Underwood Typewriter Co., 1413 New York Avenue N.W., Washington, D.C.
Ilargi: Starting today, I intend to do two posts per day, in order to lighten the huge mass of information and make the site more accessible. The idea is to post at 12.30 pm and 5.30 pm (today's second post is way late due to an appointment I hadn't counted on).
Ilargi: Bondholders are made whole where they clearly should not. The CEO for Home Depot is paid $9.2 million, while he lays of 7000 employees and the company's stock is plunging. It's finally dawning on decision makers that bankruptcy is the only way forward for the US automotive sector. It will let President Obama go into history as the man responsible for 2 million jobs lost and counting.
What will happen to the people losing their jobs, to their severance payments and their pensions? We are in for a gale force storm of protests, which won't subside until people feel that even if the economy cannot be restored, justice can and will. Politicians of the leading western -formerly- industrialized nations will need to open up and explain to their voters what they do and why.
As long as they fail to do that, more trouble will be brewing below the surface and eventually erupt. Still, when you look at the political landscape in North America and Europe, transparency and honest dialogue are missing in action, and have largely been for a long time. Politicians are no different from laundry detergent, hamburgers, chocolate bars and automobiles. They are sold to the public with slogans and images that appeal not to reason, but to base instincts. In politics, lying, twisting the truth, and hiding uncomfortable facts and numbers are so engraved and embedded in what is said and done every single day by representatives and the media they rely on for their careers, that it's hard to see how that could change any day soon. And these are the folks who have debts to, and friendships with, powerful financiers. They also have unlimited access to your money.
The G20 summit in Britain this week may show a first string indication of how fed-up people are today with what has become the norm in politics and industry. As long as the mirage of perpetual growth and increasing material wealth can be maintained, people are so occupied with their quest to get their share that they are unlikely to complain. What we are witnessing -and living- is the demise of that mirage. Real wealth has been sinking for decades, as is easily seen by looking at the development of the costs of education and health care, not coincidentally fields that have traditionally not been primarily profit based.
But the loss in real wealth since the 1960-70's has remained mostly hidden behind the curtains provided by the increase in jobs (all women work today), in transportation (every woman needs to have her own car to get to those jobs) and the ridiculous glut in trinkets and other products with a pre-ordained ultra-short term better before date. Selling has become more important than making, the package trumps the content.
Today, there are no more jobs to be had, and the ones that are available pay ever less salary. We will see our "leaders" talk about turnarounds and recoveries till their jaws are blue, but the reality is that it's simply over. And people may catch on to that much faster than the leaders anticipate. Think about this: does Gordon Brown have enough political clout left to justify turning Britain's police forces (or more) against his own citizens this week? Does Barack Obama in the months to come?
Bankruptcy Leads Possible Plans for GM, Chrysler
The Obama's administration's leading plan to fix General Motors Corp. and Chrysler LLC would use bankruptcy filings to purge the ailing companies of their biggest problems, including bondholder debt and retiree health-care costs, according to people familiar with the matter. The move would in essence split both companies into their "good" and "bad" components. The government would like to see the "good" GM to be a standalone company, according to an administration official. The "good" Chrysler would be sold to Fiat SpA, assuming that deal is completed, this person said. GM and Chrysler have had bankruptcy attorneys devising plans for such a move in recent months.
President Barack Obama's task force has told both companies that the administration prefers this route as a way to reorganize the two auto makers, rather than the prolonged out-of-court process that has thus far frustrated administration officials. GM looks increasingly like it will be forced into filing for bankruptcy protection, sometime in mid-to-late May, in a plan where the automaker breaks into two companies, the surviving entity a "new GM" that maintains key brands such as Chevy and Cadillac and some international units, say several people familiar with the situation. Stakes in this new GM could be given to creditors and UAW members. It is also possible the new company could be sold whole or in parts to investors. The auto makers could avoid bankruptcy in the next two months. And there is some brinksmanship still going on in GM's high-level talks with bondholders, union members and creditors.
A key ingredient is getting the UAW to agree to an entirely new labor contract, including major reductions in health-care benefits, according to several people involved in the matter. "That's the No.1 wildcard here," one of these people said Monday. Under this plan, the "good" GM would not be expected to hold the tens of billions of dollars in retiree and health care obligations that hurt the auto maker in recent decades. Instead, those obligations would be transferred to an "old GM," made up of less-desirable brands like Hummer and Saturn, and underperforming plants and other assets. This part of GM would likely sit in bankruptcy much longer while a buyer is sought for the parts or it is wound down. Proceeds from the sale of old GM would go to pay claims to various creditors, including GM retirees. "That is the plan, to the extent it comports with the bankruptcy laws," said one person familiar with the matter.
Some of the New GM-Old GM is laid out in the GM viability plan the company sent to the federal government last month. In it, GM estimates that it would shrink from 22% of the U.S. market to about 19%. At Chrysler, bankruptcy would be used to force new labor contracts and rework debt deals with secured creditors. People working on Chrysler's behalf say the deal is risky, because the company is still not convinced that it could survive even a short-term bankruptcy. It could be done in order to meet the Obama administration's demand that Chrysler's creditors agree to huge reductions in their expected recoveries on Chrysler debt. Also Monday, new GM Chief Executive Frederick "Fritz" Henderson told employees and dealers that the company will end up in bankruptcy court if it does not significantly accelerate its restructuring efforts in the next 60 days, according to a dealer who watched a broadcast of a meeting with Mr. Henderson.
Mr. Henderson said "we'll be in bankruptcy" if the company cannot meet the U.S. government's demands for faster progress on its turnaround plan, this dealer said. Mr. Henderson told employees that the Obama administration was disappointed with the company's viability plan, feeling it didn't move fast enough or cut deeply enough into the company's debt. GM was told it didn't leave enough money in the company's pockets to get it through a full business cycle, either, according to the dealer. GM was also told in no uncertain terms that it must learn to make money on smaller cars–not just trucks and sport-utility vehicles, the dealer said. Warning that they can't depend on unending taxpayer dollars, President Obama on Monday gave GM and Chrysler a brief window to craft plans that would justify fresh government loans. "We cannot, we must not, and we will not let our auto industry simply vanish," President Obama said at the White House. "What we are asking is difficult," he said. "It will require hard choices by companies. It will require unions and workers who have already made painful concessions to make even more. It will require creditors to recognize that they cannot hold out for the prospect of endless government bailouts."
The remarks came a day after the administration ousted GM Chief Executive Rick Wagoner and rejected the restructuring plans that GM and Chrysler had hoped would lead to another infusion of government cash. Instead, the White House is giving GM 60 days to come up with a strategy for viability. Chrysler has a month to wrap up a partnership with Italy's Fiat. Under the revised terms of a proposed alliance between Chrysler and Fiat, the Italian company would take an initial 20% stake in the U.S. auto maker, down from a 35% stake under its January pact, a person familiar with the transaction said Monday. Fiat has been in negotiations with the Obama administration's task force, and the government said on Monday that Fiat is viewed as the only route to survival for Chrysler. "We believe we will arrive at a result that will establish a credible future for this crucial industrial sector," Fiat Chief Executive Officer Sergio Marchionne said in a statement.
GM on Monday said it will address "the tough issues to improve the long-term viability of the company," including the restructuring of its financial obligations, as it responded to Washington's calls for stronger plans to stay afloat. The administration says a "surgical" structured bankruptcy may be the only way forward for GM and Chrysler, and President Obama held out that prospect Monday. "I know that when people even hear the word 'bankruptcy,' it can be a bit unsettling, so let me explain what I mean," he said. "What I am talking about is using our existing legal structure as a tool that, with the backing of the U.S. government, can make it easier for General Motors and Chrysler to quickly clear away old debts that are weighing them down so they can get back on their feet and onto a path to success; a tool that we can use, even as workers are staying on the job building cars that are being sold."
GM said it prefers to complete its restructuring out of court, saying it would complete a more accelerated and aggressive restructuring to put the company on sound long-term financial footing. "We have significant challenges ahead of us, and a very tight timeline," said new GM CEO, Mr. Henderson. "I am confident that the GM team will succeed and that a stronger, healthier GM will play an important role in revitalizing America's economy and re-establishing its technology leadership and energy independence." The auto makers, hobbled by the economic downturn and years of reliance on sport-utility vehicles, will receive an unspecified amount of working capital from the government while they hone their new plans. Without a Fiat deal, the administration said Chrysler won't receive any more taxpayer dollars. The administration expressed confidence GM can survive with more drastic action.
GM and Chrysler received a total of $17.4 billion in government loans in December and have requested roughly another $22 billion to keep them going through this year. President Obama's auto task force combed through the firms' restructuring plans to judge if they merit the additional funds. The verdict released Sunday is that in their current form, the plans don't justify any new taxpayer resources. If Fiat and Chrysler reach a definitive alliance agreement, the government would consider investing as much as $6 billion more in Chrysler. Despite the grim view of Chrysler, the administration's task force said it had no intention of replacing CEO Robert Nardelli. Unlike Mr. Wagoner, who had been at the helm of GM since 2000, Mr. Nardelli is considered an auto-industry outsider who has only been in charge at Chrysler since the company was acquired by Cerberus Capital Management LP in 2007.
