Now, many may be saying that the assets are now off of the bank's books so they can resume doing business. Well, that statement first assumes that all banks will sell all of their assets at that optimal price. It also assumes that there is a lot of business to be doing. We still have too many banks crowding into the same markets for one, and most importantly in terms of lending, the only retail and corporate borrowers who are crowing for debt right now are the ones that shouldn't be lent to in the first place. Back to the bubbly days of giving people and companies credit that really shouldn't have it? How fleeting is YOUR memory? Think about it. If you are a very good risk and have the capital and resources to repay loans easily, have you thought about buying a new home lately? You have a lot of people who are in trouble trying to refinance, but then again they are in trouble aren't they? I don't see prudent banks rushing out to lend to them at attractive rates. The same goes for the corporate sector. There are a lot of GGPs out there who need loans, but who really wants to lend to them? They want to lend to Berkshire, who doesn't seem to be in the market for loans right now.
We also have the issue of what happens to the losses. No amount of chicanery, engineering or magic will eliminate losses. Losses are losses and they need to be taken. It appears as if an overbid for assets with losses embedded will simply transfer those losses to the winning bidder. If the winning bidder has a super sweet deal, with nearly no risk, financed by the tax payer, then the losses are transferred from the winning bidder to the tax payer. If there is no winning bidder, then the losses remain with the bank. If the bank and the bidder collude in hiding the losses through inflated prices that are made to look profitable, ex. Mega fund buys the assets from the bank at the Truth + X percent, then turns around and buys a swap from the bank paying off X percent +1 to cover their exposure (which in reality is a guaranteed loss), then things look hunky dory until the underlying assets and or the cash flows start breaking down. Then the losses become apparent somewhere, most likely to the detriment of the taxpayer.
You see, no matter which way you slice it, if there are substantial losses in the system it will surface somewhere and somehow - and there are substantial losses in the system. The market is rallying as if the losses have evaporated. This is a profit opportunity, but you will have to be able to swallow a lot of volatility (or be a lightning quick trader) and have a minimum 3 month to 1 year horizon. Even if the bank and the fund make it look all hunky dory, when the losses do surface and the tax payer ends up biting it, and it will be manifested in lower consumer expenditure due to lower discretionary income which will be felt directly and immediately by the banks and the banks biggest customers. Hence, the losses will come round robin.
My suggestion??? Let's stop playing these games and force those who created the losses to take them now and we can all get back to the business of being the world's pre-eminent global economic superpower. Otherwise, that title may very well be up for grabs. I will have objective analysis of the most recent bailout plan and its potential upside and fall out very soon and will post it accordingly.
Global trade 'will shrink by 9%'
Global trade flows are set to shrink by 9% during 2009, according to a forecast by the World Trade Organization (WTO). Hardest hit will be developed nations, where trade is set to fall 10%. Poorer countries will see exports fall 2-3%. The WTO blames the deepening recession for the downturn, but says trade could be "a potent tool" for recovery. It would be the biggest drop in trade since World War II, said WTO Director-General Pascal Lamy, who called on global leaders to fight protectionism. Trade is one of the top issues on the agenda when the heads of state and government of the world's leading economic powers meet at the G20 summit in London on 2 April.
"In London G20 leaders will have a unique opportunity to unite in moving from pledges to action and refrain from any further protectionist measure which will render global recovery efforts less effective," said Mr Lamy in the organisation's annual assessment of world trade. He warned that the use of protectionist measures was on the rise, with dangerous consequences: "Many thousands of trade related jobs are being lost. Governments must avoid making this bad situation worse by reverting to protectionist measures which in reality protect no nation and threaten the loss of more jobs." The WTO report was released while Mr Lamy was in Washington to meet key officials in the Obama administration ahead of the G20 summit. While global trade grew 2% during 2008, WTO data suggest that the downturn started last summer, with trade slowing during the second half of the year.
In 2007, when the credit crunch started, world trade had still managed to grow 6%. Unusually, global trade was now falling simultaneously around the world, the WTO said. Some "commentators" had assumed "that a 'decoupling' effect would have made developing countries less vulnerable to economic turmoil in developed countries," but the WTO experts noted that "this has not turned out to be the case". The WTO also warned that it was difficult to predict the depth of the global recession. "If the drop in world trade is deeper than expected or if recovery happens more quickly, then the growth forecast will need updating." However, the WTO also reported some positive signs, with exports from China, Singapore, Taiwan and Vietnam growing again during February for the first time in months.
Double or quits in Washington
Barack Obama did not base his campaign on saving a collapsing economy. But that was what he ended up being elected to do: he pulled definitively ahead of his rival when the scale of the crisis became clear. At stake in Monday’s presentation of the US bank rescue plan, therefore, was not only Treasury secretary Tim Geithner’s authority but that of the administration as a whole – and with it Mr Obama’s ability to push through his ambitious reform agenda. Mr Geithner has to overcome pre-existing congressional ill-will from his predecessor’s inept handling of the original Tarp request. Moreover, the administration’s paranoia about being branded as socialist has made it do everything it can to avoid taking control of moribund banks or asking for more rescue money.
Instead, Mr Geithner seems absolutely determined to have markets solve the problem, even if it costs taxpayers dearly. Indeed, the paradox at the heart of this ostensibly clever and undoubtedly complex plan is its dependence on subsidies to private investors. The Treasury will match private capital with remaining Tarp money to capitalise funds for purchasing assets from banks – both securities and conventional loans turned sour by the deepening recession. The funds will then be leveraged with federal loans or loan guarantees.
Mr Geithner aims to have markets establish prices for assets now burdening banks’ balance sheets. His plan assumes buyers and sellers will agree on a price if the government is willing to subsidise them enough. But this implies that assets are not trading today mainly because of a lack of liquidity. If, instead, the cash-flows behind the assets – such as subprime mortgage payments – have deteriorated too much, disposing of them at fair long-term values would crystallise heavy losses. Banks will avoid this unless forced to sell, no matter how liquid the market. The plan’s success thus depends on the stress test – only vaguely defined – banks are supposed to undergo.
No one knows whether the market malfunction is due more to long-term losses or short-term liquidity risk. A virtue of this plan is that it should help us find out. But this is a gamble, which could fail in two ways. Even with subsidies, too few trades may take place, leaving the assets with the banks. And if private investors do take the subsidised risk, the assets may yet cause large losses for Congress to pay. Either failure would erode the administration’s authority further. Its plan may just work. If it does not, much more than the US banking system is at risk.
Obama and Geithner gambling with their country's financial reputations
Barack Obama and his Treasury secretary, Tim Geithner, are starting to look like gambling addicts. Having seen the worst elements of casino capitalism ruin Wall Street and generate billions in losses, the pair have stepped back to the roulette table and plan to place up to $1 trillion (£690bn) on black to try to win back the banks' losses and restore America's financial credibility. All they can do is hope the spin doesn't end in the red. Even the name of their latest bail-out plan – the Public Private Investment Program – sounds like the sort of financing partnership we have seen fail here all too often when applied to infrastructure investments such as the spectacular train wreck that was Metronet, the bust public private partnership (PPP) for parts of the London Underground. The UK Government's often flawed attempts at clever infrastructure funding and Geithner's plan have a lot in common. The Americans want private investors both big and small to join with it and bid for banks' toxic assets to get lending and capital markets moving again.
But what price will be bid? Just as British PPPs such as Metronet failed because the bid pricing was too low, undermining the project from the start, there is absolutely no certainty that private investors in the US will bid a price that makes it worthwhile for American banks to sell their toxic assets. Geithner's plan is on an impressive scale but that's not enough. Who will police these partnership agreements and guarantee that the rules don't change with a change in White House incumbent, for instance? If the profits soar for private investors who buy toxic assets with government help, what guarantee will there be that these super returns won't be clawed back by a deeply embarrassed Capitol Hill, or that their share of losses aren't increased if things go badly? These political risks are all too familiar to British PPP companies and will make pricing US toxic assets under Geithner's plan all the more fraught. This extra layer of complexity and uncertainty will slow the financial detox down – not something President Obama, or any of us, can afford.
The incentive for banks to sell their dodgy assets into this scheme is far from compelling because they will immediately have to write off their value and take even more losses which may exacerbate the credit squeeze, not improve it. Much of the funding for Geithner's plan was passed by a shaken Congress back in the autumn, but only now are we getting the details. The scheme is at least five months late and while it might look clever by involving private investors and the potential for profits, in reality it's ponderous, uncertain and slow. The UK's alternative of insuring banks' toxic assets comes at the price of more state ownership and greater potential taxpayer losses but it has the infinite advantage of delivering much greater certainty in a deeply uncertain world. Ultimately, President Obama's partnership plan is a test of his government's credibility among American investors and frankly it's not a test he can afford to fail. For such a young administration this is a massively risky bet to be taking within 100 days of taking office.
Geithner to seek unprecedented powers
Treasury Secretary Tim Geithner will push for unprecedented new regulatory powers on Tuesday to seize financial institutions whose failure would pose serious risks to the U.S. financial system, according to two senior administration officials. Geithner is expected to make his case in testimony before the House Financial Services Committee. With such "resolution authority," the federal government could intervene and aggressively reorganize a troubled business -- such as insurance giant AIG -- before its problems ripple through the global financial system, the administration officials said. In the absence of such early intervention, AIG ended up needing a taxpayer bailout of at least $170 billion to contain financial instability.
The authority would allow the government to sell or transfer assets and components of a troubled company, including renegotiating or dissolving executive compensation agreements and addressing risky derivatives portfolios, the officials said. According to prepared remarks, the treasury secretary is expected to tell the Financial Services Committee that this extraordinary situation is forcing the government "to take extraordinary measures." "We will do what is necessary to stabilize the financial system, and with the help of Congress, develop the tools that we need to make our economy more resilient and our system more just," Geithner plans to say.
The aim is to "ensure that our country never faces this situation again," the secretary will explain. "To achieve that goal, the administration and Congress have to work together to enact comprehensive regulatory reform and eliminate gaps in supervision. All institutions and markets that could pose systemic risk will be subject to strong oversight, including appropriate constraints on risk-taking." Geithner will call for regulators to apply standards not only to protect the financial health of individual institutions, "but to protect the stability of the system as a whole."
U.S. Seeks Expanded Power to Seize Firms
The Obama administration is considering asking Congress to give the Treasury secretary unprecedented powers to initiate the seizure of non-bank financial companies, such as large insurers, investment firms and hedge funds, whose collapse would damage the broader economy, according to an administration document. The government at present has the authority to seize only banks. Giving the Treasury secretary authority over a broader range of companies would mark a significant shift from the existing model of financial regulation, which relies on independent agencies that are shielded from the political process. The Treasury secretary, a member of the president's Cabinet, would exercise the new powers in consultation with the White House, the Federal Reserve and other regulators, according to the document.
The administration plans to send legislation to Capitol Hill this week. Sources cautioned that the details, including the Treasury's role, are still in flux. Treasury Secretary Timothy F. Geithner is set to argue for the new powers at a hearing today on Capitol Hill about the furor over bonuses paid to executives at American International Group, which the government has propped up with about $180 billion in federal aid. Administration officials have said that the proposed authority would have allowed them to seize AIG last fall and wind down its operations at less cost to taxpayers. The administration's proposal contains two pieces. First, it would empower a government agency to take on the new role of systemic risk regulator with broad oversight of any and all financial firms whose failure could disrupt the broader economy.
The Federal Reserve is widely considered to be the leading candidate for this assignment. But some critics warn that this could conflict with the Fed's other responsibilities, particularly its control over monetary policy. The government also would assume the authority to seize such firms if they totter toward failure. Besides seizing a company outright, the document states, the Treasury Secretary could use a range of tools to prevent its collapse, such as guaranteeing losses, buying assets or taking a partial ownership stake. Such authority also would allow the government to break contracts, such as the agreements to pay $165 million in bonuses to employees of AIG's most troubled unit. The Treasury secretary could act only after consulting with the president and getting a recommendation from two-thirds of the Federal Reserve Board, according to the plan.
Geithner plans to lay out the administration's broader strategy for overhauling financial regulation at another hearing on Thursday. The authority to seize non-bank financial firms has emerged as a priority for the administration after the failure of investment house Lehman Brothers, which was not a traditional bank, and the troubled rescue of AIG. "We're very late in doing this, but we've got to move quickly to try and do this because, again, it's a necessary thing for any government to have a broader range of tools for dealing with these kinds of things, so you can protect the economy from the kind of risks posed by institutions that get to the point where they're systemic," Geithner said last night at a forum held by the Wall Street Journal. The powers would parallel the government's existing authority over banks, which are exercised by banking regulatory agencies in conjunction with the Federal Deposit Insurance Corp. Geithner has cited that structure as the model for the government's plans.
Volcker Urges House Members to Take Time Writing Regulations
Former Federal Reserve Chairman Paul Volcker urged members of the House Financial Services Committee last night to take their time in writing new rules to govern the U.S. financial system to ensure they get it right. Volcker, head of President Barack Obama’s Economic Recovery Advisory Board, spent three hours discussing the genesis of the financial crisis with about 25 members of the committee at a closed-door session last night, according to capital markets subcommittee Chairman Paul Kanjorski and Scott Garrett, the panel’s top Republican. "There was a recommendation that we go softly and slowly, that we don’t rush to making decision on reforming the financial system," Kanjorski, a Pennsylvania Democrat, said in a telephone interview this morning. Volcker "challenged us to see if we can do it with moderation and deliberation rather than with speed."
"The regulatory fix is a much larger, more complicated issue and it’s going to take time," Garrett said in a telephone interview after the meeting. The New Jersey lawmaker declined to say what specific recommendations Volcker made. The gathering came at the start of a week in which the Obama administration is planning to outline its priorities for financial market regulation. Treasury Secretary Timothy Geithner, testifying before the committee today, called for expanded government powers to deal with failing non-bank financial institutions such as American International Group Inc. Last night’s session was an attempt to find "common ground, to establish things that we can all agree on, then to identify those things that we won’t agree upon," Kanjorski said.
"My takeaway from the meeting is that you cannot do this in a piecemeal approach," Garrett said. "If we do it right and spend some time on it, we can end up with something more effective and more bipartisan.’ Right now there are "two diametrically opposed" views on the committee, with some Democrats saying that nothing was regulated adequately and many Republicans, including Garrett, saying that the most heavily regulated institutions were the ones that failed. Garrett said the session, which also included Lawrence Lindsey, a head of the Council of Economic Advisers under George W. Bush, and Eugene Ludwig, founder and chief executive of Promontory Financial Group, was valuable because members could spend time asking questions and discussing issues in depth.
He contrasted it with the "amazingly frustrating" committee process in which each member gets five minutes to ask questions, then has to wait while 30 others speak before perhaps getting a second chance. "We’re all looking forward to coming back for the next one," he said. The Volcker roundtable was the first of six designed to help educate lawmakers on the financial crisis and regulatory fixes. The event, sponsored by the non-profit Bipartisan Policy Center, included members the committee’s subcommittee on capital markets Jason Grumet, the center’s president, said all the members who came to the session stayed the full three hours and many stayed afterward to continue the discussion with Volcker, Lindsay and Ludwig. "There was a real sense of what they were up against," he said. "This is a scary problem and no one thought the solution was going to be easy."
Pay no attention to the treasury secretary behind the curtain
President Obama figures out the key to selling his economic policies: Hide Tim Geithner.Maybe the secret to fixing the economy is as simple as this: Don't let Tim Geithner appear on TV. Geithner, the beleaguered treasury secretary, briefed reporters Monday morning on the details of the Obama administration's plan to get bad loans out of the financial system, which -- if it all works the way it's supposed to -- could get banks back into the business of lending money. The plan would have the government team up with private investors to buy bad mortgages and other loans from banks through an auction, then sell them off later at a profit if they recover some value. In theory, taxpayers win (though that remains to be seen), the private investors win (ditto) and the banks get some money for assets that are now worthless because there's no market for buying or selling them -- which means everyone wins, because the credit freeze that's slowly strangling the economy might begin to lift (the biggest unanswered question in the bunch).
But even though no one knows yet whether the plan will work, Wall Street reacted as if the administration had announced the recession was over. Major stock indexes closed up around 7 percent, the biggest single-day gain the markets have seen since the economy first started collapsing last fall. The contrast with last month, when Geithner flopped in his first attempt at explaining how the administration hoped to stabilize the economy, was sharp. Actually, forget last month; just last week, a heterodox herd of pundits and politicians was calling for Geithner to resign after news of the AIG bonus babies broke. Today's mixed reviews (the market was happy, some Democrats were placated, the liberal blogosphere was scornful) were probably all the White House could hope for.
Treasury went to some unusual lengths to manage coverage of the plan. It did not want any visual record of Geithner's less than reassuring countenance. The briefing was what's known in Washington as a "pen-and-pad," though in reality that just means it's closed to still photographers and TV cameras -- laptops and even voice recorders are OK, as long as the recording isn't later put out on the air. Geithner did, however, take questions afterward and later appeared at the White House with President Obama, who made a few remarks for the networks to use. At Treasury, aides distributed a 22-page, glossy info packet on the plan and labeled it "for background use only," meaning none of it could be directly quoted or photographed. And when Geithner finished speaking, a little after 9:30 a.m., one enthusiastic spokesman tried to declare that none of what his boss had said could be reported until later in the day. The reporters in the room all laughed; the gist of Geithner's remarks, and quite a few direct quotes, had already been broadcast around the world, in every form from short Twitter updates to blog posts to full-on wire stories.
All the careful handling was probably because administration officials are starting to realize that whatever strengths Geithner may have as a financial expert, he doesn't always do a very impressive job of coming across as a human being when he's discussing the state of the economy. "I am very confident this scheme dominates all the alternatives," Geithner said at the morning briefing, with a heavy emphasis on "dominates." The term may be popular in financial game theory circles, but Geithner's delivery could make Mitt Romney seem warm and fuzzy. For most of the briefing, he sat hunched over, resting his elbows on the table in front of him. Even his attempt at empathy was clinical and cumbersome: "There is deep skepticism across the country, deep anger and outrage, frustration about the place we are in as a country, where people that were careful and prudent in their financial decisions, businesses that were conservative in how they chose how much leverage they took on, are facing substantial damage because of the actions of a range of institutions that took too much risk and brought our financial system and our economy to the point where we're facing such an acute, deep recession."
