House in Houston with fruit stand
Ilargi: There are headlines today that say Wall Street is up because the job loss stats "may have" leveled off. Really? "Payrolls fell by 655,000 in January and by 681,000 in December, revised down by 161,000 from previous estimates" Translation: Initial February numbers reported today are 651.000. If they undergo a similar revision, by, say, about 15%, real February losses will end up close to 750.000. Do read the numbers, and read them well. We are talking the highest numbers in 50 years. US government figures get worse all the time, just when you think they can't anymore. What is this, China or Russia or something? If you’re always off by 15%, and you always have to revise 4 weeks later, why not publish the correct numbers right away?
Congress asks the Fed to reveal who's received the $180 billion of your money that Washington gifted to AIG, and is met with blunt refusal. There's a panel in the works that will regulate accounting standards in such a way that there will be far fewer of them, so there’ll be some sort of legal basis to hide behind when hiding banking and other corporate losses. Somewhere down the line someone will clue in to the fact that if false numbers and fake books are the law of the land, there's no escaping the reality that things are much worse than we are allowed to know. Wait till you find out that the New York Stock Exchange and the White House are nothing but cardboard façades populated by muppets and hand puppets.
The Dow has taken the plunge below 6500. On February 6, it was at 8280. That's a 20% loss in one month. Evidently, if you don't believe the official numbers, you're not the only one. What's that you said, Mr. President? We need to restore confidence? Sir, we're rapidly killing off what confidence there was left. And with it our societies.
About that confidence: The American people trust that $250.000 of deposits in each bank account is guaranteed through the FDIC. Of course, it's not the deposits, but the banks themselves that are actually insured. Also, the FHFA banks have a superlien with the FDIC on any banks that they have lent money to. As long as things go well, these things make little difference. But no matter how good or bad things pan out, it's paramount for the FDIC to look trustworthy, to maintain the impression that the agency knows what it's doing. Announcing new bank fees last week, and then slashing them again now, is not a confidence booster. To put it mildly.
The FDIC increasingly looks like it's making it up as it goes along. And Sheila Bair must be waking up in sweat several times a night thinking about Citigroup's bankruptcy prospects. She is not prepared for handling it, not at all. And that is the stuff that bank runs are made of. A lack of confidence.
U.S. Unemployment Rises to 8.1%, Highest in 25 Years, as 651,000 Jobs Lost
The U.S. unemployment rate jumped in February to 8.1 percent, the highest level in more than a quarter century and a surge likely to send more Americans into bankruptcy and force further cutbacks in consumer spending. Employers eliminated 651,000 jobs, the third straight month that losses surpassed 600,000 -- the first time that’s happened since the data began in 1939, Labor Department figures showed today in Washington. Today’s report indicates the economy is in worse shape than previously estimated and may need additional federal measures to help stop what may become the worst recession in the postwar era. The jobless rate has now already reached the level the Obama administration projected as an average for the whole year.
"The overall economy is going to be in this recession a little longer than expected," John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, said in a Bloomberg Television interview. Treasuries fell, while stock-index futures advanced. Benchmark 10-year note yields were at 2.88 percent at 9:27 a.m. in New York. Futures on the Standard & Poor’s 500 Stock Index rose 0.4 percent to 688.70. While President Barack Obama’s $787 billion stimulus plan aims at creating or saving 3.5 million jobs, today’s report showed the U.S. has now already lost 4.4 million since December 2007, with more declines coming. Tumbling global demand is prompting companies from General Motors Corp. to Sears Holdings Corp. to step up firings.
"The magnitude of these losses indicates that additional measures will likely be needed," Representative Carolyn Maloney, chairman of the congressional Joint Economic Committee, said in a statement after the release. "As unemployment continues to rise, our foreclosure crisis will only grow worse." More than 103,000 individuals and companies filed for bankruptcy in February, a private report showed this week. The destruction of U.S. household wealth left about 8.3 million Americans owing more on their mortgages in the fourth quarter than their properties were worth, other figures showed. Payroll revisions for January and December lopped off an additional 161,000 positions. The drop in January was revised to 655,000, and December’s to 681,000, the biggest decrease since October 1949.
Payrolls were forecast to drop by 650,000, according to the median of 80 economists surveyed by Bloomberg News. The jobless rate was projected to jump to 7.9 percent. Forecasts ranged from 7.8 percent to 8.1 percent. Today’s report showed factory payrolls fell by 168,000 after declining 257,000 in the prior month. Economists forecast a drop of 200,000. The decrease included 25,300 jobs in producers of machinery and 27,500 in makers of fabricated metal products. Automakers, at the heart of the manufacturing slump, continued to slash jobs and trim costs to stay in business. General Motors last month said it would cut 47,000 more positions globally while Chrysler LLC announced 3,000 more layoffs. Auto-parts makers are also suffering. Canton, Ohio-based Timken Co., the supplier of bearings to the world’s top five carmakers, said March 2 it would eliminate as many as 400 salaried jobs this year.
Service industries, which include banks, insurance companies, restaurants and retailers, subtracted 375,000 workers after cutting 276,000. Financial firms cut 44,000 positions after a 52,000 decline the prior month. Retail payrolls decreased by 39,500 after a 38,500 drop. Sears last week said it would shutter 24 stores, on top of eight closings announced earlier, after its fourth-quarter profit fell 55 percent due to weak holiday sales. "This past year was a very difficult year for the world economies and for retail in the United States, and 2009 needs to be the year of restoring confidence and trust in our financial system," Sears Chairman Edward Lampert said in a letter to shareholders. Payrolls at builders fell by 104,000 after decreasing by 118,000, as home sales and prices continued to tumble. Government payrolls increased by 9,000 after a gain of 31,000 the prior month, one of the few areas still hiring. Another 26,000 jobs were added by education and health providers.
Employers are holding the line on hours. The average work week held at 33.3 hours in February. Average weekly hours worked by factory workers dropped to 39.6 hours from 39.8 hours, while overtime also decreased to 2.6 hours from 2.8 hours. That brought the average weekly earnings up by $1 to $615.05. Workers’ average hourly wages rose 3 cents, or 0.2 percent, to $18.47 from $18.44 the prior month. Hourly earnings were 3.6 percent higher than February 2008. Economists surveyed by Bloomberg had forecast a 0.2 percent increase from January and a 3.8 percent gain for the 12-month period. Slumping sales have caused recent Chapter 11 filings by retailers such as Everything But Water LLC, the largest U.S. retailer of women’s swimwear, and Ritz Camera Centers Inc., the largest chain of camera stores. Economists polled by Bloomberg last month forecast consumer spending will contract through the first six months of this year after sliding in the last half of 2008. Purchases have not contracted for four consecutive quarters since records began in 1947. If the recession persists through the first half of this year, it would the longest since the Great Depression. The economy shrank at a 6.2 percent pace in the fourth quarter of 2008, the weakest performance since 1982.
Workers clobbered by relentless layoffs
Cost-cutting employers are resorting to even bigger layoffs as they scramble to survive the recession, feeding insecurities among those who still have jobs and those who desperately want them. The Labor Department on Friday is slated to release a report expected to show that February was an especially cruel month for America's workers. Employers likely slashed a net total of 648,000 jobs last month, according to economists' forecasts. If they are right, it would mark the worst month of job losses since the recession started in December 2007. It also would represent the single biggest month of job reductions since October 1949, when the country was just pulling out of a painful recession, although the labor force has grown significantly since then.