In addition to pushing out Mr. Wagoner, the task force said GM is in the process of replacing the majority of its directors. Kent Kresa, a longtime director, will serve as interim chairman. Mr. Wagoner will be replaced as CEO by Mr. Henderson, who was been serving as chief operating officer. Administration officials on Sunday made it clear that an expedited and heavily supervised bankruptcy reorganization was still very much a possibility for both companies. One official, speaking of GM, compared such a proceeding with a "quick rinse" that could rid the company of much of its debt and contractual obligations. The clearest losers appear to be the thousands of bondholders and lenders to both GM and Chrysler. In both cases, administration officials said that the companies were burdened by inordinate amounts of debt that would have to be scrubbed. Chrysler's survival, the administration said, would require "extinguishing the vast majority" of the company's secured debt and all of its unsecured debt and equity.
To assure consumers reluctant to buy GM or Chrysler cars, the government plans to take the unusual step of guaranteeing all warrantees on new cars from either company. These guarantees would lapse back to the companies once they return to health. Mr. Wagoner had managed GM through some of its most difficult moments. The company hasn't logged a profit since 2004, reporting losses since then of $82 billion. It nearly ran out of money at the end of 2008 before the Treasury Department provided emergency loans. GM's stock was trading above $70 when Mr. Wagoner took over as CEO in June of 2000. The shares closed last week at $3.62, placing the company's market capitalization at $2.21 billion. In Monday trading on the New York Stock Exchange, GM shares were down 76 cents, or 21%, to $2.86.
Mr. Wagoner's tenure came amid challenges that weren't entirely of his own making--including costly retiree benefits and union contracts that predate him, and the recent deep recession. Yet GM by most measures performed worse than other auto companies. Among the key decisions that hurt the company: a huge bet on trucks and SUVs that piled up on dealers' lots unsold as high gasoline prices drove Americans to look for more fuel economy offered by rival companies. Mr. Wagoner was asked to step down on Friday by Steven Rattner, the investment banker picked last month by the administration to lead the Treasury Department's auto-industry task force. Mr. Rattner broke the news to Mr. Wagoner in person at his office at the Treasury, according to an administration official. Afterward, Mr. Rattner met one-on-one with Mr. Henderson, who will fill in as GM's CEO. "On Friday I was in Washington for a meeting with administration officials," Mr. Wagoner said in a statement released by GM. "In the course of that meeting, they requested that I 'step aside' as CEO of GM, and so I have."
In a statement released by GM Sunday night, Mr. Kresa said: "The Board has recognized for some time that the Company's restructuring will likely cause a significant change in the stockholders of the Company and create the need for new directors with additional skills and experience." Mr. Wagoner's removal shows that the sacrifices could cut deep. The departure of the company's top executive promises to further shake up a company that has already been through considerable change over the past six months. The 56-year-old executive had been scrambling to craft a strategy aimed at maintaining leadership in the global sales chase with Toyota Motor Corp. and making big profits in emerging markets. But Mr. Wagoner's plans came crashing down in the second half of 2008 as the company ran short of cash and was forced to ask the government for billions of dollars in aid. At the same time, his executive team started dismantling several parts of the company, including a plan to shed several brands, slow the pace of new-product introductions and sell stakes in international operations.
The president's auto task force has spent more than a month digging into the restructuring plans that GM and Chrysler submitted last month. The team has struggled to make two determinations: when will the steep plunge in car sales end and what will the market look like once it revives. GM has based its revival plans on the U.S. market rebounding to sales of 14.3 million vehicles a year in 2011, up from a rate of about nine million vehicles so far this year. Many analysts now consider GM's short-term forecasts to be overly optimistic. Of the $21.6 billion in additional funding that the auto makers have requested, GM is seeking $16.6 billion more, while Chrysler has asked for $5 billion more.
Among challenges the administration faced leading up to this weekend's decision, foremost were the efforts to draw steep concessions from the United Auto Workers union and from the bondholders. Attempts to solidify deals with the UAW and bondholders were slowed by disagreements by both parties over how exactly the other party needed to budge. The UAW, for instance, insists it already made health-care concessions in 2005 and 2007, and argues that the bondholders have never been asked to concede anything. "I don't see how the UAW will do anything until they see what the bondholders will give up," one person involved in the negotiations on behalf of the UAW said Sunday.
The bondholders have said that they are willing to make concessions, but they have wanted to see the union make further cuts. The fact GM raised most of the unsecured debt to fund union health-care and pension costs is also seen as a reason why the union needs to take bigger steps. With Mr. Obama potentially holding off on new loans until concessions are made, analysts said GM likely has enough cash on hand to weather at least another month before its need for more government aid becomes urgent. Chrysler may need another infusion of cash sooner. Ford Motor Co. hasn't sought federal assistance. Both GM and Chrysler are negotiating with the UAW to accept a range of cost-cutting measures, including greatly reduced work forces, lower wages and a revamped health-care fund for retirees.
The U.S. auto industry has been reeling from a plunge in car sales over the last six months. Sales in February were down about 40% over the same month last year. The drop has sent shock waves through the hundreds of smaller parts companies that supply the big auto makers. To keep the sector afloat, the administration recently announced a $5 billion financing facility to help suppliers cover their expenses. The original December loans were given under the agreement that all sides would strike a compromise deal by March 31, but the administration is taking advantage of a clause allowing all sides another month to negotiate. "It was unrealistic to renegotiate a new labor agreement and the unsecured debt in so short a time," said Sean McAlinden, chief economist with the Center for Automotive Research, in Ann Arbor, Mich. "That has never happened before."
GM and Chrysler are meant to submit by Tuesday assessments of where their restructuring efforts are heading. In February, both companies put forward plans for paring their operations, reducing their work forces and eliminating vehicle models. GM and representatives for its bondholders remained in talks over the weekend about a deal that would force these investors to turn in at least two-thirds of the value of the debt they hold in exchange for equity and new debt. This arrangement would force GM to issue significantly more stock than what is currently being traded in the market. In addition, the government is being asked to guarantee the new debt with federal default insurance in order to entice bondholders who otherwise wouldn't be interested in participating in the swap.
If GM can't eventually forge a deal with the ad hoc committee representing the bondholders, the company may be forced to issue a debt-for-equity swap without the blessing of some of its biggest and most influential unsecured investors. This would heighten the possibility of the company eventually needing to file for Chapter 11 bankruptcy protection. The group representing GM bondholders was reviewing the White House documents and plans to make a formal response later Monday, according to a person familiar with the situation.>Crisis in Motown
The Rise and Fall of American Icon General Motors
Oct. 5, 1998: G. Richard Wagoner Jr. becomes president of GM.
June 1, 2000: Wagoner adds chief executive to his title.
Sept. 19, 2001: GM unveils 0% financing on new cars and trucks after the Sept. 11 terrorist attacks to "Keep America Rolling."
Oct. 28: GM agrees to sell its Hughes Electronics satellite unit to EchoStar Communications, ending GM's two-decade foray into nonautomotive businesses.
May 1, 2003: Wagoner becomes chairman of the GM board of directors
April 4, 2005: Wagoner takes control of GM's unprofitable North America auto unit
April 14: Wagoner tells The Wall Street Journal that the "one specific issue that has reached crisis proportions…(is) the health-care cost issue. It's clearly outrunning our ability to hold it off with other cost cuts."
Oct. 3: GM reports a sales drop of 24% in September 2005, compared with the same month a year ago, as sales of Detroit's trucks stall amid spiking gas prices and a consumer shift away from SUVs.
Oct. 17: GM reports a net loss of $1.63 billion. Even after a partial overhaul of retiree health-care benefits through union concessions, GM still faces a $51 billion obligation to union members.
Sept. 26, 2007: GM and the United Auto Workers union agree to a new four-year contract, ending a two-day nationwide strike and creating a new trust fund for retiree health care.
Week of June 9, 2008: Average price of gas in U.S. crests above $4; U.S. consumers abandon SUVs and pickup trucks in droves.
Aug. 1: GM reports a $15.5 billion net loss for the second quarter of the year, the third-biggest in GM's history, as analysts question whether Wagoner can keep his job.
Nov. 7: GM warns that without federal assistance, it might not have enough cash to operate its business past the middle of 2009.
Nov. 18: The chief executives of Detroit's Big Three auto makers, including Wagoner, appeal for U.S. taxpayers to help their industry.
Dec. 2: Auto makers return to Congress, this time with turnaround plans in hand. GM says it needs $4 billion to stay afloat until the end of the year. In total, the company says it needs $18 billion in loans -- $6 billion more than it said it would need just two weeks before.
Dec. 7: Wagoner comes under increasing pressure from outside the company to resign as part of any broad bailout.
Dec. 11: Effort in Senate to aid auto makers collapses amid partisan disputes.
Dec. 19: White House agrees to $17.4 billion in bailout loans.
Dec. 31: GM receives first $4 billion in loans.
Feb. 26, 2009: GM announces a $9.6 billion loss in the fourth quarter of 2008, bringing its loss for the year to $30.9 billion and raising new concern about its viability.
March 27: U.S. asks Wagoner to resign as part of an agreement to receive new package of federal aid.
GM Bondholders Back Obama’s Demand for Deeper Cuts
President Barack Obama may be winning over General Motors Corp. bondholders by calling for deeper cost reductions at the automaker. A more aggressive survival plan would boost the value of equity and new bonds that noteholders would receive in an exchange aimed at cutting $27.5 billion in GM debt, advisers to the bondholder committee said today in a statement. Bondholder representatives met with Obama’s auto task force on March 5, and expressed concern that the restructuring plan didn’t go far enough to ensure GM would stay out of bankruptcy.