But if Geithner's style left something to be desired, reaction to the substance of his plan was cautiously favorable. Never mind the stock markets, which jerk around so much on any given day that it's unwise to use them as a policy benchmark. And never mind New York Times columnist Paul Krugman, whose column bashing Geithner for caution Monday morning and whose calls for a Sweden-style bank nationalization program may have been what prompted Geithner to note, "We're the United States of America. We are not Sweden." Lawmakers -- who don't need to pass any new legislation to make the plan work -- seemed to have gotten over some of the blustery outrage the AIG stories last week generated. "The Treasury Department plan is based on the sound principle that if we are to revive our economy, we must unfreeze the credit markets so people can get the loans they need to keep their small businesses open, buy a car or send their children to college,"
Senate Majority Leader Harry Reid said in a statement. Liberal economist Brad DeLong defended the plan, picking a fight with Krugman in the process. Even Republicans, who have made Geithner into their top target lately, eased up a bit. "While it’s encouraging that the administration is trying to convince private investment funds to bid on troubled bank assets, Secretary Geithner’s plan is very troublesome because it still puts a huge amount of taxpayer money at risk," said Rep. Connie Mack, R-Fla., in a statement that might sound harsh at first -- but not compared to last week, when Mack became the first member of Congress to call for Geithner's resignation.
The plan does, indeed, put more taxpayer money at risk. Geithner plans to use $75 billion to $100 billion in the existing Troubled Assets Recovery Program as seed money for a new private/public partnership that would buy up, through auctions, any bad loans banks wanted to dump off their books. The auctions, theoretically, would help set reasonable prices for the loans; right now, many banks are still accounting for them at face value, even if they represent foreclosed mortgages, but no one believes they're actually worth what they once were. Private investors would lend the public/private fund money, backed by the Federal Deposit Insurance Corp., to buy the loans, and the government would put up half of the actual cash in the deals.
In an example Treasury officials used, a bank decides it wants to sell off a pool of bad mortgages with a face value of $100. The government auctions the mortgages, and the highest bid is $84 (which means the bank loses $16, instead of the whole $100 on the line now). The FDIC backs $72 worth of loans for the public/private fund to buy the mortgages, meaning the public/private fund has to come up with $12. Treasury kicks in $6 and private investors kick in $6. If the mortgage can eventually be sold for more than $100, everyone wins -- the private investors get a big gain after risking only $6 of their own money, the Treasury gets the same gain, and the FDIC never has to take on the $72 in loans it guaranteed because they're repaid once the mortgages are resold for a profit. But if the mortgage winds up losing money, the private investors are only on the hook for $6. The FDIC has to repay the $72 in loans regardless.
Obama has already proved himself to be the best salesman for his administration's policies, and conveniently enough -- but certainly not coincidentally -- he'll hold another prime-time news conference Tuesday night. Asked by a reporter after his photo op with Geithner Monday how he could reassure skeptical taxpayers, Obama said to wait. "You know," the president demurred, "I'll have a full press conference tomorrow night, and you guys are going to be able to go at it." Geithner's plan may not have won over everyone yet, but if nothing else, it bought the administration time to let the boss pick up the job where the treasury secretary left off.
Don't Kid Yourself, Of Course The Treasury Is Setting Asset Prices
A key feature of the Treasury's new bailout scheme is that toxic assets will now be priced based on a "market" of various investors bidding for them. This market price is supposed to be fair, in that means banks can't claim there's no market price anymore, and taxpayers won't get screwed by the government overpaying. But get real, the government is still setting the price of the assets. Just indirectly. They do this by setting the ratio of leverage. Think about it, the amount of leverage they extend to these investors is arbitrary -- currently at 12x.
Given that the loans are non-recourse -- so there's no more risk to an investor by taking on more leverage -- they could easily achieve higher auction prices by upping the leverage. Try 24x. Or they could reduce the market prices of the asset prices by reducing it. Try 6x. Point is, there's only a market prince inasmuch as the government sets the rules and parameters. So why doesn't the government seem too worried that even with the new system, the bids won't meet the ask? Probably because they already know, based on conversations, what leverage is needed to get the bids that the banks are happy to sell at. Some market.
Geithner Tempts Investors With Loans, 25% Returns
The U.S. government’s plan to rid banks of toxic assets may attract investors with financing that helps generate returns as high as 25 percent, fund managers and analysts said. Loans from the Federal Reserve and Federal Deposit Insurance Corp. debt guarantees will bring out the bidders, said Paul DeRosa, a principal of Mount Lucas Management Corp., a $1 billion hedge fund based in Princeton, New Jersey. That can drive up prices and persuade banks to clear balance sheets by auctioning off illiquid debt and troubled securities, he said. "The best part is that the buyers will have an advantage because of the government financing and the FDIC backstop," DeRosa said in a telephone interview. "You can bid more. That’s what will make these assets change hands." Returns may be 20 percent to 25 percent if the economy thrives, he said.
Treasury Secretary Timothy Geithner unveiled a plan yesterday to remove $500 billion of troubled assets from the books of the nation’s banks, seeking to revive the U.S. financial system without resorting to nationalization. The government would finance purchases of real-estate assets, using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds. Geithner said that, if successful, the program may be expanded to cover $1 trillion of assets. "This makes a lot of sense," said Laurie Goodman, a senior managing director at Austin, Texas-based Amherst Securities Group LP. Banks that haven’t yet written down the value of bad real estate loans or mortgage-backed securities will be able to sell them at higher prices because of the cheap government financing, she said.
The Public-Private Investment Program would encourage the purchase from banks of certain securities backed by mortgages and other assets, as well as whole loans. It resembles a proposal made last year by John Ryding, chief economist at RDQ Economics LLC in New York, and Matt Chasin, chief operating officer of Sorin Capital Management LLC, a Stamford, Connecticut-based hedge fund that manages about $1 billion. Ryding and Chasin said that the government should provide long-term loans at inexpensive rates. The loans should be for up to 50 percent of the value of the securities being purchased, known as a haircut, with the securities offered as collateral. They also said that the loans should be non-recourse, meaning that if the borrower defaulted the government could seize only the collateral. Specific financing terms, including the haircut, duration of loans and other details have yet to be determined, the Treasury said in its statement.
"There are a few more steps than some people anticipated and that’s causing some hesitation, but in broad outlines it’s what we thought was necessary," said Conrad DeQuadros, senior economist and a founding partner of RDQ Economics. "This could be a positive for the asset-backed securities market." The government is providing greater incentives for buyers of whole loans. Under the terms of the plan, investors could receive as much as $6 of debt for every $1 of equity invested in whole loans, boosting their returns when the economy recovers. The government has said it wants investors to hold the assets for three years or more. It would invest $1 of taxpayer money for every $1 of private capital. "It’s a step forward and as good a plan as we’re going to get," David Rubenstein, co-founder of private-equity firm Carlyle Group, said today in interview at a conference in Washington sponsored by the Wall Street Journal. "I’m encouraged by the open-mindedness Treasury has shown."
Rubenstein said funds run by the Washington-based firm will consider investing through the program. Pacific Investment Management Co., the world’s biggest bond manager, may buy whole loans and manage funds that purchase mortgage-backed securities in the Treasury plan, Bill Gross, co- chief investment officer of the Newport Beach, California-based firm, said in an interview yesterday with Bloomberg Television. BlackRock Inc., the largest publicly traded U.S. asset manager, will raise money from investors such as pension funds and endowments for the new programs, Chairman Laurence Fink said yesterday in an interview. The New York-based company may consider creating mutual funds so that individual investors can also participate. One analyst questioned whether it was appropriate for the federal government to make investments with taxpayer money in volatile securities.
"This makes the U.S. government a hedge-fund manager," said Tanya Styblo Beder, chairman of risk-management adviser SBCC Group in New York. "Investors in hedge funds do so voluntarily, after performing due diligence on the skills of the manager. But taxpayers aren’t doing this voluntarily." Beder said she also worried about a program that had private investors putting up capital with the government because it left no one clearly in charge. "The logjam in the markets is phenomenal," she said. "The illiquidity is breathtaking and this is a non-temporary phenomenon. Big measures are necessary, but you have to look at all these issues. Hasty implementation may have huge unintended consequences." DeQuadros said anger over bonuses paid at the American International Group Inc. may indirectly dampen enthusiasm for this program. An uproar over the bonuses, paid after AIG received a bailout, prompted lawmakers to approve a tax on the payments. He said investors may be wary as a result. "You get some leverage and good financing in this program, but do you feel comfortable partnering with the government at this point," asked DeQuadros. "That’s an open question."
Fed's Evans: U.S. growth should resume this year
The U.S. economy should start growing by the end of this year and unemployment, expected to peak at around 9 percent, will begin to decline in 2010, Chicago Fed President Charles Evans said on Tuesday. "I think the U.S. economy will certainly begin to grow by the end of this year. I think the unemployment rate will begin to decline sometime in 2010, though I think it's going to take some time." Evans also said the Fed would have been better off if it had started tightening policy faster than it did earlier this decade and regulations would be looked at very closely once the crisis is over.
U.S. recession to last into 2010: Feldstein
The recession in the United States will stretch well into next year, probably raising the need for another fiscal stimulus package at least as large as the first one, prominent economist Martin Feldstein said on Tuesday. Feldstein, a Harvard University professor who is a member of President Barack Obama's Economic Recovery Advisory Board, told Reuters that the stimulus would offset only a relatively small piece of the likely fall in spending, exports and construction. "I'm afraid that the economy will continue to slide down well into next year," Feldstein, a former head of the National Bureau of Economic Research, said in an interview in Beijing where he was attending a conference.
"I don't know when it will end, but the forecasts that it'll end later this year I think are too optimistic," he said of the recession. President Obama signed into law last month a $787 billion fiscal stimulus plan, comprising $287 billion in temporary tax breaks and $500 billion in public spending. That is in addition to the trillions the government has pledged or allocated to shore up the financial sector, including a public-private plan announced on Monday to help rid banks of $1 trillion in assets of uncertain value. "The fiscal stimulus is just not large enough to offset the downward pressure that comes from reduced consumer spending. So unless somehow fixing the financial markets is enough to offset that, which I very much doubt, I think there will be a need for another fiscal stimulus package at some point," Feldstein said.
He noted that it was uncertain how Congress would respond to any proposal for another stimulus plan, but he said any future package would probably have to be on the same order of magnitude as the existing one, if not larger. It should also be better designed so that more of the money actually gets translated into new economic activity through specific spending incentives, such as for purchases of cars or home improvements. Feldstein, dismissing the skepticism of some analysts, described as "ingenious" the plan unveiled by Treasury Secretary Timothy Geithner to buy banks' toxic assets.
"I think it has a good chance of buying up a substantial amount of impaired assets from the banks, and to the extent that it does that, it can start the banks lending again," he said. But there are still questions as to whether $1 trillion will suffice to clean up banks' balance sheets enough to make them feel confident to lend, Feldstein said. He added that authorities should consider holding the sales of impaired assets at the same time that they inject government capital into them through preferred stock, in order to avoid a situation in which the banks' capital base is left weakened after writing down the losses on the sold assets.
Asked about the potential impact on the dollar of recent U.S. pump-priming, including the Federal Reserve's plan to buy $300 billion in long-term Treasury bonds, Feldstein said it was natural for countries such as China, the biggest holder of U.S. government debt, to have worries. Economic fundamentals, such as the huge U.S. current account deficit, suggest the dollar could weaken over the long run and that China could again let the yuan strengthen, Feldstein said. "I think as long as we have this enormous trade deficit, there's going to be downward pressure on the dollar." China has kept the yuan in a tight range of 6.83-6.84 per dollar since the middle of last year, halting an upward climb that started after the 2005 revaluation. "If the dollar starts coming down relative to other currencies, I think at some point when China is feeling more secure about domestic demand, they will go back to a policy of allowing the yuan to appreciate," Feldstein said.
Bernanke claims he tried to stop AIG bonuses, to no avail
Federal Reserve Chairman Ben Bernanke said he tried but failed to halt payment of retention bonuses at American International Group. News of the bonus payments has set off a firestorm in Washington, calling into question whether the Obama administration and the Fed can get more funds from to fix the shattered banking system. Bernanke's written testimony on the AIG bonus issue was short on some key specifics. He did not say, for example, exactly when he became aware that the payments were going to be made. Treasury Secretary Timothy Geithner has said that he found out about the bonuses on March 10, shortly before their March 15 payment date.
For the first time, Bernanke's testimony reveals that there was an extensive debate at the central bank about the propriety of the bonus payments. Bernanke said he wanted to file suit to stop payment of retention bonuses to American International Group employees, but Fed legal staff told him it was too risky. In testimony to the House Financial Services panel, Bernanke said that the staff was concerned that state law in Connecticut could have forced the Fed to pay even more money to the employees in question if the Fed lost its legal challenge. "Legal action could thus have the perverse effect of doubling or tripling the financial benefits" to the employees of the AIG financial-products division, Bernanke said.
Bernanke and Geithner said they wanted to find a way to recoup the bonus payments. Both tried mightily to change the subject of the hearing. They spent most of their testimony requesting new power from Congress: the capacity to close down a giant financial firm in an orderly fashion. At the moment, only banks regulated by the Federal Deposit Insurance Corp. can be seized and liquidated by the government. This leaves out many of the firms that were crippled in this financial crisis -- the big banks, the insurance companies and broker-dealers. The request for this power is not controversial. Most experts and members of Congress believe it is needed. Republicans on the House Financial Services panel said before the hearing that they were planning to press Geithner and Bernanke for details of their involvement in the AIG matter.
They also promised to probe why the bulk of the initial AIG bailout payments went quickly to Goldman Sachs and to foreign banks, which were repaid in full for loans to the firm. Bernanke said the Fed found itself in an "uncomfortable situation" with AIG after the central bank decided to lend the firm $85 billion in September. The Fed has since been forced to return with two new bailouts to AIG, bringing the total to $165 billion. Bernanke repeated that the Fed believed it had no choice but to save AIG. He painted a picture of AIG as a big domino that would have caused other financial firms to topple if it was allowed to fail. Banks, state governments, and money-market funds all had enormous exposure to AIG, he said.
"Conceivably, AIG's failure could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income and jobs," Bernanke said. But the Fed's rescue left it in a strange new relationship with AIG. "We found ourselves in the uncomfortable situation of overseeing both the preservation of AIG's value and its dismantling, a role quite different from our usual activities," Bernanke said. Bernanke said that in this role as creditor, the Fed "have made clear to AIG's management, beginning last fall, our deep concern surrounding compensation issues at AIG."
Bernanke Bombshell: AIG Insurer Exposed to FP
In researching and think about AIG, I have been writing about them as if it were two separate companies: A well regulated Insurer, and a rogue derivatives products firm (FP). The working assumption has been that the regulated insurer was run fairly conservatively, and the structured financial product side run like a giant hedge fund. The 32% net profit retention on the FP side is actually better than what most hedge funds see. This dichotomy is mostly true, but with now has an interesting twist to it. In congressional testimony today, Ben Bernanke implied that had the Fed allowed AIG too fall, he detailed what might have happened had AIG been allowed to fail:The Federal Reserve and the Treasury agreed that AIG’s failure under the conditions then prevailing would have posed unacceptable risks for the global financial system and for our economy. Some of AIG’s insurance subsidiaries, which are among the largest in the United States and the world, would have likely been put into rehabilitation by their regulators, leaving policyholders facing considerable uncertainty about the status of their claims. State and local government entities that had lent more than $10 billion to AIG would have suffered losses. Workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable value funds would decline in value would have seen that insurance disappear. In addition, AIG’s insurance subsidiaries had substantial derivatives exposures to AIG-FP that could have weakened them in the event of the parent company’s failure.
If we are to take Bernanke at face value, he is saying that AIGFP had buried their own firm with junk paper. BB does not define what “substantial derivative exposure” meant — but given the $2.7 trillion dollars in derivatives exposure that FP had, even a tiny percentage might amount to an enormous sum. That the collapse of AIG Financial Products would have damaged the other Insurance half of the firm is a frightening development. Even more fascinating is this “lesson learned”To conclude, I would note that AIG offers two clear lessons for the upcoming discussion in the Congress and elsewhere on regulatory reform. First, AIG highlights the urgent need for new resolution procedures for systemically important nonbank financial firms. If a federal agency had had such tools on September 16, they could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders, and impose haircuts on creditors and counterparties as appropriate. That outcome would have been far preferable to the situation we find ourselves in now.
In other words, we should have nationalized them from the beginning . . .
Fitch Warns on Prime RMBS, Cites Negative Equity
On the heels of the Treasury’s latest plan to work with private investors to purchase private-party RMBS, Fitch Ratings said Monday afternoon that it had revised its projected cumulative loss estimates for 2005-2007 vintage U.S. prime RMBS transactions — in other words, more downgrades are coming. It’s probably more accurate to say that Fitch amplified its loss estimates, moving cumulative loss estimates for 2007 vintage prime RMBS approximately five times higher than previously estimated. “Delinquencies have increased dramatically in prime RMBS transactions as borrowers grapple with the ongoing pressures of declining home values, rising unemployment and lack of refinancing alternatives,” said to group managing director and U.S. RMBS group head Huxley Somerville.
“From a ratings perspective, the combination of declining credit enhancement and higher expected losses will result in increased ratings pressure for recent vintage prime RMBS.” As part of an ongoing monitoring of RMBS transactions, Fitch has been conducting rating reviews of prime pools over the last several weeks. The extent and rate of the portfolio deterioration associated with many of these transactions has resulted in downgrades for a significant number of subordinate and mezzanine bonds, the rating agency said. Additionally, for the 2005-2007 vintages, the deterioration in the relationship between credit protection and the revised expected loss will cause a sizable portion of the senior classes to be downgraded and/or placed on Rating Watch Negative, as well, Fitch warned.
Why defaults are surging among prime borrowers has less to do with the mortgage instrument, as was the case early in the mortgage crisis, than with more traditional risk factors tied to declining property values and rising unemployment. For example, Fitch said it found that loans with multiple risk attributes such as limited income documentation and second-liens, are defaulting at rates approximately three times that of loans without those characteristics. Negative equity, too, is a still-emerging problem: borrowers with negative equity in some recent vintage mortgage pools are approaching 50 percent, the rating agency said. Borrowers with no remaining equity are defaulting at a rate three times greater than their equity-holding counterparts.
