Wylie Mill, Chester, South Carolina. Tommy Ashville (right), has worked two years in mill. "Specks I'm about 11." Arthur Shelly, eight years in mill, 14 years old. Other boys agreed he had been in mill eight years
Ilargi: The coming week will be interesting to watch. The G20 meeting in London comes with a threat of exploding protests in the streets. There’s also the threat of deepening rifts between the Anglo world and continental Europe. Czech EU president-of-the-day Mirek Topolanek, whose government had dissolved the day before, felt free to speak his mind for once, and called Obama's economic policies on stimulus and toxic assets "the road to hell". He didn't just speak for himself, many Europeans leaders see the situation in a similar fashion. And the more American and British politicians like Summers and Brown, and pundits like Krugman and Evans-Pritchard, holler about the disastrous manner in which Europe's leaders deal with their crises, the more they will defend it. So Obama has no choice but to hush the issue, and retrace his earlier -loud- steps.
Both sides clamor for changes to regulatory laws for the financial systems. But they don't mean the same changes. Europe wants to get rid of all the excesses caused by lax regulation induced by the political influence the banking system has, especially in the Anglo countries. The US wants to give more power to its own governmental bodies, that are essentially run by that very banking system. Europe will never ever accept anything of the kind. That's the second point Obama doesn't even have to try bring to the table. And of course it's the G20, it's not just Europe and the US/UK exchanging punches. China has launched a few trial-balloons in the past week on the topic of reserve currencies, and Russia and India would like a piece of that pie. None of these countries experience great benefits of the US dollar's special status, and they see a re-weighting of the IMF’s Special Drawing Rights as a first step towards a remake of the entire global finance system. And eventually they'll get it, but for now the risks for the US are so enormous that America will fight like a cornered feral cat.
The G-20 takes place next week, April 1-2, in London England. And that city is fast becoming a truly ironic stage for an event where world finance is discussed. There is probably still a vast majority of people out there who think it's ridiculous to even contemplate the idea of England being rescued by emergency IMF loans, but I wouldn't be so sure about that anymore. Early in the week a UK sovereign debt auction failed, and though a second one went better -for shorter term bonds-, such an outcome would have been unthinkable until recently. And the UK depends on a whole lot more of these auctions succeeding throughout 2009. What if that doesn't work? The US, with its special status and all, relies on record amounts of bond issuance, which, for one thing, will threaten to crowd out Britain, as well as US states and municipalities, and then still have huge problems finding buyers. Sometime during the summer it may all come to a head. There's a limit on those markets, and we’ll see it loud and clear before this year is over.
What's more, another report was published yesterday saying the UK recession turns out worse than expected. That must be number 1001. You have to wonder why all these people get it so awfully wrong every time they look at a bunch of numbers. I mean, there's a ton of voices calling for recovery and economic growth starting later this year. What are these folks on? What drives them? Recovery to what levels? One week of desperate losers buying into last hope or a piece of rope markets and we're all back on the parade floats? Even if Summers and Geithner can entice a class of billionaires to put up 5 bucks to buy $100 worth of toilet paper, and even if they can stretch that into a $900 billion loss for the American people, there's so much more toilet paper waiting in the marble wings of Wall Street that any thought of recovery or growth can only be based on prolonged cheating and hiding. And that, in turn, is disastrous for the confidence in the markets that everyone says is crucial for any sort of recovery.
One more country that will feature prominently in next week's meetings is Japan, which looks to be on an equal plummeting level with the UK, fast approaching the likes of Latvia, Hungary, Thailand and Iceland. Japan today became the first country to admit it's set to drown itself in years of deflation. Despite an avalanche of feel-good messages we are bombarded with by media, politicians and even serious bloggers, underneath our feet things are shifting on a tectonic scale. Or do you really think that Romania and Serbia will be the last countries that need IMF emergency financing?
There are obviously lots of numbers and data and stats that I have no access to. But it's not that hard to figure that throwing trillions of dollars of your already suffering people's money into saving banks that are in reality insolvent, -re: bankrupt-, and into saving carmakers that need a market twice as big as the present one just to play even, and propping up a housing market that needs to come down another 50% just so ordinary people can afford to buy a home, and so on etc., is a dead end way of governing a country and an economy. When we get to the end of that dead end, the banks will inevitably fail, the carmakers will close up shop, and housing prices will plunge to levels where people can afford them. Only now, they can’t afford them any longer, because their money has been taken away and spent on dead ends. For the moment, I am with Europe on this one. And I'm starting to consider any and all talk about recovery and resuming growth to be borderline criminal behavior. So there.
Wall Street backlash could spread with U.S. bank plan
The potential for private investors to reap billions of dollars in profits from the U.S. government's bank bailout plan could trigger another wave of public outrage, like that seen after the payments of bonuses to AIG staff, and it might slow any economic recovery. The Obama administration is scrambling to woo top bankers, financiers and money managers like BlackRock and PIMCO to back its latest bank bailout plan. But private investors making it rich are unlikely to avoid criticism against a backdrop of mounting job losses and a deteriorating economy. "Just looking at the current political climate and populist climate," Alex Ehrlich, head of global prime services at UBS, said at the Reuters Private Equity and Hedge Funds Summit in New York this week. "You would have to ask what does the public say about the first hedge fund that is reported to make $1 billion or $2 billion in profit off the back of a public-private investment partnership?" he said.
U.S. Treasury Secretary Timothy Geithner plans to create public-private partnership to take up to $1 trillion of troubled assets off banks' books and unfreeze credit markets. The plan represents the centerpiece of the Obama administration's attempts to tackle the worst banking crisis since the Depression and the resulting global economic slump. A repeat of the outrage seen last week over the planned $165 million bonuses for executives at AIG, the insurer which was bailed out three times using taxpayers money, could set back Washington's attempts to gain momentum in its effort to pull the U.S. economy out of recession. "That was such a waste of time with AIG and distracts from getting us out of this mess and onto a recovery," said Tom Sowanick, chief investment officer at Clearbrook Financial, with $22 billion under management.
Money managers drawn by the public-private investment plan acknowledge the potential for more furor. Bill Gross, the founder and co-chief investment officer at Pacific Investment Management Co., or PIMCO, told Reuters there could be another backlash against Wall Street but it will be "mitigated, to some extent, by profit-sharing." "Still the Obama approach is to use the private system as opposed to the Krugman/Roubini philosophy of nationalization and confiscation. I prefer the former -- along with the rotten tomatoes," Gross said. Paul Krugman, a Nobel prize-winning economist, in a New York Times column on Monday slammed the Geithner plan, saying it was a "one-way bet" for private capital. "It's just an indirect, disguised way to subsidize asset purchases." he said.
He isn't alone in his view. Nouriel Roubini, one of the few economists who foretold much of the current financial turmoil, has said nationalization or receivership of a bank should seriously be considered. Under Geithner's toxic-asset plan, the Treasury will initially hire five investment managers to raise capital with a dollar-for-dollar public match. The government and private investors would share equally in gains and losses from the program. BlackRock's Curtis Arledge, whose firm intends to take part in the Treasury's public-private investment plan, said the plan is a win-win for public and private capital. "When we raise $1 billion of money for private investors, it's not our money that we are investing," Arledge, co-head of U.S. fixed-income, said in an interview. BlackRock might invest some of its own money in the public-private investment fund, but "it is not the bulk of the fund," he added. "Our private investors, in many cases, are teachers, firemen, policemen through pension funds," Arledge said.
Applicants for these investment management positions must be U.S.-based firms able to demonstrate they can raise at least $500 million in private capital and have at least $10 billion in eligible assets under management. "Pension funds and endowments are some of the private investors we raise money from, so I think the image of private investor needs to be reformulated to actually who those people are," Arledge said. An unprecedented outburst of anger against Wall Street came last week over $165 million in bonus payments made to executives at failed insurance group AIG, raising the risks for private capital firms thinking about partnering with the Treasury. Many have expressed reservations regarding retroactive curbs on compensation and profits.
But those concerns have cooled. Monday, the New York State attorney general, Andrew Cuomo, said he had already won commitments from AIG employees to pay back $50 million out of the $165 million awarded in February. Additionally, Congressional legislation to clamp down on companies receiving financial bailout money by severely taxing bonus payments now appears certain not to come up in the Senate until after a two-week recess that begins April 3. "What's different this time around is that Joe Six Pack can invest in these funds," said Sowanick of Clearbrook Financial. "I think another eruption of public anger could come, but as I said, everyone should think about this carefully as everyone will share in the profits."
Obama Backs Banks vs States, Seeks to Block Fair-Lending Probes
The Obama administration’s call for greater financial regulation may have its limits. The administration late yesterday urged the U.S. Supreme Court to bar New York and other states from enforcing their fair-lending and other consumer-protection laws against federally chartered banks including JPMorgan Chase & Co. and Wells Fargo & Co. The legal brief, which adopts the Bush administration’s position, is a setback for consumer and civil-rights groups that had urged President Barack Obama’s team to switch positions. The filing puts the administration at odds with New York Attorney General Andrew Cuomo over the respective roles of state and federal regulators. The high court will hear arguments April 28.
"National banks are created by the government to serve federal purposes," argued Solicitor General Elena Kagan, the Obama administration’s top courtroom lawyer. "Oversight of the banks is therefore principally entrusted to the United States." The court filing coincides with this week’s proposal by the administration to put large hedge funds, private-equity firms and derivatives under federal supervision for the first time. Cuomo is seeking to revive an investigation, begun by predecessor Eliot Spitzer, into the real-estate lending practices of units of JPMorgan, Wells Fargo and HSBC Holdings Plc. A lower court barred the probe, saying a regulation issued by the U.S. Comptroller of the Currency blocks state scrutiny of national banks.
The case will determine whether federal regulators have exclusive governmental authority to press fair-lending and other types of complaints against national banks. More broadly, the case will shape how much ability agencies have to shield companies from state-level scrutiny. Kagan filed the brief on behalf of the OCC, an independent Treasury Department bureau still being run by Republican appointee John Dugan, whose term expires in 2010. Obama has decided to retain Dugan, two people familiar with the decision said last month. "We’re disappointed to see it," said Gail Hillebrand, a San Francisco-based Consumers Union attorney who had sent a letter urging the administration to switch sides in the case. "We hope they just haven’t gotten around to getting rid of those regulations. It’s certainly a missed opportunity."
Consumer advocates said Dugan’s control of the OCC may have constrained the new administration in its handling of the case, particularly given that Kagan was sworn in less than a week ago. "If the OCC was unwilling to change their position, then the Justice Department had relatively few options," said Eric Halperin, a lawyer with the Center for Responsible Lending, a Washington consumer advocacy group that supports Cuomo in the case. "We would hope that in the future the OCC shows as much concern about consumer protection as they do about protecting their turf." The case bears some resemblance to a dispute resolved by the Supreme Court in 2007 in favor of the banking industry. The court ruled 5-3 that states can’t regulate the mortgage-lending subsidiaries of banks supervised by the OCC. While the 2007 case involved traditional banking regulation, including licensing and so-called visitorial powers, the latest fight concerns more general state rules, such as antidiscrimination and consumer-protection laws.
By blocking those laws, the OCC regulation "drastically alters the federal-state balance," Cuomo argued in a court filing earlier this month. The Obama administration contends that federal regulators can adequately ensure that national banks comply with both state and federal laws. The administration said last night that the OCC "vigorously enforces fair-lending laws against national banks." Civil rights groups dispute that. In a letter this month to Treasury Secretary Timothy Geithner and Attorney General Eric Holder, groups led by the Leadership Conference on Civil Rights said the OCC had filed no enforcement actions based on state antidiscrimination laws since the OCC adopted the disputed regulation in 2004. "It is painfully clear that federal regulators did little to fill the void," the letter said.
The Supreme Court case stems from Spitzer’s probe into whether lenders charged higher mortgage interest rates to minorities. Spitzer began his investigation after 2004 data released under the Home Mortgage Disclosure Act showed black and Hispanic customers in New York were more likely to receive high- priced loans.
Spitzer’s Probe OCC and the Clearing House Association, which represents commercial banks, sued in 2005 to block Spitzer’s probe. The Clearing House’s members include JPMorgan, Wells Fargo and HSBC. In a court filing, the Clearing House Association’s attorney, Seth Waxman, argued that the OCC regulation is a reasonable interpretation of the National Bank Act. That law "broadly precludes state investigations or enforcement actions that relate to a national bank’s exercise of its authorized banking powers," Waxman argued.
No One Here Is Going to a Food Bank
In Jean-Paul Sartre’s play “No Exit“–famous for the line, “Hell is other people”– a group of people is trapped in a room with no windows, no mirrors and only one door, which is locked. As they realize they can’t escape, they become increasingly irritated with each other.
The world of finance is like that right now. As the global financial crisis drags on, blame has been pinned on everyone from bankers to delinquent consumers to–according to the President of Brazil –people with blue eyes. Consumers are angry at Wall Street, Wall Street is angry at being demonized, and the Obama administration seems caught between fanning the flames and tamping them down.
At The Wall Street Journal’s Future of Finance conference this week, those tensions were in play as Wall Streeters vented their frustrations. But amid the venting, AFL-CIO Associate General Counsel Damon Silvers caused a big ripple with his talk titled “Ending Excess.” Here are some of the high points:
On the Role of Wall Street and Main Street
The financial leadership of this country, and globally, I think, basically has been deferred to around a variety of policy matters, not just in finance, but more broadly, I think on the theorem that finance has insight into value and into wealth generation. A couple problems with that: That level of deference has been pretty profound on a bipartisan basis. What’s the outcome been? Nouriel Roubini says the outcome is $4 trillion in money down a rat hole. That kind of destabilizes that basic theorem.
Secondly, there are these issues–and they’ve come up today and last night–that the public finds intolerable….One is that we’ve heard a lot about the sanctity of contracts. Secretary Geithner mentioned how important it was that the contracts with the AIG London staff had been entered into a couple years ago–all very true.
Think about how that reads if you’re an auto worker and you have a contract for health care and retirement security. Think about how that reads if your job is representing auto workers and you just basically spent the last year away from your family seeing to it that Mr. Geithner got to sit here….Think about the proposition that we need to cut back on Social Security and Medicare because we don’t have enough tax dollars to pay for it.
On Systemic Risk Regulation
The basic thing I would say to President Obama is, we must regulate, on a global basis….We must regulate the financial markets comprehensively in ordinary terms, not in emergencies, not a few prepicked, systemically significant institutions–I think that–and here, there’s somewhat odd agreement between left and right on this–but rather, comprehensively.
…All forms of money management in the public markets ought to be under a regulatory scheme–not just the systemically significant ones; all of them. If you’re selling a contract that’s about a public security, you’re effectively operating in the public securities markets.
On the Troubled Asset Relief Program
You know, I’m troubled by the widespread public discussion that institutions would like to give TARP money back. The bank is open; cut a check! I think the fact that they’re not suggests that they need the money. And if they need the money, they should kind of stop talking about how they don’t.
Journal editor John Bussey asked: Our session is called, “Ending Excess,” but you could make an argument that in our system, excess is not such a bad thing. It’s the road to the palace of wisdom. If you create an environment in which people can get really rich for their insight, entrepreneurialism and creative risk taking and create jobs along the way, isn’t that what our economy is all about?
Damon Silvers: You know, it’s funny. Who’s for excess, right? On the other hand, who’s against wealth creation? But I think these terms don’t really tell you very much…What I think we ought to keep our eye on is that systems, structures and people that vaporize trillions of dollars need to be held accountable in the case of people, and in the case of systems, need to be changed.
On Treasury Secretary Geithner’s Toxic Asset Plan
I just have two observations about what’s been proposed. One is that, as near as I can tell, the structure is basically 5% private capital, 95% public capital; the question that raises is, what exactly do we need the 5% for? What purpose is that serving? The upside split, as I understand, is 50% private capital, 50% the public.
I ask you, if you’re representing the public–as I have some responsibility to do on the TARP oversight panel–if you were representing the public and that was the deal you were involved in and your lawyers and bankers came to you and said here’s the deal I’ve struck: I take 95% of the risk, somebody else takes five; they get 50%, I get 50%. What would you say?
Secondly, the point about bank balance sheets…I think the question is, who eats the loss in the course of getting banks back to life?
I think that the president and the Treasury secretary are absolutely right – that we have to get large financial institutions back to life. That should be job one. But there isn’t, I think, a way to do so by magic or by hoodoo. I think the losses have to be eaten and banks recapitalized, and the question is, who pays? And I’m not sure that that question got answered yesterday [by Treasury Secretary Geithner]?
On the future of Finance
Russell Abrams, Titan Capital Group in New York, asked: The finance sector went up to about 35% of the economy. At the peak, the long-run average is about 20%. Do you think the administration’s making the right decision trying to keep it at an elevated level as opposed to trying to bring it back to 20%?
Silvers: ….35 to 20% financing, 40% of the total profitability of the S&P 500 in 2006–these are utterly unsustainable numbers. And they–we are not–no matter what anybody does, finance is not going to play that large a role in the U.S. economy.
It may be possible for very small societies to have finance play that kind of role, although people I talk to in Europe say that’s become quite problematic for those societies–they can’t, literally, rescue the very systemically significant institutions, for them, that are coming apart. I don’t believe anybody can do anything to revive that state of affairs. I find it very troubling, the extent to which, if you look at the comparative role of finance in our–the perception of our economy and in our politics between us and our trading partners in Asia, it’s quite dramatic, the large extent to which finance is important here.
On Having Wall Street be Part of Discussion on Fixing the Economy
I mean, I think you obviously have to tap the expertise that’s there; it’s just a question of whether people with clear interests get to dominate the discussion. And the public who, after all, is financing, at this point, indirectly or directly, most of you in this room, the public is effectively outside the dialogue, except in ways that aren’t terribly helpful, right? A lot of shouting about – sort of from the outside – about the unfairness of it all.
…… My point is that while we may all be in the same boat, we are not all in this room. And we are not all in this room because some of us can afford to be in this room and some of us cannot be….I’m the only person in this room who could remotely, plausibly claim to, in any respect, represent anyone who makes less than $100,000 a year. And yet, 85% of the United States is in that category and not in this room. To your point,if you want to avoid that type of tension, right, then other people need to be in the dialogue.
Fed needs to double balance sheet: PIMCO
Bond giant Pacific Investment Management Co said the Federal Reserve needs to double its balance sheet up to $6 trillion to replace the amount of wealth destroyed in the United States, an executive said on Thursday. Liabilities on the Fed's balance sheet should rise to between $5 trillion and $6 trillion later this year amid the financial crisis that roiled global markets, said Brian Baker, chief executive Pimco Asia Ltd. "Right now, the Fed has spent about $3 trillion. We believe there has to be further stimulus policies put in place," Baker told Reuters.
The central bank's aggressive unconventional policy measures to revive dormant credit markets have pushed its balance sheet above $2 trillion in mid-March, according to data released by the Federal Reserve. Central banks across the United States, Asia and Europe have lowered their interest rates aggressively since late 2008 as part of broader efforts to bolster the global economy, fanning hopes rates will continue to stay low for years. "In developed markets, interest rate policy is pretty much as low as it can go," he said. "We believe short-term rates in developed markets are going to be near zero for several years."
Pimco is a unit of Allianz Global Investors, which managed about $970 billion in client assets at the end of 2008 and says it is the world's biggest fund house. Pimco's chief investment officer Bill Gross is one of the industry's most widely watched figures. Pimco is buying high-yield bonds in some U.S. banks that have received government support. "We are investing in Citibank. We are investing in Bank of America. Those are, we believe, national champion banks or financial institutions that will survive," he said. The asset manager is also buying corporate and government bonds of South Korea, Indonesia and the Philippines. Pimco is underweight emerging markets after cutting its exposure recently, Baker said.
Six Bloggers of the Apocalypse
If you spend enough time surfing the Web, you might think Nouriel Roubini, the pessimistic economist profiled in the April issue of Condé Nast Portfolio, is taking a walk on the sunny side of the street. There are bloggers who have been forecasting much worse for several years. While bankers were still ordering $1,000 bottles of wine in trendy Manhattan restaurants, these internet Sybils of the impending economic apocalypse were already prophesizing food shortages and endless gas lines.
Some are on the right side of the political spectrum, others on the far left, but they all share one thing—traffic on their sites has increased exponentially since Wall Street began to implode last fall. We caught up with a few of the more provocative doommongers to see what they think is coming next. Hint: Before reading further, you may want to uncork your most expensive bottle of wine. You’ll need it.
Clusterf**k Nation: James Howard Kunstler
Novelist and journalist James Howard Kunstler is the leading popular voice of peak oil, the theory that says we have gone through more than half the world’s supply of this much-needed resource. Kunstler’s regular Monday morning posts foretell a world beset by oil shortages, which he believes will lead to everything from financial shenanigans (sound familiar?) to food riots, not to mention attacks on the wealthy, abandoned suburban housing developments and a forced return to small-town living.
Prediction: High potential for civil unrest and violence. "It won’t be good for your health to be a conspicuous consumer."
The Trends Research Institute: Gerald Celente
Not a blogger per se, trends researcher Gerald Celente publishes his predictions for the future in a quarterly journal. In December 2007, he called "The Panic of '08," featuring "failing banks, busted brokerages, toppled corporate giants, bankrupt cities, states in default.... When the giant firms fall, they’ll crush the man on the street." The journal is by paid subscription only, but Celente makes frequent radio appearances, which his many fans record and post online.
Prediction: The current economic crisis will be worse than the Great Depression, with a rise in alternative living arrangements. He’s thinking self-storage units. "People are going to self-store themselves." FYI, Roubini’s offices just happen to be located in the same building as a Manhattan Mini Storage facility. Coincidence? You decide.
Speaking Truth to Power: Carolyn Baker
The site run by Carolyn Baker, an adjunct professor of history in Vermont, is structured her site like an Utne Reader of global collapse lit, with links to sites ranging from the very mainstream Marketwatch.com to some of the bloggers on our list. Her goal is to connect the dots between peak oil, global climate change, financial collapse and other ongoing trends and debates. The common thread: Our way of life cannot be sustained. And it will all end badly.
Prediction: "It’s not going to be like falling off a cliff but a slow descent with tipping points. There are going to be different kinds of Katrinas, economic crises, natural disasters, and nuclear exchanges—but I really hope I am wrong about that."
Generational Dynamics: John Xenakis
Xenakis, a computer consultant, analyzes previous and current generations in American history to predict catastrophe to come. He believes the exit of the Greatest Generation from the workforce in the 1990s set the stage for disaster as Baby Boomers, who are uncomfortable with authority, fell prey to the amoral Gen Xer’s right behind them. The two groups combined to bring us the current financial crisis as the Baby Boomers want money badly enough not to ask many questions about its provenance, while the equally greedy Gen Xer’s are nihilistic enough to do what it takes to get it.
Prediction: The misbegotten combination of the Boomers and the Gen Xers will continue to cause trouble for several more decades, leading to complete financial collapse and war before Xers are able to turn things around in their old age. Says Xenakis, "I don’t expect to live through it."
Itulip: Eric Janszen
Janszen, an investor and analyst, first started Itulip at the height of the tech bubble. The tulip is, of course, a reference to the infamous Dutch tulip bubble of the 17th century. He retired the site when the Internet bubble burst, only to return in 2006, when he saw a housing bubble developing. Janszen predicted it would end badly, with a mass deflation leading to a multi-year economic crash. Parts of the site—including its many reader forums—are subscription only.
Prediction: The United States will, over time, right itself, but will first have to survive a period where one million folks will be added to the unemployment rolls every month by the end of 2009.
Irvine Housing Blog: Larry Roberts
Many bloggers are writing about the housing bust but perhaps Larry Roberts, a.k.a. IrvineRenter, has found the best way to demonstrate how everyone from the lowliest buyer to the highest paid financier was implicated in the bubble. Almost daily, he posts a house for sale in Irvine, California, taking readers on a journey through the home’s recent financial history. He reveals the price the home was originally purchased for, how much money was taken out of the home during various re-financings, and what the potential loss to the bank is if the house sale goes thru. Needless to say, sardonic comments abound.
Prediction: Roberts is the cockeyed optimist of our bunch. He plans to change his handle to IrvineHomeowner in 2011, when he believes the housing market will bottom out.