The Obama administration forced GM Chief Executive Officer Rick Wagoner to resign after concluding the Detroit-based automaker hadn’t done enough to prove it can survive amid the worst U.S. auto market in 27 years. Obama said today that company creditors, shareholders, workers, dealers and suppliers will be expected to make more sacrifices. The bondholder committee includes San Mateo, California-based Franklin Resources Inc. and Fidelity Investments of Boston. "After the cram-down happens and bondholders go from $27.5 billion to $9 billion or whatever the number ends up being, their fate is tied to the future success of GM," Pete Hastings, a fixed-income analyst at Morgan Keegan Inc. in Memphis, Tennessee, said in a telephone interview. "They’re going to need some assurance that is going to be worth something someday. The way to do that is to reduce their cost structure as much as possible."
The plan that GM put forward last month didn’t go far enough to ensure profitability at the automaker and unions in particular should be forced to make greater concessions, Hastings said. GM also needs the United Auto Workers to agree to cut a cash contribution to a so-called Voluntary Employee Beneficiary Association union retiree health-care fund from $20.4 billion to about $10.2 billion in exchange for equity, according to the terms of the original government loan. Carmakers "must produce plans that would give the American people confidence in their long-term prospects for success," Obama said at the White House, announcing new and final deadlines for GM and Chrysler LLC to remake themselves. "We cannot make the survival of our auto industry dependent on an unending flow of taxpayer dollars."
GM’s $3 billion of 8.375 percent bonds due in 2033 fell 2 cents to 16 cents on the dollar, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority. The debt yields 52 percent. GM shares declined 92 cents, or 25 percent, to $2.70 in composite trading on the New York Stock Exchange. What the administration is asking for "will require creditors to recognize that they can’t hold out for the prospect of endless government bailouts," Obama said. Unions and companies must also make sacrifices, he said. The committee of GM bondholders didn’t seek Wagoner’s removal, and hasn’t had contact with the task force since the meeting earlier this month, according to a person familiar with the committee representing creditors who declined to be identified because the discussions are private.
"We have been very disappointed that the government and company have had virtually no real dialogue with bondholders while designing the proposed restructuring plan," according to the statement from the advisers. "Bondholders have been and remain willing to reduce GM’s future debt burden by exchanging a substantial part of their debt for equity." GM will get "adequate working capital" over the next 60 days, while the auto task force works with the company to assess whether it has consolidated enough brands and its debt load, according to the administration. GM has received $13.4 billion of government loans since December. The original loan terms called for the carmaker to get bondholders to give up two-thirds of their debt for new equity, starting a debt exchange by tomorrow. The GM restructuring now requires "substantially greater balance sheet concessions" than those initially demanded because the auto market deteriorated, according to administration documents.
GM’s best chance at success may include a "quick and surgical" bankruptcy, according to a summary given to reporters by the administration. Unlike a liquidation or conventional bankruptcy, a structured process would make it easier for the companies to clear away liabilities. The bankruptcy process could be as short as 30 days, and the government would provide debtor-in-possession financing if needed, according to the summary. A so-called prepackaged bankruptcy may be the easiest way to achieve a debt exchange, according to the person familiar with the bondholder committee’s thinking. GM’s biggest bondholders also include Capital Research & Management Co. of Los Angeles, Boston-based Loomis Sayles & Co. and Newport Beach, California-based Pacific Investment Management Co., regulatory filings show.
Bondholders had asked the government for improvements to the original offer, such as a government guarantee of the new notes they’d receive in the debt exchange, and they were balking at a proposal from GM last week that called for them to swap more than three-quarters of their stake for equity, said the person familiar with the talks. The latest offer would have given bondholders 90 percent of the equity in the reorganized company and a combination of cash and new unsecured notes without a government guarantee, the person said. Credit-default swaps protecting against a default by GM rose 4 percentage points to 81 percent upfront, according to broker Phoenix Partners Group. That’s in addition to 5 percent a year, meaning it would cost $8.1 million initially and $500,000 annually to protect $10 million of debt for five years. The derivatives, which are privately negotiated contracts used to hedge against losses or speculate on a company’s creditworthiness, pay the buyer face value in exchange for the underlying bonds or the cash equivalent set by the auction.
Chrysler, Cerberus, Fiat Agree to Alliance to Get Aid
Chrysler LLC and parent Cerberus Capital Management LP have a "framework" for an alliance between the U.S. automaker and Italy’s Fiat SpA, meeting a requirement for receiving $6 billion more in federal aid. "Substantial hurdles" remain in closing a deal, Chrysler said today in an e-mail that didn’t give details. Under the original terms, Fiat was to get 35 percent of the equity of Auburn Hills, Michigan-based Chrysler in exchange for sharing small-car technology. The revised accord calls for an initial Fiat stake of 20 percent, said a person familiar with the plans, who didn’t want to be identified because they aren’t yet public. Following that, Fiat will hold no more than 49 percent until after Chrysler repays its U.S. loans, according to another person, who is a government official with knowledge of the plans.
"The risks for Fiat remain limited. They’ll have to build a new plan together," said Marco Santino, an auto-industry consultant at A.T. Kearney in Rome. "At this point it’s a technicality whether Fiat takes a stake before or after Chrysler’s turnaround." Under the new arrangement, Fiat would assemble engines and vehicles in the U.S., the government official said. The Turin, Italy-based automaker hasn’t sold its namesake vehicles in the U.S. since 1983, restricting the company’s offerings to luxury models from Ferrari and Maserati. Fiat and Chrysler have 30 days to consummate a deal or the government will cut off aid, which Chief Executive Officer Robert Nardelli has said would likely force the third-largest U.S. automaker to liquidate. New York-based Cerberus bought 80 percent of Chrysler from Daimler AG in 2007.
Chrysler needs to eliminate most of its $6.9 billion in secured bank loans and achieve deeper concessions than in its tentative agreement with the United Auto Workers union, President Barack Obama’s auto task force said in a report today. The automaker isn’t viable as a stand-alone company, and the best option for erasing its debt is an "expedited bankruptcy process," the task force said. As of yesterday, Chrysler hadn’t had any negotiations with its lenders, which include JPMorgan Chase & Co., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley, said people familiar with the company’s efforts.
The lack of progress with the lenders also has held up Chrysler’s efforts to reach a deal with the UAW over the retiree health-care trust fund that is pivotal to reducing labor expenses. Chrysler is asking the union to trade 50 percent of the obligation to the fund for an ownership stake in the company. Without knowing how much of a stake the banks would take, that deal can’t be finished, Chief Financial Officer Ron Kolka said in an interview March 18.
Ilargi: Canada should forget about its automotive industry and move on.
Chrysler, GM Must Rework Overhaul Plans, Canada Says
Canada extended deadlines for General Motors Corp. and Chrysler LLC to work on their restructuring plans and said it won’t provide long-term loans until the overhaul is complete. Canada’s decision follows a similar announcement by U.S. President Barack Obama’s administration. Canada said Chrysler must enter an agreement with Fiat SpA before the end of April and GM has 60 days to rework its plan because the company’s current restructuring wouldn’t leave it viable. "The plans don’t go far enough," Industry Minister Tony Clement told reporters in Ottawa today. "There is some fundamental restructuring that must take place."
Canada will provide a short-term, C$1 billion ($796 million) loan to Chrysler, with a C$250 million portion to be handed out in coming days. Chrysler needs the funds to meet its payroll requirements, Clement said. Canada will also extend a C$3 billion loan to GM to help it stay afloat until it can submit its new plan. These loans were first announced in December. The Ontario government is providing about a third of the funds for the carmakers. Clement, Finance Minister Jim Flaherty, along with Ontario Economic Development Minister Michael Bryant, made the announcement in a televised news conference. Separately, Flaherty said today that the leaders of Canada’s autoworkers’ union need to do more on compensation in order to make Chrysler and GM competitive.
"This is very serious and I encourage the union leadership very seriously to go back and speak with management," Flaherty said. "This isn’t about collective bargaining; this is about saving thousands of jobs in Ontario and in Canada." The companies are asking for loans in Canada that are proportional to their requests for U.S. aid and the weight of their Canadian production facilities. Chrysler is asking for about C$4 billion in long-term loans and GM wants as much as C$7.5 billion. Earlier today, Obama said GM and Chrysler must survive without becoming "wards of the state" and the companies have one last, limited chance to "fundamentally restructure."
Deutsche Bank Chief Risk Officer Says Crisis 'Far From Over'
Deutsche Bank AG Chief Risk Officer Hugo Banziger said the global credit crisis is "far from over" and global financial regulations must be overhauled to regain investor trust. "We are in the middle of it," Banziger, 53, said today at an event at the Frankfurt School of Finance and Management. The industry has "an opportunity" to build a stable financial system that seeks higher capital buffers, and encourage investors to return money to the market and help stem the crisis, he said. Deutsche Bank in February reported its first annual deficit in more than 50 years after the worst financial crisis since the Great Depression pummeled bond and stock trading.
