Negroes and shop front. Vicksburg, Mississippi
Ilargi: US Treasury Secretary Tim Geithner and SEC chief Mary Shapiro seek more power to control banks and other financials. There are a few things that don't fit that picture. First, neither have shown any demonstrable good deeds since they got their new jobs.Of course, I know, they'll blame that partly on the fact that they don’t have the additional powers. Funny how things always work out that way.
Another problem with the new powergrab is for instance that the SEC pre-Shapiro has almost actively sought not to use its regulatory powers. Just look at Bernie Madoff, and he's only a minor case in which the agency has neglected to do its work.There's a new person at the helm, sure, but does that guarantee a change large enough to change the entire agenda? No, of course not. The rest of the crew is nicely humming along as if nothing happened. Which happens to be the SEC's signature favorite pastime.
The first thing that needs to be done is for a team of independent experts to look at how both the SEC and the Treasury have used their existing might, and only after that maybe grant them what they demand now. If it turns out that both are either not capable of executing their present tasks, or are indeed outright corrupt and corrupted, then they shouldn't get any added tools, since these would only be used in the same ways that have led to their past failures.
But most of all, and this ties in with the possible corruptness in Washington, we should make sure the parties that the agencies allegedly seek to regulate, the large funds and financials, have no influence on the policies that are developed and executed. The Treasury needs to be completely shut off and divorced from Wall Street. It’s obvious where the main problem is then, isn’t it? The entire Obama economic team consists of people with Wall Street ties that are so strong they might as well be Kevlar umbilical cords.
Any additional powers would therefore simply be handed over to the same institutions that the government agencies seek to regulate. Granting those powers would be the most braindead move that America could make. It would provide a bunch of bankrupt institutions with the tools to de facto regulate themselves, and moreover give them even more access to the public trough, which would let them keep on pretending they are solvent going concerns. If we allow that to happen, we might as well look for some nice pieces of rope for ourselves and our children. Then again, what are the chances that the bankers' stranglehold on Washington will be broken, let alone in a peaceful way? If ever in the next two years you find yourself wondering why the problems in the economy keep on getting worse and deeper, despite the tens of trillions of dollars thrown at them, you need look no further then this. There's a new sheriff in town, and his deputies are on the Dalton Brothers' payroll.
We all know that any call for an independent assessment of how the Treasury and SEC function will be swept off the table with an appeal to reasons of national security. So in the end, your security depends on a bunch of bankrupt and corrupted corporations, and you have no way of finding out what they do, either in their own ivory towers or in the offices of your elected officials. How does that feel?
China: Financial System Better Red Than Dead
Beijing thinks developed economies 'excessively believe in the role of markets.'
The schoolyard fight between China and the United States that initially focused on the dollar's future escalated Thursday, as China said America should do some soul-searching before it tries to fix the economic crisis. In a 5,000-character report by the research arm of the People's Bank of China, authorities said financial regulators, specifically in Washington, are not doing enough and hold "wrong ideas," such as that the least regulation is the best regulation. The report said financial regulators in developed economies "excessively believe in the role of markets."
The comments follow a series of volleys back-and-forth between U.S. and Chinese officials who all commented the last few days on whether the dollar should remain the world's reserve currency. It all kicked off Monday when Governor Zhou Xiaochuan of the People's Bank of China proposed that the dollar be replaced. U.S. Treasury Secretary Timothy Geithner and former Fed chief Paul Volcker weighed in, saying they do not see the dollar disappearing anytime soon. The timing of these comments -- ahead of the April 2 meeting of the Group of 20 large industrialized and developing countries in London -- and whether China really believes what it is preaching remains to be seen.
"A lot of countries are concerned that the U.S. is the only superpower, this is a way to make them more accountable," said Marc Chandler, chief global currency strategist at Brown Brothers Harriman. "China's saying the U.S. is kind of like Spiderman: they have special powers so they should have special responsibilities." But all this talk will not lead to countries ditching the dollar for, say, the euro, Chandler said. The proof, Chandler said, is that in the second half of last year, China increased its dollar holdings by 38.0% and continued buying through January. "Central banks have their choice, and they're choosing," he said.
That won't prevent China from talking the talk. Authorities in Thursday report also said financial regulators in Western countries should carry out "self-criticism" before they try to reform the financial system. But China is highly invested in the current system, which is very dollar-dependent, as are other developed and developing countries. During the last five years, world reserve holding through the third quarter of 2008 in dollars increased by 103.4%, while euro reserves during that same period rose 119.8%.
Meanwhile, the value of the euro rose 20.6% in that time compared with the dollar, showing that even though the currency's value rose, central banks maintained their dollar positions. China's alternative to the dollar was to suggest the introduction of an apolitical world currency, namely the International Monetary Fund'sspecial drawing rights, a basket of currencies including the dollar and the euro. But any such adoption of the SDR, as the IMF's currency is called, is unlikely to happen: the United States, which is the major funder of the organization, controls 16.8% of the IMF's voting shares, giving it effective veto power over any decisions.
The Bond Market's Supply-Side Dilemma
What if they gave a bond auction and nobody came? That specter hung over the global government debt markets Wednesday as an offering of U.K. gilts "failed" while the sale of U.S. Treasury notes met with tepid demand. But reports of the demise of government securities markets as a result of their choking on the supply of securities to finance huge budget deficits are, for now at least, premature. Even so, fixed-income investors appear not to have an unlimited appetite for government debt at current, relatively paltry yields. The British government's sale of 40-year bonds drew fewer bids than the 1.6 billion pounds of securities being offered, the first time a U.K. gilt auctioned failed since 2002. More pointedly, Wednesday's failed auction came a day after Bank of England Governor Mervyn King warned the U.K. government to be "cautious" about further expanding deficits.
On the American side of the Atlantic, the Treasury's sale of five-year notes drew a tepid response, with the ratio of bids to securities offered at the low end of the normal range, resulting in a higher-than-expected yield of 1.849% vs. 1.80% in when-issued trading at the 1 PM EDT auction deadline. Nevertheless, the sale still attracted more than twice the volume of bonds being offered, which the market views as the minimum for an auction to be considered marginally successful. What's also interesting was that bond buyers on both sides of the Atlantic were shying from purchasing new government issues on the same day their respective central banks were in the market buying securities.
Both the Bank of England and the Federal Reserve were conducting open-market purchases as part of the "quantitative easing" campaigns to stimulate credit and their economies. But the central banks' plans for massive bond buying may ironically be part of the markets' problem. When the Fed announced plans a week ago to purchase $300 billion of Treasuries along with another $800 billion of agency debt and mortgage-backed securities, yields went into a free fall. The benchmark 10-year Treasury yield fell more than a half percentage point, from over 3% to about 2.5%. That, indeed, was the aim of the Fed's purchases, to bring down longer-term rates. And the move had some of the desired effect, which was evidenced in a surge in mortgage applications in the latest week.
While prospective borrowers are cheering sub-5% fixed-rate home loans, the lowest in a half century, bond buyers may be resisting paltry yields. The Treasury 10-year yield has retraced more than half of its decline of last week, to end Wednesday at 2.79%. And given the unending slate of new auctions on both sides of the Atlantic, investors simply may require higher yields than what's being offered in the government markets. Vastly better returns are available elsewhere in the U.S. debt markets. For instance, Verizon was able to sell $1.75 billion of 10-year notes Tuesday at a 6.554% yield and $1 billion of 30-year notes at 7.494%. These single-A securities provide more than twice the yield of comparable Treasuries, some 3.875 percentage points over the benchmarks.
In the municipal market, California's offering of general obligation bonds was substantially oversubscribed -- albeit at a price. Spurred on by an aggressive advertising campaign -- even with commercials on New York City radio stations—the Golden State was able to sell $6.54 billion of bonds but with tax-exempt yields of as much as 6.1% -- equivalent to 9.38% for out-of-state investors in the highest federal tax bracket and even more for California residents. The financially beleaguered state has among the lowest credit ratings in the nation, but still a solid single-A by Standard & Poor's and the equivalent from Moody's Investors, single-A2. Given the competition for bond buyers' dollars and massive supply of securities sovereign governments need to sell to fund their budget gaps, they may face the prospect of having pay up.
Surge in short selling clouds rally prospects
Short interest on the New York Stock Exchange rose to its highest level since the collapse of Lehman during the month to mid-March and at its highest rate in more than a year as hedge funds increased their bets against the rally in US equities during that period. From February 27 to Friday March 13, the benchmark S&P 500 index rose about 3 per cent, prompting talk among participants of a lasting rally in the US stock markets, which have been battered by the recession. But over that two-week period, as the equity market rallied, short interest rose to 4.2 per cent of all shares outstanding, up from 3.8 per cent at the end of February.
Short sellers aim to profit from betting on falling stocks prices. They borrow shares and then sell them, hoping to buy the shares back at a lower price, return them to the lender and keep the difference. The broader stock market rally was eclipsed by several prominent stocks, but short sellers took the view that the gains by these stocks, particularly those most affected by the crisis so far, were unsustainable. For example Citigroup, which was down 79 per cent for the year to the end of February, rose 19 per cent over the first two weeks of March. But short sellers appeared to take the view that the gains were unsustainable and increased their short position in the stock by almost five times over that period.
In fact Citigroup was the most shorted stock on the NYSE over the period with a short position of 998.7m shares. The second most shorted stock was Ford Motor , followed by General Electric, AIG and Bank of America. Borrowing securities to short has become more difficult and expensive in recent times as pension funds and endowments have cut back the amount they lend out to custodians and third-party lenders. US regulators are pondering the best way to regulate the activities of “naked” short sellers whom many blame for mounting bear raids on companies which can artificially drive down their share prices and even push them to failure. The largest US stock exchanges earlier this week urged US regulators to adopt a modified version of the so-called uptick rule, originally conceived during the 1930s, which they claim would curb abusive short selling.
The Securities and Exchange Commission considers reinstating the uptick rule after coming under political pressure to take action against short sellers.
The original rule – abolished on July 6, 2007, just as the credit crunch was slipping into high gear – prevented stocks from being shorted unless the last tick in their price was up. The rule was implemented after the 1929 market crash to prevent short sellers from driving the price of a stock down in a bear run. By the modified uptick rule the exchanges are proposing that short selling could be initiated only by posting a quote for a short sale order priced at more than the prevailing national bid. The SEC is scheduled to meet on April 8 to consider proposals for restricting abusive short selling.
Ilargi: They all keep on acting as if protectionism is something that could be prevented. Of course it can't.
WTO Report Warns of Threat of Protectionist Measures
A steady buildup of protectionist measures could "slowly strangle" international trade and undercut the effectiveness of national stimulus plans, according to a report the World Trade Organization sent its 153 members Thursday. However, the WTO added, the world will be spared "an imminent descent into high intensity protectionism" such as occurred during the Great Depression of the 1930s, thanks to existing trade treaties that cap tariffs on imports. Pascal Lamy, the director of the WTO, has been frustrated by countries' unwillingness to sign a new global trade deal since the eight-year-old Doha round of talks collapsed last summer. Since the beginning of 2009, there has been "significant slippage" in the global commitment to free trade due to the global economc crisis, the WTO said Thursday. "There have been increases in tariffs, new non-tariff measures, and more resort to trade defense measures such as anti-dumping actions."
Mr. Lamy believes he can shame countries into cutting back on protectionist measures, aides say. The report repeats the agency's recent analysis of trade trends, such as the WTO's prediction that global trade will shrink 9% this year. The report also lists examples of the measures countries are undertaking to protect their companies and economies -- everything from European import tariffs on Asian plastic bags to a ban on Chinese toys in India. In March alone, South Korea raised import tariffs on oil, Mexico raised tariffs on 89 U.S. goods, Ukraine slapped an extra 13% tariff on all imports, the U.S. raised duties on imports of Chinese steel pipes and Argentina mandated a special license for toy imports.
"Country after country are establishing trade barriers to protect parochial domestic interests," says Richard Weiner, a trade lawyer with Chicago-based Sidley Austin LLP. "The end result will be to deepen the crisis and prolong the pain." Certain sectors are more vulnerable than others to protectionism, the WTO said. It mentions shoes, cars and steel. Argentina, Brazil, Canada, Russia, Ecuador, Ukraine have recently raised import duties on shoes, mostly from China and Vietnam. Twelve countries have acted to help their automobile industries. The U.S., Brazil and France have handed out generous loans. India has required licenses and Argentina has set prices for importation of foreign car parts. Ten countries, and the EU, have raised tariffs on imported steel.
The WTO praised some nations for explicitly promoting trade. Argentina has eliminated export taxes on 35 dairy products. Brazil has expanded a program to give loans to exporters. China has scrapped imports tariffs on steel plates. The Philippines has cut tariffs on wheat and cement. "More trade policy initiatives of this kind, particularly if they were to be taken collectively by the major trading countries, would make an impact on a global scale," the WTO said. Some poorer WTO members oppose Mr. Lamy's reports because they say it neglects to blame the culprits. Angelica Navarro, Bolivia's ambassador to the WTO, says the U.S. and EU should shoulder blame for the rise of protectionism. "The financial crisis started with them," she says.
After hearing out the concerns of Ms. Navarro and others, WTO officials agreed to give members more say in drafting the report. They also softened the language. Thursday's paper includes a disclaimer, which underscores the limits of the WTO's power: "The inclusion of any measure in this table implies no judgment by the WTO Secretariat on whether or not such measure, or its intent, is protectionist in nature."
U.S. Economy Shrank 6.3% in Fourth Quarter as Profits Fell 16.5%, Most Since 1953
The U.S. economy shrank in the fourth quarter more than previously estimated, leading to the biggest plunge in corporate earnings in a half century and underscoring why companies are slashing payrolls this year. Gross domestic product contracted at a 6.3 percent annual rate from October to December, the weakest since 1982, the Commerce Department said today in Washington. Profits dropped 16.5 percent from the prior quarter, the most since 1953. Another report showed the number of people collecting jobless benefits this month reached a record 5.56 million as firings mounted. Still, recent reports showing a rebound in sales indicate last quarter’s slump may give way to smaller declines in growth. A let-up in the recession would set the stage for President Barack Obama’s stimulus plan and Federal Reserve measures to take hold in the second half.
"It’s a pretty dismal result," said Michael Gregory, a senior economist at BMO Capital Markets in Toronto. "Given the slight improvement we’re seeing in some of the recent indicators, I suspect the first quarter will be a little better than the fourth." Initial claims for jobless benefits last week rose 8,000 to 652,000, topping 600,000 for an eighth straight time, the Labor Department reported. Total benefit rolls jumped by 122,000 in the week ended March 14, from 5.44 million the previous week, as job cuts spread from manufacturers and construction companies to services such as government agencies and health-care providers. Stock-index futures held earlier gains following the reports on speculation the economy may be past the worst of the downturn. Futures on the Standard & Poor’s 500 index were up 1.2 percent at 817.5 at 9:21 a.m. in New York. Treasuries were little changed.
The drop in GDP, the sum of all goods and services produced, was larger than the 6.2 percent decline estimated by the Commerce Department last month. The median forecast of 69 economists in the Bloomberg survey called for a 6.6 percent decrease, and estimates ranged from declines of 7.1 percent to 6 percent.
This is the final of three estimates the government issues on economic growth. The world’s largest economy shrank at a 0.5 percent annual rate from July through September. For all of 2008, the economy grew 1.1 percent, the same as previously estimated, as exports and government tax rebates in the first six months helped offset the slump in consumer spending that followed. Earnings adjusted for the value of inventories and depreciation of capital expenditures, known as profits from current production, fell by $250.3 billion from the third quarter, the biggest decrease since records began in 1947.
For all of last year, profits were down 10.1 percent, the biggest annual drop since 1970. Consumer spending, which accounts for about 70 percent of the economy, fell at a 4.3 percent pace last quarter, marking the first back-to-back decreases in excess of 3 percent since record-keeping began in 1947. Retailers are doing better so far this year. Sales fell less than forecast in February and January’s 1.8 percent gain was the biggest in three years, Commerce reported earlier this month. Other drags on growth are also moderating. Builders broke ground on 22 percent more homes in February than in the previous month and sales of new and previously owned houses also increased, erasing some of the gloom surrounding the market.
A bigger reduction in inventories than previously estimated accounted for most of the GDP revision. Companies cut stockpiles at a $25.8 billion annual rate, compared with a previous estimate of $19.9 billion. Fewer goods on hand lay the foundation for growth in 2009 as manufacturers gear up to meet any improvement in demand. Inventories of long-lasting factory goods fell 0.9 percent in February after dropping 1.1 percent in January, the biggest two-month slide since 2003, Commerce figures showed yesterday. The decrease brought the ratio of inventories to sales down for the first time in seven months. "Inventories are getting low enough in some sectors that stocks might need to be replenished," said David Resler, chief economist at Nomura Securities International Inc. in New York. "It’s encouraging news that the economy may be starting to turn around a bit."
While smaller stockpiles may benefit manufacturers, a collapse in world trade is becoming a major headwind. The World Trade Organization this week predicted global trade will decline by 9 percent this year, the most since World War II. Worldwide industrial production this year may fall by as much as 15 percent and the global economy is likely to shrink for the first time since World War II, the World Bank said on March 9. Stepped-up efforts by the Obama administration and the Fed may gain more traction later this year as the economy improves. "The stimulus may keep the recession from getting a lot deeper," Patrick Newport, an economist at IHS Global Insight Inc. in Lexington, Massachusetts, said before the report. "It’s good news that consumer spending isn’t dropping as much now as before. We worked off some of the inventory so we don’t have to cut down as much."
Carmakers are counting on the policy measures for survival. General Motors Corp. Chief Executive Officer Rick Wagoner last week said a $5 billion rescue package for auto-parts suppliers and a proposal to provide consumer car-buying incentives may spark a revival of the U.S. auto market. "It does feel like, absent some other financial catastrophe, we’re bumping along the bottom," Wagoner said in an interview on March 19 from his Detroit office. "What I can’t tell you is, when we may begin to see, in this baseline case, a slow resumption."