Roubini Says Stocks Will Drop as Banks Go 'Belly Up'
U.S. stocks will fall and the government will nationalize more banks as the economy contracts through the end of 2009, said Nouriel Roubini, the New York University professor who predicted last year’s economic crisis. "The stock market is a bit ahead of the real macroeconomic and financial news," Roubini, a professor at NYU’s Stern School of Business and the chairman of consulting firm Roubini Global Economics, said in an interview with Bloomberg Television in London today. "We’ll have some major banks going belly up that will need to be taken over." The global equity rebound in March that sent the Standard & Poor’s 500 Index to its best monthly advance in 17 years is a "bear-market rally" and U.S. Treasury yields will "remain relatively low" as investors flock to the safest assets, Roubini said. Treasury Secretary Timothy Geithner’s new plan to remove toxic debt from financial companies won’t be enough for insolvent banks, he said.
Roubini’s outlook contrasts with predictions this week from Templeton Asset Management Ltd.’s Mark Mobius and Traxis Partners LLC’s Barton Biggs, who said that equities are poised to rally as government efforts to revive the economy and banking system begin to work. Investors are "way too optimistic" about the prospects for a recovery in the economy and earnings, Roubini said. The S&P 500 surged 7.1 percent on March 23 after Geithner unveiled a plan to finance as much as $1 trillion in purchases of illiquid real-estate assets, using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds. The government is conducting stress tests of banks to determine how much more capital each will need.
Roubini, who predicts loan and securities losses in the U.S. will reach $3.6 trillion, said the stress tests will reveal that some banks need to be taken over and have their good and bad assets separated before being sold to the private sector. He didn’t name which companies he thought would need to be rescued. Critics of Geithner’s plan including Nobel laureate Paul Krugman, a professor at Princeton University, say the government should take over banks loaded with devalued assets, remove their top management, and dispose of the toxic securities. Sweden adopted the temporary nationalization approach in the 1990s. "Some banks are going to have to be nationalized," said Roubini. "It’s going to be bumpy ahead of us."
Geithner and Federal Reserve Chairman Ben S. Bernanke this week called for new powers to take over and wind down failing financial companies. They said the U.S. also needs stronger regulation to constrain the risks taken by firms that could endanger the financial system. With "deflationary forces" lingering for as long as three years, Roubini said U.S. government bond yields will remain low and American house prices will fall as much as 20 percent in the next 18 months. While the dollar will initially benefit as investors seek a safe haven in the U.S., the currency will ultimately drop as the nation’s trade deficit shrinks, he said. Roubini dismissed China’s call for the creation of a new international reserve currency as a "pie in the sky idea" that’s unlikely to gain traction any time soon.
China’s central bank Governor Zhou Xiaochuan this week urged the International Monetary Fund to expand the use of so- called Special Drawing Rights and move toward a "super- sovereign reserve currency." Geithner sent the dollar tumbling yesterday by saying he would consider China’s idea, only to drive it back up by affirming that the greenback should remain the world’s reserve currency. "This was a political call and in a nut shell - it ain’t going to happen any time soon," Roubini said.
Mobius, who helps oversee about $20 billion of emerging- market assets as executive chairman at San Mateo, California- based Templeton, said March 23 the next "bull-market" rally has begun. Biggs, the former chief global strategist for Morgan Stanley who now runs New York-based hedge fund Traxis Partners, predicted the same day the S&P 500 may jump between 30 percent and 50 percent. The benchmark index for U.S. equities has surged 11 percent in March, poised for its biggest monthly gain since 1991. The MSCI Emerging Markets Index of equities in 23 developing nations is headed for the steepest monthly advance on record after rising 20 percent in March.
Ilargi: And Cohen is the archetypical optimist.
Goldman Sachs's Abby Cohen Predicts There Will Be More Bad News From Banks
There may be more bad news on banks even as the U.S. economy improves in the second half of 2009, Goldman Sachs Group Inc.’s Abby Joseph Cohen said. "We’re certainly not yet in the clear -- whether in the U.S. or around the world," the 57-year-old strategist said in a Bloomberg Radio interview in New York today. "While we have had a great deal of bad news on banks, we think there is still more to come." The U.S. economy is looking "less bad" and may post positive growth by the end of the year as the government’s efforts to stimulate the world’s largest economy feed through, Cohen said.
"The situation in Europe is of concern to us and economic activity in many countries is still lackluster." The Standard & Poor’s 500 Index has clawed back 23 percent since reaching a 12-year low on March 9 as banks from Citigroup Inc. to JPMorgan Chase & Co. said they made money in the first two months of 2009 and U.S. Treasury Secretary Timothy Geithner unveiled plans to rid financial firms of toxic assets. Stock prices got "too cheap" about a month ago, according to Cohen. "Recessions are difficult and uncomfortable when you are going through them, but they do end."
Cohen was replaced in March last year by Goldman Sachs as the bank’s chief forecaster for the U.S. stock market. She is known for her bullish predictions during the 1990s stock-market rally. Her year-end forecast of 1,675 for the S&P 500 at the beginning of 2008 was second only to the prediction of 1,700 from Bear Stearns Cos.’s Jonathan Golub, HSBC Holdings Plc’s Kevin Gardiner and UBS AG’s David Bianco. The S&P 500 has a 12-month fair value of 1,025, Cohen said today. That’s 23 percent above yesterday’s closing price of 832.86 and is based on "fundamental" value of stocks in the benchmark, according to the strategist. Profits in the measure will be near $40 a share on average this year, she added.
Cohen’s forecasts came a day after Nouriel Roubini, the New York University professor who predicted last year’s economic crisis, said U.S. stocks will fall and the government will nationalize more banks as the economy contracts. In contrast, Templeton Asset Management Ltd.’s Mark Mobius and Traxis Partners LLC’s Barton Biggs said earlier this week that equities are poised to rally as government efforts to revive the economy and banking system begin to work.
Fed Buys $7.54 Billion of Debt to Cut Borrowing Costs
The Federal Reserve bought $7.541 billion of Treasuries in its second outright purchase of U.S. government debt in three days as part of the central bank’s efforts to lower consumer borrowing rates. The majority of the purchase was $5.625 billion of the 1.375 percent note due March 15, 2012, that was issued last month. Seven of the 18 securities maturing from April 2011 through April 2012 listed for possible acquisition were bought, according to the Federal Reserve Bank of New YorkWeb site. Central banks in the U.S., U.K. and Japan are buying government debt in the latest step to broaden efforts to unfreeze credit and end the recession after cutting benchmark interest rates close to zero.
The Fed bought $7.5 billion in debt on March 25, the first purchase since the early 1960s by the central bank under a $300 billion plan announced March 18. "The Fed’s monetization of government borrowing is in economic terms a hugely powerful liquidity tool," said Lena Komileva, head of Group of Seven market economics in London at Tullett Prebon Plc, the world’s second-largest interdealer broker. "It also helps to address investor fears, by depressing government yields and private sector borrowing costs and signaling a firm commitment by the Fed to keep monetary liquidity flowing for a long time." The original auction size of the current three-year note was $34 billion on March 16. Today’s Fed purchase leaves about $28.4 billion of the so-called on-the-run security outstanding.
"The Fed focused on the on-the-run three-year note today as they likely wanted to reduce the size of the issue outstanding," said John Spinello, chief technical strategist in New York at Jefferies Group Inc. This is a good security to purchase "if they want to take something out without disturbing the market or making it tougher to finance them. The Fed’s purchases are going well." Treasuries gained for a second day as traders focused on the Fed’s purchases after the Treasury sold a record $98 billion in notes this week. The yield on the 0.875 percent note maturing in March 2011 fell 2 basis points to 0.89 percent, according to BGCantor Market Data.
Central bankers and the Treasury are working to reduce consumer interest rates along with the borrowing costs paid by banks. The difference between rates on 30-year fixed mortgages and 10-year Treasuries was 2.31 percentage points, according to data compiled by Bloomberg. That’s up from an average of 1.75 percentage points in the decade before the subprime mortgage market collapsed. Fed policy makers lowered the benchmark interest rate to a target range of zero to 0.25 percent in December and switched to using credit programs and outright purchases of Treasuries as the main tool of monetary policy, to pump cash into banks and bolster lending.
The size of the Fed’s balance sheet has increased 56 percent to $2.07 trillion in the past year. The central bank’s assets will expand further after Fed Chairman Ben S. Bernanke earlier this month announced a $1.15 trillion effort to pump more cash into the economy through purchase of Treasuries and mortgage and agency securities. The $40 billion in new two-year notes, sold on March 24 at a yield of 0.949 percent, weren’t eligible for today’s Fed purchase because the debt is still trading on a so-called when- issued basis until the transaction settles. The Fed maintains a 35 percent per security limit for each specific Treasury it holds in its System Open Market Account, or SOMA.
Securities purchased in the Treasury purchases program are held in SOMA. The central bank makes these securities available for loan to dealers against Treasury general collateral on an overnight basis. Dealers bid in a multiple-price auction held daily through its securities lending program. "They can rollover their SOMA holdings but they cannot buy new bonds at the auction so they have to buy it at the coupon pass," said George Goncalves, Treasury and agency strategist in New York at Morgan Stanley, one of the primary dealers that can sell debt to the Fed. The central bank announced plans to buy through April 2 debt maturing between March 2011 and February 2039. The Fed’s 16 primary dealers are eligible to sell Treasuries to the Fed, both for themselves and their customers, as part of the program.
China's central bank slams global lack of regulation
People's Bank of China says idea that markets can regulate themselves is fallacy
A new statement by the People's Bank of China lambastes financial regulators around the world for missing the warning signs leading up to the current crisis and dismisses the notion that markets can regulate themselves. The 2,500-word essay published on the PBOC's Web site late Thursday did not single out the U.S. or European regulatory agencies by name, but identified Enron and WorldCom as "debacles" that should have been red flags for more supervision. "The evolution of the crisis demonstrated that due to the profit-driven nature of market players, market forces, if unchecked, will lead to asset bubbles and ultimately a disastrous market clearing in the form of a financial crisis like the current one," the statement said.
It did, however, specifically mention problems the Chinese central bank sees with U.S. corporate culture. "Evidence abounds that boards of directors at some systemically important financial firms in the U.S. were rendered as a 'gentlemen's club,' which rubber-stamp all major decisions sponsored by the management," it said. "This has led to lack of effective check and balance mechanism, which tolerated excessive risk-taking in pursuit of short-term rewards," the PBOC said. The statement, published in both English and Chinese, was similar in tone to three other essays authored by PBOC Gov. Zhou Xiaochuan earlier this week. Zhou's latest essay, also released late Thursday, said economic growth in China is recovering due to the country's "superior system advantage."
The series of remarks from Zhou and his fellow bankers also come as world leaders position themselves for a meeting in London next week of top officials from the Group of 20 leading and developing economies. Divisions have emerged over the appropriate policy response to revive the global economy, with stimulus-spending measures and new financial-services rules in focus. Qu Hongbin, HSBC's chief economist for China, said Friday: "This is basically the Chinese government preparing for what they are going to say in the coming G20 meeting. They are trying to increase their voice about how they see things and what their perspective is in terms of the current global crisis."
A broad theme in the latest PBOC article is that regulation has failed to keep pace with the emergence of new financial products, institutions, and markets. "Regulators do not have a good understanding of the cross-border activities of internationally active financial institutions. In particular, there is a lack of understanding of international capital flows," the statement said. It called upon the International Monetary fund to set up an "early warning system" to watch out for destabilizing international capital flows. It added that international organizations have been pre-occupied with exchange-rate regimes of emerging economies while falling short in monitoring international capital flows. That last remark was likely a dig at U.S. and other officials who have criticized China for purportedly keeping its currency, the yuan, low against those of its trading partners in order to make its exports cheaper.
Brazil’s leader blames white people for crisis
Brazil’s President Luiz Inácio Lula da Silva on Thursday blamed the global economic crisis on "white people with blue eyes" and said it was wrong that black and indigenous people should pay for white people’s mistakes. Speaking in Brasília at a joint press conference with Gordon Brown, the UK prime minister, Mr Lula da Silva told reporters: "This crisis was caused by the irrational behaviour of white people with blue eyes, who before the crisis appeared to know everything and now demonstrate that they know nothing." He added: "I do not know any black or indigenous bankers so I can only say [it is wrong] that this part of mankind which is victimised more than any other should pay for the crisis."
Mr Brown appeared to distance himself from Mr Lula da Silva’s remarks. "I’m not going to attribute blame to any individuals," he said. Mr Brown was visiting Brazil as part of a five-day tour of Europe, the US and South America in preparation for the G20 summit to take place in London next Thursday. He made a joint appeal with Mr Lula da Silva for the world’s biggest economies to provide $100bn to boost global trade. "I’m going to ask the G20 summit next week to support a global expansion of trade finance to reverse a slide in world trade," Mr Brown said. Mr Lula da Silva also spoke out strongly against raising trade barriers in response to the global crisis. "I compare protectionism to a drug," he said. "Why do people use drugs? Because they are in crisis and they think the drug will help them. But its effects pass quickly."
The two leaders’ remarks demonstrate the desire each will have to secure the other’s support during the G20 meeting.
Brazil – which has long campaigned unsuccessfully to be given a permanent seat on the United Nations Security Council – will argue for a bigger voice for Brazil and other emerging nations in multilateral organisations such as the International Monetary Fund and the Financial Stability Forum, a group of central banks and national supervisory authorities established in 1999. Brazil is one of many nations calling for increased regulation of global financial markets and greater powers for multilateral regulators. It will also call for a resumption and conclusion of the Doha round of talks at the World Trade Organisation. In return for supporting such initiatives, Mr Brown will expect Brazil to endorse calls for fiscal stimulus in a bid to mitigate the impact of the global crisis, such as the proposed $100bn in trade finance.
Japan Heads for Deflation as Retail Sales Tumble 5.8%
apan’s consumer prices stalled in February and retail sales tumbled the most in seven years, signaling a return to deflation is likely to deepen the recession. Prices excluding fresh food were unchanged from a year earlier, the statistics bureau said today in Tokyo. Retail sales declined 5.8 percent, the Trade Ministry said, more than the 3 percent economists predicted. An unprecedented drop in exports is forcing companies to fire workers and cut wages, weakening household spending and pushing the economy closer to its worst slump in the postwar era. With the benchmark interest rate already at 0.1 percent, the Bank of Japan has little scope to stop prices from falling.
"Japan is back in deflation and the price level is set to decline for several years," said Richard Jerram, chief economist at Macquarie Securities Ltd. in Tokyo. Deflation "erodes the health of the corporate sector and means that the Bank of Japan cannot cut interest rates to appropriate levels." Central bank Governor Masaaki Shirakawa said this week that core prices are on the verge of falling and policy makers are committed to preventing the economy from sliding into a deflationary spiral. During Japan’s last bout with sustained price declines that began a decade ago, bankruptcies surged and the jobless rate advanced to a postwar high. The central bank responded by cutting interest rates to zero percent and flooding the banking system with reserves for five years through 2006.
"There are many reasons we have to worry about a return of deflation," said Azusa Kato, an economist at BNP Paribas in Tokyo. "Companies may race to discount to get rid of inventories if they keep posting losses, and wage cuts and bankruptcies will spread in coming months." Investors shrugged off the reports. The Topix index rose 0.9 percent at the lunch break in Tokyo, heading for its best week in more than 16 years as better-than-expected earnings by U.S. companies fueled speculation the global recession is abating. The yen traded at 98.27 per dollar from 98.71. Wages fell for a third month in January, leaving consumers with less money to spend and forcing retailers to lower prices. Aeon Co., Japan’s largest supermarket operator, last week said it will offer discounts on 5,100 items this month. Rivals Ito-Yokado Co. and Seiyu Ltd. already cut prices of food, clothing and household products this month.
"Clearly the consumer has taken a shock," Jerram said. "The pain in manufacturing has led to greater insecurity, and it seems to have damaged consumer spending." Excluding food and energy, prices fell 0.1 percent in February, a second monthly decline. Finance Minister Kaoru Yosano said it was "too early" to conclude that the drop meant Japan has slid back to deflation. Core prices in Tokyo rose 0.4 percent in March from a year earlier, slower than the 0.6 percent in February. Sales at large retailers, which include supermarkets and department stores, plunged 8.2 percent, the biggest drop in 11 years. J. Front Retailing Co., the holding company that operates department stores Daimaru Inc. and Matsuzakaya Co., said sales slid 15 percent in February as shoppers cut back on clothing and luxury items.
Still, the retail slump may have been overstated because there were fewer shopping days in February compared with the same month in 2008, a leap year. About half the declines were owing to a drop in revenue at gasoline retailers, reflecting crude oil’s 59 percent slide last month from a year earlier. Also, the retail report doesn’t account for the growing share of money spent through the internet or on services. Consumer spending fell 0.4 percent last quarter from the previous three months, a fraction of the record 13.8 percent drop in exports that drove the worst quarterly contraction in gross domestic product since the 1974 oil crisis.
Elusive search for harmony
by Gillian Tett
Earlier this year, a senior risk manager at a large Western insurance company discretely approached counterparts in Europe and the US to discuss how to value those pesky collateralised debt obligations, and other "toxic securities." Most notably, what this executive wanted to know was whether there was any way to get some industry-wide consistency in the valuation approach. "It seems there is a still considerable variation in how these instruments are treated by some companies," he recently confessed. "But that creates confusion for investors – they just don’t know what quite to believe." Thus far, progress seems elusive. Some large insurance groups appear far from eager to discuss their valuation techniques with others. Moreover, different insurance groups also face subtly different accounting and regulatory pressures, depending on where they are based. "We have started a dialogue, but that is all so far," this insurance official adds, with a sigh.
It is a sobering story for global policy makers preparing for next week’s G20 meeting. The gathering in London will almost certainly produce swathes of rhetoric about the need to uphold "globalisation", and promote co-ordinated policy measures to deal with the financial crisis. After all, that is what lobby groups are now urging the G20 to do. Earlier this week, for example, a clutch of senior bankers visited Downing Street where they sternly told Gordon Brown of the need to combat the rising threat of financial protectionism and fragmentation. One idea the group floated was for the G20 to create a global super-regulatory council to oversee financial policies around the world. The group also called for co-ordinated measures to boost capital flows to emerging markets, warning that without joint action, the situation in such regions could turn dire, as financial policies became more nationally-focused. But while the phrase "global co-ordination" might be wildly fashionable, on the frontline of the financial war, it currently seems that the pressures for fragmentation are rife – and rising.
Moreover, that fragmentation can not merely be seen in terms of different national policy stances, but also in relation to how activity in the financial system is measured. Part of the problem reflects differences in accounting regimes, most notably between the IFRS approach used in Europe and the US accounting system. Take the case of Deutsche Bank. In recent weeks, some analysts at US banks have expressed unease about the scale of leverage at Deutsche bank (in terms of its balance sheet, relative to its core equity.) But the Deutsche Bank management refutes such concerns – and points out the European accounting system makes the Deutsche bank balance sheet look twice its size compared to US accounting rules, due to differences in the treatment of derivatives. "There is a complete misunderstanding," one executive explained. Such arguments do not convince all critics. But what is clear is that such accounting discrepancies make it hard for investors to work out what is – or is not – going on at a host of European banks, let alone compare them to American rivals.
There are also more subtle differences in national policy. Over in the US, the Treasury is currently exerting enormous pressure on its banks to take a conservative approach towards valuing their trouble assets, partly as a result of the so-called "stress tests" that it is currently implementing. But since those "stress tests" are only being applied to American banks, they cannot provide any comprehensive snapshot of how healthy the overall system is – or is not. Over in the UK, for example, the Financial Service Authority is embarking on its own set of policies for monitoring banks and setting standards, which may (or may not) be similar to those in the US. Continental European policy makers and financiers are taking still different stances. Consider Deutsche Bank, again. Most analysts (and rival banks) believe the German giant has taken a very conservative stance on measuring its own toxic assets that puts it on a par with the most conservative American banks. But there is also a near-unanimous belief among non-German bankers that other German banks have been far less conservative.
German regulators, are apt to deny that. But inside Deutsche Bank, some of the staff have (half-jokingly) constructed a "shadow" balance sheet, that works out what the group’s assets would look like if it used a truly "German" valuation approach. And when it comes to European insurance companies, distinctions can be more stark. Hence the initiative I referred to at the start of the column. Is there any solution? The obvious one would be to harmonise global accounting regimes and co-ordinate the type of stress tests that policy makers are devising now. That – unsurprisingly – is one of the things the bankers pleaded for when they met Gordon Brown this week. But don’t bet on that happening fast. After all, men such as Brown know that accounting matters tend to look mind-numbingly dull to voters – and pleas from bankers are apt to command limited respect. The sad truth is that if next week’s summit manages to merely prevent any further drift towards financial fragmentation – let alone reverse the trend – that will mark a victory in itself.
US consumer spending fades in February
U.S. consumers retreated in February after splurging in January as income growth stalled, the Commerce Department reported Friday. Real consumer spending, representing outlays adjusted for inflation, fell 0.2% last month, a reversal after rising by a three-year high of 0.7% in January, the government estimated. February's level of spending was higher than the average seen during the fourth quarter of 2008, signaling that consumer spending could add to economic growth in the first quarter, rather than subtracting as it has done in the past two quarters. Economists at Morgan Stanley boosted their forecast for first-quarter consumption to 1.3% annualized growth after a 4.3% decline in the fourth quarter. However, they still see gross domestic product plunging at a 5.1% annual rate in the first quarter, nearly matching the fourth-quarter's 6.3% decline.
Meanwhile, personal incomes fell 0.2% in February as wages declined 0.4%, putting incomes at the lowest level since April. After-tax disposable incomes eased 0.1%. Adjusted for inflation, after-tax incomes dropped 0.4% in February, reversing direction following a 1.4% surge in January. Income figures for the first month of the year had received a boost as a result of several one-time factors, including annual cost-of-living raises and a once-a-year technical adjustment to tax payments. In current dollar terms, last month's nominal spending rose 0.2% after a 1% gain in January. With incomes falling and nominal spending increasing, the personal savings rate ticked lower, to 4.2% of disposable incomes, compared with 4.4% in January.
Consumer prices increased 0.3% in February for the second month in a row. Core prices, which exclude food and energy inputs to provide a better look at underlying inflationary pressures, also rose, up 0.2%. In the past year, consumer prices are up 1%, while core prices are up 1.7%. Economists disagree sharply about where prices are heading. Some say the large amount of idle resources will put downward pressure on prices in coming months, threatening a nasty period of deflation. That's the view of the Federal Reserve and many private-sector economists. "Core inflation has fallen about a half point over the past six months, and we expect to see a more rapid and substantial decline through the rest of the year given the enormous slack building up in the economy," wrote David Greenlaw and Ted Wieseman of Morgan Stanley.
Others say deflation is unlikely. "The odds of deflation any time soon are fading fast," wrote Stephen Stanley, chief economist for RBS Greenwich Capital. "At the risk of beating a dead horse, the empirical support for the output-gap model of inflation is scant, and those economists, including at the Fed, who are counting on several years of moderating core inflation even after the economy begins to recover are likely to be well wide of the mark." Real spending on durable goods fell 1.5%. Real spending on nondurable goods and services was unchanged for February. Income from wages and salaries fell 0.3% in nominal terms. All other sources of income also declined, except transfer payments such as Social Security and unemployment benefits, which rose 0.8%. Meanwhile, February's income from assets fell 1.3%, marking the fifth straight decline. Business income slipped 0.1%, the sixth decline in the past seven months. Compared with February 2008, real disposable incomes are up 2.2%, while real spending is down 1.4%, the Commerce Department's data showed.
Jobless Rate Exceeds 10% in 3 More U.S. States as Slump Spreads
The number of U.S. states with a jobless rate exceeding 10 percent almost doubled in February as the worst employment slump in the postwar era spread. Nevada, North Carolina and Oregon last month joined the four other states that had previously climbed above 10 percent, according to Labor Department data released today in Washington. Michigan, at 12 percent, remained the state with the highest unemployment rate, followed by South Carolina at 11 percent and Oregon at 10.8. California and Rhode Island bring the total number of states to seven. Job losses have spread from areas battered by the housing recession and auto slump to states like the Carolinas where non- auto manufacturers and service companies are cutting staff.
Economists at Merrill Lynch & Co. in New York and Wachovia Corp. in Charlotte, North Carolina, are among those projecting joblessness nationwide will surpass 10 percent. "It’s something we’re not accustomed to seeing in this country," said Mark Vitner, a senior economist at Wachovia. "Double-digit unemployment rates are simply un-American." Forty-nine states and the District of Columbia registered increases in the unemployment rate last month, led by Oregon, North Carolina and New Jersey, the Labor Department said. Nebraska was the only state to post a decrease after the rate jumped the prior month. The states where home prices surged and then crashed remain among the hardest hit, including Nevada, with its 10.1 percent joblessness.