The crisis has caused $1.3 trillion in losses for financial companies worldwide, a total that may climb to more than $3 trillion, Banziger said today, citing forecasts. Deutsche Bank has gained 40 percent this month in Frankfurt trading, valuing the bank at 18 billion euros ($24 billion), and eclipsing the 5 percent advance in the Bloomberg Europe Banks and Financial Services Index of 65 companies. The bank fell 10 percent to 28.75 euros in trading today. The German bank skirted the worst of the U.S. subprime mortgage collapse by betting against the bonds that contributed to credit losses and writedowns at the world’s largest financial companies and forced government-led bailouts from Berlin to London to Washington.
The German bank has booked about 9.3 billion euros in writedowns since the start of the U.S. subprime mortgage crisis in 2007. UBS AG in Zurich has had $50.6 billion of costs and New York-based Citigroup $88.3 billion, according to data compiled by Bloomberg. Deutsche Bank is resisting pressure to take government aid or raise additional capital to protect existing shareholders that have seen the value of their stock decline, Banziger said today. "One of my top priorities is to make sure that those who lost money recover it," Banziger said. Protecting shareholder value is "our deep philosophy" and Deutsche Bank’s management "will stand by this." Deutsche Bank has several times raised its goal for its Tier 1 capital ratio, a key measure of solvency, Banziger said. The bank’s ratio is 10 percent, which may be insufficient in the future and result in raising the standard rising to 12 percent, he said.
Japan Output Slumps for Fifth Month as Exports Tumble
Japanese industrial production fell for a fifth month in February, the longest losing streak since 2001, as exports collapsed. Factory output declined 9.4 percent from January, when it plummeted a record 10.2 percent, the Trade Ministry said today in Tokyo. Inventories fell an unprecedented 4.2 percent. Companies surveyed said they will increase production in March and April as they begin to replenish stockpiles they managed to get rid of even as demand evaporated. Manufacturers worldwide are cutting inventories, a sign that output may pick up later this year, providing relief for a global economy that is contracting for the first time in six decades.
"Production cuts may already be bottoming out," said Shinichiro Kobayashi, a senior economist at Mitsubishi UFJ Research and Consulting Co. in Tokyo. "We should remember that that doesn’t necessarily mean overseas demand is already recovering." The yen traded at 98.15 per dollar at 10:16 a.m. in Tokyo from 98.08 before the report was published. The currency is heading for its worst quarter since 2001 as the world’s second- largest economy deteriorates faster than the U.S. and Europe. The Nikkei 225 Stock Average fell 1.2 percent. Japan’s exports plunged a record 49.4 percent in February from a year earlier as sales of cars and electronics dried up. Toyota Motor Corp., forecasting its first net loss in more than five decades, plans to cut thousands of jobs and slash domestic production by half this quarter.
Sentiment among the nation’s largest manufacturers has fallen to its lowest level in more than 30 years, economists predict the Bank of Japan’s Tankan survey will show on April 1. The country’s largest firms plan to cut investment by 12 percent next fiscal year, the biggest pullback since at least 1983, economists predict the survey will show. Prime Minister Taro Aso is preparing his third stimulus package since October to counter the slump. Finance Minister Kaoru Yosano said on March 22 that a plan of as much as 20 trillion yen, double the total amount pledged since October, is "not out of line" as the economy heads for its worst recession since 1945.
"The longer this stretches out, the harder the domestic economy is going to be hit," said Martin Schulz, senior economist at Fujitsu Research Institute in Tokyo. "The government really needs to come out with another package." Governments around the world are spending billions of dollars to spur domestic demand as global trade seizes up. Economists say a Japanese recovery hinges on whether a combined $1.4 trillion of spending in the U.S. and China, the country’s two biggest markets, is enough to revive demand for its cars and electronics in the second half of the year. There are signs a recovery may be stirring in the U.S., Japan’s biggest market. U.S. orders for durable goods rose in February for the first time in seven months. Inventories of long-lasting durable goods fell for a second month and new home sales increased for the first time since July.
In Japan, the drop in inventories adds to evidence that the worst of the manufacturing slump may be over. Companies said they would increase production 2.9 percent this month and 3.1 percent in April, today’s survey showed. Nippon Steel Corp. said last month output should improve next quarter because customers have used up their stockpiles. Nissan Motor Co., Japan’s third-largest automaker, said on Feb. 26 it will raise domestic production next month. "Companies have succeeded, as you can see in today’s data, at cutting inventories back," Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo, said on Bloomberg Television. "They’re starting to move production back more into line with demand, which is still depressed but obviously going to be a stronger level than the January- February period."
Obama and the G-20: Is It 1933 All Over Again?
The newspapers these days say you have to go back three-quarters of a century to grasp the significance of this week's Group of 20 summit of world leaders. Reminiscent of the meeting of leaders of the world's largest industrial and developing nations set for Apr. 2, the June 1933 World Economic Conference assembled 20 foreign ministers, eight prime ministers, and one king from 66 countries to present a common front against the Great Depression.
Is 1933 apt? And if so, are there any lessons are to be learned? There are surface similarities. Both conferences were held in London. In 1933 world leaders filtered through Washington to confer before the conference with America's new President, Franklin D. Roosevelt. Today, Washington has been a traffic jam of world leaders. British Prime Minister Gordon Brown, Australian Prime Minister Kevin Rudd, and French Prime Minister Francois Fillon all arrived to try to influence President Barack Obama ahead of G-20. German Prime Minister Angela Merkel talked to the U.S. leader by video conference.
Dig deeper, and there are eerie reminders of the challenges leaders faced in the Great Depression. Then as now, the prevailing wisdom was that they needed to make a show of cooperation, or risk even worse global pessimism. In both cases, Europe and the U.S. had starkly different agendas (today, the U.S. wants more stimulus while Europe wants to focus on regulation; FDR was focused on economic recovery, and the Europeans wanted to stabilize their currencies around the value of gold). And before both conferences, credible voices suggested the establishment of an international reserve currency (currently it's China and Nobel economist Joseph Stiglitz; back then, it was the voice of John Maynard Keynes, who nominated the gold equivalent of the dollar as that currency).
SIMILAR, BUT MINUS THE GEOPOLITICAL BAD GUYS
And it wasn't just economics—in 1933, too, the world was attempting to reset its relationship with Moscow, which had remained isolated for 16 years after the Bolshevik Revolution. "It's the best analogy," Simon Johnson, a former chief economist for the International Monetary Fund who now teaches at Massachusetts Institute of Technology, says of the 1933 conference. Earlier this month, University of California at Berkeley economic historian Barry Eichengreen told Agence France-Presse that in both cases "political constraints [got] in the way of doing the right thing." One such example he cited: "congressional opposition to more money for Wall Street."
Yet the comparisons go only so far. The absence of an International Monetary Fund, a World Bank—or the Group of 20 nations itself—made a restoration of stability and growth more difficult, says Paul Kennedy, the Yale economic historian who wrote The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500 to 2000. And politics created a more menacing backdrop, he says. "For those getting too alarmed, by 1933 you already had bad guys who were in power," Kennedy says in an interview. "In Japan you already had a regime that had invaded and controlled Manchuria. Mussolini was in power in Italy. The Nazis were already assuming autocratic power.…[Today] I don't think anyone is busy with revengeful, prowar militaristic feelings. Certainly not any in the G-20."
LESSONS FROM 1933'S "COMPLETE FIASCO"
In terms of lessons, Harvard economic professor Dani Rodrick cautions the G-20 leaders on his blog not to repeat the main failing of the 1933 conference, which "focused on an outdated goal—restoring the rules of the classical gold standard." Today, Rodrick says, "European obstinacy" has resulted in nixing fresh financial stimulus that he says "can make a real difference to the world economy." Rodrick also says that more money for developing nations would make a huge difference, but that it's not clear this "is being pushed hard enough by any of the rich countries."
Liaquat Ahamed, the former head of the World Bank's investment division, who writes about the 1933 conference toward the end of his economic history, Lords of Finance: The Bankers Who Broke the World, agrees. The 1933 conference, he says, ended in "a complete fiasco" when FDR refused to go along with Europe's push for currency stabilization based on the gold standard. Yet, he says, the Western economies ended up "pursuing the right policies in uncoordinated moves"—all of them ended up using expansionary monetary policy. "The basic moral of the story is that it is better if you don't have international coordination if it's the wrong policies. It's far better to have uncoordinated good policies," Ahamed says.
Rage follows New York State’s $131.8 billion budget proposal
Gov. David Paterson and legislative leaders that finalized a balanced state budget Sunday night got some feedback Monday from interested parties The proposed $131.8 billion budget that lawmakers will vote on increases spending by 9 percent and includes roughly $7 billion in higher taxes. "We made the tough choices," Paterson said. "If the Legislature can maintain this [spending] discipline over the next few years, I can see the light at the end of the tunnel. I can’t tell you that our fiscal woes are over—that wouldn’t be honest. We have not found the floor of this recession." "We did the best we could in a difficult situation," added Senate Majority Leader Malcolm Smith (D-Queens). "This was an unprecedented time. As I’ve said before, we cannot cut our way back to prosperity." Paterson, Smith and Assembly Speaker Sheldon Silver (D-Manhattan) brokered the deal privately over the weekend.
Here’s a sample of what others not involved in those deliberations had to say about the proposed budget:
Senate Minority Leader Dean Skelos (R-Rockville Centre)
• "This state budget is the most fiscally irresponsible budget, produced at the worst possible time. It is a complete disaster that could push New York from recession to depression. The end result of the most secret budget process in state history is a plan that taxes too much, spends too much and does nothing to create jobs. The budget does not include any measures to create jobs. The massive personal income tax hike will hit small businesses the hardest. The $600 million tax increase on electric and gas bills will add to the highest utility rates in the country."