"The pace of layoffs is fast and furious," said Stuart Hoffman, chief economist at PNC Financial Services Group. "We're still in the teeth of this recession and the bite has not let up at all." With employers slashing payrolls, the nation's unemployment rate is expected to jump to 7.9 percent, from 7.6 percent in January. If that happens, it would mark the highest jobless rate since reaching 8 percent in January 1984, a time when the unemployment rate was still slowly moving down after having topped 10 percent during the early 1980s recession. Employers are shrinking their work forces at alarming clip and are turning to other ways to slash costs -- including trimming workers' hours, freezing wages or cutting pay -- because the recession has eaten into their sales and profits. Customers at home and abroad are cutting back as other countries cope with their own economic problems.
A new wave of layoffs hit this week. General Dynamics Corp. said Thursday it will lay off 1,200 workers due partly to plummeting sales of business and personal jets that forced it to cut production. Defense contractor Northrop Grumman Corp., and Tyco Electronics Ltd., which makes electronic components, undersea telecommunications systems and wireless equipment, also are trimming payrolls. "This is basically cleaning house for a lot of firms," said John Silvia, chief economist at Wachovia. "They are using the first quarter to cut back employment and figure out what they want." Disappearing jobs and evaporating wealth from tanking home values, 401(k)s and other investments have forced consumers to retrench, driving companies to lay off workers. It's a vicious cycle in which all the economy's negative problems feed on each other, worsening the downward spiral. "The economy is in a tailspin. Businesses are jettisoning jobs at an unprecedented pace," said Richard Yamarone, economist at Argus Research.
Some 3.6 million jobs have disappeared so far in a deepening recession, which is shaping up as the biggest job killer in the post-World War II period. The country is getting bloodied by fallout from the housing, credit and financial crises-- the worst since the 1930s. And there's no easy fix for a quick turnaround, economists said. President Barack Obama is counting on a multipronged assault to lift the country out of recession: a $787 billion stimulus package of increased federal spending and tax cuts; a revamped, multibillion-dollar bailout program for the nation's troubled banks; and a $75 billion effort to stem home foreclosures. Even in the best-case scenario that the relief efforts work and the recession ends later in 2009, the unemployment rate is expected to keep climbing, hitting 9 percent or higher this year.
In fact, the Federal Reserve thinks the unemployment rate will stay elevated into 2011. Economists say the job market may not get back to normal -- meaning a 5 percent unemployment rate -- until 2013. Businesses won't be inclined to ramp up hiring until they are sure any economic recovery has staying power. The economy contracted at a staggering 6.2 percent in the final three months of 2008, the worst showing in a quarter-century, and it will probably continue to shrink during the first six months of this year. Fed Chairman Ben Bernanke told Congress earlier this week that recent economic barometers "show little sign of improvement" and suggest that "labor market conditions may have worsened further in recent weeks."
Plunging Markets, Then and Now
The stock market tanked again today, and for 2009 has lost nearly a quarter of its value. And it is only early March. To put that in perspective, assume that the market ends 2009 at today’s prices. This would be the list of the worst years since 1900 for the Dow industrials:
- 1931, down 53%
- 1907, down 38%
- 2008, down 34%
- 1930, down 34%
- . 1920, down 33%
- 1937, down 33%
- 1974, down 28%
- 2009, down 25%
- 1903, down 24%
- 1932, down 23%
You will note that we have not had consecutive really bad years since 1930, 1931 and 1932. Here are the rankings for worst two-year periods, again assuming 2009 ends at today’s prices:
- 1930-31, down 69%
- 1931-32, down 64%
- 2008-09, down 50%
- 1929-30, down 45%
- 1973-74, down 40%
- 1906-07, down 39%
- 2007-08, down 30%
- 1940-41, down 26%
- 1916-17, down 22%
- 1920-21, down 25%
That may mean that the market really is discounting a financial disaster. Here’s another indication that investors feel more or less the way they did during the last disaster:
It has been 513 calendar days since the stock market peaked on Oct. 9, 2007. Since then, the S.&P. 500 is down 56 percent and the Dow is off 53 percent. On Jan. 29, 1931 — the identical number of days after the 1929 market peak — the S.&P. 500 was down 49 percent and the Dow was down 56 percent. The 1929 crash got off to a much faster start, but we have now more or less caught up. You will note, however, that the economic news now is not nearly as bad as it was in 1931. Could there be a tad bit of overreaction this time? Finally, the good folks at accuweather.com would like to let you know that the weather is also reminiscent of the bad old days:Dust Bowl II?
The weather pattern has some similarities to that of the 1930’s and given the state of the economy these days make it quite sobering. While modern farming practices and technological advances should prevent a 1930’s style dust bowl over the southern Plains, indeed some hardship lies ahead unless the current pattern breaks. The spring planting season begins this month in the region and crops need moisture to sprout and grow.
Ilargi: Two graphs from Doug at Dshort.com reveal quite a bit of where we’ve "landed". The Dow has "reversed" 43 years, and we are beating the Great Depression .
Big risks for the insurer of last resort
by Martin Wolf
The UK government looks increasingly like a python that has swallowed a hippopotamus. In acting as insurer of last resort to the British-based banking system, it is taking on huge risks on behalf of taxpayers. If this turned out to be a global depression, with huge losses for British-based banks, fiscal solvency might even come into question. Can this make sense? I doubt it. At the end of last year, total assets of the British-based banking system were £7,919bn ($11,188bn, €8,908bn) or 5.5 times gross domestic product. These aggregate assets increased by £956bn between the end of 2007 and the end of 2008 and by £4,493bn, or by 130 per cent, between the end of 2001 and the end of 2008.
Royal Bank of Scotland alone accounted for 45 per cent of this latter increase. At the end of last year, RBS had the largest assets of any British bank, at 166 per cent of GDP. These asset positions are enormous. It should be noted, however, that they include gross derivatives positions (which is not the case under US accounting). Net derivatives exposures were far smaller. RBS was a small Scottish bank that wanted to be big. It succeeded. Yet, today, the market capitalisation of RBS is a mere £9bn. Even this is only because the Treasury has not wiped out private shareholders. The bank is in effect nationalised. Taxpayers bear the cost of guaranteeing this fruit of megalomania. I must confess an interest: I am a depositor at RBS. As such, I am grateful.
Implicitly, the UK government is guaranteeing the liabilities of the swollen UK banks. Explicitly, it seems likely to guarantee at least £600bn of toxic assets of RBS and Lloyds under its "asset protection scheme". I am no populist. Yet when I think of the sums earned by those responsible for dumping this mess on to the UK taxpayer, even my blood boils. RBS has definitely received £325bn of insurance of toxic assets. The first 6 per cent of any losses (£19.5bn) will fall on RBS, with RBS taking 10 per cent of the losses above this limit. The overall fee paid by RBS for this insurance is about 4 per cent of the amount insured. A part of this is paid in RBS shares, which are, to put it mildly, funny money. To keep this behemoth breathing, the Treasury has pumped in £25.5bn of extra capital.
My colleague, Willem Buiter, in his magnificent blog states bluntly that: "like its American and Dutch counterparts, this toxic asset insurance scheme is without redeeming social value: it is inefficient, unfair and expensive". Is he being too harsh? Not much. Clearly, the biggest attraction of such a scheme, to both politicians and beneficiaries, is that its costs are removed from the public accounts. How large might these costs be? I understand that internal calculations of the International Monetary Fund suggest a fiscal cost of all UK bank support of 13 per cent of GDP, or £200bn. I suspect this is too optimistic. Certainly, together with the costs of the economic slump, an increase of well over 50 percentage points in the ratio of public sector debt to GDP is highly likely. Such are the wages of financial mania. They would be similar to the fiscal costs of a war.