Nicole Wolf, 39, was working for Harrah’s Entertainment Inc. in Las Vegas for the human resources department until this month when she was laid off from her job that paid $94,000 a year. With her home worth less than her mortgage, and paying $800 a month to cover student loans, Wolf is trying to find a job in marketing or communications before her severance pay runs out. "I’m assuming I’ll have a job or declare bankruptcy," Wolf said in a telephone interview. The outlook for finding work this month hasn’t improved. The world’s largest economy probably lost more than 600,000 jobs in March for a fourth straight month, and the jobless rate jumped to a 25-year high of 8.5 percent, according to the median estimate of economists surveyed by Bloomberg News before next week’s report from Labor. Federal Reserve Chairman Ben S. Bernanke said in Washington March 10 that it was "certainly well within the realm of possibility" that average unemployment nationwide could rise above 10 percent "for a period."
With the recession already matching the longest in the postwar period, the jobless and the needy are becoming more evident across the country. Gabriela Romero, who works for the Fresno County Economic Opportunities Commission, last month organized a food drive in Mendotta, California, a city where four of 10 workers are unemployed, and arrived to find a crush of people seeking assistance. "It was just a free-for-all," she said. "You have people waiting in line for hours, pregnant women, disabled people." Since the recession began in December 2007, the economy has lost 4.4 million jobs, already more than the 3.5 million jobs President Barack Obama is targeting to save or create with his $787 billion recovery program. Payroll employment in February decreased in 49 states and the District of Columbia, led by California’s loss of 116,000 jobs. Florida had the second-biggest drop with 49,500 workers dismissed, followed by 46,100 positions cut in Texas, 41,600 in Pennsylvania and 37,200 in Illinois.
Surpassing 10 percent unemployment has a psychological impact and may further curtail spending, said Doug Woodward, a University of South Carolina regional economist in Columbia. "It’s creating more anxiety and more fear," he said. "It’s feeding on itself." Job losses are spreading from manufacturers such as General Motors Corp., Caterpillar Inc. and International Business Machines Corp. to other firms like lumber producer Weyerhaeuser Co., media companies like the New York Times Co. and even the U.S. Postal Service. They are affecting all income brackets and professions. Fred Herrmann, 33, of Minneapolis, lost his job as a mortgage broker making $250,000 a year in December when his company folded. He said he’s applied for 25 finance and sales jobs, each making $14 to $18 an hour plus commission.
"There’s not a whole lot of high-paying jobs," he said. "When you go from making a quarter of a million a year to 15 bucks an hour, that’s not good." On the lower end of the scale, Arthur Bolden, 61, is finding it harder than ever to get a job as a day laborer. While he used to get $10 an hour, the prevailing wage now is $7 or $8 an hour, he said, as he waited for work outside of a Mecklenburg County, North Carolina, social services building. "People don’t even have money to pay for landscaping or to cut grass." The jobless rates in North Carolina, at 10.7 percent, and Rhode Island, at 10.5, were the highest for those states since records began in 1976. Georgia, at 9.3 percent, also set a new high mark.
Institutional investors plough back into stocks
Client data show hedge funds selling financials; pension funds buying
Led by hedge funds, U.S. clients of UBS are now buying more stocks than they are selling, breaking six straight weeks of net outflows, the global investment bank and brokerage said. UBS said average U.S. client flows for the four weeks ended March 20 turned positive for the second time this year. The previous positive flows came in January, it said in a report on its customers' transactions made public Thursday. Hedge funds led net buying after they stepped back into stocks the prior week. Before they started snapping up equities, this group had sold more stocks, on net, since October. Corporate clients were also net buyers. U.S. long-only funds such as mutual funds and pension funds remained net sellers, however. Clients of UBS' wealth management arm and other banks and brokerage firms were also net sellers.
The report comes as strategists try to determine whether the current rally will stick. The S&P 500 has gained 25% since hitting a low of about 666 points on March 6, boosted by a recovery in financials. But some of those gains may have come from hedge funds buying stocks to cover short positions. Increased buying by large institutional investors that move slowly in and out of markets, such as mutual funds and insurance companies, would bolster the outlook for a lasting recovery in stocks. These investors are still trimming their stocks portfolios, UBS data found. But their pace of net outflows has slowed: Long-only funds sold, on net, $71 million in stocks every week for the four weeks ended March 20. That's down from net outflows of $114 million a week for the four weeks ended March 13.
Tech stocks suffered. U.S. clients sold this sector, on net, after acting as net buyers of tech stocks since the beginning of the year. Hedge funds were net sellers while long-only funds were net buyers. Hedge funds and long-only funds also differed on how they treated financial stocks. Hedge funds were net sellers, while long-only funds were net buyers, placing the most bets on this sector. The UBS report coincides with rebounds in both tech and financials - as well as data that show investors have increased their bets that financials and technology would falter in the coming weeks. The financial sector in the S&P 500 has gained about 53% since the close of trading March 6. The Nasdaq Composite, one of the main barometers for the tech sector, has rallied 23% and turned positive year-to-date on Thursday.
Meanwhile, short sellers have increased their positions in both sectors, a report from data research TrimTabs said. Financials and information technology sectors received the biggest short-interest inflows among the ten Standard & Poor's industry sectors for the two weeks ended March 13, TrimTabs said. Aggregate short interest in stocks in the Russell 3,000 index rose to $227 billion from $203 billion at the end of February. That was the largest rise in short interest positions since June.
Blinded by recovery hopes, investors fooled again
It felt good for a minute there -- the collective euphoria over a 20% rally in stocks in the past two weeks. Almost like old times. Talk of technical milestones and historical comparisons to bear-market rallies past was mixed with smack about how we only need 14 more days like Monday's 500-point surge in the Dow Jones Industrial Average to get back to the market's October 2007 peak. But underneath the optimism, the shorts were laying on more bets against stocks, and debt investors grew increasingly concerned over government spending plans. The two sides finally collided Wednesday as investors balked at important sales of debt by both the U.S. and U.K. governments, sending a strong message to both countries there may not be enough demand for all the debt they need to fulfill their spending plans.
With a thud, stocks turned right around on the news and an almost 200-point rally in the Dow turned into an 80-point loss in less than an hour. Then stocks rallied back in the last half-hour of trading to finish up 90 points, proving, if nothing else, that the volatility that marked trading on Wall Street last fall still lurks. The tug-of-war sets the stage for what might be the most important meeting of global leaders in a generation next week in London, where President Obama will make his international debut amid rising public furor over protectionism, regulatory overreaching and deficit spending. And that's only in his first 50 days. Depending on how you look at it, Obama's and British Prime Minister Gordon Brown's strategies either will save the world or destroy it by summertime. No middle ground.
It's the same for the stock market. The time for this rally to either reveal itself as the third violent head fake for investors in the past year and a half, or the beginnings of a true bull market that portends an economic recovery this autumn, has arrived. By the end of the G20 in London next week, we should know for sure. The case for recovery is fragile but growing by the day. A series of better-than-expected economic reports, and talk of bank profits in the first quarter, almost certainly will lead investors to open up their 401(k) and brokerage statements next week to see higher numbers for the first time in six months. Just in time for taxes. But as Wednesday's roller-coaster ride showed, excitement can turn to despair with the slip of Timothy Geithner's tongue.
The question for the shorts is what is out there that could lead to a new decline in stocks back to their March 9 lows or beyond. The last time the market reversed a bear-market rally, back in November, it was due to a combination of bankruptcy fears in the auto sector, plunging commodities prices and holiday tidings from Bernie Madoff that rocked investors. What could it be this time? Certainly a bankruptcy by General Motors could do the trick, though that seems less likely now than it did in December. News of another major loss at a big bank or financial company such as AIG also could shake the market, though it would help Geithner and Ben Bernanke's case to develop more federal powers over the financial system. Terrorism is always a wild card. And a major trade or economic dispute between superpowers could also raise temperatures and hit equities.
Absent any of these developments, though, it's hard to see stocks going into another four- or five-month slide without a sufficient catalyst. Investors might not be calling for Geithner's head this week, but Wednesday's turmoil shows that market support for the Obama financial rescue plan remains frustratingly elusive. After six months of stranger-than-fiction trauma and the destruction of generations of economic ideals and practices, it's hard to believe that this isn't the bear rally to end all bear rallies, and that something even more frightening to the financial system still lies ahead. How bizarre it would be if what the market actually fears is the global recovery itself -- and all the change that will come with it.
Mr. Taleb Goes to Washington
Nassim Taleb is an unlikely choice to play the Jimmy Stewart role in a 21st-century remake of the Depression-era classic Mr. Smith Goes to Washington. But the tale of a naive do-gooder who tries to remind a corrupt political class of its obligations was re-enacted this week when Taleb attended the Wall Street Journal's Future of Finance conference in Washington, D.C. A French- and Arabic-speaking former options trader with a taste for obscure Greek philosophers and the ambition to be seen as a literary figure, Taleb has grown famous for his book The Black Swan, which has sold 1.5 million copies around the world in 12 countries, with 19 more still to come. Although the book does not predict the current economic crisis per se, it rather loudly, elaborately, and—with a comically baroque form of storytelling—uniquely warns of the potential for a great catastrophe in the world economic system.
Now that the catastrophe is here, Taleb's anger at the economic establishment that drove us over this cliff—and populates the Journal's conference—makes him a representative figure of ordinary people. Like most Americans, Taleb is seething with rage about the financial establishment's role in bringing the about credit crash. "Nobody saw the crisis coming," he says. "Bernanke, all these guys, I want them out. They proved incompetent, they crashed the plane." Unlike us, the innumerately dumbstruck, Taleb is comfortable with the theory and practice that undergirds the whole system of options, derivatives, and risk management that has spun so recklessly out of control. That talent mixed with his righteous anger makes him a rare bird: an Everyman who can do the equations.
In private, Taleb takes a specific kind of glee in the wreckage of modern finance. He has been arguing for years that the "adult supervision" in the financial system—the worthy academics, regulators, and heads of the large banking institutions—has been deluding itself with talk of a great moderation. To Taleb, the supposed stability brought about by complex financial derivatives, global banking connections, and accelerated flows of capital was a mirage masking the accumulation of massive amounts of hidden risk. For Taleb, along with that other Grand Guignol figure of the economic collapse, Nouriel Roubini, being right has meant sudden access to an elite that used to ignore him. It's hard to think of a more establishment figure than Alan Murray, the executive editor for the Wall Street Journal online. Murray is also the man who interviews the CEOs, politicians, and other worthies onstage when the Journal holds a conference. That makes him the public face of the Journal among the corporate elite.
In normal times, the conferencariat are an arrogant bunch. This is something Murray knows well from his travels on the conference circuit, which begins each year with the World Economic Forum in Davos. "Davos is usually filled with people who have all the answers," Murray says. "What was so striking about Davos this year was all these people, for once, didn't have all the answers. No one could tell you with certainty what was happening or what needed to be done." No one but Nassim Taleb. Before Davos, Murray read The Black Swan. At the conference, the newspaperman and the trader had many conversations over the course of four days. Murray came to the conclusion that Taleb was the iconic figure of Davos in 2009. "In my mind, he had the perfect message for the moment."
So Murray invited Taleb to the Future of Finance Conference, where 100 grandees of the financial world, ranging from Steve Schwarzman and George Soros to Meredith Whitney, Peter Fisher, and Nobel laureate Myron Scholes, got together to outline some principles for rebuilding the financial system. The conference opened with Murray interviewing Treasury Secretary Tim Geithner fresh from his 497-point victory lap after the announcement of his plan to deal with the toxic mortgage-backed assets. It closed with a field trip to the White House and an audience with Lawrence Summers. Nassim Taleb turned down the chance to kiss Summers' ring. He left after dinner the first night. While the 130-person conference debated the government's new regulations that George Soros described as merely "tinkering" with the system, Taleb has a clear-eyed plan.
First, he says, we have to unmask the charlatans of risk like Myron Scholes. To Taleb, Scholes is the Great Oz in this Emerald City because his work on options and derivatives allowed the whole of the financial system to adopt poorly understood products-like the ones that brought AIG down-that hide risk. To Taleb, Scholes' academic work, which enabled the widespread use of complex derivatives, was like "giving children dynamite." "This guy should be in a retirement home doing Sudoku," Taleb says. "His funds have blown up twice. He shouldn't be allowed in Washington to lecture anyone on risk." With complex derivatives unmasked and, in Taleb's vision of the future, outlawed, the next step is to create a more robust version of capitalism. Taleb calls it Capitalism 2.0. Robustness begins with a dismantling of debt. Leverage was the gas that inflated the financial system until it was too big, too fragile, and too volatile.
Over the past 20 years, the financial system has grown ever more complex. Building on a greater computing capacity and communication speed—"Bank runs now take place at the speed of BlackBerry"—Taleb recognizes that the financial system now possesses an efficiency that creates volatility. That cannot and will not go away. We cannot have both debt leverage and a hyper-efficient system—the volatility is just too great. What Taleb explains—which no one else does—is that efficiency is already a form of leverage. A highly efficient system removes slack and magnifies small changes. Think of the efficient system as a high-performance aircraft. Each minute of steering input creates a rapid and violent shift of course, speed, or altitude. The system itself is souped up even before you add the debt. Once you do, the pilot is equally jacked up and twitchy, creating an explosive combination. Now imagine that fighter jet trying to fly in a 1,000-plane formation, and you get an idea of the world financial system in the 21st century.
We can't erase the technology that created the planes, so we'll have to make sure we fly sober, maybe even with an onboard computer that dampens the controls. That means getting rid of the debt. It's that simple. A deleveraged financial system is a stable one, especially if we increase the redundancy within the system. That's an idea Taleb has taken from biology. But in finance, redundancy means two things: not having players in the game who are "too big to fail" and not allowing anyone—from the individual to the institution—to play with too much money. Redundancy means have cash on the side, not risking it all, and not becoming dependent upon financial assets for your economic well-being.
Did the conference see things Taleb's way? Not really. Back at the office, many of the financial leaders present had teams of analysts working on the government's newly proposed plan for toxic assets. Instead of deleveraging, here was a plan to use more leverage (provided by the government) to solve the excesses created by leverage. Although Taleb was impressed with Geithner, his anger has hardly dissipated. "The center of the problem is that they don't know the center of the problem," he says. "They have not yet entertained the idea that what we may be witnessing is a total failure of a way of doing business." It would be great to end this story the way Frank Capra ends Mr. Smith Goes to Washington: with a valiant filibuster that brings the country to its senses. But so far Washington and Wall Street are treating Taleb more like another Jimmy Stewart character, the one in Harvey, whose best friend is an invisible 6-foot rabbit.
Bank of America CEO Ken Lewis Says U.S. Should Consider Splitting Bank Functions
Bank of America Corp. Chief Executive Officer Kenneth Lewis said today the U.S. should consider separating commercial lenders from investment banking activities. Lewis made the comment on his way to a meeting with President Barack Obama and U.S. banking chiefs. Asked what he would tell Obama if given the chance, Lewis said it would be that "commercial banks are the fabric of any community in which they operate and we probably need to separate the commercial banks from the investment banking activities." The remarks may reopen the debate on whether the U.S. should reinstitute laws put in place after the Great Depression designed to insulate lenders from the risks of investment banking. Bank of America, the biggest U.S. bank by assets, bought Merrill Lynch & Co. in January, helping the largest U.S. brokerage avoid the financial collapse that drove Bear Stearns Cos. out of business.
How to Conjure Up $500 Billion
As recently as October, all it took to get a bailout bill through Congress was a few pieces of strategically placed pork. Back then, the Bush administration could insert into its stimulus bill a tax exemption for a wooden arrow factory in Oregon, and the votes would magically appear. The Obama administration must wish it were still so easy. Congress is in no mood to pass anything now, pork nuggets or no. The executive branch has to make do with what it’s got. In the case of the bank bailout plan, that means a combination of some leftover funds from last year’s Troubled Asset Relief Program bill along with a rather ingenious use of guarantees by the Federal Deposit Insurance Corporation.
The F.D.I.C. was created to do what its name implies: insure deposits. Deposits are loans of a kind: when you make a deposit at the bank, you’re lending the bank your money, normally at a very low rate of interest. The F.D.I.C. exists to make sure that whatever happens to the bank, you’ll always get your money back — up to a limit of $250,000. Now, however, instead of insuring garden-variety bank deposits, the F.D.I.C. is going to insure extremely risky loans to curious new entities called public-private investment funds. And while banks can always borrow money somewhere, these funds wouldn’t be able to borrow at all were it not for that F.D.I.C. guarantee.
Imagine going to your local bank and asking for $10 billion to gamble at the Toxic Asset Casino. The bank would say no — until you showed it a letter from your Uncle Sam saying he’d guarantee the loan. Then, the bank would lend you as much as you’d like. The F.D.I.C. has never taken on this kind of risk before. It’s not the first time that Treasury has magicked billions of dollars from some hidden back pocket, just to avoid having to ask Congress for the money. In 1995, with Robert Rubin recently installed as Treasury secretary, Lawrence Summers, the deputy secretary, along with Tim Geithner, a deputy assistant secretary, wanted to bail out Mexico in the face of Congressional opposition. They found something called the Exchange Stabilization Fund, originally intended to stabilize the value of the dollar on world currency markets, and managed to repurpose it for another use entirely.
It’s possible to step back and admire the statecraft in the present case — there’s a certain elegance with which Treasury managed to transform $100 billion in TARP funds into more than $500 billion in cash to inject into the banking system, all the while avoiding any fight on Capitol Hill. It makes the $20 billion found for Mexico all those years ago look like pocket change. Yes, it’s easy to find serious economic weakness in a plan that puts enormous amounts of government money at risk even as it promises billions of dollars in profits for private investors. But the economics don’t exist in a vacuum, and Tim Geithner doesn’t live in a world where he can simply do whatever makes the most economic sense.
Mr. Geithner needed the cooperation of the F.D.I.C., but few federal agencies ever object to an idea that involves expanding their budget and making them more important. In this case, the F.D.I.C., and its chairwoman, Sheila Bair, had particular reason to want to grab as much power as possible: the Obama administration is about to embark on the largest overhaul of the American regulatory infrastructure since the Great Depression. America’s patchwork quilt of financial regulators is looking decidedly frayed around the edges, as financial firms dance around what regulations do exist. American International Group, for example, managed to get itself regulated by the toothless Office of Thrift Supervision after buying a Delaware thrift for just that purpose.
Chances are that the Federal Reserve, rather than the Securities and Exchange Commission or any other agency, will end up regulating the entire financial system, including banks, brokers, hedge funds and insurers. Then, the Office of the Comptroller of the Currency, the National Credit Union Administration, the Commodity Futures Trading Commission and any number of other obscure regulatory animals risk being killed off. The bank bailout plan makes the F.D.I.C. well positioned to survive. Not only will it be an integral part of the new bank bailout, but it is also likely to be put in charge of taking over any failing financial firms that pose a systemic risk — be they banks, hedge funds, private-equity shops, insurers or even large corporations like General Electric. This could be the most far-reaching unintended consequence of Congress’s stubborn opposition to any bailout plan. Treasury ended up being forced to find its own way — and that meant a suboptimal bank bailout scheme, and a vast swath of new powers for the F.D.I.C.
Geithner Is Overreaching on Regulatory Power
One of the main proposals in the regulatory reforms outlined by Treasury Secretary Timothy Geithner yesterday would give the Treasury, FDIC and the Fed authority to take control when investment banks or other financial institutions (hedge funds, etc.) appear troubled, just as the FDIC presently does with deposit-taking banks. The proposal is being offered as a clever political solution to the turf war that might have erupted if the Treasury or FDIC alone were given this quasi-nationalization authority, with no input from the Fed. But the real issue is whether this expansion of regulators' powers is wise. It isn't.
Start with the FDIC's performance in practice. One would suspect that the government might not be a shrewd player in the banking business, and recent events confirm that suspicion. IndyMac, for example, was not taken over by the FDIC until long after it was obvious that it should be closed, and current estimates of the cost to taxpayers approach $10 billion. Shortly after the IndyMac failure, moreover, the FDIC brokered a deal to sell Wachovia to Citigroup at a lowball price and wound up with egg on its face when Wells Fargo emerged with a vastly superior offer. We could continue. There's also significant room for principled skepticism based on economics and law. Indeed, the case for broadening regulators' oversight to include investment banks and other financial institutions is based on three flawed assumptions.
The first is that the same factors that justify expansive powers to close banks and take control of their assets are equally applicable to investment banks and other financial institutions. But the FDIC's interest in commercial banks is unique -- because it guarantees deposits up to $250,000, the FDIC is a bank's most important creditor and has a stake in its health as the representative of American taxpayers. The government's stake and the need to assure that depositors do not lose access to their deposits, even temporarily, arguably justify the FDIC's extraordinary powers. Those factors are not present with investment banks or other financial institutions. The second flawed assumption is that our bankruptcy laws are not adequate for handling defaults by investment banks or other financial institutions. The Lehman Brothers bankruptcy, which created turmoil in credit markets, is often offered as irrefutable evidence. But the conventional wisdom is based on a serious misreading of the Lehman collapse.
The Lehman bankruptcy was so destructive because the Fed and Treasury had strongly suggested they would bail out any large troubled investment bank, as they did with Bear Stearns. Regulators' sudden shift in policy took Lehman and its potential buyers completely by surprise. If the government had instead made clear that it did not intend to rescue troubled investment banks, Lehman surely would have taken steps to prepare for the possibility of bankruptcy. Lehman and its buyers would not have played chicken with the Fed and Treasury as they did, holding out for a government guarantee of the sales of Lehman's assets. Nevertheless, the Lehman bankruptcy ultimately proceeded quite smoothly. Contrary to the widespread myth that bankruptcy is time-consuming and ineffectual, Lehman sold its major brokerage assets to Barclays less than a week after filing for bankruptcy. It is now in the process of selling its tens of billions of dollars of less time-sensitive assets at a more deliberate pace. Lawmakers should take a second look at Lehman as they decide what to do with AIG.
The third flawed assumption is that financial firms flirting with distress are somehow worse decision makers than federal regulators. But the opposite is likely true. If the Treasury, FDIC and Fed had authority over investment bank failures, troubled banks would have a strong incentive to negotiate for rescue loans, and their pleas would be heard by regulators influenced as much by political as financial factors. The involvement of three different regulators (and mandatory consultation with the president) would magnify this risk. With bankruptcy, in contrast, the decision of whether and when to file is made by an institution's managers and creditors, who have the best information and their own money on the line. Extending the FDIC's authority, in conjunction with Treasury and the Fed, to include investment banks and other financial institutions is being sold as a small and pragmatic step. In reality it is a big step, and that big step would be a big mistake.
by Francis X. Diebold and David A. Skeel Jr. Mr. Diebold is a professor of economics, finance and statistics, and co-director of the Wharton Financial Institutions Center, at the University of Pennsylvania. Mr. Skeel is a professor of law at the University of Pennsylvania.
As Oversight Plan Is Unveiled, Turf Battle Begins to Unfold
Rival Regulators Argue for Right to Expanded Authority
Even as Treasury Secretary Timothy F. Geithner yesterday was presenting to Congress his new blueprint for revamping financial oversight, federal regulators at the Securities and Exchange Commission and elsewhere were joining the battle over the creation and apportionment of any expanded powers. The Obama administration wants Congress to vastly expand federal oversight of previously unregulated financial markets such as trading in derivatives, and to impose more rigorous regulations and curbs on risk-taking by the largest financial companies, including major banks, insurers and hedge funds. SEC Chairman Mary L. Schapiro urged that her agency play a major role, telling the Senate Banking Committee that the SEC may soon ask for new authority to oversee financial firms and products, including hedge funds, derivatives and municipal bonds. At the same time, she warned that the administration's proposal to endow some federal agency with the authority to detect risks throughout the economy "could usurp" the work of the SEC and other regulators.
Rival agencies -- including the Federal Reserve, Commodity Futures Trading Commission and banking regulators -- already are pushing similar arguments. Consumer advocates, meanwhile, say they are being ignored. Industry groups caution against a surfeit of new regulation. The administration is taking advantage of what Geithner described yesterday as an "opportunity" to enact regulations that before the financial crisis might have faced much more opposition. Notable by their absence, however, were proposals addressed at the causes of the crisis. There was no mention of increased regulation of the mortgage industry, for example, or of securitization, the process of bundling loans for sale to investors that funded much of the boom in lending.