U.S. Jobless Rolls Increase to Record 5.56 Million
The number of people collecting U.S. jobless benefits rose to a record 5.56 million, indicating more Americans are spending longer periods out of work. Initial claims topped 600,000 for an eighth straight time. Total benefit rolls jumped by 122,000 in the week ended March 14, from 5.44 million the previous week, the Labor Department said today in Washington. Initial jobless applications last week rose 8,000 to 652,000, in line with forecasts. Job cuts are spreading from companies to government agencies including the U.S. Postal Service and health-care providers. Rising unemployment means it may be harder for the Obama administration to save or create the 3.5 million jobs targeted in its recovery plan.
"We’ve still got big job losses happening but we don’t think it’s accelerating," said Ellen Zentner, a senior economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. "These continuing claims are rising to record highs because people, once they file claims, are unable to find another job." A Commerce Department report today showed that the economy shrank more than previously estimated in the fourth quarter, at a 6.3 percent annual rate. That compares with the median forecast of economists surveyed by Bloomberg News of a 6.6 percent drop in gross domestic product. Treasuries were little changed after the reports, with benchmark 10-year notes yielding 2.80 percent at 9:30 a.m. in New York. Stocks rose, with the Standard & Poor’s 500 Stock Index up 0.8 percent at 820.75.
Economists surveyed by Bloomberg projected claims would rise to 650,000 from the 646,000 previously reported for the prior week. Projections ranged from 625,000 to 660,000. The four-week moving average of initial claims, a less volatile measure, fell to 649,000 from 650,000. The unemployment rate among people eligible for benefits, which tends to track the jobless rate, rose to 4.2 percent in the week ended March 14, the highest level since 1983. Thirty- eight states and territories reported an increase in new claims for that same period while applications decreased in 15 states. Initial claims reflect weekly firings and tend to rise as job growth slows.
The unemployment rate, 8.1 percent in February, may rise as high as 9.4 percent by the end of the year, according to economists surveyed by Bloomberg News. In the four months through February, job losses approached 2.6 million with the economy in its longest recession in more than a quarter century. National Semiconductor Corp. plans to cut more than 1,700 jobs, about a fourth of its workforce, as the recession eats into sales at the mobile-phone maker, the Santa Clara, California-based company said in a statement March 11. "The worldwide recession has impacted National’s business as demand has fallen considerably," Chief Executive Officer Brian Halla.
Increasing numbers of service and government jobs are being cut, along with manufacturing positions. The U.S. Postal Service said March 20 it will close six of 80 district offices, cut 15 percent of its district-level positions and offer early retirement to about 150,000 workers. New York City’s Health and Hospitals Corp., the largest municipal medical-care system in the U.S., will cut 400 jobs and close community clinics, mental-health services and tuberculosis treatment programs due to reductions in state aid and higher drug and medical supply costs, agency President Alan Aviles said last week.
US new jobless claims hit 652,000 in week
The number of new jobless claims in the United States rose by 1.2 percent to 652,000 during the week ending March 21 as the country reeled from recession, the Labor Department said Thursday. The initial claims for unemployment benefits was roughly in line with the 650,000 figure forecast by analysts and marked an increase of 8,000 from the previous week's revised figure of 644,000. The claims peaked two weeks ago at 657,000, a 26-year high. The four-week moving average of initial claims, a more reliable indicator of unemployment trends, was 649,000, down by 1,000 from the previous week's revised average of 650,000, the department said.
It said that the number of people receiving unemployment benefits for the week ending March 14 increased to a new record high of 5.56 million, an increase of 122,000 from the preceding week's revised level of 5.43 million. The weekly report gives the most current snapshot of the labor market but is subject to volatility. The latest monthly report showed February unemployment rate had jumped to a 25-year high of 8.1 percent, from from 7.6 percent in January as employers shed payrolls to cope with the economic slide.
Trade is Falling Faster in 2009 Than in 1930
U.S. Merchandise Trade Declines:July 2008 - January 2009: 33.2%
October 1929 - April 1930: 30.4%
What They Mean:
As G-20 members prepare to meet in London a week from Thursday, some dark predictions. The International Monetary Fund predicts that the world economy will contract by about 1 percent this year: The only such worldwide decline since the 1930s. The World Trade Organization foresees a nine-percent fall in trade, as businesses around the world cut back and families stay out of stores and malls: again the largest decline in trade since the Second World War. American data on merchandise imports, merchandise exports and services trade illustrate the trends:
Goods imports have dropped by 34 percent from the July 2008 record, falling from $195 billion to $129 billion by January. (The last available month.) About half the drop is in commodity imports, and half in manufactured goods. Samples:
- Africa: Down from $10 billion a month in mid-2008 to $3 billion, reflecting above all the falling price of oil, which makes up about 80 percent of Africa's exports to the United States. (Middle East data are much the same.)
- China: Down from $31 billion in July to $25 billion in January; especially sharp drops appear in consumer electronics like TVs, personal computers, DVD players, phones, and cameras.
- Canada/Mexico: Down from $48 billion to $30 billion, mainly because of lower oil and gas prices and declining car imports.
Goods exports are down from a $121 billion peak, also in July 2008, to $82 billion as of January, or by 32 percent. The drop has been fastest in manufactured goods, with cars, chemicals and semiconductors hit especially hard; agriculture, pharmaceuticals, power equipment, and scientific instruments have held up a bit better. Examples:
- Asia: By region, trends seem depressingly consistent. U.S. exports to Europe, Latin America, Africa, and the Middle East are all off by about a third. Asian trade has been hit a bit harder, with cross-Pacific exports down from $26 billion to $16 billion. The sharpest Asian declines are a nearly 60 percent drop in sales to Taiwan (from $2.5 billion in July to $1.1 billion in January) and a nearly equivalent fall in exports to Korea. Trade with Vietnam has held up best.
- FTAs: Exports to FTA partners have fallen at about the same pace as to other countries. Sales to Canada and Mexico are down from $30 billion to $20 billion a month, principally because of an especially severe slump in sales to Canada. With the other 14 partners, the drop has been from $9 billion to $6 billion.
Services trade is the comparatively good news, holding up noticeably better than goods trade. Total services trade is down about 10 percent, falling from a July peak of $81 billion to $74 billion, with exports imports both down about 8 percent.
By way of alarming comparison, this six-month drop is a bit faster than the six-month fall at the beginning of the Depression, when trade fell from $920 million in October '29 to $640 million by April of 1930: i.e., 30.4 percent. In May, the Congress added the Smoot-Hawley Act and foreign tariff retaliation to the effects of deflation and falling demand. Trade totals then fell by another 72 percent over the next three years, bottoming out at $184 million in February 1933.
Melancholy analysis from the internationals --
Growth predictions from the IMF show world GDP dropping by 1 percent this year. The U.S. economy is set to shrink by 2.6 percent, and other rich countries will fare even worse. European economies are likely to average a 3.2 percent decline; Japan's will shrink by 5.8 percent; Korea, Singapore, and Taiwan may be hit even harder. Developing-world growth rates will not go negative, but will often fall faster from their peak rates than rich-country figures: Chinese growth, for example, may fall from 13 percent in 2007 to 5 percent in 2009. The analysis takes account of "stimulus" bills around the world, which will contribute about 1.2 percent of positive GDP growth, averting an even larger contraction. The United States, China, Russia, Korea, Australia, and Saudi Arabia have launched the largest measures, at 2 percent or more of GDP. The Italian, Indian, French, and Brazilian efforts are smallest, at 0.6 percent or less.
IMF's most recent forecast (PDF)
Trade predictions from the WTO forecast a 9 percent drop in world trade
Policy alarm from the World Bank -- Bank analysts Newfarmer and Gamberoni worry about protectionism, citing imposition of 47 trade-restriction policies since the crisis began last September and singling out the European Union for special censure. (The EU has reinstituted export subsidies for butter, cheese, and milk powder. "Export subsidies are especially egregious," they say, "because they contravene the draft Doha modalities.") Other examples include Russian tariffs on cars, "Buy American" provisions in U.S. stimulus legislation, Argentine import licenses, an Indonesian policy of limiting imports of textiles and toys to a few designated ports, and Chinese and Indian tax rebates for exporters. But they also find 12 trade-opening policies, and note that both economic interests and international law provide stronger guards against broad market-closing than they did in the 1930s.
The World Bank report
And some hope?
The UK's homepage for next week's G-20 summit
Cuomo Subpoenas AIG Swap Data in Taxpayer Fund Probe
New York Attorney General Andrew Cuomo expanded his probe of American International Group Inc. to see whether its customers including Goldman Sachs Group Inc., Societe Generale SA and Deutsche Bank AG were improperly compensated with taxpayer dollars. “Our investigation into corporate bonuses has led us to an investigation of the credit-default swap contracts at AIG,” Cuomo said in a statement. “CDS contracts were at the heart of AIG’s meltdown. The question is whether the contracts are being wound down properly and efficiently or whether they have become a vehicle for funneling billions in taxpayer dollars to capitalize banks all over the world.”
AIG’s Financial Products, the unit that sold credit-default swaps blamed for crippling the company, has been under fire after paying out $165 million in retention bonuses earlier this month while taking taxpayer bailouts valued at $182.5 billion. Lawmakers led by Elijah Cummings, a Democrat from Maryland, in a letter dated yesterday called for a federal probe into whether banks including Goldman Sachs received more funds than necessary from the AIG bailout. The banks got about $50 billion in payments tied to swaps. Nobel Prize-winning economist Joseph Stiglitz also has said AIG’s settlement of credit-default swaps following its bailout by the U.S. government looks like “grand larceny.”
Cuomo will subpoena AIG’s credit-default swap contracts and compare the winding down of AIG’s contracts to those of Lehman Brothers Holdings Inc., according to a person familiar with the New York state probe. The person said that while Lehman’s counterparties got cents on the dollar, AIG’s payouts appear to have been 100 cents on the dollar. The person said there’s a possibility that AIG is becoming a portal through which the federal government is pouring money to capitalize banks in the U.S. and overseas. AIG sold swaps to more than 20 U.S. and foreign banks. After the company was rescued by the U.S. from collapse last year, banks that bought credit-default swaps got $22.4 billion in collateral and $27.1 billion in payments to retire the contracts, the insurer said earlier this month. Goldman Sachs, Deutsche Bank and Societe Generale were among the largest recipients.
The letter from Cummings and 26 other members of Congress to Neil Barofsky, inspector general for the Troubled Asset Relief Program, asked whether holders received 100 cents on the dollar for their securities, a sum they wouldn’t be entitled to get unless their bonds actually defaulted. Mark Herr, a spokesman for New York-based AIG, declined to comment on the subpoena or the wind-down payments. Credit-default swaps, conceived by bondholders, allow investors to buy protection against a possible default by a company. As the market expanded, speculators started using them to bet on a company’s creditworthiness. The contracts pay the holder face value for the underlying securities or the cash equivalent should a company fail to repay its debt.
George Soros Says 30% Drop in U.S. Commercial Real Estate Values Is `Inevitable'
Billionaire investor George Soros said U.S. commercial real estate will probably drop at least 30 percent in value, causing further strains on banks.
“Commercial real estate has not yet fallen in value,” Soros, 78, speaking at a forum in Washington, said. “It is inevitable, it is written, everybody knows it, there are already some transactions which reflect and anticipate it, so we know, they will drop at least 30 percent.”
Soros said the risk of further declines in property prices is reason for the administration of President Barack Obama to move quickly to recapitalize banks. Soros said Obama acted too slowly on a banking overhaul and should have moved immediately upon taking office.
“At that moment of enthusiasm, fresh out of the gate, he would have gotten that money, and then we could have recapitalized the banks the right way, which would be to draw a line over the existing past accumulated bad assets and create new banks on top of these old banks,” Soros said.
Soros also said that the U.S. may face a new round of inflation should the flow of credit recover because of the large increase in the money supply stemming from the Federal Reserve’s purchases of Treasury securities.
“In order to make up for the collapse of credit, we are effectively creating money,” Soros said. That creates “an incredibly swollen monetary base, which, if it were leveraged, you would have an explosion of inflation.”
New Home Sales Fell 41% in February 2009
- WSJ: Sales of new homes rose in February for the first time in seven months, the Commerce Department reported Wednesday, another sign that the housing market is thawing
- Bloomberg: Purchases of new homes in the U.S. unexpectedly rose in February from a record low as plummeting prices and cheaper mortgage rates lured some buyers. Sales increased 4.7 percent to an annual pace of 337,000 . . .
- Marketwatch: The U.S. housing sector continues to see signs of improvement. The latest government data showed new home sales climbed in February for the first time in seven months, sending shares of home-building companies soaring.
A parade of the mathematically innumerate business writers (and even worse headline writers!) continue to misread data. The latest evidence? New Home Sales. After incorrectly reporting the Existing Home Sales, the mainstream media misread the Census department report of New Homes. No, New Home Sales data did not improve. In fact, they were not only not positive, they were actually horrific. The year over year number was a terrible down 41%. Sales from this same period a year ago have nearly been halved. Why did the media report this as positive? If you only read the headline number, you saw a positive datapoint: February was plus 4.7% over January. To get to the facts, you need to read below the headline. In the present case, it wasn’t the seasonality factor that was confusing, it was the “90-percent confidence intervals” — or as it is more commonly known, the margin of error.
From the Census Bureau:Sales of new one-family houses in February 2009 were at a seasonally adjusted annual rate of 337,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 4.7 percent (±18.3%)* above the revised January rate of 322,000, but is 41.1 percent (±7.9%) below the February 2008 estimate of 572,000. The median sales price of new houses sold in February 2009 was $200,900; the average sales price was $251,000. The seasonally adjusted estimate of new houses for sale at the end of February was 330,000. This represents a supply of 12.2 months at the current sales rate.
Note that the month over month data at 4.7% — plus or minus 18.3% — is statistically insignificant. (i.e., meaningless). The reported data does not inform us if sales improved month-over-month or not. It is a range, from down -13.6% to plus 23%. Since “zero” is part of that range, we can draw no conclusion. As the Census Department itself notes, “the change is not statistically significant; that is, it is uncertain whether there was an increase or decrease.” The data does however, tell us that the year-over-year sales fell 41.1% plus or minus 7.9% gives us a range of -49% to -33.2%. The entire range is negative, therefore we can conclude sales fell year-over-year.
These are facts. This is data. This is how you interpret it. Most of the MSM reports (WSJ, Marketwatch, Bloomberg) were simply wrong. Not nuanced, not shaded, but 2+2=5 wrong. Let me remind that many of these folks incorrectly misinformed you that Housing wasn’t getting worse in 2006, 2007 and 2008 — just as Home sales and prices went into an historic freefall. Now, these same folks are misinforming you that Housing has turned around and is improving. That is simply unsupported by the data. (And don’t even ask about television — they simply read the wrong news. Here is a life lesson for you: Never believe news people who read teleprompters. They have no idea what they are doing, they are reading what someone else wrote. When it comes to data interpretation, they are quite literally clueless. Rely on news readers to your personal financial detriment). The bottom line: Learn to interpret data correctly. Avoid using the people who cannot do so as primary news sources.
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US retail investors flee to savings
US retail investors poured close to $250bn (€184bn) into bank accounts in the first months of this year, sharply accelerating a flight to safety as they continued to flee volatile stock markets. Bank savings deposits rose by $246bn to a record $4,343bn in the nine weeks to March 9, according to data from the Federal Reserve. This is more than the whole of 2008, in which savings deposits rose by $229bn. The big plunge into cash comes in spite of repeated government attempts to restart frozen fixed-income markets and restore confidence in the financial system. It is not clear where all the deposits came from but in the first two months of the year investors pulled $20bn from stock mutual funds – almost half the total $43bn redeemed during the whole of 2008 – as they appeared to lose confidence in stock markets, according to data from Financial Research Corporation.
During the first nine weeks of the year, investors pulled a small amount – $15bn – from savings accounts with a period of notice, in an apparent indication they were reluctant to lock up cash for even short periods of time. Charles Biderman, chief executive of TrimTabs, a research group, said: “Net flows into savings have gone into only two places – bank savings and US Treasuries. Both?.?.?.?offer extremely low yields with a high degree of safety. “During an economy where equity prices are down about 50 per cent and home prices down about 30 per cent or so, is there any question as to why money is flowing only into the safest bets?”
Historically, money flows more strongly into bank accounts when stock markets are falling. In 2005 and 2006, when US equities rose, retail investors put less than $100bn into savings and current accounts each year. The previous record year for a rise in bank deposits was 2002, following the dotcom boom, when deposits rose by $465bn. “During hard times people worry about return of principal, not return on principal,” Mr Biderman said. As retail investors seek cash, hedge fund managers are placing big bets on gold in the belief that paper currencies will be debased. The Federal Reserve tracks assets held in bank accounts, not actual inflows. But with interest rates at typical savings accounts hovering below 2 per cent, the rise in deposits – which includes current accounts – is overwhelmingly due to an inflow of new money rather than returns.
Geithner rescue package 'robbery of the American people'
The US government plan to free beleaguered banks of up to $1 trillion (£690bn) of toxic assets will expose American taxpayers to too much risk, leading economist Joseph Stiglitz has cautioned. The Nobel Prize-winning economist, speaking a day after the Dow Jones Industrial Average rose by almost 7pc in support of the novel public-private partnership (PPIP), said that the plan is "very flawed" and "amounts to robbery of the American people." Professor Stiglitz on Tuesday led a list of well-known economists and high-profile industry figures who have said Treasury Secretary Tim Geithner's toxic asset plan may not be as successful as it first seems.
The plan involves ensuring up to $100bn of government funding is matched by private investors, with the monies combined and leveraged up, in some cases to by as much as 20:1, with the help of the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), to buy pools of unwanted assets. Professor Stiglitz, speaking at a conference in Hong Kong, said that the US government is essentially using the taxpayer to guarantee the downside risks, namely that these assets will fall further in value, while the upside risks, in terms of future profits, are being handed to private investors such as insurance companies, bond investors and private equity funds.