Assembly Minority Leader James Tedisco (R-Glenville)
• "Gov. Paterson could have, should have, insisted upon transparency, openness and accountability, but he took the easy way out and, in so doing, broke a promise he has repeatedly made to not rely on tax hikes, or fiscal gimmicks to close the state’s budget shortfall. You have to give Gov. Paterson credit—his ineptitude has succeeded in making Eliot Spitzer look good by comparison. Instead of fixing New York, what the governor did was make living and working in New York harder—and the decision to leave our state even easier."
Kenneth Adams, president and CEO, The Business Council of New York State Inc.
• "The governor and legislature have decided to throw fiscal responsibility out the window. This reckless budget ignores economic common sense, crushes New Yorkers with $7 billion in new taxes and slams the brakes on our hopes for recovery. Just when we need private sector job growth to get New Yorkers back to work and lift us out of this recession, Albany leaders are telling [New York] employers to take a hike. It is impossible to view this budget as a path to economic recovery. Businesses and jobs will hasten their departure from the state, and how can you blame them? Albany treats them with disdain."
Danny Donohue, president, Civil Service Employees Association (300,000 members)
• "No one should have any illusion that it moves New York forward through ‘shared sacrifice.’ The agreement sticks it to state employees and undermines the future of the state’s health care system beyond reason. The budget agreement assumes $481 million in ‘savings’ from the unnecessary layoff of state employees, making the Legislature complicit in a reckless and irresponsible plan that is both impractical and nasty while eroding state services at a time when they are needed most."
Daniel Sisto, president, Healthcare Association of New York State
• "This health care budget plan contains cuts far greater than what our members can absorb without reducing services and laying off staff. The failure of the state to use the federal stimulus Medicaid funding (known as FMAP) to offset these deep cuts in any appreciable way is disturbing, as is the disproportionate negative impact this plan will have on public, rural, and most high-Medicaid hospitals. The plan will result in severe service dislocations and lost jobs. Cutbacks in staff and services should be anticipated in most communities."
Paul Macielak, president and CEO, New York Health Plan Association
• "Legislative leaders have repeatedly said they are committed to the goals of making health insurance more affordable and expanding coverage to more New Yorkers. However, this budget, which significantly increases taxes on health insurance, is in complete contradiction to that goal. The level of taxes in this budget ... makes a bad situation worse and will result in some people losing the coverage they have. Worse still, these taxes punish those who ‘do the right thing’ by providing health insurance to their employees while those employers that could afford it but don’t provide health benefits to their workers get away unharmed."
Robert Moore, executive director, Environmental Advocates of New York
• "The New York state Legislature should pass what amounts to a very ‘green’ budget during this fiscal crisis. If state lawmakers pass this budget and update the state’s bottle deposit law, keep our environmental trust fund up and running, and make polluters pay to foul our air and water, New York is taking positive steps to protect our natural resources during challenging economic times."
The Chamber of Schenectady County
• "Are you outraged at the governor and Legislature’s attempt to burden the state’s economy with $7 billion in new taxes; the largest increase in state history? Help stop our government leaders in Albany from adding $7 billion in new taxes and $9 billion in new spending to an already bloated budget. Telling your legislators you oppose these massive new tax proposals will only take a few minutes of your time."
New York State Conference of Blue Cross Blue Shield Plans
"At a time when businesses and families are struggling to pay for the cost of health insurance, the governor and Legislature have inexplicably added these taxes and fees, which will only drive up the cost even further. Neither health plans nor our customers can afford these taxes. Businesses will have to choose between raising an employee’s contributions to the company’s health plan or eliminating health insurance as a benefit. New Yorkers and businesses are struggling financially, this budget does nothing more than deliver another devastating fiscal blow."
Kenneth Brynien, president, Public Employees Federation (59,000 members)
"The governor has claimed to have only two choices to achieve the savings: union concessions or layoffs. There is a third choice: cut the enormous wasteful spending on private contractors. Unfortunately, the governor continues to move forward with the most damaging choice: layoffs."
G24 Developing Nations Urge G20 To Help Emerging Markets
Group of 24 developing nations Monday called on world leaders meeting in London this week to do more to assist less-advanced economies getting swept up in the global crisis. "Although the crisis originated in advanced economies, it is having a disproportionate negative impact on developing countries," the G24 said in a statement ahead of Thursday's Group of 20 summit. "We underscore that this crisis requires collective solutions that pay due attention to their impact on developing countries," said the statement, released by the International Monetary Fund.
The G24 is comprised of developing countries from three main regions: Africa, Latin America, and Asia and emerging Europe. Leaders of the G20 - made up by the Group of Seven leading industrialized countries and major developing economies like China, Brazil, Russia and India - are gathering for their second meeting since the crisis began to both address the immediate situation and begin work toward a fundamental overhaul of the global regulatory regime. Beyond stabilizing the global financial system and restoring growth, G20 leaders also should offset financing gaps in developing countries "caused by the crisis and the responses of advanced countries" and reform multilateral institutions like the IMF and World Bank, the statement said.
The G24 called for a "very sizeable increase" in IMF resources through borrowing in the short term but said that should serve as a bridge to a permanent general quota increase by January 2011. Reforms to increase the power of developing countries at the IMF also should take place by that point, the statement said, while urging that a realignment of votes at the World Bank be complete by April 2010 to reflect its development mandate.
Fed's Duke: Banks Can Play Key Safety Role For Financial System
U.S. Federal Reserve Board Governor Elizabeth Duke Monday said banks play "an important safety-valve role," refuting any idea that banks' role in the U.S. financial system has diminished. In fact, some banks appear to be stepping in, fulfilling the credit needs of consumers and businesses that had been turned away by their nonbank peers, Duke said in a speech in Charlotte, N.C., at the 13th annual University of North Carolina Banking Institute. She added the shutdown of the private mortgage-backed securities market has placed greater pressures on bank balance sheets to provide credit to borrowers with damaged credit histories.
When evaluating the significance of banks, it's important to take into account their off-balance sheet activities, she added. "This 'financial intermediation view' of credit, in my opinion, illustrates the importance of supporting the availability of all forms of lending, whether it be on-balance-sheet lending by banks, credit originated by banks and securitized and sold to investors, or credit supplied by nonbank lenders," said Duke. She added that off-balance sheet activities have generated considerable earnings for banks. Meanwhile, Duke said the federal government's programs to help homeowners modify their mortgages and stem foreclosures should "help to stem the runoff in mortgage debt and to damp the added downward pressure on house prices that can occur when neighborhoods have clusters of foreclosed properties."
Speaking about non-mortgage-related credit growth, Duke said history shows that credit growth is likely to slow further in the near-term. She noted many banks have tightened terms and standards for nonmortgage consumer loans. Overall, Duke said it's important to recognize banks come in all shapes, sizes, geographic concentrations and comparative advantages - and the current financial crisis has affected each bank differently. Much attention has been focused on the negative loan growth of large bank holding companies in the fourth quarter of 2008, she said. Still, if you look at the country's 20 largest banking firms, not just the largest five, the decrease in loans is much smaller, she said. Furthermore, smaller banks actually increased their lending at about a 5% pace during that quarter, said Duke.
"This loan growth may reflect that smaller banks in strong financial condition are finding that they can gain creditworthy customers - even in the current economic environment - as other banks cut back on lending to conserve capital and liquidity," she said. "Smaller banks may also be finding opportunities to reclaim consumer and business customers from nonbank competitors who have pulled back as the securitization markets have dried up."
Home Depot CEO earns $9.2 million in 2008, lays off 7000 workers
Home Depot CEO Frank Blake received compensation valued at $9.2 million in 2008 - a 20 percent increase from the previous year - as the company's profit dipped and the retailer laid off 7,000 workers , according to a regulatory filing Monday. Blake, who is also chairman of the nation's No. 1 home improvement retailer based in Atlanta, received nearly 85 percent of his compensation in restricted stocks and options valued at $7.8 million at the time they were granted - about 36 percent more than the $5.7 million in stock and options he was granted in 2007.
However, the value of those awards has fallen and some are of little value unless Home Depot's stock price rebounds. The options came with an exercise prices of $26.84, which is about 15 percent higher than the stock's current price. For the fiscal year that ended Feb. 1, Blake saw his base salary hold steady at just more than $1 million. He didn't receive a bonus in 2008 and waived a $1.2 million cash performance bonus offered to him. He received a $500,000 bonus in 2007 and wasn't awarded a performance bonus that year. Blake also received perks valued at almost $444,000, roughly the same as he received in 2007. That sum in 2008 included $132,000 for personal use of the company's airplane, $105,000 for life insurance and death benefits and $71,000 for tax reimbursements, among other items.
The Associated Press executive compensation formula is designed to isolate the value the company's board placed on the executive's total compensation package during the last fiscal year. It includes salary, bonus, performance-related bonuses, perks, above-market returns on deferred compensation and the estimated value of stock options and awards granted during the year. The calculations don't include changes in the present value of pension benefits, and they sometimes differ from the totals companies list in the summary compensation table of proxy statements filed with the SEC, which reflect the size of the accounting charge taken for the executive's compensation in the previous fiscal year.