In part, the administration appears to be deferring to Congress. Rep. Brad Miller (D-N.C.) yesterday introduced legislation to create national regulations for mortgage lending. Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, opened the Geithner hearing with a speech about the need for increased regulation of securitization. The administration, by contrast, is focused first on creating a system for regulating the largest financial companies, limiting the risks they take and granting the government new powers to seize large firms before they collapse.
In her testimony, Schapiro said she could endorse in principal the proposal to assign a single agency to regulate systemic risk but was concerned this could harm the effectiveness of the SEC. For example, a regulator that worries primarily about risks that one firm poses to the entire financial system might favor relaxing accounting standards in periods of crisis or oppose stiff penalties for an already struggling financial company. Enforcing accounting standards and securities laws are the SEC's bread and butter. "We have to have equal attention on investor protection, and an independent agency like the SEC focuses on that," Schapiro said in an interview yesterday.
Another area already being contested is Geithner's proposal to regulate derivatives, the exotic financial instruments such as credit-default swaps that have exacerbated the crisis. The SEC and CFTC are both trying to lay claim to overseeing this market. Schapiro yesterday cited the SEC's experience in regulating similar forms of trading as "a pretty compelling reason to be involved in their regulation." The CFTC released a statement asserting its own expertise and saying that it looked forward to contributing to the overhaul of derivatives regulation. Industry executives, fearful of regulatory overreach, are gearing up for marathon discussions with the administration and key members of Congress. "We want to achieve meaningful regulatory reform to make sure these products remain widely available, in a way that is cost effective," said Robert Pickel, chief executive of the International Swaps and Derivatives Association.
The turf battle between agencies is mirrored on Capitol Hill, where House and Senate agriculture committees with authority over the CFTC do not want to cede authority to the financial services and banking committees that have oversight over the SEC. Yet another conflict is brewing over regulation of hedge funds. Geithner wants larger funds to register with the SEC. Schapiro wants all hedge funds to register with the agency. Geithner has also suggested that venture capital and private-equity firms register with the SEC. Schapiro hasn't expressed opposition to this but said that such companies may need to be subject to different rules than hedge funds. James Chanos, an outspoken hedge fund manager, said yesterday that while the industry is willing to accept some new regulations, Congress shouldn't be quick to treat them the same way as banks and other financial firms.
"Hedge funds and their investors have generally absorbed the painful losses of the past year without any government cushion; the same certainly cannot be said of the major investment and commercial banks, insurance companies, and [Fannie Mae and Freddie Mac] that have had to run to the taxpayer to cushion against the losses caused by poor investment decisions, faulty risk management or fraud," he said. "Private equity can make a cogent argument that the problem was not of its own making," said an executive at a major private-equity firm who spoke on condition of anonymity because he expects to be part of the discussions with government officials in formulating details of the plan. "It poses no systemic risk. . . . The worst that can happen is the fund goes to zero. It doesn't suddenly turn into this black hole threatening to suck in everything around it." Perhaps Geithner's friendliest reception came from the House Financial Services Committee, whose members earlier this week had slammed the Treasury secretary for his role in the payment of bonuses to employees at American International Group.
Geithner: The Regulatory War Ahead
A broad plan for federal oversight of hedge funds, private equity, and derivatives is drawing approval now. But wait till the details emerge. Fresh off his hit performance with the bank-rescue plan, Treasury Secretary Timothy Geithner seems to be on a roll. His broad proposal to overhaul regulation of whole swaths of the financial sector drew applause from most quarters on Mar. 26. Investors didn't seem at all unsettled by the prospect of intensified government oversight, as the Standard & Poor's 500-stock index rose 2.3% and Wall Street closed in on a second straight week of strong gains. But the plan offered few specifics in many of the areas it addressed, from tougher regulation of complex financial derivatives to new rules for money-market funds. And Geithner steered well clear of some of the most contentious questions facing policymakers—the questions that are sure to turn agreement about broad principles into a pitched, possibly months-long political battle that pits financial interests against consumer advocates and one another. "It's like with all these programs—the devil's in the details," said Kevyn Orr, a Jones Day attorney who previously worked for the Resolution Trust Corp. as it cleaned up after the savings and loan crisis in the early 1990s. "Who's going to stand up and say, 'I don't like baseball, mom, and apple pie'?" Orr said. "But you go to Boston and New York, there's a whole lot of differences between Yankees and Sox."
The Treasury Secretary promised specifics in coming weeks, including separate proposals addressing consumer protection, gaps in U.S. regulation, and ways to coordinate regulatory reform with other countries. Those details are sure to throw into sharper relief the battles that lie ahead. Many of the proposals will bring some measure of scrutiny to corners of the financial markets that have gone for years without significant regulation, including private equity and hedge funds and the market for most financial derivatives. Defining which institutions should be deemed "systemically important"—whose failure could pose a risk not only to their own investors but to the financial system itself—and imposing stricter capital requirements on them will lead to jockeying among banks, insurers, and fund managers. Tightening consumer protections—which many Democrats say would go a long way toward preventing another financial crisis—will likely mean restricting mortgage companies and credit-card lenders, among others. Closing regulatory gaps could spark disputes among government agencies and even congressional committees with overlapping or related jurisdiction. Lawmakers on the committees that oversee the Commodity Futures Trading Commission and the Securities & Exchange Commission won't be eager to cede authority to one another, for example.
In making his case to the House Financial Services Committee, Geithner called his proposal "not modest repairs at the margin, but new rules of the game." In focusing on systemic risk, he said regulators must be retooled to look beyond the soundness of individual institutions "but must also ensure the stability of the system itself." To that end, Geithner renewed calls for a systemic-risk regulator with the authority to monitor and rein in large, interconnected financial companies, whether federal banks or hedge funds and other pools of private investments. He also called for beefing up the capital that big institutions must hold against their liabilities and requiring "leveraged private investment funds" over an unspecified size to register with the SEC and submit to closer scrutiny. Geithner also said the government should establish rigorous oversight of the now-murky market for credit default swaps and other complex financial instruments, ensuring that most are traded through exchanges and central clearinghouses. He called for the SEC to "strengthen the regulatory framework" around money-market funds, and he repeated his call, made earlier in the week, to give the executive branch authority to dismantle or reorganize big financial institutions rapidly if they threaten the broader financial system.
But Geithner didn't spell out what tougher money-market supervision might mean, or which agency would implement it. And in proposing a systemic-risk regulator, he steered clear of naming the agency that would receive broad new powers. While some, including House Financial Services Committee Chairman Barney Frank (D-Mass.), argue for giving the power to the Federal Reserve, others—including Senate Banking Committee Chairman Christopher Dodd (D-Conn.)—are cooler to the idea. Dodd has questioned whether the additional duties would distract from the Fed's existing responsibility for monetary policy and regulating bank holding companies. Moreover, regulating "leveraged private investment funds" could be tricky. A private equity fund could decide that "from now on, we won't call ourselves a private investment fund, we'll call ourselves a private investment association," Orr noted. Geithner acknowledged the gaps in his testimony, saying he wanted to concentrate on the substance of the proposals "rather than the complex and sensitive questions of who should be responsible for what." Beyond laying the foundation of a regulatory reform plan, Geithner continued to make the case for the most detailed part of the proposal, so-called resolution authority that would give the government the ability to dismantle big financial institutions whose failure threatens the entire financial system or the economy.
The broader plan, as sketchy as it was, also gives President Barack Obama something to bring to next week's meeting with the heads of other major economies—many of whom have said their top priority is coordinating global financial regulation. Still, the proposal as it stands is unlikely to be detailed enough for European leaders. And then there's the domestic political angle: Amid mounting public frustration over the U.S. financial bailout, proposals to limit, and potentially dismantle, dangerous financial institutions are likely to resonate, to the Administration's benefit. "They look like they're punishing the bad actors," says Daniel Clifton, a policy analyst with Strategas Research Partners. "The hard decisions will be made down the road." That populist edge could complicate the usual Wall Street defense mechanism against regulations: sending a flood of lobbying money to sympathetic members of the House and Senate. But overall, Clifton says, little in Geithner's proposal is surprising. "Is it going to be harder for financials to make a profit? Yes," he says. But considering the depth of the anger over the financial crisis, "that was a given," he added.
In fielding questions from lawmakers, Geithner did step into one minefield: He said he saw "a good case for an optional federal charter for insurance companies"—immediately drawing praise from large financial institutions, many of which have long lobbied for an alternative to state-by-state regulation of insurance products. But such a move is less popular with many insurance agents and brokers—historically a potent lobbying force—as well as with the state regulators and legislatures that currently oversee the insurance industry. Ultimately, given the consensus in Washington that flawed regulation helped deepen the ongoing financial crisis, many of the reforms Geithner proposed will come to fruition in one form or another. And that's significant in itself, notes Scott Talbott, a lobbyist for the Financial Services Roundtable, which represents large financial firms. "There's lots more to be done," Talbott said. "But by the time we're done it will be a sweeping reform."
Moral hazard - lite and strong
by Willem Buiter
I have always been a believer in the screw-up theory of history (and particularly of disasters) rather than of the conspiracy theory of history (disasters). The financial crisis that has engulfed the world certainly offers massive evidence for the importance of screw-ups - errors, mistakes, misunderstandings, singular stupidity verging on idiocy, misjudgements and missed opportunities. I am, however, as more detailed evidence accumulates about the genesis of the financial collapse, becoming more and more impressed with the importance of misfeasance and malfeasance - of negligent, unethical and outright criminal behaviour, ranging from high crimes to misdemeanours. Three representative examples:
- UBS agrees to pay $780m (£548m) in fines and to turn over a yet-to-be-determined number of US customer names to the US government as part of a settlement in which the Swiss bank admitted it helped thousands of clients evade taxes. I don’t understand why a bank that systematically and over many years promotes, aids and abets tax evasion, tax avoidance and tax fraud should be allowed to continue to exist. Why aren’t all those involved stamping license plates? Surely, these are criminal as well as civil offences?
- Bernie Madoff runs a $50 bn Ponzi scheme over many decades, right under the noses of the regulators in one of the two financial co-centres of the universe. It is possible Bernie Madoff was the only crook involved. Possible, but unlikely.
- Why is Barclays sufficiently desperate to avoid even partial UK government ownership, that it is willing to accept £7 billion of capital from the Middle East at a price well in excess of what was available from the UK Treasury? Is this not a clear breach of the fiduciary duty of the management and the board? Why is Barclays now even actively considering selling one one of its crown jewels, iShares, rather than accepting a public sector capital injection when this was on offer? Could it be related to the fact that Barclays runs one of the world’s largest ‘tax efficiency’ units, which it does not wish to be subject to closer scrutiny by a shareholder who is supposed to speak for the British tax payer?
On March 17, 2009, Barclays Bank obtained a court order banning the Guardian from publishing documents which showed how the bank set up companies to avoid hundreds of millions of pounds in tax. The gagging order was granted by Mr Justice Ouseley after Barclays complained about seven documents on the Guardian’s website which had been leaked to the Liberal Democrats’ deputy leader, Vince Cable. I am sure there is some legal peg that Mr Justice Mousey can hang this gagging order on, but to me this is an extraordinary interference with the freedom of the press and the public’s right to know something that is clearly of significant public interest. I tend to forget that justice and the law are two quite unrelated concepts. The internal Barclays memos showed executives from SCM, Barclays’s structured capital markets division, seeking approval for a 2007 plan to sink more than $16bn into US loans. Tax benefits were to be generated by an elaborate circuit of Cayman islands companies, US partnerships and Luxembourg subsidiaries.
These documents were leaked to Dr. Cable by a former employee of the bank, who also wrote a long account of how the bank works. It included the following telling paragraphs: "The last year has seen the global taxpayer having to rescue the global financial system. The taxpayer has already had a gun put to their head and been told to pay up or watch the financial system and life as we know it disappear into a black hole. It is a commonly held view that no agency in the US or the UK has the resources or the commitment to challenge SCM. SCM has huge amounts of resources, the best minds rewarded by millions of pounds. Compare this with HMRC [Her Majesty's Revenue & Customs] recently advertising for a tax and accounting expert with the pay at £45,000. Through the use of lawyers and client confidentiality SCM regularly circumvents these rules, just one example of why HMRC will never, in its current state, be up to the job of combating this business." ...
Financial nonfeasance, misfeasance and malfeasance thrive on opaqueness, complexity and lack of transparency
Another reason why banks (although quite willing to take the King’s shilling in the form of guarantees for assorted assets and liabilities; indeed Barclays is considering joining the UK government’s asset protection programme) may be reluctant to accept the state as a major shareholder is the more intense scrutiny of what the bank has on its balance sheet that this is likely to imply. It is clear that the vast majority of the large border-crossing banks are continuing to exploit every accounting trick in the book to avoid recognising the marked-to-market losses on their dodgy assets. With most banks cursed with paper-thin equity cushions in relation to their assets, a more intense, let alone a quasi-forensic scrutiny of the balance sheet by a nosy expert paid for and acting on behalf of the government shareholder could easily precipitate a move from partial to full state ownership and thence into insolvency and an orderly restructuring or liquidation.
Too many bank insiders have exploited their monopoly of information and the control it bestows on them, to enrich themselves by robbing their shareholders blind. There has been a spectacular failure of corporate governance. Boards have foresaken their fiduciary duties. Surely, even the liability insurance taken out by board members ought not to shelter those who are guilty of, at best, such willfull negligence and dereliction of duty? Where are the class actions suits by disgruntled shareholders? Where are the board members in handcuffs? Now that there is no meat left on the shareholder drumstick, the rogue managers and employees are going after a piece of the really juicy bird - the ever-patient tax payer. I hope they choke on it. Moral hazard refers, in insurance parlance, to a situation where the likelihood of an insured event occurring can be influenced by the insured party, without the insurer being able to observe accurately the actions of the insured party that influence the outcome. So anything that creates incentives for excessive risk taking, like limited liability and investments in toxic assets that benefit from leverage in the form of non-recourse lending by the Fed, would create moral hazard in the insurance sense of the word - moral hazard lite.
What we have seen and continue to see in much of the border-crossing financial sector, however, is a rather more literal form of moral hazard: a lack of morals in some key participants in the financial system dance causing major hazards to the financial well-being of millions of powerless victims. Corrupted morality putting at risk genuine, wealth-creating financial intermediation, innovation and risk-taking. This is moral hazard strong. Finance is one of the great social inventions of humanity; the division of labour and specialisation in effort and activity that are at the root of all prosperity depend on it. It makes me sick to see an entire branch of human endeavour brought into disrepute by the actions of a relatively small (but still far too large) number of masters of the universe. There will have to be a reckoning, and not just in the court of history.
Ilargi: And it's a surprisingly small step from Buiter's moral hazard to a bunch of Gamblers Anonymous members still in charge at AIG. Let's make sure they get their Christmas bonuses.
Top Risk Officers Remain at AIG's Helm
Inside American International Group Inc., a group of top executives called the Credit Risk Committee oversaw some of the company's biggest bets, such as the insurer's foray into credit-default swaps. But even after a $173 billion government bailout, this group, which reviewed and approved risk-taking decisions, remains largely unchanged. At least five of the 10 committee members have served for years, according to internal company documents. Some served as far back as 2003 and 2004, the documents show. Even amid change at AIG, much of the company's day-to-day infrastructure remains in place. Many of the high-level AIG executives who approved the insurer's risk-taking before the company's near collapse still are at their posts.
Among the longtime risk-committee members are Robert Lewis, AIG's chief risk officer since 2004; Kevin McGinn, chief credit officer and chairman of the committee; Win Neuger, chief executive of AIG Investments; William Dooley, head of AIG's financial-services division, which includes the financial-products unit that sold the credit-default swaps; and Barbara-Ann Livanou, director of financial institutions in the credit-risk-management department. AIG said in a statement: "AIG is committed to strong risk management....Recently, consistent with the terms of the U.S. Treasury's preferred investment in AIG, the company has clarified the authority regarding the board's now-named Finance and Risk Committee. The committee, among other things, reports to and assists the board in overseeing and reviewing information regarding AIG's enterprise risk management." The AIG spokeswoman said all five of the risk-committee members declined to comment.
The government has flagged AIG's risk management as an area of concern. As a condition of investing $40 billion in AIG in November, the Treasury Department required the company's board to create a new risk-management committee to "oversee the major risks involved in [AIG's] business operations and review [AIG's] actions to mitigate and manage those risks." Cleaning house might not be the best answer at some troubled firms, said Deborah Cornwall, managing director of the Corlund Group, a firm that helps companies evaluate executive candidates. Chief executives can change a culture over time, Ms. Corlund said. Finding new deputies with the right skills could be difficult, particularly given limits to compensation at a government-controlled firm, she said. The Credit Risk Committee members are part of a group of risk evaluators established by AIG over the years. The company's "major risks" are handled at the corporate level by Mr. Lewis's department, known as Enterprise Risk Management, according to AIG's 2007 securities filings, the last full year before the bailout.
AIG also has a separate department dedicated to credit risk, headed by Mr. McGinn, who reports to Mr. Lewis. Mr. McGinn's department's "primary role is to support and supplement" the Credit Risk Committee's work, according to the SEC filing. The committee's tasks include approving credit-risk policies at AIG and reviewing the credit-risk exposures of AIG's business units, according to the filing. It also played a role in blessing AIG's credit-default swaps. At a December 2007 conference AIG hosted for investors, Mr. McGinn said that "essentially" every such deal passed through the committee, according to a transcript. Many of the deals have gone bad. As of Sept. 30, AIG had recorded $31 billion in paper losses on credit-default swaps protecting investors from losses on packages of debt called collateralized debt obligations. AIG had said in November that the estimated credit losses would be much lower, $7.8 billion to $12 billion. Many of the swaps have since been canceled, after the underlying securities were purchased by an entity funded by the Federal Reserve Bank of New York and AIG.
AIG's outside auditor and a regulator raised concerns months before the bailout about the ability of AIG's risk management to monitor what was going on in some units. At an AIG board-committee meeting in January 2008, AIG's auditor, PricewaterhouseCoopers LLP, "expressed concern that the access" Mr. Lewis's department and other top AIG executives had into the financial-products unit, AIG Investments and other subsidiaries. Access "may require strengthening," according to minutes of the meeting released by Congress last fall. Two months later, the federal Office of Thrift Supervision, which regulated AIG's financial-products unit, sent a letter to the company, also released by Congress. OTS said the unit "was allowed to limit access of key risk control groups while material questions relating to the valuation of the [swap portfolio] were mounting." The OTS said those "control groups" included Mr. Lewis's department and an official in the financial-services division, which Mr. Dooley oversees.
At a congressional hearing last week, Rep. Gary Peters (D., Mich.) asked AIG Chief Executive Edward Liddy, "Where was the risk management of your company? Where was the failure of your own internal risk-management procedures?" Mr. Liddy responded, "We had risk-management practices in place. They generally were not allowed to go up into the financial-products business." At the December 2007 conference, Mr. McGinn described the relationship differently. He said the credit-default swaps were "a business that we have been really involved with from the very inception," according to a transcript. "We basically challenge the assumptions, we stress the book, we run some independent tests...and we indeed approve those transactions," he said, calling it "a very, very active process."
Cuomo Widens His Probe to AIG Unit Swaps Deals
New York Attorney General Andrew Cuomo is expanding his investigation into American International Group Inc. to include questions about how its financial-products unit is unwinding deals as well as examining bonus payments at the division. Mr. Cuomo subpoenaed AIG on Thursday for information largely to assess AIG's statements that it needs the expertise of the unit's employees to unwind or ready for sale its $1.6 billion in trades. "In an investigation, sometimes one thing leads to another, and here our review of bonus payments has led to questions about underlying credit-default-swap contracts," Mr. Cuomo said in an interview Thursday.
AIG declined to comment on the subpoena. The Federal Reserve, which has overseen AIG since a government rescue in September, also declined to comment. Credit-default swaps are private contracts that investors buy to insure themselves against losses on debt securities or against the default of a counterparty. Losses tied to credit-default swaps sold by AIG's financial-products unit nearly toppled the company last year, leading to the rescue. Bonuses paid to staff at the financial-products unit raised a stir this month. AIG had warned officials of "significant business ramifications" of failing to pay the bonuses, saying employees were needed to wind down the business. Mr. Cuomo has urged workers to return bonuses and has said commitments of about $50 million have been made.
One question Mr. Cuomo has raised is whether the tasks for staffers is complicated given that, at least for one line of business, AIG and the Fed effectively paid some investors 100 cents on the dollar to unwind certain trades. Still, that payout applies only to the particular type of trade tied to mortgage securities. The unit also has other types of credit-default swaps, including $234 billion of swaps tied to European banks' regulatory capital. Those could be at risk of default in light of the recent resignations of two senior managers at a subsidiary in Paris under legal terms surrounding the deals. AIG said Thursday that given the managers' commitment to see through an orderly transition, it expects the book of derivatives "will remain unchanged and in good standing."
Inquiry Asks Why A.I.G. Paid Banks
Members of Congress and the New York State attorney general demanded detailed information Thursday on how tens of billions of taxpayer dollars flowed through the American International Group during its crisis last fall and ended up in the coffers of several dozen big banks, shielding them from losses. The new inquiries shine a spotlight on a question that is exponentially bigger, in dollars, than the $165 million in bonuses that A.I.G. paid out this month, but which has been overshadowed until now by the uproar over the bonuses. "We would like to know if the A.I.G. counterparty payments, as made, were in the best interests of the taxpayers who provided the funding," said Representative Elijah E. Cummings, Democrat of Maryland, in a letter to Neil M. Barofsky, the special inspector general for the Troubled Asset Relief Program. The letter was also signed by 26 other members of the House, all of them Democrats.
The representatives asked Mr. Barofsky to find out who had made the decision to shield A.I.G.’s trading partners from any losses during last fall’s crisis, and what factors had shaped the decision. Their letter mentioned that Mr. Barofsky’s office had been created to investigate the uses of TARP money, and that A.I.G., the biggest recipient of government aid in recent months, was among the largest recipients of money from the TARP. Andrew M. Cuomo, the New York State attorney general, meanwhile subpoenaed A.I.G. on Thursday for extensive information about its derivatives portfolio and how it is being managed, including the names of people in charge of the negotiations and other activity. The new phase of Mr. Cuomo’s investigation is civil, although the subpoena was served under the Martin Act, a state law that gives the attorney general broad prosecutorial powers. A spokesman for A.I.G. said the company had no comment on the new inquiries.
The banks and investment firms that ended up with A.I.G.’s bailout money last fall were, in many cases, counterparties to derivatives contracts it had sold, known as credit-default swaps, which guaranteed the value of assets in their investment portfolios. Had A.I.G. not been bailed out, and simply allowed to go bankrupt, they would have suffered investment losses running into the billions of dollars. A.I.G. released the names of its major counterparties this month, at the urging of the Federal Reserve Board of Governors. They included Wall Street firms, like Goldman Sachs, JPMorgan Chase and Merrill Lynch, that have successfully resisted efforts to regulate credit derivatives in the past, on the argument that such contracts were valuable risk management tools, safe in the hands of the experts.
In several hearings this month, members of Congress said they believed the derivatives had often been used to speculate, not to manage risk. They have expressed outrage that A.I.G.’s trading partners got 100 cents on the dollar for their money-losing trades when ordinary Americans paying for the bailout have suffered big losses in their 401(k) accounts and other investments. Some have also been dismayed to learn that taxpayer money had ended up bailing out foreign banks. Some of the biggest beneficiaries of the bailout of A.I.G. were banks in Europe, including Société Générale of France and Deutsche Bank of Germany, each of which received nearly $12 billion, Barclays of Britain, which received $8.5 billion, and UBS of Switzerland, which received $5 billion.
Officials of the Federal Reserve and the Treasury have said they believed A.I.G.’s financial obligations had to be honored to prevent a domino effect. Had A.I.G. suddenly disappeared, banks and other financial institutions around the world would have suffered losses, bad enough in some cases to cause additional failures. But in their letter, the representatives said that while they were aware of "systemic risk," they still wanted to know who had decided that the way to contain such risk would be to completely insulate the banks from losses. "We would like to know if assessments were made of the health and total exposure risks of counterparties, such as Goldman Sachs," they wrote, pointing out that Goldman Sachs had claimed it had no material exposure to A.I.G., but turned out to have received almost $13 billion during the rescue. "If such assessments were made, by whom were they made and what were the criteria guiding the assessments? Further, was any attempt made to renegotiate and close out these contracts with ‘haircuts?’ If not, why not?"