"Quite frankly, this amounts to robbery of the American people. I don't think it's going to work because I think there'll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer." His comments echo those of fellow Nobel Prize winner Paul Krugman, who said on Monday that the plan is almost certain to fail, something which fills him "with a sense of despair." Others to criticise the plan include former Securities and Exchange Commission chairman Arthur Levitt, and Bill Gross, of bond manager PIMCO, who has said he does not believe the plan will be enough to solve the banking crisis.
It is understood that the PPIP was only finalised after Treasury officials, led by Mr Geithner, spoke to a number of senior bankers on Wall Street, including JP Morgan Chase chairman Jamie Dimon, in the hope of getting a plan that was workable for the market, following the dismissal of Mr Geithner's earlier attempt to solve the financial crisis. As a result, a number of major banks and bond houses are understood to have already agreed to sign up to the programme, with PIMCO and BlackRock among two investors to have raised their hands. Others remain less convinced.
Citi, Bofa Buying Back Laundered Loans At Lower Rates
As Treasury Secretary Tim Geithner orchestrated a plan to help the nation's largest banks purge themselves of toxic mortgage assets, Citigroup and Bank of America have been aggressively scooping up those same securities in the secondary market, sources told The Post. Both Citi and BofA each have received $45 billion in federal rescue cash meant to help prop up the economy and jumpstart the housing market. But the banks' purchase of so-called AAA-rated mortgage-backed securities, including some that use alt-A and option ARM as collateral, is raising eyebrows among even the most seasoned traders. Alt-A and option ARM loans have widely been seen as the next mortgage type to see increases in defaults.
One Wall Street trader told The Post that what's been most puzzling about the purchases is how aggressive both banks have been in their buying, sometimes paying higher prices than competing bidders are willing to pay. Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids. The secondary market represents a key cog in the mortgage market, and serves as a platform where mortgage originators can offload mortgages in bulk that have been converted into bonds. Yields on such securities can be as high as 22 percent, one trader noted.
BofA said its purchases of secondary-mortgage paper are part of its plans to breathe life back into the moribund securitization market. "Our purchases in [mortgage-backed securities] increase liquidity in the mortgage market allowing people to buy a home," said BofA spokesman Scott Silvestri. A Citi spokesman declined to comment, though people familiar with the bank say it argues the same point. Citi's and BofA's purchases highlight the challenges both banks face while operating under intense public scrutiny. While some observers concur that the buying helps revive a frozen market, others argue the banks are gambling away taxpayer funds instead of lending.
Moreover, the MBS market has been so volatile during the economic crisis that a number of investors who already bet a bottom had been reached have gotten whacked as things continued to slide. Around this same time last year some of the same distressed mortgage paper that Citi and BofA are currently snapping up was trading around 50 cents on the dollar, only to plummet to their current levels. One source said that the banks' purchases have helped to keep prices of these troubled securities higher than they would be otherwise. Both banks have launched numerous measures to help stem mortgage foreclosures, and months ago outlined to the government their intention to invest in the secondary market to expand the flow of credit.
Banks' Hidden Junk Menaces $1 Trillion Purge
The U.S. government wants to clear as much as $1 trillion in soured loans and securities from bank balance sheets with its latest bailout plan. That might prove a short-term respite. No sooner might the Treasury Department mop up those assets than $1 trillion or more in new ones spring up to take their place. That is due to the potential return of assets held in so- called off-balance-sheet vehicles that banks may soon have to put back onto their books. The end result may be that banks are in no better shape to increase lending even after the government bailout. So investors betting for quick solutions to the financial crisis could be disappointed. The tangled web that banks wove over the years will take a long time to undo.
At the end of 2008, for example, off-balance-sheet assets at just the four biggest U.S. banks -- Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. -- were about $5.2 trillion, according to their 2008 annual filings. Even if only a portion of those assets return to the banks - - as much as $1 trillion is one dark possibility -- it would take up lending capacity the government is trying to free. The hidden assets that may return to banks consist of mortgages, credit-card debts and auto loans, among others. Over the years, banks bundled them together and sold them to investors as securities. Whether these assets are “troubled” or “toxic,” their return to bank balance sheets could slow efforts to get credit flowing again. After all, banks shed the loans to make their balance sheets look smaller, allowing them to hold less capital to act as a buffer against losses. Until a couple of years ago, that boosted profits.
It also helped inflate the credit bubble, even as these accounting maneuvers made it harder for investors and regulators to see how much risk banks actually faced. Accounting rulemakers now want banks to bring some of those assets back onto their books. They are trying to crack down on transactions that banks used to sidestep rules inspired by the off-balance-sheet antics that led to Enron Corp.’s collapse. Of course, there is a danger that the rulemakers will backtrack, especially given recent congressional efforts to twist rules that will let banks polish their books. Investors have all but forgotten these out-of-sight assets. That’s a mistake.
True, banks won’t have to repatriate all of them. Mortgages guaranteed by Fannie Mae and Freddie Mac, for example, may have to be booked by those two companies, rather than banks. Yet other assets will come back to banks. The tough part for investors is gauging how much. That is because the accounting- rules changes aren’t final, and their impact will depend on judgments by bank executives and auditors. In its annual filing, JPMorgan said the rules change might lead it to bring back about $160 billion in assets. Citigroup estimated it may have to reclaim $179 billion. That would equal about 9 percent of year-end 2008 assets at Citigroup, and about 7 percent at JPMorgan.
Neither Bank of America nor Wells Fargo provided such estimates. It’s possible, though, from JPMorgan and Citigroup’s disclosures and the thrust of the new accounting rules, to get some idea of what they might face. Both Citigroup and JPMorgan said most of the assets they expect to return will be securitized credit-card debt -- $92 billion at Citigroup and about $70 billion at JPMorgan. Bank of America disclosed it had about $114 billion in off-balance-sheet credit-card debt. So a portion of that may shift back onto its books. (A similar estimate wasn’t possible for Wells, based on the information it disclosed.) The return of credit-card debt may prove especially painful for banks, since delinquencies are soaring as unemployment increases. That might force banks to add to loss reserves, eating into profits. Banks may also have to consolidate securitized commercial loans. That could be an issue for Wells, which had securitized $355 billion of this kind of debt.
And while mortgage-backed securities guaranteed by Fannie and Freddie likely wouldn’t have to be booked by banks, there are plenty of other mortgages out there. Bank of America, for example, disclosed that it had about $360 billion of securitized mortgage debt that wasn’t backed by Fannie or Freddie. Of the non-guaranteed debt, about $58 billion was subprime loans and about $138 billion was so-called Alt-A mortgages, according to Bank of America. All told, Bank of America and Wells Fargo have a combined $600 billion in assets that may be under consideration for possible consolidation. If just half these assets come back to the banks, that would equal almost 6 percent of Bank of America’s assets and about 14 percent at Wells. Granted, those are rough numbers. They underscore, though, that there is still a lot investors don’t know about banks and their books. That’s reason to worry.
US banks face big writedowns in toxic asset plan
The government’s toxic assets plan will force banks such as Citigroup, Bank of America and Wells Fargo to take large writedowns on their loans, requiring them to raise more capital from taxpayers or investors, executives and analysts have warned. Senior bankers say the authorities’ latest drive, announced on Monday, to cleanse financial groups’ balance sheets by encouraging investors to buy troubled residential and commercial mortgages will prompt banks to record losses on those portfolios. The government will also use its "stress tests" to force banks to take more aggressive provisions on these loans, creating a stronger incentive to sell. This process will increase the pressure on banks that have large loan portfolios to raise fresh funds from investors or the government if capital markets remain frozen.
The possibility of further government injections is set to weigh on banks such as Citi, in which the authorities are about to buy a 36 per cent stake, BofA, Wells and other recipients of federal aid. "The unspoken fear here is that selling off loan portfolios would lead to more government capital injections into major banks," said an executive at a large bank. Wells said it would support "any plan by the Treasury that helps financial institutions efficiently sell troubled assets while still providing an investment return to the US tax payer", but said it had not seen all the details of Treasury’s proposals. Accounting rules allow banks to carry loans on their balance sheets at their original value and set aside a percentage of the losses expected over the lifetime of the loan.
However, the government plan, which offers investors generous financing to buy banks’ distressed assets, will force institutions that sell loans at a discount to take a writedown equal to the difference between the original value and their sale price. Some analysts believe the potential writedowns would deter banks from taking part in the plan, which was unveiled by Tim Geithner, Treasury secretary. Richard Bove, an analyst at Rochdale Research, wrote in a note to clients: "[The plan] will not happen because it would destroy bank capital. It might cause a bank to fail the new stress tests under way. Banks will not take this risk." But while banks in theory have discretion over whether to sell loans, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, said this decision would be made "in consultation with regulators" – a sign that the authorities might put pressure on banks to sell toxic assets.
Policymakers say the Geithner strategy is intended to fix the disconnect between the market and the banks by restoring investor confidence in their financial statements. Outside investors and bank executives are miles apart in their assessments of the true capital position of the banks, making it impossible for them to agree a price at which to re-capitalise. By forcing a more realistic and forward-looking assessment of expected losses on bank loans through the stress test, and creating a secondary market that establishes the expected credit losses on loan portfolios, the authorities intend to force banks to write down these loans
Toxic Assets Were Hidden Assets
The Obama administration has finally come up with a plan to deal with the real cause of the credit crunch: the infamous "toxic assets" on bank balance sheets that have scared off investors and borrowers, clogging credit markets around the world. But if Treasury Secretary Timothy Geithner hopes to prevent a repeat of this global economic crisis, his rescue plan must recognize that the real problem is not the bad loans, but the debasement of the paper they are printed on. Today's global crisis -- a loss on paper of more than $50 trillion in stocks, real estate, commodities and operational earnings within 15 months -- cannot be explained only by the default on a meager 7% of subprime mortgages (worth probably no more than $1 trillion) that triggered it. The real villain is the lack of trust in the paper on which they -- and all other assets -- are printed. If we don't restore trust in paper, the next default -- on credit cards or student loans -- will trigger another collapse in paper and bring the world economy to its knees.
If you think about it, everything of value we own travels on property paper. At the beginning of the decade there was about $100 trillion worth of property paper representing tangible goods such as land, buildings, and patents world-wide, and some $170 trillion representing ownership over such semiliquid assets as mortgages, stocks and bonds. Since then, however, aggressive financiers have manufactured what the Bank for International Settlements estimates to be $1 quadrillion worth of new derivatives (mortgage-backed securities, collateralized debt obligations, and credit default swaps) that have flooded the market. These derivatives are the root of the credit crunch. Why? Unlike all other property paper, derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent.
Nobody knows precisely how many there are, where they are, and who is finally accountable for them. Thus, there is widespread fear that potential borrowers and recipients of capital with too many nonperforming derivatives will be unable to repay their loans. As trust in property paper breaks down it sets off a chain reaction, paralyzing credit and investment, which shrinks transactions and leads to a catastrophic drop in employment and in the value of everyone's property. Ever since humans started trading, lending and investing beyond the confines of the family and the tribe, we have depended on legally authenticated written statements to get the facts about things of value. Over the past 200 years, that legal authority has matured into a global consensus on the procedures, standards and principles required to document facts in a way that everyone can easily understand and trust.
The result is a formidable property system with rules and recording mechanisms that fix on paper the facts that allow us to hold, transfer, transform and use everything we own, from stocks to screenplays. The only paper representing an asset that is not centrally recorded, standardized and easily tracked are derivatives. Property is much more than a body of norms. It is also a huge information system that processes raw data until it is transformed into facts that can be tested for truth, and thereby destroys the main catalysts of recessions and panics -- ambiguity and opacity. To bring derivatives under the rule of law, governments should ensure that they conform to six longstanding procedures that guarantee the value and legitimacy of any kind of paper purporting to represent an asset:
- All documents and the assets and transactions they represent or are derived from must be recorded in publicly accessible registries. It is only by recording and continually updating such factual knowledge that we can detect the kind of overly creative financial and contractual instruments that plunged us into this recession.
- The law has to take into account the "externalities" or side effects of all financial transactions according to the legal principle of erga omnes ("toward all"), which was originally developed to protect third parties from the negative consequences of secret deals carried out by aristocracies accountable to no one but themselves.
- Every financial deal must be firmly tethered to the real performance of the asset from which it originated. By aligning debts to assets, we can create simple and understandable benchmarks for quickly detecting whether a financial transaction has been created to help production or to bet on the performance of distant "underlying assets."
- Governments should never forget that production always takes priority over finance. As Adam Smith and Karl Marx both recognized, finance supports wealth creation, but in itself creates no value.
- Governments can encourage assets to be leveraged, transformed, combined, recombined and repackaged into any number of tranches, provided the process intends to improve the value of the original asset. This has been the rule for awarding property since the beginning of time.
- Governments can no longer tolerate the use of opaque and confusing language in drafting financial instruments. Clarity and precision are indispensable for the creation of credit and capital through paper. Western politicians must not forget what their greatest thinkers have been saying for centuries: All obligations and commitments that stick are derived from words recorded on paper with great precision.
Above all, governments should stop clinging to the hope that the existing market will eventually sort things out. "Let the market do its work" has come to mean, "let the shadow economy do its work." But modern markets only work if the paper is reliable. Government's main duty now is to bring the whole toxic environment under the rule of law where it will be subject to enforcement. No economic activity based on the public trust should be allowed to operate outside the general principles of property law. Financial institutions will have to serve society and fully report what they own and what they owe -- just like the rest of us -- so that we get the facts necessary to find our way out of the current maze. They must begin learning to put on paper statements about facts, instead of statements about statements.
A Comment on Geithner’s Plan
I am an attorney who was working in Washington with RTC during the S&L crisis, so I know something about "toxic asset" sales. I have been poking around the legal and contracting market to find out what work there is out there in reviewing, collecting data on and valuing the billions and billions (trillions?) of dollars of "toxic assets," including the mortgage backed securities, CDOs and other derivatives created and backed by mortgages that are now "toxic." I have several observations after reading media accounts of the Geithner plan for so-called public-private partnerships to purchase these vaguely described "toxic assets."
POINT #1: We need to be defining exactly what these "toxic assets" are. One size does not fit all in this regard. It makes a difference whether we are talking about single family residential mortgages that are somewhere in the procedural process of being past due, in foreclosure or REO (i.e., real estate owned by the lender following foreclosure), which can be valued fairly readily, or, at the other end of the spectrum, derivatives based on derivatives that are subject to pooling and servicing agreements that put strict limitations on what work-outs can take place to resolve the "toxicity."
POINT #2: If non-performing assets are to be sold to private investors, those private investors will only pay the best possible price if they have access to reliable data upon which to base their bids. I talked to a senior partner in a DC-based law firm who knows everything there is to know about what goes on in Washington having to do with mortgages. He said he is unaware of any significant efforts to hire government contractors to undertake the type of loan due diligence, review, data collection and valuation that would have to be done to conduct sales of the "TARP" assets that have been talked about since the fall of last year and earlier.
I talked to a national legal temp firm and asked whether there was any work available in toxic asset review. The recruiter said that her firm had expected to see a lot of that type of work coming down the pike, but there is nothing of that type out there so far. By all accounts, government regulators like FDIC and SEC are short of funds, and FDIC is hiring a lot of bank examiners. If you go on USAJobs and look for job openings with FDIC and the Commodity Futures Trading Commission, there are few or no openings for experts in valuing or otherwise dealing with non-performing loans. We have been talking about the bursting of the housing bubble for over a year now, and there seems to be no one taking any initiative in categorizing, stress-testing, quantifying, defining, analyzing, valuing or otherwise collecting information to define the problem. And if any of this is going on secretly and behind closed doors in Washington, then shame on them. Real estate is all local. And if we don’t know what the problem is, any proposed solution will fail.
POINT #3: The New York Times article describing the new Geithner plan says that it is similar to what was done by RTC during the S&L crisis. Well, the Geithner "TOPS" plan not similar to anything I saw at RTC. RTC hired interdisciplinary teams of qualified major accounting, legal, investment banking and other financial advisory professionals to analyze and document all relevant information that an investor would need to value its multi-billion-dollar portfolio of non-performing commercial loans.
We knew what documentation existed and did not exist and what was the status of contractual cash flows, lien positions, bankruptcy cases, underwriting defects and local developmental approvals for the projects and often had pictures of them. We organized "war rooms" where investors could come to look at the loan and other legal documents and we performed various valuation-related calculations and provided them on a disk for a small fee to interested bidders. We interviewed potential wholesale and retail buyers to find out what kinds of sale terms would attract their interest. We provided seller (i.e., government) financing as an alternative to the cash price, with self-executing terms and government sharing in the up-side, so that there was as little future work on the part of the government as possible and the government would not be fleeced. There were very limited government representations and warranties and "put-back" rights and no government guarantees.
What was the result? The first few sales yielded fairly low prices, and the winning bidders made a killing. When others in the financial markets saw that, they bid up the prices in future sales and the government generally got respectable or even amazingly high returns for future sales. Gradually, local investors who knew of the specific projects came out of the woodwork and made informal work-out deals with owners of the projects, which allowed them to bid higher than the New York capital market investors like Goldman Sachs and GE Capital. We facilitated the formation of bidding groups comprised of smaller bidders interested in dividing up loan pools among themselves to bid against capital market bidders. This was the best outcome for the local communities, of course. Very few bidders took advantage of the seller financing, because they found private money cheaper and didn’t want to share the up-side with the government.
What Tim Geithner has proposed has virtually nothing in common with the transactions I worked on with RTC, although I admit that single family mortgage solutions are not the same as those for commercial mortgages. But we have as a model for non-performing single family mortgage sales the work of Hamilton Securities, together with Merrill Lynch, Ernst & Young Kenneth Leventhal, C & S First Boston and Cushman & Wakefield, as financial advisors to the Federal Housing Administration in the auctions of single family non-performing mortgage loans sold from FHA’s portfolio in the mid-90s. Those sales were similar to the RTC sales before, but employed more sophisticated relational databases and other digital tools as well as state-of-the-art optimization software for evaluating bids. In those sales, FHA increased its recovery rates from about $.35 on the dollar to $.70 - $.90 on the dollar, saving several billions of dollars for taxpayers. That was when a billion dollars was a lot of money. In none of these sales did the government provide guarantees, seller financing or puts or allow bidders to be in a heads-I-win-tails-you-lose position as appears to be the plan for the toxic assets in the twenty-first century housing bubble.
