Group of newsies selling on Capitol steps. Tony Passaro, 8 years old; Dan Mercurio, 9 years old, a chronic truant, said he made 8 cents today; Joseph Tucci, 10 years old; Peter Pepe, 10 years old; John Carlino, 11 years old
Ilargi: Can anyone name one thing that Tim Geithner has done well over the past 65 days? At times I feel like I’m watching a comedy show, except I keep on realizing the joke's incessantly on the huddled masses. But get real, yesterday Geithner proposed giving him hugely increased powers to deal with the crisis, or at least what he thinks the crisis is. When in doubt, be the crisis (?!). That takes me back to the opening line: I can't recall one single thing he's handled well. And it goes back to before the inauguration: Geithner is responsible for the September and Novermber/December AIG bail-outs as well. Didn't exactly hit that one out of the park, now, did he? And then to come back and ask for more powers, you’d have to be either blind or recklessly brave. In my humble view, that is. And yes, all of the above is an option.
This morning, Geithner single handedly drove down the greenback a notch or two -or ten- by answering a question without thinking. Yeah, the sort of thing that makes you wonder how often he does that sort of thing. What Geithner said is that he is quite open to China's proposals about changing terms set for Special Drawing Rights, a form of 'almost-money' at the -emergency- disposal of the IMF. If Geithner had thought through the implications of his words, I'm sure he'd have been more cautious. He later "specified" his words, no doubt after a scrubbing by the likes of Rahm Emanuel. But the damage had been done, even if the dollar has since recovered. The door is open now, and the Chinese have their foot in.
No, the Chinese are not crazy enough to demand an entirely new and different reserve currency for world trade, even if some media present the situation that way. They'll do their thing in incremental steps. And the way Geithner and Bernanke propose to handle the US deficit, the stimulus plans and the toxic asset issues, who can blame them for wanting to lower the importance of the US dollar in the 'weighting basket' for the SDR? Paul Volcker today missed the target by a dangerous mile when he suggested the Chinese were never forced to buy US debt, and therefore should blame themselves. That’s not what they think, Mr. Volcker, and it's not a smart remark. The US is in no position to play financial powergames right now, certainly not those that can easily be avoided.
As for the toxic assets plan, I see a lot of attempts to present it in a positive light, "it might just work", that sort of claim. That is all just nonsense. Look, the plan mainly addresses mortgage loans and securities based on them. And it's not as if that is some stagnant or stable field. We all know that home prices keep on dropping, foreclosures keep increasing, unemployment will rise for a long time, credit card space will be cut by $2 trillion in 2009 (as per Meredith Whitney), and there are many more developments, numbers and trendlines that will make sure that the loans and securities the plan aims to "liberate" will lead to more losses and writedowns and bankruptcies.
The only significant difference the Toxic Geithner Plan will bring about is that these inevitable losses and writedowns will no longer burden those who initiated the wagers; they will be transferred to the taxpayer. Not through fancy schemes of banks buying their own paper at lower prices, there's no need for that sort of thing. A small detour is enough, that's all the PPIP plan asks for. Citi has a large part of its applicable assets, which make up maybe as much as 44% of its total assets, at close to or over 90% of face value. Traders claim the real value is anywhere from 20-40%. Nothing but an unparalleled doling out of public funds can bridge that gap. And that is clear from the start, which means the mechanisms have long since been worked out. There is no need to game the plan, the plan is the game. It was never meant to be fair to Joe Blow, the reason it exists is that Joe has no access to his own tax money, while the bankers do.
To wrap up for now, here's Geithner most bizarre statement to date (more is undoubtedly to come), telling Congress the success of the PPiP plan has nothing to do with ability. All it takes is will. Like abiotic oil, we'll presume. Perhaps Geithner genuinely wants people to believe this grub because he recognizes the limits of his own abilities. How Congress can listen to this without demanding his resignation on the spot would be beyond me if I didn't have the idea that Congressmen too know their abilities. Or why Obama keeps him on for that matter. No wait, I do. It's all about will. Faith. Whatever there is you can believe in.
Rep Gresham Barrett: "The last question I have guys, which is the $64 million question or I guess I should say $64 trillion question is: What's the backup plan? If everything fails what do we do? Where do we go from here?"
Treasury Secretary Geithner: "Congressman this plan will work. This plan because of the authority provided not just by Congress but the treasury and the Fed gives us broad ability to do what you need to do to get through a financial crisis like this. It just requires will; It's not about ability. We just need to keep at it. We just need to work with Congress to make sure we do this on a scale that will make it work."
Well, look at the bright side: at least now we know what drives policy making these days.
Toxic Asset Plan May Involve Purchases From Funds
Treasury Secretary Timothy Geithner’s plan aimed at ridding banks of toxic real-estate assets may involve U.S.-backed purchases from hedge, pension and mutual funds at higher-than-current prices. All financial market participants will be eligible to participate in the Treasury’s new program for older mortgage- securities, an administration official said. Investment funds will be able to buy and sell into the securities program, which was announced yesterday. The Treasury also unveiled a companion program to finance purchases of whole real-estate loans that will only allow banks as sellers. The distinction may be one of several between the plan to offer Treasury and Federal Reserve financing to securities buyers, to boost market liquidity, and the effort to strengthen banks to lend more by allowing them to sell loans at higher prices to public-private funds with Federal Deposit Insurance Corp.-backed financing.
Treasury investments in funds that will buy securities will be restricted to vehicles overseen by only as many as five managers initially, the government said. Those firms each must have at least $10 billion of assets under management; the number and size of managers of the loan-buying funds wasn’t limited. Granting control of the bond-buying to firms with "already oligopolistic-like power" and not limiting sellers to banks raises the risk of abuse, especially in combination, said Graham Fisher & Co.’s Joshua Rosner in an e-mail today. "Will controls exist to prevent these five managers from buying each other’s bad investments, and make ‘confirming value,’ or excessive, bids to bid up the values of exposures on their books with tax dollars?" said Rosner, an analyst in New York at the investment-research firm.
According to guidelines for the securities program, managers of the public-private funds will be directed to only purchase assets from sellers that aren’t affiliates, overseen by other program managers or associated with investors that have put up more than 10 percent of the capital they raise. Isaac Baker, a Treasury spokesman, declined to immediately comment today. The two parts of the U.S. Public-Private Investment Program each involve using a combined $75 billion to $100 billion of Treasury funds from the $700 billion Troubled Asset Relief Program to match equity stakes from private investors in a series of funds that may buy as much as $1 trillion of assets. Both are part of larger efforts by governments worldwide to thaw credit markets to thwart a global recession.
"While I think highly of the ‘Loan Program,’ I believe the ‘Securities Program’ stinks like a ‘pay for play’ program," Rosner wrote in a note to clients yesterday. "Once the market and public figures out the truth of this program, whether tomorrow or in a few years, I expect it will become a rightful focus of public outrage on a scale not yet seen." Geithner wrote yesterday in a Wall Street Journal op-ed column that the public-private funds "will purchase real-estate related loans from banks and securities from the broader markets." One Treasury statement yesterday said the type of securities being targeted are "held by banks as well as insurance companies, pension funds, mutual funds, and funds held in individual retirement accounts."
Another said "eligible assets may be purchased solely from financial institutions from which the Secretary of the Treasury may purchase assets pursuant to" the TARP legislation passed in October, which has been used to inject capital into banks and for loans to automakers. While "the wording" of Geithner’s op-ed piece and other U.S. announcements yesterday are "ambiguous and could be back- tracked to banks" and savings-and-loan companies as sellers only, "it sure looks like he means to ‘unclog’ pension fund, insurance company and even hedge fund portfolios," said Anthony Sanders, an Arizona State University professor in Tempe and former Deutsche Bank AG mortgage-bond research director.
Successful bank rescue still far away
by Maritn Wolf
I am becoming ever more worried. I never expected much from the Europeans or the Japanese. But I did expect the US, under a popular new president, to be more decisive than it has been. Instead, the Congress is indulging in a populist frenzy; and the administration is hoping for the best. If anybody doubts the dangers, they need only read the latest analysis from the International Monetary Fund.* It expects world output to shrink by between 0.5 per cent and 1 per cent this year and the economies of the advanced countries to shrink by between 3 and 3.5 per cent. This is unquestionably the worst global economic crisis since the 1930s.
One must judge plans for stimulating demand and rescuing banking systems against this grim background. Inevitably, the focus is on the US, epicentre of the crisis and the world’s largest economy. But here explosive hostility to the financial sector has emerged. Congress is discussing penal retrospective taxation of bonuses not just for the sinking insurance giant, AIG, but for all recipients of government money under the troubled assets relief programme (Tarp) and Andrew Cuomo, New York State attorney-general, seeks to name recipients of bonuses at assisted companies. This, of course, is an invitation to a lynching. Yet it is clear why this is happening: the crisis has broken the American social contract: people were free to succeed and to fail, unassisted.
Now, in the name of systemic risk, bail-outs have poured staggering sums into the failed institutions that brought the economy down. The congressional response is a disaster. If enacted these ideas would lead to an exodus of qualified employees from US banks, undermine willingness to expand credit, destroy confidence in deals struck with the government and threaten the rule of law. I presume legislators expect the president to save them from their folly. That such ideas can even be entertained is a clear sign of the rage that exists. This is also the background for the "public/private partnership investment programme" announced on Monday by the US Treasury secretary, Tim Geithner. In the Treasury’s words, "using $75bn to $100bn in Tarp capital and capital from private investors, the public/private investment programme will generate $500bn in purchasing power to buy legacy assets – with the potential to expand to $1 trillion over time".
Under the scheme, the government provides virtually all the finance and bears almost all the risk, but it uses the private sector to price the assets. In return, private investors obtain rewards – perhaps generous rewards – based on their performance, via equity participation, alongside the Treasury. I think of this as the "vulture fund relief scheme". But will it work? That depends on what one means by "work". This is not a true market mechanism, because the government is subsidising the risk-bearing. Prices may not prove low enough to entice buyers or high enough to satisfy sellers. Yet the scheme may improve the dire state of banks’ trading books. This cannot be a bad thing, can it? Well, yes, it can, if it gets in the way of more fundamental solutions, because almost nobody – certainly not the Treasury – thinks this scheme will end the chronic under-capitalisation of US finance. Indeed, it might make clearer how much further the assets held on longer-term banking books need to be written down.
Why might this scheme get in the way of the necessary recapitalisation? There are two reasons: first, Congress may decide this scheme makes recapitalisation less important; second and more important, this scheme is likely to make recapitalisation by government even more unpopular. If this scheme works, a number of the fund managers are going to make vast returns. I fear this is going to convince ordinary Americans that their government is a racket run for the benefit of Wall Street. Now imagine what happens if, after "stress tests" of the country’s biggest banks are completed, the government concludes – surprise, surprise! – that it needs to provide more capital. How will it persuade Congress to pay up? The danger is that this scheme will, at best, achieve something not particularly important – making past loans more liquid – at the cost of making harder something that is essential – recapitalising banks.
This matters because the government has ruled out the only way of restructuring the banks’ finances that would not cost any extra government money: debt for equity swaps, or a true bankruptcy. Economists I respect – Willem Buiter, for example – condemn this reluctance out of hand. There is no doubt that the decision to make whole the creditors of all systemically significant financial institutions creates concerns for the future: something will have to be done about the "too important to fail" problem this creates. Against this, the Treasury insists that a wave of bankruptcies now would undermine trust in past government promises and generate huge new uncertainties. Alas, this view is not crazy.
I fear, however, that the alternative – adequate public sector recapitalisation – is also going to prove impossible. Provision of public money to banks is unacceptable to an increasingly enraged public, while government ownership of recapitalised banks is unacceptable to the still influential bankers. This seems to be an impasse. The one way out, on which the success of Monday’s plan might be judged, is if the greater transparency offered by the new funds allowed the big banks to raise enough capital from private markets. If that were achieved on the requisite scale – and we are talking many hundreds of billions of dollars, if not trillions – the new scheme would be a huge success. But I do not believe that pricing legacy assets and loans, even if achieved, is going to be enough to secure this aim. In the context of a global slump, will investors be willing to put up the vast sums required by huge and complex financial institutions, with a proven record of mismanagement? Trust, once destroyed, cannot so swiftly return.
The conclusion, alas, is depressing. Nobody can be confident that the US yet has a workable solution to its banking disaster. On the contrary, with the public enraged, Congress on the war-path, the president timid and a policy that depends on the government’s ability to pour public money into undercapitalised institutions, the US is at an impasse. It is up to Barack Obama to find a way through. When he meets his group of 20 counterparts in London next week, he will be unable to state he has already done so. If this is not frightening, I do not know what is.
The Geithnerconomy and the New Cold War
Let's make a deal. We'll make some bets together, and you get a fifth of the upside—but only a fiftieth of the downside. Seems awfully generous of me, doesn't it? That's the plea the Geithner Plan makes to hedge funds. Unfortunately for the global economy, the dollar, and, well, your future, that's a great bet for funds—but a terrible bet for the rest of us. The probable outcome of the Geithner plan is going to make today's crisis look like a zit on the face of the Elephant Man. Why? Let's get the bean counting out of the way. For staking $30 billion out of $1 trillion, funds take a 17% of the profits. Think about the inequity inherent in that equation for a second. Funds share 17% of the upside—but only share 3% of the downside.
That's the cold hard logic of why the Geithner plan isn't likely to work: because it doesn't fix the yesterday's perverse incentives. Sound familiar? It should: it's the same recipe for moral hazard that created this mess in the first place. What adds insult to irony is Geithner's other inverse magic trick. He simply replaced leverage from banks with leverage from...us. Yet, that's just the tip of the iceberg. The Geithner plan is a weapon of social, political, and economic mass destruction. Here's why. The Geithner plan is a financial coup d'etat. The Geithner plan is the most radical—and radically toxic—cure for a financial disease in recent history. From an organizational point of view, it is nothing short of revolution: a financial coup d'etat. Yesterday, public expenditure and private investment were kept vastly separate—because of their vastly differing goals and incentives. The Geithner plan merges them, creating an entirely new kind of financial economy altogether.
Welcome to Looting 2.0. What does that financial system look like? In it, everything is a hedge fund. The Geithner economy is Milton Friedman's revenge from beyond the grave: it is one that puts the allocation of public resources in a very small number of almost totally hidden private hands. The Geithnerconomy is a kind of financial Frankenstein: run by hedge funds, leveraged by the public, whose interests overlap by only 20%. The problem of toxic incentives hasn't gone away: in fact, the Geithner plan institutionalizes and explodes it, like a biological weapon infecting an entire country. What do these payoffs create the incentive for? For hedge funds to loot the public on a mega-scale. Heads, funds win. Tails, you lose. Wait—hasn't it always been so? Not a chance. Never before in financial history has so much money been in the hands of so few, with so little transparency, and such clearly toxic incentives. Never before in financial history has the richest country in the world actively, irreversibly, and so radically merged public expenditure with private investment.
The financial coup d'etat lays the seeds of a Great Divergence. Last week, I discussed how the AIG bailout was the most pernicious kind of cronyism—not even crony capitalism, but crony socialism. When we zoom out, that's exactly what the curiously lopsided payoffs hedge funds get are. How would you like it if Geithner offered you or your company the opportunity to invest at the same risk/return profile? Of course, you won't get the chance. What was, with the AIG bailout, a mere crack in the economic firmament is now a gaping fissure. The result of the financial coup d'etat is a Great Divergence: we have two economies running in parallel: capitalism for the poor, and socialism for the rich. The former essentially subsidizes the latter endlessly and perpetually. Shades of Karl Marx? Sure. Except this time, it's not a prediction: it's reality.
The Great Divergence is igniting a new Cold War. The Great Divergence is, I think, going to give rise to a new cold war. Yesterday, there was a cold war between capitalism and socialism, conducted across nations: the Soviet Republics + China, and America + the European states stared one another down. The New Cold War will be conducted within nations. Whether you're in China, Russia, America, or Europe, the new cold war will pit citizens of the same countries against one another, sharply reversing what it means to be a citizen, a capitalist, or a CEO. Yesterday, capitalists ruled the world. Today, socialists do: if you're a hedge fund, you should be kissing your copy of Das Kapital. Yesterday, CEOs and the poor couldn't have had more different values and interest. Today, they are both pitted against crony socialists. The New Cold War looks like this. Hedge fund manager vs CEO, plutocrat vs prole, Gatsby vs Galt.
The New Cold War is a battle between economic democracy and economic feudalism. In a democracy, you pay taxes, and elected administrators allocate those financial resources for the common good. In feudalism, taxes are appropriated from you, and allocated by private hands that the public cannot influence, for the private good. In Feudalism 2.0, hedge fund managers are essentially lords to whom people are vassals. You have the right to benefit from your financial assets—but fund managers are who determine their value. In the Geithnerconomy, the salaryman is the new slumdog. What's the biggest difference between economic democracies and feudal systems? Economic democracies grow. Feudal economies eat themselves from the inside. Listen. I know this sounds like science fiction. But so did the idea of a global financial collapse when we started discussing it, quite a few years ago. So consider the logic—instead of reacting to this post from your gut. OK. That was a pretty heavy post—so fire away in the comments and let's discuss. What do you think of the Geithner Plan?
Geithner says "quite open" to China's SDR proposal
Treasury Secretary Timothy Geithner on Wednesday said he is "quite open" to China's suggestion of moving toward a currency system linked to the International Monetary Fund's Strategic Drawing Rights. Zhou Xiaochuan, China's central bank governor, earlier this month said the world should consider the SDR, a basket of dollars, euros, sterling and yen, as a super-sovereign reserve currency. Geithner, responding to a question, said he hadn't read Zhou's proposal but added, "as I understand it, it's a proposal designed to increase the use of the IMF's Special Drawing Rights. I am actually quite open to that suggestion." However, he said it should be viewed as an "evolutionary building on the current architecture rather than moving us to a global monetary union."
Geithner about-turn on dollar status shocks currency markets
Sterling jumped more than a cent against a sharply falling dollar on Wednesday, with the greenback winded after US Treasury Secretary Timothy Geithner said he was "quite open" to China's suggestion of moving toward SDR-linked currency system, Reuters reported. By 1408 GMT, the pound had jumped to a session high of $1.4725. However, the dollar soon pared losses after the Treasury Secretary added that the dollar was likely to remain the world's reserve currency for a long time. "The market is purely reacting to the Geithner comments and it's taken out a whole load of stops [in euro/dollar and cable]," a London-based trader said. "With a comment like that people just cut all their positions."
Initially, investors viewed the comment as an about-turn because on Tuesday Mr Geithner had firmly dismissed suggestions that the global economy move away from using the dollar as the main reserve currency. In a congressional hearing on Capitol Hill, US Republican Michele Bachmann, a Minnesota Republican, asked Mr 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?" Mr Geithner replied, "I would, yes." 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. Mr 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.
Geithner And Volcker Back The Buck
Paul Volcker, the former Federal Reserve chairman, threw cold water Wednesday on a Chinese proposal to downgrade the dollar, the second day in a row he has supported the greenback's primacy. "I understand restiveness about the lopsided nature of the present international monetary system that's so dependent on the dollar," Reuters quoted Volcker as saying at a panel with Prime Minister Gordon Brown of Britain at New York University. But Volcker said when China questioned the dollar's role as the world reserve currency, "They ignore the fact that they didn't have to buy those dollars in the first place, so they contributed to the problem."
Volcker said he thought the issue of the role of the dollar "should receive more attention in the next year or two than it has in the last decade or so." Volcker, and earlier in the day Treasury Secretary Timothy Geithner, are continuing a string of comments by U.S. officials dismissing a proposal by Governor Zhou Xiaochuan of People's Bank of China that the dollar be replaced. Xiaochuan on Monday said he wants to see the elevation of the International Monetary Fund'sspecial drawing right to become the world's de facto reserve currency, effectively replacing the dollar. "As I understand his proposal, it's a proposal designed to increase the use of the IMF's special drawing rights. And we're actually quite open to that suggestion. But you should think of it as rather evolutionary, building on the current architectures, rather than moving us to global monetary union," Geithner said during an interview in New York with the Council on Foreign Relations.