Why should not more of the losses fall on creditors, other than the insured depositors? That is the question asked by many economists. It is the approach recommended by proponents of a "good bank" solution. The big point here is that the losses against which the government is now offering such generous insurance relate strictly to bygones. If we want banks to make new loans, it makes far more sense to guarantee those, rather than bail out all those who financed the mistakes of the past. So, suggest the radicals, toxic assets should have been left with the shareholders and uninsured creditors of the old bank, who would also gain a claim on a clean new bank. Moral hazard would disappear and taxpayers would be left relatively unharmed.
The arguments against this are two: first, the possibility of a default would create a wave of panic worse than the one that followed the bankruptcy of Lehman last September; and, second, for this reason, no individual government could dare to go it alone. Unlike Professor Buiter, I recognise that these could be valid arguments in the current circumstances. I certainly have no desire to make the slump even worse than it is. But, if so, they have compelling implications. One is that we must create effective mechanisms for orderly bankruptcy of very large financial institutions. Indeed, this is far and away the most important lesson of the crisis. Another is that if large institutions are too big and interconnected to fail, precisely because they are bound to get into serious trouble together, then talk of maintaining them as "commercial" operations, as the chancellor of the exchequer does, is a sick joke.
Such banks are not commercial operations; they are expensive wards of the state and must be treated as such. The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. The UK cannot afford it.
U.K. Profits Will Fall More Than in 1930s, Morgan Stanley Says
Profits in the U.K. will plunge more than during the Great Depression amid further losses in the banking industry and sliding oil prices, pushing the benchmark FTSE 100 Index lower over the next year, Morgan Stanley said. Earnings will fall 60 percent from peak to trough, London- based equity strategists Graham Secker and Charlotte Swing wrote in a report dated yesterday, adding that Morgan Stanley data suggest profits dropped about 57 percent during the early 1930s.
"While this sounds a rather draconian and hyperbolic downgrade, we believe it is realistic and incorporates the big losses that have come to light in the banking sector as well as a sharp drop in commodity prices," the strategists wrote. The New York-based brokerage lowered its 12-month forecast for the FTSE 100 to 3,500 from 4,300. The gauge closed at 3,529.86 yesterday, having slumped 20 percent in 2009. A 60 percent decline in profits implies a drop in investors’ return on equity to 8 percent from 19 percent currently, according to the report.
The financial world is stumbling blindly
by Gillian Tett
This month, Sergei Polonsky, one of Russia’s largest and most indebted property developers, is trying to prevent powerful western banks from calling in their loans. But as his company, Mirax, battles on, he admits he is in a cognitive fog. "Frankly, everything is uncertain right now," he told a gathering of bankers, business leaders and policymakers that I attended in Moscow this week. "We don’t know whether to cut any contracts in roubles or dollars, or something else. We don’t know what prices for anything will be, what demand will be, what our market will look like." It is a comment that reveals much about the way that finance is developing right now. In the past few weeks, policymakers and investors have scurried to make sense of the sharp decline in global economic activity.
In part, this can be blamed on a contraction in credit as banks get tough with their creditors. But the sheer speed of this slump and the fact it is occurring with surprising global synchronicity suggest that psychology is also to blame. It is not simply the fact that people are feeling gloomy; the really pernicious issue is extreme uncertainty – on almost every front. The type of cognitive fog besetting Polonsky is quietly shared to a greater or lesser degree by millions of other enterprises round the world. And while the Russians are apt to joke that "we have had plenty of practice in our history with uncertainty" the sense of disorientation is a bitter psychological blow to western bankers and businessmen. After all, most of the west has spent the past decade cocooned in a climate so calm it was dubbed the "Great Moderation".
In the financial sector, this cognitive fog is manifesting itself in two specific ways. First, the collapse of Lehman Brothers has created an extreme terror about counterparty risk. As fresh writeoffs keep mounting, financiers of almost any stripe are nervous about committing to long-term transactions. Second – and equally crucially – financiers are finding it increasingly hard to engage in the market "hedging" strategies they used to employ to mitigate risk. Most notably, in the wake of the Lehman collapse, the pattern of deleveraging and forced sales has been so intense that traditional price relationships have completely broken down, sending trading models haywire. "You just cannot devise any trading strategy now on a concept of a reversion to the mean, and you cannot really hedge," confesses the head of one large investment bank.
As the banking sector pulls in its horns, businesses are being tipped into a gruelling hand-to-mouth existence. In truth, plenty of banks are still extending loans and plenty of businesses are still placing orders with each other. But time horizons have collapsed. "Nobody wants to make decisions on anything," one Swedish businessman told me this week. Western governments appear to be fuelling, not removing, this sense of uncertainty. The Lehman collapse has sown a sense of terror about creditors losing money on any bank bonds they hold. The only way truly to remove that terror would be for the government to persuade investors that banks are so healthy they cannot collapse – or promise to protect creditors if they do. But while the latter route was employed – to great success – by the Swedish government 17 years ago, it has not been endorsed by Washington yet.
Instead, the US (and many European countries) are rolling out piecemeal solutions. Meanwhile, efforts to persuade voters that banks are healthy are failing to convince – mainly because there is still so much uncertainty about asset values. So that leaves Mr Polonsky holding his breath. He says a few weeks ago Credit Suisse agreed to restructure part of his company’s debt, and that gets him off the hook. But the ratings agencies remain unsure and two have since downgraded Mirax. What happens next remains anybody’s guess, for Mirax, for Russia – and for the world more widely. No wonder markets are in such turmoil – right now that seems the only rational response to a once-in-a-generation cognitive fog.
Fed won't say who benefits from AIG rescue
The U.S. Federal Reserve refused to identify trading partners benefiting from a $180-billion taxpayer bailout of American International Group as one lawmaker said Europe's financial stability was at stake in the rescue of the insurer. The identity of those being helped by the massive AIG assistance package remained a mystery on Thursday despite efforts by irritated members of the Senate Banking Committee to get answers from Fed Vice Chairman Donald Kohn. Kohn said revealing names risked jeopardizing AIG's continuing business but said the counterparties numbered in the "millions" and were spread all over the globe, including pension funds and U.S. households.
The goal was not to protect AIG or its counterparties, Kohl testified, but to prevent AIG's infection spreading. "I wish with every fiber in my body that we didn't have to come in and do what we did." Separately, Representative Paul Kanjorski told Reuters he had been informed that a large number of AIG's counterparties were European. "That's why we could not allow AIG to fail as we allowed Lehman (Brothers) to fail, because that would have precipitated the failure of the European banking system," said the Democrat from Pennsylvania who chairs the House insurance subcommittee.
Regulators failed to spot how much risk AIG was piling on in credit default swaps. By the time they understood, they had no choice but to pour in billions of public dollars, Kohn and other officials told the Senate panel. Senators were outraged at the lack of detail about where the money had gone. "That we find ourselves in this situation at all is ... quite frankly, sickening," said Senator Christopher Dodd, the Democrat who chairs the committee. "The lack of transparency and accountability in this process has been rather stunning." Under a revised bailout deal announced on Monday, the amount of funds committed to help AIG increased to about $180 billion, although the insurer has not tapped it all and plans to pay back roughly $38 billion soon. The U.S. government holds about an 80 percent stake in the insurer.