China 'Super Currency' Call Shows Dollar Concern, G-20 Ambition
China’s call for a new international reserve currency may signal its concern at the dollar’s weakness and ambitions for a leadership role at next week’s Group of 20 summit, economists said. Central bank Governor Zhou Xiaochuan yesterday urged the International Monetary Fund to create a "super-sovereign reserve currency." The dollar weakened after the Federal Reserve said it would buy Treasuries and the U.S. government outlined plans to buy illiquid bank assets "China is concerned about the potential for a slide in the dollar as the U.S. attempts to stimulate its economy," said Mark Williams, a London-based economist at Capital Economics Ltd. The "rare" sight of a Chinese official attempting to reframe an international debate may be "a sign of China becoming more engaged," he said.
Zhou’s comments may also signal ambitions for the yuan to play a bigger global role. The central bank this week signed a currency swap with Indonesia, adding to agreements since December with South Korea, Hong Kong, Malaysia and Belarus. It’s also preparing for trade settlement in the Chinese currency with Hong Kong, Macau and the Association of Southeast Asian Nations. "There is concern and even frustration among top policymakers in Beijing about China’s high exposure to U.S. dollar-denominated financial assets," said Brian Jackson, senior strategist at Royal Bank of Canada in Hong Kong. Yuan forwards rose the most in three months with traders betting on appreciation for the first time since September on speculation that the U.S. policies will weaken the dollar. The 12-month forward rate gained 0.9 percent.
Premier Wen Jiabao called on March 13 for the U.S. "to guarantee the safety of China’s assets." China’s Treasury holdings climbed 46 percent in 2008 and now stand at about $740 billion, according to U.S. government data. The nation is the biggest holder of U.S. debt. China is promoting use of the yuan to smooth currency volatility and to serve "a long-standing interest" to raise its status to that of a global reserve currency, said Ben Simpfendorfer, an economist at Royal Bank of Scotland Group Plc in Hong Kong. Such moves are not "a knee-jerk response" to the economic crisis, he said. "If turning the Chinese yuan into a global reserve currency sounds ambitious, then encouraging its adoption as a regional reserve currency is more straightforward," said Simpfendorfer.
G-20 leaders will gather in London on April 2 to forge a common response to the financial crisis that has spawned a global recession. The summit will discuss proposals for reforms of the International Monetary Fund. The timing of Zhou’s proposal is "the latest example of China’s policy of neo-assertiveness in world affairs," said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. "China is starting to flex some muscle and generally steer the debate in China’s own direction." Zhou’s article highlighted the "dilemma" that countries issuing reserve currencies face in balancing their own monetary- policy goals with other nations’ demand for their money.
The global crisis raised the question of which reserve currency would secure "global financial stability and facilitate world economic growth," Zhou said. He proposed expanding the use of the IMF’s Special Drawing Rights, which are currency units valued against a composite of currencies. "The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and gross domestic product may also be included as a weighting," said Zhou. Some economists back his case. "The world economic landscape has been changed since the establishment of the SDR 40 years ago," said Ha Jiming, chief economist at China International Capital Corp. in Hong Kong. "Specifically, no such reserve currency would make sense without the yuan being included."
Geithner, Bernanke reject new global currency idea
U.S. Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke on Tuesday dismissed suggestions by leading emerging economies that the global economy move away from using the dollar as the main reserve currency. In a congressional hearing on Capitol Hill, U.S. Rep. Michele Bachmann, a Minnesota Republican, asked Geithner: "Would you categorically renounce the United States moving away from the dollar and going to a global currency as suggested this morning by China and also by Russia, Mr Secretary?"
Geithner replied, "I would, yes." She posed the same question to Bernanke, who said: "I would also."
Chinese central bank chief Zhou Xiaochuan on Monday urged an overhaul of the global monetary system to allow for wider use of Special Drawing Rights (SDRs) created by the International Monetary Fund as an international reserve asset in 1965. Zhou's comments followed remarks by Russia last week which said it would put forward a proposal at a meeting of the Group of 20 in London on April 2 for the creation of a new global reserve currency. Australia's Prime Minister Kevin Rudd also knocked down the idea of dislodging the dollar as the world's main reserve currency, telling an audience in Washington on Monday: "The dollar's position ... remains unchallenged."
One in Five Americans Plan to Buy a House
While half of all Americans are concerned they or someone they know will face foreclosure in the next six to 12 months, 23 percent of adults plan to purchase a home in the next five years, and 53.5 percent of them happen to be first time homebuyers, according to a new survey commissioned by Move Inc., released Monday. The Move survey found the housing downturn, now entering its third year, has created demand for homeownership especially among first-time homebuyers. While 5.8 percent plan to purchase a home in the next 12 months, 12.8 percent of Americans say they plan to buy a home in the next two years and 11 percent plan to purchase a home in two to five years.
However, it’s important to remember the majority of Americans — four out of five — do not plan to buy a house in the next five years. And amid housing turmoil, homeowners have revealed changing attitudes towards owning a home. About two-thirds of homeowners now consider their home primarily a place to live as opposed to an investment, the survey said. The Move survey also found nearly one out of five homeowners plan to take advantage of the administration’s new program to help prevent foreclosures. While wading the waters of a severe economic downturn, 21 percent of all homeowners with a mortgage contacted a lender to restructure their loan over the past year. Unemployment is the driving factor causing many Americans to fear foreclosure, according to Move, Inc.’s findings. Over 27 percent of adults feel they or someone they know may default on their mortgage due to recent unemployment, future unemployment or because they owe more on their home than it’s worth.
Determined to remain in their homes, 72 percent of adults reduced spending in the past year in order to make monthly mortgage or rent payments, mostly by cutting discretionary spending such as vacations, entertainment and eating out. Regardless of age, most Americans are cutting spending back from some aspect of their life to pay housing costs, according to the survey. But “It’s not all doom and gloom,” said Move, Inc., CEO Steve Berkowitz. “We found Americans are optimistic about homeownership despite concerns. They’re doing everything they can, from reducing discretionary spending to pay their mortgages, to planning to take advantage of the administration’s new program to stop foreclosures.”
The survey found 18.1 percent of homebuyers plan to buy this year in order to take advantage of the $8,000 tax credit granted under the Economic Stimulus Plan. But nearly half said they didn’t know about the credit and 29.3 percent said it wasn’t large enough for them to act right now. It seemed potential homebuyers with higher incomes are more interested in the tax credit than those in lower income brackets, as 43.4 percent of first-time buyers earning $50,000 or more say they plan to use the tax credit. Move Inc. said the overall economy is by far the most pressing issue on the domestic agenda in the opinion of Americans, according to their findings. Opinion is split, however, over whether the government is doing enough to stabilize the housing market, with 46.2 percent indicating “yes” and 43.8 percent indicating “no.”
BlackRock's Global Macro Hedge Fund Bets on Further Stock-Market Declines
BlackRock Inc.’s global macro fund, the world’s second-best performer over two years among hedge funds that invest based on economic trends, is betting against this month’s equities rally and buying bonds as a recovery from the worst credit crisis since the Great Depression falters. BlackRock’s A$216 million ($152 million) Asset Allocation Alpha Fund returned 41 percent in 2008, when hedge funds around the world lost a record 19 percent on average. The fund is short U.S. and Australian equities, expecting them to decline, and long U.S., German, Australian, Canadian, and U.K. bonds, said its manager David Hudson. "The risk is that the economic recovery disappoints in the second half and that equity markets need to revisit their lows in the next few months and maybe go through them," Sydney-based Hudson said in an interview March 20.
The MSCI World Index, which tumbled 42 percent last year, has rallied 21 percent since March 9, boosted in part by the U.S. Federal Reserve’s decision to pump money into the economy to get credit flowing. Hudson profited from the declines last year by betting against equities. BlackRock, which oversees $1.3 trillion, is the biggest publicly traded asset manager in the U.S. Over a third of total assets are managed on behalf of non-U.S. investors, and nearly one-third of its employees are outside the U.S. The "overwhelmingly" retail investor base of the Alpha fund helped it avoid the redemptions that beset other Australian-based funds last year, Hudson said. About 35 percent of the offshore money invested in Australian hedge funds was redeemed in the last quarter of 2008, according to Australian Fund Monitors.
The fund, set up in March 2006, uses options and futures contracts to bet on currencies, stocks, bonds, commodities and cash. It gained an average 38 percent over two years. Among hedge funds with at least $20 million in assets, only the $706 million Pivot Global Value Fund performed better with an average 50 percent gain, according to data compiled by Bloomberg on the 363 funds globally with a similar strategy. In January, BlackRock launched the Global Macro Hedge Fund, a Cayman Island-based fund that is denominated in U.S. dollars and clones the Asset Allocation Alpha fund’s trading. The new fund, which is targeting fund of funds, private banks and family offices, has struggled to raise money after the credit crisis battered the appetite for hedge fund offerings.
"The interest has been good, but after a year like last year, a lot of people that would be normally allocating to this kind of fund have liquidity constraints," Hudson said. The Global Macro fund has raised $12 million. Hudson declined to specify targets for funds under management or the capacity for the funds he manages, except to say it’s "a long way north of here." The Alpha fund’s 41 percent return net of fees was the biggest gain in 2008 among the 214 Australian-based hedge funds monitored by Australian Fund Monitors. The fund is up 1.7 percent this year, according to Bloombergdata. It returned 35 percent in 2007. The Asset Allocation Alpha fund aims to provide investors with a return of 12 percentage points above the benchmark UBS Australia Bank Bill Index over rolling three-year periods, before fees.
Hudson is now looking at wagering against currencies of nations where central banks are resorting to so-called quantitative easing, where policy makers opt to purchase government bonds to push yields lower. He is considering taking short positions in the Swiss Franc, U.K. pound, U.S. dollar and Japanese yen. The fund has already taken a position on the expectation the Australian dollar will gain and the Canadian dollar will decline because Canada may be next to introduce quantitative easing measures, while Australia is unlikely to, Hudson said. It remains long gold -- a bet that bullion will go up -- versus the U.S. dollar.
We Need Honest Accounting
Mark-to-market (MTM) accounting is under fierce attack by bank CEOs and others who are pressing Congress to suspend, if not repeal, the rules they blame for the current financial crisis. Yet their pleas to bubble-wrap financial statements run counter to increased calls for greater financial-market transparency and ongoing efforts to restore investor trust. We have a sorry history of the banking industry driving statutory and regulatory changes. Now banks want accounting fixes to mask their recklessness. Meanwhile, there has been no acknowledgment of culpability in what top management in these financial institutions did -- despite warnings -- to help bring about the crisis. Theirs is a record of lax risk management, flawed models, reckless lending, and excessively leveraged investment strategies.
In the worst instances, they acted with moral indifference, knowing that what they were doing was flawed, but still willing to pocket the fees and accompanying bonuses. MTM accounting isn't perfect, but it does provide a compass for investors to figure out what an asset would be worth in today's market if it were sold in an orderly fashion to a willing buyer. Before MTM took effect, the Financial Accounting Standards Board (FASB) produced much evidence to show that valuing financial instruments and other difficult-to-price assets by "historical" costs, or "mark to management," was folly. The rules now under attack are neither as significant nor as inflexible as critics charge. MTM is generally limited to investments held for trading purposes, and to certain derivatives. For many financial institutions, these investments represent a minority of their total investment portfolio.
A recent study by Bloomberg columnist David Reilly of the 12 largest banks in the KBW Bank Index shows that only 29% of the $8.46 trillion in assets are at MTM prices. In General Electric's case, the portion is just 2%. Why is that so? Most bank assets are in loans, which are held at their original cost using amortization rules, minus a reserve that banks must set aside as a safety cushion for potential future losses. MTM rules also give banks a choice. MTM accounting is not required for securities held to maturity, but you need to demonstrate a "positive intent and ability" that you will do so. Further, an SEC 2008 report found that "over 90% of investments marked-to-market are valued based on observable inputs."
Financial institutions had no problem in using MTM to benefit from the drop in prices of their own notes and bonds, since the rule also applies to liabilities. And when the value of the securitized loans they held was soaring, they eagerly embraced MTM. Once committed to that accounting discipline, though, they were obligated to continue doing so for the duration of their holding of securities they've marked to market. And one wonders if they are as equally willing to forego MTM for valuing the same illiquid securities in client accounts for margin loans as they are for their proprietary trading accounts? But these facts haven't stopped the charge forward on Capitol Hill. At a recent hearing, bankers said that MTM forced them to price securities well below their real valuation, making it difficult to purge toxic assets from their books at anything but fire-sale prices.
They also justified their attack with claims that loans, mortgages and other securities are now safe or close to safe, ignoring mounting evidence that losses are growing across a greater swath of credit. This makes the timing of the anti-MTM lobbying appear even more suspect. And not all financial firms are calling for loosening MTM standards; Goldman Sachs and others who are standing firm on this issue should be applauded. According to J.P. Morgan, approximately $450 billion of collateralized debt obligations (CDOs) of asset-backed securities were issued from late 2005 to mid-2007. Of that amount, roughly $305 billion is now in a formal state of default and $102 billion of this amount has already been liquidated. The latest monthly mortgage reports from investment banks are equally sobering. It is no surprise, then, that the largest underwriters of mortgages and CDOs have been decimated.
Commercial banking regulations generally do not require banks to sell assets to meet capital requirements just because market values decline. But if "impairment" charges under MTM do push banks below regulatory capital requirements and limit their ability to lend when they can't raise more capital, then the solution is to grant temporary regulatory capital "relief," which is itself an arbitrary number. There is a connection between efforts over the past 12 years to reduce regulatory oversight, weaken capital requirements, and silence the financial detectives who uncovered such scandals as Lehman and Enron. The assault against MTM is just the latest chapter. Instead of acknowledging mistakes, we are told this is a "once in 100 years" anomaly with the market not functioning correctly. It isn't lost on investors that the MTM criticisms come, too, as private equity firms must now report the value of their investments.
The truth is the market is functioning correctly. It's just that MTM critics don't like the prices that investors are willing to pay. The FASB and Securities and Exchange Commission (SEC) must stand firm in their respective efforts to ensure that investors get a true sense of the losses facing banks and investment firms. To be sure, we should work to make MTM accounting more precise, following, for example, the counsel of the President's Working Group on Financial Markets and the SEC's December 2008 recommendations for achieving greater clarity in valuation approaches. Unfortunately, the FASB proposal on March 16 represents capitulation. It calls for "significant judgment" by banks in determining if a market or an asset is "inactive" and if a transaction is "distressed."
This would give banks more discretion to throw out "quotes" and use valuation alternatives, including cash-flow estimates, to determine value in illiquid markets. In other words, it allows banks to substitute their own wishful-thinking judgments of value for market prices. The FASB is also changing the criteria used to determine impairment, giving companies more flexibility to not recognize impairments if they don't have "the intent to sell." Banks will only need to state that they are more likely than not to be able to hold onto an underwater asset until its price "recovers." CFOs will also have a choice to divide impairments into "credit losses" and "other losses," which means fewer of these charges will be counted against income. If approved, companies could start this quarter to report net income that ignores sharp declines in securities they own. The FASB is taking comments until April 1, but its vote is a fait accompli.
Obfuscating sound accounting rules by gutting MTM rules will only further reduce investors' trust in the financial statements of all companies, causing private capital -- desperately needed in securities markets -- to become even scarcer. Worse, obfuscation will further erode confidence in the American economy, with dire consequences for the very financial institutions who are calling for MTM changes. If need be, temporarily relax the arbitrary levels of regulatory capital, rather than compromise the integrity of all financial statements.
Top lenders pull plug on small biz loans
At a time when small business owners desperately need loans and credit lines to help them weather the recession, some of the industry's most active lenders have bolted shut the doors to their vaults. Temecula Valley Bancorp and Capital One Bank have stopped taking applications for new loans through the Small Business Administration's flagship 7(a) loan program, and Bank of America has slowed its lending volume to a trickle. Small Business Loan Source, a non-bank SBA lender that specialized in commercial real estate financing, is closed to new applications and leaving all new SBA lending activity to its parent company, First Bank in Clayton, Mo.
These four institutions were among the 30 largest SBA lenders in the 2008 fiscal year, accounting for 4% of the program's loan volume, or $524 million of the $12.8 billion that was lent to nearly 70,000 businesses, according to data compiled by Coleman Publishing, which monitors small business lending trends. Their sudden absence from the lending scene has left a hole that the banks continuing to participate in the program have not filled in. If current lending trends continue, only two of the top 30 lenders are projected to increase their loan volume this year, according to Bob Coleman, the head of Coleman Publishing.
The sharp drop-off was apparent in the SBA's loan data for the last three months of 2008: The number of loans funded through the agency's 7(a) program fell from more than 20,000 a year earlier to fewer than 9,000. The total dollar value of all the loans funded fell 40%, from $3.2 billion at the end of 2007 to $1.9 billion last quarter. In a speech last week, President Barack Obama said that the total volume of small business loans backed by the SBA this year is trending below $10 billion, down from $18.2 billion last year and more than $20 billion the year before that. The government is scrambling to address the problems that led to the abrupt freeze in credit availability. The Small Business Administration last week implemented two new measures authorized by last month's stimulus bill.
For the rest of the calendar year, it will waive the fees it charges for participation in its loan-guarantee programs and increase to up to 90% the percentage of each loan that it will insure against default. However, those moves will only pay off for small business off if banks play ball and resume lending. Coleman, for one, is dubious that will be enough to reverse the lending decline. The banks face other obstacles with SBA loans that are also preventing them from catering to the small business community, he said. "Regulators are demanding that banks put more into their reserves right now. The SBA is being nitpicky with the defaulted loans, and lenders are finding it more difficult to get paid the government guarantee," he said.
One community banker took that view straight to President Obama last week. At a town hall meeting in Costa Mesa, Calif., Joan Earhart, the SBA manager for Fullerton Community Bank, asked Obama to set a new bar for regulators that recognizes the trouble small businesses are having meeting strict underwriting criteria. "When we make loans that are less than the normal quality, even with the SBA guarantee, the regulators tend to criticize us. And when they criticize us, they make us set aside reserves as if the loan is going to be bad, and that eats into our capital. That's part of the problem that banks are having right now," she said. "We want to make SBA loans, but we don't want to get our hands slapped by the regulators when we try to help these people." Banks are also struggling with a frozen secondary market, but on that front, the government's actions may be successful in engineering quick relief.
Many banks that make SBA loans then resell bundles of the loans to private investors. Since this fall, that market has been almost nonexistent as investors, burned by toxic mortgage bundles, shy away from such investments. Treasury Secretary Geithner said last week that his department will spend up to $15 billion buying small business loan bundles directly from banks. That initiative will begin by the end of the month, Geithner said. Temecula Valley Bank, based in Temecula, Calif., ranked eighth Coleman's list of the top 2008 lenders, with a total loan volume exceeding $197 million for the year. CEO Frank Basirico says his bank ceased its SBA loan program in January because of the frozen secondary market and because of the bank's plan to shrink its loan portfolio, a strategic move fueled by a poor liquidity situation.