"It is very important just to underscore that the future evolution of the dollar's role in the system depends really primarily on how effective we are in the U.S. in getting not just recovery back on track, our financial system repaired, but we get our fiscal position back to the point where people will judge it as sustainable over time," he said. Volcker first spoke out against the Chinese proposal Tuesday, saying at a Wall Street Journal conference that the Chinese, "are a little disingenuous to say, 'Now isn't it so bad that we hold all these dollars.' They hold all these dollars because they chose to buy the dollars, and they didn't want to sell the dollars because they didn't want to depreciate their currency."
Dollar Declines on Geithner’s Comment on IMF Drawing Rights
The dollar declined against the euro after Treasury Secretary Timothy Geithner said the U.S. is open to enlarging special drawing rights at the International Monetary Fund. The U.S. currency pared losses after Geithner predicted the dollar will remain the world’s effective "reserve currency." The special drawing rights are currency units valued against a composite of currencies. "It’s a basket of currencies, and the dollar has the biggest weight in the basket," said Brian Dolan, chief currency strategist at FOREX.com, a unit of online currency trading firm Gain Capital in Bedminster, New Jersey. "The dollar has the most to lose with the expansion of the basket."
The dollar declined 0.7 percent to $1.3558 per euro at 10:55 a.m. in New York, from $1.3468 yesterday. The U.S. currency dropped 0.2 percent to 97.64 yen from 97.86. The euro increased 0.4 percent to 132.32 yen from 131.81. Geithner commented in response to a question after a speech at a conference in New York today. He was asked to clarify earlier remarks that the U.S. would be "open" to expanding the IMF’s special drawing rights. South Korea’s won was the biggest gainer versus the dollar after a finance ministry official said yesterday the government aims to spend 17.7 trillion won ($13.3 billion) by May or June to help the economy recover.
"There’s some positive sentiment that has led to a softening of the U.S. dollar" against the won, said Thio Chin Loo, a senior currency analyst at BNP Paribas SA in Singapore. The won climbed as much as 2.1 percent to 1,362 per dollar, the strongest level since Jan. 29. South Korea’s economic stimulus plan includes funds for cash handouts, cheap loans, infrastructure and job training, the government said yesterday. South Korea’s currency is the biggest loser against the dollar this quarter, dropping 7.6 percent on speculation the nation’s economic slump will deepen. The dollar declined earlier against the euro as a government report showed an unexpected gain in orders for U.S. durable goods last month, reducing demand for safety.
Orders for U.S. durable goods increased 3.4 percent in February, the biggest gain in more than a year, the Commerce Department reported today. The median forecast of 69 economists surveyed by Bloomberg was for a decrease of 2.5 percent. The 16-nation euro gained earlier versus the dollar as a report showed German business confidence this month was in line with the expectations of economists. The Ifo institute in Munich said its business climate index, based on a survey of 7,000 executives, was 82.1 in March, compared with 82.6 in the previous month. The median forecast of 37 economists surveyed by Bloomberg was for a drop to 82.2. The reading was the worst since November 1982. "Sentiment data is pretty dire around the world at the moment, and the German Ifo is a prime example of that," said Neil Jones, head of European hedge fund sales at Mizuho Corporate Bank Ltd. in London. "However, it more or less matched expectations, and as long as things don’t get worse the euro will benefit." Business confidence in Belgium unexpectedly increased this month, the National Bank of Belgium said yesterday. The index rose to minus 28.6 from minus 31.6 in February.
China's plan to end the dollar era
Zhou Xiaochuan, China's central bank governor, has delivered a powerful message to the world this week. He wants an end to the dollar era. This is not sabre-rattling. He has made serious proposals for a reserve currency to rival the greenback and he deserves a hearing. During the 1997 crisis, Asia's emerging market economies learnt a painful lesson: do not run out of foreign reserves. China, in common with many other Asian emerging market economies, built up towering mounds of foreign assets to give itself a backstop against future emergencies. The People's Republic has, however, over-exposed itself to the US, piling up dollar-denominated securities. In January, its stock of US Treasuries was about $739bn a startling leap from $535bn in June last year.
Yet Washington puts domestic economic needs before its creditors; the Beijing authorities now worry that possible future inflation could cost them dearly. Chinese attempts to diversify into other currencies lost them money and efforts to buy higher-yielding US assets ended badly. It would be in China's interests to have another safe reserve asset but this does not mean that it would be against America's. It would, of course, make it more difficult for the US to finance its deficits. But America should not want the world to be yoked so tightly to its willingness to generate demand. Such imbalances are at the root of this crisis.
As Mr Zhou says, a reserve supercurrency could be created through further issuance of the International Monetary Fund's Special Drawing Rights, the IMF's in-house reserve asset. To enable and encourage take-up, he proposes wider uses for the SDR and giving some surplus countries' reserves to the IMF for it to manage. Married with other necessary reforms, this plan would also empower the IMF to act more flexibly. Good. But China's dollar-heavy reserve accumulation was not just insurance it supported an aggressive, mercantilist trade policy. Beijing kept its currency weak to bolster exports and measured success in terms of how export-dependent it became. Mr Zhou's proposal is useful and constructive but China should still raise domestic consumption. It must not just replace its mountain of dollar assets with heaps of other currencies. China has acted wisely in the recession, expanding demand with government spending. Beijing now wants to play an active role in reshaping the world monetary order. This outward-looking view should be welcomed. But China still has work to do at home.
Fed's Yellen says China's dollar worry "understandable"
China's concern about the dollar's value and U.S. economic policy is "understandable", San Francisco Federal Reserve Bank president Janet Yellen said on Wednesday, adding China's proposal to use the IMF's Special Drawing Right more widely is "far from practical". "It's quite understandable that country would be concerned" about the dollar due to the lack of diversification of its holdings, Yellen said in response to questions after a speech at the Forecaster's Club of New York.
China's central bank governor said earlier this month the world should consider the International Monetary Fund's SDR -- a basket of dollars, euros, sterling and yen -- as a super-sovereign reserve currency. Yellen said the proposal was "interesting," but that the idea was "far from being a practical alternative" at this point. Answering a separate question, Yellen said she was "stunned by the magnitude of the collapse in global trade." She said the global nature of the economic downturn meant a rebound would be much harder as recoveries from past crises, such as the Asian crisis, were often driven by a pick-up in trade.
"The fact this is a global downturn is very very challenging. I don't think we've ever seen it before," Yellen said. She said the Fed has sufficient tools to withdraw liquidity from the system, such as paying interest on reserves, once the economy recovers, but said she would be happier if Congress gave the Fed the authority to issue its own debt. Yellen is a voting member of the Fed's policy-setting committee this year. Asked about the outlook for banks, she said they continue to face a challenging environment. "If the downturn remains severe there will be other categories of loans where we see delinquencies," she said. "We can't say all the losses are behind us."
Yuan Forwards Show China May Buy Fewer Treasuries
Recent gains in yuan forwards show traders are betting China will scale back U.S. Treasury purchases after calling for a new international reserve currency, according to UBS AG. Twelve-month offshore yuan forwards rallied for a ninth day yesterday, signaling appreciation for the first time in six months, on speculation a $1 trillion U.S. plan to rescue banks will weaken the dollar. People’s Bank of China Governor Zhou Xiaochuan this week urged the International Monetary Fund to create a "super-sovereign reserve currency" after Premier Wen Jiabao said earlier this month that he was "worried" about the safety of U.S. debt.
"The market has correctly interpreted Zhou’s comments as a reflection that China desires to buy less Treasuries, and whether China likes it or not, the only way to do that is to intervene less in the foreign-exchange markets," Ashley Davies, a Singapore-based strategist at the world’s second-biggest currency trader, wrote in a research note today. "The market is now pricing in some yuan appreciation over the next 12 months." Yuan forwards due in 12 months climbed 0.8 percent yesterday, the most in three months, according to data compiled by Bloomberg. The contract traded today at 6.8025 to the dollar, indicating gains of 0.4 percent from the spot rate. In the spot market, the yuan traded at 6.8319 as of 12:03 p.m. in Shanghai, according to the China Foreign Exchange Trading System. The comments by Wen and Zhou have sparked concerns China will avoid buying Treasuries, hurting President Barack Obama’s efforts to raise funds for his $787 billion fiscal stimulus package.
China’s State Administration of Foreign Exchange tempered such concerns on March 23, saying that the nation will keep buying Treasuries and endorsed the dollar’s global role. The Dollar Index, which the ICE uses to track the greenback against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, tumbled last week by the most since 1985. U.S. government debt has handed investors a loss of 1.7 percent this year, according to indexes compiled by Merrill Lynch & Co. China, the biggest foreign buyer of U.S. debt, increased its Treasury holdings by 46 percent in 2008 and has about $740 billion of the securities, according to Treasury Department data. Forwards are agreements in which assets are bought and sold at current prices for delivery at a later specified time and date. Non-deliverable contracts are settled in dollars.
European Union President: US economic plans "The Way to Hell'
A top European Union politician on Wednesday slammed U.S. plans to spend its way out of recession as "a way to hell." Czech Prime Minister Mirek Topolanek, whose country currently holds the EU presidency, told the European Parliament that President Barack Obama's massive stimulus package and banking bailout "will undermine the stability of the global financial market." A day after his government collapsed because of a parliamentary vote of no-confidence, Topolanek took the EU presidency on a collision course with Washington over how to deal with the global economic recession. Most European leaders favor tighter financial regulation, while the U.S. has been pushing for larger economic stimulus plans.
Topolanek's comments are the strongest criticism so far from a European leader as the 27-nation bloc bristles from recent U.S. criticism that it is not spending enough to stimulate demand. They also pave the way for a stormy summit next week in London between leaders of the Group of 20 industrialized countries. The host of the summit, British Prime Minister Gordon Brown, praised Obama on Tuesday for his willingness to work with Europe on reforming the global economy in the run-up to the G-20 summit. The United States plans to spend heavily to try and lift its economy out of recession with a $787 billion economic stimulus plan of tax rebates, health and welfare benefits, as well as extra energy and infrastructure spending. To encourage banks to lend again, the government will also pump $1 trillion into the financial system by buying up treasury bonds and mortgage securities in an effort to clear some of the "toxic assets" -- devalued and untradeable assets -- from banks' balance sheets.
Topolanek bluntly said that "the United States did not take the right path.". He slammed the U.S.' widening budget deficit and protectionist trade measures -- such as the "Buy America" -- and said that "all of these steps, these combinations and permanency is the way to hell. We need to read the history books and the lessons of history and the biggest success of the (EU) is the refusal to go this way," he said. "Americans will need liquidity to finance all their measures and they will balance this with the sale of their bonds but this will undermine the stability of the global financial market," said Topolanek. Obama insisted Tuesday that his massive budget proposal is moving the nation down the right path and will help the ailing economy grow again. "This budget is inseparable from this recovery," he said, "because it is what lays the foundation for a secure and lasting prosperity." Obama also claimed early progress in his aggressive campaign to lead the United States out of its worst economic crisis in 70 years and declared that despite obstacles ahead, the U.S. is "moving in the right direction."
Japanese Exports Plunge 49% as Global Slump Deepens
Japan’s exports plunged by a record in February as deepening recessions in the U.S. and Europe sapped demand for the country’s cars and electronics. Overseas shipments fell 49.4 percent from a year earlier, the sharpest decline since at least 1980, when the government started to keep comparable data, the Finance Ministry said today in Tokyo. Economists predicted a 47.6 percent drop. Prime Minister Taro Aso is compiling his third economic stimulus package as a deepening slowdown in Japan’s overseas markets puts thousands out of work at home, threatening domestic demand. Finance Minister Kaoru Yosano said this week said that a new package of as much as 20 trillion yen ($203 billion) is "not out of line" as the economy heads for its worst recession since 1945.
"There’s been a structural shock to the manufacturing sector," said Hiroshi Shiraishi, an economist at BNP Paribas in Tokyo. "So yes, the government can create demand temporarily, but that can’t fill the export gap forever." The yen traded at 98.23 per dollar at 8:56 a.m. in Tokyo from 98.25 before the report. The currency has weakened 7.8 percent this year, offering some relief to exporters whose profits were eroded by its 23 percent gain in 2008. Exports of automobiles tumbled 70.9 percent from a year earlier and shipments of semiconductor parts and devices slid 51.1 percent, the ministry said.
Demand fell across all regions. Exports to the U.S., Japan’s biggest market, slid 58.4 percent and shipments to Europe dropped 54.7 percent. Exports to Asia declined 46.3 percent and goods sent to China slumped 39.7 percent. Imports fell 43 percent, helping Japan record its first trade surplus in five months. The 82.4 billion yen surplus was still 91.2 percent lower than the same month a year earlier. Japan’s gross domestic product shrank an annualized 12.1 percent last quarter, the biggest contraction among the advanced economies and the country’s sharpest decline since the 1974 oil crisis. Toyota Motor Corp., forecasting its first net loss in 59 years, yesterday said overseas shipments plunged 69 percent in February from a year earlier.
Sentiment among Japan’s largest manufacturers probably fell to a 33-year low this month, economists predict the Bank of Japan’s Tankan survey will show next week. Yosano indicated on March 22 that the new stimulus package would probably exceed the 10 trillion yen Aso has pledged since October. The spending would add to public debt already estimated at 170 percent of gross domestic product. Japan has become more reliant on exports in the past decade, making it especially vulnerable to changes in global commerce, which the World Trade Organization forecasts will shrink 9 percent this year, the most since World War II. During Japan’s expansion of 2002 to 2007, exports as a portion of GDP rose to 15.6 from 10.4 percent.
Komatsu Ltd., Japan’s biggest maker of construction machinery, expects sales of its excavators and other bulldozers to fall 20 percent in the year starting April 1. Still, there are signs that China, Japan’s second-largest overseas market, is stabilizing. The World Bank said last week that government spending on roads, power grids and housing is "working" to take up the slack left by plunging exports. "For some sectors like the chemical and raw-material industries, they’re seeing some rebound in demand coming from China," said BNP’s Shiraishi. "Basically, demand for key industries -- transportation machinery, electronics, general machinery -- those aren’t recovering."
Treasurys under pressure before record 5-year-note auction
Treasury prices declined Wednesday before the government sale of a record amount of five-year notes, the second of the week's big note auctions. Notes stayed lower after the Federal Reserve bought $7.5 billion in U.S. securities, the first operation since announcing last week it intended to buy up to $300 billion. Yields on 10-year notes, which move inversely to prices, inched up 2 basis points to 2.72%. A basis point is 0.01 percentage point. Two-year-note yields were little changed at 0.94%. The Treasury Department will accept bids on the $34 billion in five-year notes until 1 p.m. Eastern time.
The government received good demand for $40 billion in two-year securities on Tuesday, receiving the most bids for every dollar available since October 2007. On Thursday, it will auction $24 billion in seven-year notes, only the second sale of the maturity in more than a decade. Both the five- and seven-year note amounts are $2 billion more than at the last sale. The New York branch of the Fed, in charge of its market operations, bought $7.5 billion in debt maturing between 2016 and 2019 on Wednesday. About half of the debt purchased matured in 2016, with the remainder maturing in 2017-2019. Dealers submitted $21.9 billion in debt to be purchased. Traders said they expected the Fed to buy less, or about $4 billion.
Its next batch of purchases, of debt maturing in two to three years, will take place on Friday. Other maturities are slated to be bought next week. Also weighing on the U.S. market, Britain's bond sale Wednesday failed to attract enough buyers for the full amount of 40-year gilts offered, the first time that's happened at a regular bond auction since 1995. That surprised many investors, given how well gilts have performed since the Bank of England said it would buy U.K. debt to help buoy its economy, about a week before the Fed announced similar plans. "Participants are rethinking the idea that government buying of debt is a panacea of all ills," said Andrew Brenner, co-head of structured products and emerging markets at MF Global.
On the U.S. economic data front, orders for durable goods unexpectedly rose 3.4% in February, a government report showed. Economists surveyed by MarketWatch expected orders to decline 1.2%. A separate report showed sales of new homes nationwide rebounded by 4.7% in February after hitting a record low in the prior month. Sales of new homes rose to a seasonally adjusted annual rate of 337,000 last month, higher than the 323,000 that economists surveyed by MarketWatch had expected. Thursday's releases will include weekly data on jobless claims and revisions to fourth-quarter growth numbers, which is expected to be the worst in many years, noted Kevin Giddis, managing director of fixed income for Morgan Keegan & Co.
U.K. Bond Auction Fails for First Time in Seven Years on Brown Plans
The U.K. failed to find enough buyers for 1.75 billion pounds ($2.55 billion) of bonds for the first time in almost seven years as debt investors repudiated Prime Minister Gordon Brown’s plan to stem the worst economic crisis in three decades. Gilts slumped after the London-based Debt Management Office, which manages bond auctions on behalf of the Treasury, said investors bid for 1.63 billion pounds of the 40-year securities. The last time the U.K. government was unable to attract enough investors was in 2002 when it tried to sell 30- year inflation-protected bonds. Brown’s government plans to sell a record 146.4 billion pounds of debt this fiscal year and as much as 147.9 billion pounds in 2010 as he tries to pull Europe’s second-largest economy out of its worst recession since 1980.
Brown’s plan drew criticism yesterday when Bank of England Governor Mervyn King told lawmakers in Parliament in London the government should be "cautious" about spending and deficits. "This is a warning signal investors are sending to the government," said Neil Mackinnon, chief economist at hedge fund ECU Group Plc in London, who helps manage about $1 billion in assets and is a former U.K. Treasury official. "Investors are giving the thumbs down to the gilt market." The yield on the 10-year gilt rose four basis points to 3.37 percent by 1:26 p.m. in London. The 4.5 percent security due March 2019 slipped 0.36, or 3.6 pounds per 1,000-pound face amount, to 109.47. The yield on the two-year note rose two basis points to 1.28 percent. Yields move inversely to bond prices. The pound weakened to $1.4588, from $1.4681 yesterday, and to 92.33 pence per euro, from 91.72 pence.
Chancellor of the Exchequer Alistair Darling ordered 20 billion pounds ($29 billion) in tax cuts and spending increases in November and forecast a deficit of 8 percent of gross domestic product. Britain will have a deficit of 11 percent of GDP in 2010, the highest in the Group of 20, according to the International Monetary Fund. The U.K. economy shrank 1.5 percent in the fourth quarter, the most since 1980, and King yesterday predicted a similar drop for the first three months of this year. "This sinks Brown below the waterline," said Bill Jones, professor of politics at Liverpool Hope University.
"His whole strategy is based on borrowing and now he can’t get anyone to buy his gilts. This means the prospect of going cap in hand to the IMF hovers increasingly into view." Brown’s Labour Party has the support of 30 percent of voters, compared with 46 percent for the opposition Conservative Party, according to a ComRes opinion poll published in the Independent on Sunday on March 22. The company surveyed 1,002 people by telephone between March 18 and March 19. The DMO said as recently as December the government’s plan to increase spending raised the risk of a failed auction. "We are in a very different world than we were six months or a year ago," Robert Stheeman, chief executive officer for the agency, said in an interview.
The U.K. had two failed auctions in the past 10 years, the most recent in September 2002 when the Treasury received bids for 95 percent of the 900 million pounds of the 30-year inflation-protected bonds offered, according to the DMO’s Web site. The other failure was in 1999, when it tried to sell 500 million pounds of inflation-protected bonds. "The risk of uncovered auctions is a normal part of the process," said Sarah Ellis, a spokeswoman for the DMO in London. "Today’s auction was at the riskiest part of the curve. An additional factor which may have deterred some bidders is the imminent end of the financial year."
Failed gilt auction stokes fears over UK economy
The Government has suffered a major blow to its economic stimulus ambitions after an auction of Treasury gilts failed for the first time in more than a decade, underlining the market’s fears about the state of the nation’s finances. The UK Debt Management Office (DMO) attracted just £1.67bn in bids for its sale of £1.75bn of 2049 gilts this morning, its first uncovered auction of conventional gilts since 1995. The cover of just 0.93 times is believed to be the lowest in history and far worse than the 0.99 times in 1995. The average cover of the last three auctions was 2.1 times. Failure raises fears that the Government may not be able to secure the billions of pounds its needs from the markets to fund its record fiscal deficit without paying far more for the money, and reflects concerns about UK economic stability. It comes at a highly embarrassing time for Gordon Brown, who is hosting a summit of G20 leaders next week to spearhead recovery plans for the global economy. His call for further economic stimulus packages was also called into question yesterday by Mervyn King, Governor of the Bank of England, who warned that the UK finances were so stretched the Government would be unable to launch new spending plans.
