Liberty Pie Company truck wreck.Washington, D.C.
Ilargi: President Obama must be starting to sweat, maybe hyperventilate and perhaps even panic. In a move that is prone to kill a political career if it turns out wrong (and it will), he suggested today that this may be a good time for Americans to buy stocks. Now, I don't care if he really thinks that or not, the fact remains that it's a highly risky and volatile thing for a politician to say. It feels like he's moving ever closer into W territory, it sounds like something that Bush 43 would have said, like when 8 years ago he urged Americans to go out and buy a home. Where's the difference?
President Obama also insisted that he's convinced the economy will rebound. And while there will of course be some kind of bounce somewhere down the road, no matter how small, what exactly will be the good that comes from it when it happens with the Dow at 1000? I know, that's probably not what the president thinks. Or hopes for.
I'm thinking that it's starting to feel like some sort of contortionist act. Looking at the numbers of the day, I see one more instance of a jaw-dropping plunge in home sales, this time in pending sales of existing houses. Whether it's new or existing real estate, pending or actual sales, all the numbers keep on going down at Olympic speed. Where would that rebound come from, Mr. President? Prices have much more to fall still, sir, or don't you know that?
Wait, let me put it another way. Who would you recommend buys the stocks? The millions losing their homes? The even bigger numbers losing their jobs? Maybe the tens of millions who've seen their pensions lose 40% in one single year should try to make up for these losses with one more brave bet?
And what would you advice they buy? What stocks are cheap, where are the potential gains to be made? Would you want to tell Americans to buy the stock of the biggest losers (in more than one sense), the AIG's and CIti's of the world, the companies that you have now transferred trillions of dollars to that belonged to the same Americans in the first place that you now suggest buy the shares?
How about shares in GM and Ford, who today announced sales that are down 53% and 48%, respectively, numbers that ensure unemployment for millions of additional Americans, regardless of future ingestion of government billions? You want the men and women who just lost their jobs, and likely much of their pensions, to go out and buy shares in their former employers? Is that what you want? Am I the only one around here who thinks of terms like 'cynical' and 'perverted' when I think this over? How dare you sir, how dare you? Have you no shame?
How dare you abuse the trust your voters have put in you to lure them into at best highly insecure investments with what little they have left, while at the same moment your 2nd hand finance salesmen Tim Geithner and Ben Bernanke testify in Congress that the latest $700 billion banking system 'rescue' will not be -nearly- enough? We all know you will need trillions more for your policies in the near future. We know that because your minions don't even try to hide it anymore in public.
What goes through your mind if and when an impoverished old lady who wants so desperately 'to believe' that she donated $100 to your campaign even if that meant she'd eat only oatmeal for weeks, follows your advice and buys GM, Citi and AIG shares with her last remaining savings, if Congress refuses yet another, and undoubtedly bigger, round of Wall Street hand-outs? That would wipe out the old lady's savings, wouldn't it, Mr. President? And if it's not Congress, you yourself may well have to take that decision, because the bleeding will not stop..
You’ve been gambling heavily with your people's money for 6 weeks now, and that's no little feat in my eyes. Gambling with their trust, however, is a whole other ball game.
Look, I have nothing against hope and faith, but that doesn't mean I close my eyes while I drive on the highway. I do, however, sometimes sit up in the darkness, thinking of girlfriend and boyfriends, young wives and young husbands, old ladies and newborn babies, wondering what will come of us all.
Wreck On The Highway
Last night I was out driving
Coming home at the end of the working day
I was riding alone through the drizzling rain
On a deserted stretch of a county two-lane
When I came upon a wreck on the highway
There was blood and glass all over
And there was nobody there but me
As the rain tumbled down hard and cold
I seen a young man lying by the side of the road
He cried Mister, won't you help me please
An ambulance finally came and took him to Riverside
I watched as they drove him away
And I thought of a girlfriend or a young wife
And a state trooper knocking in the middle of the night
To say your baby died in a wreck on the highway
Sometimes I sit up in the darkness
And I watch my baby as she sleeps
Then I climb in bed and I hold her tight
I just lay there awake in the middle of the night
Thinking 'bout the wreck on the highway
Pending Sales of Existing U.S. Homes Fall 7.7%, More Than Double Forecasts
Fewer Americans than forecast signed contracts to buy previously owned homes in January as the housing slump deepened at the start of its fourth year. The index of pending home resales fell 7.7 percent after a 4.8 percent gain in December, the National Association of Realtors said today in Washington. A lack of credit and record foreclosures that are pushing property values even lower may keep prospective buyers out of the market for much of 2009. President Barack Obama has pledged to keep more Americans in their homes and create jobs, and Federal Reserve Chairman Ben S. Bernanke today said policy makers may need to expand aid to the banking system.
"There are just too many headwinds for homebuyers -- tight credit, mounting job losses and fears of further price declines," said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. "The housing market is showing no sign of a bottom. This could be the story for the first half of this year." Economists forecast a 3.5 percent drop in pending sales after an originally reported gain of 6.3 percent in December, according to the median forecast of 32 economists in a Bloomberg News survey. Estimates ranged from declines of 0.8 percent to 5 percent. Policy makers may need to boost aid to banks beyond the $700 billion already approved and take other aggressive measures even at the cost of soaring fiscal deficits, Bernanke said in the text of testimony before the Senate today. The chairman last week warned the recession may last into 2010 unless policy makers can stabilize the financial system.
Stocks held gains following Bernanke’s comments and Treasury securities fell. The Standard & Poor’s 500 index rose 0.7 percent to 705.81 at 10:21 a.m. in New York. The yield on the benchmark 10-year note rose to 2.94 percent from 2.86 percent late yesterday. Pending resales are considered a leading indicator because they track contract signings. The Realtors’ existing-home sales report tallies closings, which typically occur a month or two later. The pending index was first published in March 2005 and included data going back to January 2001. The group’s index decreased to 80.4 in January, the lowest level since records began.
Three of four regions dropped, led by a 13 percent slump in the Northeast and a 12 percent slide in the South. Pending sales increased 2.4 percent in the West. Compared with January 2008, pending sales decreased 6.4 percent. Sales of previously owned homes, which account for about 90 percent of the market, fell in January to the lowest level since 1997, according to the Realtors group. New-home purchases, which make up the rest, plunged to the lowest level since records began in 1963, Commerce Department figures showed. The median price for existing and new houses decreased in January from a year ago, the reports showed.
Falling prices and lower borrowing costs have brought more homes with reach of buyers. The NAR’s affordability index jumped to 166.8 in January, the highest level since records began in 1970. "Even with many serious potential home buyers on the sidelines waiting for passage of the stimulus bill, job losses and weak consumer confidence were a natural drag on home sales," Lawrence Yun, the group’s chief economist, said in a statement. "We expect similarly soft home sales in the near term, but buyers are expected to respond to much improved affordability conditions." The Standard & Poor’s 500 Supercomposite Homebuilding Index fell 20 percent in the first two months of this year as sales plunged. The index dropped 76 percent over the last three years. Pulte Homes Inc., the largest U.S. homebuilder, last month reported its ninth consecutive quarterly loss.
Housing-related companies are also struggling. Home Depot Inc., the largest home-improvement retailer, had a fourth-quarter loss, closed its Expo design unit and is cutting about 7,000 jobs. "The home improvement market in 2009 will remain just as challenging as 2008," Chief Executive Officer Frank Blake said in a statement on Feb. 24. The economy shrank at a 6.2 percent annual rate in the fourth quarter, the most since 1982, revised government figures showed last week. Home construction contracted at a 22 percent pace following a 16 percent decline in the prior quarter. Policy makers are counting on a series of steps to stem the deterioration. Obama last month introduced a plan to help as many as 9 million people restructure mortgages to avoid foreclosures. The Treasury Department is doubling the amount of stock purchases of Fannie Mae and Freddie Mac, the mortgage-finance companies now under government control.
GM slashes production as US sales drop 53 percent
Struggling General Motors announced plans to slash second quarter production by 34 percent Tuesday as it reported a whopping 53 percent drop in year-on-year US sales for February. GM estimated that total retail sales for the month were down 45 percent compared with February 2008, which would make it the weakest February since 1967. GM said its poor performance in February was driven by a 75 percent reduction in low-margin fleet sales. "It remains a tough and challenging market, but seeing some upticks in volume and showroom traffic compared with last month is encouraging," Mark LaNeve, GM's vice president for North American sales, service and marketing said.
GM delivered 127,296 vehicles in February. Car sales of 53,813 units were off 50 percent and truck sales including crossovers of 73,483 were down 55 percent compared with a year ago. GM said it would cut second quarter production to 550,000 vehicles from 834,000 vehicles in the second quarter of 2008. Truck production will fall to 355,000 units from 452,000 in 2008 while car production will be cut to 195,000 units from 382,000 vehicles in 2008.
Ford February U.S. Sales Fell 48%; Toyota’s Slid 40%; Nissan Down 37%
Ford Motor Co.’s U.S. sales tumbled 48 percent in February, Toyota Motor Corp.’s declined 40 percent and Nissan Motor Co.’s slid 37 percent as unemployment rose and consumer confidence weakened. The figures may herald monthly sales that were the lowest for the industry in almost 27 years. Seven analysts in a Bloomberg survey estimated declines averaging 45 percent for General Motors Corp. and 50 percent for Chrysler LLC. Honda Motor Co. may post a 32 percent slide, based on three analysts. "It’s going to get worse before it gets better," said Joe Barker, an analyst at consulting firm CSM Worldwide Inc. in Northville, Michigan. "We do anticipate the sales rate to bottom this quarter. That’s not to say that we’re anticipating the second quarter to be any sort of real rebound, only slightly better than the first quarter."
Ford’s sales of cars and trucks dropped to 99,400 from 192,799 a year earlier, according to a statement today from the Dearborn, Michigan-based company. Toyota reported a decline to 109,583 from 182,169, and Nissan said its sales fell to 54,249 from 86,219. Industry sales at these levels make it more challenging for Detroit-based GM and Auburn Hills, Michigan-based Chrysler to become profitable and pay back $17.4 billion in U.S. loans. President Barack Obama’s auto task force may approve as much as $21.6 billion more aid for the two automakers and support for the thousands of companies that supply them with parts. "At this point, it’s not as much credit as it is a consumer confidence issue," Al Castignetti, Nissan’s vice president of U.S. sales, said in an interview. "Even if you can afford the loan, people are not willing to take on the risk right now because of concern about jobs."
Toyota, forecasting its first loss in 59 years, may ask for 200 billion yen ($2 billion) in loans for its credit unit from the Japanese government as private financing has become too expensive, public broadcaster NHK reported today, without naming its source. "I don’t know if it’s going to climb back up quickly enough to support the struggling automakers who are borrowing money on a quarterly basis," said Stephen Spivey, an automotive analyst at Frost & Sullivan in San Antonio. "I don’t know if that is strong enough to support this industry through 2009." Automakers may report today that new vehicles sold at a seasonally adjusted annualized rate of 9.5 million cars and light trucks, according to the average estimate of 27 analysts and economists surveyed by Bloomberg. That rate would be the lowest since June 1982, when the U.S. had less than three-fourths as many licensed drivers.
"Until we get the housing market corrected, confidence back on Wall Street and the credit flowing once again I’m afraid we’re going to be stuck" near the 9 million annualized sales rate, CSM’s Barker said. Annual U.S. sales of cars and light trucks averaged more than 16 million this decade. Ford’s sales were hurt by a 55 percent decline to 23,614 for its F-Series pickup trucks. Sales for the Volvo unit, which Ford wants to sell, were also down 55 percent. The automaker trimmed its second-quarter North American production plan by 38 percent from a year earlier to reduce inventory. Sales for Toyota City, Japan-based Toyota, the world’s largest automaker, were dragged down by declines of 60 percent for its Tundra large pickup and 51 percent for the Yaris small car. Volkswagen AG said February sales for its namesake brand declined 18 percent to 13,660. Daimler AG said sales of its Mercedes-Benz and Smart vehicles fell 21 percent to 15,614.
Hyundai Motor Co., South Korea’s largest automaker, said it sold 30,621 vehicles last month, a 1.5 percent decline from a year earlier. In January, Seoul-based Hyundai was the sole major automaker to post a gain in U.S. sales. February had 24 selling days, one fewer than in the same month of 2008. The analyst estimates are based on the daily sales rate, and some automakers report on that basis. Bloomberg uses unadjusted figures, which for February would be about 4 percentage points lower that the adjusted numbers. The Conference Board said Feb. 24 its measure of consumer confidence plunged to the lowest in 42 years of record-keeping. U.S. employers probably shed 650,000 jobs last month, the most since 1949, according to the median estimates in a Bloomberg survey before the Labor Department’s March 6 report. The jobless rate for January was 7.6 percent, the highest since 1992.
Obama insists economy will rebound
President Obama today said he was "absolutely confident" that the economy will rebound as his policies take hold, and he urged Americans to look beyond the immediate impact of falling stock markets. Speaking to reporters after meeting in the Oval Office with British Prime Minister Gordon Brown, Obama cautioned that it will take time to reverse the problems caused by past government decisions. "We dug a very deep hole for ourselves," Obama said during a televised media availability. "There were a lot of very bad decisions that were made. We are cleaning up that mess. "It is going to be fits and starts to get the mess cleaned up, but it is going to be cleaned up," he said. "We are going to recover and emerge more prosperous and unified, and I think more protected from systemic risk, than ever before. "
Obama spoke on a day when top officials including Treasury Secretary Timothy Geithner testified before Congress. Defending Obama's budget proposals, Geithner told the House Ways and Means Committee that additional spending was needed to help pull the country out of one of the worst economic downturns in recent memory. He defended Obama's plan to spend on health, education and infrastructure even though it would increase the budget deficit to $1.75 trillion. In addition to spending, Obama is seeking to allow tax cuts on the rich to expire as a way of raising revenue. He successfully pushed a $787-billion stimulus package through Congress.
The Obama administration has also left open the door to a second round of funding for financial institutions and is working on details of a plan to deal with the toxic assets that have clogged the financial system and hurt borrowing. "I'm absolutely confident that they will work," Obama said of his proposals. "And I am absolutely confident that credit will be flowing again, that businesses will be seeing opportunities for investment. That they will start hiring again and that people will be put back to work." He noted the continuing slide of the Dow Jones industrial average to lows not seen since the 1990s, but urged Americans to remain focused on the future.
"What I am looking at is not the day-to-day gyrations of the stock market but the long-term ability for the United States and the world to regain its way," he said. "The stock market is sort of like a tracking poll in politics, it bobs up and down, day to day and if you spend all of your time worrying about that, then you're probably going to get the long-term strategy wrong. "The banking system has been dealt a heavy blow," he continued. "There are a lot of losses working their way through the system so it is not surprising that the market is hurting as a consequence." Brown stressed that the economic problems were global in nature and needed to be tackled everywhere. "A bad bank anywhere can affect good banks everywhere," he said.
Obama Says Now May Be Good Time to Buy Stocks
U.S. President Barack Obama said falling stock prices may mean bargains for investors with a “long-term perspective.” Obama, who is seeking to boost public confidence in his strategy to revive the economy, noted that major U.S. stock indexes have continued to fall this year as the recession in the U.S. deepens. “What you’re now seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal, if you’ve got a long-term perspective on it,” Obama said at the White House today where he was meeting with British Prime Minister Gordon Brown on battling the effects of a global recession.
The Standard & Poor’s 500 Index, the benchmark measure of U.S. stocks, has dropped 23 percent this year following a 38 percent decline in 2008 that was the steepest annual retreat since 1937. The S&P 500 was little changed at 700.67 at 1:22 p.m. in New York after closing at the lowest level since October 1996 yesterday. The Dow Jones Industrial Average rose 4.15 points to 6,767.44. “There are a lot of losses that are working their way through the system,” Obama said. “And it’s not surprising that the market is hurting as a consequence.” He compared the daily market fluctuations to a tracking poll in politics and said he wouldn’t be adjusting his policies just to meet daily market expectations.
“If you spend all your time worrying about that, then you’re probably going to get the long-term strategy wrong,” he said. He said that consumer confidence is “taking root” with enactment of the $787 billion package of spending and tax cuts he won from Congress last month. Along with the stimulus plan, Obama also has announced plans to revamp regulations for U.S. financial markets and moved to shore up banks as part of his economic recovery strategy. Obama’s budget seeks standby authority for as much as $750 billion in new aid to the financial industry.
Obama and Brown said stabilizing the banking system is crucial to reviving economies around the world. “We’ve got to isolate bad assets,” Brown told reporters. “A bad bank anywhere can affect a good bank anywhere.” Brown, who will be the host for a summit of the Group of 20 developed and developing countries in London on April 2, aims during today’s pre-summit talks with Obama to forge a partnership to fight the financial slump.
Geithner Says U.S. Financial Rescue 'Might Cost More' Than $700 Billion
Treasury Secretary Timothy Geithner said the U.S. bank rescue program may cost more than the $700 billion and pledged to crack down on companies and individuals who try to avoid paying taxes. Testifying before the House Ways and Means Committee on the Obama administration’s 2010 budget, Geithner pledged to work with Congress to "determine the appropriate size and shape" of further bailouts. "As expensive as it already has been, our effort to stabilize the financial system might cost more," Geithner said in prepared remarks. He urged lawmakers to "commit" to cutting the $1.3 trillion budget shortfall this year and reiterated the administration’s pledge to cut it to $533 billion, or 3 percent of gross domestic product, by 2013.
The Treasury chief told lawmakers that the administration will unveil a series of "legislative and enforcement measures" in coming months to crack down on companies and wealthy individuals who use offshore accounts to avoid paying taxes. The agency also plans to propose rules that would curb companies’ ability to delay paying U.S. tax on their foreign earnings, Geithner said. Today’s hearing marked Geithner’s first appearance before the panel that writes U.S. tax law. His nomination faced resistance earlier this year in the Senate after Geithner, who oversees the Internal Revenue Service, agreed to repay almost $50,000 in back taxes and penalties.
Last week, President Barack Obama sent Congress a $3.55 trillion budget for the fiscal year beginning Oct. 1. It would increase spending by 32 percent over this year, resulting in a deficit of $1.17 trillion. Obama left a $250 billion "placeholder" in the budget for additional aid to the financial industry. In his testimony, Geithner said that "doesn’t represent a specific request." Geithner said that the recently passed economic stimulus bill would save or create at least 3.5 million jobs over the next two years and boost gross domestic product by almost 1 percent this year and more than 3.2 percent in 2010. He added that the economy is projected to have recovered by 2011. He also touted an administration proposal that would increase the tax rate on managers of investment partnerships by making them pay ordinary rates as high as 39.6 percent on profit shares known as "carried interest." That income now is often taxed at the 15 percent capital gains rate. "The tax code will provide equal tax treatment for wages regardless of whether an individual works as a teacher or a hedge fund manager," he said.
Bernanke Says U.S. May Need More Than Approved $700 Billion to Fix Banks
Federal Reserve Chairman Ben S. Bernanke said policy makers may need to expand aid to the banking system beyond the $700 billion already approved and take other aggressive measures even at the cost of soaring fiscal deficits. "Without a reasonable degree of financial stability, a sustainable recovery will not occur," the Fed chairman said today in testimony prepared for the Senate Budget Committee. "Although progress has been made on the financial front since last fall, more needs to be done." Bernanke’s comments suggest he sees a role for bigger federal outlays as the Obama administration seeks congressional approval for a budget of $3.55 trillion for the fiscal year beginning in October.
President Barack Obama has already signed into a law a $787 billion economic stimulus package of tax cuts and government spending. Obama’s first budget seeks standby authority for as much as $750 billion in new aid to the financial industry. Whether those funds will be needed "depends on the results of the current supervisory assessment of banks" and the evolution of the economy, Bernanke said. Bernanke said policy makers would have "preferred to avoid" what is likely to be the largest ratio of federal debt compared with gross domestic product since the end of World War II, and he urged lawmakers not to lose sight of fiscal discipline.