But that doesn't mean the bank is shunning all small businesses - just those seeking SBA loans. Since opting out of the SBA program, Temecula has continued to lend directly to some qualifying businesses, Basirico said, without relying on the SBA's guarantee. "We're looking to support the local businesses where our bank has a branch," he says. "That's why we pulled back from the SBA presence - it's important to support the local businesses." Bank of America pulled back sharply on its SBA lending as default rates for those loans began climbing - in October, CEO Ken Lewis called that loan portfolio a "damn disaster." After making $136.1 billion in SBA loans in the 2008 fiscal year, Bank of America originated just $3.3 million last quarter, according to Coleman's data.
Representatives of Bank of America and Capital One say their banks are still active in other small business lending channels, including credit cards, credit lines, and loans not backed by the SBA. While Small Business Loan Source is no longer taking applications for SBA loans, its parent company, First Bank, says it plans to increase its SBA lending in target locales, including California, Mississippi, Illinois, Texas and Florida. But even outside the SBA program, business owners say credit availability from banks is almost nonexistent. The Federal Reserve's quarterly survey of bank loan officers has found credit for small business growing significantly tighter - and more expensive - every quarter since the recession began.
Even with higher guarantees from the SBA, many small businesses are risky borrowers. The SBA estimates that 10% of its loans went into default last year. "Right now these loans aren't profitable," Coleman said. "The stimulus hasn't taken effect, and it's still months away from helping lenders. Some lenders don't think it'll be effective - they don't think it will be strong enough by itself, that the economy also needs to turn around." With a sigh, he added: "I guess that's where you get the chicken-and-the-egg thing." At Temecula Valley Bank, Basirico says he's willing to take a look at the rescue programs government has on offer and reconsider his bank's small business lending slowdown if there's signs the loans will become less risky.
"If the Treasury starts buying loans in the secondary market on a direct basis, that will start to free up liquidity," he said. "This administration has to do something to support the SBA, because it's the small business arena that will get us out of the recession. In my opinion, I have to be optimistic and encouraged by what should take place in the next 90 to 100 days."
The threat posed by ballooning Federal reserves
An explosion of money is the main reason, but not the only one, to be concerned about last week’s surprise decision by the Federal Reserve to increase sharply its holdings of mortgage backed securities and to start purchasing longer term Treasury securities. First consider the monetary effects. When the Fed purchases public or private securities or makes loans to banks or to other private firms, it must finance them. The Fed can borrow the funds, or it can ask the Treasury to borrow the funds, or it can do it the old-fashioned way: create money. The Fed creates money in part by printing it but mostly by crediting banks with deposits at the Fed. Those deposits are called reserve balances and are the key component – along with currency – of base money or central bank money which ultimately brings about changes in broader money supply measures.
These deposits or reserves have been exploding as the Fed has made loans and purchased securities. Six months ago reserves were $8bn, in a range appropriate for its interest rate target at the time. As of last week, reserves were nearly 100 times larger at $778bn, the result of creating money to finance loans to banks, investment banks, AIG, central banks and purchases of private securities. Before last week’s federal open market committee meeting, I projected these would increase to $2,215bn by the end of this year if the new Consumer and Business Loan Initiative of the Treasury were to be financed by money creation. With last week’s dramatic announcement, the Fed will have to increase reserves by another $1,150bn to $3,365bn by the end of the year if the securities purchases are financed by money creation. Quantitative easing or credit easing means that the growth rate of the quantity of money increases, but there is no monetary principle or empirical evidence supporting such an explosion.
There is no question that this enormous increase from $8bn to $3,365bn will lead to higher inflation unless it is reversed. With the economy in a very weak state and commodity prices falling, inflation does not appear to be a problem now. The growth of reserves has led to an increase in the growth rate of the broader money aggregates, but less than proportionately because banks are still holding excess reserves. The Fed has expressed its concern about inflation with its new target-like longer term forecasts for inflation and by saying it will remove the reserves in due time. However, increases in money growth affect inflation with a long and variable lag. Will the Fed be able to change course in time? To do so, it will have to undertake the politically difficult task of getting more than $3,000bn of government securities, private securities and loans off its balance sheet. Making it more difficult are the extraordinary borrowing demands by the Treasury and the announcement of Treasury purchases by the Fed.
Some argue that the unprecedented actions by the Fed are filling in for a lacklustre performance by the Congress and the administration, especially in light of the uproar over the AIG bonuses. But even if there are short-term benefits, they will be offset by the cost of lost independence of the Fed. What justification is there for an independent government agency to engage in such selective lending activities? The announcement by the Fed that it will purchase long-term Treasuries is reminiscent of the period just before the Accord of 1951 when the Fed had little independence.
The reason for these interventions is that the Fed wants to improve the flow of credit and lower interest rates for a wide range of borrowers. However, it is by no means clear that the interventions will be effective beyond a very short period, and they may be counterproductive. I found, for example, that the Term Auction Facility, set up to improve the functioning of the money market and drive down spreads on term interbank lending relative to overnight loans, had no noticeable impact on interest rate spreads. Such actions may have prolonged the crisis by not addressing the fundamental problems in the banks. These extraordinary measures have the potential to change permanently the role of the Fed in harmful ways. The success of monetary policy during the great moderation period of long expansions and mild recessions was not due to large discretionary interventions, but to following predictable policies and guidelines that worked.
Dollar's status under attack from China
Another skirmish in the war of words in the most important economic relationship in the world – that between the US and China – broke out yesterday, as the Governor of the People's Bank of China called for reform of the IMF and the promotion of the fund's own longstanding but underused "world currency"– special drawing rights (SDR). His remarks come as the managing director of the International Monetary Fund said that any plans, such as those being pursued by the G20, to stimulate the world economy would fail unless the banking system is repaired. Dominique Strauss-Kahn said: "You can put in as much stimulus as you want. It will just melt in the sun as snow if, at the same time, you are not able to have a generally smaller financial sector than before but a healthy financial sector at work."
Zhou Xiaochuan, the governor of the Chinese central bank, implicitly criticised the status of the dollar as the world's sole reserve currency. "The price is becoming increasingly high, not only for the users, but also for the issuers of the reserve currencies," Mr Zhou said. He added: "The role of the SDR has not been put into full play due to limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system. "The goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies."
SDRs were developed by the IMF in the 1970s as a method of increasing funding for international trade, at a time of rapid growth and a shortage of public and private liquidity. In recent years, however, the SDR has been neglected, in part because of the Chinese "wall of money" lubricating the world economy. The central bank governor's intervention can be viewed as a counter-attack to the attacks on China – most recently by the US Treasury Secretary, Tim Geithner – for her refusal to revalue the yuan upwards. The gaping US-China trade deficit – running to $266bn last year – is widely regarded as the most important of the "global imbalances" that underlie the current crisis.
Currently the SDR is backed by a "basket" of the world's leading currencies, of which the American dollar is the most important, accounting for 44 per cent of its weight. The euro (34 per cent), the pound and the yen (11 per cent each) make up the rest. A downweighting of the dollar in the SDR and the "creation" of more SDRs by the IMF – in the same way that a commercial bank multiplies customer deposits through lending – would signal a further rebalancing of world economic power in favour of China. It would, presumably, be accompanied by an increase in the voting power of China within the IMF, which is roughly the same as Italy's, despite China being perhaps the third largest economy in the world, and Italy the seventh.
Reform of the IMF's governance, long promoted by Gordon Brown, has been a running sore for many years. Over the weekend the Prime Minister of Australia, Kevin Rudd, backed China's claim for a bigger role at the IMF. Australia is co-chair of the G20's group on reform of international institutions. However, at the G20 Summit in London on 2 April, a large increase in the funds available to the IMF, from $250bn to $500bn, seems set to be one of the few concrete achievements – without reapportioning voting rights. The European Union agreed in principle to the move last week. The calls from China for IMF reform are echoed by George Soros, who said that the IMF should use new SDRs to "protect the periphery countries from a storm created in the developed world".
Why Europe and the US Disagree on Stimulus
Big, US-style cash infusions wouldn't help many European countries, says European Central Bank President Trichet -- but they could weaken fiscal discipline and revive inflation. As the G-20 club of the world's wealthiest nations prepares to meet in London on Apr. 2, observers have focused increasingly on an alleged clash between the US and Europe about how to deal with the global financial crisis. The US's putative solution is to spray the economy with liquidity, while Europeans are seen as more cautious, resisting gigantic stimulus plans beyond what they've already committed to. That's leading to accusations that the Old World is dithering. Once chastised for their bloated public sectors, European leaders ironically now find themselves under attack for failing to run the euro printing presses fast enough. But is it possible that European policy is appropriate for European conditions? Everyone agrees that global coordination is needed to combat a global financial crisis, but it doesn't necessarily follow that the same remedies apply in all regions. As European Central Bank President Jean-Claude Trichet points out in an interview with the Wall Street Journal published on Mar. 23, public-sector spending is already much higher in Europe than in the US.
Indeed, massive public spending could revive fears of high taxes and inflation, hurting rather than helping confidence, Trichet said. "You have also to reassure your own people that you have an exit strategy, to reassure households that we are not putting in jeopardy the situation of the children, and to reassure businesses that what is done today is not done to the detriment of their own taxation in the years to come," Trichet said, according to a transcript of the interview on the ECB's Web site. "Activation of the economy depends crucially on confidence," Trichet added. "And confidence today needs (sic) that we can prove to our own people that we have the right balance between the short-term and the medium- and long-term perspective." It's important to remember how much effort European governments have expended in the past decade to get public spending under control, tame inflation, and create a stable basis for the common currency. Trichet didn't say so, but flouting euro zone limits on national debt might well be the signal for countries with a checkered history of fiscal responsibility, such as Italy or Greece, to return to old bad habits.
What's more, US-style domestic stimulus would have only limited effect in export-oriented economies such as Germany, the Netherlands, Scandinavia, and many Eastern European countries. Their problem isn't so much falling internal consumption as that demand from Asia and the US has collapsed. True, Europe, like the US, has a credit problem. But Trichet points out that the European economy is much more dependent on bank financing than the US, where capital markets play a bigger role. "That is why we have concentrated…on the commercial bank channel," Trichet said. To be sure, Trichet fueled talk of a US-Europe rift when he seemed to tell the Wall Street Journal that American policymakers should put their money where their mouths are. "What I would recommend for the US is to, now, as efficiently and rapidly as possible, do what has been decided. ... Let's do it! Quick implementation, quick disbursement is what is needed. Not embarking on useless and counterproductive quarrels which fortunately are over now." But it wasn't clear whether Trichet was talking about the Obama Administration or the US Congress-probably the latter. And he went on to rightly criticize a preoccupation among the press and pundits with comparing the relative size of stimulus plans. "It is not a race!" Trichet said. "We are all doing what we judge optimal taking into account the different characteristics of our economies…."
G-20 Must Freeze The $1.5 Quadrillion Derivatives Bubble
As The First Step To World Economic Recovery
On the eve of the long-awaited London conference of the G-20 nations, we are rapidly descending into the chaos of a Second World Economic Depression of catastrophic proportions. In the year since the collapse of Bear Stearns, we have moved toward the disintegration of the entire globalized world financial system, based on the residual status of the US dollar as a reserve currency, and expressed through the banking hegemony of London, New York, and the US-UK controlled international lending institutions like the International Monetary fund and the World Bank. This is a breakdown crisis of world civilization, prepared over decades by the folly of deindustrialization and the illusions of a postindustrial society, further complicated by the deregulation and privatization of the leading economies based on the Washington Consensus, itself a distillation of the economic misconceptions of the Austrian and Chicago monetarist schools.
If current policies are maintained, we face the acute danger of a terminal dollar disintegration and world hyperinflation. The G-20 leaders are must deliberate a new set of policies capable of leading humanity out of the current crisis. We must first identify the immediate cause which has detonated the present unprecedented turbulence. That cause is unquestionably the $1.5 quadrillion derivatives bubble. Derivatives have provoked the downfall of Bear Stearns, Countrywide, Northern Rock, Lehman Brothers, AIG, Merrill Lynch, and Wachovia, and most other institutions which have succumbed. Derivatives have made J.P. Morgan Chase, Bank of America, Citibank, Wells Fargo, Bank of New York Mellon, Deutsche Bank, Société Générale, Barclays, RBS, and money center banks of the world into Zombie Banks.
Derivatives are financial instruments based on other financial instruments ? paper based on paper. Derivatives are one giant step away from the world of production and consumption, plant and equipment, wages and employment in the production of tangible physical wealth or hard commodities. In the present hysteria of the globalized financial oligarchy, the very term of "derivative" has become taboo: commentators prefer to speak of toxic assets, complex securities, exotic instruments, and counterparty arrangements. At the time of the Bear Stearns bankruptcy, Bernanke warned against "chaotic unwinding." All of these code words are signals that derivatives are being talked about. Derivatives include such exchange traded speculative instruments as options and futures; beyond these are the over-the-counter derivatives, structured notes, and designer derivatives. Derivatives include the credit default swaps so prominent in the fall of AIG, collateralized debt obligations, structured investment vehicles, asset-backed securities, mortgage backed securities, auction rate securities, and a myriad of other toxic variations. These derivatives, in turn, are pyramided one on top of the other, thus creating a house of cards reaching into interplanetary space.
As long as this huge mass of kited derivatives was experiencing positive cash flow and positive leverage, the profits generated at the apex of the pyramid were astronomical. But disturbances at the base of the pyramid turned the cash flow and exponential leverage negative, and the losses at the top of the pyramid became immense and uncontrollable. By 2005-6, the disturbances were visible in the form of a looming crisis of the automobile sector, plus the slowing of the housing bubble cynically and deliberately created by the Federal Reserve in the wake of the collapse of the dot com bubble, the third world debt bubble. and the other asset bubbles favored by Greenspan. Financiers are trying to blame the current depression on poor people who acquired properties with the help of subprime mortgages, and then defaulted, thus, it is alleged -- bringing down the entire world banking system!
This is a fantastic and reactionary myth. The cause of the depression is derivatives, and this means that the perpetrators to be held responsible are not poor mortgage holders, but rather globalized investment bankers and hedge fund operators, the derivatives merchants. We are now in the throes of a world wide derivatives panic. This panic has been gathering momentum for at least a year, since the fall of Bear Stearns. There is no power on earth which can prevent this panic from destroying most of the current mass of toxic derivatives. It is however possible that the ongoing attempts to bail out, shore up, and otherwise preserve the deadly mass of derivatives will destroy human civilization as we have known it. We must choose between the continued existence of derivatives speculation on the one hand, and the survival of human society worldwide on the other. If this be crude populism, make the most of it.
The G-20 must remove the crushing mass of derivatives which is now dragging down the world economy. Derivatives must be banned going forward, but this by itself will not be sufficient. The ultimate goal must be to wipe out and neutralize the existing mass of $1.5 quadrillion in notional values of toxic derivative instruments. Some governments may be able simply to decree that derivatives be shredded, deleted, and otherwise liquidated, and they should do so at once. Virtually all governments should be able to use their emergency economic powers to freeze derivatives and set them aside for at least five years or for the duration of the crisis, whichever lasts longer. Legal issues can be settled over the coming decades in the courts. Humanity is in agony, and we must act against derivatives now. Going forward, we must ban the paper pyramids of derivatives in the same way that the Public Utility Holding Company Act of 1935 banned the pyramiding of holding companies.
Derivatives were illegal in the United States between 1936 and 1983. In 1933, an attempt was made to corner the wheat futures market using options, and the resulting outcry led to a 1936 federal law banning such options on farm commodity markets. This ban was repealed by the Futures Trading Act of 1982, signed by President Reagan in January 1983. During the G.H.W. Bush administration, Wendy Gramm of the Commodity Future Trading Commission went further, promising a "safe harbor" for derivatives. Despite the key role of derivatives in the Orange County disaster during the Clinton years, a valiant attempt by Brooksley Born of the CFTC to make derivatives reportable and subject to regulation was defeated by a united front of Robert Rubin, Larry Summers (today running US economic policy), and Greenspan. Despite the central role of $1 trillion of derivatives in the Long Term Capital Management debacle of 1998, Phil Gramm's Commodity Futures Modernization Act of 2000 guaranteed that derivatives, notably credit default swaps, would remain totally unregulated. These pro-derivatives forces must bear responsibility for the current depression, and those still in power must be ousted
The Bernanke-Bush-Paulson-Obama-Geithner policy pursued by the United States, which amounts to a $10 trillion (Fed and Treasury) effort to bail out the world derivatives bubble on the backs of taxpayers, can only make the depression worse, will never lead to an economic recovery, and must therefore he rejected. Krugman is right: "zombie ideas" rule Obama's Washington. The Fed's TALF amounts to subsidies for securitization, meaning more derivatives. The derivatives bailout was pioneered by Gordon Brown, Alistair Darling, and Mervyn King in the case of Northern Rock. These efforts are doomed to costly futility. The $1.5 quadrillion derivatives bubble is comparable to the black holes of astrophysics, those artifacts of gravity collapse which will irresistably suck in all matter that comes near them. It compares to a world GDP of a mere $55 trillion, itself a figure inflated by financial speculation. The derivatives are the black holes of financial engineering, and can easily consume all the physical wealth and all the money in the world, and still be bankrupt. Gordon Brown's demand of $500 billion for the IMF is enough to bankrupt several nations, but pitifully inadequate to deal with the derivatives. They can only be dealt with by re-regulation -- a quick freeze, leading to extinction and permanent illegality. We reject Brown's IMF world derivatives dictatorship.
Derivatives pose the question of fictitious capital -- financial instruments created outside of the realm of production, and which destroy production. In 1931-2, fictitious capital appeared as tens of billions of dollars of reparations imposed on Germany, plus the war debts owed by Britain and France to the United States. These debts strangled world production and world trade. Bankers and statesmen tried desperately to maintain these debt structures. But US President Herbert Hoover proposed the Hoover Moratorium of 1931-1932, a temporary freeze on all these payments. The Lausanne Conference of June 1932 was the last chance to wipe out the debt permanently. But the Lausanne Conference failed to act decisively, and passed the buck. By the end of 1932, there was near-universal default on reparations and war debts anyway. And by January 1933, Hitler had seized power. We urge the London G-20 to defend world civilization against derivatives. It is time to lift the crushing weight of derivatives from the backs of humanity before the world economy and the major nations collapse into irreversible chaos and war, as seen during the 1930s.