Moreover, politicians have raised concerns that an uncovered gilt auction could lead to a cut in the sovereign credit rating, which could have devastating consequences for the national debt – due to hit a record £1 trillion - as the interest bill would soar. At a recent Treasury Select Committee hearing, Michael Fallon, the committee’s deputy chairman and a Tory MP, was told by the credit rating agencies that a series of uncovered gilt auctions could be one the triggers that might lead to a change in the credit rating of a sovereign country like the UK. Analysts said the market had been knocked by Mr King’s comments on Tuesday that the central bank may not need to buy as many gilts as planned if its £75bn quantitative easing programme enjoys early success. "There has been a lot of uncertainty created over the last couple of days by the King comments," said Sean Maloney at Nomura. David Buik of BGC Partners added: "Suggestions that there were balance sheet constraints, [the] bond wasn’t cheap enough, [the] shock rise in inflation and Mervyn King’s comments yesterday didn’t help."
Investors are thought to be concerned that, should the Bank not do as much quantitative easing as planned, they could be left holding more gilts than hoped as they would not be able to offload them on the central bank. The markets are already under pressure to increase their exposure to gilts as the Government is issuing far more than usual. The DMO is expected to issue £146.6bn of gilts this year compared with £58.4m last year, and another £110bn in 2010. The shortage of demand caused gilt futures to slump as to a session low of 119.45 while 10-year yields rocketed 18 basis points to 3.5pc, illustrating that it will cost the Government more to raise the debt required. The DMO said the approach of the financial year-end may have hampered demand. "We’re aware that this is the riskiest part of the curve," said a spokesman. "An additional factor that may have deterred some bidders is the imminent financial year end." The last official failed auction was in 2002 but, unlike today, it was for an index-linked gilt.
Gordon Brown Warns on Deflation Threat
The U.K. government will do whatever is necessary to revive growth, with global deflation the main danger in the short term, Prime Minister Gordon Brown said Wednesday. "I think in the short term everybody is concerned about the problems that could come from deflation," Mr. Brown said in an interview with The Wall Street Journal in New York. The premier said his government is doing "what is necessary to resume growth in the economy," through fiscal and monetary policy and fixing the banking system The prime minister said he believes governments of the Group of 20 industrialized and developing nations will sign on to taking similar action at the upcoming G20 leaders' summit in London April 2.
"Nobody is suggesting that we will come to the G20 meeting and put on the table" national budget plans, he said. "What we are suggesting is that we have, together, to look at what we have done so far cumulatively ... what's the effect of quantitative easing and then say what should happen next. And I see a consensus not a disagreement on that." On Tuesday, Mr. Brown's government received a warning from Bank of England Governor Mervyn King that there seems to be little room for the government to launch further fiscal stimulus efforts on top of the £20 billion effort already undertaken. However, Mr. Brown brushed off differences with Mr. King on the issue in the interview Wednesday, saying the governor has signed on to the G20 finance ministers' communique calling for policy makers to take whatever monetary and fiscal policy action is needed to revive growth.
Mr. Brown said that, on monetary policy, many central banks have already moved to very low interest rates and quantitative easing. He also said that, while European Central Bank interest rates are "a lot higher" than in the U.K. and the U.S., his "expectation is that they will bring them down further." The Bank of England's benchmark interest rate stands at 0.5%, while the ECB's refinancing rate is 1.5% and the U.S. Federal Reserve's target funds rate stands close to zero. On trade, Mr. Brown said the Doha round of talks isn't dead, despite the many deadlines that have come and gone. He said the biggest stumbling block to an advance -- differences between India and the U.S. -- is "solvable" and that "people around the world are agreed" on the need for a new trade deal.
Mr. Brown also reiterated his view that protectionism "is the road to ruin," stressing the risks protectionism and a lack of cooperation among countries pose to the world economy. He pledged that preventing such moves would be at the top of the agenda at next week's summit of the Group of 20 nations in London. He pointed to the absence of trade credit as one of the "big problems" for trade. Mr. Brown has been trying to persuade leaders of the G-20 to back calls by U.S. President Barack Obama for significant new government spending measures to try to jump-start the struggling world economy, moves resisted in some parts of Europe. The U.K. prime minister said that, while the short-term economic focus will be on deflation, longer-term inflationary threats like higher oil prices, once global growth resumes, will need to be dealt with.
"That is a problem we're going to have to look at again ... We really have to be better at looking at how we can make agreements that can deal with the most volatile of commodities that affect the most vulnerable of people," he said. Mr. Brown said he wants to secure new funding for the International Monetary Fund to help smaller countries avoid financial and economic problems before the G20 meeting. While attention has focused on larger developed countries for much of the financial crisis, there are a number of smaller countries which are facing daunting problems in their banking systems or economies. Mr. Brown said such funding could be provided from a host of sources including governments and sovereign wealth funds, and the programs shouldn't carry the stringent conditions the IMF normally imposes.
The IMF has already provided support to a number of countries including Pakistan, Hungary and Ukraine. On Tuesday it unveiled a new program, the Flexible Credit Line, to help reduce difficulties many countries are facing. Mr. Brown said he doesn't expect the G20 to discuss the issue of a supra-national global reserve currency, which has been raised recently by Russia and China. The prime minister is keen to secure agreement on an overarching set of global principles on everything from banking regulation to remuneration, which he said would provide a framework for individual countries to tailor their own local solutions to the crisis. Mr. Brown, who's been facing criticism at home for his role in the crisis and its build up, said policymakers around the world face a challenge persuading their constituents that these are global, not local, problems.
The sense of pessimism which is prevalent in many countries must be challenged, he said. If the current problems are addressed correctly it will herald a new era of prosperity as producer countries, particularly in Asia, start to become consumers. The prime minister also suggested that governments should set up bilateral agreements to deal with cross-border banking issues that have arisen as a result of the global span of many large banks. The U.K. government is talking to its German counterpart about the problems generated by the Royal Bank of Scotland, which has had to receive significant U.K. financial support. The interview came on the second leg of a global tour by the prime minister, who took office in 2007, ahead of the April London summit. Mr. Brown's Labour party must face an election by mid-2010 and is behind in the polls, raising the stakes for a successful outcome to the April 2 summit. Mr. Brown, who spoke at the European Parliament Tuesday, travels to Brazil and Chile later this week.
Fed's Yellen: Fed Can Sell Treasurys When Needed In Future
Federal Reserve Bank of San Francisco President Janet Yellen said Wednesday the government bonds the Fed is buying now to stimulate the economy can easily be unloaded in a time of economic recovery. "We certainly can sell the Treasurys" and "outright sales are possible" once better times arrive and the Fed no longer sees the need to buy government debt as a stimulative activity, Yellen said. The voting member was speaking to reporters after a speech given before a group of economists in New York. Last week the Fed shocked markets when it concluded a monetary policy gathering with an announcement it would sharply increase interventions into financial markets. Most notable was the Fed's plan to buy $300 billion in government bonds over the next six months.
The Fed's balance sheet has grown markedly as it has moved to restart the financial system and aid the broader economy. Some fear growth will fuel an eventual inflation surge. Fed officials have long been able to point to the self-regulating nature of many of their current programs to assuage inflation fears. But the move to buy Treasury, agency and mortgage debt points to a more enduring expansion of the Fed's balance sheet. Yellen downplayed anxiety by saying the central bank could sell the Treasurys it's now buying at some point. She added that among other strategies, if the Fed were to gain the power to issue its own debt, that would also help manage a balance sheet contraction.
Toxic-Asset Plan: Tricky Times Ahead
Treasury Secretary Timothy Geithner's long-awaited public-private investment program, announced on Mar. 23, has fueled hopes that it will solve one of the most nettlesome problems of the financial crisis: reasonably pricing illiquid assets and getting them off banks' balance sheets once and for all. But the plan may not be the slam-dunk hoped for by the market. The only clear beneficiaries at this point appear to be the handful of asset managers to be picked by the government to oversee the sale of the toxic "legacy" securities that have dogged U.S. banks since the start of the housing downturn. Indeed, though the plan was received rapturously by Wall Street on Mar. 23, with major stock indexes shooting higher by nearly 7%, some critics are saying they don't see the PPIP as a silver bullet that will get credit flowing again soon. If anything, the events on Capitol Hill of the past couple weeks—including the AIG bonus controversy—may make it that much more difficult for potential investors to get on board.
An earlier plan for the Bush Administration to use Troubled Asset Relief Program (TARP) money to directly buy illiquid assets off the banks' balance sheets ran aground amid worries that taxpayers would end up overpaying for the assets. That's still a possibility some warn, since the government is taking on the lion's share of the downside risk by being willing to put up half the equity investment and up to six times leverage to buy legacy loans. The Treasury is willing to put up $75 billion to $100 billion of the remaining TARP funds to help pay for these assets. The benefit of the program is that to the extent private money is profitable, Uncle Sam's money will be profitable and it's a way to recoup part of the money the government is providing, says Dan Alpert, managing director of Westwood Capital, an investment bank in New York.
There are certain to be some banks that would end up being undercapitalized if they sold their assets at a true markdown, and it's to be expected that they will try to resist that as much as possible, he says. "It's going to take as much pressure by regulators to say 'We'll either seize you or recapitalize you if you're a bank that's too big to fail,'" he says. The legacy loan program will probably need some inducement from regulators such as the Federal Deposit Insurance Corp. (FDIC) since banks won't readily allow loans to come to market that have the potential to put the bank's balance sheet underwater, he adds. And even using a government-assisted market mechanism to set prices, there's still a real risk of overpricing simply because investors are likely to be willing to pay more for assets with all the government leverage available than they would in a normal market environment, says Alpert.
"The check on this whole structure is that private capital and public capital are pari passu—side by side," with neither side getting preferential treatment, he says. If the leverage encourages people to overbid, that tendency is likely to be tempered by investors' realization that they'd be putting their private equity at risk. The foremost obstacle in people's minds is the political risk of taking money in any form from the government. As the parade of Congressional hearings in which CEOs of big-name TARP recipients hauled up for interrogation attests, would-be investors know what they can expect if the public-private investment program doesn't deliver on the promise of cleansing banks' balance sheets, or worse, delivers too much profit for big investors. The rush by Congress to tax 90% of bonuses doled out to certain AIG execs has investors running scared.
"We saw what happened with executive comp rules [in the AIG controversy]. As a manager, how do I account for that risk?" asks Harold Reichwald, a partner at Manatt, Phelps & Phillips in Los Angeles and co-head of the law firm's banking and specialty finance practice group. David Rubenstein, co-founder and managing director of the Carlyle Group, said at a financial industry conference that Carlyle needed an internal rate of return of 20% to make up for the uncertainty around whether Congress might try to take back some profits later on, according to a blog post by Robert Wenzel, editor and publisher of EconomicPolicyJournal.com.
The mistrust among some investors toward the so-called gatekeepers—the handful of firms that are seen as most likely to be selected by the Treasury to raise money for and serve as asset managers for the investment funds to be created under the public-private partnership—runs deep. Some hedge fund managers cite the failure of large investment firms that acted as servicers of securitized mortgages to speak up against provisions in President Obama's Home Affordability and Stabilization Plan that indemnify servicers from claims by impaired investors. They say they expect the asset managers the Treasury chooses to be similarly incentivized to go along with any rule changes the government may impose down the road.
The more substantial issue, however, is how clear investors will be about the assets on which they are bidding. To date, financial institutions haven't provided much transparency about the quality of the loans in the assets they are holding. Even if investors are granted the opportunity to closely evaluate these securities, it's not easy to understand most of them. The multiple layers of collateralized debt obligations, residential mortgage-backed securities, and other exotic instruments make it hard for even seasoned financial pros to get a clear read on the quality of the securitized assets that may be found on a bank's balance sheet. One other potential sticking point: There's no certainty that banks will participate in the program. The ones that do could choose to play it in a couple of different ways. One is to bet the market will improve a few months out, in which case they're likely to put up lesser-quality assets for sale now and save the better assets for later, according to Mike Carlson, a partner in the finance and restructuring group at Faegre & Benson, a law firm in Minneapolis.
The other way is to put a floor on the price they can afford to accept for assets and if they don't get the bid, they won't sell, he adds. The FDIC has a critical role to play in helping to establish a market value for the legacy loan assets that have not been securitized, says Reichwald, The more engaged the FDIC is in working with banks to price their assets as realistically as possible, the better position it will be in to persuade investors to accept those prices and not try to lowball them, he says. Although banks won't be forced to participate, the FDIC's examination process of their fiscal soundness is very dynamic, he says. "The FDIC has a lot of opportunity during that process to whisper in the ear of that [bank] manager," he says. "If you're a smart manager, you understand what's at stake and you understand that the FDIC wields a lot of power and you understand that when they make recommendation, there's something behind it and you can't just dismiss it."
Still, banks that have not marked their assets down to conservative enough levels, and whose solvency is riding on a balance sheet capitalized based on the higher asset values, aren't likely to sell many of those assets into the program, says a hedge fund manager who spoke to BusinessWeek on condition of anonymity. He sees the public-private partnership program as positive but only on the margin, in terms of the impact it could have on closing the gap between market clearing prices and the values at which illiquid assets are marked on banks' balance sheets for legacy assets already trading in the secondary market. Ultimately, the goal of the program is to clear banks' balance sheets so they can afford to start lending again. If that objective isn't met, then the PPIP may turn out to be yet another disappointment in the government's efforts to get a handle on the financial crisis.
Geithner's plan isn't money in the bank
Monday's proposal by Treasury Secretary Timothy F. Geithner is the government's latest shot -- and perhaps its last clean shot -- at extricating up to a trillion dollars' worth of toxic assets from the financial system and making an economic recovery possible. But will it work? We believe the best mechanism for solving the banking-sector crisis is government-supervised bankruptcy, also known as receivership. However, the Obama administration has made it abundantly clear that it will not consider this option, except perhaps as a last resort.
Without receivership, financial institutions can't be forced to sell toxic assets unless they choose to, nor can they be forced to lower prices that are unreasonably high. The problem in the market today is that the prices demanded by the banks are much higher than the prices that private buyers (hedge funds, private equity firms, sovereign wealth funds) are willing to pay. The government has no way to bring down the banks' minimum sale prices, especially without the threat of receivership. So the only option is to induce buyers to pay more than they think the assets are worth in today's generally risky climate, and the only way to do this is through subsidies. The Geithner plan offers private investors incentives to participate. Those who put up funds will be eligible for government-guaranteed loans to purchase larger shares of the toxic assets. Because these loans do not have to be paid back, investors cannot lose more than the money they invested, even if the value of the assets plummets. At the same time, there is no limit on the amount they can make if things turn out well.
There are three reasons for concern. First, the subsidy may not be sweet enough to close the deal. According to one analysis, a specific mortgage-backed security was held on a bank's books at 97 cents, while its market price was about 38 cents. Even if you limit the buyer's potential loss to the capital he put in, it's unlikely he will raise his bid from 38 cents to anything near 97 cents. Second, there is a "lemons" problem, also known as adverse selection. Even with a reasonable degree of disclosure, the selling banks will still know more about their assets than the buyers. The banks will be trying to dump their most toxic assets (their lemons); the buyers, fearing exactly this behavior, will reduce all their bids accordingly. This will make it harder for buyers and sellers to meet.
Third, there are political pressures, which have multiplied recently. For this plan to succeed, it has to offer private investors both upfront subsidies (cheap loans) and the long-term prospect of high returns. Both of these will be broadly unpopular with the public, especially given general attitudes toward hedge funds and private equity firms. Any attempt to limit the upside for the private sector has, apparently, been vetoed by potential investors. And that will make it look and feel like a taxpayer shakedown. Public outcry against the American International Group bonuses (and the funneling of bailout money to AIG's counter-parties) was justly deserved. But it has changed the political landscape. The administration had already tied one of its hands by ruling out bankruptcy, even as a potential threat. Its other hand has since been tied by the blunders over AIG, which have ruled out in advance any plan that is too obviously a subsidy to banks or to private investors and have reduced the chances of getting new money from Congress.
Those two constraints dictated the anemic plan Geithner proposed: enough of a subsidy to raise public suspicion but not enough to guarantee that private investors will buy in or that the market for toxic assets will function smoothly. And while we're waiting to see whether banks actually get rid of their toxic assets, the economy will continue to deteriorate. The plan could work -- but only if the banks agree to sell at reasonable prices. If it doesn't work, we'll need to come up with another approach, either one that is even friendlier to banks or one that confronts them head-on. Banks in this country have become too big economically and too powerful politically. Going forward, we have to fix this. We simply cannot afford to have another problem of this magnitude.
Fed officials say policies must tackle growth, prices
U.S. Federal Reserve policy-makers fanned out across Europe on Tuesday to express confidence that current policies can restore economic growth over time. However, James Bullard, president of the St Louis Fed, warned that a deflationary trap is "a real possibility" this year for the struggling U.S. economy. Meanwhile, at a hearing on Capitol Hill, Fed Chairman Ben Bernanke said September's rescue of insurance giant American International Group helped avoid the risk of an epic financial market collapse. Investors' willingness to participate in many of the Fed's innovative programs, including the recently launched Term Asset-Backed Securities Lending Facility, is a good sign for the economy, said Charles Evans, the Chicago Fed president.
"The Federal Open Market Committee's policy decisions have been calibrated to deal with the 'adverse feedback loop' between disruptions to financial market stability and the real economy," Evans said at a conference in Prague. "They will also have a stabilizing effect on markets around the world and will therefore eventually stimulate worldwide economic recovery." Evans said TALF had already helped out the ABS market, while Bullard noted that the Fed's recent moves to buy mortgage-based securities have had an impact as well. The Fed and other central banks have considerable scope to ease the global downturn despite extremely low interest rates, Bullard said in a speech to the Cass Business School.
Allowing the Fed's balance sheet to expand further with rates at near zero, through measures often labeled "quantitative easing," can avoid a damaging rise in "real," or inflation adjusted, interest rates, he added. Evans is a voting member of the FOMC in 2009. Bullard does not have a vote this year. Evans said inflation expectations are "well maintained" despite the mammoth amounts of funding pumped into U.S. credit markets by the central bank since the worst financial crisis in 70 years erupted in 2007. "The weak outlook for growth and the prospects for unusually low inflation call for more policy accommodation," Evans said. "There are disinflationary forces at work."
Kansas City Fed President Thomas Hoenig, in an interview with Dow Jones Newswires, played down the risk of deflation. "The odds of deflation are fairly remote, I've always thought that," he said. But Bullard, who termed deflation "a real possibility" for the United States, advocated specific inflation targets for the Fed to help control the risks of both a Japan-style deflation in the short term and of high inflation further down the track. "A credible plan would also name an explicit inflation objective to help control the very diffuse expectations of medium-term inflation," he said. The FOMC moved further along the path to explicit inflation targets by issuing new "long-run" outlooks along with the minutes of its January 27-28 policy meeting.
Despite optimism about the steps the Fed has taken, Evans said the U.S. jobless rate, which hit a 25-year high of 8.1 percent in February, could peak above 8.5 to 9.0 percent. The U.S. economy will return to growth by year-end after another severe contraction in the first quarter, Evans said. But employment, a trailing indicator, will take more time to recover. "I think the unemployment rate will begin to decline sometime in 2010," he said. Bernanke, testifying to the House Committee on Financial Services, said the rescue of AIG helped avoid the risk of an outright financial market tsunami. "Its failure could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income and jobs," he said.
AIG's evolving situation "highlights the need for strong, effective consolidated supervision of all systemically important financial firms," Bernanke added. At the same hearing, New York Fed President William Dudley said the Fed lacks the ability to control AIG on a day-to-day basis and must instead exert its influence over the company in its role as creditor. "These creditor's rights do not create an ability to manage AIG," Dudley said. Questions about the running of AIG have become a sore point for the Fed, Congress and the White House after the company, which has been kept afloat by some $180 billion in government funds since September, recently paid out $165 million in executive retention bonuses. The bonuses, many of which are now being repaid, were legal but "extremely distasteful," Dudley said.