"But our economy and financial markets face extraordinary challenges," and doing less now would eventually prove to be more costly, he said. "We are better off moving aggressively today to solve our economic problems; the alternative could be a prolonged episode of stagnation" that would cause budget deficits to swell further, increase unemployment and undermine incomes "for an extended period." The Fed has more than doubled its assets to $1.9 trillion during the past year by expanding loans to banks, launching programs to revive commercial paper and other markets and backing the merger of Bear Stearns Cos. with JPMorgan Chase & Co.
The 55-year-old Fed chairman told the Senate Banking Committee last week there’s a "reasonable prospect" the recession will end in 2009 "if the actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measures of financial stability." Fed policy makers face headwinds from equity markets, with the Standard and Poor’s 500 Index falling this year by 22.5 percent and the S&P Financials Index tumbling 44.2 percent. The government is still trying to stabilize large financial institutions such as Citigroup Inc. and insurer American International Group Inc. Shares of Citigroup traded at $1.33 this morning at 9:33 a.m., and the government expanded its aid to AIG yesterday after the company reported a fourth-quarter loss of $61.7 billion, the worst loss by any U.S. corporation.
The spending blueprint delivered to Congress last month forecasts government spending this year of $3.94 trillion, up 32 percent from a year ago. That would yield a record deficit of $1.75 trillion in the year ending Sept. 30, equal to about 12 percent of the nation’s gross domestic product, the highest since World War II. Government spending of $3.55 trillion next year will include about $350 billion approved as part of the stimulus package. "By supporting public and private spending, the fiscal package should provide a boost to demand and production over the next two years as well as mitigate the overall loss of employment and income that would otherwise occur," Bernanke said.
Still, the size of the impact on the economy from government spending is "subject to considerable uncertainty," Bernanke said. Consumers may decide to pay down debt or save their cash rather than spend it, he noted. January forecasts by Fed officials suggest "a full recovery of the economy from the current recession is likely to take more than two or three years," Bernanke told lawmakers last week. The U.S. unemployment rate rose to 7.6 percent in January, the highest level since 1992. Job losses spanned almost all industries from trucking and construction to retailing and finance. Fed officials expect unemployment in the fourth quarter to average 8.5 percent to 8.8 percent, which would be the highest since 1983, according to their January forecasts. Gross domestic product will contract 1.3 percent to 0.5 percent, and inflation will run at just 0.3 percent to 1 percent this year, their projections indicate.
Fed officials don’t see labor markets improving until 2011, when growth forecast at 3.8 percent to 5 percent reduces the unemployment rate to a range of 6.7 percent to 7.5 percent. Economic models used by Macroeconomic Advisers LLC show the Obama stimulus package could keep the jobless rate at about 8.8 percent instead of the 9.5 percent rate that would result without the package. The Fed is stepping up efforts to stem the worst credit crisis in seven decades by expanding a program aimed at supporting consumer and business loans to $1 trillion from $200 billion and adding commercial real estate. It is also buying $600 billion of debt sold by government-backed housing finance companies and mortgage-backed securities they guarantee.
A $200 Billion Credit-Crunch Buster?
The Fed unveils the details behind its plan to jump-start consumer and small business lending
The federal government on Mar. 3 provided some long-awaited answers on how it plans to unlock consumer and small business credit markets, which have been frozen more solid than an icy tundra. The $200 billion joint Federal Reserve Board and U.S. Treasury program, known as the Term Asset-Backed Securities Loan Facility, or TALF, is intended to get money flowing for small employers, student-loan providers, credit-card issuers, and auto lenders. TALF was first announced late last year, but with only hazy parameters and few details. Whereas the better-known Troubled Asset Relief Program, or TARP, was created to bail out banks, TALF's purpose is to induce investors to buy up AAA-rated securities backed by new consumer and small business loans by offering $200 billion in low-interest loans to would-be investors. The idea is that these securities will spur enough investor interest to eventually generate up to $1 trillion of lending.
Since last year, the credit markets have been essentially at a standstill with no new investors willing to purchase securities backed by consumer loans. Requests for loans—which have to meet certain terms and conditions—will be accepted starting Mar. 17, and funds will start being dispersed later in the month. The program will run through December, but could be extended. The $200 billion of Fed backing could also be increased if needed. TALF was supposed to begin a month ago, but in congressional testimony Fed Chairman Ben Bernanke counseled patience and said that a number of legal steps had to be taken before the program's rollout. It remains to be seen, however, whether the program will coax investors back into the markets in a way that revives consumer lending.
Much like mortgages, student loans, credit-card loans, and auto loans normally are packaged together into a security, which is then sold to investors. During the headier years, investors were all too pleased to invest in these securities backed by consumer loans. That enabled lenders to move the loans off their books, and get cash to make new loans. After the mortgage meltdown, however, investors have grown wary of purchasing securities, because they're unsure of the risks for default. Also, some of those investors the Fed and Treasury are counting on are still struggling to off-load toxic securities backed by soured mortgages. Initially the Fed had planned on offering one-year loans to investors. However, officials extended the length of the loans to three years. A longer loan life might help persuade investors to dip their toes in again. But like so many of the government's prior efforts to revive financial markets, it is difficult to predict how the market will respond.
Bernanke Says Insurer AIG Operated Like a Hedge Fund
Federal Reserve Chairman Ben S. Bernanke said American International Group Inc. operated like a hedge fund and having to rescue the insurer made him "more angry" than any other episode during the financial crisis. "If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG," Bernanke told lawmakers today. "AIG exploited a huge gap in the regulatory system, there was no oversight of the financial- products division, this was a hedge fund basically that was attached to a large and stable insurance company." Bernanke’s comments foreshadow tougher oversight of systemically important financial firms, and come as President Barack Obama seeks legislative proposals within weeks for a regulatory overhaul.
The U.S. government has had to deepen its commitment to prevent AIG’s collapse three times since September as the company accumulated the worst losses of any U.S. company. AIG is getting as much as $30 billion in new government capital and relaxed terms on its bailout announced yesterday. The company "made huge numbers of irresponsible bets, took huge losses, there was no regulatory oversight because there was a gap in the system," Bernanke said. At the same time, officials "had no choice but to try and stabilize the system" by aiding the firm. In another sign of tighter regulation to come, Bernanke said supervisors should have authority to bar new financial products that may be destabilizing to markets.
Bernanke made the AIG comments in response to a question from Senator Ron Wyden, an Oregon Democrat, at a Senate Budget Committee hearing today in Washington. In his testimony, the Fed chief said that policy makers may need to expand aid to the banking system beyond the $700 billion already approved, and take other aggressive measures even at the cost of soaring fiscal deficits. "Without a reasonable degree of financial stability, a sustainable recovery will not occur," Bernanke said. "Although progress has been made on the financial front since last fall, more needs to be done." The Obama administration last week unveiled a budget blueprint that included standby authority for as much as $750 billion in new aid to the financial industry.
Whether those funds will be needed "depends on the results of the current supervisory assessment of banks" and the evolution of the economy, Bernanke said today. He also said that while Obama’s $787 billion fiscal stimulus should boost the economy over the next two years and alleviate the slide in payrolls, the size of the impact is "subject to considerable uncertainty." Consumers may decide to pay down debt or save their cash rather than spend it, he noted. U.S. policy makers face headwinds from equity markets, with the Standard and Poor’s 500 Index falling this year by 22.5 percent and the S&P Financials Index tumbling 44.2 percent. The government is still trying to stabilize large financial institutions such as Citigroup Inc. and AIG. Shares of Citigroup traded at $1.25 at 12:19 p.m., and AIG was at $0.45.
AIG’s fourth-quarter loss widened to $61.7 billion, the New York-based insurer said yesterday. The results brought its annual loss to almost $100 billion, prompting the U.S. to offer a package of equity, new credit and lower interest rates on existing loans designed to keep it in business and prevent a new shock to the world’s financial system. The first rescue of the insurer came in September the day after officials couldn’t find a buyer for Lehman Brothers Holdings Inc., leaving the investment bank to file for bankruptcy. AIG also marked a turning point in the relationship between the U.S. Treasury and the Fed, with the central bank pushing then Treasury Secretary Henry Paulson to seek cash from Congress for additional bailouts. "Whether we like it or not, America’s federal policy is now driven by the need to avoid another Lehman," said David Kotok, chairman and chief investment officer of Cumberland Advisors Inc., in Vineland, New Jersey.
The insurer’s first bailout package grew to $150 billion last year. After failing to sell enough subsidiaries to repay the government, the company had to turn to the government again. The company may need more support if financial markets don’t improve, the Treasury and Federal Reserve said in a joint statement yesterday. Bernanke said the revised bailout gives taxpayers "the best chance" of eventually recovering "most or all of the investments" the public has. Critics including former AIG Chief Executive Officer Maurice "Hank" Greenberg said the strategy of breaking apart the insurer and selling units wouldn’t reap enough to repay AIG loans.
Banks relied on AIG’s financial products unit to back about $298 billion of assets through derivative contracts at year-end, making the firm a "systemically significant failing institution" that has to be propped up, the Treasury said. "We’re doing our absolute best in partnership with the Fed and Treasury to unwind the very issues that Chairman Bernanke is talking about in a way that preserves systemic stability and pays back taxpayers," said Christina Pretto, an AIG spokeswoman. AIG has reduced the number of bets made by the financial products unit that sold credit-default swaps by more than 25 percent since October and cut expenses by " hundreds of millions" of dollars, she said.
U.S. rescue efforts may risk double-dip recession
U.S. companies, consumers and communities may grow so addicted to government financial help that cutting them off could trigger another recession soon after the current one ends. Between the U.S. Federal Reserve's trillions of dollars in lending programs, the $787 billion stimulus package and $700 billion -- and counting -- in bank bailout funds, no one can accuse officials of soft-pedaling their crisis response. But there is increasing concern that when the flow of public money subsides -- beginning next year when much of that stimulus package is spent -- the economy still won't be strong enough to stand on its own.
"The stuttering attempts to repair the banking and lending mechanisms so far by the new administration suggests that by late 2010, the specter of a second dip into recession will be looming large," said Merrill Lynch economist Sheryl King. The latest evidence of the government's ever-changing plans came on Monday when insurer American International Group Inc got its third bailout, each with different terms. That did nothing to improve confidence on Wall Street, where investors dumped stocks amid fears that the financial crisis was worsening. The longer it takes to stabilize the financial sector, the more the economy suffers, and that feeds back into bigger loan losses and the need for even more government intervention.
John Silvia, chief economist at Wachovia, said the government's success so far in shoring up markets and reviving the economy resembled the pattern of police patrols. "At each corner where a policeman is stationed, we witness a decline in crime," he said. "In every market where the Fed focuses its liquidity facilities," credit conditions improve. Unfortunately, where there is no direct government support, conditions are grim. Merrill expects unemployment to hit 10 percent by the end of 2009, with house prices losing 10 percent to 15 percent more and the stock market dropping another 20 percent. That could erase $6.5 trillion off of household wealth, on top of the $12 trillion hit consumers have already taken, Merrill's King estimated.
Those losses are a key reason why it is proving so difficult for the government to get much traction with its rescue plans because consumer spending accounts for more than two-thirds of economic activity. Data released on Monday showed that Americans were rapidly rebuilding savings that they had run down in recent years when it seemed like rising home values and healthy stock markets would be enough to pay for retirement. While that may be good for the global economy, which many economists say has been over-reliant on U.S. consumption, "recession has never been successfully arrested with austerity," Citigroup economist Steven Wieting said.
"While consumers in the U.S. will likely never really be the same as they were in the last decade, we can identify no source of growth for the global economy that doesn't involve a partial recovery in U.S. consumption," he said. If spending isn't going back to the way it was, that may make it even harder for the government to ease up on aid. Treasury Secretary Timothy Geithner and Fed Chairman Ben Bernanke have warned repeatedly of the risk of pulling away the economic supports too soon. However, Bernanke and other Fed officials have also stressed the need for a clear exit strategy to ensure that their repair efforts don't spawn inflation.
In essence, the Fed and Treasury have been forced to take the place of the securitization market, where countless loans were repackaged and sold off to investors all over the world. While that proved to be the transmission mechanism for the financial crisis, it was also a vital aspect of lending and its collapse contributed to the global economic slump. The Fed's own lending data shows that efforts to get money flowing again were having limited effect on the broader economy. Confidence has fallen so sharply that even those who can get credit are reluctant to borrow and spend. According to the Fed's January survey of senior loan officers, 60 percent of domestic banks reported reduced demand for commercial and industrial loans, up from 15 percent in the October survey.
Some of the Fed's lending programs should wind down with little disruption because once credit markets improve, borrowers will be able to find better terms elsewhere, and the central bank can once again be the lender of last resort instead of the only viable option. Extricating the Fed and Treasury from other means of support won't be so easy. "Major industries have become dependent on federal assistance, and they will be followed by cities and states bearing mind-boggling requests," investor Warren Buffett wrote in his annual letter to shareholders. "Weaning these entities from the public teat will be a political challenge. They won't leave willingly."
Aid to carmakers a waste of scarce money: OECD
Governments worldwide must resist the temptation to bail out car manufacturers, steel producers or any sector other than the systemically crucial finance industry, OECD chief economist Klaus Schmidt-Hebbel said on Tuesday. Even if it looks politically expedient in the time of recession, protectionism in all shades ultimately does more harm than good as the Great Depression and trade friction that preceded World War Two show, Schmidt-Hebbel said. The Organization for Economic Co-operation and Development issued a report on Tuesday where it suggested that governments should pursue policies that promote both short- and long-term economic growth while avoiding steps that shelter national industries from international competition.
Commenting on the implications of the report, Schmidt-Hebbel dismissed the idea that the troubled auto sector, which in some countries accounts directly and indirectly for one in 10 jobs, should be considered as systemically important like banks. "If you let your financial sector go down, as a sector or the main players ... an entire economy goes from recession to deep crisis and deep recession. That's what the late '20s and early '30s was about," Schmidt-Hebbel told Reuters during an interview on the report. "If you let one or two big car producers, or in the extreme you let your entire national car industry go down ... then demand for domestic cars would be substituted by higher imports," he said.
"It's not systemic from the point of view that if you let it go down the rest of the economy goes down." "If you let Ford go down, then demand for Ford vehicles goes elsewhere -- to General Motors or another competing auto producer," Schmidt-Hebbel said by way of hypothetical illustration. "When you let Lehman Brothers or Citibank go down, the demand for financial services, or the supply of deposits to other banks goes down too because everybody is scared and leaves their money under the mattress."
Schmidt-Hebbel highlighted the car sector as getting government money in many countries such as the United States, France, Spain, Italy and Germany. This did not make economic sense because the industry had made too many cars for too long and would have to shrink in the years ahead, not because of recession but overcapacity. Additionally, public aid for specific sectors was not a good idea because other sectors would queue up for similar aid from a limited pool of public funds, said Schmidt-Hebbel, arguing that broad-ranging macro-economic measures were preferable. "So where do you stop? It's totally arbitrary," he said.
"The car industry is 10 pct of GDP in some countries ... but what about the next largest? Say, consumer durables in Germany or in the U.S., where they produce maybe not 10 but 7 percent of jobs. Then comes construction at 5 percent, and so on." The OECD report recommended anti-recession measures such as rapidly deployable public spending on infrastructure and particularly in areas where the money was invested in the future, notably in schools for example. That is the case in the plans formulated by U.S. President Barack Obama and in Germany, Schmidt-Hebbel said.
Schmidt-Hebbel acknowledged that massive job losses in the car industry made it difficult for politicians to resist the temptation to provide short-term aid. Where that happened, it should be as short-lived as possible, he said. He said statements committing large groups of countries such as the G20 club of industrialized and emerging market economies to sustained free trade were positive and should help to limit the spread of protectionism even if some countries were not fully living up to those commitments.
OECD: Downturn to be deeper even than IMF forecast
The global economic downturn will be considerably deeper than even the International Monetary Fund forecast a month ago, the Organisation for Economic Co-operation and Development's chief economist Klaus Schmidt-Hebbel told Reuters. Further substantial cuts in interest rates by the European Central Bank and Bank of England are totally justified, he said in an interview. These were to be expected in response to the worst spell the economy has suffered since 1946, when military spending plunged after World War Two. "The recession will deepen...there's no doubt," he said. "I think this quarter will be the worst quarter of all."
On Jan. 28, the IMF cut its forecast for global growth to 0.5 percent in 2009 from an earlier prediction of 2.2 percent. It also forecast a 2.0 percent slide in economic output from the world's most advanced economies as a whole, an equally large downgrading of forecasts it had made in November 2008. Even those drastic revisions failed to reflect the extent of the downturn at this stage, said Schmidt-Hebbel. He is preparing new forecasts for publication at the end of March by the Paris-based OECD, which will be cutting its own predictions from those it made last November.
"The shape of it will be a significantly deeper recession than what was forecast by the IMF in January, at all levels," said Schmidt-Hebbel. "(It will be) significantly deeper and more protracted -- meaning longer than what is embodied in the IMF forecasts of late January." Last November, the OECD predicted a 0.4 percent decrease in aggregate economic output this year from its 30 member countries. These include all of the wealthy industrialised countries and a handful of less mature economies such as South Korea, Mexico and Turkey.
"The OECD economies will do significantly worse than the world economy because in emerging economy countries like the Indias, Chinas and some others, growth will still be slightly positive in 2009," he said. Schmidt-Hebbel said the current quarter would probably prove to be the worst one in the international downturn, after an already very bad final quarter of 2008 where U.S. output fell faster than in any quarter for 26 years. The U.S. Federal Reserve has pushed official interest rates close to zero and Japan's central bank is already at that point, though other central banks still have more leeway.
"We are expecting, and forecasting formally, significant further interest rate cuts by the Bank of England, the ECB and a number of other OECD countries with independent central banks, towards very low rates, which I think is absolutely justified by the outlook on inflation and activity for the next one or two years," Schmidt-Hebbel said. This would be what the OECD would say on rates when it published its new official forecasts at the end of March, he said. Reuters polls show economists expect the ECB to cut its main euro zone rate by 50 basis points from the current 2.0 percent on Thursday and that the Bank of England too will lower its rate the same day from a current level of 1.0 percent
Schmidt-Hebbel said interest rate cuts had a limited power to support economic growth. That increased the need to consider less conventional moves, such as direct asset purchases, or "quantitative easing" of credit conditions along the lines being deployed in the United States and now Britain, he said. Schmidt-Hebbel offered one relative note of optimism. "Certainly, this will be the worst recession since 1946 ... but again this is not the Great Depression, when we saw GDP fall by 20 percent in some major economies from peak to trough.
Schmidt-Hebbel was presenting a new OECD report on Tuesday in which the OECD said the governments should pursue "double dividend" policies to address both the current crisis and the need for sustainable growth in the longer term. Public investment in infrastructure should be deployed fast with a focus on areas such as school building, said the report. Money should be channelled towards retraining of workers for industries with a future and payroll taxes reduced for low earners in particular, it said. Training auto sector workers so that they could move on from an industry condemned to contract was one example, Schmidt-Hebbel noted.
Central Banks Weigh Unorthodox Steps to Stem Economic Downturn
As European central banks gear up to cut their key rates closer to zero, policy makers are increasingly considering using tools apart from interest rates to goose faltering economic growth. Tuesday's news that Switzerland slipped into a technical recession in the fourth quarter of 2008 firmed expectations that the Swiss national bank will lower its key rate closer to zero. The U.S. Federal Reserve lowered its key rate to near zero in December. The Swiss National Bank is now expected to lower its policy rate to a historic low of 0.25% from the current 0.5% when it meets next Thursday. The European Central Bank and Bank of England, both of which announce rate decisions this Thursday, are also expected to discuss taking unconventional policy steps to unclog jammed credit markets.