"It's not clear who we're rescuing -- whether it is whatever remains of AIG or its trading partners," said Dodd. "AIG's trading partners were not innocent victims here. They were sophisticated investors who took enormous, irresponsible risks with the blessing of AIG's triple-A rating," added Dodd. AIG, which had written about $440 billion in credit default swaps, lost $61.7 billion in the fourth quarter, the biggest quarterly loss in corporate history.
The generosity of the bailout to AIG's counterparties was also criticized at Thursday's hearing. Senator Bob Corker, a Republican from Tennessee, said he was surprised that AIG's counterparties were not only saved from being wiped out, but also took no discount on their securities. "They've actually made out like bandits." Lawmakers said they were running out of patience with regulators' refusal to identify AIG's counterparties. "The Fed and Treasury can be secretive for a while but not forever," said Richard Shelby, the top Republican on the banking committee.
But Kohn said the secrecy was necessary. "We need AIG to be stable and continue in a stable condition. And I would be very concerned that if we started giving out the names of counterparties here, people would not want to do business with AIG," Kohn said. Kohn admitted the Fed had "pushed the boundaries" of its authority in deciding to rescue AIG, but he said letting AIG fail would have been worse. "I think we experienced something with the Lehman bankruptcy that suggested it would have been the most disorderly thing," he said. The fact that a "multitude of regulators" missed the warning signs at AIG highlighted the need to establish a systemic risk regulator to monitor firms that are large and complex enough to destabilize the financial system, said Scott Polakoff, acting director of the Office of Thrift Supervision.
"Where OTS fell short, as did others, was in the failure to recognize in time the extent of the liquidity risk to AIG" of certain credit default swaps held in the portfolio of the company's financial products division. That unit, although a small part of the global insurance giant's worldwide operations, racked up such heavy losses that it threatened the entire company's survival. "No one was minding the whole company and looking at how things interacted, and whether the whole company would, under some circumstances, put the financial system at risk," said Kohn.
Lawmakers Propose Panel That Could Suspend Fair-Value
Two U.S. lawmakers want to create a regulatory panel that would be able to suspend accounting rules such as the fair-value standard that financial companies have blamed for worsening the global credit crisis. Representatives Ed Perlmutter and Frank Lucas introduced House legislation yesterday to establish the Federal Accounting Oversight Board, which would "approve and oversee accounting principles." It would include the Treasury secretary and the chairmen of the Federal Reserve, the Federal Deposit Insurance Corp., the Public Company Accounting Oversight Board and the Securities and Exchange Commission.
The panel, taking authority the SEC now has, would "give discretion to the regulators to consider the overall condition of the financial market," Leslie Oliver, a spokeswoman for Colorado Democrat Perlmutter, said in an interview today. The Financial Accounting Standards Board, the SEC-supervised group that sets U.S. accounting rules, takes a "narrower approach," she said. Lucas is an Oklahoma Republican. Citigroup Inc. and the American Bankers Association say the fair-value rule, which requires companies to write down assets to reflect market value, doesn’t work in illiquid markets. Fed Chairman Ben S. Bernanke, who would lead the proposed panel, said on Feb. 25 that fair-value is "a good principle" that can be improved. Treasury Secretary Timothy Geithner has said the rule enhances the transparency of company balance sheets.
"The current framework for accounting oversight, though well-intentioned, has proved inadequate and must be fundamentally revised," Edward Yingling, the ABA’s president, said in a statement today. The new panel would "help address systemic risks that accounting standards can have on the economy," he said. The ABA has asked regulators to ease the fair-value rule. By including the chairmen of regulators other than the SEC, the oversight board would "broaden the perspective" used to evaluate accounting rules, Oliver said. The board would submit reports to Congress at least once a year.
"This sounds like someone is not happy with some of the standards we have and maybe this is an indirect end-around to try to get them changed," Charles Mulford, an accounting professor at the Georgia Institute of Technology in Atlanta, said in an interview today. "I think this would make standard-setting more political, which is a step in the wrong direction. And those regulators have enough to do without overseeing accounting." The SEC in a December report rejected calls to suspend fair- value, also known as mark-to-market. The agency said the rule should be improved and "did not appear to play a meaningful role" in bank failures last year.
Wall Street spent bilions lobbying
The financial sector spent $5.1 billion in political influence-peddling over the past decade as lobbyists won deregulation that led to the nation’s financial collapse, according to a new study. The report released yesterday, "Sold Out: How Wall Street and Washington Betrayed America," found that for the past decade, Wall Street investment firms, commercial banks, hedge funds, real estate companies and insurance firms made $1.7 billion in political contributions and spent another $3.4 billion on lobbyists to undercut federal regulation. The study was done by Essential Information, a citizen activist group founded by Ralph Nader, and the Consumer Education Foundation, a nonprofit run by California lawyer Harvey Rosenfield. Nearly 3,000 registered federal lobbyists worked for the financial industry in 2007 alone, the study noted, and firms drew heavily from government in choosing their lobbyists. Surveying 20 top financial firms, "Sold Out" found 142 of the lobbyists they employed from 1998 to 2008 were previously high-ranking officials or employees in the executive branch or Congress.
Congressman Barney Frank, chairman of the House Financial Services Committee, received nearly $100,000 in campaign contributions from Bear Stearns, Lehman Brothers, Bank of America, Wells Fargo, KPMG, PricewaterhouseCoopers and Deloitte & Touche from 2006 to 2008, the study said. The report documents a dozen deregulatory moves "that, together, led to the financial meltdown." These include prohibitions on regulating financial derivatives; the repeal of regulatory barriers between commercial banks and investment banks; a voluntary regulation scheme for big investment banks; and federal refusal to act in order to stop predatory subprime lending. "Americans were betrayed, and we are paying a high price - trillions of dollars - for that betrayal," Rosenfield said.
FDIC's Bair agrees to trim new bank fees
The head of the Federal Deposit Insurance Corp. has agreed to halve a new emergency fee on U.S. banks in exchange for Congress more than tripling the agency's borrowing authority to tap federal aid if needed to replenish the deposit insurance fund. Word of the move by FDIC Chairman Sheila Bair came Thursday, four days after she warned that the fund insuring Americans' deposits could be wiped out this year without the new fees on U.S. banks and thrifts. Banks, especially smaller community banks, have been chafing over the new insurance fees, saying they will place an extra burden on an already struggling industry.
Bair is agreeing to cut the new emergency premium, to be collected from all federally-insured institutions on Sept. 30, to 10 cents for every $100 of their insured deposits from the 20 cents the FDIC approved last Friday. That compares with an average premium of 6.3 cents paid by banks and thrifts last year. At the same time, the FDIC has been seeking a permanent increase in its line of credit with the Treasury Department to $100 billion from the current $30 billion. The agency has never drawn on that long-term credit line, but Bair told lawmakers in letters Thursday that such an increase "would leave no doubt that the FDIC will have the resources necessary to address future contingencies and seamlessly fulfill the government's commitment to protect insured depositors against loss."
FDIC spokesman Andrew Gray said the idea behind increasing the credit line is to give the agency additional flexibility in funding, and is unrelated to its ability to meet obligations to bank depositors. The FDIC is "backed by the full faith and credit of the United States government," Gray said. "We can and always will be able to meet our obligations to depositors." In addition to $18.9 billion now in the insurance fund, the FDIC also has a contingency reserve of $22.4 billion set aside for potential bank failures this year. Housing rescue legislation approved by the House on Thursday evening includes the boosted borrowing authority for the FDIC. The package faces a tougher road in the Senate amid the same banking industry opposition and reservations among moderate Democrats that nearly derailed it in the House.