Obama to Name Volcker-Led Task Force to Overhaul 96-Year-Old U.S. Tax Code
President Barack Obama plans to name a task force to review and overhaul the U.S. tax code, a spokesman for the Office of Management and Budget said today. Obama will ask the Economic Recovery Advisory Board, led by former Federal Reserve Board Chairman Paul Volcker, for a top- to-bottom review of the 96-year-old law in an effort to "rebalance the federal tax code," spokesman Tom Gavin said in an interview. "The goal is a tax system that works better for the American people," Gavin said. "The president’s going to ask the board that they find ways to simplify the tax code, protect progressivity in the revenue base, close tax loopholes and find ways to reduce tax evasion and that they reduce corporate welfare."
Austan Goolsbee, the president’s senior economic adviser, will be named staff director of the tax-review panel. Members of the panel will include Harvard’s Martin Feldstein, former chief economic adviser to President Ronald Reagan; Laura D’Andrea Tyson, professor of economics at the University of California at Berkeley and former economic adviser to President Bill Clinton; Roger Ferguson, chief executive of Teachers Insurance and Annuity Association and former vice chairman of the Federal Reserve; and William Donaldson, former chairman of the Securities and Exchange Commission. A date for the formation of the task force hasn’t been decided, Gavin said.
Obama plans to ask Volcker, Goolsbee and the panel for a package of recommendations to be on his desk Dec. 4. That would leave enough time for decisions to be made and included as proposals in the White House budget for fiscal 2011, to be submitted to Congress in February 2010. There will be two restrictions imposed on the tax review task force, Gavin said. There should be no increase in taxes on families earning less than $250,000 per year, and taxes should not be increased in 2009 or 2010, he said. Continuing the tax cut beyond 2010 "remains a major pillar of the president’s budget," Gavin said. The review panel will be charged with consulting "a pretty wide range of tax-policy experts and other public voices" before recommendations are made to the president, Gavin said.
The tax-review plan comes as Obama faces opposition in his own party as he pushes for approval of a $3.6 trillion budget that Republican critics say would pile a mountain of debt on taxpayers for years to come. The president scheduled a meeting with congressional leaders on Capitol Hill today to persuade them to back his long- range plans for an overhaul of health care, energy programs and education to revive the U.S. economy. House and Senate lawmakers are struggling to work on the 2010 non-binding spending blueprint amid a worsening deficit. Lawmakers are tentatively scaling back on some domestic programs, including curbing greenhouse gas emissions.
Senator Kent Conrad, a North Dakota Democrat who heads the Budget Committee, has drafted a spending plan to generate a smaller deficit than Obama’s plan, with next year’s shortfall totaling $1.2 trillion. Obama’s budget would generate a $1.4 trillion deficit next year, according to the nonpartisan Congressional Budget Office. Conrad’s plan deletes an Obama budget proposal that called for $250 billion to aid the banking industry. His plan pledges to reduce the deficit from a forecast $1.7 trillion this year to $508 billion in 2014. Tax credits, under the "Making Work Pay" program, which lead to $400 tax cuts for most workers and $800 to couples, would expire at the end of 2010.
White House to Hunt for New Tax Revenues
The White House said it would launch a search for new tax revenues, as Congressional leaders moved to scale back proposed spending increases and tax cuts in President Barack Obama's ambitious budget. The Obama administration plans to create a task force to consider elimination of corporate loopholes and subsidies, tougher enforcement against tax avoidance, and tax simplification, White House Budget Director Peter Orszag said late Tuesday. Mr. Obama's budget proposal began the process of addressing problems such as the tax gap, the difference between taxes owed and taxes collected. "The question is whether we can be even more aggressive" in those areas, Mr. Orszag said in an interview late Tuesday. The task force will be run through a White House advisory board being headed by former Federal Reserve Chairman Paul Volcker, Mr. Orszag said.
No target for a dollar figure has been set. But the effort theoretically could lead to tens of billions of dollars in additional collections. The tax gap alone is estimated at $300 billion a year, of which more than $100 billion is believed to be collectible, according to IRS statistics. By congressional estimates, annual spending on basic government services -- programs other than defense and entitlements -- would rise by more than 10% in fiscal 2010 under the $3.6 trillion Obama plan. Sen. Kent Conrad (D., N.D.), chairman of the Senate Budget Committee, presented his version of Mr. Obama's budget to his colleagues on Tuesday, including an increase in annual nondefense spending of 7% for 2010 -- a $15 billion reduction from the president's.
Rep. John Spratt (D., S.C.), the House Budget Committee chairman, was expected to make somewhat smaller reductions when he rolled out his plan on Wednesday. Lawmakers also are trimming back several of the president's longer-term spending and tax plans. Mr. Conrad, for example, squeezes spending growth in part by dropping tens of billions of dollars set aside in the president's budget for more rescue funds for the financial-services industry. Lawmakers said they could add the money back if it is needed. Lawmakers also were effectively excluding several middle-class tax-cut pledges that Mr. Obama made in his budget, including long-term relief from the Alternative Minimum Tax, and even long-term extension of his Making Work Pay credit. Extending AMT relief and the Making Work Pay tax credit could run around $200 billion each over the next five years. Both are in effect now but expire soon.
The pressure on the Obama budget reflects the difficult fiscal hand that officials have been dealt, Mr. Conrad said. Despite the changes, Senate Democrats sought to depict the Conrad plan as workable. "I think the president still can achieve health-care reform, can get a significant bill on energy and the environment, and has all his spending for education," said Sen. Ben Cardin (D., Md.). But Sen. Tom Harkin (D., Iowa) predicted, "We're all going to feel a little pain in this." The annual budget debate is important because it influences many major decisions that Congress will make in coming months, including spending bills. The budget resolution also can lay out powerful fast-track procedures for major policy changes, making them far easier to pass. This year, for example, many progressive Democrats are looking to the budget resolution to put health-care and climate-change legislation on a fast track.
But many moderate and conservative Democrats fear the consequences of the White House's additional spending, on top of the big stimulus bill and fiscal 2009 appropriations, plus massive federal bailouts for financial institutions. Those Democrats -- organized in the House as the "Blue Dog Coalition" -- have been pushing congressional leaders to reduce or offset the costs of any new initiatives. Some moderate Democrats, along with Republicans, also are pushing for slowing down some of Mr. Obama's big policy changes, climate change in particular, but also health care. As of late Tuesday it appeared that climate-change legislation wouldn't be on a fast track in either the House or Senate resolution, and health care would only be in the House version, setting up a tough negotiation with the Senate.
Progressive activists who favor Mr. Obama's budget plans are pushing back against the moderates. On Tuesday, two groups, the Campaign for America's Future and USAction, announced a publicity campaign to get Blue Dog members to support Mr. Obama's budget initiatives. Progressives say now isn't the time for fiscal restraint, given the economy's fragile state and the need for long-term overhauls in health care and energy. Mr. Obama will be on Capitol Hill on Wednesday to rally support for his budget, following Tuesday's prime-time White House news conference.
Meredith Whitney : Big Banks Are Dead, Regional Banks Are the Future
The big-bank model isn’t going to last much longer, banking industry analyst Meredith Whitney said at the Journal’s Future of Finance Initiative, and said a more sustainable approach would be bigger regional banks. Whitney, famous for foreseeing the troubles facing Citigroup, suggested that key parts of the big banking model made them susceptible to the types of problems that caused the financial crisis. One issue is the physical distance between loan originators and borrowers. Good lending results from a relationship with borrowers, and regional banks are in a better position to take advantage of those relationships.
She added that five banks controlling two-thirds of mortgage origination and credit cards is fundamentally unbalanced. Instead, she suggested "supercharging" regional lenders. One possibility is that if stress tests help healthy banks and lead them to return TARP money, some of those funds could be transferred to local banks to encourage consolidation (on a smaller scale) in that sector. She also sees the potential for regional banks to take on business from nonblank lenders who were decimated by the subprime crisis.
Regional lenders have grown angry at their larger counterparts, as evidenced by a conference in Phoenix last week. They are angry that the big players have given bankers a bad name. They cheered comments from Federal Reserve Chairman Ben Bernanke and Federal Deposit Insurance Corp. chief Sheila Bair about the need to clamp down on megabanks. However, not all smaller banks are created equal. While the majority of local banks are faring well and didn’t receive any TARP money, most of the 42 banks that have failed since the start of last year were community institutions.
Treasury Plans Rules to Tackle Financial Fraud, Seeks Power With FDIC to Seize Firms
The Obama administration plans to unveil new rules to protect consumers and investors against financial fraud, aiming to stamp out practices that helped cause the mortgage-market crisis. The administration will also release this week proposed legislation to give powers to the Treasury and Federal Deposit Insurance Corp. to take over failing financial institutions and wind them down. Treasury Secretary Timothy Geithner said in prepared remarks to a conference in New York today that the plan for a so-called resolution authority would include a mechanism for raising funds to cover related losses. The U.S. also will coordinate internationally to press for stronger global standards for financial companies, Geithner said in a speech to the Council on Foreign Relations in New York.
New rules on financial fraud "will help us deal in the future with threats like the practices in subprime lending that kicked off the current crisis," Geithner said. Banks and other financial institutions need stricter oversight that reins in their ability to damage the overall financial system, Geithner said. He said regulators need new tools to prevent "cascading damage" when financial companies run into trouble, such as higher capital standards and restrictions on the amount of risk they can take on. To get through the crisis, the U.S. must continue "extraordinary actions" to prop up the financial system and also seek changes to prevent a recurrence, Geithner said.
He is scheduled to lay out the administration’s regulatory strategy tomorrow at a House Financial Services Committee hearing. "This framework will significantly raise the prudential requirements, once we get through the crisis, that our largest and most interconnected financial firms must meet," Geithner said. The Treasury chief called yesterday for new authority to seize and wind down failing financial companies in the aftermath of the rescue of American International Group Inc., which has ballooned to $182.5 billion from an initial $85 billion in September. Obama said in a news conference yesterday that he expects the proposal to gain "strong support."
In details released today, the Treasury said it and the FDIC should be the agencies to trigger either a wind-down of, or financial assistance to, a struggling financial company that isn’t a bank. The plan uses procedures similar to the way the FDIC handles bank failures, without tapping the Deposit Insurance Fund used to safeguard bank deposits. Instead, the administration will seek new funding mechanisms. This could take the form of a "mandatory appropriation" to the FDIC or a special assessment on financial institutions, the Treasury said.
Treasury's Top Candidate to Run TARP Drops Out
The leading candidate to run the Treasury Department's $700 billion bailout program has withdrawn his name from consideration, according to people familiar with the matter. Frank Brosens, a hedge-fund manager and big Democratic donor, was considered the top contender to run the Treasury's Troubled Asset Relief Program. Treasury Secretary Timothy Geithner is now considering several other candidates, including Herb Allison, who currently heads mortgage titan Fannie Mae. The withdrawal comes as Mr. Geithner moves to fill out other parts of his team at the Treasury. He has been operating with a small crew of advisers since taking office in January.
The lack of manpower at the Treasury comes at a precarious time, given the focus on fixing the financial crisis. Mr. Brosens, who campaigned for Mr. Obama, said he withdrew his name for personal reasons, including wanting to remain at his hedge fund, Taconic Capital Advisors. "I very much wanted to find a way to serve," he said. Among the reasons he cited for withdrawing was the need to commute between Washington and New York, where his son is in school. Mr. Obama tapped one of his own economic advisers to serve as Mr. Geithner's top deputy. Neal Wolin, who briefly served as a deputy counsel to the president for economic policy, will be nominated for the post of deputy secretary. Mr. Wolin served as general counsel at the Treasury in the Clinton administration.
US Refinance Applications Up 41.5% Last Week: MBA
Applications filed to refinance an existing mortgage rose an unadjusted 41.5% last week from the week before after an announcement by the Federal Reserve caused fixed-rate mortgage rates to fall, according to the latest Mortgage Bankers Association survey results, released Wednesday. Mortgage applications filed to purchase a home were up a seasonally adjusted 4.2% compared with the prior week, the Washington-based MBA said. "Mortgage rates fell sharply to low levels not seen in six decades following the Federal Reserve's announcement on the Treasury bond and mortgage-backed securities purchase programs. The drop offered a sizable refinance incentive for most homeowners sparking a pickup in refinance activity," said Orawin Velz, associate vice president of economic forecasting for the MBA, in a news release.
The 30-year fixed-rate mortgage averaged 4.63% last week, down from 4.89% the previous week, the MBA said. Fifteen-year fixed-rate mortgages averaged 4.48%, down from 4.52%. One-year adjustable-rate mortgages averaged 6.22%, up from 6.20%. The survey covers about half of all U.S. retail residential mortgage applications. All mortgage applications, including refinance and purchase applications, were up a seasonally adjusted 32.2% last week, compared with the week before. Applications were up 18% compared with the same week in 2008. The four-week moving average for all mortgages was up 13.9%. Refinance applications made up a 78.5% share of all applications, up from 72.9% the previous week. ARMs made up a 1.4% share of applications, down from 2% the previous week.
California jobless rate forecast to soar to 12%-15%
California's unemployment rate will soar to between 12 percent and 15 percent by next spring and remain in the double digits until at least the beginning of 2012, according to forecasts released by two teams of University of California economists. The state's unemployment rate has not reached those heights since the Great Depression. The projections – one released today by UCLA's Anderson Forecast, the other last week by UC Santa Barbara's Economic Forecast – paint a grim picture of declining economic growth, lower retail sales, a troubled housing market and falling office prices lasting through much of 2010. "It looks like it will be a nasty recession, but not a depression, although the possibility that we could get to a depression has increased," said Dan Hamilton, director of the UCSB forecast. "Every month and every quarter that goes by is noticeably worse than the month or quarter that went before."
The dire predictions come despite the multibillion-dollar stimulus package passed in Washington. The UCLA forecast projected that the California jobless rate will average 11.3 percent this summer – topping the postwar record of 11 percent during the 1982 recession – and hit a peak of 11.9 percent in the spring of 2010. Unemployment will average 11.7 percent in 2010 and 10.8 percent in 2011, before dipping into single digits in 2012. "The stalled California economy is simply not producing the jobs required for the new entrants to the labor force," said Jerry Nickelsburg, regional economist at UCLA. The projection marks a major shift for the UCLA forecasters, who have been more optimistic than most other experts about the shape of the economy. As recently as six months ago, the UCLA forecast said the nation was not in recession – even though the national recession technically began in December 2007 – and projected that unemployment would average 7.2 percent this year.
"What we did not realize was how fast things would deteriorate," Nickelsburg said. "The current forecast reflects a deeper and longer recession than we previously thought." The UCSB economists have an even darker view of the state's economy, with unemployment peaking at 14.7 percent in early 2010 and remaining above 13 percent for the rest of the year. If that forecast comes true, it would mean that by the end of 2010, California would have lost all of the jobs created in the state over the past decade. "We've become more pessimistic than most consensus forecasts," Hamilton said. "A key difference between us and many of the other forecasts is that we don't think the federal stimulus package is going to provide much help for the economy."
The economists of both universities say the job market will worsen despite the Obama administration's $787 billion national stimulus package, which aims at creating or maintaining 3.5 million jobs over the next two years. Hamilton said he is skeptical about the job-creation projections, since they include both direct employment and a "multiplier" for additional jobs that are created as a result of employment growth. "We believe the multiplier effect is actually pretty small," Hamilton said. Nickelsburg also has doubts about the stimulus package, partly because he fears that it will only fill in for spending that has been cut from the state's budget. "The simple story is that on a Tuesday in February we got a federal stimulus package that cut taxes and increased government spending, and then just three days later, we got a budget package out of Sacramento that raised taxes and cut government spending," Nickelsburg said.
"The federal government and the state are going in opposite directions," he said. "When you combine the two, what comes out of it is a very limited stimulus that could keep us from losing so many schoolteachers and could help keep some state programs going." Esmael Adibi, economist at Chapman University in Orange, is more optimistic about the effect of the stimulus. "There's so much money in that stimulus that if you threw it at a dead body, that body's going to start moving," he joked. As a result, he said the UCSB unemployment projections were too dire. But UCLA economist David Shulman said the stimulus package may be too small to have a noticeable effect. Thus far during the recession, he said, Americans have lost $14.5 trillion in wealth, including $9 trillion in stocks and $5.5 trillion in home values. "Against this backdrop, the $787 billion stimulus package, although helpful, looks like a drop in the bucket," he said.
Although the economists at UCLA and UCSB agreed that the economy will get far worse before it gets better, they disagreed over the particulars:
Retail. UCSB and UCLA agree that retail spending will continue to decline through at least the first half of 2010. But the UCSB report projects a sharper, longer decline. UCSB economist Bill Watkins predicted that retail spending during the fourth quarter – including the Christmas season – will be 6.1 percent lower than last year, compared with a 0.1 percent decline forecast by UCLA.
Income. With rising layoffs and workers being asked to work fewer hours for less pay, UCSB projects that income will decline through at least the end of 2010. The economists project that income during the fourth quarter of this year will be 7 percent lower than the same period of last year. The UCLA economists project a shorter, shallower dip, with a 1.2 percent decline between last fall and this fall.
Office prices. Both are pessimistic about nonresidential real estate. UCLA projected that office markets will remain sluggish through 2010 in San Francisco and Los Angeles, 2011 in Silicon Valley and 2012 or later in San Diego County and other areas of the state.
Home prices. UCSB projects double-digit declines in California home prices in 2009 and 2010. But UCLA says the continuing downturn in residential construction is leading to a shortage of housing that could help the market stabilize as early as the end of this year.
"In the fourth quarter of 2009, the number of housing units built will no longer be keeping up with the historical average per household," Nickelsburg said. Hamilton predicted a continuing wave of foreclosures, adding that government programs designed to help people stay in their homes are like "putting a very loose-fitting bandage over a festering sore." Economists say there is a reason for the wide divergence of opinion over how bad the economy might get. The economic situation is so fluid and the circumstances so unprecedented that it is hard to make solid predictions, they say.
"There are so many structural changes happening that it makes forecasting extremely difficult," Adibi said. "The way that consumers have suddenly put the brakes on spending has never happened before in such a rapid period of time. And we've never experienced the steps that federal agencies are taking in the economy. It's all very unconventional. There's no model to capture that." Jack Kyser, economist for the Los Angeles Economic Development Corp., agreed. Kyser is revising the 2009-10 forecast he released a month ago, which predicted an average of 11.7 percent unemployment next year. After the state released data last week showing that the jobless rate has risen to 10.5 percent, he thinks his previous prediction might be low. "The problem is that by the time that you put a forecast out the door, the situation changes," he said.
Buffett’s Berkshire May Lose AAA S&P Credit Rating
Billionaire Warren Buffett’s Berkshire Hathaway Inc. may lose its AAA credit rating from Standard & Poor’s because values have fallen in its equity portfolio and capital has shrunk at the insurance operations. The rating could be cut in the next 12 months, S&P said in a statement yesterday about the Omaha, Nebraska-based insurance and investing firm. An S&P downgrade would be the second for Berkshire after Fitch Ratings stripped its AAA rating on March 12. S&P said any downgrade probably would be a one-level cut. "Pretty much any company in the world has to have a negative outlook at this point," said Gerald Martin, a finance professor at American University’s Kogod School of Business in Washington who has studied Berkshire. "It’s a reflection of the economy more than it is something that’s happening at Berkshire Hathaway."
Berkshire stock fell 32 percent in 12 months on concern that the equity portfolio may decline and amid speculation that Buffett’s bets on derivatives -- instruments he has called "financial weapons of mass destruction" -- will crush profit. S&P noted that the derivatives still have at least 10 years to run before Berkshire would face payments. S&P may cut its rating if "continued substantial deterioration in the equity markets hurts capital further, or if it appears that the insurance group will not be able to restore capital back to the ‘AAA’ level," according to the statement. Buffett didn’t immediately respond to a message left with assistant Carrie Kizer. Berkshire’s book value per share, a measure of assets minus liabilities that Buffett highlights in his yearly letter to shareholders, slipped 9.6 percent for 2008, the worst performance since Buffett took control in 1965.