Switzerland's gross domestic product contracted by 0.3% in the fourth quarter from the third quarter, government agency Seco said. That marks two consecutive quarters of declines, a common definition of a technical recession. "Contracting exports combined with slumping investment and easing private consumption is a worry for Switzerland and suggests that economic growth will come in significantly weaker in 2009," said Moody's economy.com economist Melanie Bowler. Swiss central bank officials have in the past few weeks indicated that their next monetary-policy steps could include elements such as buying government bonds to boost the amount of money in the Swiss economy or intervening on the foreign-exchange market to weaken the Swiss franc or stem a rise in its value relative to other currencies.
Separately, U.K. Chancellor of the Exchequer Alistair Darling indicated that the Bank of England could boost the money supply through the purchase of assets such as government debt as soon as this month. "We've given them the levers," Mr. Darling said in an interview with the Daily Telegraph conducted Monday. "They may decide this month that it's appropriate to do so." The framework under which the measures would be implemented is due to be published in an exchange of letters between Mr. Darling and Bank of England Governor Mervyn King. Most economists expect the central bank's Monetary Policy Committee to announce the start of such steps following its two-day meeting ending Thursday.
Markets expect the government to allow the central bank to increase money supply by about £100 billion to £200 billion (about $140 billion to $280 billion) by purchasing public and private-sector securities. The bank also is widely expected to cut its main policy rate to 0.5% from 1% on Thursday. The European Central Bank, expected to cut interest rates again on Thursday after more signs of economic contraction in February, also could soon begin introducing unorthodox monetary policies to feed cash into companies. ECB governing-council member Christian Noyer said the central bank for the 16 countries using the euro was studying whether to go ahead with plans to release more money in to the economy by unconventional means, saying the ECB was considering all options. The ECB is expected to cut interest rates to 1.5% from the current 2% after witnessing a string of negative economic indicators, including contracting manufacturing and rising unemployment.
Our Great Recession
by Niall Ferguson
This recession, which began in December 2007, has already lasted longer than the average postwar recession. If it turns out to be as bad as the most protracted of the postwar downturns, we will touch bottom next month. But my strong suspicion is that we are now in something more like a Great Recession. It won’t produce as steep a fall in American output as the Depression did, but it may prove to be as prolonged. The depression that began in August 1929 did not hit its nadir until 43 months later. The one that started in October 1873 was shallower but lasted 65 months. If the economy were to keep shrinking for that long, we wouldn’t start coming out of this until after May 2013. Is that possible?
This is a crisis of excessive debt, the end of the Age of Leverage. It will take longer than a few more months to resolve bank and household insolvency, especially with asset prices continuing to fall so rapidly. Even with zero interest rates and huge deficits, Japan suffered a "lost decade" in the 1990s — and that was when the rest of the world was doing well. This recession is taking place as the rest of the world is doing even worse than the United States. The collapse of trade as measured by East Asian export data is petrifying. So far in this recession, remember, we have had only two consecutive quarters of declining gross domestic product. At the moment, I find it quite easy to imagine two consecutive years of contraction. And I don’t rule out two more lean years after that.
Fed, Treasury Launch TALF Program
The U.S. Treasury and Federal Reserve launched a highly anticipated lending facility Tuesday aimed at generating up to $1 trillion in consumer and small business loans. The Term Asset-Backed Securities Loan Facility, which is scheduled to begin disbursing funds March 25, will make loans to purchasers of AAA-rated securities backed by new auto, credit card, student and Small Business Administration guaranteed loans. The facility is commonly referred to as the TALF. "By reopening these markets, the TALF will assist lenders in meeting the borrowing needs of consumers and small businesses, helping to stimulate the broader economy," the Treasury and Fed said in a joint statement. Requests for funding from the facility will be accepted beginning March 17. The program will offer new funding on a monthly basis through December 2009 or later, at the Fed's discretion.
The L Curve
by Nouriel RoubinI
Last year, the debate over how long the recession will last was between those in the consensus who argued that it would be V-shaped — only about eight months long like those in 1990 to 1991 and in 2001 — and those like me who argued that it would last at least three times as long, 24 months, and be more than three times as deep as the previous two. Today, as we enter the 15th month, it’s obvious that we are already in a painful U-shaped recession that has become global and will last at least until the end of the year — 24 months, the longest since the Great Depression.
Even if the gross domestic product grows in 2010, it is likely to be no higher than 1 percent. And at that rate, with the unemployment rate rising toward 10 percent, we will still be substantially in a recession. Even if appropriate aggressive policy actions were undertaken — monetary and fiscal stimulus, bank clean-up and credit restoration, mortgage debt reduction for insolvent households — the growth rate would not rise closer to 2 percent until 2011. So this recession may last 36 months.
And things could get worse. We now face a 1 in 3 chance that, if appropriate policies are not put in place, this ugly U-shaped recession may turn into a more virulent L-shaped near-depression or stag-deflation (a deadly combination of economic stagnation and price deflation) like the one Japan experienced in the 1990s after its real estate and equity bubbles burst.
What A "Bad Asset" Is
As Joe Weisenthal notes, the idea that there's "no market" for the mountains of crap the big banks have piled on their balance sheets is a crock. There is absolutely a market. It's just a market that produces a price that the banks don't want to accept. Sound familiar? It should. Millions of American homeowners are telling themselves the same story. It's not that their houses are only worth 50% of what they paid for them. It's that there's a "liquidity crisis" and buyers can't the financing necessary to pay 125%. So it's time we had a more accurate definition of "bad asset." Here it is:A "bad asset" is an asset that is worth less than the owner says it's worth.Which is to say, most assets these days. The problem for our banks is not that they own assets that are worth pennies on the dollar. It's that the banks are still claiming the assets are worth, say, 80 cents on the dollar. It's the difference between the claimed value and the actual value that makes the asset "bad." (In fact, for a potential buyer with cash, some of these assets could prove to be quite "good." As long as the banks are forced to sell them for what they're actually worth.)
Get bad assets off bank books, Fed's Rosengren says
A central lesson of the banking crisis in Japan a decade ago is that so-called bad assets must be quickly removed from banks' balance sheets or else management will fixate on the errors of the past to the exclusion of making new loans, the president of the Federal Reserve Bank of Boston said Monday. "I believe it would be desirable to move quickly to remove problem assets from bank balance sheets, so banks can once again focus on future prospects rather than past mistakes," Boston Fed chief Eric Rosengren told a conference of international bankers. "Banks without troubled assets focus on avoiding further losses and further depleting capital," he said. The assets should not be managed by the government, according to Rosengren. Japan's experience in the 1990s -- called the "lost decade" in which government reluctance to deal with problem institutions gave rise to what were known as "zombie banks" -- has been a subject near and dear to the hearts of U.S. policy makers recently as they seek to hit upon a solution to the nation's lending woes.
The current U.S. model -- in which the Federal Deposit Insurance Corp. closes a bank, removes the bad assets and quickly disposes of the good assets -- works well, Rosengren said. Conversely, allowing weak banks to struggle on in hopes of recovery is not a good idea, he said. In some cases, weak Japanese banks supported troubled borrowers in an effort to prop up loans while at the same time they ignored more creditworthy borrowers. Troubled banks have an incentive to postpone reserving problem loans because it would further deplete capital. So allowing wounded banks to continue operating only serves to hurt prospects for recovery, he said. "The evidence from Japan and previous problems in the U.S. indicates that allowing poorly capitalized banks to continue operations with insufficient capital is likely to exacerbate problems with credit availability," Rosengren said.
"This is a reason for moving to resolve, as quickly as possible, banks that are clearly insolvent," he said. Another lesson from Japan in the 1990s is that regulators must act with a soft touch because troubled banks are reluctant to make new loans or address problems with troubled assets, he said. For instance, under present rules, loan-loss reserves at banks soar after a crisis has occurred -- precisely when the economy needs bank capital to be put to use. Rosengren didn't propose a solution to this problem but said it was something that regulators should think about. Rosengren didn't address nationalization in his remarks.
'Bad Bank' Funding Plan Starts to Get Fleshed Out
The Obama administration, filling in some of the blanks in its bank bailout, is considering creating multiple investment funds to purchase the bad loans and other distressed assets that lie at the heart of the financial crisis, according to people familiar with the matter. The Obama team announced its intention to partner with the private sector to buy $500 billion to $1 trillion of distressed assets as part of its revamping of the $700 billion bank bailout last month. It's central to the administration's efforts to unglue credit markets, alongside a Federal Reserve program aimed at spurring consumer lending in areas such as credit cards and home loans that will be officially launched Tuesday.
No decision has been made on the final structure of what the administration is calling a private-public financing partnership, but one leading idea is to establish separate funds to be run by private investment managers. The managers would have to put up a certain amount of capital. Additional financing would come from the government, which would share in any profit or loss. These private investment managers would run the funds, deciding which assets to buy and what prices to pay. The government would contribute money from the $700 billion bailout, with additional financing likely coming from the Federal Reserve and by selling government-backed debt. Other investors, such as pension funds, could also participate. To encourage participation, the government would try to minimize risk for private investors, possibly by offering non-recourse loans.
The public-private partnership grew out of the "bad bank" concept, an idea popular among some economists that would have required the government alone to buy up the troubled assets. The Obama administration jettisoned that idea after running into the thorny issue of pricing. To help banks, the government must pay enough so that firms don't have to suffer additional losses from selling or writing down the value of other similar assets. But there is little public tolerance for overpaying with taxpayer money. Instead, the government wants to encourage private investors to buy up the assets in a way that would come closer to setting a market price where no market currently exists. Some within the administration believe establishing multiple funds could help with that goal. The funds would most likely target all types of assets, such as mortgage-backed securities, rather than focusing on one specific type of distressed security.
Many details remain unclear, in particular, how the government and the private sector will share the risk. An administration official said a key goal is to provide investors with "price safety" so they feel safe enough to get back into the market. Under the Fed's program to jump-start consumer lending, known as the Term Asset-Backed Lending Facility (TALF), investors, including many hedge funds, will get access to cheap loans from the Fed to purchase securities backed by consumer debt like car loans and credit-card receivables. The Treasury has agreed to provide up to $100 billion of capital to the TALF, and the Fed will lend up to $1 trillion through the program. The Fed and the Obama administration also are mulling whether to expand the TALF to existing distressed assets, also known as legacy assets. Such a move could allow the Fed to provide low-interest loans to investors who use the money to purchase distressed mortgage-backed securities or commercial real-estate loans. But such a move also would raise many new questions, among them the amount of protection the Treasury would offer against such risky assets. As a result, the idea might not move forward.
The TALF, which was announced in November, has taken months to get off the ground. To date, no deals have been done under the program. The first is expected to be launched later this month. Officials and some investors see great promise in the effort to jump-start securities markets. "What the Fed has done, and I think it will be effective, is to provide a balance sheet to finance assets for investors who identify credit risks they're willing to take," said Curtis Arledge, co-head of U.S. fixed income at Blackrock. Still, other investors have raised questions about the TALF. For example, issuers of asset-backed securities that benefit from Fed financing must be willing to submit themselves to new Treasury Department limits on executive compensation. Some issuers could be reluctant to travel down that road. Fed officials have spent months sorting out these and other details with market participants. Earlier this year, they had pledged to launch the program by February, but missed the goal.
Worst year for dividend cuts since 1938
US investors are facing the worst year for dividend cuts since 1938, Standard & Poor’s has forecast, as a growing tally of blue-chip companies across the globe slash pay-outs for investors. HSBC and heavyweight US stocks PNC Financial and International Paper on Monday joined the list of companies that moved to save cash by cutting previously sacrosanct dividend pay-outs, confounding investors who had sought the refuge of high yields in the belief they signified the stock market was cheaply valued. The moves dealt a further blow to the confidence of investors still dealing with last week’s bombshell cut from General Electric, which had been the largest US payer of dividends at $13bn (£9.3bn) annually.
The conglomerate slashed its quarterly dividend, reducing its annual pay-out to $4bn in its first cut since 1938. That year marked a decline in S&P 500 dividends of 36.3 per cent, according to Standard & Poor’s. Dividend pay-outs for 2009 are forecast to slide at least 22.6 per cent, the worst year since 1938, said Howard Silverblatt, senior index analyst at Standard & Poor’s. "Cash flow is crucial for companies now and their need to conserve cash will outweigh their desire to pay dividends," he said. JPMorgan took an axe to its dividend last week, while investors in US companies as diverse as Dow Chemical, Motorola and Pfizer and Europe’s insurance groups Axa and Allianz have seen their dividends shrivel. Such cuts have undermined the rationale that high dividend yields for global benchmarks are a buy signal for equities.
The S&P’s current trailing dividend yield – the past pay-outs of companies as a percentage of market capitalisation – of 4 per cent has been well above that of the 10-year Treasury yield since last year, but already this year the S&P has slumped more than 20 per cent. Consensus estimates for the S&P 500 dividend pay-out for 2009 is 3.49 per cent. The FTSE 100 yields 5.46 per cent, more than a percentage point higher than at the turn of the year. However, there has been rising investor concern over whether there could be cuts from BP or Royal Dutch Shell, which comprise 20 per cent of dividends on the index. Gareth Evans, UK strategist at UBS, said: "We do not expect BP or Shell to cut their dividends but there is still a lot of uncertainty given the persistent weakness in the oil price. If they did, this would have a big effect on the market yield." The trailing dividend yield on Europe’s DJ Stoxx 600 Index has risen to 5.27 per cent compared with 4.79 per cent at the start of the year.
AIG: 'Really No Longer With Us'
American International Group is being broken up in exchange for getting yet another lifeline from the government To the average U.S. taxpayer, the math may not sound right: After pumping in about $150 billion of federal money, American International Group (AIG) posts a quarterly loss of almost $62 billion—the largest in American corporate history. And now it will have access to $30 billion in new cash from Washington. American International Group is being broken up in exchange for getting yet another lifeline from the government. The former insurance giant posted a staggering $61.7 billion loss for the fourth quarter (about $22.95 per diluted share).
Now, AIG is putting what many consider to be its most valuable insurance assets—American International Assurance and its Asian operations—under direct government control. Once the businesses are sold, taxpayers will reap the benefits. I was struck by what Hugh Hendry, chief investment officer at Eclectica Asset Management, told cable channel CNBC on Mar. 2: "AIG is really no longer with us…I think the reality is (a lot of financial companies) left the business last year."
This is the fourth iteration of government support. Its goals in stepping up yet again are likely threefold:
- Avoid a downgrade in AIG's credit rating, which would make it even tougher for the insurer to sustain its businesses and could prompt collateral calls, forcing it to default on its debt. (Many contracts require a company to post additional collateral if its credit rating drops.)
- Avoid the specter of AIG going bankrupt, which could cause even wider panic in the market. (That said, the value of its stock—still hovering below 50¢ when I last checked—would suggest that few shareholders are optimistic that anyone is going to save them.)
- Preserve as much of the assets of AIG in the hope that taxpayers can recover at least some money when they're sold off. That seems to be the toughest task, given how commercial clients are already starting to defect to other players and few are lining up to buy AIG's prized holdings. That could mean bargain-basement prices for assets such as AIG's marquee building in Tokyo, the loss of which could also be a big blow to the insurer's reputation in that country.
A move to further boost the ailing company is perhaps inevitable and necessary, but Treasury Secretary Timothy Geithner should be prepared for a burst of public anger. AIG has become a potent symbol for anyone who thinks the bailout has thrust taxpayers into quicksand, with commitments that seem to rise with every passing week. This time, at least, no one is pretending that AIG might return to its glory days any time soon. The former $100 billion-a-year giant will be smaller, humbler, and less of a force in the marketplace.
Sale of AIG's Asian assets in doubt
The sale of the Asian life assurance assets of AIG is expected to be delayed or scrapped in the aftermath of the stricken insurer's latest $30bn bail-out by the US government on Monday, according to people familiar with the process. As part of the revised terms, AIG is to hand to the US government a large stake in American International Assurance, the leading pan-Asian foreign insurer.
AIG was in the process of selling AIA to raise up to $20bn in funds to help repay its debts, and three groups made first-round bids before last week's deadline. People familiar with the situation said Prudential of the UK, ManuLife Financial of Canada and Temasek of Singapore had shown interest in acquiring the asset, and no Chinese buyer had stepped forward. However, none of the bids is understood to have been close to AIG's valuation of the asset, which is seen as the company's crown jewel.
AIA has 20m policyholders across 13 countries, employs 200,000 tied agents and last year made an aggregate profit of about $2bn. AIG is assessing the bids before deciding whether to hold the auction but people familiar with the matter said it was unlikely a sale could proceed as envisaged. Interest in AIA has been limited and I don t think this [auction] process will continue in this form, said one person.
AIG acknowledged on Monday the paucity of buyers for its assets. The very same global forces that we face have greatly diminished the ability of qualified buyers to raise the capital necessary to buy AIG's businesses right now, said Paula Rosput Reynolds, the insurer's head of restructuring.As a result, AIG is redirecting the divestiture process away from relying solely on immediate sales for cash and will use a greater variety of tools to maximise the value of individual businesses.
People familiar with the matter said at this stage it appeared the most likely scenario would be for AIA to be listed on the stock market. But equity markets are currently anaemic and it could be a long wait before investor sentiment improves. Potential buyers of AIA, or a large stake in it, will also prefer to wait to see how the governance and capital structure of the unit materialises, now that AIG has decided to transfer its equity in AIA to a special purpose vehicle.
AIG Sued by Ex-CEO Maurice Greenberg Over ‘Inflated’ Shares
Former American International Group Inc. Chief Executive Officer Maurice "Hank" Greenberg accused the insurer in a lawsuit of securities fraud after it reported the biggest loss by a publicly traded U.S. firm. Greenberg sued yesterday in federal court in Manhattan, saying the company’s "material misrepresentations and omissions" caused him to acquire New York-based AIG shares in his deferred compensation profit-participation plan at an "artificially inflated price." The complaint came on the same day that AIG CEO Edward Liddy told Bloomberg News that Greenberg was at the helm during the formation of AIG’s financial products unit, which sold derivatives that cost the company more than $30 billion in writedowns and prompted a government rescue. After reporting its fourth-quarter loss widened to $61.7 billion, AIG announced it reached an agreement to restructure its federal bailout.
AIG’s alleged misrepresentations caused Greenberg to pay excessive income tax on the AIG shares, according to his complaint. Greenberg seeks to recover the difference between the price he paid for the shares and a fair price had the misrepresentations not occurred, according to the suit. Greenberg also seeks to recover the extra income tax he claims to have paid. Christina Pretto, an AIG spokeswoman, said Greenberg’s lawsuit is without merit and that AIG will defend itself. Greenberg, 83, who led AIG for almost 40 years before being forced to retire in 2005, has said Liddy isn’t equipped to run the company and called the sale of the firm’s insurance units to repay the government a "tragedy." Greenberg told Congress last year that risk controls he put in place were weakened or eliminated after he left.
Liddy, the former CEO of home and auto insurer Allstate Corp., was appointed in September to run AIG after the insurer agreed to turn over an 80 percent stake to the government in exchange for an $85 billion loan. AIG said yesterday it will get as much as $30 billion in new government capital and relaxed terms on its bailout after posting the worst loss by any U.S. corporation. "I think he’s responsible" for some of the insurer’s struggles, Liddy said yesterday in an interview, referring to Greenberg. "The formation of the AIGFP unit, which has literally brought us to our knees, that happened on his watch. The compensation systems that have gone astray, happened on his watch. I don’t think it’s as clean and simple as sometimes Hank would like to portray."