POINT #4: There needs to be a plan to figure out how to deal with some problems going forward. I see no sign of new government regulations that would prevent more of the same, including credit default swaps in the trillions of dollars.
- No Congressional or regulatory action is in the works, to my knowledge, to exercise regulatory authority over these "financial weapons of mass destruction."
- For all we know, more credit default swaps are being issued as we speak to bet on future financial institution collapses.
- The Financial Accounting Standards Board is talking about loosening the mark-to-market rules that require banks to disclose to regulators and stockholders the actual current value of their assets, with no hue and cry from the SEC (which has the power of regulation over financial statement standards for public companies).
- Hedge fund investments are still unregulated by the SEC.
- The Chairman of the SEC says the agency doesn’t have enough money to do its job, including the conduct of investigations of things like the illegal naked short selling that appears to have brought down Lehman Brothers.
When I was an internal auditor of a NYSE member firm, there was a rule (apparently dropped at some point during the last ten years) that prevented short sales except on an up-tick, meaning that there had to be a purchase for every short sale. This prevented severe market drops as the result of massive short-selling. And, of course, my firm had to borrow a share of stock for each share our clients sold short. There was no naked short selling. And fails to deliver were investigated, with strict disciplinary action taken unless a good explanation was forthcoming.
POINT #5: In my view, the only hope we have to make good on, or reduce the losses on, the "toxic" mortgages at issue is to manage them on a local level with community involvement. I have a friend in the real estate business who is interested in purchasing houses in foreclosure and working out a plan to help the former owners get jobs or otherwise deal with the financial problems giving rise to their defaults. He would allow them to continue to occupy the houses as renters and repurchase the homes in the future after getting back on their feet if they so desire. If this type of action were taken on a community-wide basis with the cooperation of local governments and businesses, a lot of heartache in all sectors could be avoided. We cannot guarantee or borrow our way out of this as a society. We need to put people to work producing things of value.
Is the Floating Dollar Sunk?
Last year's election was something completely new for 40-year-olds: for the first time since they were able to vote, they wouldn't be choosing either a Bush or a Clinton. And if Hillary had won the Democratic nomination, Americans in their fifth decade would see one of those names on the presidential ballot for the sixth straight time. But you'd have to be into your sixth decade to have been of voting age when the dollar was anything but a free-floating currency without a defined value. That would exclude our youthful president and his Treasury secretary.
For the first time in adulthood of anybody who doesn't qualify for AARP, however, there is a suggestion of reform of the current, dollar-centric system. It may not go anywhere anytime soon, but it would be foolish to ignore it. President Richard Nixon ended the dollar's convertibility into gold at a rate of $35 an ounce on Aug. 15, 1971, and by March 1973, all major currencies were free to float. Under the Bretton Woods regime, currencies were pegged to the dollar, which in turn was fixed in terms of gold. For the last 36 years, the dollar's value has been set by the currency markets.
In theory, floating exchange rates were supposed to allow economies to reduce trade deficits by letting the currency adjust. A weaker exchange rate would drive up the cost of imports and make exports more competitive, thus reducing deficits. Under fixed exchange rates, the economy would have to be constricted to eliminate imbalances, reducing imports and lowering prices to make exports more competitive. That's a more painful process than the seemingly benign adjustment of the exchange rate to bring things into balance. That's what the textbooks said anyway. The reality has been more complicated.
It's the flow of money that dominates the flow of goods, not the other way around. Governments, moreover, manipulate the quantity or the value of money to their ends, which is also outside the textbook model. The rest of the world holds dollars as investments. Foreign central banks use dollars predominantly for their reserves. Dollar-based financial markets are the deepest and biggest in the world. In other words, the liabilities of the U.S. are the main assets of the rest of the world. This has conferred on the U.S. something that King Midas couldn't imagine. We can effectively print dollars and the rest of the world takes them. Imagine what you'd do with a money-printing press in your basement. You'd spend like crazy on stuff. Or you'd acquire real assets, such as houses.
Extend that notion globally. Since the rest of the world takes our paper money, we get to acquire their products or assets in exchange. As a result, America can spend more than it earns and save less than it invests. The difference is made up by foreigners accepting our dollars and lending them back to us. The clearest example is China. Its massive trade surplus with the U.S. gives it boatloads of greenbacks. The textbook says that would make its currency, the yuan, rise, which would make Chinese exports dearer in world markets. That's the last thing Beijing wants as it tries to keep the economy growing at 8% to provide jobs and maintain social stability. So, China's central bank accumulates billions and billions of dollars, which it invests in U.S. securities. Much of that money went into Fannie Mae and Freddie Mac securities, which in turn helped finance the U.S. housing boom. But the bulk of China's dollars went into U.S. Treasury securities, which helps fund the budget deficit.
Last summer, when there were concerns about Fannie's and Freddie's finances, especially on the part of foreign investors such as China, Uncle Sam bailed them out and wound up placing them into conservatorship. More recently, Chinese officials have voiced concern about their massive holdings of U.S. Treasuries and dollar assets in general. A couple of weeks ago, Premier Wen Jiabao expressed concern about the safety of U.S. Treasury securities. Last month, a Chinese official put it bluntly: "We hate you guys. Once you start issuing $1 trillion-$2 trillion, we know the dollar is going to depreciate." But given the lack of viable alternatives, they're stuck buying Treasuries, he said. Now comes a suggestion from the head of China's central bank for an alternative to the dollar, echoing a similar proposal made previously by Russia.
Those nations proposed expanding the use of the International Monetary Fund's Special Drawing Rights as a substitute for dollars. SDRs, based on a basket of currencies, have never gained much usage except for IMF transactions. Asked about global confidence in the dollar at Tuesday's press conference, President Obama called the currency "extraordinarily strong" and dismissed the need for an international currency. Americans should realize that the nation's most successful export isn't Coke or Boeing airliners or Microsoft software or even Hollywood films. It's the dollar, which is accepted around the world as a store of value. Under the current floating exchange-rate system, the U.S. wasn't limited by the gold in Fort Knox as to how many dollars it could issue. It was limited only by the willingness of the rest of the world to accept greenbacks in payment for their goods and services.
No other country has that ability. Europe has tried to get a piece of the action by establishing the euro, but the currency has gotten a relatively small share of the market. But, for the first time since the early 1970s, America runs the risk of being constrained by international considerations. Nixon could get around them simply by abrogating the promise to maintain the dollar's value in gold. Now, America's main creditors could impose the discipline on the U.S. that gold couldn't. Next week, the Group of 20 nations will discuss the unprecedented stresses facing the world's economy. President Obama may not be able to dismiss calls for a new monetary order as easily as he did at Tuesday's press conference, even if the dollar is unlikely to be supplanted for some years to come.
US backing for world currency stuns markets
US Treasury Secretary Tim Geithner shocked global markets by revealing that Washington is "quite open" to Chinese proposals for the gradual development of a global reserve currency run by the International Monetary Fund. The dollar plunged instantly against the euro, yen, and sterling as the comments flashed across trading screens. David Bloom, currency chief at HSBC, said the apparent policy shift amounts to an earthquake in geo-finance. "The mere fact that the US Treasury Secretary is even entertaining thoughts that the dollar may cease being the anchor of the global monetary system has caused consternation," he said. Mr Geithner later qualified his remarks, insisting that the dollar would remain the "world's dominant reserve currency ... for a long period of time" but the seeds of doubt have been sown.
The markets appear baffled by the confused statements emanating from Washington. President Barack Obama told a new conference hours earlier that there was no threat to the reserve status of the dollar. "I don't believe that there is a need for a global currency. The reason the dollar is strong right now is because investors consider the United States the strongest economy in the world with the most stable political system in the world," he said. The Chinese proposal, outlined this week by central bank governor Zhou Xiaochuan, calls for a "super-sovereign reserve currency" under IMF management, turning the Fund into a sort of world central bank. The idea is that the IMF should activate its dormant powers to issue Special Drawing Rights. These SDRs would expand their role over time, becoming a "widely-accepted means of payments". Mr Bloom said that any switch towards use of SDRs has direct implications for the currency markets. At the moment, 65pc of the world's $6.8 trillion stash of foreign reserves is held in dollars. But the dollar makes up just 42pc of the basket weighting of SDRs. So any SDR purchase under current rules must favour the euro, yen and sterling.
Beijing has the backing of Russia and a clutch of emerging powers in Asia and Latin America. Economists have toyed with such schemes before but the issue has vaulted to the top of the political agenda as creditor states around the world takes fright at the extreme measures now being adopted by the Federal Reserve, especially the decision to buy US government debt directly with printed money. Mr Bloom said the US is discovering that the sensitivities of creditors cannot be ignored. "China holds almost 30pc of the world's entire reserves. What they say matters," he said. Mr Geithner's friendly comments about the SDR plan seem intended to soothe Chinese feelings after a spat in January over alleged currency manipulation by Beijing, but he will now have to explain his own categorical assurance to Congress on Tuesday that he would not countenance any moves towards a world currency.
Russia adds to calls for currency reform
Russia wants to convene an international conference at government envoy level to discuss the creation of a new global currency, RIA news agency on Thursday quoted Andrei Denisov, first deputy foreign minister as saying. "This proposal is aimed at a practical realisation of the idea about a new global accounting unit or a new global currency. It is a question which should be discussed to create a consensus," said Mr Denisov, according to the RIA news agency. Chinese central bank chief Zhou Xiaochuan on Monday urged a wider use of Special Drawing Rights (SDRs) created by the International Monetary Fund, outlining how the dollar could eventually be replaced as the world’s main reserve currency.
US Treasury Secretary Timothy Geithner said on Wednesday he was open to expanding the use of the International Monetary Fund’s special drawing rights. Investors initially interpreted his remarks as an endorsement of China’s proposal and the dollar fell. However, Mr Geithner clarified his remarks, saying he expected the dollar to remain the world’s dominant reserve currency for a long time to come. Analysts said any dollar sell-off on similar remarks was likely to have little impact. Derek Halpenny at Bank of Tokyo-Mitsubishi UFJ said an adjustment in global imbalances was now taking place and while that was ongoing, the appetite for any substantial shift in foreign exchange dynamics would be limited. "If in years to come, we have a move balanced current account position in the global economy, that would be the correct basis for shifting away from the dollar," he said. "Now is certainly not that time," he added.
It is not yet clear whether G20 leaders will touch upon the issue at the summit next week. Mr Denisov told RIA the conference could take place some time after the summit. He said in the long term the global currency reform was inevitable. "One way or another, we will have to do it, if we are seriously talking about reforms," Mr Denisov said. "This proposal is aimed at a practical realisation of the idea about a new global accounting unit or a new global currency. It is a question which should be discussed to create a consensus," said Andrei Denisov, Russia’s First Deputy Foreign minister. Russia said it would put forward a similar proposal to China’s at the meeting of the Group of 20 in London on April 2 and had the backing of other key emerging market economies including Brazil, India, China, South Korea and South Africa. The comments from Russia on Thursday had little effect on the dollar.
Geithner to Propose Vast Expansion Of U.S. Oversight of Financial System
Treasury Secretary Timothy F. Geithner is proposing a sweeping expansion of federal authority over the financial system, breaking from an era in which the government stood back from financial markets and allowed participants to decide how much risk to take in the pursuit of profit. The Obama administration's plan would extend federal regulation for the first time to all firms trading in financial derivatives and to companies including large hedge funds and major insurers such as American International Group. The administration also will seek to impose uniform standards on all large financial firms, including banks, an unprecedented step that would place significant limits on the scope and risk of their activities.
Geithner's testimony before the House Financial Services Committee calls for regulators to impose executive compensation standards on all financial firms. The guidelines would push firms to base pay on employees' long-term performance, curtailing big paydays for short-term victories. Long-simmering anger about Wall Street pay practices erupted last week when the Obama administration disclosed that insurance giant AIG had paid $165 million in bonuses to employees of its most troubled division, despite losing so much money that the government stepped in with more than $170 billion in emergency aid. Most of these initiatives would require legislation. The administration sent the first piece of proposed legislation to Congress this morning, which would grant the government the power to seize any large, troubled financial firm. The government currently wields that power only over banks.
Geithner is discussing the proposed legislation at the hearing on Capitol Hill this morning, in addition to other steps aimed at limiting the risk that the largest financial firms pose to the economy. In coming months, the administration plans to detail its strategy in three other areas: protecting consumers, eliminating flaws in existing regulations and enhancing international coordination. "Our system failed in basic fundamental ways. The system proved too unstable and fragile, subject to significant crises every few years," Geithner said. " . . . To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game." Today's testimony does not call for any existing federal agencies to be eliminated or combined. The plan focuses on setting standards first, leaving for later any reshaping of the government's administrative structure.
The nation's financial regulations are largely an accumulation of responses to financial crises. Federal bank regulation was a product of the Civil War. The Federal Reserve was created early in the 20th century to mitigate a long series of monetary crises. The Great Depression delivered deposit insurance and a federally sponsored mortgage market. In the midst of a modern economic upheaval, the Obama administration is pitching the most significant regulatory expansion since that time. An administration official said the goal is to set new rules of the road to restore faith in the financial system. In essence, the plan is a rebuke of raw capitalism and a reassertion that regulation is critical to the healthy function of financial markets and the steady flow of money to borrowers.
The administration's signature proposal is to vest a single federal agency with the power to police risk across the entire financial system. The agency would regulate the largest financial firms, including hedge funds and insurers not currently subject to federal regulation. It also would monitor financial markets for emergent dangers. Geithner plans to call for legislation that would define which financial firms are sufficiently large and important to be subjected to this increased regulation. Those firms would be required to hold relatively more capital in their reserves against losses than smaller firms, to demonstrate that they have access to adequate funding to support their operations, and to maintain constantly updated assessments of their exposure to financial risk.
The designated agency would not replace existing regulators but would be granted the power to compel firms to comply with its directives. Geithner's testimony does not identify which agency should hold those powers, but sources familiar with the matter said that the Federal Reserve, widely viewed as the most obvious choice, is the administration's favored candidate. Geithner and other officials have said in recent weeks that such powers could have kept in check the excesses of AIG and other large financial companies. "The framework will significantly raise the prudential requirements, once we get through the crisis, that our largest and most interconnected financial firms must meet in order to ensure they do not pose risks to the system," Geithner said yesterday in a speech before the Council on Foreign Relations in New York.
Hand in glove with this expanded oversight, the administration also is seeking the authority to seize these large firms if they totter toward failure. The administration yesterday detailed its proposed process, under which the Federal Reserve Board, along with any agency overseeing the troubled company, would recommend the need for a takeover. The Treasury secretary, in consultation with the president, then would authorize the action. The firm would be placed under the control of the Federal Deposit Insurance Corp. The government also would have the power to take intermediate steps to stabilize a firm, such as taking an ownership stake or providing loans.
"Destabilizing dangers can come from financial institutions besides banks, but our current regulatory system provides few ways to deal with these risks," Geithner said yesterday. "Our plan will give the government the tools to limit the risk-taking at firms that could set off cascading damage." The administration compared the proposed process with the existing system under which banking regulators can take over failed banks and place them under FDIC control. One important difference is that the decision to seize a bank is made by agencies that have considerable autonomy and are intentionally shielded from the political process. Some legislators have raised concerns about providing such powers to the Treasury secretary, a member of the president's Cabinet.
The cost of bank failures is carried by the industry, which pays assessments to the FDIC. The Treasury said it has not yet determined how to pay for takeovers under the proposed system. Possibilities include dunning taxpayers or collecting fees from all institutions the government considers possible candidates for seizure. FDIC chairman Sheila C. Bair issued a statement that expressed support for an expansion of her agency's responsibilities. "Due to the FDIC's extensive experience with resolving failed institutions and the cyclical nature of resolution work, it would make sense on many levels for the FDIC to be given this authority working in close cooperation with the Treasury and the Federal Reserve Board of Governors," Bair said. The administration also wants to expand oversight of a broad category of unregulated investment firms including hedge funds, private-equity funds and venture capital funds, by requiring larger companies to register with the Securities and Exchange Commission. Firms also would have to provide financial information to help determine whether they are large enough to warrant additional regulation.
Hedge funds were designed to offer high-risk investment strategies to wealthy investors, but their role quickly grew from one on the fringe of the system to a place near the center. Some government officials have sought increased regulation of the industry since the 1998 collapse of Long-Term Capital Management threatened the stability of the financial system. Geithner is calling for the SEC to impose tougher standards on money-market mutual funds, investment accounts that appeal to investors by aping the features of checking accounts while offering higher interest rates. He will not make specific suggestions. SEC chairman Mary Schapiro plans to testify today that the SEC supports both proposals.
The administration's broad determination to regulate the totality of the financial markets also includes a plan to regulate the vast trade in derivatives, complex financial instruments that take their value from the performance of some other asset. Derivatives have become a basic tool of the financial markets, but trading in many variants is not regulated. Credit-default swaps, a major category of unregulated derivatives, played a major role in the collapse of AIG. Geithner is calling for the entire industry to be placed under strict regulation, including supervision of dealers in derivatives, mandatory use of central clearinghouses to process trades and uniform trading rules to ensure an orderly marketplace. The Fed already is moving to improve the plumbing of the financial system, including of the derivatives trade. The administration wants to expand and formalize these efforts. Senior government officials view these highly technical arrangements as critical to the restoration of a healthy financial system.
SEC Chief Wants More Oversight Powers
Securities and Exchange Commission Chairman Mary Schapiro unveiled a broad agenda Thursday, telling the Senate Banking Committee the SEC is drafting proposals to toughen oversight on everything from money-market funds to investment advisers who have custody of client assets. Ms. Schapiro also made it clear she isn't going to shy away from asking Congress to expand the SEC's authority, and she signaled the agency may request new legislation over hedge funds and their investment advisers, credit-default swaps and municipal securities. "Every day when I go to work, I am committed to putting the SEC on track to serve as a forceful capital markets regulator for the benefit of America's investors," Ms. Schapiro said in prepared remarks.