For the 2008 fiscal year, Home Depot's profit fell 49 percent to $2.26 billion, or $1.34 per share, from $4.4 billion, or $2.37 per share. Earnings from continuing operations dropped to $2.31 billion, or $1.37 per share, compared with $4.21 billion, or $2.27 per share a year before. Adjusted earnings from continuing operations were $1.78 per share. Charges related to a decision to close Expo Design Centers, YardBIRDS, Design Centers and the bath remodeling business HD Bath dragged down results. The Atlanta-based company decided to close the stores because fewer customers are buying new homes or spending money on repairs and remodeling. Because of those closures, Home Depot plans to eliminate 7,000 jobs, or about 2 percent of its 300,000 workers. Full-year revenue dipped 8 percent to $71.29 billion from $77.35 billion, while same-store sales slid 8.7 percent. Home Depot shares fell 80 cents, or 3.4 percent, to $22.83 in midday trading Monday amid broader market declines.
Ilargi: Not surprisingly, Spain increasingly shows cracks in its facade. The out-of-control home building excesses of the 2002-2007 period will have lasting impacts. And nowhere more than in teh banking sector. Someone wrote the loans for the millions of empty unsold properties in the country, and many of those will have to be written off, along with the securities issued on them. It may not be a popular thing to do, but I still strongly suggest the Spanish government come clean on what is really happening to the economy, and seek help where it's needed and possible while it still can.
Spanish Bank Shares Plunge After Savings Bank Takeover
Spanish banking stocks plunged Monday as a banking bailout announced this weekend indicated the country's financial sector may not be as immune to the current financial crisis as previously thought. The Bank of Spain has taken over management of small savings bank Caja Castilla La Mancha and will provide it with as much as €9 billion of liquidity, the government said Sunday. Stocks in Banco Santander SA fell 5.6% to €5.04 at 0854 GMT, while rival BBVA was down 4.9% to €6.02, and Banco Popular SA fell 5.5% to €4.68, pressuring the IBEX-35, which declined 3.3%.
Spanish Finance Minister Pedro Solbes Sunday said the intervention in Caja Castilla La Mancha was an isolated case, and that the overall Spanish banking system remained "extremely healthy." Yet some analysts are not convinced. "This intervention supposes that the Spanish financial system isn't immune to the international situation," Banesto analyst Ignacio Soto Palacios. "We expect a bad performance of the sector in the short run." Given the stretched situation some Spanish savings banks are experiencing, there is a possibility of other institutions also requiring intervention by the central bank or the government, said Carlos Peixoto at BPI.
Although that risk is highest among the savings banks, which don't trade on the stock exchange, smaller banks could also experience liquidity problems, Peixoto says. Yet, he adds that "(Banco) Pastor and Bankinter have no refinancing needs during 2009." Bankinter SA shares traded 3% lower at EUR7.51, while Banco Pastor SA fell 4.1% to €4.22. Finance Minister Solbes Sunday said further banking takeovers were not necessary at this point, though if the current crisis drags out, that could not be ruled out. The Caja Castilla La Mancha takeover could also have consequences for shareholdings the savings bank has in other companies, says Bruno Almeida, chief financial analyst at BPI in Lisbon. Spanish energy firm Iberdrola SA, in which the savings bank holds 0.6%, also underperformed the IBEX-35 Monday, falling 3.7% to €5.23.
Deflation fears grow in Spain
Spain’s consumer price index appears to have contracted in March compared with the same period last year, fuelling fears that the recession-hit country could be entering a deflationary cycle. The National Statistics Institute said on Monday that a preliminary indicator showed that inflation had slowed to a negative 0.1 per cent for the month, down from a 0.7 per cent increase in March last year. It was the first contraction in prices since the current method of calculation was introduced in 1997. The weaker-than-expected Spanish data coincided with a European Commission report showing that the rate of price increases expected by eurozone consumers for the next 12 months was the weakest since its survey began in 1985.With the eurozone economy showing only modest signs of stabilisation after a dramatic contraction in the past six months, the latest economic data will heighten fears of eurozone deflation – general and protracted falls in prices that wreak substantial economic damage.
Economists attributed Spain’s negative reading to a sharp fall in energy costs over the year, and heavy discounting in consumer items such as clothes and shoes. Pedro Solbes, finance minister, immediately sought to allay concerns about the risk of deflation, describing Monday’s figure as "simply one negative piece of data". "For this reason, one has to give it the importance it merits: neither downplay nor exaggerate it," he said.Spain, which has among the highest levels of household and corporate indebtedness in Europe, has been identified by global economists as at risk from deflation, along with the UK and Ireland. Although lower prices boost purchasing power, constant disinflation actually encourages consumers to stop spending as they await further declines. At the same time, deflation also pushes up the real cost of debt for all sectors of the economy. Standard & Poor’s, the credit rating agency, said in a recent report that "the UK, Ireland and Spain are likely to experience a sharp decline in consumer demand this year, followed by an extended period of stagnation in 2010 and 2011."
Economists on Monday described the Spanish data as statistical blip rather than a trend. "This is simply a month of disinflation, which should be viewed as something positive," said Emiliano Carluccio, an economist at the Instituto Flores de Lemus in Madrid. "There is absolutely no suggestion that Spain is entering a deflationary cycle." March eurozone inflation figures on Tuesday are expected by economists to show the annual rate falling to about 0.6 per cent, after 1.2 per cent in February. Since the middle of last year, European Commission surveys have shown eurozone consumers becoming progressively less worried about inflation, but the March survey showed expectations about price rises in the next 12 months had almost vanished. The same survey showed eurozone economic confidence continues to plunge. The Commission’s "economic sentiment" indicator fell by 0.7 points to 64.6 in March, setting another record low for the survey. However the Commission said the rate of decline had slowed compared with the first two months of the year "amid signs of stabilisation in some sectors.
Ilargi: Though I think he focuses too much on maintaining what is long lost, John Hussman writes an important article on what goes wrong with the bail-out trillions Washington showers on its favorites. No one is held accountable for what happens with the money, and transparency is nowhere to be found.
On the Urgency of Restructuring Bank and Mortgage Debt, and of Abandoning Toxic Asset Purchases
Last week, the U.S. Treasury Secretary advanced two proposals; one was a call for regulatory reform that is absolutely essential to the resolution of the current financial crisis. The other was a recipe for the insolvency of the FDIC, which would squander public funds to subsidize private speculation in troubled mortgage securities.
To begin this discussion, it is important to consider the balance sheet of a typical leveraged financial institution. The example below is similar to the one I presented last year in You Can't Rescue the Financial System if You Can't Read a Balance Sheet, but makes allowance for the fact that assets continue to be impaired due to policy failures, and that deposit banks such as Citigroup use more bond financing than investment banks. At the beginning of the recent crisis, the condition of U.S. financial institutions was much like the following:
Good Assets: $90
Questionable Assets: $10
TOTAL ASSETS: $100
Liabilities to Customers: $65
Debt to Bondholders: $30
Shareholder Equity: $5
TOTAL LIABILITIES AND SHAREHOLDER EQUITY: $100
Now suppose there are losses in those questionable assets - not all the way to zero, but to $4:
Good Assets: $90
Questionable Assets: $4
TOTAL ASSETS: $94
Liabilities to Customers: $65
Debt to Bondholders: $30
Shareholder Equity: $-1
TOTAL LIABILITIES AND SHAREHOLDER EQUITY: $94
The above institution is insolvent. There are several ways to address this situation.
Direct Capital Infusions
The first possible response is to provide public capital directly to the banks, which is what the Treasury did last year by purchasing newly issued preferred stock of banking institutions. A capital infusion increases the asset side of the balance sheet (cash on hand) and increases the shareholder equity side of the balance sheet by the same amount. The difficulty is that without clear restrictions on the use of that capital, banks have the freedom to continue business as usual, including using the public capital to finance bonus payments and other expenditures. Absent explicit restrictions, there is also no assurance that the public funds will be lent out. To some extent, financing additional loans is not the purpose of capital infusions. The purpose is to replace the cushion of equity ("Tier 1 capital") that stands between the bank's customers and bankruptcy.
Capital infusions are certainly a viable option to respond to the immediate threat of insolvency. These infusions were largely responsible for reducing the immediate threat to the U.S. financial system in late 2008. However, in the face of large and increasing losses, capital infusions are not sustainable. The public stands to lose the entire amount of funding if the institution fails, unless the infusions can be provided as a senior claim ahead of bondholders in the event of bankruptcy, and still be counted as "Tier 1 capital" otherwise. There are currently no legal or regulatory provisions to accomplish this.
Note that gross private debt currently stands at about 350% of GDP, about double the historical norm. Meanwhile, many of the assets underlying this debt are being marked down in value by 20-30% or more. Given that GDP itself is about $14 trillion, a continued policy of bailouts will eventually require a commitment of public funds amounting to a significant fraction of $14 trillion. The "real" burden of the mounting federal debt will have to be devalued through inflation, or it will place an onerous claim on the nation's future production and capital investment (which might otherwise be able to provide for the needs of an aging population).
Ultimately, if a financial institution is not capable of surviving without large and constant infusions of public capital, the stockholders and bondholders of that company – not the public – should be responsible for the losses incurred. As noted below, this can be achieved without customer losses or a disorganized Lehman-style unwinding.