By that metric, Berkshire has outperformed the S&P 500 Index in 38 of the 44 years Buffett has run the firm and handled its investments, according to the company’s 2008 annual report. The firm had $25.5 billion in cash at yearend, according to a regulatory filing, and Buffett has said he may be hunting for acquisitions in the U.S. "There’s a lot of liquidity on the Berkshire balance sheet, and a lot of opportunities for Mr. Buffett," said Martin. Fitch cited the potential for losses on the insurer’s equity and derivatives holdings for dropping Berkshire’s issuer default rating to AA+. Buffett’s role as chief investment officer also puts the company at risk if the 78-year-old executive becomes unable to do the job, Fitch said in a statement.
Downgrades at insurer American International Group Inc. triggered a wave of collateral calls by firms that held derivatives from the New York-based firm. The deals included provisions that required AIG to put up cash after a ratings cut, and the resulting demands for funds pushed the firm to the brink of bankruptcy. Buffett said in an e-mail in November that collateral calls as a result of ratings downgrades are "under any circumstances, very minor." He told shareholders in his annual letter last month that "most" Berkshire’s derivative contracts "contain no collateral posting requirements." Insurers depend on high credit ratings to keep down the cost of raising capital and reassure policy holders that their claims will be covered. "If Berkshire isn’t triple A, I’m not sure which company would be," Buffett said in a Bloomberg interview at last year’s annual shareholders’ meeting.
Municipal Market Regulator Regrets Enabling Swap Losses for U.S. Taxpayers
The former chief regulator of the $2.69 trillion municipal bond market for the first time acknowledged that the governing board failed to save taxpayers in Detroit, Jefferson County, Alabama, and local California governments from suffering more than $1 billion of losses because of opaque financial instruments that backfired. Christopher "Kit" Taylor, the executive director of the Municipal Securities Rulemaking Board from 1978 to 2007, said his board wouldn’t allow the group to set rules on swaps and derivatives. Many of these deals went awry last year as credit markets seized up, saddling taxpayers with unexpected bills just as the slowing economy reduced tax revenue.
"The big firms didn’t want us touching derivatives," said Taylor, 62 and now a consultant on financial markets and regulatory policy, in a telephone interview from his home in Alexandria, Virginia. "They said, ‘Don’t talk about it, Kit.’" Congress set up the MSRB in 1975 to make rules for firms that underwrite trade and sell municipal debt. The board is funded by fees paid by member firms, which generated revenue of $22.2 million in fiscal 2008. As a self-regulatory organization, members of the industry are granted the authority to supervise their own practices. A 15-member board oversees the organization and 10 of the directors are from Wall Street firms. Enforcement is handled by the U.S. Securities and Exchange Commission.
Derivatives led to the near bankruptcy of Jefferson County last year and JPMorgan Chase & Co. canceled swap contracts with the municipality on March 2 at a cost to the county of $657 million. Pittsburgh councilman Patrick Dowd said this month he wants an independent audit of a $419 million water and sewer bond and derivative deal that he says put taxpayer money at risk and cost the city $19 million of fees. Financial instruments similar to the ones that contributed the collapse of Lehman Brothers Holdings Inc. in September were bought by municipalities in attempts to reduce interest costs. Use of swaps "appears to have grown substantially" the National Federation of Municipal Analysts said in a February 2004 report, though it noted the difficulty in trying to assemble a precise estimate because the arrangements weren’t routinely reported.
Swaps are agreements to exchange interest payments, usually a fixed rate for one that varies based on an index. They are a type of derivative, contracts whose value is tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather. California is investigating if banks and financial advisers conspired to overcharge local governments for derivatives. Detroit is trying to reduce a $400 million payment required to end a swap after its credit rating was cut to below investment- grade. The amount equals almost one-third of the city’s $1.5 billion annual budget. The U.S. Justice Department is looking into allegations that banks and advisers rigged bids or fixed prices on financial contracts, according to regulatory filings by banks including New York-based JPMorgan and UBS AG of Zurich.
Banks discussed the risks to municipalities as they marketed derivatives to states, towns, schools and municipal utilities, said Thomas Doe, an MSRB director from 2003 to 2005. "One topic at nearly every board meeting was that there was a clear recognition that swaps posed a risk to the municipal market," said Doe, the head of Concord, Massachusetts-based research firm Municipal Market Advisors. Doe said board members and staff told him Congress didn’t give the MSRB power to oversee derivatives. "Every time I talked to the board about swaps, I made it clear that the MSRB had no authority to take action," said Taylor, in an e-mail. "My ‘regret’ is that MSRB would not speak out loudly that swaps were going to cost taxpayers a bundle if issuers did not clearly understand what they were doing."
Taylor said interest-rate swaps increased in the final years of his tenure, coinciding with a decline in fees for underwriting bonds. Fees fell to $5.27 per $1,000 of municipal bonds in 2007 from $7.07 in 1998, according to Thomson Reuters. Municipalities bought swaps to limit their risk to interest-rate movements, usually by locking in a fixed borrowing cost on variable-rate debt or in other cases getting cash payments upfront. Now some issuers are finding they must pay fees to unwind swaps when credit ratings are cut or interest rates move against them.
The costs are coming at a bad time for state and local governments. The economy will likely shrink 2.5 percent this year, according to the median estimate of 55 analysts surveyed by Bloomberg. The unemployment rate rose to 8.1 percent in February, the highest rate since 1983. State governments are working to reduce deficits estimated at about $160 billion this year and next, according to the National Conference of State Legislatures in Denver. "I saw more bankers looking out for their self interest in my last years at the MSRB," Taylor said. "The attitude had changed from, ‘What can we do for the good of the market,’ to, ‘What can we I do to ensure the future of my business.’ The profit wasn’t in the underwriting, it was in the swap." There has been no increase in oversight of derivatives by the MSRB since Taylor left. Doe said board members and staff told him Congress didn’t give the MSRB power to oversee the contracts.
Lynnette Hotchkiss, the MSRB’s executive director, declined to comment on events before she replaced Taylor in 2007 and said underwriters and dealers haven’t undermined effort to provide information to the public. She cited the development of the Emma disclosure system to provide price data and other financial information about borrowers to investors via the Internet. "To hear that the bankers are slowing things down just doesn’t resonate with me," Hotchkiss said. "The members have been willing to spend a lot of their own money for transparency that benefits the market." Taylor says bankers consistently stood in the way of efforts to increase transparency in the municipal bond market.
The first system for disclosing trades was established in 1994. It took until 2005 to provide real-time prices, where details of a trade are released within 15 minutes instead of the next day or several days later. Before the MSRB forced the issue, there was no public information on trades, so investors depended on brokers for pricing data. Stock and Treasury prices were widely available, and the corporate bond market started developing a disclosure system in 1998 and had it operating in 2002. "Right up until the day we went to real-time disclosure, I was getting calls from bankers wanting to delay it," Taylor said. "The only ones who benefited from delaying transparency were those who profited from the trades."
Taylor also said he got calls from bankers attempting to delay the board’s initiative in 2005 to ban underwriting firms from hiring former politicians and lobbyists as consultants to help win municipal bond sales. "Those who opposed the ban on consultants kept calling for more studies," Taylor said, declining to name bankers who thwarted his efforts. There’s no cumulative data available on the amount of potential losses because swap are unregulated. If there is an effort by Congress to bring regulation to the swap market, the MSRB would want to play a role, Hotchkiss said. The MSRB proposed in a letter to Congress on Feb. 6 that it be given greater authority to oversee interest-rate swap advisers and other parties that aren’t monitored in the municipal bond market, according to an MSRB release.
"We believe that the MSRB is the appropriate regulatory body to regulate these unregulated municipal market participants," the board said in a letter to Senate and House committee officials who oversee banking. The Securities Industry and Financial Markets Association, representing securities dealers and underwriters, supports granting the MSRB broader regulatory authority, said Tim Ryan, its chief executive officer, in testimony to the Senate Banking Committee March 10. Doe said he’s in favor of centralized regulation with the provision that the industry needs a role and input involving rulemaking. Letting the industry oversee itself when proposals threaten potential income streams doesn’t work, he said. "Not wanting to put that revenue stream at risk can very intimidating," Doe said. "It makes it very challenging to advocate for change."
Oppenheimer's Canadian Parent May Seek TARP Funds to Repay Auction-Rate Clients
Oppenheimer & Co.’s Canadian parent said it may seek money from the U.S. government’s financial- bailout programs to repay brokerage customers facing losses on frozen auction-rate securities. Oppenheimer Holdings Inc., based in Toronto, asked shareholders to approve an incorporation switch to Delaware, which would make the firm more likely to qualify for the rescue funds, according to a March 13 proxy statement. Money from the Treasury’s Troubled Asset Relief Program "could assist us" in repurchasing securities from clients trapped when the $330 billion auction-rate market seized up, the company said in the filing.
"It takes your breath away," Anthony Sanders, a finance professor at Arizona State University, said in an interview. "We’re going to ask taxpayers, the people who got hurt by these securities, to pay for buying them back." Sanders, a former head of mortgage-backed securities research at Deutsche Bank AG, testified before Congress this month on TARP fund use. Federal and state regulators forced companies including New York-based Citigroup Inc. and UBS AG of Zurich to buy back more than $50 billion of auction-rate securities that plunged in value in February 2008 after underwriters pulled out of the market. Oppenheimer Holdings, whose retail clients were stuck with about $930 million of the debt, said in a March 3 regulatory filing that repurchasing the securities "would likely have a material adverse effect" on its financial condition.
Brian Maddox, a spokesman for the company, said getting TARP money is only one reason to reincorporate in the U.S. The move also would simplify its corporate structure and provide greater access to U.S. capital markets. "We have no assurance that we would qualify for" U.S. bailout funds, Oppenheimer Holdings said in the proxy statement, "nor have we determined that we would participate in any of these programs." Oppenheimer Holdings, formerly Fahnestock Viner Holdings Inc., owns Oppenheimer & Co., which is already incorporated in Delaware. The New York-based unit’s roots go back to the late Leon Levy and Jack Nash, founders of the hedge fund Odyssey Partners LP. The company is separate from OppenheimerFunds Inc., a unit of Massachusetts Mutual Life Insurance Co. of Springfield, Massachusetts.
Auction-rate securities typically are long-term bonds or preferred shares whose interest rates are set at weekly or monthly auctions run by broker-dealers. Wall Street firms marketed the securities as a cash equivalent that offered higher yields than conventional money-market funds. Many investors got stuck holding auction-rate securities when outside bidders disappeared and investment banks that ran the auctions refused to buy the securities. After getting underwriters such as Citigroup to buy back the securities at face value, state regulators began focusing on banks and brokerages that resold the auction-rate debt. In November, the Massachusetts Securities Division filed an administrative action seeking to compel Oppenheimer & Co. to make state residents whole on as much as $56 million of auction- rate securities.
The state said Oppenheimer & Co. promoted auction-rate securities to clients as Chief Executive Officer Albert Lowenthal and members of management sold their personal holdings amid the market’s decline. Oppenheimer Holdings denied the allegations at the time and said it planned to "vigorously" defend the brokerage unit. A Financial Industry Regulatory Authority arbitration panel last month ordered Credit Suisse Securities USA LLC of New York to pay some $400 million in fees to resolve claims it misled STMicroelectronics NV into buying auction-rate securities. At the time, experts said it could lead to a spate of other arbitration claims. Oppenheimer & Co. was notified last month that two clients, US Airways Group Inc. and Hansen Beverage Co., had filed arbitration claims with FINRA, according to the firm’s March 3 annual report. US Airways, the Tempe, Arizona-based airline, wants Oppenheimer & Co. to buy back $250 million in auction-rate securities. Hansen Beverage is seeking to have a $60 million purchase rescinded.
"Many of our competitors have redeemed auction-rate securities from their customers and our failure to have done so presents a significant issue for us with our clients and regulators," Oppenheimer Holdings said in its proxy statement. Programs such as TARP, "might under certain circumstances provide the liquidity necessary" to redeem auction-rate securities held by clients. Daniel Cravens, a spokesman for US Airways, declined to comment on the airline’s arbitration claim. Heather Marsh, an attorney at Hansen Natural Corp. of Corona, California, the parent company of Hansen Beverage, didn’t immediately return a call.
Exxon, Chevron Count $40 Billion Nightly to Protect Cash From Bank Crisis
Exxon Mobil Corp. and Chevron Corp., their coffers swollen by last year’s record oil prices, are maneuvering to preserve a combined $40 billion in cash amid a global financial crisis that roiled the banking system. Exxon Mobil Chief Executive Officer Rex Tillerson says he checks in every night with Treasurer Don Humphreys to make sure the money is still there. The largest U.S. oil producers won’t say where they’re putting cash, even as both acknowledge going to greater lengths than in the past to protect their funds. "Relative to the financial markets, the biggest challenge we’ve had is making sure all the cash is there every morning," Tillerson said in a presentation this month to investors and analysts in New York. "I tell Don he has to count every dollar before he goes to bed at night, and he tells me he does."
The company began shifting cash around last year as prices for credit-default swaps signaled greater risk of collapse at some financial institutions, Humphreys said at the same meeting. Cash stockpiles are key to funding capital budgets that total almost $1 billion a week combined at Exxon Mobil and Chevron, especially after crude prices dropped $100 a barrel from 2008’s all-time high, said David Lundberg, an analyst at Standard & Poor’s Ratings Services in New York. Irving, Texas-based Exxon Mobil, the world’s biggest company by market value, had $31.4 billion in cash and cash equivalents as of Dec. 31, more than Warren Buffett’s Berkshire Hathaway Inc. or Microsoft Corp. Chevron had a $9.3 billion cash hoard, four times its total at the start of the 6 1/2-year bull market for oil that ended in mid-2008.
"The cash placement has changed dramatically over the last 12 months," Tillerson said in the March 5 presentation. "We had to make a lot of fairly significant moves very quickly as this whole situation unfolded last year to protect the cash, and we have protected the cash." Investing in corporate debt and money-market funds became riskier after Lehman Brothers Holdings Inc. filed for bankruptcy protection on Sept. 15, sending credit markets into a tailspin. At risk for Exxon Mobil and Chevron is money that could be used for acquisitions. Major international oil producers will likely boost reserves by buying stakes in offshore fields from cash-strapped state oil companies, according to Nansen Saleri, CEO at advisory firm Quantum Reservoir Impact in Houston and formerly reservoir-management chief at Saudi Arabian Oil Co.
Exxon Mobil and Chevron declined to say how their cash is invested or to comment on how it’s managed. Humphreys and Chevron Chief Financial Officer Patricia Yarrington declined to be interviewed for this article. Many companies with cash on hand now invest in low-risk government securities, according to analysts including Brian Gibbons at CreditSights Inc. in New York. Those investments will be liquid so the money can be tapped quickly when it’s needed, Gibbons said. Chevron, which halted share buybacks this year to conserve funds, has most of its $9.3 billion cash stockpile outside the U.S., Yarrington said in a March 10 presentation to investors and analysts in New York. The company is relying on that bankroll to help finance projects such as the Gorgon natural-gas development in Australia. The project is a joint effort with Exxon Mobil and Royal Dutch Shell Plc to liquefy gas from offshore reservoirs for shipment to markets in Asia and elsewhere on tanker ships.
Western Australia Premier Colin Barnett this month said Gorgon will cost A$50 billion ($33 billion). Chevron also is involved in a $13.7 billion expansion of a Canadian oil-sands project and $17.4 billion in developments in West Africa and Brazil. Combined, those outlays would be enough to fund the U.S. space program for more than three years. "From a cash standpoint, let me assure you that we’re well protected," Chevron Chief Executive Officer David O’Reilly said in this month’s presentation. "Our folks have done a tremendous job in looking at where to put our cash." Crude prices plunged as recessions around the world crimped fuel demand. Natural-gas futures in New York touched a six-year low on March 18.
Exxon Mobil is still buying back shares, even as analysts predict the largest decline in profit since Exxon Corp.’s 1999 acquisition of Mobil Corp. Chevron’s profit this year will drop 59 percent, according to the average of analyst estimates compiled by Bloomberg. "The challenge for companies sitting on a lot of cash is to earn the highest return they can," said Gibbons of CreditSights. "There’s little doubt they are earning less on their cash than they were a year ago." Exxon Mobil’s return on its cash fell to 4.3 cents on the dollar last year from 5.4 cents in 2007, public filings showed. The 2008 result was less than one-tenth the 54-cent return on each dollar invested in oil and gas wells. Chevron earned 2.3 cents per dollar on its cash in 2008, down from 4.3 cents a year earlier. That compared with last year’s 27 percent return on oil, gas and refinery investments.
Canada facing "something bigger than a recession" says opposition
Canada opposition leader Michael Ignatieff said the country may need a second round of stimulus measures to emerge from its slump and threatened to topple the government if it rejects proposals to help the economy. Canada could be facing "something bigger than a recession," Ignatieff, 61, said in an interview in his Parliament office. "I have a feeling that we’re going to need to do more. We’re going to need to do more as the jobless numbers begin to drive this." Ignatieff’s Liberals hold the balance of power in Parliament and kept Prime Minister Stephen Harper in office by supporting the governing Conservatives’ budget, which contained a two-year, C$40 billion ($32.7 billion) stimulus plan. The Liberals backed the January budget after the government agreed to publish regular reports on its implementation.
Any new demands for stimulus may put the Liberals on a collision course with the Conservative government. Finance Minister Jim Flaherty has said he’s in no rush to add to his stimulus plan until existing measures are in place. Ignatieff said he’s prepared to trigger an election if Harper ignores future Liberal ideas. "I am trying to make Parliament work, but it takes two to tango," Ignatieff said. "If we have some good ideas on the economy and he says no to them, then it’s going to be difficult. We may have to go to the people."
Canada’s economy, the world’s eighth largest, shrank at a 3.4 percent annual pace in the fourth quarter, the most since 1991, and recent reports showing record job losses and trade deficits suggest the recession may be deepening. Canada’s dollar appreciated 0.5 percent to C$1.2257 per U.S. dollar at 12:24 p.m. in Toronto, from C$1.2321 yesterday. One Canadian dollar buys 81.59 U.S. cents. Canada, which generates about a quarter of its output from exports to the U.S., is being squeezed by plunging demand from that country, a drop in commodity prices and tight credit markets. Flaherty has been cool to the idea of adding to his stimulus package. "I’m not going to put the cart before the horse," Flaherty said in a March 14 interview in Rome, where he was attending a meeting of officials from the Group of 20. "I’m going to see how the economy does with the stimulus, especially in the next six months."
The other two opposition parties -- the New Democrats and Bloc Quebecois -- voted against the fiscal plan, which projects C$84.9 billion in deficits over the next five years, putting an end to a series of 11 straight budget surpluses for the energy- rich country. New Democratic Party leader Jack Layton said in an interview earlier this week he supports a "second iteration" of stimulus. Ignatieff said changes in the global economy, including a "reordering" of global production, mean additional stimulus should aim to boost Canada’s productivity, while maintaining fiscal discipline. He cited recent comments by former Bank of Canada Governor David Dodge, who has argued the government should focus on longer-term investments that boost productivity.
"Something bigger than just a recession is going on here and it has a lot of implications for Canada because it isn’t just a recession, it’s a restructuring," he said. "We may have to then be putting in measures not simply that put aggregate stimulus in there but maybe targeting the very logic of plant location decisions by multinational companies," the Liberal leader said. More funding for universities and other measures to help companies add value to their goods should also be considered, said Ignatieff, a former Harvard University professor who took over the reins of the Liberals in December. "We’ve got to bet the store on post-secondary education, investments in research and technology, because that’s where, it seems to me, safety lies," Ignatieff said.
Mervyn King's salvo first in wider war
Mervyn King has fired what could be the first salvo in a wider war. The Bank of England governor’s warning that the government can’t afford another big fiscal boost should be seen as an attempt to avoid no fewer than three crises that could be looming: a fiscal crisis, a constitutional clash and an inflation crisis. The budget crisis is the most obvious one. The UK’s fiscal deficit will in the next financial year rise to 11pc of GDP, according the latest International Monetary Fund forecast. Fortunately, the UK’s public debt isn’t terribly high. So it can probably carry an annual deficit this big, at a pinch, for a year or two. But if such humungous deficits continue for several years – let alone get larger - there is a risk financial markets could lose faith in the economy. International investors wouldn’t just send sterling lower; they could also refuse to buy government bonds.