Looking to enhance those prospects in the Senate for the expanded FDIC borrowing authority, Banking Committee Chairman Sen. Christopher Dodd, D-Conn., has authored specific legislation to do that. He was expected to soon introduce the measure, which also would provide a temporary increase in the FDIC's credit line to as much as $500 billion until Dec. 31, 2010 — with required approval of the Federal Reserve, the Treasury Department and other federal regulators. In a letter to Dodd Thursday, Bair said raising the permanent credit line to $100 billion "would give the FDIC flexibility to reduce the size" of the emergency premium to be charged to banks.
The twin moves "are important for maintaining a strong deposit insurance fund while also ensuring that banks can continue to meet the credit needs of their communities," Edward Yingling, president and CEO of the American Bankers Association, said in a statement. "We remain deeply concerned about (the cost of the new premium) and appreciate the FDIC's willingness to consider alternative approaches," he said. As the economy sours, home prices tumble and loan defaults soar, bank failures have cascaded and sapped billions out of the fund that insures regular accounts up to $250,000. The fund now stands at its lowest level in nearly a quarter-century, $18.9 billion as of Dec. 31, compared with $52.4 billion at the end of 2007.
The law requires the insurance fund to be maintained at a certain minimum level, but it fell below the mandated 1.15 percent of total insured deposits in mid-2008.
The FDIC now expects that bank failures will cost the insurance fund around $65 billion through 2013, up from an earlier estimate of $40 billion. There have been 16 bank collapses already this year, following 25 in 2008 — which included two of the biggest savings and loans, Washington Mutual Inc. and IndyMac Bank. The new emergency premium approved last week, plus an increase in regular insurance fees for banks, was intended to raise $27 billion this year to replenish the fund. The regular insurance premiums will rise to between 12 and 16 cents for every $100 in deposits starting in April, up from a range of 12 to 14 cents.
Bill Seeks to Let FDIC Borrow up to $500 Billion
Senate Banking Committee Chairman Christopher Dodd is moving to allow the Federal Deposit Insurance Corp. to temporarily borrow as much as $500 billion from the Treasury Department. The Connecticut Democrat's effort -- which comes in response to urging from FDIC Chairman Sheila Bair, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner -- would give the FDIC access to more money to rebuild its fund that insures consumers' deposits, which have been hard hit by a string of bank failures. Last week, the FDIC proposed raising fees on banks in order to build up its deposit insurance fund, which had just $19 billion at the end of 2008. That idea provoked protests from banks, which said such a burden would worsen their already shaken condition. The Dodd bill, if it becomes law, would represent an alternative source of funding.
Mr. Dodd's bill could also give the FDIC more firepower to help address "systemic risks" in the economy, potentially creating another source of bailout funds in addition to the $700 billion already appropriated by Congress. Mr. Bernanke said in a Feb. 2 letter to Mr. Dodd that such a "mechanism would allow the FDIC to respond expeditiously to emergency situations that may involve substantial risk to the financial system." The FDIC would be able to borrow as much as $500 billion until the end of 2010 if the FDIC, Fed, Treasury secretary and White House agree such money is warranted. The bill would allow it to borrow $100 billion absent that approval. Currently, its line of credit with the Treasury is $30 billion.
The FDIC's deposit-insurance fund has fallen precipitously with 25 bank failures in 2008 and 16 so far in 2009. Some bank failures have a bigger impact on the fund than others, as IndyMac's failure cost the fund more than $10 billion, while many others cost the fund less than $100 million. A 1991 law generally caps the amount of money the FDIC can borrow from the Treasury at $30 billion, and the FDIC hasn't borrowed money from the Treasury in more than a decade. Ms. Bair said a change in the law would give the FDIC more options to determine the best way to rebuild its depleted fund. In an interview, she stressed that all insured deposits were already backed by the "full faith and credit of the United States government." A change in the law would ease "the mechanics of how seamlessly we can access our lines of" funding. "I'm the kind of person that likes to be prepared for all contingencies," she said.
Banks That Shunned Subprime Ask Why They're Paying for Wall Street Greed
TCF Financial Corp., the Wayzata, Minnesota-based bank that never made a subprime loan and hasn’t lost money since 1995, is asking why it should help clean up the mess made by Wall Street. "I’m kind of bitter," said William Cooper, chief executive officer of the 448-branch bank, adding that over the years TCF has invested about $1 billion in the Federal Deposit Insurance Corp.’s fund that guarantees bank deposits. "We pay for the excesses of our competitor over and over again."
TCF is among more than 8,300 banks and lenders insured by the FDIC facing increased fees and a one-time "emergency" charge designed to raise $27 billion this year for the agency’s depleted coffers. Community banks may take a 10 percent to 20 percent hit to 2009 earnings even if the FDIC halves that charge, said Camden Fine, president of the Independent Community Bankers of America. The ICBA and its 5,000 mostly locally owned member banks are rebelling against the costs, as well as curbs on pay and business practices imposed on recipients of U.S. capital after public outrage over bonuses and perks at the biggest lenders. Community banks rely more heavily on deposit funding, so they suffer a "much heavier burden" as a result of deposit insurance proportionate to size than peers such as New York-based Citigroup Inc. and Wells Fargo & Co., with its headquarters in San Francisco, Fine said.
Community lenders "are feeling like they are paying for the incompetence and greed of Wall Street," Fine said this week in an interview. The ICBA encouraged its members to flood the FDIC with letters protesting the emergency fee. Fine said he’s received more than 1,000 e-mails and telephone messages from angry bankers since the FDIC approved the fee on Feb. 27. U.S. Senate Banking Committee Chairman Christopher Dodd said he plans to introduce legislation that would temporarily raise the FDIC’s $30 billion borrowing authority with the Treasury to $500 billion, with a permanent increase to $100 billion. The change may give regulators room to reduce the emergency fee, FDIC Chairman Sheila Bair said.
U.S. Representative Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee, said on March 5 that there is legitimate concern about FDIC fees among community banks, which the ICBA defines as "locally owned" with assets ranging from less than $10 million to "multibillion dollar institutions." The House approved a measure yesterday increasing the borrowing authority to $100 billion and making permanent the $250,000 deposit-insurance limit in the financial bailout measure enacted in October. Without the fees, the FDIC fund might become insolvent because of a surge in bank failures, Bair said in a March 2 letter. Sixteen banks have failed so far in 2009 after 25 were seized last year, most of them with less than $1 billion in assets.
FDIC-insured banks lost $26.2 billion in the fourth quarter, the first loss for a three-month period since 1990. U.S. banks and securities firms have reported more than $800 billion in writedowns and credit losses since 2007 in the worst financial crisis since the Great Depression. The FDIC fee increases are "not going to make or break a community bank, but they are having to suffer as a result, and they are quite angry," said Josh Siegel, co-founder of StoneCastle Partners LLC, which manages about $2.3 billion in assets and invests in more than 220 community banks. The FDIC needs to explore alternatives that don’t "levy a burdensome, ongoing assessment on the only banks that are really in a position to pull this country out of the economic turmoil," Fine said.