Disparity in nations’ saving slows recovery
When leaders of the world’s 20 largest economies meet in London on April 2, they’ll have a lot on their plates, from preventing a global depression to fixing a broken banking system. But economists are hoping they also will pay some attention to what many see as a root cause of the financial crisis: a vast disparity in the way big nations save. In recent weeks, a growing chorus of prominent economists—including U.S. Federal Reserve Chairman Ben Bernanke and Bank of England Governor Mervyn King—have pointed out that it took more than greedy bankers, profligate American consumers and lax regulation to generate a crisis of global proportions. While all those factors played important roles, they say, the conditions were created in part by China and other Asian nations, which over a decade of export-led growth socked away trillions of dollars in the form of foreign-currency reserves.
Their efforts to invest those savings flooded Western financial markets with cash, making it cheaper to borrow at a time when people in places like the U.S. and the U.K. were building up debts at an alarming rate. The huge machine of subprimemortgage lending that triggered the crisis, the logic goes, was just one of the many ways bankers took advantage of these so-called "global imbalances" by putting savers and borrowers together. "Bankers have always been avaricious, regulation didn’t get worse and we’ve always had crises—it’s just that this crisis has some special features, and the key special feature is the global imbalances," says Richard Portes, professor of economics at London Business School and president of the Centre for Economic Policy Research.
As the G-20 meeting approaches, Mr. Portes and others are offering a menu of remedies, from boosting the authority of the International Monetary Fund to making the fund a central repository for foreign-currency reserves—an idea reminiscent of the global central bank economist John Maynard Keynes had in mind in 1944, when world leaders created the IMF at a meeting in Bretton Woods, N.H. All the options have their drawbacks, but if some way can’t be found to get Asians to save less and Americans to save more, economists warn that the world will inevitably find itself in trouble again. "It’s a big mistake to ignore the imbalances despite all the other stuff that’s going on, and the G-20 would do so at its peril," says C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington.
Even as global economies have taken a turn for the worse, one measure of the imbalances—China’s vast current-account surplus—has hardly subsided. The IMF estimates that the surplus, which reflects both China’s net exports and how much capital it sends abroad, grew to about $399 billion last year from $372 billion in 2007. If the surplus persists, it could fan the flames of protectionist sentiment, as Western politicians worry that their countries’ huge stimulus packages are boosting exporters on the other side of the planet. Asian nations’ penchant for thrift can be traced back to the financial crisis they suffered in the late 1990s. At the time, countries in the region were living beyond their means and building up foreign debts. That ultimately spooked foreign investors, who fled en masse, triggering sharp currency devaluations and painful recessions.
After the crisis, the countries changed tack, focusing on spurring exports by keeping their exchange rates low against the dollar—a strategy that boosted foreign-currency reserves to record levels. As they invested those reserves in places like the U.S. and U.K., they put an unprecedented strain on financial markets. One indicator of that strain—net cross-border capital flows—stood in 2008 at about $1.9 trillion, or 3% of global gross domestic product, according to IMF estimates. That’s more than twice the level of 1997, before the Asian financial crisis hit. As the latest financial crisis takes a toll on global trade, the imbalances are likely to ease somewhat. But many economists believe more must be done to get both Asia and the U.S. to change their ways.
In a recent paper, Steven Dunaway, who directed the IMF’s country work in China from late 2001 through 2008, proposes changing the fund’s rules to allow its experts to provide franker assessments of countries’ economic policies, without the involvement of the fund’s highly politicized board. That, he says, would allow the fund to generate "peer pressure" that will be hard for the U.S. and China to ignore. Others, though, believe persuasion alone won’t be enough. Mr. Portes sees the main impetus for China’s and other nations’ accumulation of foreign reserves in their desire to insure themselves against a crisis like that of the late 1990s. One solution, put forth in a list of proposals to the G-20, is to provide a substitute for that insurance—for example, by pooling foreign-exchange reserves at the IMF and giving the fund greater power to step in and provide crisis-stricken countries with unconditional emergency financing.
To make the insurance more credible, China and other emerging markets would be given more say at the IMF—a direction in which the G-20 is moving. One problem with the insurance plan, though, is that if it worked, it could encourage countries to act irresponsibly, keeping their exchange rates at unsustainable levels on the assumption that the IMF would come to the rescue in an emergency. " It’s putting barrels of propane around your house to protect it," says Catherine Mann, professor of international economics and finance at Brandeis International Business School in Massachusetts. In other words, as Asia’s response to the late 1990s shows, policy makers will have to be careful that the solution to one crisis doesn’t set the stage for the next.
Iron Ore to Decline for Two Years on 'Whopping Oversupply,' Citigroup Says
Contract iron ore prices will drop for two years, undermined by a "whopping oversupply" of the steelmaking raw material, Citigroup Inc. said. Global demand may decline 7.5 percent this year, while supply rises 7 percent, Citigroup analyst Alan Heap told a conference in Perth, Australia. Contract iron ore prices may drop 30 percent this year and 20 percent in 2010, he said. Steelmakers in Asia and Europe are slashing production and cutting jobs as the global economic slowdown curbs demand from builders and carmakers. Prices of hot-rolled coil, an industry benchmark, have more than halved since June to $505 a metric ton, according to U.K. industry publication Metal Bulletin. Iron ore producers, including BHP Billiton Ltd., the world’s largest mining company, and Rio Tinto Group, the second- largest iron ore producer, are negotiating annual benchmark contract prices with steelmakers for the year starting April 1.
Japan Auto Sales Forecast to Hit 32-Year Low
Auto sales in Japan are expected to drop to the lowest level in 32 years in the next fiscal year, as the prolonged slump in consumption amid the economic slowdown will continue to dent appetite for new cars in the world's third largest auto market, an industry body said. The Japan Automobile Manufacturers Association also said it will shorten this autumn's Tokyo auto show as major U.S. and European auto makers have opted not to attend. Toyota Motor Corp. and other Japanese car makers the same day reported sharp falls in domestic production in February, as they continued to scale back output in line with flagging sales at home and abroad. "Looking at [the sales outlook and production drop], we still can't see any clear sign for a recovery [in production] from the latter half of the year," said Shigeru Matsumura, an analyst at SMBC Friend Research Center.
Auto sales in Japan are expected to drop 8% to 4.3 million vehicles in the fiscal year ending March 2010, the JAMA said. This will be the lowest sales figure since the fiscal year ended March 1978, and will mark the fourth consecutive year of decline. The latest outlook follows the association's earlier projection for 2009 made in December that domestic auto sales will fall 4.9% to 4.9 million vehicles -- the lowest volume in 31 years. For the fiscal year ending this month, the industry group estimates auto sales will total 4.7 million vehicles, down 12%. Reflecting the industry's troubles, JAMA said it will shorten the Tokyo Motor Show's duration to 13 days from its initially planned 17 days as major global brands such as General Motors Corp., Ford Motor Co. and Chrysler LLC, as well as four Japanese truck makers, decided to pull out of the show this year.
"It's regrettable that the number of makers participating ... will decline. But we are facing a once-in-a-century unprecedented crisis, and this is the decision made by each maker. We hope to bring back a festive show next time," said JAMA Chairman Satoshi Aoki, adding that the association has no plan to stop holding the Tokyo auto show in the future. Toyota, the world's biggest car maker by volume, said its domestic production for the month was down 64% from a year earlier. Honda, Japan's second biggest car maker, said it reduced its output at home by 48%, while Nissan, the country's third largest, said it cut its production by 69%. For the January-March quarter, Toyota plans to scale back production in Japan by 54%. Honda seeks to bring down domestic output by 38% in the same quarter and Nissan plans a 59% cut.
Airline Industry Seen Losing $4.7 Billion in 2009
The International Air Transport Association significantly expanded its industry-loss forecast Tuesday, reflecting expectations for a heavy slump in travel for the Asian-Pacific, Europe and Latin America regions. For 2009, the IATA said it now expects an aggregate industry loss of $4.7 billion, compared to a loss of $2.5 billion that it forecast in December. "The state of the airline industry today is grim," said Giovanni Bisignani, head of the trade group. "Demand has deteriorated much more rapidly with the economic slowdown than could have been anticipated even a few months ago." IATA represents some 230 airlines that account for 93% of scheduled international air traffic.
Falling fuel prices are helping to curb even larger losses for the airline industry. "Fuel is the only good news," Mr. Bisignani said. "But the relief of lower fuel prices is overshadowed by falling demand and plummeting revenues. The industry is in intensive care," he said. Hardest hit will be the Asian-Pacific region, where carriers are expected to post losses of $1.7 billion, compared to IATA's earlier forecast of $1.1 billion for 2009. Demand for travel to and from China is expected to contract between 5% and 10%, while the region's largest market, Japan, will likely see its gross domestic product shrink by 5.5%, under the revised forecast. European carriers are expected to post a $1 billion loss for the year with a 2.9% drop in the continent's GDP, the group said. Latin America's GDP is forecast to grow, but a collapse in the demand for commodity products will likely lead to a 7.8% decline in air traffic.
For its part, North America is expected to deliver the best regional performance, with 2009 profit pegged at $100 million, as the industry offsets a steep falloff in demand with seat-capacity cuts, IATA said. Overall, industry revenues are now expected to fall by 12% to $467 billion in 2009, magnified by even greater weakness in premium traffic than previously forecast, while passenger traffic as a whole will likely contract by 5.7%, the group said. "Airlines face two immediate fundamental challenges: conserving cash and carefully matching capacity to demand," Mr. Bisignani said. Among the major U.S. carriers, Delta Air Lines and United Airlines parent company UAL Corp. have announced sharp reductions in their international capacity as air-traffic demand has declined, with smaller cuts for Continental Airlines and AMR Corp., the parent of American Airlines. In Europe, Deutsche Lufthansa, Aer Lingus and Air France-KLM have warned of a tough 2009.
Midwest home sales fall 18 percent in February
Home sales in the Midwest fell again in February as doubts about the economy and tighter credit requirements stymied potential buyers, according to two reports released Monday. PMZ Real Estate Agent Michelle Zeiter, left, walks into a bank owned home she is showing to clients Maurice McJimsey, center, and Irene Mello in Stockton, Calif., Friday, March 13, 2009. Existing home sales in the 12-state region slid 18 percent from February last year, according to the National Association of Realtors. The median price in the Midwest declined 8 percent to $131,000 -- the second-smallest drop of any region. By contrast, nationwide home sales slipped 10 percent from a year ago, without adjusting for seasonal factors, while prices tumbled almost 16 percent to $165,400.
Home sales fell in 11 of 12 major Midwestern cities with seven of those plummeting by more than 20 percent from prior-year levels, according to The Associated Press-Re/Max Monthly Housing Report, also released Monday. The survey includes all home sales recorded in the metropolitan statistical area by all local agents, regardless of company affiliation. Chicago; Wichita, Kan.; Indianapolis; Des Moines, Iowa; and Kansas City, Mo., posted the biggest losses in the region, dropping by 25 percent or more. The only Midwestern city seeing an annual increase in sales was Detroit, where deeply depressed home prices have brought in a truckload of investors and other bargain hunters. Overall sales increased 5 percent in February while the median sale price fell 50 percent -- the biggest drop in the country -- to $41,000.
Home sales in Chicago plummeted by 65 percent in February from a year ago, one of the worst showings in the nation, according to the AP-Re/Max report. The median home sale price has also fallen, declining 23 percent to $179,000. Israel Fuentes, a real estate agent with Home Center in Chicago, said buyers who would normally have taken advantage of lower home prices are now staying out of the market, afraid that prices will continue to crater. He said the problem has only worsened as more homes go into foreclosure or are being sold short -- that is for less than the balance on the mortgage. "I have never seen so many short sales," Fuentes said. "Everything that is selling is mostly short sales. There are huge, huge, entire neighborhoods that have basically plummeted (in value)."
Those stressed sales make it virtually impossible for regular sellers to put their properties on the market for good prices, even in higher-valued neighborhoods, he said. "Everywhere has been touched and affected," he said. "Properties that I sold for $410,000 a year ago now go for $120,000." Sean Christie, an agent with Century 21 Realty Group in suburban Indianapolis, said the market isn't quite as dire in his area. According to the AP-Re/Max report, sales in the Indianapolis market fell 29 percent in February while the median sale price fell 15 percent to $93,900. Christie said he's seen fewer buyers than normal and believes it's partly because lenders have increased their requirements for mortgages, forcing potential buyers to provide more documentation on income and other financial factors.
"It used to be a couple years ago you could have hair on your head and be alive and get a mortgage," he joked. "Now you need your grandmother's toenails from 1932 and prove her DNA before they'll give you any money." In Fargo, N.D., the problem has been less financial and more meteorological, said Kris Sheridan, an agent with Park Company. Blizzards struck frequently on weekends this winter, keeping home shoppers indoors. Home sales in Fargo fell 25 percent in February compared with a year ago, according to the AP-Re/Max report. But the median sale price has remained relatively steady, declining only about 2 percent to $139,900. Sheridan said there were few subprime mortgages in Fargo and foreclosures aren't affecting home prices. Still, she said the economic woes affecting much of the country have scared away some potential buyers.
"I think there's a lot of fear," she said. "There's not a lot of good news and that makes people become more conservative about their purchasing power." She said the market for first-time home buyers has been a bright spot, especially after the federal government began offering an $8,000 tax credit to first-time buyers as part of the new economic stimulus plan. Rebecca Loney is one of those responding to the tax credit. Loney and her fiancee, Mickey Bahe, are in the process of buying their first home, a four-bedroom, two-bathroom split-level across the Red River in Moorhead, Minn. "For us, (the credit) is going to go toward furniture and a washer and dryer and other things we don't have," Loney said. "It's icing on the cake and makes us feel a little better about the extras that come along with it."
Loney said she and Bahe, who plan to marry before they move in, negotiated the sales price on the house down almost $4,000 to $156,000 but were afraid to wait longer because they felt it was a great house in their price range and didn't want to see it sold out from under them. "We weren't in a rush so we could have waited," Loney said, "but I don't think we'd have seen the price drop much further."
$50 Million in A.I.G. Bonuses to Be Repaid
The New York State attorney general, Andrew M. Cuomo, said on Monday that he had persuaded nine of the top 10 bonus recipients at the American International Group to give the money back, as the Senate retreated on plans to tax such bonuses. Mr. Cuomo said he was working his way down a list of A.I.G. employees, ranked by the size of their bonuses, and had already won commitments to pay back $50 million out of the total $165 million awarded this month. But in a reversal of the stand he took last week, he said he did not intend to release any names. "If the person returns the money, I don’t think there’s a public interest in releasing the names," Mr. Cuomo said in a conference call with reporters.
In Washington, the Senate majority leader, Harry Reid, said that efforts to recover bonuses like the ones at A.I.G. through punitive taxes would be delayed. Other officials said momentum in Congress had slowed considerably, given misgivings voiced by President Obama. Mr. Cuomo said that he hoped eventually to recover $80 million in bonuses paid in March to A.I.G. employees in the United States. But he said an additional $85 million had gone to people outside the United States, and he did not believe his office had the legal standing to pursue them. That would appear to spare people in A.I.G.’s financial products office in London, the seat of the company’s business in credit-default swaps — the derivatives that nearly sank the company and paralyzed the global financial system last fall.
"We have a very aggressive theory about our jurisdiction, but we don’t have a theory that gets us to London," Mr. Cuomo said. A person with knowledge of the investigation, who spoke on the condition of anonymity, said that two recipients in the London office had returned their bonuses voluntarily, however. Mr. Cuomo said that of the top 20 recipients in the United States, 15 had returned their payments in full. The rest included people who refused, who were still reviewing their options or who had not yet been located, he said. A spokeswoman for A.I.G., Christina Pretto, confirmed that employees had been agreeing to give back their bonuses, and said there had also been "a handful of senior-level resignations." She said the company expected more resignations.
This bore out the predictions of A.I.G.’s chief executive, Edward M. Liddy, that if employees had to give back their bonuses, they would probably resign. In remarks to a House Financial Services subcommittee last week, Mr. Liddy expressed concern that such resignations would make it harder for A.I.G. to wind down its portfolio of derivatives, currently worth $1.6 trillion. The company wants to minimize losses while exiting the derivatives business. Ms. Pretto said the company thought so far that the situation was manageable. On the same day Mr. Liddy spoke, lawmakers began rushing to impose heavy taxes on bonuses paid to executives of companies receiving federal support. The House on Thursday voted overwhelmingly in favor of a near total tax on such bonuses.
But after complaining last week that Republicans were blocking a similar bill in the Senate, Mr. Reid, Democrat of Nevada, indicated on Monday that any action would be delayed. "Republicans have asked for more time to study the legislation, and they’re entitled to that," Mr. Reid said as he opened the Senate on Monday afternoon. Aides said the Senate would spend the next few days on a bill to expand national community service programs, and could return to the bonus issue this week. The Republican leader, Senator Mitch McConnell of Kentucky, said there were important reasons to put the brakes on the legislation. "This bill ought to slow down, and we ought to think about the ramifications of what we are doing," Mr. McConnell said at a news conference. "I gather from listening to the administration over the weekend that they are having some second thoughts about whether this is the right way to go."
After the House vote last week, the White House said that Mr. Obama looked forward to signing a final bill. But within hours, the president began to back away from that position, and in an interview on Sunday on "60 Minutes," he said he had not reached a conclusion. "We can’t govern out of anger," Mr. Obama said. Pressed about the constitutionality of a steep tax on bonuses, the president, who is a former constitutional law professor, said, "Let’s see if there are ways of doing this that are both legal, that are constitutional, that uphold our basic principles of fairness, but don’t hamper us from getting the banking system back on track." He added, "That’s why we’re going to have to take a look at this legislation carefully." Some officials said that the president’s questions had created significant reluctance to act in the Senate, because lawmakers do not want to get too far out in front of the administration if the president ultimately is not going to back the tax.
Man Up, Capitalists!
Why does the treasury secretary have to bribe investors to take risks?