The financial products unit was profitable until after Greenberg left, his spokeswoman, Liz Bowyer, said in a statement yesterday. The losses "never would have happened -- and in fact did not happen," while Greenberg was in charge, Bowyer said. "Under Mr. Greenberg’s leadership, AIG grew from a modest enterprise into the largest and most successful insurance company in the world. Its market capitalization increased approximately 40,000 percent between 1969, when AIG went public, and 2004, Mr. Greenberg’s last full year as chairman and CEO." Greenberg denies any wrongdoing in a New York State civil lawsuit filed against him in May 2005, which is still pending.
Then-New York Attorney General Eliot Spitzer dropped portions of the lawsuit in 2006 that included four other allegations tied to the investigation. Greenberg still controlled the largest stake of AIG shares before the government takeover through personal holdings and investment firms C.V. Starr & Co. and Starr International Co. AIG was unchanged at 42 cents in New York Stock Exchange composite trading yesterday. The insurer has plunged 99 percent in the past 12 months.
Fed risks independence, losses in AIG stake
The U.S. Federal Reserve, by taking an equity stake in American International Group, is moving further into uncharted territory and may be risking potentially large investment losses and its independence.As part of the latest bailout effort of the troubled insurer, the U.S. central bank will reduce a $60 billion credit facility in exchange for taking a preferred interest in AIG subsidiaries American Life Insurance Company and American International Assurance Company Ltd. The Fed's exposure to AIG now totals roughly $93 billion, and could put it on the line for sizeable losses should the value of the stake deteriorate.
"This continues the steady erosion in the Fed's balance sheet," said Steven Ricchiuto, chief economist at Mizuho Securities. "They are getting further and further pulled into this crisis." "The Fed should be looking to extricate itself from this and put responsibility for this at the Treasury's doorstep." Some regional Federal Reserve Bank presidents agree. Richmond Fed President Jeffrey Lacker and Philadelphia Fed chief Charles Plosser have been vocal in their concerns the central bank's unorthodox measures could make it vulnerable to political pressure and risk its independence.
"Using the Fed's balance sheet is at times the path of least resistance, because it allows government lending to circumvent the congressional approval process," Lacker said on Monday. "This risks entangling the Fed in attempts to influence credit allocation, thereby exposing monetary policy to political pressure." The U.S. central bank has taken a number of nontraditional steps to shore up key credit markets, including buying mortgage-backed securities, that have drawn it away from its traditionally safe balance sheet consisting only of U.S. government debt.
The stake in the two AIG units, both of which have large Asian operations, is a further step in that direction. "Having a large direct equity stake on the Fed balance sheet is sure to make a lot of people justifiably nervous about the central bank getting into the business of running private companies," said Michael Feroli, economist at JPMorgan. That, in turn, risks undermining monetary policy, some worry.
Stephen Stanley, chief economist at RBS Greenwich Capital said the conflicts of interests "are pretty obvious." "The Fed now essentially owns part of an overseas life insurance business," he said. "And does it become a consideration when setting monetary policy? Would they want to make sure things are OK with AIG before raising rates, for example?" "While I don't think this is a clear and present danger, it has to be asked as the Fed has never gone down this road before," Stanley said.
The Fed's path down that road began when it set up a holding company called "Maiden Lane LLC" in March 2008. This company was to hold an asset portfolio JPMorgan said was too risky for it to take on in its fire-sale purchase of investment bank Bear Stearns. The Fed has reduced the estimated value of the assets held in Maiden Lane LLC by about 12 percent since June 2008, according to the latest available Fed data. When the Fed and Treasury first rescued AIG in September, the Fed set up two more Maiden Lane facilities.
Some investors and Fed officials worry the central bank has positioned itself to pick winners and losers, rather than focusing on the economy more broadly. Even those who say the Fed had little choice are feeling discomfort. "At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one," renowned investor Warren Buffett said in a letter to shareholders this weekend. Buffett complained that while the credit of his company, Berkshire Hathaway, was "pristine" as one of only seven triple-A rated U.S. companies, "our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing."
Fed's Lacker: Fed credit programs risk independence
Emergency credit market support from the Federal Reserve has sidestepped Congress and could expose the U.S. central bank to political pressure that hurts its independence, a top Fed policy-maker said on Monday. "Using the Fed's balance sheet is at times the path of least resistance, because it allows government lending to circumvent the congressional approval process," Richmond Federal Reserve Bank President Jeffrey Lacker said. "This risks entangling the Fed in attempts to influence credit allocation, thereby exposing monetary policy to political pressure," he told the National Association for Business Economics during a luncheon speech. Lacker, a voting member of the Fed's policy-setting committee this year, dissented at its meeting in January to protest against targeted credit easing programs that have pumped hundreds of billions of dollars into financial markets, which have been locked up in panic over bank losses.
He objected to the intrusion of the Fed into private sector lending decisions, and would have preferred the U.S. central bank ease credit conditions via the purchase of U.S. Treasury securities. The Fed has cut interest rates to almost zero and more than doubled the size of its balance sheet to around $2 trillion through programs to support private lending in a bid to prevent the more than year-long recession from getting much worse. "At some point in the future, the Fed will need to withdraw monetary stimulus to prevent a resurgence of inflation when the economy begins to recover," Lacker said. "That time could arrive before credit markets are deemed to be fully enough 'healed.'... If monetary policy and credit programs remain tied together, as they currently are, we risk having to terminate a credit program abruptly, or else compromise on our inflation objective," he said.
To protect the independence of the central bank, Lacker said the Fed's lending role could "just as well be performed by the U.S. Treasury and financed by the issue of Treasury securities." There would be no change in the assets and liabilities held by the public, as the additional amount of debt the Treasury issued would exactly match the additional need for assets by the Fed, if the monetary base were to remain unchanged. Unlike the Fed, however, the Treasury can only lend under explicit authorization from Congress. In the latest government bailout of the financial sector, the U.S. Treasury and the Federal Reserve on Monday agreed to give insurer American International Group Inc access to another $30 billion, on top of prior commitments for $150 billion in government funds. Lacker declined to comment on the controversial topic of U.S. nationalization of big financial firms, but said government intervention deters investors on the fear future official action will dilute private capital.
"It is going to be difficult to attract private equity investment into any banking firm, as long as market participants see a material probability of future government capital injections," he told reporters after the speech. Asked about the economic outlook, Lacker said growth would rebound when the sense of panic currently encouraging households to slash spending fades over time. "I think that eventually, people are going to stop cutting discretionary spending. ... They've cut as much as they need to. ... That will limit the decline in aggregate demand." Lacker also played down the danger that the United States would suffer a Japan-style deflation, where prolonged price declines contributed to a decade of economic stagnation. "In November, I said the risk of deflation was small. If anything, I think the risk of deflation has diminished in the last month or two. ... We're seeing firmer core (inflation) numbers and the energy prices seem to have stabilized," he said.
JPMorgan Said to Reap $5 Billion Derivatives Profit
JPMorgan Chase & Co. managed to generate $5 billion in profit during the worst year in Wall Street history by trading over-the-counter fixed-income derivatives, two people with knowledge of the results said. The largest U.S. bank by market value, which reported $5.6 billion of total net income in 2008, hasn’t disclosed earnings for its interest-rate swap, municipal bond and foreign-exchange derivatives group. The unit was among the most profitable at the New York-based company, said the people, who declined to be identified because they weren’t authorized to divulge the figures. JPMorgan spokeswoman Kristin Lemkau declined to comment.
The JPMorgan trading desk, led by the 38-year-old Matt Zames, who previously worked at hedge fund Long-Term Capital Management LP, may have benefited as the collapse of Lehman Brothers Holdings Inc. and JPMorgan’s takeover of Bear Stearns Cos. left companies and hedge funds with fewer trading partners in the private derivatives markets. JPMorgan emerged "unscathed by the disasters" on Wall Street and positioned to capture more revenue as trading volumes grew, said Craig Pirrong, a finance professor at the University of Houston. "It’s a flight to quality," Pirrong said. "They expanded the scale of business, the number of trades people wanted to do with them, and it gave them pricing power."
Derivatives are contracts whose value is derived from an underlying asset such as stocks, commodities or interest rates. Over-the-counter refers to a type of private, unregulated derivative contract banks trade amongst themselves or with clients. The derivatives trades for JPMorgan are often linked to corporate debt underwritten by the bank. JPMorgan led its competitors last year with $132 billion in U.S. corporate bond underwriting, according to Bloomberg data. Corporations often enter into interest-rate swaps with banks to manage rate exposure on the debt they issue. Among commercial lenders, JPMorgan dominates OTC derivatives trading, according to data compiled by the Office of the Comptroller of the Currency. The bank held $87.7 trillion worth of outstanding OTC contracts as of Sept. 30, more than the next two banks, Bank of America Corp. and Citigroup Inc., combined.
The OCC hasn’t yet released figures for Goldman Sachs Group Inc. and Morgan Stanley, the New York-based securities firms that converted into bank holding companies in September. JPMorgan told investors at a Feb. 26 conference in New York that client fees from interest rates and foreign exchange rose 60 percent last year from 2007. William Winters, co-head of JPMorgan’s investment bank, said the gap between bids to buy and offers to sell in OTC derivative markets doubled in the past 18 months. As that so-called spread widens, firms like JPMorgan that create the trades for clients can capture higher earnings. "You take two times the bid offer, the volumes have stayed robust and an increase in market share, it’s a good business," Winters, 47, said at the conference.
Chief Executive Officer Jamie Dimon, 52, touted the firm’s trading results in the current quarter during a conference call with investors three days earlier. "We’ve had strong quarter-to-date trading results, solid fee income in the investment banking side," Dimon said on Feb. 23. "I should point out to you that this is my general conservatism. If it was up to the folks in the investment bank, they would have said extremely strong trading results." The majority of JPMorgan’s OTC trading profit may have stemmed from interest-rate swaps in 2008, according to revenue figures reported by the OCC. During the first three quarters of last year, JPMorgan took in a total of $6.36 billion in OTC derivatives-trading revenue. Of that, $4.87 billion resulted from interest-rate positions, according to data from the OCC. The remaining $1.49 billion came from foreign-exchange trading. The OCC doesn’t report how much profit banks wring from OTC trading. The regulator hasn’t yet released fourth quarter results.
Goldman Sachs, JPMorgan Increase Rights Offer Fees
Goldman Sachs Group Inc. and JPMorgan Chase & Co. are charging companies 50 percent more than a year ago to guarantee rights offers to compensate for the risk they may be forced to buy unwanted stock. HSBC Holdings Plc will pay Goldman Sachs, JPMorgan and eight other firms 2.75 percent in fees from the 12.85 billion pounds ($18.3 billion) the London-based bank plans to raise. Royal Bank of Scotland Group Plc paid underwriters led by Goldman Sachs, Merrill Lynch & Co. and UBS AG 1.75 percent for its 12.3 billion-pound sale in June. On average, fees have jumped to 2.9 percent from 1.9 percent in 2008, filings show.
The risk for underwriters in rights offers is investors balk, leaving the banks to buy what’s left over. That could more than wipe out any fees on a transaction. Morgan Stanley and Dresdner Kleinwort Ltd. were among firms left with as much as 92 percent of Edinburgh-based lender HBOS Plc’s 4.2 billion-pound sale in July after the shares fell below the offer price. "In tumultuous times such as these underwriting becomes riskier and sales more complicated," said Giorgio Questa, a finance professor at London’s Cass Business School and former investment banker at Italy’s IMI SpA. "The last thing banks would want is to remain on the line for weeks," he said.
Xstrata Plc, the largest exporter of coal used by power stations, and Snam Rete Gas SpA, Italy’s gas grid operator, are among companies that have announced plans to sell stock over coming months. Enel SpA, Italy’s biggest utility, has also said it’s considering a stock offering, without giving details. Officials at JPMorgan and Goldman Sachs in London declined to comment. European corporate law and securities rules typically require companies to offer existing shareholders first refusal over new stock. In a rights offer, a company gives existing investors the option to buy new stock, often at a discount. Shareholders can choose to buy the shares or sell the rights.
The process takes time, as long as eight weeks on some sales. Companies often need to convene shareholder meetings to vote on the plan and then give buyers a few weeks to decide whether to purchase shares. HSBC, Europe’s biggest bank, will ask investors to vote on the plan March 19 before it completes taking orders for the stock on April 3, almost five weeks after yesterday’s announcement. RBS, the Edinburgh-based owner of the U.K.’s NatWest bank, took seven weeks to complete its offering. The underwriters face an unprecedented risk that the market may turn against them. Stock market volatility, measured by the VIX, or Chicago Board Options Exchange Volatility Index, is at 49, about 50 percent higher than last year’s average.
Deutsche Bank AG and JPMorgan are underwriting part of Xstrata’s 4.1 billion-pound rights offer. The banks are charging about 3.3 percent for their share of the underwriting, the offer document shows. "The fees are not out of line with our previous rights offers," Claire Divver a London-based spokeswoman for Xstrata said in an interview. Xstrata paid about 2.75 percent in offerings in 2003 and 2006, said Divver. The fee is bigger this time because the company has had to hold a shareholder vote, drawing out the offer period, she said. Securities firms are using the higher fees to lure other financial institutions to help them spread the underwriting risk. Banks are passing on fees of as much as 2 percent to so-called sub-underwriters, often investors in companies that guarantee part of the sale for the bank. That fee has more than doubled from the 1 percent sub-underwriters historically received.
Cookson Group Plc, which is raising 255 million pounds in a rights offer set to be completed tomorrow, has lured its biggest shareholders, Standard Life and Aviva Plc, to sub-underwrite its sale. Merrill Lynch & JPMorgan are managing the offer. Billionaire Li Ka-shing, Hong Kong’s richest man, and a group of fellow tycoons are sub-underwriting about $1.1 billion of HSBC’s stock sale, lending support in a city that accounts for a third of the bank’s investor base. Li, Lee Shau-kee, Joseph Lau and Cheng Yu-tung, who between them have a combined wealth of $33 billion according to Forbes magazine, will sub- underwrite the sale, their representatives said today. Rights offerings are providing a lone bright spot for equity capital markets bankers amid the slowest year for stock sales since 2003, Bloomberg data show. That year, fees for rights offers peaked at 4.3 percent, the commission Allianz SE paid on a 4.4 billion-euro ($5.5 billion) offering, a sign fees could yet rise further.
Latest plunge cuts Dow in half from its high in 2007
Investors' despair about financial companies and the recession has brought the Dow Jones industrial average to another unwanted milestone -- its first drop below 7,000 in more than 11 years. The market's slide Monday, which took the Dow down 300 points to 6,763, was nowhere near the largest it has seen since last fall, but the tumble below 7,000 was painful. The credit crisis and recession have slashed more than half the average's value since it hit a record high of more than 14,000 in October 2007. And now many investors fear the market could take a long time to regain the lost 7,000.
Each of the 30 stocks in the index lost value for the day, and the Standard & Poor's 500 stock index, a much broader measure of the market's health, dipped below the psychologically important 700 level before closing just above it. It hadn't traded below 700 since October 1996. "As bad as things are, they can still get worse, and get a lot worse," said Bill Strazzullo, chief market strategist for Bell Curve Trading. Strazzullo said he believes there's a significant chance the S&P 500 and the Dow will fall back to their 1995 levels of 500 and 5,000, respectively. The "game-changer," he said, will be the housing market and whether it can stabilize.
Investors also were worried anew about the stability of the financial system after insurer American International Group posted a staggering $62 billion loss for the fourth quarter, the biggest in U.S. corporate history -- and accepted an expanded $30 billion bailout from the government. The Dow's descent has been breathtaking. It took only 14 trading sessions for the average to fall from above 8,000 to below 7,000. For the year, the Dow has lost 23 percent of its value. Its last close below 7,000 was May 1, 1997 -- a time when the market was barreling to one record high after another because of the boom in technology stocks, but often suffered big drops as investors worried about inflation and rising interest rates.
This time around, it's not just U.S. companies that have Wall Street frightened. HSBC PLC, Europe's largest bank by market value, said Monday it needs to raise $17.7 billion. The company reported a 70 percent drop in 2008 earnings and said it would cut 6,100 jobs. In U.S. reports out Monday, consumer spending and incomes rose more than expected at the start of the year, but the gains were seen as fleeting in light of the recession and the waves of layoffs battering Americans. Two other reports Monday on manufacturing and construction also showed little reason for optimism. Analysts said any start to an economic rebound is at best months away, with the most pessimistic predicting a sustained recovery won't begin until next year.
One measure of unease in the market has been rising after coming down from the fall. The Chicago Board Options Exchange Volatility Index, or the VIX, is just below 53. Ordinarily what's known as Wall Street's fear gauge might be in the 20s and 30s but it had been near 90 in October. Market historians would be quick to note, however, that market bottoms often come just as most investors are prepared to give up in disgust or fear. For investors, that will take several months of economic and corporate reports that point to signs of a turnaround in housing and job losses and signs that the economy is at least leveling off. Analysts are looking for indications that businesses and consumers are starting to boost spending after months of cutting back.
Toyota wants a government loan. Let the outrage begin.
In yet another sign that Toyota Motor Corp. is run by human beings, the company’s finance unit is asking the Japanese government for a $2 billion loan, writes my colleague, Ian Rowley. Toyota blames tight credit in the U.S. for its newfound borrowing needs. For all its strength, Toyota is not immune. But here’s my question: Will we see outrage among Japanese voters and some media as a company hoarding $20 billion in cash asks for government money? My guess is no.
The Japanese government and Central Bank have a long history of intervening on behalf of their home companies. The Central Bank has kept the yen weak for years to boost exports of cars, electronic goods and other items to the U.S. So loaning a few billion bob to Toyota won’t raise a hackle in Japan. Here in the states, however, loaning to U.S. automakers sparks some outrage. This is despite the fact that state governments have showered foreign carmakers with hundreds of millions in tax incentives. I understand the argument.
Toyota performs year in, year out. The U.S. car companies have been stumbling for decades. The sad part of it is that Detroit was finally fixing some long-standing intractable problems. The 2007 labor deal slashed wages, found a creative solution for retiree benefits and the cars are much, much better. All of this was rolling out just as the financial crisis hit. But these days, Americans have little sympathy for home teams that have lost for so long. Detroit’s fixes may have come too late to save all three companies and get the popular imagination to look their way.
Toyota Sees Global Output Dropping 12%
Toyota Motor Corp. expects its world-wide production to drop roughly 12% in the next fiscal year to its lowest level in seven years, reflecting the prolonged woes confronting the auto industry. The world's biggest car maker by volume told its suppliers that it projects manufacturing roughly 6.2 million vehicles in the fiscal year starting April 1, compared with an estimated 7.08 million this business year, a person familiar with the matter said Monday. The volume doesn't include vehicles produced by its Daihatsu Motor Co. and Hino Motors Ltd. subsidiaries.
The company's outlook comes at a time when collapsing auto demand due to the global economic slump forces Toyota, like its global rivals, to rush to cut back production by halting part of its output lines and hold off on manufacturing capacity increases. Falling auto demand and damage from a strong yen have caused Japan's major auto makers to predict grim earnings figures. Toyota itself is forecasting its first net loss in 59 years this fiscal year ending March 31. Data released Monday showed that overall February auto sales sank 32.4% in Japan, the seventh straight month of declines, according to the Japan Automobile Dealers Association.
Recent statistics have revealed a similar picture in major overseas markets, with overall auto sales skidding 37% in the U.S. and European sales sagging 27% in January. Toyota's projected production level for its next fiscal year would be its lowest since the fiscal year that ended March 2003. The production level would follow this fiscal year's estimated 19% slide to 7.08 million vehicles. However, analysts said that Toyota's expected output cuts are in line with expectations. Mamoru Kato, an analyst at Tokai Tokyo Research Center, said the next fiscal year's production was expected to be reduced to between six million and 6.5 million vehicles. Other Japanese car makers are also likely to build fewer vehicles in the next fiscal year.