Such a fiscal crisis must be one of King’s nightmares, not only because it would be bad for the country but because it could trigger the second crisis: a constitutional clash. The BoE has just embarked on its policy of quantitative easing, under which it is creating money to buy government bonds with the aim of boosting the economy. This policy is risky enough as things stand. But, if investors in gilts went on a buyers’ strike, the BoE would be left as the only purchaser of government bonds. King would then have an uncomfortable choice: print yet more money to hand to Gordon Brown, the prime minister, a policy that would lead to a total debasement of the currency; or refuse to bail out the government.
Even if these scenarios don’t materialise – and, at present, they must be viewed as "tail" risks – King presumably has a third worry. Will the BoE be free to rein in inflation when the good times start rolling again? After a severe recession, there could be political pressure to run a loose monetary policy for longer than is advisable. The BoE’s monetary policy committee is theoretically independent of government. But there’s no harm in King showing now that he is not too cosy with the politicians. King’s intervention is inconvenient for Brown as he prepares for next week’s G20 summit meeting, which will discuss the need for coordinated global fiscal stimulation. But the prime minister should take King’s warnings to heart. When the government presents its budget next month, it needs not just to refrain from another big short-term boost. It should show it has a credible medium-term plan for bringing the country’s finances into balance.
Ilargi: Note: Holland's unemployment stands at 2.7%.
Dutch Officials Announce Stimulus
The Dutch government will launch a €6 billion ($8 billion) stimulus package for the economy, Prime Minister Jan Peter Balkenende said Wednesday, addressing the parliament. Mr. Balkenende also announced an additional €1.5 billion stimulus from the Dutch provinces. The stimulus package will enable the government to invest in jobs, infrastructure and energy-saving and fiscal measures, Mr. Balkenende said. In addition, the Dutch government will launch a set of cost-saving measures for 2011, including a rise of the state pension age to 67 years from 65, the prime minister said. The Dutch economy is set to shrink by 3.5% in 2009 and by 0.25% in 2010, according to data from the Dutch government's planning agency released last week. This would be the largest contraction in the country since 1931.
German Business Confidence Declines to 26-Year Low
German business confidence fell to the lowest level in more than 26 years in March, adding to signs that the recession is deepening. The Ifo institute in Munich said its business climate index, based on a survey of 7,000 executives, dropped to 82.1 from 82.6 in February. That’s the worst reading since November 1982. Economists expected a decline to 82.2, according to the median of 37 forecasts in a News survey. A global slump in demand has forced German companies to scale back production and cut jobs, pushing the economy into its worst recession since World War II. Metro AG, Germany’s largest retailer, yesterday reported an unexpected drop in fourth- quarter profit as consumers pared spending. Commerzbank AG expects gross domestic product to decline as much as 7 percent this year.
"These data are a reminder of just how bad conditions are in Europe’s largest economy and put paid to any thoughts of a swift rebound in activity," said Colin Ellis, European economist at Daiwa Securities SMBC Europe Ltd. in London. "We have not reached the bottom yet, by any means." European government bonds erased declines after today’s report. The yield on the German two-year note fell one basis point to 1.38 percent by 9:07 a.m. in London. The euro was little changed at $1.3462. Ifo’s gauge of current conditions declined to 82.7 from 84.3. Still, the measure of expectations increased to 81.6 from 80.9. "The Ifo’s absolute level is still depressingly low," said Carsten Brzeski, an economist at ING Group in Brussels. "Nevertheless, the gradual improvement of the Ifo’s expectation component is at least a tender green shoot of stabilization."
The European Central Bank has signaled it’s ready to lower its key interest rate further from a record low of 1.5 percent. Chancellor Angela Merkel’s coalition also plans to spend about 82 billion euros ($110 billion) to stimulate growth, including tax breaks and investment in infrastructure. Ifo economist Gernot Nerb said in an interview with Bloomberg Television today that it’s "too early" for government measures to have an impact on the economy. He also called on the ECB to lower its key rate by a full percentage point when policy makers next meet on April 2. The global economic crisis has exposed Germany’s reliance on exports as an Achilles Heel. German exports dropped for a fourth month in January, manufacturing orders plunged 38 percent from a year earlier and industrial output declined the most on record.
Volkswagen AG Chief Executive Officer Martin Winterkorn said on March 12 that 2009 "will be one of the most difficult years" in the company’s history. ThyssenKrupp AG, Germany’s biggest steelmaker, on March 19 forecast its first quarterly loss in three years and said it may cut more than 3,000 jobs. This year will be a "big challenge," Wolfgang Reitzle, CEO of Linde AG, the world’s second-largest maker of industrial gases, said on March 16. "A certain chain reaction has been generated that we feel too." German Economy Minister Karl-Theodor zu Guttenberg said last month that while most indicators are "definitely very negative," others offer "hope" that the economy could begin to turn around before 2010.
German investor confidence unexpectedly rose to the highest level in almost two years in March and the country’s benchmark DAX share index has gained about 13 percent this month. In neighboring Belgium, business confidence increased in March, the central bank said yesterday. Deutsche Bank AG Chief Executive Officer Josef Ackermann said yesterday Germany’s largest bank had a "good start" to the year. In 2010, "some degree of recovery in the banking industry is foreseeable," he said. The RWI institute said on March 23 it expects the German economy to expand 0.5 percent in 2010. "We can see some light at the end of the tunnel but it’s too early to give the all clear," said Tobias Basse, an economist at Norddeutsche Landesbank in Hanover. "The current difficult situation will persist for a while."
Romania Gets $27 Billion Bailout Aid From IMF, EU
Romania got a 20 billion-euro ($27 billion) loan from the International Monetary Fund, European Union and other lenders, the sixth eastern European nation to be bailed out as the region’s economies struggle to stay afloat. About 13 billion euros will come from the IMF and the rest from the EU, World Bank and the European Bank for Reconstruction and Development, the Washington-based fund said in a statement. The "package should more than cover Romania’s financing needs this year," said Ozgur Yasar Guyuldar, an emerging markets strategist in Vienna at Raiffeisen Centrobank, in an e- mail today. "The IMF deal will certainly bring some discipline to the budget. I view this aid package as a big relief."
The Balkan nation, which had the fastest-growing economy in the EU last year, is plunging into a recession and the central bank has little scope to lower interest rates to revive growth. The loan brings to more than $60 billion the total handed out to eastern Europe. Hungary, Ukraine, Belarus, Latvia and Serbia have also sought bailouts to prevent defaults and aid banks. "The objective of the policy package is to cushion the effects of the sharp drop in private capital inflows," IMF Managing Director Dominique Strauss-Kahn said in the statement. Romania’s leu strengthened 0.3 percent against the euro today after weakening as much as 0.1 percent before the announcement. It was trading at 4.2825 to the euro as of 1:40 p.m. in Bucharest.
The benchmark BET stock index pared its earlier loss after the announcement and was trading unchanged at 1:40 p.m. after falling as much as 1.5 percent earlier. Romania’s credit risk, as measured by credit default swaps, fell to the lowest in four and a half months to 501.5 basis points after the announcement, according to CMA Datavision in London. The loan agreement was not "an appeal to be saved," said President Traian Basescu at a news conference in Bucharest. "Romania has made a preventative accord taking into account what could have happened in the future. It would be hard to explain in the future if we didn’t buckle our seatbelt through the accord with the IMF and the EU." He also said about 13 billion euros of the package will go directly to central bank foreign exchange reserves, which stood at 25.9 billion euros as of the end of February.
The loan from the IMF will be disbursed over the next two years with 5 billion euros coming in the next few months after approval by the executive board, Jeffrey Franks, head of the IMF negotiating team, told reporters in Bucharest today. The government will target a budget deficit of 4.5 percent of gross domestic product this year, compared with 4.8 percent last year, even as the economic contraction cuts revenue, Franks said. The budget approved in December would have led to a deficit of about 9 percent of GDP, he said. The country, which had a record current-account deficit of about 13 percent of GDP last year, has predicted it will narrow to less than 10 percent this year as a weaker leu trims imports. Romania requested talks with international organizations this month as exports suffer from waning demand in its key western European trading partners. "Core measures under the program are designed to strengthen fiscal policy to reduce the government’s financing needs and improve long-term fiscal sustainability, thus preparing Romania for euro-zone entry," the IMF release said. The country aims to adopt the European common currency in 2014.
Romania’s economy expanded 7.1 percent last year. Private lending soared as much as 64 percent, wages increased more than 20 percent on the year and rising foreign investment brought unemployment to a 16-year low. This year, the international financial crisis has deterred new investment and persuaded foreign investors to withdraw cash, weakening the leu and restricting growth to an annual 2.9 percent in the fourth quarter. The government predicts the economy will shrink as much as 4 percent this year. Prime Minister Emil Boc, elected in November to head a coalition of his Liberal Democrat Party and former communists from the Social Democrat Party, has said the government will ensure social protection for pensioners and the poor while cutting spending in other areas and raising some taxes. The IMF said the agreement contains "explicit provisions to increase allocations for social programs." It said the conditions placed on the government were "ambitious but realistic," though state wages and pensions will not be cut.
Frederic Oudea, chief executive officer of Societe Generale SA which owns BRD-Groupe Societe Generale, Romania’s second- biggest bank, said the loan agreement is "a very good piece of news." "I would like to confirm our commitment in Romania in the long term," Oudea said at a news conference in Bucharest today to commemorate 10 years of activity in the country. He also said he and representatives from nine other Romanian banks will hold talks with the IMF on Thursday about the financing package. He said his bank won’t repatriate funds from Romania. The EBRD, in a separate news release, said about half of its 1 billion-euro contribution "will be dedicated to the financial sector and the rest invested across the broader economy, including in the corporate, energy and energy efficiency and national and municipal infrastructure sectors." Moody’s Investors Service, which affirmed Romania’s credit rating at Baa3 on March 20, said it would consider a downgrade if the country didn’t obtain aid.
Pension Glut Lies at Heart of Crisis Wracking Hungary
To understand why Hungary's economic crisis is imperiling Eastern Europe and the rest of the Continent, consider the pension application of 40-year-old Tamás Szabó. A year and a half ago, Mr. Szabó was riding his motorcycle to work when an oncoming car turned suddenly and slammed into his bike. Now he says he has trouble moving his left ankle. He can't carry boxes, he says, limiting his career as a truck driver. He hasn't sought retraining and isn't sure he can find other work.
So on a recent morning, Mr. Szabó limped to the counter at a government building here and put in his paperwork for a state pension. The odds are good that he'll receive a monthly check for much of what he'd make if still working, for the rest of his life. It's a story that goes to the heart of the country's economic mess. Hungary, a nation of 10 million, has three million pensioners. Besides writing checks for regular retirees, the government gives special benefits to accident victims, the disabled, military and police veterans, mayors, widows, farmers, miners and "excellent and recognized" artists. The average Hungarian retires at 58, and just 14% of Hungarians between 60 and 64 are working, compared with more than half of Americans.
Hungary's pension obligations are helping to remake the country's politics. On Tuesday, former Hungarian central bank governor György Surányi emerged as a preferred candidate to replace Prime Minister Ferenc Gyurcsány, who announced on Saturday that he would step down amid battles over spending cuts. Hungary has run fiscal deficits for years to pay for social programs, and its annual tab for pensions now surpasses 10% of its gross domestic product. The government had sold bonds to finance these outlays. In October, investors stopped buying them. The International Monetary Fund provided an emergency bailout so Hungary could pay its bills. But many international investors have pulled out of Hungary, sending the country's currency tumbling and darkening its economic outlook. Hungary poses the global financial crisis's biggest challenge yet to the European Union, which is fiercely debating how, or whether, to attempt a rescue. The country's economy is 10 times the size of Iceland's, the victim of Europe's deepest collapse.
Similar problems with deficit spending and declining currency have hit neighboring Romania, which is expected on Wednesday to agree to an IMF aid package of €19 billion, or about $25.6 billion. On Tuesday, political turmoil spread to the Czech Republic, whose coalition government lost a no-confidence vote and will be forced to step down. The Czech Republic, Poland and others in Central and Eastern Europe -- in less dire straits thanks to healthier government finances -- fear that if Hungary spirals into collapse or deep recession, investors will pull money out of the whole region. That would hurt the Western European economies that have mined their emerging neighbors for growth. Hungary imports heavily from Germany, and borrows from Austrian and Italian banks. Pensions weigh heavily on Hungary's public finances. Employers and employees in the country's work force of roughly four million pay into the state pension program. But their contributions don't cover all the benefits paid. The government makes up the difference out of the central budget. Members of Prime Minister Gyurcsány's Socialist party have been protective of pensioners, wary that cuts could fall hard on the older Hungarians who form a key Socialist voting bloc.
Critics say the country can't afford not to reform pensions. The system, many say, gives Hungarians an incentive to retire young or leave the work force for relatively minor ailments. The IMF, backed by Hungarian reformers, wants cuts -- particularly to a bonus monthly payment made to all retirees, known as the "13th month."
The system "fails on pretty much every level," says Mark Pearson of the Organization for Economic Cooperation and Development, of which Hungary is a member.
Paring back will be difficult, especially at the moment when economic crisis and rising unemployment threaten to leave those at society's margins with little else to lean on. Aging retirees accuse politicians of dismantling the promises of a previous generation and leaving them to dangle in the breeze.
"They are taking the 13th month away from pensioners, but amongst each other they give millions," says Sándor Nyéki, a trim 73-year-old out for an afternoon swim at the Széchenyi baths in central Budapest, a popular spot for retirees. (A common complaint among Hungarians is that politically connected insiders profited from privatization.) Asked what he'll cut from his budget if the 13th month disappears, he answers: "Food." This country of fertile plains has been conquered by Turks, forced into empire with Austria and occupied by Germans. Its widespread pension programs are a holdover from the country's domination by the Soviet Union. After the Soviets crushed the 1956 Hungarian Revolution, leaders in Budapest made an implicit deal with the people, says Yusaf Akbar, an associate professor at Central European University's business school. In exchange for no more social disruptions, the leaders would provide modest freedoms and a comfortable state welfare net.
After the fall of the Soviet Union, Hungary's formerly communist neighbors were keen to dismantle the old state system. The Baltic countries of Latvia, Lithuania and Estonia became showcases for shrinking government. Slovakia moved to a low flat tax. Budapest, too, embraced capitalism and championed privatization, but even as it shrunk the state it attempted to retain its social safety net. The number of pensioners swelled in the early 1990s as newly privatized companies dumped workers who had been on the state payroll. Unemployment was high, and drawing a pension was an attractive alternative to working. When his state-owned employer went private in 1993, Mr. Nyéki, the 73-year-old bather, didn't bother looking for another job. A truck driver who worked hauling aluminum, Mr. Nyéki took a pension he says was "good money" at the time. Today, it comes to 62,000 forints a month -- about $280.
Communism left a mentality of dependence on the state, says Péter Holtzer, the chairman of a round-table group of experts convened by the government to examine the pension system. "Those 40 years -- it seems one generational change is not enough. It requires one or two more," he says. "Many of the problems we have are because this new democracy has not had time to create checks and balances." A stab at reform in 1997 shifted the country toward private pensions, but politicians eager for votes subsequently larded the public system back up -- the biggest hunk of pork being the 13th month, introduced in 2003 by Mr. Gyurcsány's predecessor. Now, the average pension runs about 80,000 forints, or $350 a month. The untaxed benefit goes a good way in a country where the average after-tax wage amounts to just over $500 a month.
In Eastern Europe, only Slovenia and Poland spend a greater portion of gross domestic product on pensions. But Slovenia is far richer, and Poland is working to pull the figure down sharply in coming years. Hungary's pension outlays, on the other hand, will be among Europe's fastest-growing in coming decades, the OECD estimates.
Critics say the problems with Hungary's pension system are manifold. Higher-income workers receive a larger share of their working wages than those in many other countries do. Men reach full retirement by 62, but can take a pension earlier if they have 40 years of service -- giving little incentive to continue working. There are also myriad ways, they say, for workers to retire even earlier than that.
The office charged with scrutinizing disability claims, the National Rehabilitation and Social Assistance Institute, has 166 examiners to scrutinize pension claims, and reviewed 72,500 new disability applications last year. Disability approvals have fallen, but critics say Hungary still awards pensions to workers whose conditions wouldn't keep them out of other countries' work forces. The state office relies heavily on the assessments of workers' own doctors, according to its deputy chief, Erzsébet Forgó. She says the office can't afford optometry machines to verify claims of poor eyesight. "Unfortunately, for now, if someone says they are disabled with certain illnesses, we can't investigate," Ms. Forgó says. Mr. Szabó, the injured motorcyclist, concedes that he could seek retraining for a different line of work. But finding a field "where you make a living and get hired, that's a problem," he says. A pension, he says, is his best guarantee of a stable income. To pay for all of this, Hungary levies high taxes and has borrowed to make up the rest. The tax burden has driven the cost of labor up faster than in neighboring countries, hurting Hungary's competitiveness.
"Today, Hungary is no longer at the cutting edge," says Les Nemethy, a Canadian who came to Hungary in 1991 to work for the state privatization entity. Mr. Nemethy, who runs a small investment-banking firm in Budapest, says his firm has to spend just over one million forints a month in income and payroll taxes so that an employee can have 395,000 forints in take-home pay. This "tax wedge" -- the difference between what the employer pays and what the employee takes home -- is the second-highest in the OECD, behind Belgium. Hungary's budget deficit makes tax reform difficult. Even as other counties around the globe are pumping stimulus funds into their economies, Budapest is cutting costs. Mr. Gyurcsány had proposed some changes. He preached austerity starting in 2006, after he was caught on tape admitting that the government lied to camouflage how bad the fiscal situation was ahead of elections. He has since proposed cutting the 13th-month bonus, but for existing retirees would spread the money out over the other 12. He proposed raising the retirement age to 65, but not until 2050.
His replacement, expected to begin work within the month, will likely be forced to suggest deeper cuts that could prove particularly disruptive for a generation of older Hungarians. Ilona Brebán, 77, retired two decades ago from the state mine agency. Picking up vegetables at a central Budapest market for a cabbage fözelék, a hearty stew, she said she lives on 89,000 forints a month, or about $400. Her heating bill can reach 29,000 forints. "How do you make a living on the rest of it?" she asked. There's no easy political solution, said pensioner István Szücs. On a recent weekday, the 76-year-old former mechanic and driver sat in a bar on the market's lower level, sipping at a late-morning pilsner. "They put a lot of money into the hat to give to people," Mr. Szücs said, doffing his ribbed tan trilby. "But now, if you don't have any money in the hat, it doesn't matter who is prime minister."
Czech Republic joins East Europe's falling dominoes
The economic crisis sweeping Central and Eastern Europe has claimed a third victim in a month after the Czech government lost a vote of no confidence on Tuesday night in a drama that risks setting off a fresh round of investor flight from the region. Latvia's government fell last month following violent street protests. Hungary's premier Ferenc Gyurcsany resigned last week after struggling to impose austerity measures required under the terms of a $25bn (£17bn) bail-out from the International Monetary Fund. But the Czech crisis has unnerved investors even more because the country has been seen as a rock of stability. It kept a tight rein on credit and avoided the stampede into euro and Swiss franc mortgages that occurred in other parts of Eastern Europe.
The fate of premier Mirek Topolanek – toppled in the middle of the Czech Republic's EU presidency – shows how fast the crisis is moving from finance into the core economy. Czech industrial output fell 23pc in January as car plants moth-balled production lines. "This is the next leg of the crisis," said Neil Shearing from Capital Economics. "We're seeing the political backlash as this spreads into the labour market. The risk is that we will see a move to populist nationalism in some countries. That could prove dangerous." Capital Economics says no country in the region will be spared a crisis that evokes the "shock therapy" devastation after the fall of communism. It expects output to fall by 7.5pc in Hungary and Romania this year, 10pc in Estonia and Ukraine, and 15pc in Latvia and Lithuania. Russia and the Czech Republic will fare better at -5pc, but this is still a wrenching adjustment after years of stellar growth.