What to think of the latest plan to get crummy mortgage-related assets off the books of large financial institutions? Two of the economists whose views I most respect differ widely on it. Paul Krugman hates it. Brad DeLong is more optimistic. The stock market, which is a poor barometer of public policy, totally loves it. In its wisdom, Wall Street could easily decide tomorrow, or next month, that it hates the plan. That's been the pattern for the last six months of bailouts—excitement and exuberance that the cavalry is about to arrive followed by disappointment that it's armed with pop guns. We should sympathize with the dilemma the Treasury Department faces in trying to clean up this mess.
As Treasury Secretary Timothy Geithner said last week: "Many banks in this country took too much risk, but the risk now to the economy as a whole is that you take too little risk." (Moneybox made a similar point.) But who is taking the risk? And who stands to reap the rewards? The Treasury acknowledges that private investors will be subsidized to take on the ownership of what it's calling "legacy loans" and "legacy securities." (If these horrific securities are legacy loans, then the funeral industry should reclassify corpses as "legacy bodies.") The Treasury cites as an example a loan valued by a bank at $100 that is sold for $84. In that instance, the private investor and the government would each put in $6, and the investor would borrow the other $72 from the government. If you're keeping score at home, it means the private investor would put in 7 percent of the cash but would receive a much higher percentage of the profits.
The plan raises the disturbing question: Where the hell are the capitalists? Where are all the people who are willing to put their own money, and that of people willing to lend them cash, at risk in pursuit of profit? Why are Wall Street's tough guys such a bunch of girly men? The Geithner plan assumes that Wall Street's bravest investors won't spend a penny or borrow unless the government is willing to cover losses, make loans, and give away extra profits. It assumes, in short, that these great businesspeople are afraid to do business. Dislocations create opportunities for investors with the courage to jump in and the vision to extend their investment horizon beyond a year or two.
Many fortunes were made by purchasing assets from the Resolution Trust Corp., the agency formed to handle the leftovers from the savings-and-loans debacle. After the junk-bond market crashed in the early 1990s, investors deploying new pools of capital jumped in, purchased the bonds, and used them to acquire control of companies—a bet that paid off handsomely. Earlier this decade, Warren Buffett and others pounced on telecommunications and energy-trading companies that had become impaired. The current environment should be a great moment for vulture investors. We've just gone through the mother of all dislocations when it comes to debt. In fact, the New York Times reports, several name-brand firms are plunging into distressed debt.
But while these firms have plenty of cash, and (limited) access to other people's money, they won't wade into the mortgage morass—without something like a guaranteed return. Yes, the market for these assets isn't functioning properly. But improperly functioning markets are a feature of life. Just as there's always a bull market somewhere, there's always a market in which something is significantly underpriced because of macroeconomic, geopolitical, or industry-specific issues. There may be good reasons why capitalists aren't yet lining up to buy discounted junk from banks. It could be that potential buyers have lost their nerve (although you can never lose money going long on the nerve of Wall Street operators).
It could be that the prices at which sellers are willing to part with lousy "legacy securities" still aren't sufficiently low to make these trades worthwhile without major leverage. It could be that investors today can't fathom waiting a couple of years to get paid. It could be, as economist Mark Thoma suggests, that the combination of complex instruments and a totally FUBAR market makes these legacy assets simply uninvestable at any price. Or it could be that Wall Street has lost its nerve. In this past decade, the controlling assumption of the financial-services industry was that you could have "wealth without risk." Now it seems to be that you can have "capitalism without capitalists."
Goldman Sachs eyes Barclays iShares unit
Barclays is in talks with Goldman Sachs about a sale of the British bank's iShares unit, a source familiar with the situation said, adding one more name to a growing list of possible bidders. This weekend, sources said that private equity groups Hellman & Friedman, Bain Capital and TPG had all shown interest in iShares, the exchange-traded funds provider. H&F wanted to form a consortium and was eyeing an offer of around $5 billion, while Bain Capital and Goldman were mulling separate offers, the first source said on Monday. Bids for the business are not due until at least this Thursday, the person said. Separately, the Financial Times reported on its website that other trade bidders that are thought to be interested in iShares include Vanguard, the U.S. fund manager specializing in index-tracking funds.
Barclays, which said last week it may sell the iShares exchange-traded funds provider, declined to comment. Analysts have put the value of iShares -- part of Barclays Global Investors, the San Francisco-based fund management arm -- at around 3 billion pounds ($4.37 billion), more than one-third of Barclays's market capitalization. The Wall Street journal reported on Friday that Barclays was offering to finance the purchase of the unit, lending up to 80 percent of the unit's price. Barclays Capital, the investment bank, is one of the biggest providers of funding for buyouts, but like all banks it has pulled back on providing buyout loans during the crisis. It might be more willing to provide a big loan for a business it knows so well, however, especially if it helps its parent achieve a deal to secure much-needed cash.
Barclays could use the proceeds of any disposal to cover the cost of joining a government scheme to insure banks against losses on risky assets. A sale could also remove the need for the bank to sell new shares, or issue them directly to the state. That would enable Barclays to avoid surrendering a stake to the government, in contrast to other British banks such as Royal Bank of Scotland and Lloyds Banking Group.
Obama nominates deputy at the Treasury Department
President Barack Obama on Monday moved to fill three top jobs at the Treasury Department to help Secretary Tim Geithner manage the federal bureaucracy charged with helping the nation's struggling economy. In nominating Neal Wolin to be deputy treasury secretary, Obama now has named or nominated four of the five top jobs at the department, where critics said the new administration has been slow to fill major positions. Wolin, who will require Senate confirmation, is a Clinton-era official who previously was the department's general counsel. The other two announced Monday were Lael Brainard, a Clinton-era official, to be the Treasury Department's top official for international affairs, and Stuart Levey, who will stay on as the top counterterrorism official at the department.
"I am grateful for the service of these dedicated and talented individuals and have the highest confidence that, under the leadership of Secretary Geithner, they will serve the American people well as we tackle the challenges ahead of us," Obama said in a statement released Monday evening announcing his intention to nominate them. Part of the reason these top jobs haven't been filled is some people who were on track to be nominated withdrew their names, including Lee Sachs, who now is counselor to Geithner, a position that does not require Senate confirmation. Others under consideration withdrew under scrutiny or pressure -- something Obama himself bemoaned in an interview that aired Sunday.
"You know, this whole confirmation process, as I mentioned earlier, has gotten pretty tough. ... It's gotten tougher in the age of 24/7 news cycles," Obama said on CBS News' "60 Minutes." "And a lot of people who we think are about to serve in the administration and treasury suddenly say, 'Well, you know what? I don't want to go through some of the scrutiny, embarrassment, in addition to taking huge cuts in pay." When asked whether his administration had offered jobs to people who had turned them down, Obama replied: "Absolutely. Yeah. And not because people didn't want to serve. I think that people just felt that, you know, that the process has gotten very onerous."
Those nominated Monday have Washington experience. Wolin most recently served in the White House as a deputy counsel focusing on economic policy. Before that he was president and chief operating officer for casualty operations at The Hartford Financial Services Group. During President Bill Clinton's administration, Wolin worked as National Security Council lawyer, assistant to the national security adviser and a Treasury Department lawyer. He also worked as an assistant to three CIA directors, as a private lawyer at a Washington firm and as a part-time professor at Harvard University. Brainard, who will have the title undersecretary for international affairs, most recently founded the Global Economy and Development Program at the Brookings Institution, a Washington think tank. She was a deputy national economic adviser for international affairs during the Clinton administration and has taught economics at the Massachusetts Institute of Technology.
President George W. Bush nominated Levey as the nation's first undersecretary for terrorism and financial intelligence, a job that put him in charge of the department's effort to monitor and break up the flow of money to people intending harm to the United States. He previously worked at the Justice Department on counterterrorism activities. He worked as a private lawyer and clerked for a U.S. appeals court judge.
Bank of China Has Bigger-Than-Expected 59% Profit Drop as Writedowns Swell
Bank of China Ltd., the world’s third-largest lender by market value, had a wider-than-expected 59 percent drop in fourth-quarter profit on writedowns of U.S. mortgage investments and higher bad-loan provisions. Net income declined to 4.42 billion yuan ($647 million) from 10.77 billion yuan a year earlier, based on figures released by the Shanghai-based company. That fell short of the average 7.59 billion yuan estimate among 25 analysts surveyed by Bloomberg. Bank of China has lost more on mortgage investments than all other Chinese lenders combined as the U.S. housing collapse sparked a credit seizure. Speculation that most of the bank’s writedowns are behind it has helped push the stock 12 percent higher in Hong Kong this year, the second-best performance among Chinese lenders traded there.
"People knew Bank of China would underperform peers in 2008 because of the investment loss, but we are still surprised by how much it missed the estimate," said Liu Yinghua, a Shenzhen-based analyst at Ping An Securities Ltd. who plans to maintain her "neutral" rating on the stock. "There’s a silver lining though: it has a clean slate to start in 2009." Bank of China wrote down the value of subprime-related assets and other securities by $894 million in the three months, taking total writedowns to about $4.46 billion since the quarter ended December 2007. The Chinese lender still held $2.59 billion of subprime- mortgage investments, $1.15 billion of securities backed by Alt- A home loans and $3.51 billion of other "non-agency" mortgage investments as of Dec. 31. "After the 2008 writedowns, those investments won’t be a major problem," Lee Yuk-Kei, a Hong Kong-based analyst at Core Pacific-Yamaichi International Ltd., said before the announcement. "We think the bank will recover in 2009 and its profit and shares will start to outperform peers."
Bank of China’s quarterly profit was derived by subtracting net income for the first nine months from the 2008 figures released today. For the full year, the lender’s net income gained 14 percent to 64.36 billion yuan. The stock gained 2.2 percent to close at HK$2.38 in Hong Kong today before the earnings were announced. It has dropped 21 percent in the past year. Losses on overseas credit investments haven’t kept Bank of China Chairman Xiao Gang, 51, from trying to catch up with local rivals that avoided the contagion because of limited operations abroad. Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp., the world’s two largest lenders by market value, get less than 3 percent of revenue from overseas. Bank of China aims to increase lending by 17 percent this year, Vice President Zhu Min said at a pres briefing in Hong Kong today. It will add 10,000 employees, the most since becoming a publicly traded company in 2006, Xiao said this month.
Chinese Premier Wen Jiabao this month set a new loan growth target of 5 trillion yuan for the banking industry in 2009 to help finance the government’s 4 trillion yuan stimulus package and "reverse the economic slide as soon as possible." Chinese banks offered a record 2.69 trillion yuan of new loans in the first two months, more than half of the total for 2008. Even so, China’s six largest publicly traded banks may report an 11 percent drop in profit in 2009, after growth of 35 percent last year, hurt by "narrowed net interest margin and decelerated fee growth," Credit Suisse AG said on March 11. The People’s Bank of China has cut lending rates by 216 basis points since mid-September to stimulate the economy while lowering the deposit rate by 189 basis points, hurting loan profitability at banks. One basis point is 0.01 percentage point.
Bank of China faces less pressure on net interest margins, a measure of lending profitability, than local rivals, partly because its lower loan-to-deposit ratio shields it from the impact of falling lending rates, said Sarah Wu, an analyst at Macquarie Securities Ltd. The lender’s net interest income, or revenue earned on loans after deducting interest paid for deposits, rose 6.7 percent to 162.9 billion yuan for the full year. Non-interest income gained 56 percent to 65.96 billion yuan. Net interest margin contracted 13 basis points to 2.63 percent in 2008. Bank of China expanded lending by 15.7 percent in 2008 to 3.2 trillion yuan. It set aside 16.8 billion yuan to cover bad loans last year, more than double of the amount for 2007, after the banking regulator required publicly-traded banks to boost their coverage ratio to 130 percent. The lender’s non-performing loan ratio narrowed to 2.65 percent as of Dec. 31.
Loan defaults are the single biggest threat to Chinese banks, which face "a choppy 2009" as the economy weakens, Fitch Ratings said in January. About 7.5 percent of the country’s 42 million smaller and medium-sized firms closed down or suspended operations by the end of last year, official estimates show. Bank of China’s Hong Kong unit said today 2008 profit fell 78 percent on provisions, its first full-year earnings decline since a 2002 initial public offering. Central Huijin Investment Co., a unit of China’s $200 billion sovereign wealth fund and Bank of China’s biggest stakeholder, bought 74.6 million shares in the lender in the fourth quarter.
Europe's buyout default rate a major worry
The default rate of Europe's private equity portfolio companies looms as the single biggest worry for Billy Gilmore, investment director of SWIP, as he looks into an uncertain future. "It's the tip of the iceberg today," he said on Monday, speaking at the Reuters Hedge Funds and Private Equity Summit in London. "We all know it's going to get a lot worse. It's just a question of how much worse." Europe's default rate for high-yield companies has, so far, been much lower than in the United States, but some analysts predict, however, that the European default rate will ultimately be worse. Late on Friday saw the first-ever credit event -- which will trigger payment under credit default swaps (CDS) -- by a member of Europe's high-yield Crossover credit derivatives index, after petrochemical company LyondellBasell Industries failed to make a coupon payment.
The auction for settling cash payouts on its CDS is set for April 16. "That it's taken so long into this crisis to get the first Crossover default is indicative of the fact that most high-yield companies (in Europe) used the credit bubble to term out their debt maturity profile," Deutsche Bank credit strategists wrote in a note to investors. Default figures for the United States, so far, have been higher, with 18 high-yield bond CDS credit events since 2005. Without any further government intervention, "we are convinced that well over half the high-yield market will default," they said. Europe's leveraged loan arena has so far produced three credit events that have triggered payments under CDS contracts -- for Sanitec, British Vita and Ferretti.
"I don't think we are in a position where there have been massive defaults among buyouts just yet," Gilmore told the summit. "But I'm sure that day will come in the months to come." Figures from Moody's Investors Service show the trailing default rate for speculative grade companies for the 12 months to February at 5.7 percent for the United States versus 2.7 percent for Europe. Moody's, however, earlier this month forecast that Europe's 3speculative-grade default rate would rise to 22.5 percent by the end of this year, while the U.S. rate would reach 13.8 percent. "Looking ahead, we think the European high-yield market will underperform the U.S.," Goldman Sachs credit strategists Alberto Gallo, Lotfi Karoui, Annie Chu and Charles P. Himmelberg wrote in a recent note, citing Europe's weaker monetary and fiscal policy.
Also, the size of Europe's high-yield market, at only 13 percent the face value of the U.S. market, means that high-yield investors have historically focused on the United States as the core of their portfolios, they wrote. "In a deteriorating environment, we think U.S.-based investors have been shifting away from European high-yield corporates, which typically offer less disclosure." Furthermore, U.S. credit investors altered their focus months ago from fears of a systemic collapse to differentiating between good and bad companies, the Goldman strategists said. This shift is coming in Europe, making the strong credits stronger, and the weak weaker, they added.
In Europe, loans are the primary source of high-yield corporate funding, and the distress in its leveraged loan market is escalating, they said, citing Standard & Poor's data that 19 loan issuers were rated D or underwent restructuring in January and February. "The European loan market is already under intense pressure, and we think similar weakness will soon be evident in bonds." They recommend that investors buy protection on the Markit iTraxx Crossover index.
David Blanchflower warns of 'horrible' things to come
The Bank of England policymaker who last year correctly predicted the current surge in unemployment and deep recession yesterday warned that the British economy may not recover this year, and repeated his view that unemployment is likely to climb above the 3 million mark. He said the rising jobless figures show "the taste of something horrible" to come. David Blanchflower, an independent or "external" member of the Bank's Monetary Policy Committee, in effect rubbished the Bank's own forecasts for growth that were published in its Inflation Report last month. The report pointed to the probability of a recovery in economic activity and a return to positive growth by the end of this year. Now Mr Blanchflower says that "there are plausible arguments to say this will not happen".
The IMF said last week that the UK economy would decline by a massive 3.8 per cent this year, followed by a further contraction of 0.2 per cent in 2010, one of the worst performances among advanced economies. Mr Blanchflower believes unemployment and the apparent timidity of policymakers in the face of the crisis are the main obstacles to reversing that catastrophe. "Job creation needs investment in infrastructure, with particular emphasis on shovel-ready projects that can be started quickly," he said. In response to the Confederation of British Industry's assertion that the "alarming" state of the public finances left the Government no room for an additional "discretionary" fiscal stimulus in the Budget, due on 22 April, Mr Blanchflower said: "Fine, but what are we going to do about unemployment?"
Official figures released last week showed the number of people claiming jobless benefits rose faster last month than at any time since at least 1971, while the number of people out of work passed 2 million for the first time since 1997. Most independent economists believe the total will peak at between 3 and 3.5 million by this time next year. Should the jobless total exceed the post-Second World War peak of 3.3 million seen in 1984, during Margaret Thatcher's premiership, it would be acutely embarrassing for ministers. Mr Blanchflower added: "Forecasters in a recession tend to be overly optimistic ... The worry is that any forecast we do have of unemployment or output, [it is likely that] we've undercooked it."
Nor did he draw back from highlighting the political consequences of rapidly lengthening job queues in the run-up to a general election. "We're all in this, we're going to have to do something about it. In six months' time it's going to be the biggest issue in every constituency," he warned. Thus far, the plethora of business and banking support initiatives announced by the Treasury, the Bank of England and the Department for Business have failed to stem the loss of jobs in the economy. The deprecation of sterling – which has seen more than a quarter of its value lost on the international exchanges since mid-2007 – has been of no help to the jobless, argued Mr Blanchflower.
"I think the decline in the exchange rate has not been generating jobs in manufacturing. In fact, they have been plummeting," he said. As to the policy of quantitative easing, or printing money, recently implemented by the Bank of England, Mr Blanchflower agreed that he had voted for it, and pointed to the fear of powerlessness among policymakers at the Bank. "The greatest fear of all is that you have no real tools at all in the area of disinflation ... We've got to get ourselves out of that. We've got to do whatever is necessary," he said. Mr Blanchflower is due to retire from the MPC in June. He will be replaced by David Miles of JP Morgan.
Weak pound stops inflation falling below zero
The plunging level of the pound and a spike in petrol prices stopped inflation falling into negative territory - or deflation - catching economists off guard. The Retail Prices Index, the widest measure of inflation, fell from 0.1 per cent in January to 0 per cent in February – the lowest level since March 1960, but far higher than economists were expecting. Most thought RPI would fall well into negative territory, hitting minus 0.8 per cent, as falling mortgage costs for the millions of people on tracker rate mortgages pushed the index down. The Consumer Prices Index, which excludes housing costs, actually increased from an annual rate of 3 per cent to 3.2 per cent. However, an increase in the cost of food, alcohol, clothes, petrol and car tax offset the falling cost of mortgages.