A person briefed on Mr. Cuomo’s investigation said that A.I.G.’s list of its counterparties gave information only through the end of 2008, and the company was still winding down a vast portfolio of derivatives, including more swaps. He said the attorney general wanted to see whether the termination of the derivatives contracts was being done as efficiently as possible, given the federal resources available to A.I.G. "Credit-default swap contracts were at the heart of A.I.G.’s meltdown," Mr. Cuomo said in a statement. "The question is whether the contracts are being wound down properly and efficiently, or whether they have become a vehicle for funneling billions in taxpayers’ dollars to capitalize banks all over the world."
U.S. Deters Hiring of Foreigners as Joblessness Grows
As more Americans lose their jobs, the U.S. government is actively discouraging the recruitment of foreign workers, from dude ranchers and fruit pickers to lifeguards and computer programmers. At least three avenues of legal immigration have seen roadblocks erected. In the most visible and controversial move, companies receiving federal bailout money now face extra hurdles before they can hire highly skilled guest workers on an H-1B visa. On Friday, the Labor Department will close a public-comment period for a proposal to suspend an agricultural guest-worker program, known as the H-2A. The State Department is asking some sponsors of the J-1 visa -- seasonal employers such as hotels, golf resorts and summer camps -- to reduce dependence on foreign labor. "Basically, because of the economic downturn, it will be difficult to place these people in jobs," said State Department spokesman Andy Lainey, confirming that a letter from the agency asked sponsors to make cuts "voluntarily."
With the unemployment rate at 8.1% and approaching double digits, the U.S. finds its longstanding quandary over immigration growing even more difficult. On one hand, fewer Americans have jobs and competition for available work is intensifying. On the other, the Obama administration says it wants to resist moves toward protectionism -- at least in the trade of goods and services -- and will push that view at next week's London summit with the leaders of the Group of 20 nations.
Immigration advocates say it is hypocritical not to apply the same approach to the flow of people. "You don't abandon regulations because you have one bad year," said Jeanne M. Malitz, an immigration lawyer in San Diego who represents many growers who are trying to plan their harvests but are uncertain of their labor source. They have relied on the H-2A program, which allows guest agriculture workers to stay as long as 10 months. A spokeswoman for the Labor Department said a decision on whether the program will be suspended for nine months will be made in "a couple of months."
The H-2A program requires growers to try to fill vacancies with Americans first. Some farms, Ms. Malitz said, are seeing U.S. applicants for the first time in years, but remain apprehensive. "Will they stay?" she asks. "They quit in the middle of the season. They don't like it." Indeed, an economic downturn tests an argument that has been the bedrock of legal, employer-sponsored migration: Americans won't or can't do certain jobs. Among the highly skilled, perhaps they didn't know programming languages such as Java or C++. Among the lower skilled, they didn't want to work with their hands, get dirty, or sweat. At the Bitterroot Ranch in Dubois, Wyo., owner Bayard Fox said the dude ranch has sponsored equestrians from the U.K. and France, and cooks and housekeepers from Germany, under a summertime J-1 visa -- intended for foreign college students and trainees. But he doesn't plan to do that this year. Business is off, he said, and for a change there are enough Americans applying for jobs. Wyoming's 3.7% unemployment rate is the nation's lowest.
"The American pool may be small for highly qualified equestrian jobs, but has gotten bigger on account of the employment crisis," he said. "Some dude ranches are not getting the bookings, so they are just not opening this year." Jack Brooks is the rare employer who calls himself "desperate to find people." Every year, the co-owner of the century-old J.M. Clayton Co. in Cambridge, Md., has relied on a dozen seasonal guest workers, mostly from Mexico, to pick the meat out of Maryland blue crabs all day long, March till November. But H-2B visas, as they are known, were all exhausted this year. So Mr. Brooks is trying to find Americans to do the job. Three people responded to a newspaper advertisement. On the day one was to report to work, she called and said she had found something permanent.
"I can't blame her," said Mr. Brooks. "Imagine losing your job every year around Thanksgiving....I fear if we hire a few locals, they'll be gone as soon as the economy turns around." Nearby, Bryan Hall, the fourth-generation owner of G.W. Hall & Sons, is in the same predicament. Dorchester County, where the crab-processing industry is based, had a 9.1% unemployment rate in January, second highest in the state. "I know unemployment's up, but I can't find Americans to do this job," Mr. Hall said. Critics of the visa programs blame sponsors for driving down wages. Mr. Brooks said he offered the no-show hire an entry-level salary of $6.71 plus some incentives by piece and pound, and the potential to double her salary with experience. "With our competition in Southeast Asia, we can't pay more," he said. "It's just better to close." The irony isn't lost on both sides of the debate: Foreigners are needed so Americans can compete with...foreigners.
To be sure, nearly all players in the global economy have grappled with the question of how open borders should be. In Europe, several countries with steep unemployment rates are paying migrants to return home. The U.S. government's attitude marks a stark turnaround. During the boom years, Congress actually raised the number of H-1B visas, reserved for highly skilled immigrants. Now, some economists have suggested that allowing more foreigners into the U.S. -- say, an immigrant who buys a house in exchange for a green card -- would actually help jump-start the economy. But a public beleaguered by lost jobs seems loath to embrace such an idea. The federal economic-stimulus package restricts H-1B hires among companies that receive funds from the Troubled Asset Relief Program. They must prove they have tried to recruit American workers at prevailing wages and that foreigners aren't replacing U.S. citizens.
GM Unlikely To Meet March 31 Deadline
General Motors Corp. has been chipping away at the massive restructuring plan it submitted to the U.S. government last month, but it is unlikely to meet a March 31 deadline for gaining concessions from its main union and bondholders. The company said Thursday that 7,600 U.S. factory workers volunteered to leave the company under a buyout program, fewer than GM had hoped. The auto maker has negotiated another agreement with the United Auto Workers union that could allow it to trim as many as 10,000 more positions by October, according to people familiar with that plan. But GM still has ample work to do, including convincing the UAW to return to the bargaining table to restructure $20 billion in health-care benefits for retirees.
The UAW has said it prefers to negotiate a health-care agreement similar to one it reached recently with Ford Motor Co., but GM has said the Ford deal won't meet GM's cost-cutting needs. The UAW also has said it won't negotiate with GM on the health plan until the company's bondholders, who carry $27 billion in unsecured debt, offer deeper concessions. Under terms of its government loans, GM is expected to cut its unsecured debt by two-thirds by offering a debt-for-equity exchange. GM earlier this week made a new offer to a committee representing the bondholders, but the two sides are not closer to an agreement, according to people familiar with the matter. The stalemate means GM could trip a March 31 deadline for the bondholder and union health-care deals imposed by the Treasury Department. However, officials on President Barack Obama's auto-industry task force appear willing to extend the deadline by 30 days, said several people briefed on the matter.
The deadline was put into place by the Bush administration when it granted $13.4 billion in emergency loans to the company, along with $4 billion for Chrysler LLC, in December. GM and Chrysler have asked for as much as an additional $22 billion in funding. Mr. Obama's task force is expected to address that and other auto-restructuring issues by March 31. The task force has had a web of issues to consider. Last week, it laid out a $5 billion plan to aid auto-parts suppliers, and this week it is trying to sort out how to revive auto sales and testing the merits of a proposed alliance between Chrysler and Italian auto maker Fiat SpA, said people familiar with the situation.
Chrysler Concession Talks Stall in Canada as Automaker Faces Aid Deadline
Chrysler LLC, seeking $2.3 billion in aid from the Canadian government, has been unable to reach an agreement with the country’s auto union to reduce costs ahead of a March 31 deadline. Talks with Chrysler are continuing as the two sides try to reach an accord, Ken Lewenza, president of the Canadian Auto Workers, said today in a call with reporters. Chrysler needs the savings to qualify for Canadian assistance. The Auburn Hills, Michigan-based company is seeking $5 billion more in U.S. loans after getting an initial installment of $4 billion to keep operating. "Two times we were within inches of a collective agreement to establishing a collective agreement," Lewenza said. "Both times, the deal was pulled back, and both times, the goal post shifted."
Eurozone manufacturing orders plunge
Manufacturers in the eurozone saw the flow of new orders plunge by a third in January from the same month 2008, a record drop that signals the 16-member currency bloc is in even deeper recession than it was late last year. Marking the biggest decline since records began in 1996, industrial orders booked in the first month of 2009 were 34.1 per cent below levels seen 12 months before. The European statistics office Eurostat said the month-on-month decline hit 3.4 per cent. "Plunging industrial orders in January reinforces fears that eurozone GDP will contract in the first quarter 2009 by even more than the 1.5 per cent quarter-on-quarter drop seen in the fourth quarter of 2008," said Howard Archer, an economist at HIS Global Insight. Hammered by slowdowns in domestic and foreign demand for their products, eurozone manufacturers will be looking to the European Central Bank to continue cutting interest rates when monetary policy makers meet on Thursday.
The ECB has already reduced its main rate to a record low of 1.5 per cent and policymakers have made clear that they see "room for manoeuvre" in the cost of lending. Most economists think this means the bank will cut its main rate by 25 or 50 basis points on 2 April, with ever-more gloomy economic data increasing the chances of a the larger move. Pressure on monetary-policy makers could also rise as fears emerge of deflation, the persistent fall of prices – even if the ECB sees this as unlikely. Inflation data from six of Germany’s 16 states in recent days offered new indications that consumer prices in the eurozone’s largest economy could stop rising by mid-year. Declines in food and energy prices meant consumer prices were lower in these states in March than in February, although prices were still up between 0.2 per cent and 0.8 per cent in annual comparison. Alexander Koch at Unicredit said the state data suggested that national inflation in March – data will be released this afternoon - could have dropped to an annual rate of 0.4 per cent in March from 1.0 per cent in February. This number was likely to drop further towards the summer, he said.
Ilargi: Ambrose Evans-Pritchard reminds me more each day of other ADHD sufferers who write about finance. An utter lack of self-criticism and acknowledgment of having put their feet in their mouth is a typical trait. It's not that long ago when Ambrose wrote about hyperinflation, but don’t count on him explaining his U-turn, he finds it far more fulfilling to pretend he's always said what he says today. Meanwhile, ECB policies may shift, but claiming that they have drastically changed overnight to what the visionary writer has urged since time immemorial is disingenuous on more fronts than one. Ambrose was once interesting because of his ability to collect facts and numbers and his access to people. Now he’s just another bad writer.
Europe fetches the monetary helicopters, at long last
Rejoice. After much pious posturing – and criminal wastage of time – the European Central Bank at last seems ready join the Anglo-Saxons, Japanese, Swiss, and Isrealis in printing money to fend off disaster. Two key governors tipped us off today that the bank is ready to buy assets outright on the open market, including mortgage debt. This is a huge development, exactly what is required to help restore the animal spirits of global investors. Until now the ECB has offered unlimited liquidity in exchange for collateral from banks. That is not the same thing at all. It is sterilized stimulus. The bank has adamantly refused to cross the Rubicon by scattering money through the economy in real blast of QE (quantitative easing). ECB is clearly alarmed by the outright contraction of credit. Loans to non-financial corporations fell in February (minus €4bn). Yes, the M3 money supply is still up 5.9pc year-on-year, but that is backward-looking. M3 growth has collapsed. The credit crunch that was not supposed to exist in the eurozone is already well advanced.
The bank's vice-president Lucas Papademos (ex-MIT, a heavy-weight) said: "It may be warranted that the central bank purchases private sector bonds to enhance liquidity. No decision has been taken, but it is a possibility that could improve the markets". "Potential measures could include an extension of the maturity of the central bank liquidity provided to banks and purchases of private debt securities in the secondary market". Hallelujah. Nout Wellink, governor of the Dutch central bank, in turn said there is now "an increasing risk of deflation". Thank you Mr Wellink. ECB president Jean-Claude Trichet has been insisting for month after month that there is no risk whatsover of deflation. At least a million workers are going to lose their jobs over coming months unneccesarily because of this blind refusal to face the reality of what is happening in the world. (Or perhaps that is unfair to Mr Trichet's boss – Bundesbank chief Axel Weber. One suspects that Mr Weber does indeed understand what is happening but knows that once the ECB starts buying bonds, it is on the slippery slope to an EU debt union – at German expense. The pressure to bail out Club Med governments may become unstoppable. He is right about that.)
Mr Wellink went on to admit that the ECB had screwed up royally by raising rates last July in response to a phoney inflation scare (oil futures speculation) at a time when much of the eurozone was already in recession. "In hindsight, this measure was based on a faulty estimate of inflationary risks and real growth prospects." Bravo, Mr Wellink. This is the first time – to my knowledge – that any ECB governor has admitted any fault in what must be described as the most remarkable act of monetary primitivism in modern times, or indeed admitted any error on anything. One was beginning to think they were incapable of self-criticism. Thank goodness for Dutch honesty. The ECB will be much stronger for it. Chippy central banks do not command respect. It has taken a long time to get here: a lot of damage has been done. A German contraction of 6pc to 7pc (Commerzbank forecast) is already baked into the pie this year. German unemployment may reach 5m in 2010 (RWI Institute). Ireland's GDP has already dropped 7.5pc (year-on-year to Q4). Eurozone industrial output fell 17.3pc in January (y/y). It was down 31pc in Spain. This is a greater fall than anything suffered in Spain over a 12-month period during the 1930s. Sadly I have little confidence that the ECB will undertake QE with adequate dispatch, but at least they seem willing to swallow their pride and start to do their part to mitigate the global depression that we are already in. If they move fast enough they may even prevent the eurozone breaking. Big if.
ECB Eyes a New Tactic: Buying Corporate Bonds
The European Central Bank could start buying corporate bonds in an unusual move to support the euro zone economy, ECB Vice President Lucas Papademos said on Thursday. His comments are the strongest signal yet about the ECB's plans to ramp up efforts to keep funds flowing through clogged euro-zone credit markets. The remarks indicate that policy makers are prepared to take more-aggressive steps to stem the problem than they have thus far. Mr. Papademos said at a conference in Brussels that the ECB may decide to buy corporate bonds on the secondary market to help ease companies' financing problems, and would also consider extending the maturity of its lending to banks beyond six months. He said risk-averse banks are denying credit to companies and consumers, and that is contributing to the economic downturn. "It may be warranted that the central bank purchase private-sector bonds in the secondary market," he said.
Ivan Sramko, a member of the ECB's governing council, said Tuesday there had been debate within the ECB about more-intense use of unconventional monetary-policy measures, including asset purchases, and that a decision about such measures could come within a month. Up to now, the ECB has concentrated on keeping euro-zone banks flush with funds. In October, it began offering banks unlimited loans at fixed rates for up to six months. But it has been criticized by private-sector economists and businesses for its reluctance to follow major central banks -- including the Federal Reserve and the Bank of England -- in buying assets. ECB policy makers have said they were focusing efforts on banks rather than securities markets because bank lending accounts for some 70% of euro-zone private-sector financing -- unlike in the U.S., where most private-sector funding comes from securities markets.
Mr. Papademos's comments are an indication that policy makers now believe more drastic steps may be needed. It remains unclear how the ECB would finance such action. It could buy the bonds using freshly created money, a process known as quantitative easing. Figures released by the ECB Thursday showed the extent of the problem. Lending to businesses fell by €4 billion ($5.4 billion) in February from January, the second drop in three months, the ECB said. Over the 12 months to February, growth in lending to the private sector -- which includes households -- eased to 4.2% from 5.0% in the 12 months to January. The ECB has cut rates by 2.75 percentage points since October, and is expected to lower its key rate by another half percentage point to 1.0% at its April 2 meeting.
Economists say rate cuts alone won't be enough to get euro-zone economies going. Unlike the Fed and the BoE, the ECB so far hasn't increased the money supply by buying government bonds or other securities. The ECB is prohibited from funding the governments of the euro zone's 16 nations by directly purchasing their debt instruments, shutting it out of that option taken by the Fed. But the ECB could buy such bonds in the secondary markets. Economic data out Thursday underlined the dire state of Europe's economy. New housing starts in Spain fell 42% last year to 360,044. In the U.K., the euro zone's largest export market, retail sales fell 1.9% in February from January.
Bank of England's Corporate Bond Adventure
Is the Bank of England shooting at the wrong target? Its first purchases of corporate bonds under its Asset Purchase Facility certainly raise questions. So far, it has spent £128 million ($187.3 million) buying bonds of companies that haven't had any trouble raising money. That's not obviously a winning strategy. The theory is that buying high-quality bonds will reduce the illiquidity premium in the market. The BOE has £50 billion of firepower to spend in the secondary market. Once in the pockets of market participants, the BOE hopes this cash will trigger a trickle-down effect, boosting risk appetite and unblocking the market for less creditworthy companies.
So much for theory. In practice, the BOE is buying assets that are not obviously illiquid. Investment-grade sterling corporate bond issuance is running at a record pace: year to date it stands at £22.9 billion, more than four times the total for the same period of 2008 and not far off the long-term average for a whole year, according to Dealogic. Of the 17 companies whose debt the BOE bought on in the first auction on Wednesday, nine had issued bonds already this year to strong demand; 10 were utilities or telecommunications firms such as Vodafone and Electricite de France, whose bonds have remained in demand throughout the crisis. Thursday's tender saw the BOE buy just £42.4 million of bonds against an offer to buy £128 million, suggesting little desire to sell high-quality paper.
The risk is that the BOE's cash will simply be recycled into new bond issues by the same or similar companies who are flooding the market while they can to build cash reserves. Companies that have not so far been able to raise money are likely to find that nothing has changed. Investors continue to steer clear of anything that looks risky. Comments by Vice President Lucas Papademos on Thursday suggested the European Central Bank is considering a similar policy. It should certainly wait to see the results of the U.K. experiment before pushing ahead.
UK recession: 'It's even worse than we thought'
New figures on the UK economy show that it fell even deeper into recession in the fourth quarter of last year than first thought, piling the pressure on the prime minister. Revised data from the Office for National Statistics (ONS) showed that gross domestic product shrank by 1.6% in the last three months of 2008, rather than the 1.5% previously reported. Worse than previously expected output in construction and services was blamed for the downward revision. It is the worst performance since the second quarter of 1980 and confirms Britain is in the middle of a deep downturn following a contraction of 0.7% in the third quarter of last year and zero growth in the second.
The annual decline was also revised lower, to 2% from 1.9% previously, the worst since 1991. Opposition politicians claimed the data was another blow to Gordon Brown's authority. The shadow chief secretary to the Treasury, Philip Hammond, said: "Far from being better prepared for the recession as Brown told us, the UK economy is shrinking more than the United States, and faster than in the previous recession." The Liberal Democrat Treasury spokesman, Vince Cable, added: "These figures confirm just how hopelessly optimistic the government's assessment of the state of the economy has been. "Gordon Brown has become his own worst nightmare, presiding over a fall in the UK economy not seen since the dark days of the last Tory recession."
The breakdown of the data also showed a big jump in the so-called savings ratio - the amount households save rather than spend - probably resulting from the big cuts in interest rates in recent months which have improved cash flow to some people. It also showed that destocking by firms hit a record £4.2bn in the three-month period. The running down of stocks by firms is always a key part of a recession and usually has to run its course before firms are ready to boost production again. "Inventory shedding in the UK economy is well under way," said Philip Shaw, chief economist at Investec bank. "It is somewhat more advanced than in other industrialised economies. Hence we are very sceptical of the IMF's claim that the British economy will contract by 3.8% this year and that it faces a worse downturn than the majority of its competitors."
Economists fear the current quarter could show an even deeper contraction after retail sales data on Thursday showed the biggest drop for 14 years, suggesting that consumer spending overall has flagged in the face of tens of thousands of job losses. Separate data from the Land Registry today suggested that the housing market remains in freefall. It said prices in England and Wales fell by 2% in February, from January, leaving them 16.5% down from a year earlier. The average house price is now down to £153,862. "While latest mortgage approvals data suggest that housing market activity may have bottomed out and survey evidence indicates that buyer enquiries have picked up significantly recently as people are attracted by lower house prices and the Bank of England slashing interest rates, we remain sceptical that sales will pick up substantially anytime soon and put a floor under prices," said Howard Archer, economist at IHS Global Insight.
The Bank of England's chief economist, Spencer Dale, said in a speech this morning that the economy would probably recover at the end of 2009 but the risks were weighted to the downside and policymakers may need to take more action. "As we go through 2009, I believe that it is most likely the pace at which output is contracting will ease and that we will see some signs of recovery by around the turn of this year," he told an Association of British Insurers conference.
"I think the risks around this central path are weighted to the downside, reflecting the possibility that the actions taken by the authorities around the world to improve the availability of credit and to restore business and consumer confidence are slow to take effect. So there may still be more to do." The Bank has already cut interest rates to a record low of 0.5% and has started flooding the economy with cash through quantitative easing. Dale said it was too early to say whether the easing was having the desired effect but he said there were some "good signs". But consultancy Capital Economics issued new research predicting that government borrowing could shoot up to £200bn in the fiscal year 2009/10 and then stay at that elevated level for five years.
British car industry in 'state of emergency'
The car industry is "reaching a state of emergency" and needs government action in the Budget otherwise the supply chain and the country’s industrial capability will be irreparably damaged, the Society of Motor Manufacturers and Traders warned today. The industry group is stepping up the pressure for access to consumer finance and a scrappage programme to encourage people to scrap old cars and buy new ones. It also wants wage subsidies for employees on short-time working. In a letter to Alistair Darling, the Chancellor, the SMMT also called for a series of other measures in the April 22nd Budget.
Paul Everitt, chief executive of the group, said: "The UK motor industry is reaching a state of emergency and the rate of government action is crucial to the future success of the sector." He added: "Government has an opportunity to support UK manufacturing as a key global player in the low carbon future but immediate action is needed to protect the country’s industrial capability." The SMMT also wants changes to vehicle excise duty; an increase in capital allowances to encourage more investment in factories making cars and vans; and other changes to tax and emissions regulations governing the automotive industry. The car industry has been lobbying for help for several months since car markets around the world suffered sharp falls because of the global slowdown.
In January, the Government offered £2.3 billion in loans both from the UK and the European Investment Bank but it has not delivered on the other two key demands from the industry for consumer credit and a scrappage scheme. Two weeks ago, Lord Mandelson, the Business Secretary, rounded on the Bank of England for not moving quickly enough. But the Bank was quick to hit back saying that it wasn’t its role to lend money to specific industry sectors. SMMT sources complain that there seems to be no overall responsibility for the help it is seeking and that the Treasury fears it cannot instruct the Bank to make resources available because it is an independent organisation.
The car industry has been backed by the CBI in its call for a scrappage incentive programme. The employers’ organisation has said that there should be scrappage incentives for all vehicles and also consumer appliances. The introduction of a scrappage scheme in Germany led to a 21 per cent leap in sales last month while sales remained depressed in other markets. Yesterday the Netherlands became the latest European country to introduce a scrappage programme, meaning that most countries now operate an incentive to get rid of old cars and buy new ones. Lord Mandelson has said he is considering whether Britain can introduce a programme.
UK household savings surge
The household savings rate jumped in the final three months of last year and spending fell, as mounting job losses and fears for the future encouraged consumers to put more money aside. Household savings leapt from 1.7 per cent as a proportion of disposable income in the third quarter of 2008 to 4.8 per cent in the final three months of last year, the Office for National Statistics reported on Friday. Meanwhile, household expenditure fell by 1 per cent, more than the 0.7 per cent previously estimated, even though household real incomes rose by 2.3 per cent. The rise in household real incomes comes as commodity and oil prices fall from last year’s record levels and the interest charges on debt falls. The savings rate is the money left over after consumption and its rise in part reflects households heightened efforts to pay off mortgages and credit card loans as the recession deepens. "It [the rise in savings] underlines the severe pressure households are under to repair their balance sheets," said Richard McGuire, fixed income strategist at RBC Capital Markets. "It fits very well with the idea that this is a structural downturn … and is a rather undesirable counterbalance to the fiscal and monetary stimulus."
The rise in savings during the fourth quarter came as the economy shrank by 1.6 per cent, a bigger decline than initial estimates of a 1.5 per cent contraction. The fall in GDP over the final three months of last year was the greatest since 1980, and compares with a 0.7 per cent contraction in the previous quarter. Growth was 2 per cent lower in the fourth quarter than it was a year earlier. The rapid rise in savings will prompt fears that the economy is facing an even deeper recession. Growth is widely expected to contract at a similar pace this quarter to the final quarter of last year, while the IMF recently warned that the UK’s economy could decline by 3.8 per cent this year which would be the biggest annual fall since comparable records began in 1949 and among the worst forecast for any industrialised economy. The jump in the savings rate has happened much more quickly over the last few quarters than it fell during 2006 and 2007 as commodity prices rose. Savings rates hit their nadir in the first quarter of last year when they turned negative for the first time in more than 50 years.