In the wake of the Bernard Madoff scandal, Ms. Schapiro said she has directed her staff to develop a series of reforms aimed at better protecting clients' money. Among the things being drafted include a proposal to require investment advisers who have custody of client assets to undergo an annual, unannounced third-party audit to ensure the funds are safe. Other plans in the works include proposals requiring investment advisers with custody of funds to be audited for compliance with the law and forcing senior officers from firms to attest they have safeguards in place. "The list of certifying firms would be publicly available on the SEC's Web site so that investors can check on their own financial intermediary," Ms. Schapiro said. "In addition, the name of any auditor of the firm would be listed, which would provide both investors and regulators with information to then evaluate the auditors."
To prevent money-market funds from having their net-asset value fall below a $1 a share, or "break the buck" as the Reserve Fund did last year, Ms. Schapiro also said the SEC staff plans to unveil proposals this spring to "improve credit quality, maturity," and "liquidity standards." Although Ms. Schapiro has signaled in the past that she believes there should be more federal oversight of hedge funds and credit-default swaps, she made it clear Thursday the SEC is actively involved in contemplating legislative proposals to put before Congress. Other areas the SEC is exploring include eliminating disparities over regulations between broker-dealers and investment advisers and possibly asking for new laws aimed to improve disclosures in the municipal securities market. "It is time for those who buy the municipal securities that are critical to state and local funding initiatives to have access to the same quality of information as those who buy corporate securities," she said.
In addition to those efforts, Ms. Schapiro said she intends to push in the coming months for "proxy access," which would allow a minority group of shareholders to have their candidates for corporate boards included on company-printed proxy ballots. She also reiterated that the agency will consider proposing to reinstate the uptick rule "or something much like it" in April and that she is preparing to come before Congress soon to get permission to allow the agency to pay whistleblowers who provide key information on non-insider trading cases. In response to the major issues Congress is exploring right now as it seeks to create a new systemic risk regulator, Ms. Schapiro said she is supportive of the effort, but she thinks a systemic risk regulator should complement a strong "investor-focused capital markets regulator." "Congress made us independent precisely so we can champion those who would otherwise not have a champion, and when necessary take on the most powerful interests in the land," she said. "Regulatory reform must guarantee that independence in the future."
Plenty of Rahm at the AIG Table
Over the past ten days, as the furor over AIG retention plan bonuses has focused on Sen. Chris Dodd and Secretary of the Treasury Timothy Geithner, the White House has undertaken a PR offensive to protect the highest ranking Obama Administration official who was involved in the House and Senate negotiations over the stimulus bill, in which the AIG waiver language was inserted. "Right now, you get the feeling this is all about protecting [White House Chief of Staff] Rahm Emanuel," says a former Treasury Department lawyer, who worked in that department's counsel's office on the Troubled Asset Relief Program (TARP) before joining a D.C.-based law firm in February. "At the time, we were led to believe there were basically three or four people from the Administration at the table when the final deals were cut and one of them was Emanuel."
Informal advisers to Geithner are growing increasingly frustrated, they say, that Geithner is being held up as the straw man for the public anger over the bonuses. "Just over the weekend you saw a new guy added to the target list, [White House economics adviser Larry] Summers," says a longtime Geithner colleague at the New York Fed. "You have Dodd, Geithner, Summers, but there were other, more senior political people involved in this mess, and their names aren't being mentioned. Why isn't anyone asking Rahm Emanuel, 'What meetings were you in?' 'What did you and the President know and when did you know it?' Tim has some culpability, but he's not the guy who signed off on the Dodd language. He wasn't that empowered to do something like that."
[A few days ago], Obama supporter and New York Times columnist Frank Rich fingered Summers as a key player in the AIG bonus mess. "Summers is so tone-deaf that he makes Geithner seem like Bobby Kennedy," Rich wrote. Summers currently serves as head of the National Economic Council in the White House, and has been mentioned as someone who might be forced to return to the Secretary of the Treasury post he once held in the Clinton Administration should Geithner not survive the political storm he finds himself in. It isn't just Rich, though, who has placed Summers in the center of the controversy. Last week, Sen. Ron Wyden, who was led to believe that language he was inserting into the stimulus bill, which would have heavily taxed such payouts as the retention bonuses, told reporters that it was the "Obama economic team" that stripped his and Sen. Olympia Snowe's provision from the bill.
When he was asked about who he dealt with during the February negotiations over his language, he said, "Secretary Geithner, Larry Summers, and I'll leave it at that." He declined to name other names, though he indicated to reporters present that he was aware of others in the negotiations. Senior Democrat leadership aides in both the House and Senate, however, insist that both Emanuel and Office of Management and Budget Director Peter Orszag were present at the meetings where the decision was made to strip out the bonus taxation language and insert the Dodd waiver. Further complicating the situation is that at the time of the negotiations, Geithner had in his possession Treasury Department memorandums outlining November negotiations between the department's counsel's office and AIG officials over the very retention bonuses that were preserved in the final bill.
As early as November 5, 2008, AIG lawyers and senior executives and Treasury officials were in negotiations over just which bonuses and retention-plan payouts could and could not take place. "We indicated that UST wants to put in place a limitation on annual bonuses that assure that AIG executives/employees will not be enriched out of TARP funds," wrote a Treasury official to colleagues involved in the negotiations. In preparing Geithner for the stimulus negotiations, Treasury staff provided him, as well as Obama Administration officials, detailed memorandums outlining the extensive negotiations the agency had had with AIG, among other financial institutions, about bonus payouts, and recommending steps that could be taken legislatively to at least limit taxpayer exposure.
"[Geithner] had the information," says the former Treasury lawyer. "What he did with it we don't know. But our input didn't seem to make much of a difference in the room when it mattered." Neither did Republican input; no Republicans were present in the negotiations in the Speaker's office. Both Nancy Pelosi and Harry Reid, who served as a conference manager on the bill, barred Republicans from the negotiation table. And, surprisingly, neither was Chris Dodd, who was not one of the three Senate managers for the conference negotiations. So the mystery remains: who had final sign-off on the Dodd language insertion on AIG's retention bonuses? One thing seems certain, Rahm Emanuel isn't talking, and neither are Pelosi or Reid, who were also in the room with Emanuel, Orszag, and Summers when the final language was worked out.
Obama: GM, Chrysler Could Receive More Federal Aid
President Obama said Thursday that struggling U.S. auto companies could expect some government aid if they commit to restructuring as part of an official rescue plan due to be unveiled soon. In a town hall-style meeting featuring questions from a live audience and sent over the Internet, Obama also warned that the United States was likely to lose more jobs in the recession and that the economy was in for a "difficult time" for much of this year. Obama's White House task force has a March 31 deadline to determine whether and Chrysler, controlled by Cerberus Capital Management, can be made competitive and worthy of up to $22 billion in additional bailout funds.
GM and Chrysler have been driven to the brink of failure by a deepening downturn in U.S. car sales, which slumped by more than a third in January and February and hit their lowest levels in 27 years. The White House said Thursday that Obama would unveil his plan to aid the auto industry before leaving on a European trip Tuesday. "What we're expecting is that the automakers are going to be working with us to restructure. We will provide them some help," Obama said in the White House question-and-answer session. "I know that it is not popular to provide help...to auto companies," he added.
"If they're not willing to make the changes and the restructurings that are necessary, then I'm not willing to have taxpayer money chase after bad money." White House spokesman Robert Gibbs said later that Obama had been frustrated with U.S. carmakers for some time. "I think there's a frustration on the part of this president and on the part of many Americans that we didn't just get into this situation because of the global economic slowdown," Gibbs told a briefing. GM and Chrysler received $17.4 billion in taxpayer assistance in December after saying they could not survive without it. Ford Motor, which is also struggling financially, has not sought a bailout.
Obama, who has long said U.S. car companies should focus on more fuel-efficient cars, said all of the players connected to the industry would have to make sacrifices. "Everybody's going to have to give a little bit: shareholders, workers, creditors...suppliers, dealers," he said. "Everybody is going to have to recognize that the current model—economic model—of the U.S. auto industry is unsustainable." The request for additional funding, which is being reviewed by a White House panel led by former investment banker Steve Rattner, hinges on their ability to win concessions from the United Auto Workers union and creditors.
As part of its sweeping restructuring efforts, GM said Thursday that 7,500 U.S. hourly workers represented by the UAW had accepted buyout offers to leave its payroll by April 1. Including the latest round of buyouts, GM has cut 60,500 jobs since 2006 — more than half of its U.S. factory work force — as U.S. auto sales have slowed and its own cash position has weakened. Separately, Chrysler said it would extend a buyout program that it offered to all its 26,000 U.S. hourly workers last month. GM and Chrysler have won pending contract changes from the UAW intended to help them cut hourly wage costs to the level of Japanese automakers operating plants in the United States.
But both automakers have yet to reach related deals with the UAW that would allow them to pay the union in stock rather than cash for half of their remaining obligations to a trust fund for retiree health care, Voluntary Employee Beneficiary Association. GM bondholders also face pressure to write off two-thirds of the more than $27 billion they are owed in exchange for stock in a recapitalized company. Advisers to GM bondholders met with Rattner and the autos task force earlier this month but complained as recently as Sunday that they had been shut out of ensuing talks with both U.S. government representatives and the GM executives. A person briefed on those negotiations said Thursday that the two sides had begun talking again this week.
Obama Auto Task Force Set to Back More Loans
President Barack Obama last month handed his auto-industry team a seemingly impossible task: to engineer the most complicated industrial restructuring ever attempted by the federal government, and to do it fast. With almost no experience in the car business, the team's dozen core members have undergone a crash course in the myriad woes plaguing the U.S. auto industry. Within days, just over a month after setting to work, they'll begin announcing decisions. Interviews with task-force members indicate that the administration doesn't want to let General Motors Corp. and Chrysler LLC slip into bankruptcy protection, a course advocated by some critics of the industry. Instead, the task force is expected to say that it sees viable futures for both GM and Chrysler, but only if there are sacrifices from their managements, unions and GM's bondholders. The team will also lay out a firm timeline for action.
The government is prepared to lend the companies more money. The two companies have requested $22 billion more -- including $9 billion for the second quarter. But the task force may not disburse new aid immediately, choosing instead to preserve that as leverage. Hanging in the balance are the jobs of 140,000 GM and Chrysler employees, more than 10,000 dealerships across the country, and a large swath of the industrial base in the Midwest. On Wednesday, the task force met with officials from Chrysler and Italy's Fiat SpA and indicated it is still interested in seeing the two companies form an alliance, as the companies have proposed, according to two people who attended the meeting. It's clear the team is not yet ready to put forward a comprehensive fix. "It's a steep learning curve that they've been climbing, and there is still a lot to do," said Michigan Rep. Gary Peters, whose district in suburban Detroit houses hundreds of auto suppliers, a few days after meeting with the task force. "That's why I suspect they'll come out with some preliminary statements, and then get back to work."
In session after session in a warren of offices at the Treasury Department, the team has sat through tutorials on dealer financing, studied basic data and debated the future of U.S. car sales. They have spent days trying to understand the complexities of the hundreds of companies that supply the car companies with axles, seats and other parts. Steven Rattner, a former journalist-turned-investment banker, was picked last month to head the team. He reports to Treasury Secretary Timothy Geithner and Lawrence Summers, the chief White House economic adviser. Mr. Rattner compares the challenge to a complicated puzzle. "It's like a Rubik's cube, trying to untwist it and trying to get all the colors to line up," he said in an interview. "So we've learned a lot about how car dealers work, and how companies get paid when they sell a car to a dealer, and why there are a certain number of dealers more than are optimal. Have we learned everything? Of course not, but I think we are learning what we need to learn to do this job."
The team's industrial expertise comes from Ron Bloom, a scrappy Harvard Business School graduate who gave up investment banking in 1996 to work as a top adviser to the United Steelworkers union. When Mr. Bloom's aging 1997 Ford Taurus conked out a few weeks ago, he traded it for a green Mustang with 50,000 miles on the clock. Several team members, such as Brian Deese, a 31-year-old former Obama campaign aide, are on loan from the White House's National Economic Council. Three others specialize in climate change. The rest come from agencies such as the Energy and Labor departments. Backing them up are about 30 accountants and advisers.
Mr. Rattner dismisses the idea that his team may not have enough auto expertise to tackle the job. "We are not trying to run car companies," he says. He compares the work to what he and others have done in the private sector. "This is the type of investment decision that many of us on this team are used to making."
Before the team got started, the federal government already had sunk $17.4 billion in loans into GM and Chrysler. (Ford Motor Co. said it didn't need government assistance.) The two car makers received emergency cash in December on the condition they put forward plans by mid-February proving their long-term viability. When that deadline rolled around, the auto makers asked for up to $22 billion in loans and promised major changes. Chrysler's plan included two options: remaining a standalone company, and striking the alliance with Fiat. GM's blueprint called for 47,000 job cuts, the elimination of brands such as Saturn, and the sale of stakes in international operations. The team didn't get fully up and running until the last week of February, nearly a week after the companies submitted their plans. Among its first tutors was Sean McAlinden, chief economist at the Ann Arbor, Mich.-based Center for Automotive Research. "They called on a Sunday and wanted us [in Washington] the next day," Mr. McAlinden says.
His verdict was gloomy. Americans this year will buy around 10 million new vehicles, he predicted, down from 13 million last year. And the market would never again top the 16 million units it last hit in 2007. "They just soaked it up," says Mr. McAlinden. The team got another dismal take from Deutsche Bank's auto analyst, Rod Lache, who made a splash in November when he set a target price of zero for GM's stock. His advice was to ignore the data. He recalls telling them: "This is a policy decision, not an economic one. One way or another, GM will have to be saved." A few days later, Virg Bernero, the mayor of Lansing, Mich., and 10 other city officials from around the country packed into a Treasury conference room with Messrs. Bloom and Deese. The son of a retired GM line worker, Mr. Bernero gave a heated defense of the importance of the auto industry. "We need to make saving the industry a national initiative like the Apollo project," he told the team. Mr. Bloom, jotting notes, reminded the mayors that he'd spent time both on Wall Street and among the unions.
The team met the next day with executives from Fiat and an adviser who was working on the Italian auto maker's proposed alliance with Chrysler. Fiat Chief Executive Sergio Marchionne led the team through a 75-page presentation, then served as a "color commentator" as others discussed portions of the document, a person who was at the meeting says. Mr. Bloom focused on minute aspects of the business strategy, and Mr. Rattner, on how the deal would be structured. People on the Fiat team came away thinking that the task force's questions betrayed a limited understanding of the industry. "It's fair to say we walked out of the meeting and were a little unsettled," says one member of the Fiat team. In the wake of that meeting, the executives and advisers working on the alliance were bombarded with questions from the task force. In the latest meeting about the alliance on Wednesday, the task force indicated that the two companies may need to make adjustments to the deal in order to make it more acceptable to the U.S. government, according to the two people who attended the meeting.
Late last year, Chrysler and GM had discussed the possibility of themselves merging. Those talks have been suspended. The task force has discussed the prospect of forcing the two companies back to the table if they cannot be stabilized, although that seems unlikely at the moment, according to several people involved in the talks.
The task force met with a committee representing GM's bondholders on the same day it met with Fiat executives. GM's bondholders hold about $27 billion in unsecured GM debt, and consequently will play a critical role in efforts to save the company. In June, GM will owe the bondholders $1 billion on convertible debt coming due. The bondholders' attorneys laid out the details of a plan to exchange debt for equity, which would reduce pressure on GM to repay the bondholders. As the lawyers walked through a litany of potential challenges, Messrs. Rattner and Bloom took notes, offering minimal commentary, according to people who attended the meeting. Since then, the bondholders committee has had little contact with the task force. Its lawyers say they were surprised two weeks later when Mr. Rattner publicly criticized them for not being flexible enough.
Mr. Rattner and the Treasury Department haven't responded to requests for comment on the complaints by bondholders. On Sunday, a committee representing the bondholders sent a letter to Treasury Secretary Geithner that said they are "disappointed" that they haven't received a response to their proposal. They reminded Mr. Geithner that "the result of a failed [debt-for-equity] exchange would likely be a bankruptcy that would have dire consequences for the company." The letter claimed that bondholders "have been asked to make deeper cuts than other stakeholders." But in a series of meetings with the task force, Michigan lawmakers have complained that bond investors aren't willing to make sacrifices as deep as those offered by the United Auto Workers. Several auto experts who've met with the panel say they've been struck by the group's focus on trying to determine exactly when car sales will rebound. "They are absolutely concerned with the short-term, so it's hard to see them grasping the medium or longer-term issues," says Daniel Roos, an automotive expert at the Massachusetts Institute of Technology, who briefed the team in Washington on March 6.
Toyota's Jim Lentz, who directs sales for North America, says he was grilled by Messrs. Rattner and Bloom on his predictions. "They were very intent on understanding what was causing this huge drop in car sales, and how long it would last," he recalls. Mr. Rattner says the focus on basic market forces makes sense. "The biggest variable" the team has had to wrestle with, he says, is "what the demand for cars will be in five years." If his team knew the answer to that, "a lot of this would get easier." John McEleney owns two Chevy dealerships in Iowa and is chairman of the National Automotive Dealers Association. He flew into Washington March 6 with four other dealers, he says, to instruct the team "on how the dealer model works between the dealers and the car companies." Mr. Bloom asked the dealers what they saw as the core cause of plunging car sales: low consumer confidence or tight credit? Mr. McEleney said they were equally to blame. Toyota's Mr. Lentz told the panel that plunging consumer sentiment was the primary culprit.