Toyota, Facing First Loss in 59 Years, Seeks Aid From Japan
Toyota Motor Corp., forecasting the first loss in 59 years, is seeking loans from the Japanese government as private investors demand up to 50 percent more in interest for the company’s debt. The company’s financial unit may ask for 200 billion yen ($2 billion) in loans, public broadcaster NHK reported today, without saying where it got the information. Toyota Financial Services Corp. is in talks with state-owned Japan Bank for International Cooperation, said Toyota Financial spokesman Toshiaki Kawai without confirming the timing or amount.
The carmaker expects a net loss of 350 billion yen after vehicle sales in the U.S., traditionally Toyota’s most profitable market, plunged 31 percent last quarter. The global recession has also forced General Motors Corp. and Chrysler LLC to get bailouts from the U.S. government. "Toyota should take advantage of anything it can to get through this crisis," said Hitoshi Yamamoto, chief executive officer of Tokyo-based Fortis Asset Management Japan Co., which manages $5.5 billion in Japanese equities. "Money is not flowing in the capital markets."
Automakers usually raise funds through bonds and loans for their financial companies to offer loans for their customers. The government aid would mostly be used to help offer loans to customers in North America, Toyota Fiancial’s Kawai said. Toyota sold 80 billion yen in 10-year bonds priced to yield 2.012 percent last month. That compares with 150 billion yen of 10-year bonds sold in August 2002, priced to yield 1.337 percent. Japan will use some of its foreign-exchange reserves to lend to the state-owned corporation that gives financing to Japanese companies operating abroad, Japanese Finance Minister Kaoru Yosano said today.
Toyota follows other carmakers seeking government help as sales plunge worldwide. GM has received $13.4 billion in U.S. aid and is seeking more to keep its operations in its home market running through this month. France granted PSA Peugeot Citroen and Renault SA a total of 6 billion euros in five-year loans last month. In the U.K., carmakers are seeking support for their finance units from the Bank of England. Mitsubishi Motors Corp. has gotten subsidies from Japan’s Ministry of Health, Labor and Welfare to help pay wages, as it cuts domestic production.
Toyota, the maker of the Corolla compact, may slash production 12 percent next fiscal year, it said yesterday. Worldwide vehicles sales may fall 14 percent to 55 million units in 2009, according to Nissan Chief Executive Carlos Ghosn. The Toyota City, Japan-based company has 2.34 trillion yen in loans and bonds maturing this year, according to data compiled by Bloomberg. The company had 2.3 trillion yen in cash reserves as of Dec. 31. The extra yield over government debt of similar maturity that investors demand to own Toyota’s 1.22 percent bond due 2011 has more than doubled to 56.75 basis points as of yesterday from September according to data compiled by Bloomberg.
Toyota’s sales in Japan plunged 32 percent last month. In the U.S., sales also dropped 32 percent in January. Toyota fell 0.3 percent to 3,060 yen, as of 1:44 p.m. in Tokyo. The shares have risen 5.3 percent this year compared with a 19 percent drop in the benchmark Nikkei 225 Stock Average. In response, automakers are shutting factories and cutting jobs. Toyota plans to halve the number of contract workers in Japan to 3,000 by March 31. GM last month said it is cutting another 47,000 jobs globally, as it reported a $30.9 billion annual loss. Volkswagen AG, Europe’s largest carmaker, on Feb. 28 said it will cut all 16,500 temporary jobs globally and shuttered five factories in Germany last week.
Ilargi: Can we agree to stop the delusional hallucinogenic discussion on electric cars already? There will never be any significant number of electric cars produced. Do those who "believe" ever wonder what the credit crisis will mean for the electric grid? The only purpose served by this non-issue is to give bankrupt carmakers access to whatever money is still left in your pockets in the form of subsidies. There are real issues out there, we don't need made-up stupidity driven ones.
Electric cars center stage at Geneva
GM's troubled Adam Opel GmbH subsidiary presented the lithium-battery powered hatchback Ampera Tuesday at the Geneva Motor Show, where electric-powered vehicles gathered momentum as a way to persuade environmentally aware consumers to buy new cars during the global recession. Other automakers — including Chrysler, Mitsubishi and Ford — also touted their plans for cars equipped with electric motors as the industry both seeks to overcome the current crisis that has decimated sales and meet increasingly tough environmental and carbon emission standards. Only European giant VW bucked the trend, saying its answer to the electric car would come out "in the coming decade."
European drivers could be silently cruising around in the Ampera by the end of 2011 — the first 60 kilometers on pure electricity augmented by another 500 kilometers of extended range from a gasoline engine, which would generate less than 40 grams of C02 emissions per kilometer. The Ampera presented in Geneva was a white four-door sedan with a hatchback — and a set of front headlights that created a menacing, masculine impression. An Opel official demonstrated how the car could easily be plugged into any household electrical supply. "This is the kind of game-changing technology that the auto industry needs to respond to energy and environmental challenges," President of GM Europe Carl Peter Forster said.
Mitsubishi Motors Corp. said it has reached an understanding with Peugeot Citroen PSA to sell its new electric car "i MiEV" to European customers as early as late next year. Mitsubishi's president Osamu Masuko said the collaboration could help pave the road to "tomorrow's sunny days" for the automotive industry, which is struggling amid the global economic downturn and a decline in global sales. Peugeot will sell the car under its own brand in Europe, while Mitsubishi will launch the car in Japan this year. The four-door electric-only hatchback produces no carbon dioxide emissions and has a top speed of 130 kilometers per hour (80 mph). It has a range of 145 kilometers once its 330-volt lithium ion battery is charged for 14 hours.
By contrast, Ford and Chrysler showed only concept cars that illustrate the company's thinking about electric cars. Ford's presented at its stand a five-seater passenger vehicle called the Tourneo developed for European markets by Smith Electric Vehicles, part of the Tanfield Group, which developed the the Ford Connect van in the United States. "The plan is to go into production as soon as we feel the market is ready for production," Tanfield CEO Darren Kell said. Chrysler showed its Dodge Circuit EV sports car, which was unveiled in Detroit. VW is moving more slowly. Chairman Martin Winterkorn said the German automaker would launch its first electric vehicle "in the next decade."
"Announcements alone have never brought new technology onto the road," Winterkorn told a presentation at the Geneva Auto Show. "It's a long path to safe electric cars that are available for everyone. We are not talking about being the one with the fastest solution. We want the best solution." "We expect to increase market share. Not volumes," Winterkorn said. Translation: VW cars will outsell their competitors, even as new car sales shrink. Opel faces a particularly difficult situation and such new technologies are critical to the restructuring plan it has laid out seeking government funds. GM Europe has proposed that Opel loosen its ties with its beleaguered U.S. parent and said it would need €3.3 billion in financing or guarantees from European authorities over the next two years. The aim would be to pay the money back in 2014 or 2015. At the same time, the Ampera, the European relative to the North American Volt, and the Chevrolet Spark, which Opel also presented in Geneva for sale in Europe by early next year, represents the kind of technology that it can get from its U.S. parent company.
SEC charges Sunwest with 'massive fraud'
Sunwest Management Inc. committed "massive fraud" and violated federal securities law in its dealings with hundreds of investors, the federal Securities and Exchange Commission alleged in a suit filed Monday in U.S. District Court of Oregon. The suit names Sunwest, the Salem-based senior living home operator, its founder, Jon Harder, 44, of Salem, and affiliates, Canyon Creek Development Inc., as defendants. Clyde Hamstreet and Clyde A. Hamstreet & Associates LLC, the Portland turnaround firm that has control of Sunwest, is identified as a relief defendant though it is not accused of wrongdoing.
The widely anticipated suit sought a temporary restraining order to enjoin the company and its affiliates from further securities violations. U.S. District Court Judge Michael Hogan ruled on the request Monday and encouraged an ongoing agreement between Sunwest creditors and its founder to preserve the company in order to preserve equity and return funds to its approximately 1,300 investors. "We were pleased that the judge recognized the cooperative efforts," said Steve English, an Bullivant Houser Bailey P.C. shareholder who is representing Harder in his personal Chapter 11 bankruptcy case, which is separate from the SEC suit.
The SEC suit accuses Sunwest of misrepresenting itself when it sold ownership interests in individual assisted living homes it managed nationwide between January 2006 and June 2008. Investors believed they were purchasing an ownership interest in specific properties that would yield 10 percent annual returns. In reality, the government said Sunwest did not run the retirement homes as individual businesses. "Defendants ran Sunwest as a single, integrated enterprise, co-mingling all investor funds and operational revenue into essentially a single fund from which all operating expenses and investor returns were paid," the government said in its 23-page complaint.
"Contrary to Defendants’ representations, including written representations and marketing pitches, Sunwest paid investors steady returns on their investments not from successful management of a particular property, but from cash generated in the operations of other facilities, from funds obtained in refinancings, from loans from Harder and Harder’s friends, and from funds raised through offerings to new investors. None of these facts were disclosed to investors," said the complaint, which characterized Sunwest as a "Ponzi scheme."
Sunwest problems mounted in June 2008 when credit markets seized and Sunwest was no longer able to refinance its properties, which had been a key source of operating revenue for the former $2 billion company. The government notes that Harder, who resigned as president but who retains a significant ownership stake, took "tens of millions of dollars" from the company. As part of the bankruptcy case, Harder receives a $54,000 monthly allowance. Attorneys say Harder needs the outsized allowance to continue making payments on several homes that are assets of the bankruptcy case. Ultimately, the homes will be used to satisfy creditors.
As of January, more than 100 Sunwest-managed properties have been placed in foreclosure, receivership or bankruptcy. The SEC suit complicates Harder’s personal bankruptcy case, already one of Oregon’s most complicated business cases ever because of how Harder's assets are intertwined with Sunwest's. English is attempting to stay foreclosure activities pending a reorganization in order to preserve approximately $300 million in equity value in order to protect unsecured creditors. The government’s case bolsters the arguments of the banks who have secured interests in Sunwest-managed properties and want to press ahead with foreclosures.
The company’s ongoing practice of shifting money from profitable properties to unprofitable ones violates loan covenants and must be halted, they have said in court. The SEC seeks civil penalties from Harder, Hamstreet and co-defendants Darryl E. Fisher, 45, of Salem, who served as chief operating officer, J. Wallace Gutzler, 80, of Salem, who was general counsel, Harder’s wife Kristin, who provided personal guarantees and managed a group of homes, Encore Indemnity Management LLC, a Cayman Island company that provides workers compensation and automobile insurance to Sunwest entities and is controlled by Harder and Fisher, Senenet Leasing Co., which employs Sunset workers and is controlled by Harder and Fisher, Fuse Advertising Inc., a Harder-controlled business and KDA Construction Inc., a Harder-controlled business.
The SEC said Hamstreet and his company are identified as relief defendants because they possess the Sunwest assets and not because of any wrongdoing. "(Hamstreet) is named as a relief defendant in this action solely for the purpose of assuring complete relief," the government stated.
Bank of Canada Cuts Lending Rate to 0.5%, Lowest Ever, Readies Plan for 'Quantitative Easing' if Needed
The Bank of Canada cut its benchmark lending rate to a record, and said it may use policies beyond interest rate moves, if needed, to revive an economy hit by a recession and tight credit markets. Governor Mark Carney cut the target rate on overnight loans between commercial banks to 0.5 percent from 1 percent today, and signaled he may reduce it again. Fifteen of 23 economists surveyed by Bloomberg News predicted today’s rate cut. "The Bank is refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing," the Ottawa-based central bank said in a statement. Details of how such a plan would be used will be released in April with a new economic forecast, the bank said.
Carney’s view of so-called quantitative easing has changed from January when he said it was a "highly unlikely, remote situation," because the country’s banks were among the world’s strongest through the biggest global financial crisis in decades. Canada is being pulled into a recession as global demand for its automobiles and lumber plunges and prices fall for the commodities it produces. Canada’s economy will shrink faster than predicted in January, the Bank of Canada said today. The world’s eighth- largest economy shrank at a 3.4 percent annualized pace in the fourth quarter, Statistics Canada reported yesterday, the most since 1991. Canada’s dollar was unchanged at C$1.2934 against the U.S. dollar at 9:10 a.m. in Toronto.
"The target for the overnight rate can be expected to remain at this level or lower at least until there are clear signs that excess supply in the economy is being taken up," the bank said. Canada’s decision comes two days before the European Central Bank and the Bank of England are also expected to cut their key interest rates to new lows. ECB President Jean-Claude Trichet signaled policy makers may pare their benchmark rate to a record low of 1.5 percent March 5 as a recession in the euro region deepens. The Bank of England cut its policy rate to 1 percent this year, the lowest since it was founded in 1694, and economists expect the rate to fall to 0.5 percent this week. The U.S. Federal Reserve has reduced its benchmark to a range of between zero and 0.25 percent on Dec. 16.
Carney has cut the central bank’s policy rate from 4 percent since taking over in February 2008. "Those who have an expectation that things are going to recover dramatically and quickly as we come out of this, that’s less and less likely all the time," Royal Bank of Canada Chief Executive Officer Gordon Nixon told reporters Feb. 26. Statistics Canada has reported a record job loss of 129,000 in January, and the agency’s leading economic indicator fell the most since 1982 in January. Bankruptcies in December also jumped 47 percent from a year earlier.
Business executives say they’re struggling with the tightest credit climate since at least 2001, according to a Bank of Canada survey released Jan. 12.
Carney has said the Bank of Canada has already injected as much as C$41 billion into financial markets to spur lending, sought wider legal power to fix markets and accepted new types of collateral. The federal government is also buying up to C$125 billion of mortgages to give banks more cash to use for new loans. Quantitative easing is designed to leave banks with so much free cash that they stop hoarding and expand lending. It can involve a central bank buying securities and creating money to pay for them. A central bank can also try buying up securities to drive down longer-term market interest rates, extending efforts to keep short-term rates low with their benchmark rates.
Australia Unexpectedly Leaves Benchmark Interest Rate Unchanged at 3.25%
Australia’s central bank left its benchmark interest rate unchanged for the first time in seven months, saying the lowest borrowing costs in four decades and government spending are supporting the economy. The nation’s currency surged after Governor Glenn Stevens kept the overnight cash rate target at 3.25 percent in Sydney today. Only four of 18 economists surveyed by Bloomberg forecast the decision. The rest tipped at least a quarter-point cut. Australia’s economy may skirt a global recession after Stevens slashed the benchmark by four percentage points between September and February and the government announced almost A$88 ($56 billion) of spending. A report tomorrow will probably show the economy grew 0.2 percent in the fourth quarter, according to a Bloomberg survey of economists today.
"The Australian economy has not experienced the sort of large contraction seen elsewhere," Stevens said in a statement. The bank’s rate cuts and government spending will provide "significant support" to the economy, he said. The Australian dollar rose to 63.97 U.S. cents at 3:45 p.m. in Sydney from 63.45 cents just before the decision was announced. The two-year government bond yield rose 16 basis points to 2.80 percent. A basis point is 0.01 percentage point. Australia’s benchmark S&P/ASX 200 stock index pared its decline to 1.1 percent from 3 percent earlier today. Today’s decision "sends a message that rates are on hold, probably for several more months," said David de Garis, a senior economist at National Australia Bank Ltd. in Sydney. "They are waiting to see whether what has been done will be sufficient to support the economy given the global trends."
The U.S. economy shrank at a 6.2 percent annual pace in the fourth quarter, the biggest contraction since 1982. Japan’s economy contracted at the fastest pace since the 1974 oil shock. Exports from China, Australia’s biggest trading partner, slumped 17.5 percent in January, the most in almost 13 years. The deepening global recession and slumping share markets have forced central banks around the world to slash borrowing costs. Stocks tumbled worldwide this week, sending the Dow Jones Industrial Average to its lowest level since 1997 after American International Group Inc. posted the largest corporate loss in U.S. history.
The U.S. Federal Reserve’s benchmark rate is close to zero, the Bank of England’s is the lowest since its creation in 1694 and the European Central Bank will probably trim its main rate on March 5 to 1.5 percent, the lowest level in 10 years of setting policy, according to economists. "Significant macroeconomic policy stimulus is being put in place around the world, but it is too soon to see the effects of those measures," Stevens said today. The International Monetary Fund may cut its month-old forecast for the global economy to predict a contraction this year, Nicolas Eyzaguirre, director of the fund’s western hemisphere department, said yesterday.
"Economic conditions are clearly weak, and given the speed and scale of the global economic deterioration and its effect on confidence, weak conditions are likely to continue in the near term," Stevens said. Australia’s economy probably expanded 0.2 percent in the fourth quarter from the previous three months and 1.2 percent from a year earlier, according to the median forecast in a Bloomberg survey of economists today. The gross domestic product report will be published tomorrow. The economy may have escaped a contraction in the quarter because of a 3.8 percent surge in retail sales in December, driven by cash handouts to the elderly and families totaling A$8.9 billion. Business investment and home lending also gained. Retail sales rose 0.2 percent in January, a report today showed.
Prime Minister Kevin Rudd last month said he will spend another A$42 billion on cash handouts and on infrastructure to drive economic growth. "The government stands ready to take further action if necessary to support the Australian economy and jobs," Treasurer Wayne Swan told reporters in Sydney today. Banks have passed on more than 375 of the 400 basis points policy makers cut from the benchmark rate between September and February, saving home borrowers with an average A$250,000 ($160,000) mortgages about A$600 a month. "Market and mortgage rates are at very low levels by historical standards and business loan rates are below recent averages," Stevens said today. "Together with the substantial fiscal initiatives, the cumulative decline in interest rates will provide significant support to domestic demand over the period ahead."
China Targets Economic Stimulus
The annual meeting of China's parliament, which begins Thursday, will reveal how far Beijing will go to support families hit by the economic downturn and to boost the nation's consumer spending. The policies rolled out at the National People's Congress session will be watched by the U.S. and other countries that want China to help the global economy by awakening the spending power of its vast population. To do that, economists say, Beijing needs to invest more in health care, education and social welfare, so people have the confidence to spend, instead of adding to savings. China, the world's third-largest economy after the U.S. and Japan, has seen its growth slow sharply in the past year, but its trade surplus remains high. China's trading partners hope the country will import more.
Despite the limited power of the legislature, its annual session is China's political event of the year, where major policies are discussed and announced. Expectations are high that Premier Wen Jiabao and other officials will make substantial new commitments to social programs. "China has the resources to reinvigorate and reorient its economy," said Eswar Prasad, a professor at Cornell University and former head of the International Monetary Fund's China division. Announcing an "ambitious agenda" of higher social spending would reassure Chinese consumers, offsetting some uncertainty the crisis has brought, he said. "This could also have a broader payoff for China in the international arena by providing support to global demand, rather than just relying on demand in the rest of the world to help the recovery of Chinese growth," Mr. Prasad said.
The government has already announced a major stimulus package aimed mainly at boosting spending on infrastructure and construction. Currently, 1% of the stimulus is allocated to health care and education spending and 7% to public housing, with the rest going to corporate subsidies and infrastructure. "The original stimulus plan was heavily focused on investment and infrastructure. There needs to be some adjustment in the structure," said Zhuang Jian, an economist with the Asian Development Bank. "Excess investment, particularly in heavy industry and manufacturing, could cause problems if there isn't strong consumption to match it." Greater spending on social services would not only cushion the blow to Chinese families who have lost jobs and income, some economists say, but also lay a foundation for growth.