Economists are afraid that savings will rise even more sharply – possibly exceeding the double digit levels reached in the early 1990s – as consumers hoard cash as the threat job losses rises. Unemployment rose above 2m in February for the first time since just after Labour came to power in 1997 and economists are forecasting the jobless total will reach 3m before the recession is over. Rising savings could also limit the effectiveness of the Bank of England’s efforts to increase the supply of broad money through quantitative easing. The rise in savings reduces "the scope for the Bank of England’s liquidity injections being recycled not only owing to lenders’ reticence to lend but also borrowers’ unwillingness to borrow", Mr McGuire said. The surge in savings levels comes despite record low interest rates. The bank of England has rapidly reduced its main lending rate in the last six months from a high of 5 per cent to the current level of 0.5 per cent. In other data, the current account deficit was £7.6bn in the fourth quarter, worse than £5.9bn that economists had expected and reflecting "a slump in investment income as UK firms’ earnings on overseas investments fell sharply", according to Vicky Redwood of Capital Economics.
Incensed French workers secure bonus cuts at GDF Suez
Strikes and other forms of direct action by workers rarely seem to achieve their aim on the British side of the Channel, but the more militant proletariat in France appears to be having more success. The two most senior executives of GDF Suez, the French utility, gave up their stock options yesterday after their group was hit by a strike over executive pay as industrial unrest spread across France. As protests over their remuneration gathered pace, Gérard Mestrallet, the chairman, announced that he was abandoning his 830,000 options, and Jean-François Cirelli, the vice-chairman, said that he would do likewise. The U-turn came after a strike that began on Monday at GDF Suez’s liquefied natural gas sites in France escalated rapidly because of the controversy over the stock options. Unions said that workers had "blown a fuse" when they learnt of the awards to Mr Mestrallet and Mr Cirelli.
"It was the straw that broke the camel’s back," Robert Rozy, representative of the left-wing Confédération Générale du Travail union, said. The options were worth €10 million (£9.4 million) when they were approved by the board in November, but GDF Suez said that they were "worth nothing now because the share price is less than the exercise price". The climbdown by GDF Suez comes amid increasing tension. The industrial director for France of 3M, the American conglomerate, was taken hostage for almost two days by workers protesting against the size of redundancy payments. Luc Rousselet was released unharmed early yesterday after the company agreed to renegotiate.
How Korea Solved Its Banking Crisis
by Lee Myung-Bak, President of the Republic of Korea
When world leaders met at the G-20 summit in Washington, D.C., last November, our hope was that by the first quarter of this year we would have largely overcome the financial crisis. At that time, leaders were primarily concerned with macroeconomic stimulus -- primarily fiscal stimulus -- to shorten the severe global recession. Unfortunately, we are still struggling to deal with the financial turmoil, and financial institutions have yet to regain investors' confidence. The U.S. government recently announced its expanded plan to buy troubled assets that have been burdening banks. While I join others in hoping for the success of this plan, I believe that a true recovery requires all countries to do everything they can to stabilize the economy. If world leaders fail to come up with creative ways to deal with the current difficulties, credit will not flow.
For this reason, when the G-20 leaders meet in London next week, solving the financial meltdown -- with a special focus on removing impaired assets from the balance sheets of financial institutions -- must be our priority. In the late 1990s, Korea was hit by a financial crisis, and having successfully overcome it, we have valuable lessons to offer. By committing to the following basic principles based on the Korean experience, world leaders will be well prepared as they create a plan to remove impaired assets. First, bold and decisive measures, rather than incremental ones, are required to regain market confidence. Korea's successful experience illustrates this point. The Korean government tapped various sources to raise a public fund of $127.6 billion (159 trillion KRW) during the period from 1997 to 2002 -- equivalent to 32.4% of Korea's GDP in 1997 -- to resolve impaired assets and recapitalize financial institutions. Given the magnitude of the current challenges, the world cannot afford a minimalist approach.
Second, our experience suggests that bank recapitalization and creating a "bad bank" are not mutually exclusive options; the simultaneous application of both can have a positive effect. Korea established a specialized independent agency, the Korea Asset Management Corporation (Kamco) as a bad bank, while at the same time, the Korea Deposit Insurance Corporation was involved in recapitalizing financial institutions. Kamco purchased the impaired assets and settled the gains or losses with the financial institutions involved once the assets recovered their value. It acquired impaired assets at $30.9 billion -- the book value of which amounted to $85.1 billion by 2002 -- and recovered $33.9 billion by 2008 by reselling to private investors through various methods, including public auctions, direct sales, international tenders, securitization and debt-equity swaps.
Third, it is critical to ensure that the implemented measures are made politically acceptable and that moral hazard is minimized. A special mechanism should be devised for shareholders, managers, workers and asset holders to bear their fair share of the burden. In the case of Korea, capital injections were limited to financial institutions that were systemically important and deemed to be viable after recapitalization. Fourth, these measures should have built-in exit strategies with clear time frames. There should be a plan for shares of entities that are held by the government to be turned over to the private sector. Additionally, nationalization of banks shouldn't be a goal, but a temporary measure.
Fifth, although government will take the lead in such plans, private capital should be encouraged to fully participate in the process. Obviously, the process itself must be transparent. Korea's experience suggests that it would be useful, on a temporary basis, for governments to purchase impaired assets at a price agreed to with the troubled financial institutions, and then settle the gains or losses with the financial institutions after reselling. The problem of impaired assets today may be of a different nature, since they arise from off-balance sheet bundled derivatives. But this difficulty makes the ex post settlement scheme all the more useful.
Sixth, all forms of financial protectionism should be rejected in the process. Ideally, countries would have a common method for dealing with impaired assets. However, since countries have different financial realities, we should leave it up to each country to craft their own policy. And a coordinated effort is needed to ensure that regular cross-border capital flows are not interrupted. To that effect, I welcome the G-20 finance ministers' agreement called "Restoring Lending: A Framework for Financial Repair and Recovery," which reflects Korea's proposal. Without abiding by these principles, macroeconomic stimulus measures will not do much good in alleviating the severe global economic recession.
The Haunting Legacy Of ABN Amro
Remember ABN Amro? The Dutch lender that a bunch of European banking giants, including Barclays, were fighting each other to buy before the market collapsed? The three banks that ended up carving up the company between them, Royal Bank of Scotland, Banco Santander, and Fortis (or at least the part of Fortis that has now been nationalized), were reminded on Friday of just what a bad idea it turned out to be to try to win that auction in late 2007. The parts of ABN Amro that have yet to be fully integrated into RBS or taken over by the Dutch state reported a net loss for 2008 of 12.9 billion euros ($16.9 billion). Most of that is attributable to the global markets business snapped up by RBS, which originally bought 38% of ABN Amro. Fortis purchased 24%, and Banco Santander came away with 28% of the company. Banco Santander has already fully integrated ABN Amro's Banca Antonveneta in Italy and Banco Real in Brazil.
In February Royal Bank of Scotland unveiled its consolidated financial results for 2008: it had lost 24.1 billion pounds ($34.2 billion) for the year, following 7.8 billion pounds ($11.1 billion) of credit markets losses and a 16.2 billion pound ($23.0 billion) write-down on assets, including goodwill for ABN Amro assets that it had taken over. "What we're seeing clearly [is that] ABN Amro was not in great shape to go to through this stage of the credit cycle," said Leigh Goodwin, an analyst at Fox-Pitt Cochran Caronia. The joke going round banking circles in London has been that, with valuations now so low, RBS could have bought a handful of banks now for what it paid for a chunk of ABN at the top of the market. The consortium it led had paid a total 70.6 billion euros ($92.6 billion) for the Dutch bank.
Fortis Bank Nederland posts record Dutch loss
Fortis Bank Nederland, which contains the bulk of ABN Amro's activities in the Netherlands, reported the biggest-ever Dutch corporate loss of 18.5 billion euros. The net loss included a 922 million euros charge from the bank's investments with Bernard Madoff's investment business, which he admitted earlier this month was fraudulent. Belgian-Dutch financial group Fortis, together with Royal Bank of Scotland (RBS.L) and Spain's Santander (SAN.MC), bought ABN AMRO in 2007 for more than 70 billion euros. The financial group was later broken up along national lines after losing the confidence of investors and depositors having fallen victim to the financial crisis while trying to complete the ABN acquisition.
Dutch central bank (DNB) President Nout Wellink, who had warned in 2007 of the risks involved in taking over a large bank such as ABN, called for an investigation into the ABN takeover deal by parliaments in Britain, Belgium and the Netherlands, Dutch broadcaster NOS cited Wellink as saying. Governments should carry out a close examination of national supervisors' roles, including DNB, during the takeover, NOS cited Wellink as saying. A DNB spokesman confirmed Wellink talked to NOS but was not able to verify his comments. Unlisted Fortis Bank Nederland, which contains the Dutch activities of Fortis and ABN, was fully nationalised by the Dutch government for 16.8 billion euros and is now separate from what remains of Fortis in Belgium. The newly combined bank will be run by former Dutch finance minister Gerrit Zalm.
Excluding the write-downs and other charges, Fortis Bank Nederland said in a statement that it had a 2008 operating profit of 604 million euros. The comparable business a year earlier had 1.2 billion euros in profit. The total net loss, driven mainly by a 17.7 billion euros charge for the ABN write-down, is more than twice that of the loss by KPN in 2001. Investment losses and a drop-off in income, which came mainly in the second half of 2008, was the main cause for the sharp fall in operating profit, the bank said in a statement. Still, thanks to the Dutch government refinancing Fortis Bank Nederland's debt after taking it over, the bank now has a tier 1 capital ratio of 11.1 percent under Basel II guidelines, which recommends that banks keeps a capital cushion of 8 percent of risk-weighted assets.
The Dutch government is planning to merge all the activities of the group and sell it off in 2011 or later. Still unresolved is the on-hold sale of 709 million euros worth of ABN assets to Deutsche Bank (DBKGn.DE), which Fortis had agreed to sell at a loss to comply with European Commission antitrust demands. The regulator approved the sale, but it was put on hold by Dutch central bank (DNB) as it worked with the government to nationalise ABN and Fortis's Dutch business. In Thursday's statement, the bank said that full integration would not start until the sale of the assets is resolved.
Zapatero Leaves Door Open to More Stimulus in Spain
Spain can launch a fresh fiscal stimulus plan if current measures fail to revive the economy, Prime Minister José Luis Rodríguez Zapatero said on Thursday, pointing to the country's relatively low level of public debt. "Spain has the capacity" for a new fiscal boost if needed, Mr. Zapatero said in an interview with five foreign newspapers. "We are going to have a (fiscal) deficit, but we have plenty of room on the debt." Mr. Zapatero said he thought Europe should wait until this summer to see if the current round of spending measures and tax cuts has an effect. If it doesn't, he said, Europe should coordinate new spending and focus it on two areas he views as key to the region's future: the "green economy" and biotechnology. Mr. Zapatero said he would use Spain's presidency of the European Union, which begins in January, to press the region to follow this agenda.
Stimulus plans adopted by European governments in December "have started to have an effect, to reach the nervous system, just this month," the Spanish prime minister said. "Let's wait at least four months to see if the symptoms of recovery have appeared in the economy." If they haven't, "we must make a new (fiscal) effort, but a different one," he said. "It mustn't be a general new fiscal stimulus, like we have had until now. We should have a concerted effort in...green energy and biotechnology." Spain has moved to shore up its economy with one of Europe's biggest stimulus plans. The government has announced tax cuts and new spending measures valued at €21 billion ($28.34 billion), or 2% of gross domestic product, in 2008 and €31 billion, or 3% of GDP, in 2009.
The Spanish government calculates that its stimulus efforts, coupled with a sharp downturn in tax receipts, will result in a budget deficit equal to 5.8% of GDP this year. However, public-sector debt is around 36% of GDP, far below the euro-zone average. Although Spain isn't a member of the Group of 20 industrialized and developing nations, Mr. Zapatero lobbied for his country to have a seat at the table at the coming summit to discuss the new global financial framework. He said he would push for Spain's much-praised system of banking regulation -- which forced banks to build up big cash reserves -- to be adopted more widely. The Bank of Spain's "dynamic provisioning" system, which was introduced in 2000, has been credited with helping Spanish banks weather the global financial turmoil thus far. Unlike many U.S. and European banks, Spanish banks haven't yet needed capital injections from the government.
Spain's Socialist Party leader won a second term a year ago with campaign promises of full employment and continued economic growth. Since then, the country's building boom has ground to a halt, pushing the economy into recession. On Thursday, the Housing Ministry said 2008 housing starts plunged 42%, from 615,976 to 360,044. Spain's 14% unemployment rate is the highest in the 27-nation European Union. The European Commission predicts it will top 19% next year. Mr. Zapatero said his government would seek to boost Spain's lagging competitiveness through reforming the education system. He also said he wants to boost Spain's investment in research and development. The prime minister dismissed talk that he is about to reshuffle his cabinet, saying, "I am not planning to change the government."
Ilargi: Latvia, Hungary, Romania earlier this week, and now (unless you count Iceland too), Serbia makes four. Will Britain be next?
New $4.1 Billion IMF Loan Will Help Struggling Serbia
Serbia will get a €3 billion ($4.1 billion) bailout loan from the International Monetary Fund, as the country's economy struggles to stay afloat amid the global financial turmoil. "Serbia's GDP will almost certainly decline in 2009," said Albert Jaeger, the IMF's chief of mission for Serbia. "It looks more likely to be minus 2%. And we believe that growth in 2010 will be flat." He said Serbia has a few weeks to revise its 2009 budget and adopt legislative changes to implement agreed-upon fiscal measures before the proposed loan could be presented to the IMF's Executive Board in May for final approval. The new IMF program replaces a $520 million loan approved in January and relies on fresh spending cuts to offset weak tax revenue, as the Serbian economy has suffered a worse-than-expected downturn.
Mr. Jaeger said Serbia's "external and domestic economic environment has deteriorated abruptly and relentlessly" since the global financial crisis erupted late last year. "As elsewhere in the region, exports and imports have plummeted, external borrowing has dried up, and economic activity has slumped," he said. Serbia's Central Bank Gov. Radovan Jelasic said the IMF's financial support would help the country negotiate additional loans from the World Bank, the European Union and other foreign creditors. Finance Minister Diana Dragutinovic said that despite her conservative estimates, she had never believed that economic growth -- which was nearly 7% last year -- would drop so quickly. The deal with the IMF calls for drastic cuts in public spending, a freeze in wages, pensions and hiring in the state sector, and the introduction of an additional 6% tax on salaries and pensions to cope with the budget deficit, she said.
Chinese Firms Post Declining Profits
Despite some recent signs of improvement in China's economy, profits at many Chinese companies continued to deteriorate in the first two months of the year, new data show. Profits of China's industrial companies in the January-February period fell 37% from a year earlier to 219.1 billion yuan (around $32.1 billion), the National Bureau of Statistics said Friday. The drop contrasts with a year-to-year increase of 16.5% in the first two months of 2008 and was steeper than a 27% profit decline in the three months to November. While the performance in the coal and oil sector improved, profit in other industries including steel, power, chemicals, construction materials, equipment manufacturing, chemical fiber and non-ferrous metal all fell. The trend of declining profits follows a years-long string of 20% to 40% profit growth.
The Chinese economy, the world's third-largest, depends heavily on the financial health of its companies. At a time when Beijing is pouring four trillion yuan into a massive stimulus plan, falling profits mean companies have less money to buy new equipment or expand their businesses, increasing the burden on government stimulus to drive China's growth. The recent rise of the Shanghai stock market has come on the back of optimism about the effect of stimulus measures. Jiang Jianqing, the chairman of Industrial & Commercial Bank of China Ltd., China's largest bank by market value, said Thursday that China's domestic consumption is already picking up some – though not all -- of the slack caused by the sharp decline in exports.
But many analysts say industrial profitability is likely stay weak in coming months, though it could improve after the stimulus has had more time to take effect. Publicly traded companies are now reporting 2008 earnings, with many saying 2009 will be a tough year. The Chinese government forecasts growth of around 8% this year, although many outside economists expect slower growth. As export orders to the U.S. and Europe fall, companies tied to global trade are being hit particularly hard. China Shipping Container Lines Co. Ltd. said Wednesday that its 2008 net profit fell 96% due to the export slump. The company expects excess shipping capacity to push revenue down a further 15% in 2009.
The export decline also means a drop in oil demand as fewer trucks are needed to transport goods and as oil-fired plants reduce capacity. PetroChina Co., China's largest listed oil producer by output, said Wednesday its net profit fell 22% last year, its first fall in annual earnings since 2001. Financial companies, which aren't included in the statistics for industrial companies, have also seen profits erode. While ICBC and Bank of China Ltd. this week posted profit increases for the full 2008, calculations of their results showed that in the final quarter of the year, net profit rose less than 1% at ICBC and fell 59% at Bank of China. China's auto makers don't report 2008 earnings until next month, but SAIC Motor Corporation Ltd., the biggest local auto maker by sales, has warned it will post a profit decline of more than 50% on weaker sales. However, car sales in the early part of the year have gotten a boost by government incentives and some analysts expect China's auto sales to grow in line with last year's 6.7% rise, the slowest in a decade. Others are less optimistic.
The statistics bureau, whose data cover all state-owned industrial enterprises and non-state-owned industrial companies with annual sales of more than five million yuan, said that state-owned or state-controlled companies' profit in the two-month period fell 59% from a year earlier. The coal industry's profit rose 15%. And as an industry, crude processing and refinery companies swung to a combined profit in January-February of 11.7 billion yuan from a net loss of 19.4 billion yuan in the year-earlier period, a result of changes in the way China prices gasoline and diesel. The reform, effective Jan. 1, guarantees refiners a profit margin as long as oil prices remain below a ceiling of $80 a barrel. This is in contrast to a year earlier when refiners were unable to pass on surging crude oil costs to consumers in full, due to government-set price caps.
China Stocks Optimism 'Overdone,' Morgan Stanley Says
China stock investors’ optimism over a rebound in growth is "overdone" and shareholders will endure "pain" as government measures to stimulate the economy fail to stem the slide in earnings, Morgan Stanley said. Profits of companies on the CSI 300 Index, measuring so- called A shares listed in Shanghai and Shenzhen, will tumble an average 15.4 percent in 2009, Morgan Stanley analysts Jerry Lou, James Cao and Allen Gui wrote in a note today. Earnings for companies on Hong Kong’s Hang Seng China Enterprises Index will plunge 26.6 percent, they said. "The poor-quality GDP growth, driven by policy stimulus, won’t make much difference to the earnings recession path in 2009," they said. "Recent market optimism, triggered by early recovery of several macro indicators, we believe is overdone."
Earnings fell 31 percent in the second half of 2008, compared with growth of 147 percent in the first half, according to the full-year results of 537 companies, the report said. Companies may report "deep investment losses" considering the domestic stock market tumbled in the second half of 2008, the analysts wrote.
China’s urban fixed-asset investment jumped 26.5 percent in the first two months from a year earlier, new lending quadrupled in February and vehicle sales rose 25 percent as the government implements a 4 trillion yuan ($585 billion) stimulus package. People’s Bank of China Governor Zhou Xiaochuan said in an article on the central bank’s Web site that "leading indicators are pointing to recovery of economic growth."
The Shanghai Composite Index has advanced 30 percent this year, the second best after Peru among 89 global stock gauges tracked by Bloomberg, on speculation the government’s stimulus package will help nation’s economy overcome the global recession. Chinese industrial companies’ profits sank 37 percent in the first two months from a year earlier to 219.1 billion yuan, the statistics bureau said today. Profits expanded 16.5 percent in the same period last year. "Even if the economy achieves the 8 percent GDP growth target set by the government, it will mean very little to corporate earnings growth," according to Morgan Stanley.
China Slowdown Stunts Entrepreneurs
Tony Yu grew rich helping build China into the world's factory floor. Over a decade, his small firm outfitted more than a thousand assembly lines with specialized equipment: pumps and pipes to sluice chemicals through high-tech plants. Business was so good his biggest challenge was keeping up with manufacturers impatient to cut the ribbons on their next plant. Mr. Yu poached engineers from rivals as he grew and acquired a mansion overlooking Shanghai's fanciest golf course. Now his order book is emptying. China's February exports fell nearly 26% from a year before, the fourth in a series of worsening monthly declines. The building boom in Chinese factories is over, and Mr. Yu is casting about for business ideas. "We have ridden the wave of economic development in the last few years," he says. "We are at a loss as to what to do in the immediate future."
His fate echoes a broader challenge for China itself. The country has relied heavily for its often double-digit growth on a furious pace of investment in manufacturing. More than 40% of China's gross domestic product traces to factory construction and other kinds of fixed-asset investment. Contributing to this have been hundreds of thousands of bootstrap entrepreneurs like Mr. Yu who appeared from nowhere, helping the Chinese economy to multiply 14-fold, adjusted for inflation, since 1980. Their bold dives into business -- dubbed xia hai, or "jump into the sea" -- and often unorthodox methods both thrilled and chilled the wider business community. Tiny firms shocked global goliaths with aggressive cost-cutting and sometimes corner-cutting as well. Speed was everything. "You didn't need to be good," Mr. Yu says. "You needed to be there."
Over a decade these go-getters created five million businesses of at least eight employees each, according to the State Administration for Industry & Commerce. They spawned some 75 million jobs for China's university graduates, workers discarded from state companies and streams of people from the countryside. The output of China's private companies and their investment spending made up half of last year's $4.42 trillion GDP. Now, with the global customers for Chinese factories in recession, tens of thousands of plants are closed and manufacturers have slashed expansion plans. Beijing has responded with a $585 billion economic-stimulus program, and domestic consumption is picking up some of the slack for the export decline, the head of Industrial & Commercial Bank of China said Thursday. But the stimulus is largely government spending on infrastructure that won't necessarily benefit manufacturers such as Mr. Yu's traditional customers.
"Can they build enough roads to offset the fact that they aren't building as many factories?" asks Ben Simpfendorfer, an economist in Hong Kong for Royal Bank of Scotland. He calculates that a drop of 15%, say, in spending on business equipment would cut 1.6 percentage points off China's 2009 growth rate. Although China's economy grew a powerful 9% last year, it slowed sharply to a 6.8% pace in the fourth quarter. Industrial production, which has risen an average of 16% annually for five years, slacked off to 3.8% in the first two months of this year. For China's small businesses, it's the first slowdown they've faced, and many are struggling to reinvent themselves.
Mr. Yu, 49 years old, built a business tied to the unrelenting investment spending by his fellow entrepreneurs. His Shanghai GenTech UHP Co. provides containers, pumps and piping that can safely carry the often dangerous gasses and other chemicals that manufacturers use in making semiconductors and other high-tech products. Operated with his wife, Joan Cui Rong, and generating $20 million in revenue last year, the business positioned itself to compete with far larger companies such as Air Products & Chemicals Inc. and Praxair Inc. of the U.S. Mr. Yu, whose given name is Dong Lei, studied mechanical engineering in Beijing and earned a Ph.D. in agricultural engineering in 1987 at England's Newcastle University. Bored with his professors' directive to research farm equipment, Mr. Yu says, he spent much of his four years writing poetry. Back then, nearly everyone in China worked for the government, but Mr. Yu joined U.S. commodity giant Cargill Inc., which sent him to China to build an oilseed-crushing plant and then to Sioux City, Iowa, to run one.
Working in Iowa in the early 1990s, Mr. Yu sensed that more-dynamic opportunities were opening up back in China. The Chinese "need a lot of stuff from the outside world," he recalls thinking. So he quit Cargill to try his hand at exporting equipment to China from his house in Iowa. A friend of a friend in China helped him win $1 million of orders from a new computer-chip maker for U.S.-made chemical tubing, an item so specialized that Mr. Yu wasn't entirely sure what he was promising to deliver. He also exported routine items like ambulance equipment and gas-station pumps. After a detour working in Shanghai for a U.S. pork producer that wanted to break into that market, Mr. Yu struck out on his own.