On March 9, four members of the team -- Messrs. Rattner, Bloom, Deese, and White House economic adviser Diana Farrell -- flew to Detroit. Their first stop was the United Auto Workers' headquarters. They met over coffee for two hours in a conference room, union officials say. The three men from Washington wore suits and ties. UAW President Ron Gettelfinger and his three main vice presidents wore oxford shirts embroidered with a UAW crest. Mr. Gettelfinger and other officials shared specifics about how many retirees GM has in each state, in an effort to paint the problem as a national one, not just a Michigan one. Florida, California, New York and Indiana all have tens of thousands, they said. Alabama, the home state of Sen. Richard Shelby, has less than 50, Mr. Gettelfinger noted. Sen. Shelby has repeatedly pointed to union contracts as a key problem for car makers, and has urged the federal government to lead the Big Three into bankruptcy filings. The foursome toured a 71-year-old plant where pickup trucks are built. Later, some UAW officials joked about the visitors wearing suits to tour auto plants, a breach of Detroit protocol. At the Chrysler Dodge truck assembly plant, located in nearby Warren, Mr. Rattner says, the importance of the task force's work hit home. "At the end of all the numbers we are generating," he says, "there are real people."
Moody's downgrades Bank of America, Wells Fargo
Moody's Investors Service downgraded Bank of America Corp. and Wells Fargo & Co. Wednesday on concern the banks may need more government support to boost their capital. The downgrade of Bank of America contrasted with comments from Chief Executive Kenneth Lewis, who told the Los Angeles Times that he wanted the company to start paying back $45 billion of investments from the government's Troubled Asset Relief Program, or TARP, in April. Moody's cut B. of A.'s senior debt rating to A2 from A1, the senior subordinated debt rating to A3 from A2 and the junior subordinated debt rating to Baa3 from A2. The ratings agency also downgraded the bank's preferred stock rating to B3 from Baa1 and Bank of America N.A.'s bank financial strength rating to D from B-. "Bank of America's capital ratios could come under pressure in the short term, increasing the probability that systemic support will be needed," Moody's said in a statement.
Bank of America's regulatory capital position is quite strong, with a Tier 1 capital ratio of 10.7%. However, that is boosted a lot by preferred stock and so-called hybrid capital instruments, including $45 billion of preferred stock that the bank sold to the U.S. government via TARP, according to Moody's. Bank of America's tangible common equity, a more conservative measure of capital that gives less credit for hybrid securities, was roughly 4.3% of risk-weighted assets at the end of 2008 and could fall to "comparatively low levels," Moody's added. The agency downgraded Wells Fargo as well for similar reasons. It's more difficult to raise tangible common equity "because U.S. banks' access to the equity market is shut or very limited at best," said David Fanger, Moody's senior vice president, in a statement. "This increases the likelihood of a capital initiative by the U.S. government to support Bank of America" and Wells. Despite the downgrades, shares of Bank of America and Wells climbed almost 7% and 6% respectively on Wednesday.
B. of A.'s Lewis told the L.A. Times that he wants to start repaying $45 billion in federal bailout funds next month, after the government's "stress test." He commented that he's seen nothing from the government to indicate that Bank of America will fail the stress test that will be used to gauge the strength of the 19 largest U.S. banks. That test is scheduled to be completed at the end of April. In the newspaper's report published Wednesday, Lewis also said several financial indicators -- higher stock prices, slowing of home-price declines and improvements in certain consumer-delinquency gauges -- "leads me to think we're starting to see the bottom" of the recession. Bank of America will be ready to return all the bailout money as soon as the nation's financial system is stabilized, he added.
Moody's Sued in Ratings Case
A former Moody's Investors Service credit analyst has sued the company, alleging he was fired after his call on a bond rating was trumped by a manager's concern about how much the bond issuer was paying Moody's. Paul Bienstock, a former vice president at the unit of Moody's Corp., said in a lawsuit in U.S. District Court in New York that he was dismissed after complaining to Moody's compliance department about his manager. The lawsuit alleges the supervisor caused an upgrade for Express Scripts Inc. to be withheld, arguing that the company "doesn't pay us."
Moody's spokesman Michael Adler said Mr. Bienstock was laid off in December 2007 as part of a "reduction in force," and called his claims "without merit." He said "Moody's is strongly committed to protecting the integrity of its ratings and we have robust policies and procedures in place to do that." A spokeswoman for Express Scripts, a Missouri-based pharmacy-benefits manager, declined to comment.
In his complaint, Mr. Bienstock says that on Dec. 4, 2007, he presented Express Scripts debt to a Moody's committee for an upgrade from a speculative Ba1 to an investment-grade rating of Baa3, based on improved company performance. Mr. Bienstock alleges that the committee voted 5-2 for the upgrade, but his supervisor, Patrick Finnegan, the ratings committee chairman and then director of Moody's corporate-finance group, called for a revote saying "Express Scripts doesn't pay us," and "they don't visit us and they don't deserve our upgrade."
Mr. Bienstock said he protested, but the committee voted again, this time 6-1 against the upgrade. The next day, Dec. 5, 2007, Mr. Bienstock said he complained to the Moody's compliance department about a "breach" of the company's conflicts policies. The lawsuit, filed by the law firm of Sack & Sack, alleges he was fired by Mr. Finnegan on Dec. 12. Mr. Finnegan, who has since left Moody's, didn't return calls seeking comment. Moody's confirms that Mr. Bienstock complained to the compliance department about Mr. Finnegan, and that his layoff came a week later. But it says he had been designated for a layoff in November, before his complaints.
Ilargi: Canada has an independent parliamentary budget officer, Kevin Page, who was appointed by the present government. When he comes out with numbers that make official government 2009 budget predictions look ridiculously rosy, what does the government do? They try to ridicule their own budget officer. Mr. Page also complained the government refuses to supply him with documents essential for his job. Instaed of being on top of the story, Canadian media are remarkably silent. They don't have the chutzpah to question their government. Which makes them useless.
Canada's budget officer sees 8.5% drop in GDP
Canada's independent parliamentary budget officer forecast Wednesday the economy would deteriorate at a historic rate, and much faster than the government had expected when it produced its budget in late January. The budget officer, Kevin Page, said gross domestic product figures and unemployment levels would prove to be much worse than the minority Conservative government predicted on Jan. 26, providing fodder for opposition parties to demand more stimulus spending and aid for the unemployed. Mr. Page told the House of Commons finance committee that, based on private-sector forecasts and his own assessments, he expected GDP to contract by about 8.5% in the first quarter of 2009 and by 3.5% in the second quarter.
In the budget, the government cited private-sector forecasters as saying GDP would shrink by 0.8% in 2009 as a whole. "We provided a different, more detailed outlook for the first half of this year because we think that what we're seeing now is actually historic, in terms of quarter to quarter declines," Mr. Page told the committee. Liberal finance critic John McCallum said the forecast, if true, would mean that Canada would post its worst economic performance since at least World War Two. "What we learned today is that we're in more trouble than the government believed at the time of the budget," Mr. McCallum told reporters after the testimony.
The Liberals are asking the government to improve the employment insurance system to allow laid off workers to access benefits more quickly. Mr. Page, who complained the government was not providing enough data or funds to allow his office to do its job properly, also forecast nominal GDP would contract by 15% in the first quarter and by 4% in the second quarter. The budget cited forecasts that nominal GDP would fall by 1.2% in 2009. Mr. Page said the private-sector surveys "suggest that the current Canadian recession will be sharper than assumed in budget 2009, with real output expected to fall further below its trend potential than in either the 1980s or the 1990s recessions."
In the January budget, the government unveiled a two-year package of temporary stimulus measures that it said would result in a total of $64 billion in budget deficits in 2009-10 and 2010-11. Mr. Page said the weakening economy and lower tax revenues meant the deficits over those two years would in fact total $73-billion. He also said employment levels would drop by around 2% this year from 2008 compared with the budget forecast of a 0.5% drop. But he would not comment directly on whether more stimulus was needed to jumpstart the economy. "The policy challenge faced by all Canadians, by parliamentarians, is much more significant because of what we've seen already in the first quarter of 2009," he said.
Euro-Zone February Leading Indicator -0.3%
The composite index of leading indicators for the euro-zone economy decreased 0.3% in February to 92.9, according to estimates published Thursday, the Conference Board said. The leading indicator, which comprises several forward-looking data items and survey information, can show turning points in the economic cycle. In January the figure was up 0.9% following a 1.7% drop in December. In February, falling stock prices as well as a decline in economic sentiment index offset the widening interest rate spread, the conference board said. "As the plunge of new orders shows no signs of abating, the short term should remain dominated by the run-off on inventories.
The first quarter of 2009 is on its way to becoming as weak as the fourth quarter," said Jean-Claude Manini, the organization's senior economist for Europe. The continued downward trend in the Euro Area index together with worsening job market conditions don't bode well for a turnaround in the next few months, Manini added. "While recovery before 2010 can't be ruled out, the odds are growing slimmer," Manini said. The Conference Board, a U.S.-based nonprofit group, began publishing the indicator for the euro-zone economy in December. The group has examined older data and said the euro-zone leading indicator has been declining since June 2007, falling more than 14% since then. A decline of this magnitude preceded the region's 1992-93 recession, the organization said.
U.K. February Retail Sales Fall Four Times Faster Than Predicted as Jobless Lines Grow
U.K. retail sales tumbled more than four times faster than economists forecast last month after unemployment rose and the recession deepened.
Sales plunged 1.9 percent from January, the biggest decline since June, the Office for National Statistics said today in London. Economists predicted at 0.4 percent drop, the median of 26 forecasts in a Bloomberg News survey shows. Sales rose 0.4 percent from a year earlier, the least since September 1995. Next Plc Chief Executive Officer Simon Wolfson said today that trading conditions are "tough," after Britain’s second- biggest clothing retailer reported a 15 percent drop in full- year profit. Bank of England Governor Mervyn King said this week that the U.K. economy probably shrank further at the start of this year after the biggest contraction in almost three decades.
British consumers are "trimming expenditure on the High Street," said David Tinsley, an economist at National Australia Bank in London and a former Bank of England official. "As the year goes on and the labor market deteriorates, we’d expect that to continue." The pound dropped as much as 0.4 percent against the dollar after the release of the data, and traded at $1.4554 as of 10:38 a.m. in London. Sales fell on the month in all categories of stores, the statistics office said. Food sales dropped 0.3 percent, while non-food sales declined 3.2 percent. Kingfisher Plc, Europe’s largest home-improvement retailer, said today that profit fell 23 percent on a writedown of the value of its Chinese unit and declining U.K. sales. Debenhams Plc, the second-largest U.K. clothing department chain, said March 17 that first-half same-store sales dropped as the economic slump and winter storms dissuaded shoppers.
Inflation unexpectedly accelerated to 3.2 percent in February, driven by the cost of imports such as food. J Sainsbury Plc, Britain’s third-largest supermarket chain, yesterday reported its fastest quarterly sales growth in two years. The retail price deflator, a measure of cost changes in shops, rose an annual 0.3 percent, today’s data showed. King said in an open letter to the government on March 24 that the inflation rate will resume its drop from a peak of 5.2 percent in September. The bank’s forecasts show the rate slipping to 0.3 percent by early 2011, below the 2 percent target. The U.K. economy shrank 1.5 percent in the fourth quarter, the most since 1980, and King told lawmakers on March 24 he expects a similar rate of contraction in the first three months of this year.
The bank has embarked on a program to spend as much as 150 billion pounds ($219 billion) to buy U.K. government debt, corporate bonds and other assets with newly created money in order to ease credit strains and encourage spending. Business investment fell 1.5 percent in the last three months of 2008, revised from a previous report of 3.9 percent, the statistics office said in a separate report today. The final estimate of fourth-quarter gross domestic product will be published tomorrow.
Gordon Brown 'Terribly Fragile' After Bond Auction Flops
The first failed British bond auction in more than seven years leaves Prime Minister Gordon Brown’s reputation for economic competence even more tarnished as he battles recession and a rising tide of voter anger. Brown, who had the backing of 30 percent of the electorate in a ComRes Ltd. poll last week, must now cope with what amounts to a vote of no confidence by investors in his ability to end the recession. Bank of England Governor Mervyn King, his ally for much of the past decade, warned a day earlier that there’s no more money for further spending. "The notion that Brown is leading us to the promised land is laughable," said Ruth Lea, economic adviser to the Arbuthnot Banking Group Plc in Solihull, England. "He cannot get to grips with how other people see this country now, as the sick man of Europe."
Chancellor of the Exchequer Alistair Darling brushed aside concerns about the gilt auction, noting that a sale of bonds today was fully covered. "You always have to be careful about reading too much into one particular auction," Darling said in response to a question in Parliament in London today. Brown, 58, succeeded Tony Blair in 2007 on the strength of his record as finance minister during a decade of uninterrupted growth. That reputation is deserting him little more than a year before he must call an election, Brown’s first as leader and the Labour Party’s third in office The Treasury yesterday tried to sell 1.75 billion pounds ($2.6 billion) of 40-year gilts and got 1.63 billion pounds of bids, a sign that investors are reluctant to finance his record borrowing. "Brown’s strategy now looks terribly fragile," said Mark Wickham-Jones, a professor of politics at Bristol University. "His situation is economically extremely uncertain, politically risky and this auction again highlights how we are now in un- chartered territory."
The auction failure couldn’t have come at a worse time for Brown, who set off on a five-day tour this week to win support for his economic-reform plans before a summit of leaders from the Group of 20 nations he’s hosting in London on April 2. He’s in Brasilia today and due to visit Chile after speaking in New York yesterday. German Chancellor Angela Merkel has resisted Brown’s push for a new fiscal stimulus, saying her country already has committed to a boost worth 4.7 percent of gross domestic product. "If we want to increase the effectiveness of such a stimulus package, then we first have to implement it, so to speak, and not to begin speaking of the next measure when the first one isn’t through," Merkel told after meeting Brown in London on March 14. "We’ve already taken a huge step."
The government says the G-20 will focus on stabilizing financial markets, reforming global financial institutions and helping people get through the recession. Brown wants them to agree on a fiscal stimulus to support growth, something King warned might not be affordable. "Given how big these deficits are, I think it would be sensible to be cautious about going further in using discretionary measures to expand the size of those deficits," King said in Parliament on March 24. Brown’s spokesman Tom Hoskin said yesterday the prime minister wasn’t troubled by the auction failure. "There have been other auctions that have been uncovered in other countries," he told reporters in London. "The underlying strength of the market in gilts is there." While issues of inflation-protected bonds went unfilled in 2002 and 1999, it’s the first failure of non-indexed bonds since 1995.
For his part, Brown didn’t mention the gilts auction during an appearance in New York and said he had "consensus, not a disagreement" with King. Britain’s economic outlook is looking increasingly gloomy. The economy will shrink 2.8 percent this year, the biggest contraction among the Group of Seven nations, according to the International Monetary Fund. That compares with declines of 2.6 percent in Japan, 2 percent in the euro area, 1.6 percent in the U.S. and 1.2 percent in Canada. The European Commission this week forecast Britain’s budget deficit would touch 9.6 percent of gross domestic product in the year ending March 2010, triple the EU limit.
When the 1995 gilt auction failed, investors were concerned that John Major’s Conservative government was on course to lose the general election and was about to announce tax cuts it couldn’t afford. Now, it’s gild yields that are to blame, according to Robert Stheeman, the head of the Debt Management Office, which manages sales of the securities for the Treasury. The Bank of England cut its benchmark lending rate to 0.5 percent this month, the lowest ever, and started a program to boost the money supply. "Yields at these levels are not at all attractive," Stheeman said yesterday. Opposition lawmakers seized on the comments from Stheeman and King to suggest Brown’s reputation for smooth handling of the economy is in tatters.
The Conservatives said the auction was the latest signal of a collapse in confidence in the government. "The Brown rescue model is broken," said Michael Fallon, an opposition Conservative lawmaker and deputy chairman of Parliament’s Treasury Committee. "The governor made a hole in it, now it looks as if sterling can’t stand it." Outside Parliament, government rescues of Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc have failed to shore up confidence. House prices have fallen 20.6 percent since peaking at 186,044 pounds in October 2007 and stood at 147,746 pounds in February, according to Nationwide Building Society. Banks approved 31,000 mortgages in January, less than a third of the monthly average in 2007, Bank of England data show.
A British Chambers of Commerce survey in February found nine out of 10 respondents unaware their banks were offering access to government-support programs. A 1 billion pound program to guarantee mortgage-interest payments for homeowners who suffer a drop in income, announced in December, has yet to materialize. "Businesses are still experiencing difficulties accessing credit," said John Cridland, deputy director-general of the Confederation of British Industry, the biggest business lobby group. "The government has taken the right steps to get credit moving, but this has yet to feed through." Brown has trailed the Conservatives in every poll since January 2008. Labour had the support of 30 percent of voters compared with 41 percent for the opposition, according to the ComRes poll conducted March 18 and March 19. No margin of error was given.
Shadow of debt mountain forces Gordon Brown to back off tax cuts
Gordon Brown sounded a retreat yesterday from injecting more borrowed cash into the economy, amid evidence that confidence in Britain’s ability to repay its record debts is faltering. The Prime Minister played down the prospect of further tax cuts in the Budget the day after Mervyn King, the Bank of England Governor, warned that the country might not be able to afford a second fiscal stimulus. Mr Brown’s room for manoeuvre was reduced further when it emerged that an auction of government debt had failed, in what analysts said was a clear warning from investors over Britain’s borrowing. Speaking in New York, on the latest stage of his world tour before next week’s G20 summit in London, Mr Brown also backed away from demands for other countries to pump in more cash. His remarks took him closer to the position taken by Mr King and Alistair Darling, the Chancellor.
The Prime Minister arrives in Brazil today to continue to build support for "the biggest financial stimulus the world has ever seen". But his efforts are being increasingly hampered by constraints in Britain. Asked by Robert Thomson, Editor-in-Chief of The Wall Street Journal, about Mr King’s appeal for caution, Mr Brown said fiscal measures were only one of three ways of stimulating the economy. "We’re doing it by interest rates being incredibly low, we’re doing it by our fiscal stimulus and we’re doing it by what is probably not yet understood by the public as one of the most effective and quicker ways of getting activity moving in the economy — by quantitative easing," he said. In a further sign that Mr Brown has been forced to rethink another package of tax cuts in the Budget next month, he said that it was important to monitor how existing measures were working first.