It is becoming clear that the raft of bargains on the High Street, which shoppers enjoyed over Christmas and January, are now coming to an end, and any small benefit from the cut in VAT has dissipated. The price of petrol, which had fallen to as low as 85.9 p for a litre of unleaded in the first week of January, has now climbed back up to 90.6p, according to Petrolprices.com. The British Retail Consortium has also warned that food prices, which had started to fall markedly thanks to plunging commodity costs such as wheat, are now rising once again. This is because the majority of goods on shop shelves – from food, to electrical goods, toys and clothing – are imported. Investors, fearing for the state of the British economy, have sold sterling on the international currency markets, forcing down the value of the pound from above $2 a year ago to $1.46 this week. This has pushed up the price of any imports. The Office for National Statistics said that cucumbers, carrots and courgettes all increased in price during February. Prawns, strawberries, frozen pizza and boxes of chocolates also have increased in price by more than expected.
Economists, despite being caught unawares by the data, insisted the long-term trend was for prices to continue falling, as shopkeepers resort to cutting prices. This would leave the economy facing deflation for the first time since Harold Macmillan was prime minister. Howard Archer, chief UK economist at IHS Global Insight, said: "Despite the rise in February, we still expect annual consumer price inflation to fall back substantially over the coming months. "This is expected to be the consequence of heightening pressure on retailers to price competitively as consumer spending increasingly wanes, companies' diminishing pricing power through the supply chain, sharply lower oil and commodity prices compared to 2008's peak levels, and favourable base effects as last year's sharp rises in utility prices increasingly drop out of the calculation."
UK population must fall to 30 million
Jonathon Porritt, one of Gordon Brown’s leading green advisers, is to warn that Britain must drastically reduce its population if it is to build a sustainable society. Porritt’s call will come at this week’s annual conference of the Optimum Population Trust (OPT), of which he is patron. The trust will release research suggesting UK population must be cut to 30m if the country wants to feed itself sustainably. Porritt said: "Population growth, plus economic growth, is putting the world under terrible pressure. "Each person in Britain has far more impact on the environment than those in developing countries so cutting our population is one way to reduce that impact."
Population growth is one of the most politically sensitive environmental problems. The issues it raises, including religion, culture and immigration policy, have proved too toxic for most green groups. However, Porritt is winning scientific backing. Professor Chris Rapley, director of the Science Museum, will use the OPT conference, to be held at the Royal Statistical Society, to warn that population growth could help derail attempts to cut greenhouse gas emissions. Rapley, who formerly ran the British Antarctic Survey, said humanity was emitting the equivalent of 50 billion tons of CO2 into the atmosphere each year. "We have to cut this by 80%, and population growth is going to make that much harder," he said. Such views on population have split the green movement. George Monbiot, a prominent writer on green issues, has criticised population campaigners, arguing that "relentless" economic growth is a greater threat.
Many experts believe that, since Europeans and Americans have such a lopsided impact on the environment, the world would benefit more from reducing their populations than by making cuts in developing countries. This is part of the thinking behind the OPT’s call for Britain to cut population to 30m — roughly what it was in late Victorian times. Britain’s population is expected to grow from 61m now to 71m by 2031. Some politicians support a reduction. Phil Woolas, the immigration minister, said: "You can’t have sustainability with an increase in population." The Tory leader, David Cameron, has also suggested Britain needs a "coherent strategy" on population growth. Despite these comments, however, government and Conservative spokesmen this weekend both distanced themselves from any population policy. "
Ireland given more time to bring budget deficit down
The European Commission has today given Ireland until 2013 to bring its budget deficit below 3 per cent of gross domestic product (GDP). Britain, France, Spain and Greece have also given additional time to correct their swelling budget deficits. "National budgetary positions in the EU and elsewhere have deteriorated considerably in the last year and are set to deteriorate further on account of the economic crisis we are living through and the discretionary measures rightly adopted by Member States to sustain demand and promote investment," said Economic and Monetary Affairs commissioner Joaquín Almunia today. "To limit the costs of the debt for generations present and future, it is crucial that governments devise an adjustment path whereby they commit to correct public deficits from the moment the economy starts to recover, which is expected to happen gradually in 2010.
"The Stability and Growth Pact provides the framework for this exit strategy and a return to sound and sustainable public finances in the medium-to-long term," he added. While general government debt in Ireland stood at 40.6 per cent of GDP in 2008 - below the 60 per cent reference value - the exchequer deficit reached 6.3 per cent of GDP. According to the Commission's January forecasts, this deficit is expected to widen to 11 per cent this year and to 13 per cent in 2010 on the assumption of no new Government measures. The Commission said that in view of the" very weak economic situation" in Ireland and the size of its deficit, a multi-annual deadline for the correction of the excessive deficit was warranted.
The European Commission said France and Spain should cut their ballooning budget deficits below 3 percent of gross domestic product by 2012 while Greece should do the same by next year. The EU's executive arm said Britain should cut its excessive deficit back below the 3 per cent ceiling by 2013/14. The recommendations are the first indication of the flexibility with which EU budget rules, the Stability and Growth Pact, are applied by the 27-nation bloc amid the worst global economic and financial crisis in living memory. The Commission has said it would follow EU rules in starting disciplinary steps against countries exceeding the 3 percent limit, but would be flexible in setting the deadlines for reining in the gaps because of the severity of the crisis.
German economy to contract 7% this year
Germany faces the sharpest economic downturn of any major country in the Western world as unemployment rockets to 5m. The country may be on the cusp of a Japanese-style "Lost Decade", according to a clutch of grim forecasts by leading banks and economic institutes. Commerzbank said output is likely to contract by 6pc to 7pc this year as the global recession wreaks havoc on German industrial exports. Foreign industrial orders have fallen by 37pc over the last year. "The recent collapse in orders compels us to make a massive downward revision to our economic outlook. January orders and production data plunged at a dramatic pace that has no precedent in Germany's post-World War Two history," said Jrg Kramer, the bank's chief economist. The country's leading think tanks have been scrambling to adjust as it becomes ever clearer that the country went off a cliff over the winter. The IMK Institute has slashed its forecast to minus 5pc this year. The RWI Institute warned that unemployment could reach 5m by the end of 2010 as the delayed time-bomb of mass lay-offs finally detonates.
The mounting social damage is likely to have a transforming effect on the German political landscape when election are held this Autumn. The neo-Marxist Left Party, which proposes nationalisation of huge chunks of the economy, is already angling for 30pc of the vote in Thuringia's regional elections in June as it tears into the Social Democrat flank. Mr Kramer said Germany is suffering the brunt of the global slump because 40pc of GDP stems from exports. It is heavily reliant on machine tools and engineering that is levearaged to global industrial cycle. "There will be no upward movement next year that deserves to be called an upturn," he said. The only other G10 country likely to face the same sort of destruction this year is Japan (-7pc), another industrial export power. The bank expects Italy to contract by 4.5pc this year, the US by 4pc, Britain by 3.9pc, and France by 3.5pc. Axel Weber, the Bundesbank chief, signalled on Monday that European Central Bank is ready to cut interest rates again. "Rates are at 1.5pc in the euro area and heading down," he said. Mr Weber defended the ECB against a chorus of criticism that it has misread the threat of global deflation and held monetary policy too tight, amplifying the downturn. "We have put in as much monetary stimulus in a short period of time as the central banks in the US and UK," he said.
He said it was unfair to contrast the meagre stimulus packages in Europe with spending blitz in other parts of the world, insisting that generous unemployment pay in most eurozone states acts as an automatic "stabiliser". There is little doubt however that hawkish policies in Europe have pushed the euro to levels that are taking a toll on manufacturing industry. Eurozone exports fell 24pc in January from a year earlier. Charles Dumas, global strategist at Lombard Street Research, said Europe's leadership class have ensured "likely disaster" for EMU by assuming for so long that they could continue to rely on "predatory export-led growth" by feeding off world demand rather adopting radical stimulus measures of their own. "It looks as if surplus countries, particularly those of north-central Europe clustered around Germany, imagine they can wait for recovery and then enjoy export-led growth again," he said. Mr Dumas said that Europe was paying a high price for refusing to signal its disdain over quantitative easing in the US, Britain, and a growing number other countries. "The higher euro is a disaster for the overvalued countries of Club Med as well as Germany. Italy is overvalued by almost 50pc and is completely sunk in current conditions," he said. Luxembourg's premier Jean-Claude Juncker, head of the Eurogroup of finance ministers, said the EU had plans to rescue any eurozone state in serious trouble "within hours" but insisted that no such need would ever arise.
Germany May Use Banks to Sell its Debt, Calyon Says
Germany, Europe’s benchmark sovereign borrower, may opt to hire banks to help it sell bonds for the first time in three years as governments compete to raise record amounts of cash, according to Calyon. European governments more than doubled the amount of debt sold through banks, so-called syndicated deals, in the first quarter to 66 billion euros ($90 billion), said Calyon, the investment-banking unit of Credit Agricole SA. The Frankfurt- based Federal Finance Agency, which is scheduled to announce the nation’s second-quarter funding program this week, has no plans to appoint banks for regular bonds, Boris Knapp, a spokesman for the agency, said in an interview.
"The way funding needs are increasing across Europe there is a danger that Germany will need to turn to syndication," said Orlando Green, a fixed-income strategist in London at Calyon, one of the 28 financial institutions authorized to bid directly at German bond auctions. "If they are going to use syndication, it will be sooner rather than later." The U.K. said last week it may use banks for gilt sales starting next month, joining Ireland, Spain and Belgium in syndicated deals as the deepest economic slump since the Great Depression prompts governments to turn to banks to ensure sufficient demand for their securities. The last time Germany used banks was in March 2006, when it hired lenders including Deutsche Bank AG and Barclays Plc to sell its first inflation- protected bond.
The Federal Finance Agency may outline the timing for sales of an extra 20 billion euros of bonds on top of the already planned record 323 billion euros for 2009. The announcement, initially scheduled for noon Frankfurt time today, was postponed to tomorrow, the agency said. Britain, which said on March 18 it plans to sell a record 147.9 billion pounds ($213 billion) of government bonds in the year starting April, risks "failed auctions," Robert Stheeman, chief executive officer of the U.K.’s Debt Management Office, said in an interview published in January. The last and only time the DMO offered its AAA rated debt through banks was in September 2005, when it sold 50-year inflation-linked securities for the first time.
Ireland’s debt agency said on March 17 it will issue some of its remaining debt for 2009 through banks after a combined 10 billion euros in syndicated sales in January and February. Belgium and Greece also used banks this year. "The need to raise money this way reflects nervousness among sovereign issuers," said David Scammell, a money manager at Schroders Plc in London who helps oversee $158 billion in assets. "Those supply numbers are horrendously big. The demand for bonds might be strong now, but if there’s any tailing off in demand at any particular point, it will become quite uncomfortable." In syndication, governments or companies pay banks fees to sell bonds directly to investors including pension funds and central banks. Issues typically involve at least 3 billion euros of securities. In auctions, dealers bid for government debt and then resell some of the securities on the secondary market.
Bank bailouts and economic stimulus packages are swelling budget deficits in some of Europe largest economies, leading to sovereign-credit downgrades. Spain lost its AAA rating at Standard & Poor’s in January. Greek and Portuguese government debt was also lowered. As bank losses and writedowns tied to the U.S. subprime- mortgage crisis approach $1.3 trillion since the start of 2007, balance sheets at primary dealers that were once available for buying bonds at government auctions have contracted. That has meant relying on auctions alone might not be practical, said Dan Shane, head of sovereign, supranational and agency syndication in London at Morgan Stanley.
"The risk of failed auctions has increased because of rising borrowing needs, increased volatility and shrinking balance sheets among banks," Shane said in an interview. "The trend of greater use of syndication among sovereign issuers will certainly continue in this environment." Under the German auction system, the Federal Finance Agency retains unsold notes and bonds to sell in the secondary market. Without such a system, nine out of the 37 auctions last year would have failed, based on a comparison of planned issuance and bids received. That’s a reflection of the challenges of the auction system during the financial crisis rather than the quality of German bonds, said Jason Simpson, a fixed-income strategist in London at Royal Bank of Scotland Group Plc.
"With an auction, because everyone’s buying at the same time, you do have a potential problem if not enough people turn up on the day," he said. The first time Germany used a bank syndicate was in 2005, when it sold dollar-denominated bonds, according to the Federal Finance Agency. Syndicated issues accounted for more than 25 percent of all debt sales in the euro region this year, compared with 19 percent a year ago, according to Calyon.
Baltic Currency Pegs Are 'Burning Fuse' as 50% Devaluation Looms
The Baltic currency pegs are a "slow-burning fuse" that will deepen the region’s economic crisis before eventually collapsing, with devaluations of as much as 50 percent, Royal Bank of Scotland Group Plc said. Latvia, Estonia and Lithuania have kept fixed pegs to the euro throughout the global financial crisis, even as their economies suffer the deepest recessions in the European Union and Latvia receives a 7.5 billion-euro ($10.2 billion) bailout from the International Monetary Fund. Lithuania’s credit rating was cut by one level by Standard & Poor’s today to BBB, the second-lowest investment-grade ranking.
"In such a unique and extreme situation as this, if you can’t let currencies go, you need to massively deflate domestic demand," Timothy Ash, head of research on emerging European economies at RBS in London, said in an interview. "Policy makers will soon be asking: Why are we doing this again? Latvia’s economy shrank 10.3 percent in the last quarter, the EU’s worst decline. It is on track to fall 15 percent in 2009, Swedbank AB said March 18. Estonia’s economy last quarter shrank 9.7 percent, and Lithuania’s contracted 2 percent in the last three months of 2008, the first slide in nine years. A weaker currency tends to lift exports and help the economy. Latvia will be forced either to abandon or reconfigure its peg by the end of this year, and devalue its currency by as much as 50 percent as the economy contracts by about 25 percent, Ash said today.
The country will probably run a "big fiscal deficit" and be forced to take on more state debt, he added. Interdependence between the three nations’ economies mean "if Latvia goes, the others will too," according to Ash. The IMF, which tends to favor flexible exchange-rate regimes, allowed Latvia to keep its peg because of the government’s preference for a fixed regime and the possible impact of a devaluation on Estonia and Lithuania, according to a posting by regional representative Christoph Rosenberg on the RGE Monitor Web site Jan. 6.
Nouriel Roubini, the New York University professor who forecast the U.S. recession two years ago, said last month the IMF made a "mistake" in letting Latvia get a loan while retaining the peg. Latvia buys and sells foreign-currency reserves to prevent the lats from fluctuating more than 1 percent either side of 0.702804 per euro. The currency has lost 0.1 percent against the euro in the past six months, while the pound slumped 20 percent and Russia’s ruble fell 25 percent versus the dollar. Neighboring Estonia and Lithuania employ currency board systems, where the kroon is kept at 15.6466 per euro and Lithuania’s litas stays at about 3.4528 per euro.
The Baltic countries should either readjust their pegs at weaker levels or allow their currencies to float freely, Ash said. "They say they need the pegs to preserve the banking sector, but they’re driving their economy into recession to keep the banks’ liabilities low," he said. Latvia is the most indebted among eastern European nations with external debt equivalent to 130 percent gross domestic product, according to data compiled by New York-based private bank Brown Brothers Harriman & Co. The ratio for Estonia is 108 percent and for Lithuania, it’s 70 percent. Russian debt by comparison is 34 percent of GDP.
That political instability can come hard on the heels of economic breakdown is more and more apparent in central and eastern Europe. News that the Hungarian prime minister Ferenc Gyurcsany is stepping down was confirmed yesterday after he blamed himself for mishandling his country’s economic crisis. Today the Czech government faces a vote of no confidence in parliament on its economic and political record, which could see it ousted in the middle of the country’s presidency of the European Union.
Although other governments in the region are also vulnerable, it is a mistake to generalise too much, since some have handled these issues more effectively than others. That understanding was seen in the EU summit decision last week not to adopt Mr Gyurcsany’s proposal for a €180 billion regional bailout. This was resisted by other such governments and instead the EU decided to double to €50 billion its emergency funding reserve fund for balance of payments support for non-euro zone states, in what was described as a gesture of European solidarity. A parallel decision was made to provide €75 billion in new loans to the International Monetary Fund. And many of the €5 billion energy and IT related special projects will also go to the central and eastern European region. These were sensible decisions with potentially more universal application.
Mr Gyurcsany’s government was forced to call on the IMF for help last October after its bonds failed to sell on international markets. Since then he has had even more difficulty balancing a large state debt with high social benefit payments. Whoever succeeds him will be expected to take tough action or face a highly divisive election campaign. These problems are specific to Hungary. Although Slovakia and Poland are also facing deep economic problems in this crisis they have resisted blanket comparisons and sought a more modulated EU response at the summit.
It should be remembered that Latvia’s government also fell, but not Estonia’s. Romania and Bulgaria, too, have their problems, but so far their governments are not threatened. Elsewhere in Europe Iceland’s government fell, and Belgium’s was long delayed. Rightly or wrongly Greece and Ireland among the older EU member states are perceived to be vulnerable too. If the Czech government falls today it will nevertheless inevitably put the spotlight on political instability in that region. Its conduct of the EU presidency would be thrown into great uncertainty as well.
Eastern Europe's Economic Crash
The global downturn has hit Eastern Europe with particular vengeance. Countries that profited more than many others from globalization and were previously capitalism's rising stars are now seeing demand for exports collapse, along with their currencies. They are bracing for a hard landing. Ryszard Delewski is a businessman on the verge of bankruptcy. After spending anxious months worrying about the future of his company, it seems to be all over. Delewski was meeting with a customer in Minsk, Belarus when the telephone rang and the crisis hit home. His bank was calling to inform him that his company, Delkar, was in the red to the tune of 4 million zloty, or about €850,000 ($1.1 million). The amount had accumulated because Delewski had used foreign exchange options to hedge against an appreciation of the zloty. But now the Polish currency had lost almost a quarter of its value against the euro. And no one had explained to Delewski that, if this happened, he would owe compensation payments. Each month the 150 employees at Delewski's plant, near the central Polish city of Kielce, stamp 250 tons of sheet metal and aluminum into gutters, lightning rods and other building elements. About half of the finished products are exported to France, Portugal, Germany and other European Union countries, while the remainder is sold in Poland. "Exports have declined sharply in the past few months. But that alone would not have finished us off," says Delewski.