The concern is that mass lay-offs will stoke bitter feelings of betrayal over the promises of free-market ideology. Britain's Prime Minister Gordon Brown assured the European Parliament in Strasbourg that EU leaders "will not walk away" from the region in its hour of need and renewed his call for an IMF fighting fund of $500bn to meet potential threats. European banks account for the lion's share of the $1.7bn of foreign loans to the region – a considerable chunk on short maturities that must be rolled over this year. Austrian banks have lent the equivalent of 70pc of Austrian gross domestic product.
AIG Plane Unit Says Survival in Doubt Without Funds
American International Group Inc.’s plane-leasing unit, the largest customer of both Airbus SAS and Boeing Co., said it may not survive unless it gets help from its parent company or new access to credit. "Without additional support from AIG or obtaining secured financing from a third-party lender, in the future there could exist doubt concerning our ability to continue as a going concern," Los Angeles-based International Lease Finance Corp. said today in its annual report. ILFC said it has 168 planes valued at $16.7 billion on order through 2019 and plans to pay for them with operating cash flows and by incurring debt. New York-based AIG said today it will support the unit’s short-term liquidity needs until ILFC is sold or the end of March 2010, after ILFC was cut off from its usual sources of funding in part because of ratings downgrades.
"ILFC has a huge need in terms of financing for future commitments," Bertrand Grabowski, the board member responsible for aviation at Germany’s DVB Bank SE, said in an interview yesterday. "The problem is not to find equity for value for the company, it’s finding committed funding for planes coming in." AIG is trying to find a buyer for ILFC to help pay back the loan portion of the $182.5 billion government bailout the insurer has received. The attempted sale comes as demand for new planes has dropped amid slumping air travel and airline capacity cuts because of the recession. Global traffic has fallen every month since September. ILFC said today it will need additional funding, in excess of the $4 billion of secured debt it’s currently allowed to incur, in order to pay contractual obligations during the next 12 months. ILFC lost access to the U.S. commercial paper program after credit downgrades because of concern over AIG’s future.
AIG provided a loan of $800 million to ILFC on March 12 to fund operations at the plane-leasing unit through the end of the month, and approved another $900 million to be distributed on March 30 to pay costs through the end of April. The insurer, which the government has deemed too big to fail, was rescued with a federal infusion of capital in September, and the bailout has been restructured three times since. Paula Reynolds, AIG’s chief restructuring officer, said March 2 that the government had agreed to "some form of backstop financing" for the buyer of ILFC. ILFC earned profit of $703.1 million in 2008, a 16 percent increase from a year earlier, as the unit added 55 planes to its fleet and revenue from renting flight equipment rose, the company said today. Fourth-quarter profit fell 34 percent to $115 million, and 12 of ILFC’s customers filed for bankruptcy last year. ILFC, which was founded 36 years ago and owns a fleet of about 1,000 jets, is the world’s largest aircraft lessor by value of planes. The company’s fate will have an impact on Airbus and Boeing as well as airlines and leasing companies around the world.
"We have seen airlines cancel routes, eliminate jobs, and retire aircraft," ILFC said in today’s filing. "This financial stress is causing a slow-down in the airline industry which will likely have a negative impact on future lease rates and could begin to influence our future results." ILFC Chief Operating Officer John Plueger said in an interview last week that the company had placed all its deliveries scheduled for the next two years -- 49 in 2009 and five in 2010 -- with customers. ILFC didn’t order any planes last year as the industry struggled with high oil prices, followed by the collapsing economy. "We’re in uncharted waters, because the world as a whole has never been in this kind of economic position," Plueger said. Credit-default swaps protecting against a default by ILFC rose 0.7 percentage point to 27.5 percent upfront, according to CMA DataVision. That’s in addition to 5 percent a year and means it would cost $2.75 million initially and $500,000 annually to protect $10 million of ILFC debt against default.
Gerald Celente: The Greatest Depression is still to come
US postmaster general: 'Situation is critical'
With predictions that mail volume will plunge this year, U.S. Postmaster General John E. Potter is asking Congress for help in finding ways to survive. During testimony Wednesday before the House Subcommittee on Federal Workforce, Postal Service and the District of Columbia, Potter urged lawmakers to allow for greater flexibility with regard to mandated retiree health benefits. He pointed out that, based on current law, the Postal Service will pay almost $70 billion from now through 2016 for retiree health benefits. "We simply cannot afford the current method of funding these benefits," Potter told lawmakers. "Without a change, we will exhaust our cash resources." He also outlined several strategies that the Postal Service has come up with to help close the budget gap – a "chasm, widening each day," created by the agency's revenue shortfall. These include:• A new process for evaluating and adjusting city delivery routes.
• Reduction of employee work hours and overtime by pursuing even greater efficiencies throughout the organization.
• Halting construction of new postal facilities and directing funds to the sites with the most critical needs (i.e., buildings badly damaged or destroyed by natural disasters).
• Improved fleet management and delivery routing to reduce fuel usage.
• Expanded energy efficiency to reduce energy use throughout Postal Service facilities.
• Reductions in employee travel budgets through the use of Web and video technology to conduct meetings and conferences.
• Renegotiations of supplier contracts to reflect reduced needs.
"Even with our aggressive cost-cutting measures, our situation is critical," Potter said. "We cannot overcome the economic forces without help from Congress." He also said they would begin discussions regarding adjusting its delivery schedule from six days to five days. "This offers a significantly higher cost benefit than any other single option for operational cost reductions," Potter said. "If we reject this approach, we rule out our largest cost-management opportunity at this time when we are facing such staggering financial pressures." The removal of a legal requirement regarding days of delivery could result in annual savings of $3.5 billion, according to the Postal Service. Congress mandated the six-day delivery service in 1983 when technology and consumer access were much different than they are today.
On Wall Street, Talk of Trust and Civil War
Finance executives expressed anger and betrayal at Washington's latest anti-Wall Street rhetoric during Tuesday's sessions of the Future of Finance Initiative, a conference hosted by The Wall Street Journal. The conflict suggested that the lines of communication between government and the private sector remain limited just as government is hoping to expand cooperation with private investors. Those tensions flared over the last week, as the U.S. House passed a bill taxing bonuses by 90% for banks and other companies receiving large government capital injections. "Washington and Wall Street are the equivalent of Gettysburg and Antietam right now," said Glenn Hutchins, co-chief executive of private-equity firm Silver Lake.
"To point the finger at one group means, No. 1, you're not understanding the problem, two, you're stretching our social fabric thinly, and you're throwing the baby out with the bathwater," Mr. Hutchins noted. "Trust goes both ways." The divide between Main Street and Wall Street surprised even Arthur Levitt, a former chairman of the Securities and Exchange Commission. "This is an issue of 'we' and 'they,'" Mr. Levitt said. "Compensation is a part of it, but a symbolic part of it. We are a centrist nation ... We're now shifting to the left pretty far in terms of business-bashing and it has reached extremes of incivility that are intolerable." Meanwhile, President Obama plans to meet Friday with about a dozen of the U.S.'s top banking chiefs in an unusual gathering designed to discuss the administration's plans to shore up the financial sector.
Attendees are expected to include Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Citigroup Inc. At the conference, Goldman's president and co-chief operating officer Gary Cohn spoke in support of his firm and its investment-banking focus. Mr. Cohn said that profitability is still possible for investment banks. "Wall Street is alive and well," Mr. Cohn said. Asked if Goldman Sachs would be the first financial institution to return funds granted by the Treasury's Troubled Asset Relief Program, Mr. Cohn said he didn't know, adding that he couldn't speak for the other banks that had accepted TARP money. He also said he would be surprised if any institution repaid TARP funds "until ... stress tests and first-quarter earnings are out of the way."
Mr. Cohn also said Goldman wouldn't have lost money had insurer American International Group been allowed to fail. He said the firm's greatest exposure at any one time was about $2.5 billion and that Goldman's credit-default swaps and collateral would have covered those sums in the event of default. "We would have been 100% fine," he said. Fund manager George Soros dismissed many of the proposals discussed at the conference as "tinkering." Mr. Soros sought a thorough overhaul of regulation of the markets. "The idea that the markets are self-correcting has been proven false. ... The market, rather than reflecting the underlying reality, is always distorting it." Paul Volcker, former Federal Reserve chairman, spoke for many of the attendees when he acknowledged that "we're in a government-dependent financial system; I never thought I'd see the day."
Top Hedge Fund Managers Do Well in a Down Year
The financial crisis may have turned much of Wall Street’s wealth into dross, but a select group of hedge fund managers has managed to maintain a golden touch that might make King Midas blush. As major markets and economies careened downward last year, 25 top managers reaped a total of $11.6 billion in pay by trading above the pain in the markets, according to an annual ranking of top hedge fund earners by Institutional Investor’s Alpha magazine, which comes out Wednesday. James H. Simons, a former math professor who has made billions year after year for the hedge fund Renaissance Technologies, earned $2.5 billion running computer-driven trading strategies. John A. Paulson, who rode to riches by betting against the housing market, came in second with reported gains of $2 billion. And George Soros, also a perennial name on the rich list of secretive moneymakers, pulled in $1.1 billion.
Of course, their earnings were not unscathed by the extensive shakeout in the markets. In a year when losses were recorded at two of every three hedge funds, pay for many of these managers was down by several million, and the overall pool of earnings was about half the $22.5 billion the top 25 earned in 2007. The managers’ compensation, which was breathtaking in the best of times, is eye-popping after a year when hedge funds lost 18 percent on average, and investors withdrew money en masse. Government scrutiny, over Wall Street pay and the role all kinds of institutions play in the financial markets, is also mounting. Hedge funds are facing proposals for new taxes on their gains, and on Tuesday, Treasury Secretary Timothy F. Geithner said he would seek greater power to regulate hedge funds.
Some people on the list disputed Alpha’s calculations, which are estimates that include the increase in value of personal investments the managers made in their funds. But none offered different values for their bonuses or the soaring wealth in their funds. To make the cut this year, a hedge fund hotshot needed to earn $75 million, down sharply from the $360 million cutoff for 2007’s top 25. Still, amid the financial shakeout, the combined pay of the top 25 hedge fund managers beat every year before 2006. "The golden age for hedge funds is gone, but it’s still three times more lucrative than working at a mutual fund and most other places on Wall Street," said Robert Sloan, managing partner of S3 Partners, a hedge fund risk management firm. "But this shouldn’t pop up on the greed meter. They made money. That’s what they’re supposed to."
In an interview, Mr. Paulson — whose lofty 2008 earnings were down from the $3.7 billion that Alpha estimated he earned in 2007 — said his pay was high in large part because he is the biggest investor in his fund. In fact, he said he receives no bonus. The pensions, endowments and other institutions that invest in his fund do not mind the hefty cut of profits he and his team take, he said. "In a year when all their other investments lost money, we’re like an oasis," Mr. Paulson said. "We have investors who were invested with Madoff, and they can’t thank me enough," he added, referring to the disgraced financier Bernard L. Madoff. Even as the spotlight intensifies, these hedge fund managers and others who made it through last year with cash on hand are the sort of investors the federal government hopes will step in and buy troubled assets from banks. The richest managers are also in the best position to take advantage of the distressed environment to build their wealth.
"The guys who own the future are the guys like John Paulson and the others on the Alpha list," said Keith R. McCullough, the chief executive of Research Edge, a firm in New Haven that provides trading analysis for hedge funds. "Ironically enough, we’re going to go beg for capital from the very people we’ve been trying to vilify." Mr. Paulson, though, said he did not plan to participate in the new public-private investment program. One hedge fund manager on the list, Paul Touradji, said he understood the public outcry against people who are paid regardless of whether they earned money for their clients. "Wall Street should get paid only when they reward their clients," he said. "For every dollar we made, our clients earned multiples." Mr. Touradji, $140 million richer than in 2007, according to Alpha, said he gave his investors advice by sharing strategies — something rare in the black-box hedge fund world. Last year, for instance, he spotted the commodities bubble early and warned his investors, which include pension funds and endowments, to reshuffle their other holdings, saving them from losses.
Some hedge funds made so much that they had two people on the list. While Mr. Simons of Renaissance Technologies landed the No. 1 spot, one of his partners, Henry B. Laufer, is also on the list with earnings of $125 million. John D. Arnold, an energy trader in his early 30s who was third on the list, with $1.5 billion, did not respond to a request for comment. A spokesman for George Soros, Michael Vachon, said his boss gave away more than half his earnings in 2008. A spokesman for Raymond T. Dalio, who is said to have earned $780 million, said his boss had made so much money because he anticipated the crisis. Two of the three managers who tied for ninth, at $250 million, are based in Britain: David Harding of Winton Capital and Alan Howard of Brevan Howard Asset Management. A second employee of Brevan Howard, Christopher Rokos, also made the list.
Mr. Harding, who runs Winton, said his success last year was part luck, part knowledge from 25 years of hard work in which he often struck a solitary path in a type of trading that had many naysayers. "It is nice to have a golden life and a purpose to engage in, a reason to go to work," said Mr. Harding, who doubted that many people would be willing or able to do his job. "Obviously I wouldn’t have set out to be a futures trader if I hadn’t wanted to make a lot of money." John R. Taylor, the third hedge fund manager who tied as ninth on the list, said even winning hedge funds should acknowledge that they had benefited from the government’s bailout of the banking system. "Thank God for the government, because if they hadn’t intervened, we wouldn’t have had anybody to trade with," said Mr. Taylor, who has run his currency fund, FX Concepts, since the 1980s. But he said he was not grateful to be on Alpha’s list, which he said overestimated his pay by a multiple of five. The last time he received lots of publicity, Mr. Taylor said, was in 1993, and that preceded his worst year ever. "This is bad luck with the trading gods," Mr. Taylor said. "We’re doomed next year if you write about us."
Dear A.I.G., I Quit!
The following is a letter sent on Tuesday by Jake DeSantis, an executive vice president of the American International Group’s financial products unit, to Edward M. Liddy, the chief executive of A.I.G.
Dear Mr. Liddy,
It is with deep regret that I submit my notice of resignation from A.I.G. Financial Products. I hope you take the time to read this entire letter. Before describing the details of my decision, I want to offer some context: I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage. After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials.
In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself. I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.
You and I have never met or spoken to each other, so I’d like to tell you about myself. I was raised by schoolteachers working multiple jobs in a world of closing steel mills. My hard work earned me acceptance to M.I.T., and the institute’s generous financial aid enabled me to attend. I had fulfilled my American dream. I started at this company in 1998 as an equity trader, became the head of equity and commodity trading and, a couple of years before A.I.G.’s meltdown last September, was named the head of business development for commodities. Over this period the equity and commodity units were consistently profitable — in most years generating net profits of well over $100 million. Most recently, during the dismantling of A.I.G.-F.P., I was an integral player in the pending sale of its well-regarded commodity index business to UBS. As you know, business unit sales like this are crucial to A.I.G.’s effort to repay the American taxpayer.
The profitability of the businesses with which I was associated clearly supported my compensation. I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses. In this way I have personally suffered from this controversial activity — directly as well as indirectly with the rest of the taxpayers. I have the utmost respect for the civic duty that you are now performing at A.I.G. You are as blameless for these credit default swap losses as I am. You answered your country’s call and you are taking a tremendous beating for it.
But you also are aware that most of the employees of your financial products unit had nothing to do with the large losses. And I am disappointed and frustrated over your lack of support for us. I and many others in the unit feel betrayed that you failed to stand up for us in the face of untrue and unfair accusations from certain members of Congress last Wednesday and from the press over our retention payments, and that you didn’t defend us against the baseless and reckless comments made by the attorneys general of New York and Connecticut.
My guess is that in October, when you learned of these retention contracts, you realized that the employees of the financial products unit needed some incentive to stay and that the contracts, being both ethical and useful, should be left to stand. That’s probably why A.I.G. management assured us on three occasions during that month that the company would "live up to its commitment" to honor the contract guarantees. That may be why you decided to accelerate by three months more than a quarter of the amounts due under the contracts. That action signified to us your support, and was hardly something that one would do if he truly found the contracts "distasteful." That may also be why you authorized the balance of the payments on March 13.
At no time during the past six months that you have been leading A.I.G. did you ask us to revise, renegotiate or break these contracts — until several hours before your appearance last week before Congress. I think your initial decision to honor the contracts was both ethical and financially astute, but it seems to have been politically unwise. It’s now apparent that you either misunderstood the agreements that you had made — tacit or otherwise — with the Federal Reserve, the Treasury, various members of Congress and Attorney General Andrew Cuomo of New York, or were not strong enough to withstand the shifting political winds. You’ve now asked the current employees of A.I.G.-F.P. to repay these earnings. As you can imagine, there has been a tremendous amount of serious thought and heated discussion about how we should respond to this breach of trust.
As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house. Many of the employees have, in the past six months, turned down job offers from more stable employers, based on A.I.G.’s assurances that the contracts would be honored. They are now angry about having been misled by A.I.G.’s promises and are not inclined to return the money as a favor to you. The only real motivation that anyone at A.I.G.-F.P. now has is fear. Mr. Cuomo has threatened to "name and shame," and his counterpart in Connecticut, Richard Blumenthal, has made similar threats — even though attorneys general are supposed to stand for due process, to conduct trials in courts and not the press.
So what am I to do? There’s no easy answer. I know that because of hard work I have benefited more than most during the economic boom and have saved enough that my family is unlikely to suffer devastating losses during the current bust. Some might argue that members of my profession have been overpaid, and I wouldn’t disagree. That is why I have decided to donate 100 percent of the effective after-tax proceeds of my retention payment directly to organizations that are helping people who are suffering from the global downturn. This is not a tax-deduction gimmick; I simply believe that I at least deserve to dictate how my earnings are spent, and do not want to see them disappear back into the obscurity of A.I.G.’s or the federal government’s budget. Our earnings have caused such a distraction for so many from the more pressing issues our country faces, and I would like to see my share of it benefit those truly in need.
On March 16 I received a payment from A.I.G. amounting to $742,006.40, after taxes. In light of the uncertainty over the ultimate taxation and legal status of this payment, the actual amount I donate may be less — in fact, it may end up being far less if the recent House bill raising the tax on the retention payments to 90 percent stands. Once all the money is donated, you will immediately receive a list of all recipients. This choice is right for me. I wish others at A.I.G.-F.P. luck finding peace with their difficult decision, and only hope their judgment is not clouded by fear.
Mr. Liddy, I wish you success in your commitment to return the money extended by the American government, and luck with the continued unwinding of the company’s diverse businesses — especially those remaining credit default swaps. I’ll continue over the short term to help make sure no balls are dropped, but after what’s happened this past week I can’t remain much longer — there is too much bad blood. I’m not sure how you will greet my resignation, but at least Attorney General Blumenthal should be relieved that I’ll leave under my own power and will not need to be "shoved out the door."
Sincerely, Jake DeSantis
Jim Rogers: The Dollar is Doomed
Jim Rogers on China
The new toxic and bad legacy assets programs of the US Treasury: surreptitiously squeezing the tax payer and the Fed until the PPIPs squeak
by Willem Buiter
Ecce! The Public Private Partnership Investment Program (or should that be the Public-Private Investment Program?) is here, albeit not yet with quite enough information on some of the key practical details to make a full assessment. A picture is worth a thousand words, so here is my transcription of a picture from the US Treasury’s own website:
There is very little Treasury money in it. The first thing that struck me is how little money the Treasury appears to be putting in. On reflection, this is not surprising. The government simply has no money in the kitty to recapitalise banks or purchase toxic or bad assets on any scale. Of the $700bn TARP money, no more than $300 bn is left. The Congress is in one of its more infantilist phases and will not, unless and until the threat of utter financial collapse becomes even more apparent, appropriate new money for saving US banking. If future recapitalisations of US banks (and other systemically important institutions), the cleaning of the balance sheets of legacy toxic assets and guarantees or subsidies for new lending and borrowing are constrained to cost no more than $300 bn, God help us all. If we have to wait too long for reality to dawn on the dunderheads in Congress, the decimal point on the $300.00 bn will surely have to be shifted one place to the right.