"It takes a bite out of earnings," said Joseph Conners, chief financial officer of Beneficial Mutual Bancorp, the largest lender based in Philadelphia, with $2.7 billion in deposits. Conners said halving the fee would help. "It’s better than paying a triple assessment, but it’s still a double assessment." FDIC assessments are set per $100 in deposits and not weighted by bank size. That’s a formula that could be modified to shift the cost burden to the largest banks "that caused this train wreck," Fine said. TCF never "securitized anything, we never engaged in any of those unscrupulous activities," said Cooper, 65. The bank pays a 25-cent quarterly dividend and applied to return $361.2 million in U.S. funds.
More than 500 banks, insurers and credit-card companies applied for money from the government’s Troubled Asset Relief Program, which has distributed more than $290 billion to companies including Citigroup and American Express Co. While regulators encouraged both ailing and healthy banks to take TARP money, losses by big banks and pressure to cut dividends, pay and perks have stigmatized the program for others, Cooper said. "The regulators wrongly suggested we take it," Cooper said. "Everybody who took the TARP money now is a crook and an evil character." Lafayette, Louisiana-based Iberiabank Corp. last month became the first lender to apply to return the money, saying that TARP placed it at "an unacceptable competitive disadvantage." "Unfortunately, healthy banks, such as ours, have been categorized with troubled banks," Iberiabank CEO Daryl Byrd said in an e-mailed statement.
Darth Wall Street Destroying Distressed Debtors With Credit-Default Swaps
Amusement-park operator Six Flags Inc. and automaker Ford Motor Co. may be pushed toward bankruptcy by bondholders trying to profit from credit-default swaps that protect against losses on their high-yield debt. By employing a so-called negative-basis trade, investors could buy Six Flags bonds at 20.5 cents on the dollar and credit- default swaps at 71 cents. If the New York-based chain defaults, the creditors would receive the face value of the debt, minus costs. In a Feb. 27 note, Citigroup Inc.’s high-yield strategists put that profit at 6 percentage points, or $600,000 on a $10 million purchase.
Investors who bet on the collapse of a company are pitting themselves against traditional debt holders at a time when Moody’s Investors Service projects defaults will more than triple this year to the worst level since the Great Depression. The clash may stall restructuring efforts to prevent bankruptcies, as basis traders may be less inclined to participate in distressed debt exchanges, said Matthew Eagan, an investment manager at Boston-based Loomis Sayles & Co., with $7 billion in high-yield assets. "Before, you really had to worry mostly about where you were in the" company’s capital structure, he said. "Now, you have to consider the possibility that you might have this large holder of CDS incentivized to see it go into bankruptcy. It’s something that’s going to come up more and more."
Six Flags debt is rated Caa3 by Moody’s and CCC+ by Standard & Poor’s, three and five levels above default. Both rankings were put on "negative outlook" last year. Sandra Daniels, a spokeswoman for the New York-based company, didn’t return a phone call seeking comment. Ford, the only one of the so-called Big Three U.S. automakers to avoid taking federal bailout funds, may run up against basis traders as it seeks to restructure its debt. The Dearborn, Michigan-based car company plans to offer cash and shares to retire as much as $10.4 billion in debt, according to a U.S. regulatory filing yesterday. It may be "difficult" for Ford to do an exchange, in part because of investors with basis trades, said Rod Lache, an analyst at Deutsche Bank in New York, commenting last month before the restructuring was announced.
The parent and its Ford Motor Credit finance arm had a net $8.1 billion credit-default swaps outstanding, versus about $54 billion in bonds, according to data compiled by Bloomberg and the Depository Trust & Clearing Corp., which runs a central credit derivatives registry. Bill Collins, spokesman for Ford, didn’t return calls seeking comment. "Say you’ve lent $100 million to a company and you had bought $100 million in credit-default swaps," said Henry Hu, a law professor at the University of Texas in Austin. "In that circumstance, the creditor really doesn’t care whether or not the company goes under." Following a meltdown last year in the relationship between prices on bonds and credit swaps after the Lehman Brothers Holdings Inc. bankruptcy, basis traders often stand to make the most money if companies default. They can also profit by holding the trade until the debt matures or unwinding the position after the market value gap between the bonds and derivatives closes.
Hedge-fund manager Citadel Investment Group LLC in Chicago and Frankfurt-based Deutsche Bank AG were among firms that piled into trades based on the spread between debt and swaps prices. Buying before the Lehman failure and the subsequent seizing up of the corporate bond market, many suffered losses and retreated. Deutsche Bank was among those who held onto trades, forecasting the gap would close and the losses disappear, according to a person familiar with the lender’s trades. The German bank made money by owning the debt and credit swaps of Lyondell Chemical Co., a Houston-based oil refiner and chemical producer that went bankrupt in January, the person said. Lyondell sought and won a 60-day injunction in New York on Feb. 26 against creditors in an attempt to prevent basis traders from going after its Rotterdam-based parent, LyondellBasell Industries AF SCA, and other solvent units, documents filed in U.S. bankruptcy court in Manhattan show.
Bondholders with swaps filed objections to the ban, according to the documents. Jonathan Guy, a lawyer with San Francisco-based Orrick, Herrington & Sutcliffe who represents Deutsche Bank, said in court last month that his client owned Lyondell debt and credit derivatives. Michele Allison, a spokeswoman in New York for Deutsche Bank, declined to comment, as did Lyondell spokesman David Harpole. "You’re given these control rights under loan agreements or bond indentures on the general assumption that if you’re a creditor, you have an interest in the borrower surviving," said Hu, who’s written about so-called empty creditors. "Because of things like credit-default swaps, that assumption no longer holds." While basis traders may stymie efforts by companies to stay out of bankruptcy, they’re not the corporate bond market’s Darth Vader, the former Jedi Knight in the Star Wars film series who destroyed a planet and sliced off his son’s hand, according to Brian Yelvington, a strategist at CreditSights Inc. in New York. The traders didn’t put the companies into the situation, and derivatives are bringing a measure of efficiency to the market that didn’t exist during earlier recessions, he said.
"You’ve got more information from a side of the market that didn’t exist before," he said. "People point at CDS causing all of this volatility. To me, it’s always been there. People haven’t been able to place the bets they would have liked." For distressed companies such as building materials-maker Louisiana-Pacific Corp., which raised $375 million by selling notes and stock warrants this week, the negative basis also can help generate demand for debt because investors have a cheap way to hedge it, said Bradley Rogoff, a strategist at Barclays Capital in New York. Residential Capital LLC faced bondholder resistance to a debt-exchange proposal in December, in part because the investors also held derivatives, Rogoff said in a report that month. With more than $2 billion in credit swaps and about $9.3 billion of bonds at the time, according to Moody’s, the Minneapolis-based company enlisted the support of only 39 percent of its creditors, falling far short of its goal of 75 percent.
During negotiations with creditors, ResCap’s Detroit-based parent, GMAC LLC, threatened creditors to initiate an asset exchange that may have left them with losses on the swaps, according to a written statement released at the time. GMAC accepted a taxpayer bailout in late December. Credit swaps were created by JPMorgan Chase & Co. more than a decade ago to hedge against losses from bank loans. As dealers made the contracts more standardized, hedge funds, insurance companies and asset managers began using them to speculate on the creditworthiness of companies, sending trading in the swaps up to $47 trillion in 2008, according to the latest data from the New York-based International Swaps and Derivatives Association. Richard Fuld, Lehman Brothers’ chief executive officer, blamed his firm’s collapse on "destabilizing factors" including credit-derivatives trading in Oct. 6 congressional testimony. "People are having a hard time trusting anyone," said Timothy Coleman, co-head of the restructuring group at Blackstone Group LP in New York. "The motivations on the other side of the table are different."