Chinese households save more than a quarter of their income -- one of the highest rates of any major economy -- but could spend more if assured of government support for old age as well as lower education and medical costs. "Consumption is not based on slogans, but on whether consumers really have money in their pockets," Mr. Wen, the premier, said Saturday in a rare online exchange with Chinese citizens, promising that "peoples' livelihoods will definitely be the top priority for government spending." He conceded the government has not yet done enough to improve health care -- the target for an 850 billion yuan ($124 billion) overhaul announced in January. The government should also encourage workers who have lost their jobs to start their own businesses by offering tax incentives and training opportunities, Mr. Wen said.
How the government follows through on those promises is the question. Although social spending remains low, under the current administration it has risen to 5.8% of gross domestic product in 2007 from 5% in 2004. But with tens of millions already jobless, and the economy likely to get worse this year before it gets better, many observers say China has reached a turning point that requires a big move. "We are now facing a choice: Do we increase public spending on security and the police, or on social benefits?" asked Lu Mai, secretary-general of the China Development Research Foundation. Mr. Lu's organization published a report last week estimating that the government needs to spend 2.6 trillion yuan by 2012 to roll out the first phase of a social safety net that would cover all Chinese citizens. A further 5.74 trillion yuan is required by 2020 to complete the improvement of health care, education, pensions for the elderly, low-income housing, disability benefits, unemployment protections and welfare for the poorest.
Germany Must Bail Out its Ailing Eurozone Neighbors
Countries as export-dependent and politically reliant on the EU as Germany and the Netherlands cannot afford to be blasé about economic crises in neighboring countries. They should support proposals for eurobonds that share risks. Twelve months ago it seemed inconceivable that any European Union member could face a sovereign debt crisis. It would have been the stuff of fantasy to argue that Ireland or Austria could be among those at risk. Yet such an outcome is now within the realm of possibility. And if one country suffers a crisis, it will almost certainly trigger a wave of crises, plunging the EU, and especially the euro zone, into turmoil. There is nothing inevitable about this. But a way out requires Germany and other fiscally sound but highly export-dependent economies, such as the Netherlands, to show more vision.
Some members of Europe's common currency euro zone -- including Italy and Spain -- are vulnerable because they have lost competitiveness over the years and investors are skeptical that they will be able to regain it. Others -- like Austria and Belgium -- have disproportionately large banking sectors and/or banks with huge exposures to crisis-hit regions such as Eastern Europe. The tensions within the euro zone are evident in the government bond market. A year ago, all eurozone governments faced similar borrowing costs. However, there is now a big -- and growing -- gap between the interest rate on German government bonds and those of struggling members of the euro zone. For example, the Greek and Irish governments are now forced to pay an interest rate on bond issues that is 2.5 percentage points higher than what Germany has to spend to borrow funds.
This trend partly reflects temporary phenomena: In times of financial distress investors want the most liquid and safest assets, so they pile into German bonds. But the widening spreads also reflect the concerns of investors over the solvency of some member states, and conceivably even over their continued membership of the euro. One way forward might be for governments to collectively issue euro zone bonds, rather than their own national bonds. Initially, euro zone bonds would complement rather than supplant the government bonds of the individual member states. Euro zone finance ministers would have to agree how to allocate the debt burden among the member states. Over time, however, national bonds would be fully replaced by euro zone bonds.
The integration of euro zone government bond markets would help address the problem of poor liquidity that has bedevilled many of the smaller euro zone financial markets. And it would reduce borrowing costs for most euro zone countries. An important obstacle is that German and Dutch borrowing costs would rise as they shared their fiscal credibility with the rest of the euro zone. It might be hard for governments in those countries to convince taxpayers that they should help pay for other countries' mistakes. However, the opposition of the German and Dutch governments to the pooling of bond issuance -- that it would cost them too much money -- is parochial. The alternative, failing to help their neighbors, would be much more costly for Germany, the Netherlands and Europe. Berlin and The Hague are mistaken if they think a fiscal crisis in one member state would be a cleansing experience, with other countries learning the lesson of their errant ways.
First, one sovereign crisis would almost certainly lead to others as investors rapidly turned their attention to the next weakest link. The direct costs of a bailout could be surmountable in the case of Ireland or Greece, but would pose a much bigger challenge in the case of larger member states, such as Spain or Italy. Second, there would be indirect costs to Germany and Holland from fiscal (and then economic) crises in neighboring countries. Both economies depend heavily on exports to the rest of the euro zone. Dutch and German exports are already falling rapidly. The last thing the two countries need is a further collapse in external demand. Third, there is a worst-case scenario. If Italy or Spain were to default on their sovereign debt, the repercussions for the euro zone could be dramatic and could well lead to its breakup. For large, inflexible economies, it is far from clear that default within the currency union is more plausible than a default and a move to leave it. A member state could decide that having defaulted, it may as well exit the euro zone and devalue.
This would at least help to restore competitiveness and get the economy growing again. Export-dependent economies like Germany and the Netherlands should not be complacent about such an outcome. German (and to a lesser extent Dutch) companies have spent years holding down costs. The result has been improved competitiveness compared to the rest of the euro zone. If the euro zone were to unravel, Germany and the Netherlands would experience a huge real appreciation, reversing almost overnight the competitiveness gains they have ground out. A move to issue euro zone bonds may help prevent such a worst-case scenario. And it would not mean the Germans and the Dutch were sacrificing their own interests for the good of Europe. Countries as export-dependent and politically reliant on the EU as Germany and the Netherlands cannot afford to be blasé about economic crises in neighboring countries.
Eurozone ready to rescue members if crisis hits
Eurozone authorities would help a member-state in serious economic difficulties before it needed to turn to the International Monetary Fund because of a risk of debt default, a senior EU policymaker said on Tuesday. "If crisis emerges in one eurozone country, there is a solution before visiting the IMF," Joaquín Almunia, the EU’s monetary affairs commissioner, said. "It’s not clever to tell you in public the solution. But the solution exists." Mr Almunia’s remarks echoed several statements last month by Peer Steinbrück, Germany’s finance minister, to the effect that Berlin would support emergency action to protect the eurozone if a country appeared at risk of not being able to refinance its debt.
Nervous financial markets are focusing their attention on Greece and Ireland, which among the 16 eurozone nations are the two that have come under most pressure because of the world financial crisis. Mr Almunia told a think-tank briefing in Brussels that the crisis, though unprecedented in its severity, would not cause the eurozone’s break-up. "The probability of this happening is zero. Who is crazy enough to leave the euro area? Nobody. In fact, the number of candidates to join is growing. The number of candidates to leave is zero," he said. The range of instruments at the eurozone’s disposal to rescue a member-state is limited by two rules contained in the European Union’s governing treaty. One rule bans the European Central Bank from directly buying EU government bonds, and the second – known as the "no bail-out" clause – prohibits collective liability for debt incurred by a EU state.
However, Mr Almunia’s comments made clear not only that EU policymakers would not remain impassive in the face of a crisis in a eurozone country, but would act pre-emptively before a bail-out became necessary. "By definition this kind of thing should not be explained in public. But we are equipped intellectually, politically, economically," he said. Mr Almunia also turned on critics of the EU who say its response to the gathering economic storm in eastern Europe – both among countries in the EU, and others beyond its borders – has been inadequate. At an EU summit on Sunday called to discuss the crisis, it was not the bloc’s western European countries but several central and eastern states that had spoken most loudly against a Hungarian proposal for a €180bn financial aid plan for the region, Mr Almunia said.
"When someone says, ‘Give me a plan for the region’, I say, ‘It’s not a question of a plan, but of analysis, of monitoring, case by case, problem by problem’," he said. Commenting on proposals for joint government debt issuance as a way of helping the most crisis-stricken EU countries, Mr Almunia said: "It’s possible and reasonable, but as a politician I know it’s not politically viable today." He was referring to opposition from Germany, the Netherlands and others which suspect that common bond issuance would impose costs on themselves for the benefit of countries guilty of fiscal indiscipline.
GM Europe will run out of cash 'within weeks'
General Motors’ European operations will run out of cash within weeks unless they get government support, the US carmaker warned today, saying that a collapse would put up to 300,000 jobs at risk. Fritz Henderson, the chief operating officer, said that the division, which includes Germany’s Opel and Britain’s Vauxhall, will hit liquidity problems early in the second quarter. At the Geneva motor show, he said: "We will try to stay alive but there is no reassurance that we could stay alive and we would become insolvent then." GM is looking for €3.3 billion (£3 billion) from European governments to keep the division going. It has already said that it will partially spin off the European operations but retain a strong link with GM, unlike its decision to cut off its Swedish Saab unit.
Today Mr Henderson said that GM could keep only a minority stake in GM Europe if other investors were prepared to buy the bulk of the business. He said: "We have to be prepared to consider all options and I haven’t taken anything off the table." Carl-Peter Forster, the head of GM Europe, warned that if the unit collapsed there would be a "a massive reduction in employment". GM Europe employs 50,000 directly and Mr Forster said that up to 250,000 more jobs were dependent or heavily reliant on the company in the supplier chain, dealerships and in more remote employment. The company is in talks with the governments of Germany, the UK, Spain, and Belgium. The stricken US carmaker, which last year lost $30 billion, began talks with Germany first because Opel is by far the biggest part of the European operations employing 25,000.
But Mr Forster warned: "The UK cannot expect for the German taxpayer to shoulder all the burden." GM has been in talks with the British Government and said that it had had a positive approach but that it was concerned about the exact nature of the European division. Mr Henderson described Ellesmere Port, Vauxhall’s only British plant on Merseyside, as one of the leaner of GM’s factories, in a remark which could signal that it could escape a wave of cost cutting if GM Europe survives and it pushes through €1.2 billion of cost savings. Mr Forster said that the production cuts that the European operations need to make could be achieved by closing three factories. But he said that unions were pressing for alternatives to this action. GM has said that it is commiting €3 billion to its European division. However, Mr Henderson admitted that this came partly from technology transfer and possibly consolidating the sales units which it owns rather than the €3 billion being straightforward liquidity.
British shares crash as savers raid £8bn from accounts
The pressure of an intensifying recession saw British companies and households launch an £8bn raid on their savings in January, according to the figures from the Bank of England. As stock markets round the world slumped to record lows yesterday, with the Dow Jones at its lowest since 1997 and the FTSE 100 index touching a six-year nadir, the Bank also revealed that the UK's building societies granted just 2,000 new mortgages in January – a record low, and about one-tenth of their "normal" level. Given that giants such as Nationwide and Britannia are still writing much of the business, it implies that some of the smaller regional societies made few if any home loans in the first weeks of this year.
Altogether, mortgage approvals from banks, building societies and brokers ran to just 21,000 in the first four weeks of 2009. Even on a seasonally adjusted basis, mortgage approvals were still at an astonishingly low pitch – 31,000, against a normal 100,000. Net mortgage lending amounted to £690m in January, down from £1.8bn in December and the £6.9bn net mortgage lending seen in January 2008. Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors said: "Ominously, this disconnect between buyer enquiries and actual mortgages approved highlights the inability of buyers to access the property market ... because of the substantial deposits being sought by lenders. It demonstrates the need for the Government to make speedy progress with the guarantee scheme for mortgage-backed securities."
However, it is the raid on savings that offers the strongest evidence of financial hardship. Companies and individuals withdrew £8.5bn from bank and building society savings accounts during the first few weeks of the year. To some degree this follows a normal pattern... but the extent of the withdrawals is unusually large: in January 2008 the equivalent figure was £1.3bn. On a seasonally adjusted basis, the flow of savings by households in January was £3.3bn down on the previous month. Colin Ellis, economist at Daiwa Securities, commented: "Despite households' efforts to increase their savings, short-term factors seem to be hampering them. Some may be emptying savings accounts instead of borrowing from banks that are unwilling or unable to lend, and individuals may be lacking confidence to borrow large sums. Others may be using savings to maintain their standard of living and others may be drawing savings down as they are made redundant.... Many may simply feel that the measly interest rates on offer give them little financial incentive to save."
The Bank said yesterday that average rates of return on savings had collapsed to 1.14 per cent on instant access accounts. The latest figures are especially disturbing because they provide strong evidence that the various Government initiatives to boost credit are having little or no impact. The Department for Business's £10bn loan guarantee scheme, announced by Lord Mandelson in January, has been hit by delays, and the two recapitalisations of the banks by the Bank of England are yet to make their presence felt. Government pleas for the banks to resume lending to 2007 levels seem to have fallen on deaf ears, as they continue to be consumed by bad loans and write-offs. Yesterday HSBC declared that it would seek a further £12bn from shareholders to cover bad debts.
Banks are concentrating on getting their own houses in order rather than helping business: the Bank of England data shows that the level of unused credit facilities granted by UK banks continues to fall, down 11.2 per cent in the year to January. The monthly drop in credit facilities in January – down £18.4bn, or 6.9 per cent on December – is the second-biggest monthly drop in 20 years. Michael Saunders, Head of European Economics, at Citigroup said: "This is a sign of the extent to which banks are cutting back on new credit supply, hence further pressuring companies to cut back on jobs, investment and inventories."
The Bank of England is expected to cut rates again on Thursday, from 1 to 0.5 per cent, and to announce a programme of "quantitative easing" – injecting cash directly into the economy to boost spending. *Gordon Brown last night said lawyers were looking at "every possible avenue" to reduce the failed Royal Bank of Scotland boss Sir Fred Goodwin's £693,000-a-year pension. The move came as the City Minister Lord Myners said that he did not "endorse" the pension. He told the House of Lords he did not know the figures, although he was aware that it would be a "large sum".
Poland renews pledge to join euro early
Poland on Monday renewed its commitment to bid for rapid accession to the eurozone amid signs the financial crisis has prompted European Union leaders to consider shortening the entry process. Warsaw’s declaration came after Sunday’s EU summit, where some leaders indicated they would think over Hungarian proposals for reducing the two-year period candidates spent in the exchange rate mechanism-2 preparing for euro entry. Amid tense scenes, EU leaders rejected separate Hungarian plans for an eastern European banking bail-out. But the summit backed a case-by-case approach to aid while some participants suggested reviewing the time spent in the ERM-2, but not relaxing other euro entry criteria.
The failure of the €180bn bail-out plan caused eastern European currencies to fall on Monday, led by a 2.5 per cent drop in the Hungarian forint. While Poland, which wants to adopt the euro by 2012, might benefit from a shorter ERM-2 wait, Warsaw on Monday made clear it did not necessarily support any change in entry rules. "We have not changed our position at all. We want to join ERM-2 in the first half of the year, if market conditions permit," Jacek Rostowski, Poland’s finance minister, told the Financial Times. Poland’s tough approach, which is shared by the Czech Republic, is in line with a policy of differentiating itself from the more troubled countries of the region including Hungary. Warsaw and Prague reacted coolly at the summit to both Budapest’s bail-out and ERM-2 proposals. Mr Rostowski said: "We think a one-size-fits-all approach to the region is not right.
What’s needed is differentiation. Countries should be helped according to their needs, whether they are in eastern Europe or in western Europe." Despite the concern about central Europe’s stability, some central European officials argue that weaker eurozone countries including Ireland and Greece are in much worse shape than Poland or the Czech Republic. At the summit, some EU leaders indicated they were open to shortening the period spent in ERM-2. "There are requests to enter ERM-2 faster. We can look at that," Angela Merkel, Germany’s chancellor, said. The European Central Bank would not comment on Monday, but it is likely to demand a strict interpretation of the eurozone entry rules.
Latvia's Crisis Mirrors Eastern Europe's Woes
Until recently, it was regarded as an economic success story. Now, Latvia could be on the "brink of bankruptcy." Linards Naglis says he can't sleep at night. For the past 15 years, the enterprising Latvian has made a good living as a project manager for a consortium of Western investors in his Baltic homeland, buying up land to be used for real estate development. But recently, Naglis -- and nearly all of his company's staff -- was handed his notice as business evaporated. Now, instead of planning family holidays to Florida, he worries about how he will pay household bills. His life savings, invested in property in Bulgaria, have vanished, too. "I never thought I'd be in this situation, to be honest," he says. "I wasn't expecting to be a millionaire, but I expected a comfortable, decent life. Now I really don't know what will happen."
Naglis' story is in many ways a metaphor for his entire country. Of all the nations hit by the global financial crisis, none has suffered such a devastating reversal of fortune as Latvia. The tiny Baltic Republic saw its economy shrink by a heart-stopping 10.5 percent year-over-year in the last quarter of 2008. A further gross domestic product slump of 12 percent is forecast for 2009. Despite a $7.5 billion bailout from the International Monetary Fund in December, the government is being forced into severe economic measures, including public-sector wage cuts of 15 percent. It's a remarkable turn of events for a country that until recently was regarded as an economic success story. In the capital Riga, what immediately catches the eye is the striking evidence of recent economic development. The city has become a magnet for Western tourists, turning the city center into a colorful maze of fancy boutiques, cafés, and restaurants.
Modern bank branches, mostly Scandinavian banks such as Sweden's Swedbank and SEB, are visible on every street corner. Yet these conspicuous signs of wealth are deceptive. In January the picturesque streets of Riga's medieval old town became the unlikely setting for violent clashes between stone-throwing youths and police, after a peaceful demonstration by 10,000 anti-government demonstrators turned sour. Political turmoil culminated with the resignation of the center-right coalition government on Feb. 20. Latvia's newly appointed Prime Minister, Valdis Dombrovskis, has admitted the country is "on the brink of bankruptcy," urging the nation to accept the IMF-backed austerity package or face financial ruin. What went wrong? As the global recession bites, Latvia, a small and open economy, is being hit especially hard by declining exports. Its problems are exacerbated by having a currency pegged to the euro -- a linchpin of the country's economic policy that now looks increasingly problematic. But the foundations of the crisis were in fact laid years earlier. It's a familiar tale of an overheated property market, fed by lax credit, excessive borrowing, and complacent regulators.
"This real estate market was insane," says Aleksis Karlsons, a hotel owner and property developer in Riga. "The mentality set in: I own an apartment or two-that means I'm rich. People thought they were wealthy without doing anything." At their peak two years ago, apartment prices in Riga reached €2,000 per square meter ($234 per square foot). They have since plunged by more than 50 percent. While ordinary Latvians can be partly blamed for their naivete, the government bears an even heavier responsibility for failing to prick the bubble when it had the opportunity. "The government did nothing to stop the party. Instead it joined in," says Peteris Strautins, chief economist of Swedbank in Riga. Even at the height of the boom, when the economy was growing by an unsustainable 11 percent a year, Latvia ran a budget deficit. Latvia's current account deficit, the excess of imports over exports and capital inflows, reached a colossal 25 percent of GDP in 2007.
These clear failures of macroeconomic management go a long way toward explaining why Latvia's situation is now so dire. But in some respects, like its Baltic neighbors Lithuania and Estonia, whose economies also are in trouble, Latvia is suffering because it followed orthodox economic advice, liberalizing its financial sector and opening the economy to outside capital and investment. "Accession to the European Union and the promise of accession to the euro gave investors a great feeling of security," says Jerry Wirth, president of RBM Property Group in Riga. He notes that many investors from Western Europe, including both individuals and banks, rushed to participate in the great property bubble. The implications go well beyond Latvia. To a greater or lesser extent, all the countries in Central and Eastern Europe are now waking up to a painful hangover after years of credit-fueled growth financed largely by Western banks.
"They adopted a growth model that we used to think was the right one, based on capital flows, convergence, and European values," admits Erik Berglof, chief economist for the European Bank for Reconstruction & Development in London. "The model wasn't the mistake. The mistake was the lack of architecture to support the model," he adds, referring to the failure to monitor credit flows and the resulting bubble in asset prices. Now, he says, concerted international action is vital to manage the crisis facing the entire region, backed up by "significant financial resources." That idea has become a topical theme of late, amid growing recognition that Eastern Europe's mounting economic woes could become contagious and start to affect Western European economies as well. But recognizing the danger of international contagion is so far proving easier than figuring out an appropriate response.