The present and previous administrations have not helped themselves by failing to realise that it is possible to saving banking - the activities, that is, lending, deposit-taking and borrowing - without saving the existing banks. If they did realise this, they failed to act on the realisation. The US Treasury is putting at most $100 bn into the PPIP pot. "Using $75 to $100 billion in TARP capital and capital from private investors, the Public-Private Investment Program will generate $500 billion in purchasing power to buy legacy assets - with the potential to expand to $1 trillion over time." The programme is hoped to do up to $1000 bn worth of toxic and bad legacy asset purchases. Hope is good. Cash is better. Where is the remaining $900 bn going to come from? The answer is loans or loan guarantees from the FDIC and the Federal Reserve and co-investment with private sector investors. The answer differs for the two components of the PPIP, the Legacy Loan Program and the Legacy Securities Program. I will take them in turn. The two tables below, with their illustrative examples, are again taken from the US Treasury’s own website.
The total amount of money put at risk by the private investor in this example is $ 6, the private equity investment. The Treasury would also be on the hook for $6, its 5o% share of the total equity investment. The FDIC would lend $72 or guarantee lending of that amount. That’s what meant by the FDIC being "…willing to leverage the pool at a 6-to-1 debt-to-equity ratio." First note that the public sector as a whole (Treasury plus FDIC) is at risk for $78 out of a total investment of $84. The public sector has the same upside as the private sector (through its $6 worth of equity). However, the private sector gets this upside by putting only $6 at risk, against the public sector’s $84 at risk. Small wonder the stock markets loved this. If there were a stock market for taxpayer equity, it would have tanked by a commensurate amount.
It must be recognised that the FDIC is in this picture only for cosmetic, window-dressing reasons. The FDIC has no resources of its own to spend on leveraging the PPIP. It cannot raise taxes and it cannot print money. It obtains revenue from the insurance premia paid by the banks whose deposits it insures, but that is hardly a secure source of income at the moment, let alone one that can be expanded drastically, should the need arise. What little money the FDIC has is earmarked to meet future claims of depositors insured under its Deposit Insurance scheme (Congress has temporarily increased FDIC deposit insurance from $100,000 to $250,000 per depositor through December 31, 2009). The FDIC has no money to spare. Indeed, if any major deposit-taking bank were to go belly-up, the FDIC would have to rush to the Treasury for money.
The FDIC’s lending or guarantee of the loans to the PPIP is no more than a convenient way to move the Treasury’s exposure into supposedly independent ‘government agency land’. The Treasury could have provided the loans or the guarantees itself. As a guarantee involves only a contingent claim on the entity providing it, a Treasury guarantee would have created an off-balance-sheet liability for the Treasury. Given the constrained state of the Treasury’s resources, even that was apparently deemed too much for comfort, and the FDIC was stuck with the task of providing the guarantee. In substance, however, this is a Treasury guarantee. The FDIC is there only to confuse Congress by making it difficult to follow the money.
Under the Legacy Securities Program, the Treasury will provide equity of $100 for every $100 of private equity put in. The Treasury will also lend up to $200 for each $100 of private equity. So the Treasury puts at risk $300 to gain the same upside that the private sector will only put $100 at risk for. Nice work if you can get it (if you work in the private sector). Again, the tax payers’ stock takes a hammering.
Enter the Fed
The Legacy Securities Program further enhances the quasi-fiscal role of the Fed, and turns the Fed even more blatantly into an off-balance sheet and off-budget special purpuse vehicle of the US Treasury. It does this by extending the scope of the Term Asset-Backed Securities Lending Facility (TALF) to legacy asset-backed securities (especially mortgage-backed securities, residential and commercial and consumer debt-backed securities). The original TALF was created to lend up to $1000 bn to private institutions willing to invest in newly originated mortgage-backed securities. The US Treasury only guarantees up to $100 bn of this proposed lending, so in the worst-case scenario, the Fed could be in the hole for $900 bn, through its exposure to private credit risk. I assume that this expansion of the scope of the TALF to include legacy assets will take place within the overall total ceiling of $1000 bn set for the TALF, but I fear that greater demands on the Fed will be made through the TALF in the future than is currently envisaged.
The role of the Fed in the PPIP, through the expanded TALF, is deplorable. First, the main redeeming feature of the TALF was that it was focused on new securitisations of mortgages, in an attempt to revive the market for new securitised mortgages and through it new mortgage lending. Diverting these resources to the ex-post insurance of losses that have already been made on legacy MBS (commercial and residential) and legacy consumer debt-backed securities is a serious waste of scarce public resources. Using the good bank model of Bulow and Klemperer, Hall and Woodward, Buiter, Romer, Stiglitz and Soros, public resources (whether in the form of capital, guarantees, insurance or other subsidies, should be directed exclusively at new lending and borrowing by banks. The legacy toxic and bad assets should be left with the shareholders and unsecured creditors of the ‘rump’ legacy bad banks, consisting of the old banks, minus insured deposits and good assets, plus the equity in the new good bank, minus their banking license, and minus any future government financial support.
The Fed is the financier of last resort for the PPIP
In the joint statement of the Board of Governors of the Federal Reserve System and the Department of the Treasury of March 23, we find the assertion that the "Treasury has in place a special financing mechanism called the Supplementary Financing Program, which helps the Federal Reserve manage its balance sheet. In addition, the Treasury and the Federal Reserve are seeking legislative action to provide additional tools the Federal Reserve can use to sterilize the effects of its lending or securities purchases on the supply of bank reserves."
I would welcome the extension of the Fed’s arsenal to include the ability to issue Fed Bills and Fed Bonds, similar to Treasury Bills and Treasury Bonds, that is, non-negotiable interest-bearing bearer bonds, so the Fed can expand its balance sheet without expanding the monetary base. At the moment, sterilisation of the monetary base impact of private sector asset purchases by the Fed either requires the Fed to reduce its holdings of Treasury securities (which could become exhausted) or it requires the US Treasury to engage in Treasury Bill or Treasury Bond sales, with the proceeds from the sale deposited in the Treasury’s deposit account with the Fed, which does not count as part of the monetary base. The Supplementary Financing Program (created on September 17, 2008) is just the last of the two options mentioned above: The Treasury sells "…a series of Treasury bills, apart from Treasury’s current borrowing program, which will provide cash for use in the Federal Reserve initiatives."
None of this addresses the issue of the massive private sector credit risk the Fed is taking on its balance sheet, a risk greatly enhanced by the modification of the TALF to include legacy toxic assets. Even if the short-run consequences for the monetary base of enhanced Fed operations under the TALF are sterilised, the Fed will, should it suffer major capital losses on its investments in private sector securities, have no option but to expand the monetary base to maintain its solvency, unless the US Treasury comes to its rescue. The terms of the TALF (with the US Treasury guaranteeing only 10 cents on the dollar, if the full $ 1 trillion is lent by the Fed) suggest that the US Treasury cannot and will not come to the rescue of the Fed. Monetisation of the Fed’s capital losses and inflation will be the inevitable consequence of the lack of fiscal firepower of the US sovereign. This threat of future inflation from Fed decapitalisation through losses on its portfolio of private assets is in addition to the threat of future inflation caused by doubts about the reversibility of the Fed’s forthcoming purchases of Treasury securities through its quantitative easing (QE) policy. The recent Chinese comments on finding/creating a substitute for the US dollar as the international reserve currency demonstrate that concerns about the medium-term and long-term inflation consequences of the Fed’s QE, its credit easing and its quasi-fiscal rescue efforts of large US banking and shadow-banking institutions, are growing.
The plan muddles up toxic assets and bad assets
The legacy assets to be purchased by the two legs of the PPIP are legacy securities and legacy loans. The legacy securities are toxic assets. Toxic assets are assets whose value cannot be established with any reasonable degree of accuracy, because there are no liquid markets for them and because their complexity prevents too much faith being put in mark-to-model valuations. The legacy loans, however, are just bad assets. They are plain vanilla household and commercial loans that have become impaired. Their value can be calculated quite readily by any reasonably competent banker. It is likely to be low relative to the notional or face value of the loan. That’s sad and too bad, but not a reason for getting the state involved through the PPIP. By bundling toxic assets and bad assets, the Treasury muddles up price discovery issues and the recapitalisation of or subsidies to loss-making banks.
Participation is voluntary where it ought to be mandatory
Banks with toxic assets on their balance sheet can choose to keep them there rather than participate in the Legacy Loans or Legacy Securities Programs. Citigroups and Bank of America already have government insurance/guarantees for hundreds of billions worth of toxic and bad assets. They are not going to be in a hurry to clear their balance sheets. By making participation voluntary the Treasury has created an adverse selection machine. Only those whose toxic or bad assets are priced higher than the reservation value of the banks who hold them will offer them for sale. Surely, the designers of the scheme must have read George Akerlof’s famous ‘lemons’ paper (JSTOR access required)? Participation in the programs should have been mandatory for all FDIC-insured banks with balance sheets in excess of $100 billion.
The proposal safeguards all unsecured creditors
The Treasury is desperate to make whole anyone senior to the holders of preference shares (possibly even anyone senior to ordinary shareholders) in the capital structure of the banks. Two quotes from Geithner’s Opinion piece in the March 23 Wall Street Journal make this clear.
"This requires those in the private sector to remember that government assistance is a privilege, not a right. When financial institutions come to us for direct financial assistance, our government has a responsibility to ensure these funds are deployed to expand the flow of credit to the economy, not to enrich executives or shareholders."
"Our nation deserves better choices than, on one hand, accepting the catastrophic damage caused by a failure like Lehman Brothers, or on the other hand being forced to pour billions of taxpayer dollars into an institution like AIG to protect the economy against that scale of damage."
So unsecured creditors other than insured depositors, which get recourse up to $250,000.00 from the FDIC, are off the hook - even those holding subordinated debt. Because even the holders of senior unsecured bank debt have earned interest rates higher than those on Treasury debt of similar maturity, it was clear that such senior unsecured bank debt was subject to default risk. The investors in such risky instruments should not get ex-post insurance from the tax payer, after cashing in the ex-ante excess returns over Treasuries. Treasury Secretary Geither also appears to accept at face value the assertion that the failure of Lehman caused catastrophic damage. Although I accept that the failure of Lehman was handled very badly by the authorities and did unnecessary damage, I also believe that it was, even at the time the choice was made to pull the plug, the right thing to do. The ‘rescue’ of Merrill Lynch by Bank of America undoubtedly did more damage, both to the institutions directly involved and to the reputation and stability of the US financial sector. In any case, the uniquely vulnerable category of stand-alone US investment banks, without a special resolution regime (SRR) and the associated prompt corrective action (PCA) apparatus, no longer exists. No US bank is too large or too interconnected to be put into the SRR administered by the FDIC.
Will it stop banks from failing?
The answer depends in part on how generous the valuations are that are put on the legacy securities and loans. I fear that, despite the involvement of competing private parties with responsibility for valuing the toxic securities, the assets will only leave the balance sheets of their owners at a price well above fair or fundamental value. That represents a poor use of public resources, and an unnecessary one, if the government were to pursue one of the ‘good bank’ solutions on offer. The one consolation is all this is that the amount of money the Treasury is putting on the table ($100 bn at most) and the money the FDIC can honestly put on the table (zero) amount to so little that not too much damage is done by wasting it on the PPIP. My worry is that the Fed will be induced to put a lot more than this on the table. I can easily envisage a situation where, directly or indirectly, the Fed finances $800 bn or so of the $ 1 trillion envisaged for the PPIP. That would be a huge waste of public resources, as well as a deplorable debauching of the Fed.
The proposal encourages price discovery for the toxic assets.
To reduce the likelihood that the government will overpay for these assets (or perhaps better: to reduce the magnitude of the virtually certain overpayment for these assets), private sector investors competing with one another will establish the price of the loans and securities purchased under the program. This is valuable even if it were to just reveal something closer to fundamental or fair value for the existing toxic assets, because it would reduce the size of the subsidy of the tax payers to the shareholders and unsecured creditors of the banks. It would be even more valuable if some of the toxic assets belong to asset categories that do have a long-term future, but that have become temporarily illiquid due to exceptional and extraordinary circumstances. My suspicion is that rather few of the toxic assets will turn out to fall into these potentially sustainable categories. Most of the CDO junk, and indeed most of the fancier securitisations ought never to have been created in the first place and, with a bit of luck, will never be created again. There are therefore unlikely to be major market-recreation benefits from the price discovery in the Legacy Securities Program.
The PPIP is a bad program, but it could have been worse. With the Treasury out-of-pocket and not yet properly staffed at the key senior levels, it is amazing an almost-implementable plan was birthed at all. Even within the parameters of the PPIP, it should have been made mandatory for all US banks with a balance sheet over $100 billion, to offer up for sale/auction all their asset-backed securities and other complex structured products. The impaired but non-toxic loan arm of the PPIP should have been omitted altogether, because - unless the Fed goes wild under a much expanded TALF. There simply is no money to do it on any scale. It would have been preferable to nationalise the dodgy banks (they know who they are), possibly by using the SRR, and to pursue a good bank - bad bank solution for them. Even better would have been to use the SRR to pursue a good bank solution along the lines of Bulow-Klemperer and Hall-Woodward for the majority of the large, cross-border US banks.
Doing anything right, effectively and honestly would, however, require much more than the $100 bn the US Treasury is willing/able to put up - much more even than the $300 bn that is still in the TARP kitty. Indeed more that the $1 trillion that is the current limit of the Treasury’s ambitions. When the Treasury talks about ‘leveraging’ tax payers’ money, it is talking window-dressing and financial shenanigans. In the TALF, the US Treasury is ‘leveraging’ the US tax payer 10 to 1, by debauching the Fed. US citizens will not thank the Treasury for that in the future. The abuse of the innocent word ‘leverage’ and the repeated use of special-purpose vehicles and off-balance-sheet entities to hide the economic and financial reality from scrutiny, reveal how close current and past Treasury officials are to the very practices that brought the US private financial sector to its knees. So stop ‘leveraging’ the tax payers’ money. Stop using the Fed as an opaque SPV of the Treasury. Tell the people the truth. Ask for more resources and pay for them by raising taxes or cutting public spending.
How Big Is That Widening Gyre of Floating Plastic?
In the Pacific, Ocean Flows Sweep Litter Into a Flotilla That Could Be the Size of Quebec or Maybe the U.S. -- No One Knows
A soup of plastic debris floats off the coast of California, a testament to humanity's reliance on plastic and the failure to dispose of it properly. Just how big is this oceanic zone? Some say it is about the size of Quebec, or 600,000 square miles -- also described as twice the size of Texas. Others say this expanse of junk swept together by currents is the size of the U.S. -- 3.8 million square miles. Or, it could be twice that size. The Great Pacific Garbage Patch, as it has been called, has become a symbol of what some say is a looming crisis over trash. But this floating mass of plastic in the Pacific Ocean is hard to measure, and few agree on how big it is or how much plastic it holds. That makes it difficult to determine what to do about it.
That hasn't stopped activists and the media from using only the biggest estimates of the patch's size to warn of an environmental catastrophe. "We've found it really captures the public's imagination and its focus," says Eben Schwartz, marine-debris program manager for the California Coastal Commission, a state agency. However, "as hard as [environmental advocates] try to characterize it accurately, it is prone to mischaracterization." The plastic-rich portion of the ocean is a product of swirling currents, known as the North Pacific Subtropical Gyre, that gather and concentrate debris. It captured public attention thanks to the efforts of Charles Moore, a woodworker-turned-sea captain who sailed through the zone in 1997 and was stunned to find plastic debris hundreds of miles from land. "That set off alarm bells and made me want to monitor it, made me want to quantify it, made me want to get a better handle on it," says Capt. Moore, a licensed merchant-marine officer. He dedicated the Algalita Marine Research Foundation that he had founded to studying this region of the ocean and publicizing its plastic problem.
Researchers at the foundation have attempted to quantify the gyre by sailing deep into the Pacific and trawling for plastic and zooplankton using a contraption that resembles a manta ray. Sifting through the entire gyre for plastic would be impossible, so researchers survey a small sample. But it is difficult to know how to extrapolate their findings to the entire region, or even what that region is. The borders of the gyre shift between seasons, and some scientists, such as Holly Bamford, director of the National Oceanic and Atmospheric Administration's marine-debris program, argue that the high-plastic area is confined to a relatively small part of the gyre. "I admire Charles," says David Karl, an oceanographer at the University of Hawaii. But Capt. Moore's estimate of the size of the plastic patch -- up to twice the size of the U.S. -- strikes Prof. Karl as guesswork. "He doesn't know the edge" of the area.
Capt. Moore has relied on models of ocean currents from a retired NOAA scientist to help estimate the scope of the concentrated-plastic zone, with debris lurking, often in tiny, barely perceptible pieces, at or just below the surface. "I just did a very crude estimate, by getting a globe and placing my hand over the area defined by this current, and placing my hand over the continent of Africa" to see how the two compared, he says. "The condensed-soup part may be considerably less than the whole," he concedes, but he is frustrated by critics who play down the scope of the problem without doing any fieldwork.
Even as the debate over the plastic patch's size continues, some of the foundation's estimates have been reported as scientific certainty. For instance, a decade ago, researchers found that the ratio of plastic to zooplankton by mass was six to one. A more-recent visit turned up an increase in this ratio, to 46 to one, according to the foundation's Web site. But that is an average of the ratio at each testing site, which included some very high ratios, probably anomalies. A more comparable figure is eight to one, representing a more modest increase when results are aggregated across all testing sites. In addition, comparing plastic and plankton weight might not be an ideal way to measure the problem, according to Angelicque White, a biological oceanographer at the University of Oregon who accompanied Prof. Karl on a recent voyage to the gyre. Dr. White points out that many plankton are too small for the nets, and might not have been included in the count. What's more, while the heaviest bits of plastic inflate the measure of the debris patch, those pieces pose less of an environmental threat, because they are too large for marine creatures to mistake for food.
Capt. Moore said that his scientific papers have made these distinctions clear. But news articles generally haven't. Dr. Bamford says inconsistent units of measurement of the plastic problem have impeded research. "We're trying to develop a standardized method," she says of NOAA, "so we can really get a handle on how this compares to various locations around the world." It's possible that consistent measurement will reveal that other parts of the ocean without a catchy name are just as plastic-rich, or more so. Some misinformation comes from other environmental groups exaggerating the alarming research. Environmental advocate David Suzuki has written of a "massive, expanding island of plastic debris 30 meters [98 feet] deep and bigger than the province of Quebec." Asked whether the high-plastic region could really be called an island, Bill Wareham, senior marine conservation specialist with the David Suzuki Foundation, says, "It's not going to look like island in the context of, 'Gee, I can walk across that.' But it is a very high density of plastic." He adds, "David speaks in a way where he's framing the issue in a way people can understand it."
Other advocates object to such terminology. "The problem with superlative statements that this is somehow a huge floating mass of plastic is that they inevitably lead to desensitizing people when they learn the truth of it," says David Santillo, a senior scientist with Greenpeace. Even if scientists and advocates could agree on numbers for the size and plastic concentration of the gyre, it is unclear what they would do with the information. Plastics can harm ocean birds and mammals who eat it, because they carry toxins, can pierce internal organs and can trick animals into thinking they are full. But hard numbers are tough to come by. "It's so hard to say a bird died due to plastic in its stomach," says Dr. Bamford. "We have seen birds mature and live out their whole life, and necropsies show plastic in their stomach."
Though no one thinks any possible benefits of plastic outweigh risks, Prof. Karl did find some positive aspects of the patch -- a high concentration of microorganisms clinging to the debris. "The microorganisms are good for the ocean, because it turns out they're making oxygen," Prof. Karl says. "If plastics were otherwise neutral to the environment, then they'd be helping by harvesting more solar energy." Dr. Bamford says it is possible that a cleanup, even if it were feasible, would do more harm than good, by removing these organisms. Capt. Moore says quantifying the plastic could provide a starting point for measuring the effectiveness of land-based efforts to choke the flow of plastic to ocean waters. "I would love to have a government agency form a concerted program to quantify the debris," he says. "It's a tragedy of the commons: Nobody owns the problem."