The combined average price on high-yield bonds and swaps dipped to as low as 85.06 percent of face value on Dec. 8, after Lehman’s failure Sept. 15, according to Barclays Capital. Two weeks before the bankruptcy, the cost was 92.13 percent, and rose to 94.12 percent as of yesterday. Investors who had done trades around the bottom would make as much as 15 percent with a default. Idearc Inc., a Dallas-based publisher of phone directories, may come up against bondholders hedged with credit swaps, said people familiar with basis trading. The company may be forced into a distressed debt exchange or pre-packaged bankruptcy after hiring Merrill Lynch & Co. and Moelis & Co. to advise on its capital structure, Moody’s wrote in a Feb. 9 note. Credit-default swaps protected a net $1.15 billion of Idearc debt from default as of Feb. 20, according to the Depository Trust. Idearc has $2.85 billion of bonds outstanding.
At the start of November, investors could buy the company’s 8 percent notes due in 2016 at 15.5 percent of face value. They could also purchase credit swaps protecting the bonds from default for seven years for 68 percent of face value, in addition to a 5 percent annual premium. The gross payout would be 16.5 percentage points if the company were to default. That gap has since narrowed to 5.75 percentage points, according to data from CMA DataVision and Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. "We intend to look closely at all available opportunities to strengthen our balance sheet and improve our risk profile," said Andrew Shane, an Idearc spokesman who declined to discuss specific options for the company. Because the gap between bond prices and swaps converged, many basis traders may have been prompted to exit their positions and take profits. The combined price of Ford’s 7.45 percent notes due in 2031 and five-year credit swaps, for example, has jumped from about 96 percent of face value two months ago to more than 107 percent today, CMA and Trace data show.
In 2008, companies got investors to exchange $29.7 billion of bonds in a record 13 trades, according to Edward Altman, a professor at New York University’s Leonard N. Stern School of Business. Altman created the Z-score mathematical formula that measures a company’s bankruptcy risk. Debt exchanged last year was more than three times the total amount from 1984 through 2007, said Altman. "Firms appear to be scrambling to avoid bankruptcy like never before," he wrote in his annual report on defaults, published last month. "Defaults are one of several ways that basis holders can benefit, so it would not surprise me if names with high concentrations of basis holders encounter resistance in their efforts to restructure," said Michael Anderson, a high-yield debt strategist at Barclays Capital in New York.
The $700 trillion elephant
There's a $700 trillion elephant in the room and it's time we found out how much it really weighs on the economy. Derivative contracts total about three-quarters of a quadrillion dollars in "notional" amounts, according to the Bank for International Settlements. These contracts are tallied in notional values because no one really can say how much they are worth. But valuing them correctly is exactly what we should be doing because these comprise the viral disease that has infected the financial markets and the economies of the world. Try as we might to salvage the residential real estate market, it's at best worth $23 trillion in the U.S. We're struggling to save the stock market, but that's valued at less than $15 trillion. And we hope to keep the entire U.S. economy from collapsing, yet gross domestic product stands at $14.2 trillion. Compare any of these to the derivatives market and you can easily see that we are just closing the windows as a tsunami crashes to shore.
The total value of all the stock markets in the world amounts to less than $50 trillion, according to the World Federation of Exchanges. To be sure, the derivatives market is international. But much of the trouble we're in began with contracts "derived" from the values associated with U.S. residential real estate market. These contracts were engineered based on the various assumptions tied to those values. Few know what derivatives are worth. I spoke with one derivatives trader who manages billions of dollars and she said she couldn't even value her portfolio because "no one knows anymore who is on the other side of the trade." Derivatives pricing, simply put, is determined by what someone else is willing to pay for the contract. The value is based on an artificial scenario that "X" will be worth "Y" if "Z" happens. Strip away the fantasy, however, and the reality of the situation is akin to a game of musical chairs -- without any chairs. So now the music has finally stopped. That's why stabilizing the housing market will do little to take the sting out of the snapback we are going through on Wall Street.
Once people's mortgages were sold off to secondary buyers, and then all sorts of crazy types of derivative securities were devised based on those, and those securities were in turn traded on down the line, there is now little if any relevance to the real estate values on which they were pegged. We need to identify and determine the real value of derivatives before we give banks and institutions a pass-go with more tax dollars. Otherwise, homeowners will suffer as banks patch up the holes left in their balance sheets by the derivatives gone poof; new credit won't be extended until the raff of the old credit is put behind. It isn't the housing market devaluation, or the sub-prime mortgage market defaults that have us in real trouble. Those are nice fakes to sway attention away from the place where greed truly flourished -- trading phony instruments to the tune of $700 trillion. Let's figure how to get out from under that. Then maybe the capital will begin to flow again through the markets. Right now, this elephant isn't just in the room, it's sitting on us.
Ilargi: I don't read or quote Karl Denninger too often. Too much of his knowledge and facts gets habitually lost in emotional showboating, forcing him to eat many of his words and playing havoc with his credibility. Can't predict the end twice a week for too long. This summary below is quite good, though, even if I cut off the last bit, which veers into "Are you taking your meds?" territory again.
What's Dead (Short Answer: All Of It)
Just so you have a short list of what's at stake if Washington DC doesn't change policy here and now (which means before the collapse in equities comes, which could start as soon as today, if the indicators I watch have any validity at all. For what its worth, those indicators are painting a picture of the Apocalypse that I simply can't believe, and they're showing it as an imminent event - like perhaps today imminent.)
- All pension funds, private and public, are done. If you are receiving one, you won't be. If you think you will in the future, you won't be. PBGC will fail as well. Pension funds will be forced to start eating their "seed corn" within the next 12 months and once that begins there is no way to recover.
- All annuities will be defaulted to the state insurance protection (if any) on them. The state insurance funds will be bankrupted and unable to be replenished. Essentially, all annuities are toast. Expect zero, be ecstatic if you do better. All insurance companies with material exposure to these obligations will go bankrupt, without exception. Some of these firms are dangerously close to this happening right here and now; the rest will die within the next 6-12 months. If you have other insured interests with these firms, be prepared to pay a LOT more with a new company that can't earn anything off investments, and if you have a claim in process at the time it happens, it won't get paid. The probability of you getting "boned" on any transaction with an insurance company is extremely high - I rate this risk in excess of 90%.
- The FDIC will be unable to cover bank failure obligations. They will attempt to do more of what they're doing now (raising insurance rates and doing special assessments) but will fail; the current path has no chance of success. Congress will backstop them (because they must lest shotguns come out) with disastrous results. In short, FDIC backstops will take precedence even over Social Security and Medicare.
- Government debt costs will ramp. This warning has already been issued and is being ignored by President Obama. When (not if) it happens debt-based Federal Funding will disappear. This leads to....
- Tax receipts are cratering and will continue to. I expect total tax receipts to fall to under $1 trillion within the next 12 months. Combined with the impossibility of continued debt issue (rollover will only remain possible at the short duration Treasury has committed to over the last ten years if they cease new issue) a 66% cut in the Federal Budget will become necessary. This will require a complete repudiation of Social Security, Medicare and Medicaid, a 50% cut in the military budget and a 50% across-the-board cut in all other federal programs. That will likely get close.
- Tax-deferred accounts will be seized to fund rollovers of Treasury debt at essentially zero coupon (interest). If you have a 401k, or what's left of it, or an IRA, consider it locked up in Treasuries; it's not yours any more. Count on this happening - it is essentially a certainty.