Some Eastern European leaders were dismayed when, on March 1, German Chancellor Angela Merkel flatly rejected a Hungarian proposal for a €180 billion ($226 billion) aid package for the region. Other lifelines may be available, however. In February, G-7 finance ministers agreed in principle to double the IMF's funding this year to $500 billion, with details still to be hammered out at the IMF's annual meeting in April. Even if such support measures are eventually put in place, they will do little to ease the immediate pain in badly affected countries such as Latvia. Long-term relief depends on global economic recovery, which still seems depressingly distant. In the meantime, most Latvians are putting a brave face on their difficulties, and praying for better times.
Ukraine risks unrest as ills worsen
Olexander Pavlenko, a young computer programmer, is one of tens of thousands of Ukrainians who cannot get their money out of the bank. He stood in line in Kiev at Nadra Bank and Ukrprombank, two big troubled banks, planning to withdraw more than $10,000 (€7,950, £7,125). But like many others, he was told the cash was not available. "I stood in line a couple times with other bank clients who were protesting, crying and screaming. But the bank told me: ‘Sorry, we simply don’t have the money now and can’t help you.’"
With about nine banks now under the central bank’s special control, Ukrainians are increasingly worried. Even those with their money in apparently solid banks, including those controlled by west European banking groups, are concerned because the central bank has banned the early redemption of term deposits, the most popular form of saving in Ukraine. Altogether, hryvnia bank deposits have dropped 20 per cent since September and those in foreign currency 10 per cent.
"This is very serious," said Olexander Suhonyako, president of the Association of Ukrainian Banks. The growing discontent among bank clients is matched by other signs of public anger at the impact of the global crisis – and at the seeming inability of the country’s divided leaders to respond effectively. Recent weeks have seen protests by truck drivers complaining about taxes and the dramatic decline of the hryvnia, which has complicated the repayment of foreign currency vehicle loans.
Meanwhile, the owners of street kiosks in Kiev successfully demonstrated against the city’s plans to take over their stalls. But with demonstrations drawing only up to 5,000 people, the authorities are confident there is no serious threat to stability. They say Ukraine is remarkably calm given the country’s economic problems. Gross domestic product growth is forecast to contract 5-10 per cent in 2009, while unemployment is rising and non-payment of wages is becoming more common. But with political leaders focused on the forthcoming presidential elections due before the end of the year, some observers fear that the protests will become bigger.
Oleksiy Haran, a political science professor at Kiev’s Mohyla University, says: "If [the economic situation] worsens, if more banks run into trouble, and if more layoffs pile up, then I would expect large crowds to materialise. This will be dangerous for a country that is struggling already to deal with the economic crisis." There seems to be no end to the disputes between Viktor Yushchenko, president, and Yulia Tymoshenko, his prime minister. Much now depends on the implementation of the $16.5bn package assembled by the International Monetary Fund, including money for bank refinancing. After disbursing $4.5bn last autumn, the IMF suspended further loans after a policy disagreement with Kiev.
But Mr Yushchenko and Ms Tymoshenko pledged at the weekend to co-operate with each other and the IMF on implementing reforms. Meanwhile, the IMF agreed to relax its desired deficit target from less than 1 per cent of GDP to about 3 per cent, in the light of the deepening recession. Co-operating with the IMF will allow Ukraine not only to secure loans but also support from other international institutions including the World Bank and multinational banks, which have pledged to back their local subsidiaries.
On Monday, Austria’s Raiffeisen International promised to support Aval, its Ukrainian affiliate. Hryhoriy Nemyria, deputy prime minister, insists Ukraine "is not a basket case". Ceyla Pazabasioglu, the IMF’s Ukraine mission chief, agrees, saying the country’s difficulties are not "insurmountable". But investors are not so sure. Ukraine’s credit default swap rate – a risk measure – stands at around 3,700, compared with about 1,000 for Latvia and 560 for Hungary, two other east European states on IMF support. Every week seems to bring a new crisis – the next could come this weekend, when Kiev is due to pay a $400m bill to Gazprom, the Russian gas monopoly.
Road from the Orange revolution
• Jan 2005 Viktor Yushchenko sweeps to power in the Orange Revolution
• Sept 2005 Mr Yushchenko sacks Yulia Tymoshenko, his prime minister, after repeated disputes
• March 2006 Parliamentary elections and appointment of Viktor Yanukovich as prime minister
• 2007 Efforts by Mr Yushchenko and Mr Yanukovich to co-operate collapse and new elections are called. Ms Tymoshenko returns to power
• 2003-2007 Strong growth, with GDP rising at an annual average of 8 per cent
• 2008 GDP growth slows to 2 per cent. Gloom spreads into property and banking
• March 2009 Economy worsens, with a decline of at least 6 per cent in growth predicted this year
Journey that brings tales of woe:
The overnight train ride from Kiev to Mariupol, a steel town of 500,000 on the Azov Sea in south-east Ukraine, is not an uplifting journey, writes Roman Olearchyk in Mariupol. Travellers exchange accounts of how they, or their friends, have lost their jobs in the country’s economic crisis. In Mariupol itself, Volodymyr Boyko, general director of Ilyich Metallurgical Plant, one of the city’s two giant steel mills, is equally blunt: "The crisis started in America and spread to us. The bubble burst. People took loans that they couldn’t pay. It exploded. Only God knows how long it will last." The recession is eating at Ilyich’s revenues. The 100,000 workers are increasingly worried about their jobs, as the national total of unemployed has almost doubled to 1m since the autumn and could double again this year.
Mr Boyko is desperate to keep the workforce busy and paid at the mill and at related businesses, including Soviet-style farms and fisheries. Asked if layoffs could spark uncontrollable protests, Mr Boyko said: "God forbid, everything would fall apart." Global steel prices have plummeted two-thirds since last year’s peak to about $400-per-tonne levels. Ilyich is afloat for now, working at 60 per cent of its 6m tonne per annum capacity. But for how long? "Ilyich is not driven by profits, but to support our working collective," the Soviet-style director says. A rare exhibit of socialism in capitalistic Ukraine, the Soviet-built mill was named in honour of Vladimir Lenin, who carried the patronymic Iliyich. Owned by workers yet tightly controlled by Mr Boyko, it stands apart from Ukraine’s other mills, owned by billionaires that have borrowed heavily from abroad in recent years to expand and modernise.
As Italy's Banks Tighten Lending, Desperate Firms Call on the Mafia
When the bills started piling up and the banks wouldn't lend, the white-haired art dealer in the elegant tweed jacket said he drove to the outskirts of Rome and knocked on the rusty steel door of a shipping container. A beefy man named Mauro answered. He wore blue overalls with two big pockets, one stuffed with checks and the other with cash. The wad of bills he handed over, the art dealer recalled, reeked of the man's cologne and came at 120 percent annual interest. As banks stop lending amid the global financial crisis, the likes of Mauro are increasingly becoming the face of Italian finance. The Mafia and its loan sharks, nearly everyone agrees, smell blood in the troubled waters. "It's a fantastic time for the Mafia. They have the cash," said Antonio Roccuzzo, the author of several books on organized crime. "The Mafia has enormous liquidity. It may be the only Italian 'company' without any cash problem."
At a time when businesses most need loans as they struggle with falling sales, rising debt and impending bankruptcy, banks have tightened their lending to them. Italian banks, which for years had been widely criticized for lending sparingly to small and medium-size businesses, now have "absolutely closed the purse strings," said Gian Maria Fara, the president of Eurispes, a private research institute. That is great news for loan sharks. Confesercenti, the national shopkeepers association, estimates that 180,000 businesses recently have turned to them in desperation. Although some shady lenders are freelancers turning profits on others' hard luck, very often the neighborhood tough offering fat rolls of cash is connected to the Mafia, the group said. "Office workers, middle-class people, owners of fruit stands, flower stalls are all becoming their victims. . . . We have never seen this happen," said Lino Busa, a top Confesercenti official. "It is as common as it is hidden."
Many experts say organized crime is already the biggest business in Italy. Now, Fara said, the untaxed underground economy is growing even larger. "Certainly I am worried," he said. "The banking system doesn't work, and the private one that is operating is often managed by organized crime." The consequences for Italy and its 58 million people are huge, Fara said: "Stronger organized crime means a weaker state." Nino Miceli, an adviser to Confesercenti, said the Mafia's goal is to take over the struggling businesses. When the loans, typically at interest rates in triple digits, are not repaid, the threats of violence begin, and restaurants, grocery stores and bars become the property of criminal gangs. "As we sit here in this cafe," he said over an espresso near the Colosseum, "do we really know who owns it?"
With a burgeoning portfolio of properties and businesses, the Mafia becomes more entrenched in the economy and has more outlets to "clean their money," Miceli said. Confesercenti estimates in a new report that organized crime syndicates -- including Naples's Camorra, Sicily's Cosa Nostra, Calabria's 'Ndrangheta -- collect about 250 million euros, or $315 million, from retailers every day. Some of that money is the classic "pizzo," or protection money demanded of business owners. Miceli said his auto dealership was burned down when he refused to pay. But the mob's booming business, he and others agreed, is loan-sharking. "The loan sharks are growing like mushrooms and becoming bolder and more visible," Cardinal Severino Poletto, the archbishop of Turin, was quoted as saying in La Stampa newspaper last month. "They grow like mushrooms when the time is right, and unfortunately, it's evident that the time is right now."
Many victims get tangled up with the mob by believing that they can find a "good" loan shark. Fausto Bernardini, 46, ran an amateur soccer club in Rome that depended on money from sponsors, including a real estate company. But in the grim economic climate, the sponsors pulled out. With players, coaches and fans depending on him to keep their beloved club afloat, Bernardini asked a local businessman for a loan. He, in turn, recommended another man, who handed Bernardini 9,000 euros, or about $11,400, at 120 percent annual interest. "I knew it was steep," said Bernardini, a burly father of two with a deep passion for soccer. He never imagined borrowing from a loan shark but said he had no choice. He said he planned to repay the money quickly. His winning team, he hoped, would attract new sponsors. But no fresh funds came, and he fell behind in payments.
One day a man jumped him on the street, shoved him into a car and drove him around for an hour, threatening to tie him to a tree in the woods until payment was made, he said. Later, another man came to his home and threatened to break his legs and harm his daughter. "Then I went to the police," he said. In his case, two men were convicted and sent to jail last year. The Mafia is most famous in Sicily and southern Italy, but its tentacles spread throughout the country. In Vigevano, a northern city of 60,000 near Milan, a group called Free Vigevano has helped nearly 100 people who had become entangled with the mob. One of them, a 40-year-old salesman, said he got his desperately needed $15,000 -- but at 30 percent monthly interest. He met a man who was dressed in Versace, drove a Mercedes convertible and handed him the cash in a bar.
The salesman said he has since moved away because of threats from the loan shark. Once when he made a partial payment of more than $5,000, the man scoffed at him and said that sum "had as much value as a cup of coffee." The salesman said he blames banks for pushing people like him into the arms of the Mafia. "If they would be a bit more open with their credit, many people wouldn't fall into this trap," he said. "They only give money to those who already have it." Usury, charging exorbitant interest rates, is a crime in Italy. The legal rates lenders charge depend on the type of loans and are fixed by the government every quarter, but generally, charging more than 30 percent a year is considered illegal. But convicting a loan shark, commonly called "strozzino," one who strangles you, or "cravattaro," one who grabs you by the necktie, can be difficult.
For one thing, said Fausto Mario Amato, a lawyer who defends Mafia victims, there is rarely a paper trail. Amato said police are investigating Mauro, the man who worked out of the shipping container and lent money to his client, the art dealer. Interviewed in his art gallery in Rome, the soft-spoken art dealer spoke on the condition that he not be identified. With his wife on one side of him and his lawyer, Amato, on the other, he sat at his desk in his softly lit gallery. If clients knew he had gotten tangled up with a loan shark, he said, he would "lose social prestige and honor." At his first meeting with Mauro, he said, he wrote out a check for 15,000 euros, or $19,000. He signed it, dated it so it could be cashed in 30 days, and left the name blank, as instructed. Mauro deducted his first month's 10 percent fee, and handed him 13,500 euros in a wad of 50 euro bills. "I had hoped I could pay him back in a month," he said, shaking his head.
Over and over he drove to the lot where Mauro also leased heavy construction equipment. He pulled in beside a Porsche and Lamborghini and gave Mauro whatever cash he had toward the escalating interest payments. When he couldn't keep up, the threatening calls at night started. "Be careful," the voice would say. That's when he called police and hired a lawyer. "How did I get to this point?" he said, his tired eyes tearing up. He said he wanted to tell his story because, as the economic crisis deepens, more and more lives are being destroyed by loan sharks. "I could have decided to go bankrupt and not gotten involved with all this," he said. "But that is a hard decision to make."
Stanford Bank Collapse Threatens Venezuela
The collapse of a Venezuelan bank owned by R. Allen Stanford, the Texas financier accused of fraud, is raising concern that the run on its deposits could spread to other banks, threatening the nation's economy. On Saturday, President Hugo Chávez blamed his political enemies for rumors about mass withdrawals, and urged depositors not to pull their savings from domestic banks. "If there were any reason to do it, I would be the first to act," Mr. Chávez said, in statements distributed by his press office. "I refute these rumors that attempt to sow panic among savers, not just regarding what happened with Stanford, but about the Venezuelan financial and banking systems."
Mr. Chávez moved to restore confidence a day after speculation spread among brokerage-house trading desks and businessmen that at least one major bank had faced unusually large deposit withdrawals. The speculation is difficult to confirm because it is too recent to be reflected in the latest official bank data. While Mr. Chávez may succeed in restoring confidence, the concerns underscore the problems facing the 54-year-old, anti-American former soldier, who recently completed a decade in power and last month won a referendum to alter the constitution to permit indefinite re-election. Mr. Chávez's ability to fund welfare programs and other subsidies at the core of his popularity is undercut by plunging oil prices. Increasingly, residents of Venezuela say they believe Mr. Chávez will have to devalue the "strong bolivar" currency he introduced last year. Price controls meant to contain 30% inflation have led to food shortages. On Saturday, Mr. Chávez dispatched troops to force rice makers to boost production.
Mr. Chávez has even lost his longtime foil, former President George W. Bush. In recent days, Mr. Chávez has tried tirades against President Barack Obama, who nonetheless remains a popular figure among Venezuelans. The U.S. fraud allegations against Mr. Stanford are a recent addition to Mr. Chávez's woes. In February, Venezuelan authorities seized Stanford Bank, which is owned by Mr. Stanford, after a U.S. Securities and Exchange Commission lawsuit accused the Texas financier of fraud. A spokeswoman for Stanford Group Venezuela declined to comment on speculation about other banks. The U.S. lawsuit triggered a run on deposits at the bank -- a small retail operation in Venezuela with about 20 branches. The Venezuelan government guaranteed the deposits of Stanford Bank and says it will sell the bank. Observers say the bank's problems revive memories of a mid-1990s banking crisis that wiped out the savings of many in the middle class.
Pension bombs going off
Exploding pension fund shortfalls are blowing billion-dollar holes in the balance sheets of some of the Chicago area's biggest companies, forcing them to make huge contributions to retirement plans at a time when cash flow and credit are already under stress. Boeing Co.'s shareholder equity is now $1.2 billion in the hole thanks to an $8.4-billion gap between its pension assets and the projected cost of its obligations for 2008. At the end of 2007, Boeing had a $4.7-billion pension surplus. If its investments don't turn around, the Chicago-based aerospace giant will have to quadruple annual contributions to its plan to about $2 billion by 2011.
Stock market losses also pounded pension funds at Abbott Laboratories Inc., Caterpillar Inc. and Exelon Corp., with others sure to emerge as companies file their annual financial reports with the Securities and Exchange Commission in coming weeks. The pension gaps underscore a growing conundrum. Unfunded pension liabilities have to be subtracted from shareholder equity, weakening balance sheets at a time when it's already tough to borrow money. Barring a reprieve from Congress, companies may be forced to make more layoffs or curb capital investments to divert cash to shore up pensions.
"There are companies out there faced with paying their pension plan or staying in business," says Mark Ugoretz, president and CEO of the ERISA Industry Committee, a Washington, D.C., lobbying group. ERISA refers to the Employee Retirement Income Security Act of 1974, which sets standards to ensure pension plans are sufficiently funded. The Chicago companies are symptomatic of nationwide woes. Last year, the 100 largest corporate pension funds in the U.S. saw their net assets decline by 21%, while liabilities increased 1.2%. Applying those averages to any of the region's top funds puts almost all of them into the red by at least $1 billion.
The situation is far worse at companies that entered 2008 with plans already in poor shape. They are now even harder-pressed to come up with huge increases in pension fund contributions to erase the gap in seven years, as federal law requires. A Boeing spokesman says the pension deficit is "clearly a situation we don't like," but adds that the company's credit rating hasn't been affected. Stricter federal pension-funding requirements, enacted when the stock market was riding high, threaten to undermine the economy further. Business interests are lobbying for more time to close the gaps, but with lawmakers focused on the housing and banking crises, the issue hasn't gained much traction in Washington.
As a result, "many of the country's largest employers are being forced to make short-term trade-offs between maintaining employment and funding long-term obligations," Sears Holdings Corp. Chairman Edward Lampert wrote in a note to shareholders last week. Hoffman Estates-based Sears, which announced the closings of 24 stores this year, expects its pension expense to soar as high as $175 million this year from $1 million last year due to the markets' decline. Underfunded pensions also are forcing borrowing costs higher for some companies. At Peoria-based Caterpillar, shareholder equity dropped more than 25% from the previous year after the company booked a $5.8-billion pension shortfall and its plan went from 93% funded to 61% funded. That means Cat has to pay an additional 1.5 percentage points of interest to keep its untapped credit lines intact, according to SEC filings. Its pension assets sank 30% last year, and this year's contribution will more than double to about $1 billion. A Cat spokesman declines to comment.
A decline in interest rates last year also fueled widening pension liabilities, says Lynn Dudley, senior vice-president of policy for the American Benefits Council, another Washington, D.C., group lobbying for more time to fund plans. Generally, the current value of a future obligation goes up when interest rates come down. In essence, last year's drop in stock prices and interest rates was a double whammy for pension funds, Ms. Dudley says. "The law kind of slams you. In extreme markets, it's really unpredictable," she says. Absent relief from Congress, she says, "there have been some layoffs, and there are going to be more layoffs" to save cash for pension contributions. The most notable Chicago-area exception is Moline-based Deere & Co., which began 2008 with a plan that was 17%, or $1.5 billion, overfunded. Deere may have escaped the worst of the 21% average decline in assets. The company's fiscal year ended Sept. 30, before the worst of the stock downturn hit, and only 27% of its fund — far less than most — was in equities. A Deere spokesman declines to comment.
Many Hires Needed for Budget Goals
Tens of Thousands Could Be Added to Federal Payroll
President Obama's budget is so ambitious, with vast new spending on health care, energy independence, education and services for veterans, that experts say he probably will need to hire tens of thousands of new federal government workers to realize his goals. The $3.6 trillion plan released last week proposes spending billions to begin initiatives and implement existing programs, and given Obama's insistence that he would scale back the use of private-sector contractors, his priorities could reverse a generational decline in the size of the government workforce. Exactly how many new workers would be needed remains unclear -- one independent estimate was 100,000, while the conservative Heritage Foundation said it is likely to be closer to a quarter-million.
Administration officials said they cannot determine overall hiring projections until the president's full budget is released this spring, but acknowledged that significant new hiring will occur. "It is premature to be making any assumptions about overall federal employment levels," White House budget director Peter Orszag said. "We have no desire to bloat bureaucracy -- indeed, just the opposite -- and the budget will not do that." But, he added, "in several key areas -- from properly auditing contracts to providing quality medical care to veterans and reducing errors in Medicare and other programs -- investing in skilled professionals will not only pay off over time but also immediately deliver better service to taxpayers."