Toxic Asset Purchases
The Treasury's proposal to address insolvency is to finance the purchase of impaired assets from the banks, primarily using taxpayer funds. But note that if the questionable assets are taken off of the bank's books at their actual value ($4 in the example above), there is absolutely no change on the liability side of the balance sheet. The bank's capital position does not improve. The "toxic asset sale" simply replaces the bad assets with cash. While this might improve the "quality" of the bank's balance sheet, it does not make the institution solvent.
Indeed, the only way for the toxic asset sale to increase shareholder equity is if the buyer overpays for the asset. To accomplish this, the Geithner plan creates a speculative incentive for private investors, by effectively offering them a "put option," whereby taxpayers would absorb all losses in excess of 3-7% of the purchase amount. This is essentially a recipe for the insolvency of the Federal Deposit Insurance Corporation itself, which would provide the bulk of the "6-to-1 leverage." To the extent that it is not acceptable for the FDIC to fail, the Geithner plan implies an end-run around Congress, and would ultimately force the provision of funds to cover probable losses.
An equal concern is that there is no link between removing "toxic assets" from bank balance sheets and avoiding large-scale home foreclosures and loan defaults. All the transaction accomplishes is to take the assets out of the bank's hands, to offer half of any speculative gains to private "investors," and to leave the public at risk for 93-97% of the probable losses. What the plan emphatically does not do is to affect the payment obligations of homeowners in a way that would reduce the likelihood of foreclosure. Moreover, the last thing that a bank would do with the proceeds would be to refinance such mortgages, because that would provide full repayment to the original lenders while taking on the risk of the newly refinanced loans.
If part of the intent of Congress is to increase lending, this could be done directly by providing funds to GSEs or by broadly providing capital to solvent regional banks. This would be a much more effective way of increasing the volume of lending in the U.S. economy without putting taxpayers at risk of major losses. There is no need for the public to purchase impared assets in order to increase lending activity.
Remember that the "toxic assets" held by banks represent pools of mortgages that have been cut up into dozens of individual pieces; the higher grade pieces having first claim to payments made on the underlying mortgages, and the lower grade pieces having claims to less likely payments. It is improbable that banks will be interested in selling off the better "tranches," and yet there is no benefit (aside from rank speculation) to owning the lower tranches unless the underlying mortgages can be restructured.
As a result, the only point in the public having anything to do with these securitized mortgages is if all of the tranches of a given issue can be purchased simultaneously, so that the underlying payment obligations of the homeowners can be restructured. That is, if the entire issue could be purchased at 50% of the original face amount, the underlying mortgages could be written down by the same proportion. Those mortgages would then be far more likely to be repaid, and as a result, the restructured debt could be sold back into the financial markets without the need for taxpayers to hold it to maturity. There is no "all or none" mechanism in the Treasury's toxic assets plan to accomplish this.
While the U.S. equity market advanced strongly on the day the Treasury plan was announced, most market indices were lower by the end of the week, and credit spreads (indicators of bondholder concerns about default risk) did not budge. It is far from clear that the Wall Street has confidence in the plan, beyond the fact that a trillion dollars to speculate on mortgage securities at taxpayer expense was not immediately rejected.
From the beginning of the recent crisis, starting with Bear Stearns, I have emphasized that nearly all of the financial institutions at risk of insolvency have enough liabilities to their own bondholders to fully absorb all probable losses without any loss to customers or the American public. The sum total of the policy responses to this crisis has been to defend the bondholders of distressed financial institutions at public expense.
Note that in the example balance sheet above, 30% of the liabilities of the institution represent debt to the company's own bondholders. It is these individuals – not homeowners, not the American public – that are being defended by the promise of trillions of dollars in public money.
For example, while Citigroup has approximately $2 trillion in assets, those assets are financed not only by customer deposits, but also by nearly $600 billion in debt to Citigroup's own bondholders. It is these private bondholders who provided the funds for Citigroup to acquire questionable assets.
The bondholders of distressed financial institutions – not the American public – should bear responsibility for the losses of those institutions. This can be accomplished, without harm to customers or the broader financial system, in one of two ways:
1) The bondholders could voluntarily agree to move a portion of their claims lower down in the capital structure, swapping debt for equity (preferred or common), allowing the bank to have a larger cushion of Tier-1 capital, avoiding insolvency, and hopefully allowing the bank to recover by its own bootstraps , preferably assisted by debt restructuring on the borrower side (via property appreciation rights and the like). Alternatively;
2) The U.S. government could take receivership of the financial institution, defend the customer assets, change the management, wipe out the stockholders and a chunk of the bondholders claims entirely, continue the operation of the institution in receivership, and eventually sell or reissue the company to private ownership, leaving the bondholders with the residual. Indeed, this is how the largest bank failure in history – Washington Mutual – was handled so seamlessly last year that it was almost forgettable. This is not Argentina-style "nationalization," but receivership – a form of "pre-packaged bankruptcy" that protects the customers and allows the institution to continue to operate, followed by re-privatization. This would fully protect all of the customers and depositors at no probable expense to the public.
What should not be done is what was allowed in the case of Lehman Brothers – a disorderly failure, by which the company was allowed to fail with no conservatorship of the existing business. It was not the failure of Lehman per se, but the disorder resulting from its piecemeal liquidation, that caused distress to the financial markets.
That said, it is true that the bondholders of major banks include pension funds, insurance companies, mutual funds, foreign investors and other holders that would be adversely affected by a writedown in bond values. But this is part of the contract – when one lends money to a financial institution, one also assumes the risk and responsibility of bearing the losses. Congress always has the ability to mitigate the losses of some parties, such as pension funds, if it is agreed that this is in the public interest. But to defend all bondholders of financial institutions at public expense is to commit the future economic output of innocent citizens to cover the losses of mismanaged financial institutions. As a result of the intervention by the Federal Reserve and the U.S. Treasury, even the bondholders of Bear Stearns stand to receive 100% repayment of both interest and principal on their bond investments. This is absurd.
1) Enable receivership of distressed bank and non-bank financial institutions (including bank holding companies), encouraging voluntary debt-equity swaps as an alternative to the seizure of insolvent institutions.
2) Allow "toxic asset" purchases using public funds only to the extent that entire issues of these securitized mortgages can be purchased "all or none" at a moderate percentage of face value, thereby allowing the underlying mortgages to be written down to the same percentage of face.
3) Establish a Treasury conduit to administer (but not guarantee) property appreciation rights on restructured mortgages, again encouraging voluntary restructuring, using the Treasury conduit as a coordinating mechanism (additional details below).
4) Allow bankruptcy judges to substitute a portion of foreclosed mortgage obligations with equivalent claims on subsequent property appreciation. "Push-down" of mortgage principal without offsetting compensation rights to lenders should be emphatically avoided.
More than a year ago, in a March 24, 2008 comment (Why is Bear Stearns Trading at $6 instead of $2?), I emphasized the need for immediate authority to take distressed financial institutions into receivership in order to cut away the stockholder and bondholder obligations, while preserving the ongoing business, as well as its obligations to customers and counterparties:
"At what point will investors figure out that the liquidity problems are nothing but the precursors of insolvency problems? At what point will investors stop begging the government to save private companies and recognize that the losses should be taken by the stock and bondholders of the offending financial institutions? If the Fed and the Treasury are smart, they will act quickly to figure out how to respond to multiple events like we've seen in recent days, to expedite turnover in ownership and quickly settle the residual claims of bondholders, without the kind of malfeasance reflected in the Bear Stearns rescue."
It is essential for regulators to have the ability to take distressed institutions into receivership, so that customers and counterparties of insolvent financial companies can be fully protected. Ideally, this determination should be made not by the Treasury, but by the FDIC, which has a clearer regulatory role. The objective of receivership provisions would be to allow the failing institution to be partitioned into an operating entity (including whatever questionable loans are on the books), while cutting away the obligations to the stockholders and bondholders of that institution. Upon the sale, liquidation, or re-privatization of the institution, the bondholders would receive the portion of the proceeds that are not required as regulatory capital.
To reduce the indirect effects of such receivership on other institutions, it would be helpful to legislate a restriction on the use of credit default swaps (essentially insurance contracts against the failure of a company's bonds), requiring that such swaps may be used for bona-fide hedging purposes only. That is, a credit default swap could not be entered for purely speculative purposes, but only to offset the default risk of the same or similar bonds held by the investor.
Although trillions of dollars have been promised or committed in hope of resolving the current financial crisis, the simple fact is that virtually nothing has been done to reduce the incidence of foreclosures. Even if the plan to remove toxic assets from bank balance sheets is successful (however "success" might be defined), the rate of foreclosure will be unaffected, because no change in the payment obligations of homeowners will result.
As with financial institutions, insolvent mortgages would best be addressed by a) voluntarily swapping debt for equity, or failing that; b) technical default and restructuring of the debt obligation.
From the standpoint of homeowners, a debt-equity swap is equivalent to writing down the mortgage principal, while at the same time giving the lender an equal and offsetting claim on the future appreciation of the home. As I noted in The Economy Needs Coordination, Not Money, From the Government,
"The most useful feature of government in resolving the foreclosure crisis is not its ability to squander taxpayer money, but its ability to provide coordinated action. I still believe that the best approach to foreclosure abatement would be for the Treasury to set up a special "conduit" fund to administer "property appreciation rights" or what I've called PARs.