Ever since his early sale to a chip maker, Mr. Yu had kept the semiconductor industry in his sights. So when chip manufacturers began moving to the low-cost Yangtze River delta near Shanghai around 2000, he reached for a piece of the action. Casting himself as a veteran of China's nascent high-tech industry, Mr. Yu began winning contracts to outfit new factories. In 2001 he did a deal that put him at the helm of a business that refit pharmaceutical factories. Mr. Yu refocused it toward the high-tech sector. Following the semiconductor industry into China were makers of optical fibers and flat-panel television sets, all of them wanting assembly-line equipment and wanting it quickly and cheaply. For Mr. Yu, winning orders was less of a challenge than keeping his engineers from walking out the door to open a competing business. All of his darting around China to sign deals left him little time to consider where the high-tech industry was going. Indeed, "most of the time we didn't know what the customers were making," he says.
Amid a frenzy of small businesses rushing to be cheapest to supply whatever was needed, Mr. Yu says he decided to build a company with more "professionalism." He moved into an industrial park, wrote an employee handbook and built a "clean room" of the kind chip makers use, to raise the quality of his products. He relaunched the business as GenTech, stitching the name in English on engineers' blue jackets. "Everything we did we wanted to do it professionally," he says. The company got a chance to show that when a customer had an accidental release of a "pyrophoric" gas that can ignite on contact with air. Mr. Yu and his team worked through the Chinese New Year to prevent a catastrophe.
Soon, GenTech was nipping at the heels of industry giants. By quoting low prices but maintaining standards, it won subcontracting work from majors like Air Products and Chemicals. With his ambitions growing faster than his expertise, Mr. Yu poached engineers and salesmen, including so many from Air Products that GenTech was nicknamed "Little AP." After he grabbed one highly regarded manager from Air Products, an executive of that company called to protest, asking in frustration, "Do you really need to have this guy?" say people familiar with the conversation. The poaching ran both ways. Mr. Yu says a headhunter called one desk after another at his business trying to lure people away.
Meanwhile, he was growing wealthy. With his wife and business partner, Ms. Cui, who is also an engineer, he toured Tibet, Europe and South Africa. They bought two peacocks for the yard of their large house. After Ms. Cui won a bet with her husband by closing a difficult deal, he settled the wager by buying her a black Porsche Boxster. One thing keeping GenTech busy was a burst of investment in the photovoltaics industry, which makes equipment to turn sunlight into electricity. Mr. Yu directed his sales and engineering teams to focus primarily on the sector. Anticipating a windfall, last year he expanded production floor space tenfold and borrowed for the first time, an $880,000 working-capital loan. But the rise in solar spending disguised a weakening elsewhere in technology, especially semiconductors. One bellwether Shanghai chip maker, Semiconductor Manufacturing International Corp., had multiplied its capacity eightfold over five years, averaging about $1 billion in annual capital spending. But this year, it expects to spend only about $190 million.
Chip demand fell off so much last year that China's industry could sell only 80% of the semiconductors it had the capacity to make, according to Raman Chitkara, head of the technology practice at PricewaterhouseCoopers. As a result, "most of the companies are being extremely selective in [expanding] capacity," Mr. Chitkara says. The worry for Mr. Yu: "If there's no capital expenditure, there's no business for us." As he fired up a laptop in his tiny office each morning, he recognized the growing clouds over China's exports. But his focus on the details of his business had left him little time to consider strategic issues that might have made GenTech less vulnerable to a downturn, he acknowledges. Near the middle of 2008 he was taken by surprise when a major company in the solar industry postponed a contract signing, citing a financing snag. In the past, Mr. Yu says, "They didn't need to talk to the banks -- the banks would talk to them." More contract delays followed. By October, cancellations from solar-equipment customers were flooding in.
This year one customer, Suntech Power Holdings Co. of Wuxi, China, slashed its 2009 capital-spending budget to a third of last year's level. The changes left GenTech more vulnerable than the big multinational suppliers of pipes and pumps that move chemicals. Those companies also supply the chemicals themselves, getting most of their revenue that way. GenTech just makes the equipment -- equivalent to selling only razors when most of the money is in razor blades. Suddenly, GenTech found its revenue wasn't covering the expenses of its 150-strong team of engineers and salespeople. Then in January Intel Corp. said it would eliminate Shanghai as an assembly base. Though Intel wasn't a GenTech customer, Mr. Yu saw this as a sign tech companies were starting to see the Shanghai area as too expensive. Months before turning 50, Mr. Yu faces humbling times. He says GenTech "will have a tough year" but should avoid its first annual loss, thanks to unexpected orders from fiber-optics makers who want to get in on third-generation cellphone service in China. He vows to avoid layoffs or pay cuts this year.
Over coffee in his boardroom, Mr. Yu spoke of his hopes for a new "killer application" to spark a fresh round of high-tech investment in China -- even as, in the next breath, he recited reasons that is unlikely for now. In an unused half of GenTech's expanded production facility, engineers set up two badminton courts. But Mr. Yu told them to use their idle time to try to invent new kinds of equipment that might make the company more valuable if he decides the best strategy is to sell. His wife, Ms. Cui, is exploring a way to turn their decade's worth of contacts into a new trading business. Mr. Yu is taking a series of weeklong executive training classes at Beijing's Tsinghua University to "meet new people and hear new ideas." Having learned the perils of dependence on an ever-growing manufacturing industry, Mr. Yu is determined to find another way. "One hundred percent of our business relies on investment, expansion," he says. "That's what's got us scared. It's not a sustainable business model."
Australia Blocks China’s Purchase of Mining Company
Citing national security, Australia on Friday blocked one of several acquisitions China is seeking in the country’s natural resources sector, a move that may stoke concerns about rising protectionist tendencies around the globe. The decision to block the purchase of OZ Minerals, a mining company, by state-owned China Minmetals Corporation, coincides with a heated debate concerning a much larger investment that the Chinese metals company Chinalco is planning to make in the British-Australian mining group Rio Tinto. It also comes two weeks after Chinese anti-trust authorities blocked a move by Coca-Cola to take over Huiyuan Juice Group, a Chinese juice manufacturer, for $2.4 billion — a decision that caused widespread concern about China’s attitude to foreign takeovers of local companies.
Australia’s treasurer, Wayne Swan, said on Friday that he decided to block the OZ Minerals transaction was because the company’s Prominent Hill gold and copper mine, its core asset, is near a sensitive defense facility. "The government has determined that Minmetals’ proposal for OZ Minerals cannot be approved if it includes Prominent Hill," Mr. Swan said in a statement. He added that discussions were continuing "in relation to OZ Minerals’ other businesses and assets, and the government is willing to consider alternative proposals relating to those other assets and businesses." The chief executive of OZ Minerals, Andrew Michelmore, said the company and Minmetals were discussing potential changes to the deal and would make an announcement "as soon as possible."
Battered by falling earnings as raw materials have plunged in line with the slowing global economy, both OZ Minerals and Rio urgently need the cash injection that the Chinese companies’ investments represent. OZ Minerals is scheduled to repay more than $900 million in debt next week, and must now renegotiate the deal or obtain a loan extension. Analysts on Friday said it was unclear whether Minmetals would proceed without Prominent Hill, which is considered a core asset. In a statement issued in Australia, Minmetals said Friday it wanted to continue talks: "Our focus is on delivering an agreed solution to OZ Minerals that meets national interests, can satisfy lenders, deliver stability to employees and protect existing operations."
Whatever happens, Friday’s announcement will fuel the debate about a rise in global protectionism — even if Canberra’s rejection was due to security concerns rather than business protectionism. A recent flurry of bids for some of Australia’s most prized natural resource assets has caused public and political unease in the country, as well as, in the case of the proposed Chinalco transaction with Rio, angry protests from shareholders. At the same time, however, China is the main buyer of the natural resources that form the bedrock of Australia’s economy, making the approval of such deals politically sensitive.
Chinalco, or Aluminum Corporation of China, as it is officially known, last month proposed investing $19.5 billion in the miner. That deal, currently being evaluated by Australia’s anti-trust authorities, would be the biggest foreign investment to date by a Chinese company and increase its leverage in pricing negotiations for iron ore from Rio’s mines. The attempted OZ Minerals takeover, and a separate bid by the Chinese steel manufacturer Hunan Valin Iron for a 17.5 percent stake in Fortescue Metals Group, another Australian company, are much smaller — $1.7 billion in the case of OZ Minerals. But all three transactions, each announced in the last few months, reveal China’s desire to take advantage of the recent drop in commodities prices to secure its hold over natural resources.
Ilargi: Yves Smith has taken the time and trouble to address the article below, as published in the Financial Times, and dissect the mud slide emanating from Greenspan’s talking carcass.
We need a better cushion against risk
by Alain Greenspan
The extraordinary risk-management discipline that developed out of the writings of the University of Chicago’s Harry Markowitz in the 1950s produced insights that won several Nobel prizes in economics. It was widely embraced not only by academia but also by a large majority of financial professionals and global regulators. But in August 2007, the risk-management structure cracked. All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firms’ capital and risk positions. For generations, that premise appeared incontestable but, in the summer of 2007, it failed. It is clear that the levels of complexity to which market practitioners, at the height of their euphoria, carried risk-management techniques and risk-product design were too much for even the most sophisticated market players to handle prudently.
Even with the breakdown of self-regulation, the financial system would have held together had the second bulwark against crisis – our regulatory system – functioned effectively. But, under crisis pressure, it too failed. Only a year earlier, the Federal Deposit Insurance Corporation had noted that "more than 99 per cent of all insured institutions met or exceeded the requirements of the highest regulatory capital standards". US banks are extensively regulated and, even though our largest 10 to 15 banking institutions have had permanently assigned on-site examiners to oversee daily operations, many of these banks still took on toxic assets that brought them to their knees. The UK’s heavily praised Financial Services Authority was unable to anticipate and prevent the bank run that threatened Northern Rock. The Basel Committee, representing regulatory authorities from the world’s major financial systems, promulgated a set of capital rules that failed to foresee the need that arose in August 2007 for large capital buffers. The important lesson is that bank regulators cannot fully or accurately forecast whether, for example, subprime mortgages will turn toxic, or a particular tranche of a collateralised debt obligation will default, or even if the financial system will seize up. A large fraction of such difficult forecasts will invariably be proved wrong.
What, in my experience, supervision and examination can do is set and enforce capital and collateral requirements and other rules that are preventative and do not require anticipating an uncertain future. It can, and has, put limits or prohibitions on certain types of bank lending, for example, in commercial real estate. But it is incumbent on advocates of new regulations that they improve the ability of financial institutions to direct a nation’s savings into the most productive capital investments – those that enhance living standards. Much regulation fails that test and is often costly and counterproductive. Regulation should enhance the effectiveness of competitive markets, not impede them. Competition, not protectionism, is the source of capitalism’s great success over the generations. New regulatory challenges arise because of the recently proven fact that some financial institutions have become too big to fail as their failure would raise systemic concerns. This status gives them a highly market-distorting special competitive advantage in pricing their debt and equities. The solution is to have graduated regulatory capital requirements to discourage them from becoming too big and to offset their competitive advantage. In any event, we need not rush to reform. Private markets are now imposing far greater restraint than would any of the current sets of regulatory proposals.
Free-market capitalism has emerged from the battle of ideas as the most effective means to maximise material wellbeing, but it has also been periodically derailed by asset-price bubbles and rare but devastating economic collapse that engenders widespread misery. Bubbles seem to require prolonged periods of prosperity, damped inflation and low long-term interest rates. Euphoria-driven bubbles do not arise in inflation-racked or unsuccessful economies. I do not recall bubbles emerging in the former Soviet Union. History also demonstrates that underpriced risk – the hallmark of bubbles – can persist for years. I feared "irrational exuberance" in 1996, but the dotcom bubble proceeded to inflate for another four years. Similarly, I opined in a federal open market committee meeting in 2002 that "it’s hard to escape the conclusion that ... our extraordinary housing boom ... finan?ced by very large increases in mortgage debt, cannot continue indefinitely into the future". The housing bubble did continue to inflate into 2006.
It has rarely been a problem of judging when risk is historically underpriced. Credit spreads are reliable guides. Anticipating the onset of crisis, however, appears out of our forecasting reach. Financial crises are defined by a sharp discontinuity of asset prices. But that requires that the crisis be largely unanticipated by market participants. For, were it otherwise, financial arbitrage would have diverted it. Earlier this decade, for example, it was widely expected that the next crisis would be triggered by the large and persistent US current-account deficit precipitating a collapse of the US dollar. The dollar accordingly came under heavy selling pressure. The rise in the euro-dollar exchange rate from, say, 1.10 in the spring of 2003 to 1.30 at the end of 2004 appears to have arbitraged away the presumed dollar trigger of the "next" crisis. Instead, arguably, it was the excess securitisation of US subprime mortgages that unexpectedly set off the current solvency crisis. Once a bubble emerges out of an exceptionally positive economic environment, an inbred propensity of human nature fosters speculative fever that builds on itself, seeking new unexplored, leveraged areas of profit. Mortgage-backed securities were sliced into collateralised debt obligations and then into CDOs squared. Speculative fever creates new avenues of excess until the house of cards collapses. What causes it finally to fall? Reality.
An event shocks markets when it contradicts conventional wisdom of how the financial world is supposed to work. The uncertainty leads to a dramatic disengagement by the financial community that almost always requires sales and, hence, lower prices of goods and assets. We can model the euphoria and the fear stage of the business cycle. Their parameters are quite different. We have never successfully modelled the transition from euphoria to fear. I do not question that central banks can defuse any bubble. But it has been my experience that unless monetary policy crushes economic activity and, for example, breaks the back of rising profits or rents, policy actions to abort bubbles will fail. I know of no instance where incremental monetary policy has defused a bubble. I believe that recent risk spreads suggest that markets require perhaps 13 or 14 per cent capital (up from 10 per cent) before US banks are likely to lend freely again. Thus, before we probe too deeply into what type of new regulatory structure is appropriate, we have to find ways to restore our now-broken system of financial intermediation.
Restoring the US banking system is a key requirement of global rebalancing. The US Treasury’s purchase of $250bn (€185bn, £173bn) of preferred stock of US commercial banks under the troubled asset relief programme (subsequent to the Lehman Brothers default) was measurably successful in reducing the risk of US bank insolvency. But, starting in mid-January 2009, without further investments from the US Treasury, the improvement has stalled. The restoration of normal bank lending by banks will require a very large capital infusion from private or public sources. Analysis of the US consolidated bank balance sheet suggests a potential loss of at least $1,000bn out of the more than $12,000bn of US commercial bank assets at original book value. Through the end of 2008, approximately $500bn had been written off, leaving an additional $500bn yet to be recognised. But funding the latter $500bn will not be enough to foster normal lending if investors in the liabilities of banks require, as I suspect, an additional 3-4 percentage points of cushion in their equity capital-to-asset ratios. The overall need appears to be north of $850bn. Some is being replenished by increased bank cash flow. A turnround of global equity prices could deliver a far larger part of those needs. Still, a deep hole must be filled, probably with sovereign US Treasury credits. It is too soon to evaluate the US Treasury’s most recent public-private initiatives. Hopefully, they will succeed in removing much of the heavy burden of illiquid bank assets.
More on robbing the US tax payer and debauching the FDIC and the Fed
by Willem Buiter
The US authorities have no money to fulfil their ambition of stopping large US banks from failing without taking them into public ownership. The $300 bn left in the TARP kitty is all that is available for recapitalising banks, purchasing toxic assets and providing other financial support. Congress has thrown its toys out of the pram and is unwilling to appropriate more funds for the rescue of the banking sector. As an aside: it is astonishing that Congress and much of the US populace are apoplectic about $165 mn (perhaps $182 mn) of bonuses paid to AIG executives and employees, when $170 billion or so of public money is at risk (and tens of billions probably already gone out of the window) in the rescue of this most undeserving of companies. Perhaps you can only get indignant about what you can comprehend… .
The US authorities are reduced to begging, stealing and borrowing the rest of the funds they believe they will need. The two main proximate sources of funds are the FDIC and the Fed. The ultimate sources of funds will be (1) the US tax payer and the beneficiaries of future US spending programs that will have to be cut, (2) the holders of nominally denominated liabilities of the US state, including the monetary liabilities of the Fed and US Treasury bills and bonds. Owners of dollar-denominated debt instruments will see the real value of their claims on the government eroded by future inflation if, as I expect, the recent and prospective future increases in the US monetary base (driven by credit easing and, in the future also be quantitative easing) cannot be reversed in the future. The main obstacle to such a reversal will be the US fiscal authorities, who are unlikely to let the Fed dump large amounts of US Treasury debt, acquired by the Fed as part of its quantitative easing program, into the markets. I believe that the raids by the US Treasury on the FDIC and on the Fed are illegitimate and, in the case of the FDIC, quite possibly illegal.
The FDIC is supposed to be an independent agency of the US federal government. Its website tells us that "The FDIC receives no Congressional appropriations - it is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities" . The FDIC also has no borrowing capacity except that granted it by the US Treasury. The operating budget of the FDIC for 2009 is $2.24 billion, a big increase from the $ 1 billion set in 2008, but still a tiny number. Its current Treasury borrowing limit is $30 bn, again nowhere near enough to make an impact on the black hole that is the asset side of the balance sheet of the US cross-border banking system. With an insurance fund of just over $45 billion, the FDIC insures more than $5 trillion of deposits in U.S. banks and thrifts. The insurance fund is therefore less than one percent of the amount of insured deposits. The near-demise of the US banking system means that, should even a single large deposit-taking bank go bust, there is not enough money in the kitty to pay off all insured depositors. The FDIC would have to borrow - hence the usefulness of the increase in the borrowing limit. It is both unwise and illegitimate to use that borrowing limit instead to subsidise potentially non-viable banks (likely to still be non-viable even after the subsidy) as well as the private investors who plan to purchase these banks’ bad loans through the Legacy Loans Program.
The FDIC’s Mission Statement is clear: "The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress that maintains the stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions, and managing receiverships." I don’t see anything there about guaranteeing debt from or loans to private entities wanting to buy bad loans from bad banks. The Federal Deposit Insurance Corporation Improvement Act of 1991 also does not, as far as i can see, authorise the FDIC to engage in the kind of quasi-fiscal activities it is engaging in through the Temporary Liquidity Guarantee Program (see below) and is about to engage in under the Legacy Loans Program. But help is on the way! Senate Banking Committee Chairman Chris Dodd of Connecticut is proposing, in a bill submitted on March 5 2009 (the Depositor Protection Act of 2009) to increase the FDIC’s Treasury borrowing limit from $30 billion to $500 billion. With the deposit insurance limit now at $250,000 at least until the end of 2009 (up from $100,000) and so many large deposit-taking banks in the US insolvent but for past, present and anticipate future hand-outs from the tax payer, the increased borrowing limit of $500 bn may come in handy to make whole the insured depositors if and when one or more large banks keel over.
But this does not appear to be the use (the proper use) that the US authorities have in mind for it. Instead the increase in the FDIC’s Treasury borrowing limit to $500 billion is likely to be diverted to the entirely improper use of providing debt guarantees for debt used to co-finance the purchase bad loans from the banks under the Legacy Loans leg of the Private-Public Investment Program (PPIP). This quasi-fiscal role of the FDIC is on top of the earlier prima-facie illegitimate use of FDIC resources under the FDIC’s Temporary Liquidity Guarantee Program (TLGP), under which the FDIC guarantees newly issued senior unsecured debt of banks, thrifts, and certain holding companies. The FDIC, under the TLGP also provides full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. This is a legitimate use of its resources, albeit an unwise one. As of February 28, 2009 the amount of debt insured under the TLGP was more than $268 billion. After debauching the Fed to pay for the bail-out of insolvent US banks, the US administration is now subverting the purpose of another so-called independent government agency. The debauching of the FDIC is, however, different in one respect from that of the Fed. The Fed has an independent source of revenue - seigniorage, that is, the revenue from issuing base money, part of which is non-interest-bearing (bank notes) and part of which (commercial bank deposits with the Fed) earns an interest below what the Fed earns on its assets.
The FDIC has no independent source of revenue (ignoring the premia charged for the deposit insurance, which is chicken feed). Getting the FDIC to guarantee loans is therefore just a cute and non-transparent way of having the US Treasury guarantee those loans. But it’s off the books, off-budget and off-balance sheet as far as the US Treasury is concerned. With a bit of luck the guarantees will not be called. And if they are called - well, that will be then and this is now. If the FDIC can insure $ 5 trillion worth of deposits with a mere $45 bn fund, think of what amount of lending the FDIC can guarantee when it borrows its full allotment of $500 bn! The bill will be presented to the tax payers later. How large could the bill be, that is, how much money could be transferred from the US tax payers to the banks or the investment funds bidding for toxic assets? The potential for subsidies to the private parties involved in the PPIP’s Legacy Loans and Legacy Securities Programs is truly astonishing. Jeff Sachs, in a recent Financial Times column, provides a representative calculation for the Legacy Loans Program. Note that this is targeted not at toxic assets (assets whose value is unknown) but on bad loans, whose (low) fundamental value can be ascertained without too much effort.
What follows paraphrases Jeff Sach’s argument and calculation. I put all of it in quotation marks, even though a few words have been changed. "For every $1 of bad assets that an investment fund authorised under the PPIP buys from the banks, the FDIC will lend up to 85.7 cents (six-sevenths of $1), and the Treasury and private investors will each put in 7.15 cents in equity to cover the balance. The Federal Deposit Insurance Corporation (FDIC) loans will be non-recourse, meaning that if the bad assets purchased by the investment fund fall in value below the amount of the FDIC loans, the investment funds will default on the loans, and the FDIC will end up holding the bad assets. The investment fund is not responsible for part of the FDIC loan not covered by the liquidation value of the bad assets. At most it loses the equity it put in. Consider a portfolio of bad assets with a face value of $1 trillion. Assume that these assets have a 20 percent chance of paying out their full face value ($1 trillion) and an 80 percent chance of paying out only $200 billion. The fair value of these assets is given by their expected payout, which is 20 percent of $1 trillion plus 80 percent of $200 billion, i.e. $360 billion. Investment funds will bid for these assets. It might seem at first that the investment funds would bid $360 billion for these toxic assets, but this is not correct. The investors will bid substantially more than $360 billion because of the massive subsidy implicit in the FDIC non-recourse loan. The FDIC makes a "heads you win, tails the taxpayer loses" offer to the private investors."
"With a little arithmetic, we can calculate the size of the transfer from the tax payer to the banks and the investment funds. In this example, the private investment fund will actually be willing to bid $636 billion for the $360 billion of fair value of the bad assets, in effect transferring excess $276 billion from the FDIC (taxpayers) to the bank shareholders. Under the rule of the Geithner-Summers Plan, private equity investors and the TARP each put in 7.15 percent of the purchase price of $636 billion, equal to $45 billion each. The FDIC will loan $546 billion. (All numbers are rounded). If the bad assets actually pay out the full $1 trillion (which happens with 20 percent probability), there will be a profit of $454 billion, equal to $1 trillion payout minus the repayment of the FDIC loan of $546 billion. The private investors and the TARP will each get half of the profit, or $227 billion. Since this outcome occurs only 20 percent of the time, the expected profits to the private investors are 20 percent of $227 billion, or $45 billion, exactly what they invested. Similarly, the TARP’s expected profits are also equal to the TARP investment of $45 billion. Thus, both the TARP and the private investors break even. As competitive bidders, they have bid the maximum price that allows them to break even. The bank shareholders, however, come out $276 billion ahead of the game, while the FDIC bears $276 billion in expected losses! This transfer occurs because the investment fund defaults on the FDIC loan when the bad assets in fact pay only $200 billion, an outcome that occurs 80 percent of the time. When that happens, the investment fund is "underwater" (holding more in FDIC debt than it gets in payouts on the bad assets). The investment fund then defaults on its debt to the FDIC. The FDIC gets $200 billion instead of repayment of $546 billion, for a net loss of $346 billion. Since this outcome occurs 80 percent of the time, the expected loss to the taxpayers is 80 percent of $346 billion, or $276 billion. This is exactly equal to the overpayment to the banks in the first place."
The problem of collusive behaviour between the private investment funds and the banks for whose assets they bid will undoubtedly rear its ugly head. Indeed, the banks could set up their own investment funds (through SPVs registered in places where information is even harder to obtain than in Liechtenstein) and so make sure the underpriced put provided by the FDIC through its non-recourse loan can indeed be exercised. This is a very bad deal for the tax payer indeed. And the Legacy Securities Program works on the same principles, although the non-recourse leverage provided by the Fed will be less than that provided by the FDIC for the Legacy Loans Program.