Several major agencies said they are already making plans to grow their workforces, some significantly. Officials at the Department of Veterans Affairs, for instance, said they expect to hire more than 17,000 new employees by the end of the year, many at hospitals and other facilities to fulfill Obama's pledge to expand veterans' access to health care. The agency -- whose budget will grow by 11 percent, to $56 billion, under Obama's plan -- will add about 7,900 nurses, 3,300 doctors, 3,800 clerks and 2,400 practical nurses, spokeswoman Josephine Schuda said. At the Social Security Administration, the budget will increase by 10 percent, to $11.6 billion, enabling the agency to hire new staff to handle backlogs on frontline operations, such as local field offices, hearing offices and teleservice centers, spokesman Mark Lassiter said.
Said Max Stier, president of the Partnership for Public Service: "This is obviously a new world. We've had a government that has been starved. . . . When you look at virtually every agency in government -- whether it's food inspectors at the Food and Drug Administration or claims examiners at the Social Security Administration -- across the board, we've had all too few people doing the business of government." Between 1940 and 1970, the federal civilian workforce swelled from 707,000 to 2.1 million, according to government statistics provided by Stier. But ever since Ronald Reagan swept into the White House in 1981 with a call to decrease the government's footprint, presidents have limited the size of the workforce. Although President George W. Bush added tens of thousands of airport baggage screeners and other homeland security jobs, he offset much of that increase by limiting hiring at other agencies.
In reversing this trend, Obama would make himself politically vulnerable to charges that he is growing not just the power of government, but also its size. If the outside estimates are realized, Obama could spur a government hiring spree on a scale unseen since President Lyndon B. Johnson's Great Society agenda in the 1960s. "What group of socialists got in the room and wrote this budget? Do they have any idea what the implications are?" asked Republican Newt Gingrich, who as House speaker in the 1990s advocated a shrinking of the government. "This is the most aggressive 180-degree turn that we have seen in the American system."
Obama, in his radio address Saturday, acknowledged that the budget signals "real and dramatic change" to the status quo in the federal city. "I know these steps won't sit well with the special interests and lobbyists who are invested in the old way of doing business, and I know they're gearing up for a fight as we speak," he said. "My message to them is this: So am I." But the new president is "caught between a rock and a hard place," said Paul C. Light, a professor of public service at New York University.
Obama inherited a federal workforce of about 2 million that Light described as woefully understaffed, especially to fulfill his bold domestic policy agenda. He predicted that Obama's budget and the $787 billion economic recovery package could require an additional 100,000 federal workers, but warned that the number may be even higher. "I think that's just a start," Light said. "You kind of look across the federal landscape and you say there has to be more bodies with more expertise, as well as more bodies that can just deliver the basic services we've already promised." At the conservative Heritage Foundation, the Center for Data Analysis estimated that Obama's budget and the stimulus bill could result in 230,000 to 260,000 new federal employees, primarily in areas such as education and health care.
"We found in the Obama plan that the increases in employment were overwhelmingly in the public sector," said William W. Beach, the center's director. "We haven't seen this much growth for a while." Beach cautioned, however, that "any number of things can happen once these budgets become the subject of debate in Congress." The Office of Management and Budget has not determined how Obama's budget would impact the federal workforce. Managers may reassign employees in some areas to more critical functions, such as overseeing or enforcing stimulus grants and contracts, OMB spokesman Kenneth Baer said. "The federal workforce is going to undergo a fundamental transformation over the next decade as baby boomers who entered government service in the 1960s retire," Baer said. "Much of the human capital needs for new initiatives will be met by reorganizing, so as to reallocate positions left unfilled by retirements."
In some agency headquarters across Washington, the potential for expanding the federal workforce is the subject du jour. "It's being discussed in this building around every water cooler and cafeteria line there is," said one official who spoke on the condition of anonymity because he was not authorized to discuss budget plans. Colleen M. Kelley, president of the National Treasury Employees Union, which represents workers in 31 federal agencies, said the administration appears to be "rebuilding workforces that have not been properly maintained and supported." At the Internal Revenue Service, she said, "there are hundreds of thousands more taxpayers today than there were 10 years ago, and there are 27,000 fewer employees."
At the Environmental Protection Agency, the employee base is expected to grow, but more modestly. The agency, which has about 17,000 employees, expects to add 100 to 200 positions, said a senior EPA official who spoke on the condition of anonymity because the agency's plans have not been made public. "We have the authority to have additional folks, because we want to ensure proper oversight and management of these [stimulus] resources," the official said. The EPA is being "cautious" about expanding the workforce because of the long-term costs associated with permanent employees, he said. "Not only are you paying for the people today," he said, "but you have to think about what are the implications for the future as well."
The U.S. Economy: Designed to Fail
President Barack Obama showed a great deal of gumption in standing before Congress last week delivering his first speech to the joint assembly. All the trappings of power were on display as members of the House and Senate, the Supreme Court, the Joint Chiefs, the Cabinet, and the VIP guests hugged and waved at each other, radiant in their tailored attire only two nights after the Hollywood stars put on their own show on Oscar night. Too bad neither the president, nor Vice President Joe Biden and Speaker of the House Nancy Pelosi applauding on the podium behind him, nor the jubilant Democrats with their solid majorities, nor the grumpy Republicans slouching in the minority across the aisle, know what they are doing as economic extinction stares the United States of America in the face.
Yes, it’s that bad. The day after the speech the Dow-Jones dropped to 7,271, almost 50 percent off its October 2007 high, with no bottom in sight. According to the Washington Post, the Big Three automakers are now facing a "bottom-up" collapse of their component supply lines if their vast network of suppliers doesn’t receive new federal loans within a week. Worldwide the situation is just as bad. The U.N.’s International Labour Organization reports: "What began as a crisis in finance markets has rapidly become a global jobs crisis. Unemployment is rising. The number of working poor is increasing. Businesses are going under."
President Obama’s speech was long on resolve but short on substance. He assured the nation: "We will rebuild, we will recover, and the United States of America will emerge stronger than before." But accomplishing this depends entirely on one thing: more federal deficit spending to serve as the economic engine in an economy where bank lending has dried up because businesses and consumers can no longer repay their loans. Unfortunately, the deficit is approaching the breaking point. During fiscal year 2009 the U.S. Treasury is on-track to pay over $500 billion just in interest payments to finance the already-existing debt. New debt this year will likely exceed a trillion dollars.
The total debt burden on the economy as a whole could reach $70 trillion by 2010, with annual interest payments for individuals, households, businesses, and all levels of government likely to reach $3 trillion out of a $14 trillion GDP that is now in sharp decline. Financing the deficit continues to depend on whether China will still purchase Treasury bonds. This is why Secretary of State Hillary Clinton said frankly during last week’s trip to China : "We are relying on the Chinese government to continue to buy our debt." But at least President Obama is trying. He knows the economy can only recover if growth is rekindled. So he is focusing on the creation of jobs that translate into real worker income. But can he reverse a generation of job outsourcing and income stagnation? I don’t know of anyone who believes he can.
Will the Republican nostrum of tax and spending cuts do anything? You jest. Not when unemployment is approaching Great Depression levels.. But neither President Obama, nor his Democratic supporters or Republican antagonists, should feel badly about what is happening. This is because the system they have been given to work with was designed to fail. The U.S. was saddled long ago with a debt-based monetary system, whereby the only way money can be introduced into circulation is through bank lending. It was the system that was instituted in 1913 when Congress gave away its constitutional power over money creation to the private banking industry by passing the Federal Reserve Act.
It was then that the catastrophe we are now facing became inevitable. It took nearly a century to get here but it finally happened. We should have known it was coming when Federal Reserve-created bubbles replaced economic growth from our disappearing heavy industry, starting with the recession of 1979-83. We could have seen it coming when the dot.com bubble collapsed in 2000-2001, and Fed Chairman Alan Greenspan worked with the George W. Bush administration to substitute the housing bubble for a real recovery. The day of reckoning is here. So don’t worry, Mr. President. It’s not your fault. When the collapse takes place the international bankers who will take over might even let you keep your job.
The unfortunate uselessness of most ’state of the art’ academic monetary economics
by Willem Buiter
The Monetary Policy Committee of the Bank of England I was privileged to be a ‘founder’ external member of during the years 1997-2000 contained, like its successor vintages of external and executive members, quite a strong representation of academic economists and other professional economists with serious technical training and backgrounds. This turned out to be a severe handicap when the central bank had to switch gears and change from being an inflation-targeting central bank under conditions of orderly financial markets to a financial stability-oriented central bank under conditions of widespread market illiquidity and funding illiquidity. Indeed, it may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding .
It was a privately and socially costly waste of time and other resources. Most mainstream macroeconomic theoretical innovations since the 1970s (the New Classical rational expectations revolution associated with such names as Robert E. Lucas Jr., Edward Prescott, Thomas Sargent, Robert Barro etc, and the New Keynesian theorizing of Michael Woodford and many others) have turned out to be self-referential, inward-looking distractions at best. Research tended to be motivated by the internal logic, intellectual sunk capital and esthetic puzzles of established research programmes rather than by a powerful desire to understand how the economy works - let alone how the economy works during times of stress and financial instability. So the economics profession was caught unprepared when the crisis struck.
The most influential New Classical and New Keynesian theorists all worked in what economists call a ‘complete markets paradigm’. In a world where there are markets for contingent claims trading that span all possible states of nature (all possible contingencies and outcomes), and in which intertemporal budget constraints are always satisfied by assumption, default, bankruptcy and insolvency are impossible. As a result, illiquidity - both funding illiquidity and market illiquidity - are also impossible, unless the guilt-ridden economic theorist imposes some unnatural (given the structure of the models he is working with), arbitrary friction(s), that made something called ‘money’ more liquid than everything else, but for no good reason. The irony of modeling liquidity by imposing money as a constraint on trade was lost on the profession.
Both the New Classical and New Keynesian complete markets macroeconomic theories not only did not allow questions about insolvency and illiquidity to be answered. They did not allow such questions to be asked. It is clear that, when searching for an appropriate simplification to address the intractable mess of modern market economies, the starting point of ‘no markets’, that is, autarky or no trade, is a much better one than that of ‘complete markets’. Goods and services that are potentially tradable are indexed by time, place and state of nature or state of the world. Time is a continuous variable, meaning that for complete markets along the time dimension alone, there would have to be rather more markets for future delivery (infinitely many in any time interval, no matter how small) than you can shake a stick at. Location likewise is a continuous variable in a 3-dimensional space.
Again rather too many markets. Add uncertainty (states of nature or states of the world), never mind private or asymmetric information, and ‘too many potential markets’, if I may ruin the wonderful quote from Amadeus attributed to Emperor Joseph II, comes to mind. If any market takes a finite amount of resources (however small) to function, complete markets would exhaust the resources of the universe. Beyond this simple ‘impossibility of complete markets’ proposition, there is the deeper point, that the assumption of complete markets in most of the New Classical and New Keynesian macroeconomics assumes away the problem of contract enforcement. This problem is especially acute in trade over time or intertemporal trade, where the net value to each party to a contract of fulfilling the terms of the contract varies over time and can change sign.
In a world with selfish, rational, opportunistic agents, able and willing to lie and deceive, only a small set of voluntary transactions will ever be observed, relative to the universe of all potentially feasible transactions. The first set of voluntary exchange-based transactions we are likely to see are self-enforcing contracts - those based on long-term relationships, repeated interactions and trust. There are some of those, but not too many. The second are those voluntarily-entered-into contracts that are not self-enforcing (say because interactions between the same sets of agents are infrequent and market participants have a degree of anonymity that prevents the use of reputation as a self-enforcement mechanism) but are instead enforced by some external agent or third party, often the state, sometimes the Mafia (sometimes it’s hard to tell who is who). Third party enforcement of contracts is again often complex and costly, which is why it covers relatively few contracts. It requires that the terms of the contract and the contingencies it contains be third-party observable and verifiable. Again, only a limited set of exchanges can be supported this way.
The conclusion, boys and girls, should be that trade - voluntary exchange - is the exception rather than the rule and that markets are inherently and hopelessly incomplete. Live with it and start from that fact. The benchmark is no trade - pre-Friday Robinson Crusoe autarky. For every good, service or financial instrument that plays a role in your ‘model of the world’, you should explain why a market for it exists - why it is traded at all. Perhaps we shall get somewhere this time. In both the New Classical and New Keynesian approaches to monetary theory (and to aggregative macroeconomics in general), the strongest version of the efficient markets hypothesis (EMH) was maintained. This is the hypothesis that asset prices aggregate and fully reflect all relevant fundamental information, and thus provide the proper signals for resource allocation. Even during the seventies, eighties, nineties and noughties before 2007, the manifest failure of the EMH in many key asset markets was obvious to virtually all those whose cognitive abilities had not been warped by a modern Anglo-American Ph.D. eduction. But most of the profession continued to swallow the EMH hook, line and sinker, although there were influential advocates of reason throughout, including James Tobin, Robert Shiller, George Akerlof, Hyman Minsky, Joseph Stiglitz and behaviourist approaches to finance. The influence of the heterodox approaches from within macroeconomics and from other fields of economics on mainstream macroeconomics - the New Classical and New Keynesian approaches - was, however, strictly limited.
In financial markets, and in asset markets, real and financial, in general, today’s asset price depends on the view market participants take of the likely future behaviour of asset prices. If today’s asset price depends on today’s anticipation of tomorrow’s price, and tomorrow’s price likewise depends on tomorrow’s expectation of the price the day after tomorrow, etc. ad nauseam, it is clear that today’s asset price depends in part on today’s anticipation of asset prices arbitralily far into the future. Since there is no obvious finite terminal date for the universe (few macroeconomists study cosmology in their spare time), most economic models with rational asset pricing imply that today’s price depend in part on today’s anticipation of the asset price in the infinitely remote future. What can we say about the terminal behaviour of asset price expectations? The tools and techniques of dynamic mathematical optimisation imply that, when a mathematical programmer computes an optimal programme for some constrained dynamic optimisation problem he is trying to solve, it is a requirement of optimality that the influence of the infinitely distant future on the programmer’s criterion function today be zero.
And then a small miracle happens. An optimality criterion from a mathematical dynamic optimisation approach is transplanted, lock, stock and barrel to the behaviour of long-term price expectations in a decentralised market economy. In the mathematical programming exercise it is clear where the terminal boundary condition in question comes from. The terminal boundary condition that the influence of the infinitely distant future on asset prices today vanishes, is a ‘transversality condition’ that is part of the necessary and sufficient conditions for an optimum. But in a decentralised market economy there is no mathematical programmer imposing the terminal boundary conditions to make sure everything will be all right. The common practice of solving a dynamic general equilibrium model of a(n) (often competitive) market economy by solving an associated programming problem, that is, an optimisation problem, is evidence of the fatal confusion in the minds of much of the economics profession between shadow prices and market prices and between transversality conditions that are an integral part of the solution to an optimisation problem and the long-term expectations that characterise the behaviour of decentralised asset markets. The efficient markets hypothesis assumes that there is a friendly auctioneer at the end of time - a God-like father figure - who makes sure that nothing untoward happens with long-term price expectations or (in a complete markets model) with the present discounted value of terminal asset stocks or financial wealth.
What this shows, not for the first time, is that models of the economy that incorporate the EMH - and this includes the complete markets core of the New Classical and New Keynesian macroeconomics - are not models of decentralised market economies, but models of a centrally planned economy. The friendly auctioneer at the end of time, who ensures that the right terminal boundary conditions are imposed to preclude, for instance, rational speculative bubbles, is none other than the omniscient, omnipotent and benevolent central planner. No wonder modern macroeconomics is in such bad shape. The EMH is surely the most notable empirical fatality of the financial crisis. By implication, the complete markets macroeconomics of Lucas, Woodford et. al. is the most prominent theoretical fatality. The future surely belongs to behavioural approaches relying on empirical studies on how market participants learn, form views about the future and change these views in response to changes in their environment, peer group effects etc. Confusing the equilibrium of a decentralised market economy, competitive or otherwise, with the outcome of a mathematical programming exercise should no longer be acceptable. So, no Oikomenia, there is no pot of gold at the end of the rainbow, and no Auctioneer at the end of time.
If one were to hold one’s nose and agree to play with the New Classical or New Keynesian complete markets toolkit, it would soon become clear that any potentially policy-relevant model would be highly non-linear, and that the interaction of these non-linearities and uncertainty makes for deep conceptual and technical problems. Macroeconomists are brave, but not that brave. So they took these non-linear stochastic dynamic general equilibrium models into the basement and beat them with a rubber hose until they behaved. This was achieved by completely stripping the model of its non-linearities and by achieving the transsubstantiation of complex convolutions of random variables and non-linear mappings into well-behaved additive stochastic disturbances.
Those of us who have marvelled at the non-linear feedback loops between asset prices in illiquid markets and the funding illiquidity of financial institutions exposed to these asset prices through mark-to-market accounting, margin requirements, calls for additional collateral etc. will appreciate what is lost by this castration of the macroeconomic models. Threshold effects, non-linear accelerators - they are all out of the window. Those of us who worry about endogenous uncertainty arising from the interactions of boundedly rational market participants cannot but scratch our heads at the insistence of the mainline models that all uncertainty is exogenous and additive. Technically, the non-linear stochastic dynamic models were linearised (often log-linearised) at a deterministic (non-stochastic) steady state. The analysis was further restricted by only considering forms of randomness that would become trivially small in the neigbourhood of the deterministic steady state. Linear models with additive random shocks we can handle - almost !
Even this was not quite enough to get going, however. As pointed out earlier, models with forward-looking (rational) expectations of asset prices will be driven not just by conventional, engineering-type dynamic processes where the past drives the present and the future, but also in part by past and present anticipations of the future. When you linearize a model, and shock it with additive random disturbances, an unfortunate by-product is that the resulting linearised model behaves either in a very strongly stabilising fashion or in a relentlessly explosive manner. There is no ‘bounded instability’ in such models. The dynamic stochastic general equilibrium (DSGE) crowd saw that the economy had not exploded without bound in the past, and concluded from this that it made sense to rule out, in the linearized model, the explosive solution trajectories.
What they were left with was something that, following an exogenous random disturbance, would return to the deterministic steady state pretty smartly. No L-shaped recessions. No processes of cumulative causation and bounded but persistent decline or expansion. Just nice V-shaped recessions. There actually are approaches to economics that treat non-linearities seriously. Much of this work is numerical - analytical results of a policy-relevant nature are few and far between - but at least it attempts to address the problems as they are, rather than as we would like them lest we be asked to venture outside the range of issued we can address with the existing toolkit. The practice of removing all non-linearities and most of the interesting aspects of uncertainty from the models that were then let loose on actual numerical policy analysis, was a major step backwards. I trust it has been relegated to the dustbin of history by now in those central banks that matter.
Charles Goodhart, who was fortunate enough not to encounter complete markets macroeconomics and monetary economics during his impressionable, formative years, but only after he had acquired some intellectual immunity, once said of the Dynamic Stochastic General Equilibrium approach which for a while was the staple of central banks’ internal modelling: "It excludes everything I am interested in". He was right. It excludes everything relevant to the pursuit of financial stability. The Bank of England in 2007 faced the onset of the credit crunch with too much Robert Lucas, Michael Woodford and Robert Merton in its intellectual cupboard. A drastic but chaotic re-education took place and is continuing. I believe that the Bank has by now shed the conventional wisdom of the typical macroeconomics training of the past few decades. In its place is an intellectual potpourri of factoids, partial theories, empirical regulaties without firm theoretical foundations, hunches, intuitions and half-developed insights. It is not much, but knowing that you know nothing is the beginning of wisdom.