Echoing Angela Merkel, the German Chancellor, who is resisting pressure for another fiscal stimulus, he said: "Nobody is suggesting that people come to the G20 meeting and put on the table the budget that they’re going to have for the next year. What we are suggesting is that we have together to look at what we have done so far . . . and then say, ‘What should happen next?’." He added: "Every country will have its own timing for announcing its fiscal and monetary decisions. Nobody is trying to upset that timing." Nevertheless, international leaders were determined to do "whatever it takes to make sure that we can restore the economy to growth". "Some people have taken fiscal action. Some people have had two fiscal stimuli. Monetary action has been common around the world. Some authorities have still to discuss whether they go further down on interest rates. Quantitative easing has been the new decisions of the last few weeks."
"It is the combination of all these initiatives that make the difference. You will see in the communiqué a determination to do what is necessary and to monitor what is happening." Mr Brown’s intervention came as fresh doubts were raised over the state of Britain’s public finances. An auction of government-guaranteed bonds failed for the first time in conventional circumstances since 1995. The Debt Management Office (DMO), which sells the gilts, said it had not attracted enough bidders for its latest issue. The £1.75 billion of Treasury gilts maturing in 2049 being sold received bids worth only £1.63 billion. Despite the failure, the DMO said it had sold £145.3 billion in gilts in the current financial year, which is £1.1 billion below its target, with one more auction to go. Technical factors such as financial year-end constraints in taking on slightly riskier 40-year gilts may also have played a part in buyers failing to take up the full amount.
However, experts have been worried that investors would snub future issues as the public finances deteriorate, unless interest rates rise. Downing Street tried to play down the failure. An official said: "There have been other auctions that have been uncovered in other countries. Germany had two this year and eight last year. "The underlying strength of the market in gilts is there, demonstrated by the fact that yields remain low." The Government’s forecast of £118 billion in net borrowing during 2009-10 is set to rise even higher in April’s Budget. There were also more signs of international tensions over how best to tackle the downturn.
The Czech Prime Minister, Mirek Topolánek, called President Obama’s fiscal stimulus package and financial bailout the "way to hell". Mr Topolánek, whose country holds the EU presidency, told the European Parliament in Strasbourg that the measures would "undermine the stability of the global financial market". Mr Brown faced further embarrassment when the US Treasury Secretary Timothy Geithner criticised excessive borrowing for its role in the present economic situation. "No crisis like this has a simple or single cause, but as a nation we borrowed too much and let our financial system take on irresponsible levels of risk," he told the Council on Foreign Relations, a think-tank in Washington.
"Those decisions have caused enormous suffering, and much of the damage has fallen on ordinary Americans and small business owners who were careful and responsible. This is fundamentally unfair, and Americans are justifiably angry and frustrated." The remarks echo closely the Conservatives’ critique of Mr Brown’s policies when he was Chancellor, which they say left Britain too indebted to withstand a downturn. Asked about Mr Topolánek’s comments, a Downing Street spokesman said: "The Czech Prime Minister signed up to the language in the communiqué which was agreed at the European Council last week, which committed the EU to taking a range of measure — including fiscal measures, but other stimulus measures as well. That remains the position of the EU." Mr Topolánek’s remarks came soon after his coalition lost a vote of confidence in the Czech parliament. He has indicated that he may resign when he returns from Brussels.
Labour recruits Obama’s pollsters
- Labour has hired Barack Obama’s pollster in the party’s latest attempt to capitalise on the President’s electoral success. Joel Benenson — one of Mr Obama’s key strategists during last year’s presidential election — has agreed to help Gordon Brown try to overturn the Conservative poll lead
- Labour has also hired Pete Brodnitz — also of the Benenson Strategy Group — to help to prepare for the next election. Both were described as "formidable assets" by the party’s election co-ordinator, Douglas Alexander
- The Conservatives are likely to point out that Mr Benenson’s explanation for the success of his strategy would seem to favour David Cameron. "I don’t think we thought the general election would be anything other than change versus more of the same," the pollster said on the day of the US election last year
- Labour believes that the recruitment of the pollsters is not an attempt to mimic the Obama campaign but to access the most sophisticated methods of assessing public mood possible
- The hiring is the first fruit of secret talks between David Muir, Downing Street’s director of political strategy, and David Plouffe and David Axelrod, the political strategists behind Mr Obama’s victory. Both main parties in Britain have been seeking to learn how technological shifts are changing the nature of political campaigning
Irish economy plunges deeper into recession
Ireland’s economy plunged deeper into recession in the final quarter of 2008 with the worst full-year performance in 25 years, setting the stage for an even bleaker 2009 than originally feared. Gross domestic product (GDP) fell 7.5 percent from the same period a year ago, far worse than even the most pessimistic forecast in a Reuters poll, as consumers and businesses put the brakes down hard on spending. "We have now moved into 2009 with even stronger headwinds than we thought," said Dan McLaughlin, chief economist at Bank of Ireland. "You’ll probably see further downward revisions (in 2009 consensus forecasts) on the back of this." GDP fell 2.3 percent for the whole of 2008, data from the Central Statistics Office showed on Thursday -- far lower than the 1.5 percent decline forecast in a Reuters poll and the weakest level since 1983. Economists had forecast fourth quarter GDP would drop by 2.9 percent. The lowest estimate in the Reuters poll was for a fall of 6.1 per cent.
The government has already downgraded its forecast for this year’s contraction to 6.5 percent from 4.5 percent, already predicted to be the worst recession on record as the former "Celtic Tiger" economy suffers from the double whammy of a global recession and a collapsing local property bubble. The rapidly deteriorating economy has sent tax revenues nose-diving and the government is set to hike taxes and slash spending on April 7, in its second emergency budget in six months. Gross National Product (GNP) fell 6.7 percent in the fourth quarter from a year ago, worse than expectations for a 3.9 percent fall. GNP is the government’s favoured measure of the domestic economy because it excludes profits earned by multinational companies which have a big presence in Ireland.
German CEOs See Massive Pay Drop
A new study shows that executive salaries, including bonuses, dropped by one-quarter at Germany's leading publicly traded companies in 2008. Deutsche Bank's CEO saw his earnings decline by 90 percent. In recent months, the debate has raged globally about the payment of bonuses to executives of banks, insurance and other companies that are the recipients of government bailouts. In the US, there has been criticism of millions-strong bonus payments at insurer AIG and banking giant Citigroup, and in Germany payments to managers at Dresdner Bank despite losses in the high millions have outraged voters. The system in place at most corporations is aimed at rewarding executives during boom times, but critics say it has been insufficient to curb excesses during leaner, crisis times like the present.
A new study of companies on Germany's blue chip DAX index conducted by the consulting firm Kienbaum and published by the Financial Times Deutschland newspaper on Wednesday appears to counter that view, though. The study, which looked at 24 of 30 companies listed on Germany's DAX blue chip stock index, found that salaries of top executives at these firms fell by around one-quarter in 2008. Six DAX companies were omitted from the study because they had not yet released their annual reports. Still, the paper argued that the firms included were representative because they included German blue chips like Siemens, Allianz and BASF. The trend reflected a fall in revenues for 2008 at many of the companies surveyed. Leading the pack in losses was Deutsche Bank CEO Joseph Ackermann who, according to the Frankfurt- based consulting firm, saw his salary fall by 90 percent to €1.4 million -- after foregoing his bonus for 2008. Bankers like Ackermann were particularly hard hit, but captains of industry also took blows, especially in the automotive sector. At BMW, for example, CEO Norbert Reithofer's compensation fell by 40 percent to €2.3 million, while at Daimler, CEO Dieter Zetsche's income dropped by 55 percent to €5 million. Meanwhile, at insurer Allianz, chairman Michael Diekmann has seen his earnings decline by 40 percent.
As in the United States, the debate about swollen executive salaries has simmered in Europe as a result of the financial crisis. It's long been a subject of dispute, but the economic downturn and credit crunch has brought a new sense of urgency to the discussion. Many politicians and executives have reacted to such public pressure, and a number of executives are voluntarily giving up the bonuses that are part of their contracts. The chief executive at Postbank in Germany, which is partially owned by the government, announced recently that he would work this year for a token salary of €1. Meanwhile, on Tuesday, the CEO of German media giant Bertelsmann said he would give up half his salary. According to the Financial Times Deutschland, it's a development that was spearheaded by Ackermann, who forewent his bonus for 2008. Elsewhere in Europe, the paper reports that French government politicians pressured Thierry Morin, the outgoing chief of automobile parts supplier Valeo, to give up his €3 million severance package. The government recently came to the company's rescue by providing fresh capital, and French Industry Minister Luc Chatel called the planned payment to Morin "shocking." Meanwhile, in Sweden, the government said Tuesday that it wanted to eliminate performance-based bonuses altogether in the future.
China raises jobless migrant count to 23 million
China estimates the number of its unemployed migrant workers has risen to 23 million since January's Lunar New Year holiday, with 11 million of those who returned to cities still searching for jobs. China is worried about the potential for unrest among its migrant workers, most of whom work in the hard-hit construction, textile and export manufacturing sectors. Previous estimates before the holiday, when Chinese return to their home provinces, had put the number of unemployed migrants at about 20 million. Millions of former migrant workers were still in the countryside, trying to find work close to their home towns rather than venturing afield in a weak job market, the National Bureau of Statistics said on Wednesday.
About 225.42 million Chinese were classified as "rural workers", the Chinese term for migrants, at the end of 2008, the bureau said in an estimate higher than that used in the past. Of those, 140.41 million work outside their home county, often travelling thousands of miles to seek work in the big cities or the coast. Chinese government estimates in January had put the total number of migrant unemployed at 20 million, as the country struggled with a severe downturn in the real estate sector and demand for its exports. Remittances from migrant workers have been an important source of income for families in rural China, where incomes, education and access to health care lag far behind the cities.
Most of the migrant workers surveyed by the bureau have a middle school education or below. Almost all have some legal claim to farmland, although in most cases that land is being farmed by their relatives or has been leased to fellow villagers, the study said. China's labour problems are not limited to migrants, as college graduates also struggle to find jobs. About 70 percent of upcoming graduates had yet to have an offer, a Shanghai employment agency estimated on Tuesday, adding that normally at this time of year 70 percent already know where they would work.
US Corporations Face Sharply Higher Costs From Underfunded Pensions
The amount by which U.S. pensions are underfunded has almost doubled since October to $373 billion, increasing pressure on companies to give more to retirement plans as the global recession saps earnings. U.S. retirement plans are able to meet 74 percent of their future obligations, down from 89 percent five months ago, after global stocks fell and contributions were delayed, according to Mercer’s Financial Strategy Group, a Marsh & McLennan Cos. unit. DuPont Co., Caterpillar Inc. and Lockheed Martin Corp. are among the companies that say they expect higher pension costs in 2009. Last year’s drop in U.S. stock prices, the deepest in seven decades, will saddle the 53 percent of companies in the Standard & Poor’s 1500 Index with defined-benefit plans with about $70 billion in pension expenses this year, a sevenfold increase from 2008, as they seek to close the funding gap, Mercer analyst Adrian Hartshorn said yesterday in an interview.
“Everybody is facing the same problem: big companies, charities, non-profits,” said Judy Schub, managing director of the Bethesda, Maryland-based Committee on Investments of Employee Benefit Assets, whose members’ plans are responsible for more than 11 million workers and retirees. “The call on their cash is going to be significantly higher, two or three times higher, than they had planned.” Legislation passed last year requires the companies to pay down the shortfalls in seven years, Mercer’s Hartshorn said. Watson Wyatt Worldwide Inc., an Arlington, Virginia-based consulting firm, has analyzed the 100 largest U.S. pension plan sponsors and said some companies are making contributions in advance, anticipating larger future commitments.
DuPont’s pension expenses may rise 40 cents to 50 cents a share this year after the plan’s assets fell 28 percent to $16.2 billion, the company said in a Feb. 12 filing. The pension is underfunded by $5.3 billion, compared with a $412 million surplus a year earlier, DuPont said. The $5.14 billion decline in the value of the plan’s holdings last year won’t change the company’s investment strategy, Valerie Sills, DuPont Capital Management president, said in an interview.
“Equities are very attractive at this point in time,” Sills said. “We’ve always had a healthy equity weighting.” DuPont, the world’s third-largest chemical maker, plans to increase the amount of equities in its plan to 52 percent this year from 49 percent in 2008, according to its filing. About a third of its portfolio will remain in fixed income, with the remainder divided between real estate and other investments. Equities made up 55 percent of DuPont’s assets in 2007.
Wilmington, Delaware-based DuPont said in a filing it hasn’t determined how much it may contribute to its pensions this year and it isn’t required to add funding to the plan at this time. DuPont in January reported a fourth-quarter loss of $629 million as global demand for materials used in cars and homes deteriorated. The company has cut 2,500 jobs and 8,000 contractor positions. Lockheed Martin, the nation’s largest defense contractor, slashed its 2009 earnings forecast by more than 60 cents a share after falling stocks eroded pension assets. The negative return on plan assets in 2008 and the change in the discount rate will increase 2009 pension expenses to about $1.04 billion, more than double the $462 million in 2008, Bethesda, Maryland-based Lockheed said in its annual report filed in February. About 85 percent of the increase was driven by the drop in plan assets, Lockheed said.
Dow Chemical, the largest U.S. chemical maker, expects to more than double pension contributions to $376 million from $185 million last year, according to a Feb. 20 filing. Midland, Michigan-based Dow’s pension was underfunded by $4 billion at year-end after posting a $526 million surplus a year earlier. Sears Holdings Corp., the largest U.S. department-store chain, may need to almost triple its pension contributions to $500 million in 2010 from $170 million this year if pension reforms aren’t enacted and the markets fail to recover, the Hoffman Estates, Illinois-based company said in a filing. Caterpillar, the largest construction-equipment maker, said Jan. 26 that it had a $3.4 billion year-end charge because of lower returns on pension assets. The company plans to put $1 billion into the pension fund this year, Chief Executive Officer Jim Owens said on a Jan. 26 conference call with analysts. “Hopefully, the equity markets will return to some semblance of normal multiples and therefore recover,” Owens said.
Caterpillar’s pension obligations were $5.8 billion underfunded at the end of 2008, according to a Jan. 26 filing. The Peoria, Illinois-based company said in the filing it aims to keep its portfolio 70 percent invested in equities. “Some companies that see the market as near the bottom and are expecting a rebound do not want to take money out of equities now and are definitely not rebalancing,” Mercer’s Hartshorn said President George W. Bush late last year signed a law easing pension-funding requirements by eliminating some penalties on companies whose funding falls below federal guidelines. Trade groups have lobbied lawmakers on four Congressional committees for more regulatory changes, according to the lobbying group Committee on Investments of Employee Benefit Assets. One proposal would allow companies to make contributions to their pension funds for 2009 and 2010 based on 105 percent and 110 percent of their 2008 required contribution. Another proposal would prevent the growth in pension-fund shortfalls for companies paying interest on their plans’ 2008 losses. No legislation has yet been introduced, the group said. “Members of Congress do recognize there is a problem,” the Committee on Investments’ Schub said. “Unfortunately, this stuff is complicated and they have so much on their plate.”
Fiscal dimensions of central banking: the fiscal vacuum at the heart of the Eurosystem and the fiscal abuse by and of the Fed: Part 2
by Willem Buiter
The Bank of England
When the Bank of England gets around to making outright private asset purchases, it will do so with an indemnity provided by Her Majesty’s Government to cover any losses arising from the use of the Facility. This is as it should be. In principle, a central bank should only take the credit risk of its sovereign – the state. If its monetary, liquidity, or credit-easing operations expose it to the credit risk of the private sector, it ought to do so with a full indemnity (guarantee for any losses) from the Treasury. The Bank of England has a full indemnity for outright purchases of private securities, but not for the private credit risk it assumes through repos and other forms of collateralised lending to banks where the collateral offered consists of private securities. I believe the UK Treasury should insure the Bank of England – for free – against all losses incurred as a result of the Bank of England taking private credit risk on its portfolio.
The Fed does not have a full indemnity from the US Treasury even for its outright purchases of private securities. It has no guarantee or indemnity for private credit risk assumed as a result of its repo operations and collateralised lending. For the Fed’s potential $1 trillion exposure to private credit risk through the Term Asset-Backed Securities Loan Facility, for instance, the Treasury only guarantees $100 billion. They call it 10 times leverage. I call it the Fed being potentially in the hole for $900 billion. Similar credit risk exposures have been assumed by the Fed in the commercial paper market, in its purchases of Fannie and Freddie mortgages, in the rescue of AIG, and in a host of other quasi-fiscal rescue operations mounted by the Fed and by the Fed, the Federal Deposit Insurance Corporation, and the US Treasury jointly.
I consider this use of the Federal Reserve as an active (quasi-)fiscal player to be extremely dangerous and highly undesirable from the point of view of the health of the democratic system of government in the US. There are two reasons for this. First, it undermines the independence of the Fed and turns it into an off-budget and off-balance sheet special purpose vehicle of the US Treasury. Second, it undermines the accountability of the Executive branch of the US Federal government for the use of public resources – taxpayers’ money.
As for the Fed’s independence (whatever independence remains), first, even if the central bank prices the private securities it purchases appropriately (that is, there is no ex ante implicit quasi-fiscal subsidy involved), it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources. Even if it gets the resources, there is likely to be a price tag attached – that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.
As regards democratic accountability for the use of public funds, even if the central bank has sufficient capital to weather the capital losses it suffers on its holdings of private securities, the central bank should never put itself into the position of becoming an active quasi-fiscal player or a debt collector. The ex post transfers or subsidies involved in writing down or writing off private assets are (quasi-)fiscal actions that ought to be decided by and accounted for by the fiscal authorities. The central bank can act as a fiscal agent for the government. It should not act as a fiscal principal, outside the normal accountability framework.
The Fed can deny and has denied information to the Congress and to the public that US government departments like the Treasury cannot withhold. The Fed has been stonewalling requests for information about the terms and conditions on which it makes its myriad facilities available to banks and other financial institutions. It even at first refused to reveal which counterparties of AIG had benefited from the rescue packages (now around $170 billion with more to come) granted this rogue investment bank masquerading as an insurance company. The toxic waste from Bear Stearns’ balance sheet has been hidden in some SPV in Delaware. The opaqueness of the financial operations of the Fed in support of the financial sector (which are expanding in scale and scope at an unprecedented rate) and the lack of accountability for the use of taxpayers’ resources that it entails threaten democratic accountability. Even if it enhances financial stability, which I doubt, democratic legitimacy and accountability are damaged by it, and that is too high a price to pay.