I have written at length before about the ever-expanding quasi-fiscal role of the Fed. This began as soon as the Fed began to take private credit risk (default risk) onto its balance sheet by accepting private securities as collateral in repos, at the discount window and at one of the myriad facilities it has created since August 2008. It is possible - I would say likely - that the terms on which the Fed accepted this often illiquid collateral implied even an ex-ante subsidy to the borrower. But the Fed is refusing to provide the necessary information on the valuation of the illiquid collateral, interest rates, fees and other key dimensions of the terms granted those who access its facilities, for outsiders, including Congress, to find out what if any element of subsidy is involved. Should the borrowing bank default and should the collateral offered also turn out to be impaired, the Fed will suffer an ex-post capital loss on its repos and other collateralised lending operations against private collateral. It does not have an indemnity from the Treasury for such capital losses.
The Fed also created the Maiden Lane I (for Bear Stearns toxic assets), Maiden Lane II (for AIG’s secured loans and Maiden Lane III (for AIG’s credit default swaps) special purpose vehicles in Delaware. The losses made by Maiden lane II and III when the Fed paid off the investors (counterparties) of AIG at par, were, however, not booked on the balance sheets of the two Maidens, but were booked on AIG’s balance sheet, keeping Maiden Lane I and II, and the Fed, clean for the time being. The financial shenanigans used by the Fed (in cahoots with the US Treasury) to limit accountability for these capital losses are quite unacceptable in a democratic society. Clearly, the US authorities are using the financial engineering tricks and legal constructions whose abuse by the private financial sector led to our current predicament, to engage in Congressional- and tax payer accountability avoidance/evasion. To watch the regulators engage in regulatory arbitrage is astonishing. With the onset of credit easing, the Fed now also takes private credit risk onto its balance sheet through outright purchases of private securities (including commercial paper and possibly corporate bonds) and by making non-recourse loans through the TALF (that is, though unsecured lending). There is no full (100 percent) Treasury guarantee for this credit risk taken by the Fed. In fact, the $1 trillion TALF has at most $100 billion of Treasury funds to back it up.
I don’t envy Ben Bernanke the extremely uncomfortable position he finds himself in. He can insists on minimizing the quasi-fiscal role of the Fed by insisting on a 100% US Treasury guarantee for any credit risk, other than the credit risk of the US sovereign, that the Fed assumes. In that case the amount of financial ammunition that the US state, broadly defined to include the US Treasury, the FDIC and the Fed, have at their disposal to deal with financial sector reconstruction is inadequate. Or he can compromise the independence of the Fed and let the central bank be used as an off-balance sheet and off-budget special purpose vehicle of the US Treasury, reducing transparency and undermining democratic accountability. Talk about a rock and a hard place. Even faced with this kind of dilemma, however, certain practices are clearly improper and unacceptable. The (ab)use of the Maiden Lane SPVs to hide some of the losses made by the Fed and the US Treasury and to channel money non-transparently to AIG counterparties (in the case of Maiden Lane II and III is just plain wrong. So is the refusal to make public the information required to judge the appropriateness of the terms and conditions attached by the Fed to the use of its facilities.
Conclusion: we need banking; we don’t need these banks
The raiding by the US Treasury of the financial resources of the FDIC and the Fed is not just unwise, illegitimate and possibly illegal, it is also unnecessary. For some reason, perhaps an example of cognitive capture of the Treasury and White House policy makers by the spin doctors and skilled persuaders of Wall Street, Tim Geithner, Larry Summers, Ben Bernanke and Sheila Blair all appear to believe that to save the banking sector you have to save the existing banks as going concerns. Indeed, in view of the astonishing survival rate of CEOs and other top managers in the zombie banks, they may even believe that to save the banking system you have to rely on the continued contribution of those whose past best efforts brought us this crisis and debacle. All that matters is banking as a function and activity, that is, new lending and borrowing by banks. When a massive disaster strikes the existing banks, it is essential to decouple the stocks of existing assets and liabilities from the flows of new lending and borrowing. The good bank model does that.
Both Fed Chairman Bernanke and US Treasury Secretary Geithner have called for the creation of a special resolution regime (SRR) with prompt corrective action (PCA) for non-bank systemically important institutions. Bernanke clearly had AIG in mind when he told the US Congress on March 20, that there was a need for a special insolvency regime that "permits the orderly resolution of a systemically important nonbank financial firm". With a proper federal resolution authority, AIG could have been put into conservatorship or receivership and could have been unwound slowly, with not just the shareholders but also the unsecured creditors taking the haircuts (losses) justified by the financial condition of AIG. Bernanke’s words that a proper special resolution regime for non-banks would permit the Conservator or Administrator to "unwind it slowly, protect policymakers, and impose haircuts on creditors and counterparties as appropriate," truly are music to my ears. I also agree with Chairman Bernanke’s statement that "given the interconnected nature of our financial system and the potentially devastating effects on confidence, financial markets and the broader economy that would likely arise from the disorderly failure of a major financial firm in the current environment, I do not think we have had a realistic alternative to preventing such failures."
But with a proper SRR, there can be orderly failures of major financial firms, banks and well as non-banks. The US has a proper SRR for FDIC-insured banks. That now includes all Wall Street banks. The orderly failure and resolution of one of more Wall Street banks need therefore pose no threat to financial stability. Indeed, with the limited resources the US authorities have at their disposal, the failure and orderly resolution of all dodgy Wall Street banks may well be the best way to stabilise the financial sector and to get financial intermediation - new lending and borrowing between banks and the non-financial sectors - going again. With the information the authorities now are acquiring (I hope) about the soundness of the large banks (whose balance sheets and financial fitness are being scrutinised as part of the Treasury’s Capital Assistance Program), the authorities will soon know which banks should be allowed to survive and which ones should be put out of their and our misery. Why hasn’t the FDIC’s special resolution regime been used to resolve the large Wall Street zombie banks, but just the tiddlers in the boonies (OK, add WAMU)?
Any large, deposit-taking Wall Street bank (the old bad bank or OBB) with a significant amount of non-insured deposit liabilities on its balance sheet and a survival-threatening amount of toxic assets, can be split into a new good bank and a new bad fund virtually with the stroke of a pen, using the proposal by Bulow and Klemperer and Hall and Woodward. The new good bank gets the insured deposits and the non-toxic assets. If liabilities net of insured deposits of the OBB exceed toxic assets, the new good bank will have positive equity. Give that equity in the new good bank to the new bad fund. The new bad fund does not have a banking license and cannot make new loans or acquire any new assets. It simply manages down its portfolio of existing assets in the interests of its owners. It gets no further government financial support of any kind. If it fails, it goes into Chapter 11 or Chapter 7. Both the shareholders and the unsecured creditors can be expected to take a hit. That is as it should be. If the new good banks needs additional capital, it can go to the market or obtain it from the government. Government guarantees (just from the Treasury, please) are only granted to new bank borrowing or bank lending. Save banking. Allow the zombie banks to die.
"Goodbye, Homo Economicus"
Via an email suggestion (there's much, much more in the full version):
Goodbye, homo economicus, by Anatole Kaletsky: Was Adam Smith an economist? Was Keynes, Ricardo or Schumpeter? By the standards of today’s academic economists, the answer is no. Smith, Ricardo and Keynes produced no mathematical models. Their work lacked the "analytical rigour" and precise deductive logic demanded by modern economics. And none of them ever produced an econometric forecast (although Keynes and Schumpeter were able mathematicians). If any of these giants of economics applied for a university job today, they would be rejected. As for their written work, it would not have a chance of acceptance in the Economic Journal or American Economic Review. The editors, if they felt charitable, might advise Smith and Keynes to try a journal of history or sociology.
If you think I exaggerate, ask yourself what role academic economists have played in the present crisis. Granted, a few mainstream economists with practical backgrounds—like Paul Krugman and Larry Summers in the US—have been helpful explaining the crisis to the public and shaping some of the response. But in general how many academic economists have had something useful to say about the greatest upheaval in 70 years? The truth is even worse than this rhetorical question suggests: not only have economists, as a profession, failed to guide the world out of the crisis, they were also primarily responsible for leading us into it. ...
Academic economists have thus far escaped much blame for the crisis. Public anger has focused on more obvious culprits: greedy bankers, venal politicians, sleepy regulators or reckless mortgage borrowers. But why did these scapegoats behave in the ways they did? Even the greediest bankers hate losing money so why did they take risks which with hindsight were obviously suicidal? The answer was beautifully expressed by Keynes 70 years ago: "Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."
What the "madmen in authority" heard this time was the distant echo of a debate among academic economists begun in the 1970s about "rational" investors and "efficient" markets. This debate began against the backdrop of the oil shock and stagflation and was, in its time, a step forward in our understanding of the control of inflation. But, ultimately, it was a debate won by the side that happened to be wrong. And on those two reassuring adjectives, rational and efficient, the victorious academic economists erected an enormous scaffolding of theoretical models, regulatory prescriptions and computer simulations which allowed the practical bankers and politicians to build the towers of bad debt and bad policy. ...
Which brings us to the causes of the present crisis. The reckless property lending that triggered this crisis only occurred because rational investors assumed that the probability of a fall in house prices was near zero. Efficient markets then turned these assumptions into price-signals, which told the bankers that lending 100 per cent mortgages or operating with 50-to-1 leverage was safe. Similarly, regulators, who allowed banks to determine their own capital requirements and private rating agencies to establish the value at risk in mortgages and bonds, took it as axiomatic that markets would automatically generate the best possible information and create the right incentives for managing risks. ...
The scandal of modern economics is that these two false theories—rational expectations and the efficient market hypothesis—which are not only misleading but highly ideological, have become so dominant in academia (especially business schools), government and markets themselves. While neither theory was totally dominant in mainstream economics departments, both were found in every major textbook, and both were important parts of the "neo-Keynesian" orthodoxy, which was the end-result of the shake-out that followed Milton Friedman’s attempt to overthrow Keynes. The result is that these two theories have more power than even their adherents realise: yes, they underpin the thinking of the wilder fringes of the Chicago school, but also, more subtly, they underpin the analysis of sensible economists like Paul Samuelson.
The rational expectations hypothesis (REH), developed by two Chicago economists, Robert Lucas and Thomas Sargent in the 1970s, asserted that a market economy should be viewed as a mechanical system that is governed, like a physical system, by clearly-defined economic laws which are immutable and universally understood. Despite its obvious implausibility and the persistent attacks on it, especially from the left, REH has continued to be regarded by universities and funding bodies as the most acceptable foundation for serious academic research. In their recent book Imperfect Knowledge Economics, two American professors, Roman Frydman and Michael Goldberg, complain that "all graduate students of economics—and increasingly undergraduates too—are taught that to capture rational behaviour in a scientific way they must use REH."
In Britain too the REH orthodoxy has remained far more powerful than is often realised. As David Hendry, until recently head of the Oxford economics department, has noted: "Economists critical of the rational expectations based approach have had great difficulty even publishing such views, or maintaining research funding. For example, recent attempts to get ESRC funding for a project to test the flaws in rational expectations based models was rejected. I believe some of British policy failures have been due to the Bank accepting the implications [of REH models] and hence taking about a year too long to react to the credit crisis." ...
To make matters worse, rational expectations gradually merged with the related theory of "efficient" financial markets. ... This was the efficient market hypothesis (EMH), developed by another group of Chicago-influenced academics, all of whom received Nobel prizes just as their theories came apart at the seams. EMH, like rational expectations, assumed that there was a well-defined model of economic behaviour and that rational investors would all follow it; but it added another step. In the strong version of the theory, financial markets, because they were populated by a multitude of rational and competitive players, would always set prices that reflected all available information in the most accurate possible way. Because the market price would always reflect more perfect knowledge than was available to any one individual, no investor could "beat the market"—still less could a regulator ever hope to improve on market signals by substituting his own judgment. ...
Why did such discredited theories flourish? Largely because they justified whatever outcomes the markets happened to decree—laissez-faire ideology, big salaries for top executives and billions in bonuses for traders. And, conveniently, these theories were regarded as the gold-standard by academic economists who won Nobel prizes. So what is to be done? There are two options. Either economics has to be abandoned as an academic discipline, becoming a mere appendage to the collection of industrial and social statistics. Or it must undergo an intellectual revolution. ...
Economics today is a discipline that must either die or undergo a paradigm shift—to make itself both more broadminded, and more modest. It must broaden its horizons to recognise the insights of other social sciences and historical studies and it must return to its roots. Smith, Keynes, Hayek, Schumpeter and all the other truly great economists were interested in economic reality. They studied real human behaviour in markets that actually existed. Their insights came from historical knowledge, psychological intuition and political understanding. Their analytical tools were words, not mathematics. They persuaded with eloquence, not just formal logic. One can see why many of today’s academics may fear such a return of economics to its roots.
Academic establishments fight hard to resist such paradigm shifts, as Thomas Kuhn, the historian of science who coined the phrase in the 1960s, demonstrated. Such a shift will not be easy, despite the obvious failure of academic economics. But economists now face a clear choice: embrace new ideas or give back your public funding and your Nobel prizes, along with the bankers’ bonuses you justified and inspired.
Japan: G20 Focus Not On New Reserve Currency
Group of 20 leaders won't likely debate the immediate need for a new reserve currency to replace the U.S. dollar at their summit next week, a senior Japanese Finance Ministry official said Friday. "At this stage, nobody is discussing whether a new key currency is necessary instead of the dollar," the official told reporters on condition of anonymity. G20 leaders will meet in London on April 2 to discuss how to limit the depth and length of the global economic and financial crisis. The official's remark came as the debate over the greenback's role as the global reserve currency is heating up. Earlier this week, China's central bank chief Zhou Xiaochuan suggested the dollar should be replaced as the key currency by the International Monetary Fund's Special Drawing Rights - a basket of dollars, euros, sterling and yen - that wouldn't be easily influenced by individual countries.
Although U.S. Treasury Secretary Timothy Geithner said Wednesday the greenback remains the world's dominant reserve currency, market players still anticipate that some G20 leaders may support more widespread use of the SDR. But the MOF official played down such speculation. "In the long run, there may be a debate on whether the dollar should be the key currency, but I don't expect such a discussion to arise" at the upcoming G20 meeting. Prime Minister Taro Aso has reiterated that any sharp drop in the dollar would have a negative impact on Japan, given its large dollar reserves. Therefore, supporting the dollar-centered global currency system is in Japan's national interest.
The official said measures to boost the IMF's capital base will likely become a topic at the G20 summit. Last month, Japan signed an agreement with the IMF to offer up to $100 billion in emergency loans to the multilateral institution to support its mission to aid developing nations hit hard by the economic crisis. Japan has said the IMF's capital base "should be largely strengthened," the official said. "What Japan started saying is spreading (across the globe), so it's expected that the IMF's loanable funds will increase drastically" down the road. The official also said G20 leaders are in agreement over the need for fiscal stimulus to prop up growth, but the details should be determined according to the economic conditions of each country.
London Braces for Massive Protests
London is bracing itself for the G-20 meeting next week, as thousands of demonstrators prepare to descend upon the British capital. While most protestors will be peaceful, those working in the financial industry are being advised not to wear suits to work or even to stay at home to avoid potential violence.
Mirina Pepper has just been panhandled by a homeless man near London's Liverpool Street Station. She reaches into her handbag and grabs a bundle of £20 notes. "Here, you can give them out," she says. The homeless man looks perplexed at the notes, not knowing whether he should take this as a good or bad thing. It's funny money with the words "G-20 Meltdown" printed on it. They're flyers for a "Party in the City." Pepper gets the homeless man to agree to come the event next Wednesday and to bring along as many of his buddies as he can. Another homeless man just a few meters away experiences the same fate.
Pepper, 41, is responsible for organizing "G-20 Meltdown," a coalition of groups that plan to protest against the London financial summit next week that has even earned the respect of Scotland Yard. "They have some very clever people and their intention on April 1 is to stop the City," Commander Bob Broadhurst of the Metropolitan Police said last week. "They are innovative and we have to be innovative, too." The policeman's concerns put a smile on Pepper's face. She's delighted by the idea of a cat and mouse chase through this city of more than 7.5 million people. "It's all a question of numbers," she says. Five-thousand police officers will be deployed, many in combat gear. It's the largest police operation the city has seen in 10 years.
But there are doubts about whether that will be enough. Police will have to provide security for 22 world leaders, including the United States president, and 40 motorcades will have to be directed through the streets of London. In addition, dozens of embassies and hotels will have to be guarded, the conference center has to be sealed off from the public and the banks in the city's financial district will also have to be guarded from potentially violent anarchist protestors. It's a mission with an incalculable outcome -- after all, nobody knows how many people will actually turn up. Current estimates put the figure at about 3,000. That may not be a huge figure, but with technologies like Twitter and mobile phone text messaging, the demonstrators have become dangerously mobile. For weeks, protesters have been discussing possible locations for their actions in Internet forums and they have also leaked out names to the public. The idea is to send out decoys to throw police off, so that they focus their efforts on the wrong people.
The G-20 summit is scheduled to take place on April 2 at the Excel Center conference facility in east London's Docklands area. The first anti-summit protest is expected to take place on Saturday. Over 100 non-profit organizations and labor unions have called a protest march. But the most creative event will take place on April 1. At 11 a.m., parade floats will depart from four different Underground stations and head towards the financial district before forming a cross in front of the Bank of England, where a "Bankers Banquet" is planned. "It will be very funny and very English," Pepper promises. She says she'll be schlepping an old copper kettle along to the picnic. "In emergencies, the English make tea," she explains.
Climate change activists in London, who tend to spend their time fighting against the expansion of the city's airports, want to create a 24-hour "Climate Camp" tent city in front of the European Climate Exchange on Liverpool Street. At the same time, a giant iceberg is going to be placed in front of the Excel Center that will slowly melt. Another action is planned in front of the Royal Bank of Scotland, the financial institution that has so far cost British taxpayers the most money. Another march will be directed towards the US Embassy. Meanwhile, G-20 critics will hold a shadow summit at the University of East London near the conference center. On April 2, the plan is to get as close to the Excel Center as they possibly can -- though with massive security measures in place, protesters are unlikely to get too far.
Police and activists agree that they have never seen so many groups planning to take to the streets. Most of them will stage peaceful demonstrations, often with a political message about climate change (as environmentalists struggle to keep the issue on the agenda despite the financial crisis). But militants, on the other hand, are gearing up for a "summer of anger." Police fears were vindicated when, on Tuesday night, vandals attacked the Edinburgh villa of former Bank of Scotland chief Fred Goodwin, breaking windows and damaging his Mercedes. In February, the group "Government of the Dead" publicly hung a puppet of a banker. Meanwhile, Bone's anarchist troop "Class War" harbors its own fantasies of violence. A recent edition of their newspaper called for the burning of bankers. The current edition has the slogan "Ready to Riot" above a picture of Fred Goodwin's head on the guillotine.
There is a chance this will all turn out to be empty rhetoric. But in the City of London the business community is worried. Industry organizations like the Chamber of Commerce are recommending that members leave their suits and ties at home to avoid provoking the demonstrators. Leading banks like the Royal Bank of Scotland and UBS have told their employees to work from home wherever possible and postpone meetings. The financial district has witnessed a string of protests in recent months -- but none of them turned violent. This time round, organizers are also urging that the demonstration should be peaceful. Their aim could be aided by "protest tourists" staying at home. Activists from France and Germany will likely converge on the NATO summit in Strasburg, where Obama is expected on April 3.
But even without an influx of visitors, there is enough simmering anger in London. The mood is very different from the G-8 summit at Gleneagles in Scotland, Pepper says. During the boom years street protests were not popular but in this crisis new generations are being initiated into the protest culture. And while there will be the usual civil disodience, there are also ideas like pouring sand onto the streets and allowing kids to play there. Ironically the G-20 gathering is the first in generations to try to restrain global capitalism with rules and regulations. Protesters, in theory, could take comfort that some of their old demands are now being tackled. At the same time, the exclusive G-8 gang is, in effect, consigned to history and developing countries are joining the debate. Former taboo subjects like tax havens and banker bonuses are among the topics to be discussed.
But the coalition of protesters still see the event as the "biggest April Fool's Joke of all time," according to their Web site. In their eyes, this summit will be mostly about saving the banks. They want to articulate the widespread resentment that tax payers are having to pick up the tab for the City's reckless gambling. They will probably achieve their goal of immobilizing the whole financial district -- not least because of the logistics of the G-20 itself. There will be severe traffic blockages due to the 40 delegations driving from the embassies to the conference center in the east of the city. Demonstrators also plan to indirectly recruit the police to help hinder the opening of the London Stock Exchange on April 2. "All you have to do is announce you are planning something and they start building up a ring of defense around the building," Pepper said.
Obama to Woo European Public on Overseas Trip
Barack Obama, heading overseas for the first time as president next week, aims to use a combination of summit protocol and campaign flash to corral support for his programs. Facing political headwinds but with a European public still on his side, Mr. Obama will attend three high-profile international events -- the meeting of Group of 20 nations that kicks off Wednesday evening in London, a North Atlantic Treaty Organization meeting at the end of the week, and a European Union-U.S. summit in Prague on April 5.
But Mr. Obama also intends to extend his efforts beyond official meetings. He will hold a town hall-style meeting at a sports arena in Strasbourg, France, European diplomatic officials said. And the White House is looking for a site in Prague for the first public foreign-policy speech of Mr. Obama's presidency, according to Petr Kolar, the Czech Republic's ambassador to the U.S. Turkish press reports say Mr. Obama's visit to Istanbul after the Prague summit will include a stop at the Hagia Sophia, a Byzantine-era church converted to a mosque under the Ottomans, and a stop at the national Sultan Ahmed Mosque. The emphasis on including public events, a deliberate nod to Mr. Obama's successful tour through Europe as a presidential candidate, stands in contrast to the divisions that have opened on policy since he took office.
Czech Prime Minister Mirek Topolánek, who resigned on Thursday after an earlier parliamentary vote of no-confidence, this week called Mr. Obama's economic prescriptions "the road to hell." Paris and Berlin have been openly hostile to the U.S. president's calls for more fiscal stimulus. And his pleas for more troops for Afghanistan have given way to more modest calls for help in propping up Afghanistan and Pakistan's civilian governments. A senior administration official shrugged off those concerns. "If there's a positive receptivity to the president, it does help enhance America's image abroad and moves along the agenda," the official said. "We're not afraid to be a world leader, and people want to be seen with our president. That's a good thing." Mr. Obama spent much of his campaign lamenting his nation's diminished status and influence after eight years under President Bush.
On his trip, President Obama will meet leaders from more than 40 countries and will see first hand whether the damage he spoke of is there and lasting. "President Obama has been talking for many months, if not a year or more, about the need to restore U.S. leadership around the globe," said Reginald Dale, a senior fellow at the Center for Strategic and International Studies' Europe program. "This trip is the first chance, actually, to start doing something about that." In a news conference Tuesday, Mr. Obama said the steps he has taken have been aimed at "restoring a sense of confidence and the ability of the United States to assert global leadership." Such trips are carefully choreographed and many of the tensions evident before the meetings will have been defused ahead of time.
Mr. Obama's star may have dimmed slightly in the U.S., but politicians in Europe hope some of his stardust rubs off on them. "Everybody's jockeying to be seen by his side," says one person familiar with the preparations for the NATO summit. "People are squabbling to be in the camera shot with him and be seated next to him."
That won't do much to tackle some differences. The U.S. had wanted each nation to sign on to a 2% of gross domestic product target for a fiscal boost to help the global economy, but isn't likely to press the point after France and Germany publicly opposed it.
Spain's Prime Minister José Luis Rodríguez Zapatero said on Thursday that the nation has room for a fresh fiscal stimulus if needed, but that Europe should wait until the summer to see if the current round of spending measures and tax cuts has an effect. Spain has one of Europe's biggest stimulus plans, with tax cuts and new spending measures valued at €21 billion ($29 billion), or 2% of GDP, in 2008 and €31 billion, or 3% of GDP, in 2009. The U.S. will agree to Franco-German calls for heightened regulation of the global financial system but -- like the U.K. -- interpret this differently when it comes to making policy, U.S. and European officials say.
Differences will also remain beneath the surface at the NATO meeting, or at least couched in the most diplomatic terms, officials say. The U.S. would like its European partners in NATO to commit more troops to Afghanistan, and wishes some, such as Germany, would ease restrictions that prevent their forces from playing a combat role. But the U.S. isn't expected to press the point at the NATO summit, focusing instead on the alliance's 60th birthday, the readmission of France into NATO's military command, and the expected future admission of new members Croatia and Albania.