Given the magnitude of the current crisis, he can understand that demand for his products in the West is down. But why the zloty is falling and why he suddenly owes money is a mystery to him. "We Poles work hard," he says. "Our products are as good as those in the West, and we service our loans." Delewski feels taken in by his lender, Millennium Bank. It took Eastern Europe 20 years to overcome the old, inefficient structures of the state-run planned economy. The big, unprofitable combines were privatized, and, as Eastern European companies moved into new markets, the region became integrated into the globalized economy. After joining the EU, the Baltic countries in particular made enormous progress in catching up with their Western neighbors, sometimes growing at double-digit rates. Romania, a latecomer to the EU, recorded the largest number of new registrations of Porsche Cayennes worldwide in 2008. In downtown Warsaw, the Stalin-era Palace of Culture and Science, once the city's only skyscraper, disappeared behind new steel-and-glass office towers within the space of a few years. The Czech Republic still enjoyed almost full employment in 2008. Now the once-booming Eastern European economy has ground to an abrupt halt. The worldwide economic crisis, which began with the bursting of the real estate bubble in the United States, is now making itself felt in the former communist countries. And it is hitting them with more force and more quickly than the newcomers to capitalism, spoiled by success, had expected.
The Estonians, Latvians and Lithuanians, who for years could enjoy growth rates of between 7 and 10 percent, must resign themselves to the fact that their economies are shrinking. Hungary has already tapped the International Monetary Fund, the World Bank and the EU for €20 billion ($27 billion), and Romania will need just as much. In the fourth quarter of last year alone, the Poles produced 5 percent less than in the same period in 2007. In the Czech Republic, unemployment has risen to 12 percent. Is it now up to the Western European countries, which already have their hands full dealing with the worst economic crisis since World War II, to pay Eastern Europe's bills? On the other hand, what happens if no one helps? Could the crisis in the EU's new member states jeopardize the cohesion of the union as a whole? One thing is clear: Western Europe cannot simply abandon the new member states to their fate. Aid for the East was one of the key topics of discussion at the EU summit in Brussels late last week. At the suggestion of the European Commission, an emergency loan fund for distressed members that have not yet joined the euro zone was increased to €50 billion ($68 billion). Commission President José Manual Barroso called the decision a "signal of strong support." That signal was urgently needed. Eastern Europeans have long wondered how resilient the rich Western Europeans' solidarity really is. They accuse their EU partners of recapitalizing only domestic companies with -- in part lavish -- bailout packages, while at the same time eliminating the competition from the East.
The view in the East is that the onset of the world economic crisis has suddenly reversed globalization. Hundreds of thousands of Poles, Bulgarians and Romanians had found relatively well-paid jobs in western EU countries, but now an army of migrant workers is making its way back home to the East. At the same time, the capital the region so desperately needs is flowing in the other direction, as Western banks and investors pull out their money. The fact that the crisis in the West is now pulling down the East is largely attributable to a single mistake. For years, Eastern Europeans took out loans denominated in euros, Swiss francs and Scandinavian kroner. The loans stimulated domestic consumption and allowed the economies to grow. Many new member states imported more goods than they exported. Now the mountains of debt are high, and the current account deficits of countries like Lithuania and Bulgaria are a massive 15 percent of GDP. Capital flight and declining demand from the West have pushed down exchange rates. The currencies that are not pegged to the euro have experienced particularly drastic slumps in value. In the last six months, the Romanian leu lost more than 16 percent of its value and the Hungarian forint close to 20 percent. Private citizens and even governments can no longer service their foreign-currency loans.
Massive bankruptcies in the East are now affecting the reckless lenders in the West, which also happen to control about 70 percent of all banks in Eastern Europe. Austrian banks alone have outstanding loans in Eastern Europe worth €293 billion ($396 billion). Thomas Mirow, the president of the European Bank for Reconstruction and Development in London, expects that up to €76 billion ($103 billion) in Western loans will come due this year in EU members in Eastern Europe and Ukraine. Concerns about the creditworthiness of Eastern businesses could deter cash-strapped Western banks from issuing loans for investments. According to Mirow, a vicious circle is developing as Eastern European economies run out of steam and the crisis gains momentum. At any rate, it will not be possible to fulfill the promise of the revolution of 1989 -- freedom and prosperity for all Europeans -- as quickly as promised. Instead, citizens in the new EU member states can expect to see their wages stagnate at lower levels compared with those in the West, assuming they have not already been cut drastically. In addition to mass layoffs, ailing Eastern European business owners have resorted to wage cuts of up to 30 percent in recent months. And someone who is out of work in the east quickly finds him- or herself in a very tight spot. Governments are out of money, and social services were cut back in many places during the boom years.
Now trouble is beginning to brew in these young democracies. In Bulgaria, Latvia and Lithuania, angry citizens have taken to pelting government buildings with eggs, rocks and -- weather permitting -- snowballs. In the Latvian capital, the government of Prime Minister Ivars Godmanis was even forced to step down. Meanwhile in Hungary, Prime Minister Ferenc Gyurcsany announced Saturday he was resigning, saying he was an "obstacle" to the reforms needed to help his country overcome the financial crisis. The new EU countries, after experiencing a dizzying boom, are in trouble once again. But in contrast to the recession in the early 1990s, there are different reasons for their problems today. In fact, the face of the crisis varies from country to country. In the Baltic states, it was primarily cheap money from Scandinavia that ignited a consumption-driven flash in the pan. After 40 lean years of communism, Hungary, the Czech Republic and Slovakia had a great deal of catching up to do, and yet the manufacturing industry's share of growth in recent years was disproportionately greater than in the Baltic states. However, companies and private citizens there, as well as in Romania, have also incurred too much debt. Unfortunately, much of that debt is denominated in euros, Swiss francs or dollars. Foreign banks muscled their way into the new markets in the East and were simply able to offer better terms than their domestic competitors. But now that the forint and the leu have lost value, many borrowers can no longer afford to make their loan payments.
Poland, the Czech Republic and Slovakia are in better shape than their northern and southern neighbors. The major automakers from Western Europe and Asia have built new plants in these countries, such as Korean carmaker Kia's plant in Zilina, Slovakia, which opened in 2007 -- and where employees have now been put on short-time as a result of the crisis. Nevertheless, these plants are often more modern than those in the West, and wage costs are much lower. This fuels hopes that these countries will come out of the crisis in a more favorable position for the future. The Polish economy is currently in the best shape. An independent small- and medium-sized business sector has developed there in the last two decades, and the country is big enough that domestic demand can support the economy for the time being. Even though the Finance Ministry in Warsaw had to revise its growth forecast downward on Thursday, experts still expect to see growth of 1.5 percent in the coming months. Entrepreneurs like Ryszard Delewski, with their hard work and ingenuity, are the ones who helped produce the Polish economic miracle. But since receiving the call from his bank in Minsk, he too is at a loss. The Millennium Bank is now demanding payment of 8 million zloty, money that Delewski does not have. "I am liable with my personal assets," he says, glancing at a photo of his sailing yacht on the wall. "I'm not worried about myself, but I have 150 employees."
About 10,000 Polish companies entered into such currency transactions, and now they could face bankruptcy while thousands of workers risk losing their jobs. This has already been the fate of many workers in the Baltic states. In Latvia, unemployment rose from 5 percent in 2007 to 12 percent today. To make matters worse, private citizens are deeply in debt. "Some people are so broke that they have to spend the night in Internet cafes," says a German real estate agent in Riga. Many brand-new office buildings on the outskirts of the city's picturesque downtown are half-empty. "The market for houses is dead at the moment," says the broker. After decades under communist rule, the Latvians and their neighbors embarked on a wild party, paid for with borrowed money. In Estonia, it was even possible to secure a loan by cellphone text message. A would-be borrower simply had to send a message to a lender asking for a specific amount, and the money would be wired to his bank account. "In only a few years, the Balts have developed a tremendous sense of entitlement," says a software entrepreneur, "that was often no longer in line with performance." Everyone, says the businessman, expected the boom to last forever and wages to rise automatically.
Meanwhile, say experts, important work was left undone. Although the Estonians, Latvians and Lithuanians liquidated the big state-owned businesses after the fall of communism, they failed to develop new products for export. Instead, the governments in Tallinn, Riga and Vilnius focused on a radical course of deregulation, which included the introduction of a uniform flat tax throughout the Baltics. It was enough to attract capital to the region, but not enough to stimulate sustainable industrial growth, says Sten Tamkivi, a 30-year-old Estonian who works for the IT firm Skype. Tamkivi is one of the few people doing well in the crisis. Estonia is banking on widespread broadband penetration and likes to advertise itself as "E-stonia." Almost all banking in the country is done online. Estonians use their mobile phones to pay for movie and parking tickets, and they can even vote on the Internet. Nevertheless, Skype is the country's only global success story. The company offers a program on the Internet that allows computer users to make telephone calls and videoconference for free. "The number of Skype users has grown since the crisis began," says Tamkivi. "Companies are apparently saving on business trips, and many meetings are now conducted through Skype." But now the Balts are also feeling helpless. The krone, lats and litas are tied to the euro. To stimulate exports, the Baltic currencies would need to be devalued. But then many banks and businesses with large amounts of foreign-denominated debt could face insolvency -- a difficult dilemma.
Romania and Bulgaria are reacting to the crisis by investing billions in infrastructure, education and environmental protection, and both countries expect a small amount of growth this year. So far other new EU member states have rejected such stimulus programs, although they could hardly come up with the necessary funds even if they wanted to. "Economic stimulus programs increase debt, and their effects fizzle out very quickly," says Vratislav Kulhánek. His comment reflects a widely held attitude in the East. Kulhánek was a senior executive with Czech carmaker Skoda before striking out on his own as a business consultant in Prague. "The government cannot really run the economy. That much we learned in 40 years of communism." He does concede, however, that the Czech Republic benefits from Germany's so-called "scrapping bonus," a new initiative to promote consumption whereby owners of old cars are paid €2,500 to junk their wrecks and buy a new car. Indeed, Skoda, a subsidiary of Volkswagen, sold 9190 units of its Fabia model in Germany in February -- almost three times as many as it did in January. But the Skoda example is an exception. Many new EU states, scenting protectionism, are deeply mistrustful of the Western stimulus programs. In early February, the governments of the Czech Republic and France became embroiled in a battle of words. French President Nicolas Sarkozy has promised government help for his domestic auto industry -- but only if companies agreed to produce all their products at home in the future and no longer outsourced production to the Czech Republic.
Last week, Czech Prime Minister Mirek Topolánek described debt-financed stimulus packages as a "deadly idea." Even a normally mild-mannered man like Polish Prime Minister Donald Tusk takes on a sharper tone when commenting on the German and French crisis policies. "We see the biggest risk in crumbling solidarity in Europe, and in growing national egoism," Tusk told SPIEGEL, noting that he fears the possibility of a "virtual division." For years, the West imposed a strict course of privatization on Eastern European countries aspiring to join the EU. It was the condition for joining the exclusive Brussels club in 2004. This makes it all the more irritating to the East to see the West, once the role model when it came to capitalism, now seeking to combat the crisis with nationalization and government bailouts. Eastern Europe overcame the decades-long, ongoing crisis of communism because "we worked very hard for 20 years," says Tusk. "We are deeply convinced of that." The question is whether this conviction among his fellow Poles can remain truly unshakeable, especially if the zloty continues to fall while the number of bankruptcies and the unemployed rises. The government in Prague, at any rate, despite all professions of faith in the liberal market economy, approved a small rescue package for an ailing domestic industry last week: Workers in the deeply traditional Bohemian glass industry had not received wages in months.
Brazil Shouldn't Count on Washington
If a leader's job during a crisis is to inspire confidence, then last week, on a visit to New York, Brazilian President Lula da Silva was working overtime. Yet sprinkled between the marketing pitch to investors and the requisite socialist pledges to drive toward greater redistribution of income, Mr. da Silva also issued some subtle warnings about how difficult things might become if the U.S. further mishandles its financial leadership role. Speaking to an investor conference sponsored by The Wall Street Journal, Mr. da Silva did his best to accentuate the positive. He noted that Brazil's debt to gross domestic-product (GDP) ratio is now 35% (a level not seen since 1978) and that "capital inflows have been going against the global tide."
More broadly, he talked of how the middle class, the domestic market and exports have all expanded under his guidance. Though the financial crises of the 1990s emanating from Mexico, Asia and Russia were all less severe than this one, Brazil is doing much better this time around, the president said. The lunch crowd at the Plaza Hotel seemed to approve of the message, and perhaps the messenger even more. A former metal worker and union organizer, Mr. da Silva terrified investors with his fiery antimarket rhetoric in Brazil's 2002 presidential campaign. But since taking the helm in January 2003, he's earned a reputation for pragmatism. He has become one of the world's most ardent defenders of global free trade. Once renowned for its periodic hyperinflationary bouts, Brazil now enjoys relative price stability, and Mr. da Silva, who adopted former President Fernando Henrique Cardoso's anti-inflation stance, deserves credit.
Yet stability without growth doesn't get a poor country very far; that's why there's still plenty to fret about. Lula fretted out loud about some of it at a breakfast with Journal editors before the conference. Brazil has become an export powerhouse over the past decade, and the main impediment to growth this year will be the collapse of global trade. This is showing up in falling industrial production, which contracted 12% in December. It was the largest drop in the 17 years that the government has been recording the data. Mr. da Silva says the economy will still grow this year, but a number of independent analysts forecast a contraction. Global deleveraging is the main problem. Battered by the drop in housing prices, the American consumer has withdrawn from frenzied buying and has begun saving. This has reduced demand, and there is not much to do about it from Brazil.
Mr. da Silva would be better off using his bully pulpit to push for a reform of Brazil's cumbersome tax code, which damps job growth, rather than pinning his hopes on U.S. government action to resuscitate the consumer. But it is also true that there has been a contraction in trade financing. This is because, as bad assets have weakened the balance sheets of large global institutions and destroyed their capital bases, bankers have pulled in their horns. Citigroup, for example, was one of the leaders in trade financing in the region, and Brazil may be feeling the pinch from Citi's troubles. Mr. da Silva sees a parallel to Japan in the 1990s, with its zombie banks unable to restore lending. The world, he warned, cannot afford to have the same thing happen in the U.S. because the U.S. plays a crucial role in the global economy.
Translation: Washington has dropped the ball on dealing with the problem in the financial crisis -- bad assets. Will someone please pick it up? He has a point. Treasury has spent hundreds of billions of dollars through its Troubled Asset Relief Program (TARP), but the distressed asset mess is still undermining the lending capacity of financial institutions. What is more, the public now appears fed up with "bailouts" and "earmarks" and doublespeak from Washington. When Treasury finally gets around this week to asking taxpayers to open their wallets to fund the long-awaited "public-private" solution to the toxic asset quandary, Congress may balk. What then? There is no small irony in the fact that the socialist president of Brazil is now smarting from too much government intervention in the U.S.
Had financial institutions been told months ago that rescue is not an option, things would be different. Instead of waiting for the Treasury, they might have begun deconstructing bundled assets to figure out their worth and how to raise new capital. Allowing illiquid assets to be priced using cash-flow analysis for regulatory purposes months ago would have helped too. The government could even have acted as lender of last resort, with stipulations on dividends until the loans were repurchased. None of that happened, and now the Federal Reserve is being instructed to paper over the problems. In the process it risks crashing the dollar. That may boost the prices of Brazil's commodity exports, at least in nominal terms, but it's not a recipe for restoring to health the economy that Mr. da Silva says is so necessary to global growth.
Blue Whales May Get Lifeline From `Fertilizing' Antarctic Ocean With Iron
The blue whale, the largest animal on Earth, may be saved from extinction with help from an ocean- fertilization experiment in the seas off Antarctica that has sparked growth of its main food source. Dumping a by-product of metal processing, iron sulfate, into the ocean stimulates the growth of plankton, which is consumed by krill, said Victor Smetacek of Germany’s Alfred Wegener Institute for Polar and Marine Research. Adult blue whales eat about 4 tons of the shrimp-like animal daily. "Fertilizing the feeding grounds is analogous to creating water holes in the desert," Smetacek, who led a research expedition to the South Atlantic this year to test a theory that fertilizing the ocean can help reduce carbon-dioxide emissions, said yesterday in an interview. "It’s ecosystem restoration."
The blue whale, which averages 25 feet (7.6 meters) at birth, is listed as endangered by the International Union for Conservation of Nature of Switzerland. Japan conducts an annual hunt in the northern Pacific and Southern Ocean using a loophole in a 1986 global whaling moratorium that allows "lethal research" on whales. What Japan’s government refers to as a research hunt began in 1987 and kills minke and fin whales. Japan’s plan to hunt humpback whales was postponed in 2007 after protests from New Zealand and Australia. The program also takes skin and blubber samples of blue and other whales using non-lethal methods. The population of blue whales, which can reach 105 feet in length with tongues weighing as much as an elephant, has declined up to 90 percent the past century, the IUCN said. Blue whales were heavily hunted until a worldwide ban in 1966. "We have a solution to saving the whales -- why wouldn’t we want to use it?" Smetacek said in Berlin.
Conservationists today questioned whether staving off the extinction of blue whales, which can weigh about 200 tons and have an average lifespan in the wild of 80 to 90 years, is simply a matter of dumping iron sulfate in the ocean. Fertilizing the seas with iron may even violate international agreements on marine protection, said Stephan Lutter, a marine policy expert at World Wildlife Fund in Hamburg. Promoting algae growth with fertilization can also result in eutrophication, or a proliferation of plant life that reduces oxygen content in water and eliminates other sea life. "It’s much more essential to solve the significant impacts of humans on the ocean environment, like overfishing and habitat destruction," Lutter said in a telephone interview. In the experiment, Smetacek’s team of 48 scientists from Germany, India and other countries dumped six tons of dissolved iron sulfate in a 300 square-kilometer (116 square-mile) part of the Southern Ocean, spurring rapid growth of the area’s algae.
The test successfully reduced CO2 emissions in specific areas with high amounts of silicic acid, crucial in the construction of algae cells. Using the technique as a large- scale means of reducing emissions of greenhouse gas in the atmosphere "makes no sense" due to high costs, Smetacek said. Researchers around the world are studying ways to counter global warming and climate change, which scientists say is worsened by industrial emissions of carbon dioxide in the air from coal plants and other sources. In December, negotiators from about 190 countries are to meet in Copenhagen for UN climate talks to finalize plans for reducing CO2 emissions from cars, factories and planes. One proposal includes using carbon credits from projects that absorb the gas or generate energy with less pollution.