The ECB has no fiscal backup. There is no guarantee, insurance, or indemnity for any private credit risk it assumes. This huge error and omission in the design of the ECB and the Eurosystem threatens to make the ECB significantly less able than the Bank of England and the Fed to engage in unconventional monetary policy, including quantitative easing and credit easing. The exposure of central banks to private sector default risk applies, of course, not only to central banks making outright purchases of private securities. It applies equally to central banks that make loans to the private sector using private financial instruments as collateral. Repos are an example. The Eurosystem has taken private sector credit risk onto its balance sheet ever since it was created. It now accepts a vast collection of private securities as collateral in repos and at its discount window (just about anything issued in euro and in the Eurozone that is rated at least BBB-).
The Eurosystem has already taken some significant marked-to-market losses on loans it made to eligible Eurozone counterparty banks against rubbish ABS collateral. In the autumn of 2008, five banks (Lehman Brothers Bankhaus AG, three subsidiaries of Icelandic banks, and Indover NL) defaulted on refinancing operations undertaken by the Eurosystem. The amount involved was just over €10 billion, and over €5 billion of provisions have been made against these impaired assets, because the mainly ABS dodgy collateral is, under current market conditions, worth rather less than €10 billion.
Any losses incurred as a result of these defaults are, like all losses incurred by the Eurosystem in the pursuit of its monetary and liquidity operations, to be shared by all 16 national central banks in proportion to their shares in the ECB’s capital. But while the Eurosystem as a whole shares any losses incurred by its individual national central banks, there is no mechanism for recapitalising the Eurosystem as a whole. The ECB/Eurosystem is not yet hurting financially, however. The Eurosystem’s income from monetary policy operations was probably around €28.7 billion in 2008.
A high degree of price stability and large denomination notes (including €500 and €200 notes, while the best the US can come up with is a $100 bill) make the euro the currency of choice for tax evaders, tax avoiders, money launderers, and other criminal elements everywhere. This makes for massive seigniorage revenue for the ECB and the Eurosystem. The combination of the obvious willingness of the ECB/Eurosystem to take serious private sector credit risk through collateralised lending to banks and its unwillingness to consider outright purchases of private securities or to engage in unsecured lending to the banking sector is difficult to rationalise.
Let us Prey
Years from now, when historians carbon-date that extinct species known as the celebrity CEO, they will trace its demise to a brisk February morning in 2009 and a wood-panelled room in Washington, D.C. Eight Wall Street high rollers, their bearing sombre, their faces exsanguinated, were dutifully lined up for a congressional flogging. They had made a few frugal gestures in advance—leaving the corporate jets at home in favour of Amtrak; choosing modest hotels—yet these were quickly derided as posturing by a group of angry lawmakers. "You come to us today on your bicycles, after buying Girl Scout cookies and helping out Mother Teresa, telling us, 'We're sorry. We didn't mean it. We won't do it again,'" sneered Democratic Representative Michael Capuano of Massachusetts. "America doesn't trust you any more."
Capuano could have put it more dramatically: America didn't revere them any more. This grilling was many things: theatre, catharsis, political stagecraft. Yet it may ultimately prove to be something more: a definitive rupturing of the cult of the CEO, a kind of secular worship that has been steadily gaining adherents for the past 20 years. The men who had assembled in Washington—Vikram Pandit of beleaguered Citigroup, Ken Lewis of the suddenly ailing Bank of America, and Lloyd Blankfein of the resilient Goldman Sachs, among others—weren't the worst offenders in their industry. They hadn't been accused of doing anything illegal, and they hadn't been dragged into court.
Yet that is precisely the reason that the financial industry's self-destruction may sound the death knell for the celebrity CEO. These men were disgraced even though they were pillars of the system, not rogues. They were feted in the media and richly rewarded, even as their cavalier bets paralyzed an entire economy. And they did it with full disclosure, not to mention the imprimatur of the boards of directors that were their supposed gatekeepers. The rot wasn't hidden, in other words, but systemic—and the public's belated awakening to this fact may finally augur a changing of the guard, toward a new, and less transcendent, kind of corporate leader.
Crooked CEOs like Ken Lay and Bernie Ebbers had their day, notes Gideon Haigh, author of Fat Cats: The Strange Cult of the CEO. "But if anything, the excesses of Wall Street are an even greater indictment of the cult. The sums were accumulated in plain sight by the best and the brightest—the excuse that the miscreants represent merely a few bad apples is not available." On May 9, 1986, Miami Vice aired "Sons and Lovers," the last episode of its sophomore season. As detectives Crockett and Tubbs loitered on a stakeout, Park Commissioner Lido—a tall, bespectacled man with greying hair and an avuncular mien—wandered over with some unsolicited assistance.
"If it's any help," he confided, "I know how to handle a gun." This was a watershed moment. Lido was none other than Lee Iacocca, the shoot-from-the-hip executive credited with rescuing Chrysler Corp. from the brink and refashioning it as an automotive powerhouse. Iacocca's visage was plastered everywhere in the 1980s. He graced magazine covers and newspaper pages. He made it onto lists of the most intriguing and influential men in America. His autobiography sold seven million copies. And he anointed himself pitchman for Chrysler's new line of K-cars, boldly telling viewers: "If you can find a better car, buy it."
The fact that a Detroit CEO was offered a cameo on prime-time's hottest series was one thing; the fact that people recognized him was something else entirely. Iacocca had brought the executive suite to Main Street, almost single-handedly creating the manager-as-saviour archetype and reshaping the way Americans thought about CEOs. Some would argue that CEOs have always occupied a mythic place, for better and worse, in the popular consciousness. A century or so ago, big business was defined by robber barons and self-made industrialists—think Carnegie and Rockefeller—who amassed huge fortunes and later used this wealth to cement their legacies. But these were entrepreneurs, and the successful ones came to embody the logic of individualism and self-reliance: They had worked hard, harnessed the free markets and grasped the American dream.
As the Depression took hold, however, there was a gradual separation of ownership and control. Widely held companies may have been owned by shareholders, but they were now controlled by professional managers. This was a new breed of leader, one who wasn't self-made, and who wasn't necessarily steeped in the particulars of a given industry, but whose skill was in managing a company's operations and ensuring its healthy future through a kind of custodianship.
According to Rakesh Khurana, a professor of management at Harvard Business School, this was the heyday of the man in the grey flannel suit. CEOs viewed themselves as stewards, and a big part of their job description was to ensure that these companies survived in perpetuity. Shareholder returns mattered, of course, but so did the needs of many other stakeholders, from employees and governments to communities and, more abstractly, the corporate image. This "Organization Man," a term coined by William Whyte in a book of the same name, persisted into the 1960s, when a more financially literate breed of chief executive came into vogue—leaders who built conglomerates through aggressive mergers and acquisitions. Yet they largely manoeuvred behind closed doors; members of the wheelers-and-dealers club still remained a faceless lot, at least by today's standards, even though they controlled increasingly powerful companies.
By the end of the 1970s, though, some significant changes were afoot. Companies began switching from defined benefit pension plans to defined contribution plans, so more and more workers found that their retirement hinged on the performance of stock markets. Mutual funds began to gain traction as supplements to—and in some cases replacements for—these pensions, and, over the next decade, their popularity exploded. Even public pension funds got into the act, weaning themselves off the meagre, if safe, returns of fixed-income products, like bonds, in favour of betting on stocks. As market fundamentalism flourished, the United States became a nation of shareholders, and MBA programs adjusted in kind, laying the foundation for a sudden shift in the sort of leaders populating the country's largest companies.
"In the golden age, business schools taught CEOs to be trustees of companies," says Khurana, who in 2007 published From Higher Aims to Hired Hands: The Social Transformation of American Business Schools and the Unfulfilled Promise of Management as a Profession. "That has been displaced over the past three decades by a shareholder maximization model—[the notion] that CEOs should see themselves as the hired hands of shareholders." Not surprisingly, as people increasingly saw their financial fate linked to stock prices, they became more hungry for information about the so-called captains of industry. In 1989, CNBC began chronicling executive exploits and turning CEOs into television fixtures—the surest path to stardom. The print media also became a vehicle for glamorization: According to Khurana, BusinessWeek placed only one CEO on its cover in all of 1981. In 1999, the number had risen to 19. The hagiography had begun.
Iacocca exemplified this new order: He was a charismatic manager in whom sad-sack Chrysler investors could place their faith and find a measure of redemption. He was hardly alone. Jack Welch, who was "Neutron Jack" at the beginning of his career (a nod to his habit of ripping out layers of management at General Electric), soon became a corporate demigod; by the time he left GE, its market capitalization had increased more than 5,000%. Al (Chainsaw) Dunlap may be the most famous case. Despite his thuggish reputation as head of Scott Paper (he titled his autobiography Mean Business), investors only cared about his returns. When he joined Sunbeam, the company's stock immediately skyrocketed, but before long it had cratered again, and Dunlap, who was accused of juicing revenue numbers, was fired.
But that did little to dent the cult. Outsized CEOs often dwarfed the corporations they served, and their personalities, as much as their performance, could steer investor sentiment. This wasn't merely the age of Wall Street but of Wall Street, a film that came to define the new-found spirit of corporate excess, and made explicit the growing suspicion that "greed is good." Many firms felt they needed a name-brand CEO, and they soon realized that star appeal came with a substantial price tag. Compensation was no longer benchmarked internally; instead, it was measured against a peer group chock full of celebrities. In 1980, chief executives made roughly 40 times the compensation of the average worker; last year, they made about 350 times more.
With this hired-gun mentality also came unprecedented movement in and out of the corner office. Welch may have persisted with the same company, but as star CEOs flourished, more of them were enticed to other companies with hefty monetary packages. This itinerant behaviour was mirrored in investing habits. In the era of the Organization Man, investors trading on the New York Stock Exchange held on to a stock for an average of about five years; now they were holding on for less than a year on average—more like renting than owning. The inexorable climb of major market indexes blunted criticism of outsized pay packages, which continued to swell through the 1990s and much of this decade. The collapse of Enron, and tales of lavish spending at Tyco, created a furor among investors, but this mainly led to more prescriptive rules for corporate governance and accounting. Jeff Skilling and Dennis Kozlowski may have illustrated how celebrity could beget renegade behaviour, but their actions didn't inspire a full-fledged crisis of belief in the markets themselves.
Not like the ongoing saga of Wall Street's meltdown has, at any rate. Everybody seems complicit in the current crisis: lax government overseers, boards of directors and, of course, CEOs who, even when ousted, left with tens of millions of dollars. Stan O'Neal was forced from his perch at Merrill Lynch but took solace in a $162-million (U.S.) compensation package, even though the company was in such bad shape it had to be swallowed by Bank of America. Chuck Prince got turfed at Citigroup, which is now a ward of the state, but he left with $68 million (U.S.) for his troubles. Dick Fuld, Jimmy Cayne—the list of Wall Street CEOs who ran their legendary brokerage houses into the ground stretches on. These brokerages were the linchpin of the global economy—and now that the pin has corroded, the architecture of that economy is threatening to collapse. One needn't visit Detroit to get the picture.
Canada, whose financial system has fared among the best in the world during the downturn, has also stood apart as being more resistant to the allure of celebrity CEOs. (Quick: Name some prominent executives here who have published their autobiographies. Bonus points for those that have sold more than a handful of copies.) There have been a few on Bay Street in recent years—Ed Clark of Toronto-Dominion Bank and Dominic D'Alessandro of Manulife seem closest to the mould—and then, of course, there was the odd one who routinely graced magazine covers during the tech boom, like John Roth. Conrad Black also comes to mind. Yet the fever never quite peaked here as it did in the United States, possibly because so many of our major businesses remain family-run enterprises, or because of a culturally inherent sense of modesty and a lack of star-making machinery.
And then there are the skeptics who might point to the likes of Apple's Steve Jobs as proof that the cult of the CEO will withstand the financial-industry-fuelled recession. There is some validity to this thinking. When Jobs recently announced he was taking a medical leave, the company's stock sank 7%. And one could mention other tech CEOs like Bill Gates and Larry Ellison, whose personalities became inextricably woven into their companies' brands. Yet the distinction here is important: These CEOs more closely resemble the entrepreneurs of yesteryear than they do the managerial gurus typified by Lee Iacocca and Jack Welch. They weren't placed on a pedestal for their ability to navigate corporate bureaucracy, or to cut costs or charm investors. They are entrepreneurs, and the value they created sprang from a mixture of creativity and vision that remains the lifeblood of their companies.
The cult of the manager-CEO, however, will have to come to grips with its own mortality. According to Harvard's National Leadership Index, confidence in business leaders has dropped more than that of leaders in any other sector—about 13.5% last year. Khurana believes that history will look back on the era of the celebrity executive as an aberration, and that business will gravitate to a new style of leadership: a cosmopolitan, global version of the man in the grey flannel suit. These leaders will still cater to shareholders, but will also understand the needs of a diverse set of constituents: They will be custodians whose mandate takes into account not just the long-term viability of their charges, but their companies' relationships with governments and communities, too. "The celebrity model has to be replaced with someone who has institutionally minded leadership—who understands that corporations are embedded in society," says Khurana. "You have to spend a lot more time building not just financial capital, but social capital as well."
Water Worries Shape Local Energy Decisions
Last month, Tri-State Generation and Transmission Association, a utility that provides power to mostly rural areas, agreed to conduct a major study to see if it might meet growing energy needs through energy efficiency and not a big, new coal-fired power plant, as it had proposed for southeast Colorado. One reason for the move was a challenge by Environment Colorado, an advocacy organization, about the amount of water a new plant would require. Changes like these are happening with increasing frequency, particularly in the arid West, as mounting concerns about water begin to shape local energy decisions. In some cases, power companies are pulling back from plans to build traditional power plants that require steady streams of water to operate. In others, renewable-energy projects such as wind farms or solar arrays are gaining momentum because their water needs are minimal.
Tri-State no longer is sure what it might build in southeast Colorado but it is going ahead with plans to build a 500,000-solar-panel project in northeast New Mexico in partnership with First Solar Inc. "There's no water requirement with solar," said Mac McLennan, senior vice president for Tri-State, based in Westminster, Colo. Advocates for alternative energy are discovering that water issues may prove to be as important a selling point for the industry as reducing carbon-dioxide emissions.
"The more we wean energy companies off consumptive use of water, the better for everyone," said Craig Cox, executive director of the Interwest Energy Alliance, a Colorado trade group that represents power-project developers.
The electric-power industry accounts for nearly half of all water withdrawals in the U.S., with agricultural irrigation coming in a distant second at about 35%. Even though most of the water used by the power sector eventually is returned to waterways or the ground, 2% to 3% is lost through evaporation, amounting to 1.6 trillion to 1.7 trillion gallons a year that might otherwise enhance fisheries or recharge aquifers, according to a Department of Energy study. The study concluded that a megawatt hour of electricity produced by a wind turbine can save 200 to 600 gallons of water compared with the amount required by a modern gas-fired power plant to make that same amount. Earlier this month, Jeff Bingaman (D., N.M.), chairman of the Senate Energy and Natural Resources Committee, noted during a hearing that the "nexus" of water and energy is becoming an issue "in [power plant] permitting decisions across the country."
Landowners in the far northeast corner of California were riled recently by Sempra Energy's proposal to build a coal-fired power plant just across the state line in Nevada.
One reason residents objected was that the plant would have required vast amounts of water for cooling. "Use of groundwater is always a sensitive issue up here because we don't have much," said Jack Hanson, a member of the Lassen County Board of Supervisors. Sempra pulled the plug on the project in late 2006, citing, among other things, water use. Since then, another big energy proposal has surfaced, but it hasn't kicked up much opposition: A dozen companies are considering building hundreds of wind turbines along Lassen County ridgelines. So far, 17 meteorological towers have been erected to verify wind speeds. In turn, conventional power plants are turning to technology that aggressively cuts water use as they weigh the costs of installing more complicated cooling systems versus leaning on scarce resources.
A power plant recently put into service by Pacific Gas & Electric Co., a unit of PG&E Corp., in the Northern California town of Antioch has a cooling system to cut its water intake from 40,000 gallons a minute to 1.6 gallons. In the past, power plants commonly were built with "once-through cooling," in which water was drawn from waterways, used once, and then put back. But the Antioch plant uses a "dry" cooling technique that recirculates water in a closed system, reducing evaporation. Environmental groups that oppose coal and nuclear power plants are discovering that water can be a powerful tool to challenge power companies. In 2004, Riverkeeper Inc., an environmental organization in Tarrytown, N.Y., along with six states, sued the Environmental Protection Agency over the use of once-through cooling by as many as 500 older power plants in the U.S.
The suit charges that the practice violates the Clean Water Act because it harms aquatic life and fails to utilize the best technology available, a requirement of the federal act. The case, now before the U.S. Supreme Court, stands to test how water-use issues will determine which power plants continue to operate as well as what kind of plants are built. Nuclear plants face particular scrutiny, since they require more water than any other form of steam generation. Virginia Power, a unit of Dominion Resources, is facing a legal challenge over its right to draw one million gallons of water a minute per reactor from a man-made lake it uses to cool its North Anna nuclear power plant and into which it discharges heated water. The utility built the lake in 1978 exclusively for the plant's cooling purposes.
A group called the Blue Ridge Environmental Defense League Inc. argued that heat is a form of pollution and said the state water board shouldn't have renewed the plant's water permit. Last month, a state court upheld much of the environmental group's case; the utility plans an appeal. Dominion says the man-made lake is a private body of water and therefore shouldn't fall under the federal Clean Water Act. Water is also emerging as an important point for analysts in the investment community. "We definitely have noticed more companies having water issues," said Swaminathan Venkataraman, an analyst at Standard & Poor's credit-rating agency. "If it continues, it will give renewables another important advantage."