"Suppose a $300,000 mortgage is in foreclosure (or the homeowner and lender can agree to the following arrangement outside of foreclosure court). A reasonable mortgage restructuring might be to cut the principal of the mortgage to $200,000, and to create a $100,000 property appreciation right. The homeowner would agree to pay off the PAR to the Treasury (and administered through the IRS) out of future price appreciation on the existing home or subsequent property. The homeowner would be excluded from taking on any home equity loans or executing any "cash out" refinancings until the PAR was satisfied. The maximum PAR obligation accepted by the Treasury would be based on the value of the home and the income of the homeowner.
"The lender would receive not a direct claim on that homeowner, but a participation in the Treasury's "PAR fund" which would pay out proportionately from all PAR proceeds received by the Treasury (technically, new shares in the PAR fund would be assigned based on a ratio reflecting the extent to which existing shareholders have already been paid off, so earlier shareholders don't receive more than they have coming to them).
"Importantly, the Treasury would not guarantee repayment, but would simply serve as a conduit. There would be no "free lunch" at taxpayer expense. If the homeowner was to eventually sell the home and not purchase another, the obligation would become a low-interest loan obligation and would eventually be a claim on the estate of the homeowner, but with an initial exclusion at low income and a progressive recovery rate based on the size of the estate. The PARs would be tradeable, since they would be based on a single pool of cash flows, though they would almost certainly trade at a discount to face value. Assuming that the PAR obligations are fixed and don't increase at some rate of interest, then even if home prices were expected to take about 15 years to recover, the PARs would still trade at more than 50% of face. Given that recovery rates in foreclosure are running at only about 50% of the entire loan, it is clear that this sort of approach would be preferable to foreclosure in most cases. If this sort of mechanism were available, lenders might agree to outright principal reductions as well in preference a costly foreclosure process.
"This sort of approach would reduce foreclosures without relying on free money from the government, or violating contract law. The PARs would provide a legally enforceable, diversified stream of cash flows at far lower cost than individual lenders would have to spend to collect from individual homeowners. Since home sales are taxable events, the IRS would be in an ideal position to enforce these obligations."
The Danger of Inaction
If there is any good news at present, it is that the capital infusions of late-2008 have temporarily stabilized the banking system, and that the U.S. economy is presently enjoying a brief and modest reprieve from the financial crisis. This is largely the result of an ebbing in the rate of sub-prime mortgage resets, which reached their peak in mid-2008, with corresponding mortgage losses and foreclosures a few months later. Since this crisis began, the profile of mortgage resets has been well-correlated with subsequent foreclosures.
Unfortunately, the reset schedule above depicts only sub-prime mortgages. As the recent housing bubble progressed, the profile of mortgage originations changed, so that at the very peak of the housing bubble, new originations took the form of Alt-As (low or no requirement to document income) and Option-ARMs (teaser rates, with no required principal repayments).
A broader profile of mortgage resets is presented below (though even this chart does not include the full range of adjustable mortgage products).
This reset profile is of great concern, because the majority of resets are still ahead. Moreover, the mortgages to which these resets will apply are primarily those originated late in the housing bubble, at the highest prices, and therefore having the largest probable loss. Though many of these mortgages are tied to LIBOR, and therefore benefit from low LIBOR rates, the interest rates on the mortgages are typically reset to a significant spread above LIBOR, and this spread remains constant as interest rates change. Undoubtedly, some Alt-A and option-ARM foreclosures have already occurred, but the likelihood is that major additional foreclosures and mortgage losses lie ahead. If we fail to address foreclosure abatement during the current window of opportunity (early to mid-2009), there may not be time for legislative efforts to contain the resulting fallout.
As a foreshadowing of the probable foreclosures ahead, the following is what the Federal Reserve, FDIC, and the Office of Thrift Supervision noted about option-ARMs and other loans in a colorful little booklet entitled "Interest-Only Mortgage Payments and Payment-Option ARMs: Are They For You?" , published in November 2006:
"Owning a home is part of the American dream. But high home prices may make the dream seem out of reach. To make monthly mortgage payments more affordable, many lenders offer home loans that allow you to (1) pay only the interest on the loan during the first few years of the loan term or (2) make only a specified minimum payment that could be less than the monthly interest on the loan.
"Whether you are buying a house or refinancing your mortgage, this information can help you decide if an interest-only mortgage payment (an I-O mortgage)--or an adjustable-rate mortgage (ARM) with the option to make a minimum payment (a payment-option ARM)--is right for you. Lenders have a variety of names for these loans, but keep in mind that with I-O mortgages and payment-option ARMs, you could face
* "payment shock." Your payments may go up a lot--as much as double or triple--after the interest-only period or when the payments adjust.
"In addition, with payment-option ARMs you could face
* negative amortization. Your payments may not cover all of the interest owed. The unpaid interest is added to your mortgage balance so that you owe more on your mortgage than you originally borrowed.
"Payment-option ARMs have a built-in recalculation period, usually every 5 years. At this point, your payment will be recalculated (lenders use the term recast ) based on the remaining term of the loan. If you have a 30-year loan and you are at the end of year 5, your payment will be recalculated for the remaining 25 years. The payment cap does not apply to this adjustment.
"Lenders end the option payments if the amount of principal you owe grows beyond a set limit, say 110% or 125% of your original mortgage amount. For example, suppose you made minimum payments on your $180,000 mortgage and had negative amortization. If the balance grew to $225,000 (125% of $180,000), the option payments would end. Your loan would be recalculated and you would pay back principal and interest based on the remaining term of your loan. It is likely that your payments would go up significantly.
"Be sure you understand the loan terms and the risks you face. And be realistic about whether you can handle future payment increases. If you're not comfortable with these risks, ask about another loan product."
Judging from the reset schedule above, it is clear that more than a few borrowers ignored this advice.
As of last week, the Market Climate for stocks was characterized by reasonable valuations – moderate undervaluation on earnings-based measures that assume a reversion to above-average profit margins in the future, but continued overvaluation on measures that do not rely on future profit margins being above historical norms.
This is an important distinction, because much of my constructive perspective about valuations late last year was based on the expectation of something of a "writedown recession" whereby our policy focus would have been on properly defending customers through greater use of the receivership process – demonstrating that the financial system itself could remain sound even while allowing the writedown and restructuring of debt. I believed, as I wrote a year ago, that "The U.S. economy will get through this without the requirement of massive public bailouts. What is required, however, is that the stock and bondholders of financial companies take due losses. Customers and counterparties need not, and I expect will not, be harmed." My optimism that our policy-makers would see clearly enough to follow this course was mistaken (fortunately, we are within 5% of where we stood at the beginning of this bear market).
The misguided policy of defending bondholders against losses with public funds has increased uncertainty, crowded out private investment, harmed consumer confidence, and prompted defensive saving against possible adversity. We observe this as a plunge in gross domestic investment that is much broader than just construction and real estate, and a corresponding but misleading "improvement" in the current account deficit as domestic investment plunges.
Aside from a few Nobel economists such as Joseph Stiglitz (who characterized the Treasury policy last week as "robbery of the American people") and Paul Krugman (who called it "a plan to rearrange the deck chairs and hope that that keeps us from hitting the iceberg"), the recognition that this problem can be addressed without a massive waste of public funds (and that it is both dangerous and wrong to do so) is not even on the radar.
In short, attempting to avoid the need for debt restructuring by wasting trillions in public funds increases the likelihood that the current economic downturn will be prolonged, places a massive claim on our future production in order to transfer our nation's wealth to the bondholders of mismanaged financial companies, and raises the likelihood that any nascent recovery will be cut short by inflation pressures. We are nowhere near the completion of this deleveraging cycle.
To the extent that we continue to force add-on effects in the form of declining employment and capital investment, we also reduce the likelihood that profit margins and returns on equity will recover to the historically above-average levels which have prevailed in recent years.
The advance of the past few weeks has cleared the prior oversold condition and the market is now overbought in a generally negative Climate. As should be clear from last year's decline, the market can be severely oversold and only become more oversold, so an oversold condition is not a timing tool. That said, oversold conditions in clearly favorable Market Climates are often followed by strong advances, and overbought conditions in clearly unfavorable Market Climates are often followed by spectacular declines. At the recent market low, the Market Climate could certainly not be characterized as favorable, but at the present overbought level, there is considerable risk of a fresh plunge.
Thus far, the recent advance has been focused on low-quality and distressed sectors such as financials, insurance and homebuilders. If the current advance is durable, we would expect to observe stronger market internals, greater participation among higher quality sectors, and a clear easing of credit spreads, which remain near their highs despite the advance in equities. On sufficient improvement in market internals, we would be inclined to establish call option positions that would gradually take us to a significantly less hedged position on persistent market strength, but we do not expect to eliminate our put option defenses until the combination of valuations and market action becomes clearly favorable, or until it is reasonable to expect a sustained economic recovery within a quarter or two. Nothing in our analysis of valuations, market action, or economic conditions compels us that removing downside protection is reasonable at present.
In bonds, the Market Climate last week was characterized by unfavorable yield levels and relatively neutral yield pressures. The yields on Treasury Inflation Protected Securities have declined further in recent sessions, with inflation-adjusted yields on some issues dropping below 1%. I expect that a further decline in real yields would prompt us to reduce our holdings modestly, as it is doubtful that persistent inflation surprises will be a near-term outcome. I continue to view the U.S. dollar as vulnerable to depreciation given the rapid expansion in government liabilities, so the Strategic Total Return Fund continues to hold about 20% of assets in precious metals shares and foreign currencies, with a few percent in utility shares on the basis of longer-term total return prospects.