- Any firm with debt outstanding is currently presumed dead as the street presumption is that they have lied in some way. Expect at least 20% of the S&P 500 to fail within 12 months as a consequence of the complete and total lockup of all credit markets which The Fed will be unable to unlock or backstop. This will in turn lead to....
- The unemployed will have 5-10 million in direct layoffs added within the next 12 months. Collateral damage (suppliers, customers, etc) will add at least another 5-10 million workers to that, perhaps double that many. U-3 (official unemployment rate) will go beyond 15%, U-6 (broad form) will reach 30%.
- Civil unrest will break out before the end of the year. The Military and Guard will be called up to try to stop it. They won't be able to. Big cities are at risk of becoming a free-fire death zone. If you live in one, figure out how you can get out and live somewhere else if you detect signs that yours is starting to go "feral"; witness New Orleans after Katrina for how fast, and how bad, it can get.
CNBC discusses guns, riots and tent cities
About 3 minutes in.
Freddie Mac, Fannie Mae fee dispute seen brewing
Freddie Mac 's elimination of significant fees to boost refinancings under President Barack Obama's housing plan may force major recalibrations in the $5 trillion mortgage bond market unless rival Fannie Mae follows suit, lenders and investors said. Freddie Mac on Wednesday followed the announcement of the Obama housing plan details by dropping fees that compensate for risks of low credit scores and little equity. By cutting fees, the government-controlled company can sharply increase the number of loans eligible under the Obama administration's refinancing initiative, analysts said. But the larger Fannie Mae surprised investors by opting against a similar move despite urging by major lenders who also advised Freddie Mac, an industry source said.
Fannie now risks angering its lender partners whose customers would be left paying higher fees. 'I suspect Fannie Mae is moving very quickly to change their minds on this,' said Garry Cipponeri, a senior vice president at Chase Home Finance in Iselin, New Jersey. Failure to follow Freddie Mac would be a public relations 'disaster,' he added. Under government control since September, the two largest U.S. mortgage finance companies have been taking further steps to underpin the market with a nod toward U.S. policy against shareholder profit. But the different approaches on fees may suggest the rivalry between the two companies is still alive.
Freddie Mac cut the fees to 'align' itself with the Obama program, which aims to help as many as five million borrowers lower loan rates, a Freddie spokesman said. The program will begin on April 1, and will help borrowers that have been unable to refinance because their home values have dropped. Freddie Mac 'delivery' fees eliminated for the program run as high as 2.75 percentage points to borrowers with high loan-to-value ratios and low credit scores. To illustrate the disparity, a Fannie Mae-funded borrower with a 620 FICO score and 105 percent loan-to-value, combining first- and second-liens, would be charged 5.25 percentage points, he said. The same loan funded by Freddie Mac would face a 0.25 percent fee.
For loans supporting 6.5 percent MBS originated in 2006 and 2007, Freddie Mac's move could be boost refinancing incentives 0.5 to 0.7 percentage point, according to Barclays Capital. Bonds issued by Freddie Mac, which would be hurt the most if refinancing quickened, underperformed on Wednesday. But the move was muted on Thursday amid expectations that Fannie Mae will remove its fees, market analysts said. Lenders that sell most of their loans into Fannie Mae's MBS program will 'scream loudly,' said Chase's Cipponeri.
Steve Kuhn, partner and head of fixed-income trading at Pine River Capital Management in New York, said: 'So far, there has been very little relative price movement which suggests most participants believe that ultimately there will be uniformity in the fees charged.' Investors have been placing bets that federal initiatives to spur refinancings, such as Federal Reserve purchases of MBS, would fall short of goals because of credit constraints. If refinancings soar, MBS paying high interest rates are more exposed to losses because principal prepayments occur at 100, or par, on bonds currently priced at 103-1/2 to 104-1/2. If the prepayments are slower than expected, those bonds should rise in value.
'Obama Bear Market' Punishes Investors as Dow Jones Industrials Tumble 20%
President Barack Obama now has the distinction of presiding over his own bear market. The Dow Jones Industrial Average fell 20 percent since Inauguration Day, the fastest drop under a newly elected president in at least 90 years, according to data compiled by Bloomberg. The gauge has lost 53 percent from its October 2007 record of 14,164.53, slipping 4.1 percent to 6,594.44 yesterday. More than $1.6 trillion has been erased from U.S. equities since Jan. 20 as mounting bank losses and rising unemployment convinced investors the recession is getting worse. The president is in danger of breaking a pattern in which the Dow rallied 9.8 percent on average in the 12 months after a Democrat captured the White House, according to data compiled by Bloomberg.
"People thought there would be a brief Obama rally, and that hasn’t happened," said Uri Landesman, who oversees about $2.5 billion at ING Groep NV’s asset management unit in New York. "It speaks to the carnage that’s in the economy and the lack of confidence in the measures that have been announced." A bear market is defined as a decline of 20 percent or more. Buying shares "is a potentially good deal" for long-term investors, Obama said March 3. He compared daily fluctuations to a tracking poll in politics and said he wouldn’t adjust his policies just to meet market expectations. Congress last month enacted Obama’s $787 billion package of tax cuts and spending on roads, bridges and public buildings. His 2010 budget indicated the government’s financial rescue may need another $750 billion after an initial $700 billion.
The Dow average has dropped 31 percent since Obama’s election. The 30-stock gauge trades at 8.04 times annual earnings, the cheapest since 1995 and down from 10.06 times on Inauguration Day. Citigroup Inc. led the plunge, losing 71 percent. The government proposed taking a 36 percent stake in the New York- based bank, cutting the percentage owned by shareholders. Detroit-based General Motors Corp. tumbled 53 percent after the largest U.S. automaker said it needs more government aid. "It’s the Obama bear market," said Dan Veru, who helps oversee $2.8 billion at Palisade Capital Management in Fort Lee, New Jersey. "We don’t know what the rules are in so many different areas the government is touching." The Dow average gained 2 percent to 6,726.18 as of 9:49 a.m. in New York today after a government report showed the rate of job losses slowed last month.
The U.S. economy contracted at a 6.2 percent annual rate in the fourth quarter, the most since 1982, the Commerce Department said last week. Unemployment jumped to 7.6 percent in January, the highest since 1992, as Americans fell behind on their mortgages and banks seized homes at a record pace. Losses at financial companies worldwide that grew to about $1.2 trillion sent the Standard & Poor’s 500 Index to a 38 percent retreat last year, the steepest since 1937. "Prospects for recovery in the financial sector, despite all the government help, still seem rather remote," said John Carey, who manages about $8 billion at Pioneer Investment Management in Boston. "We’ve had a weak economy for a couple of years, and we aren’t seeing the stimulus working at this point. That is what weighs on investors’ minds." The Dow average took eight months to decline 20 percent following the inauguration of George W. Bush, reaching the level on Sept. 20, 2001, nine days after terrorists attacked the World Trade Center in New York and the Pentagon in Washington.
The crash of 1929 occurred seven months into the administration of Herbert Hoover, who presided over an 89 percent plunge in the Dow between September 1929 and July 1932, the steepest retreat ever. Only twice has the benchmark gauge slipped in the 12 months after the election of a Democratic president since 1900, after Woodrow Wilson’s victory in 1912 and Jimmy Carter’s in 1976. The Dow entered its most recent bear market on July 2, 2008, when a 167-point decrease gave it a 20 percent loss from its record 14,164.53 on Oct. 9, 2007. Unlike the Standard & Poor’s 500 Index, the Dow’s rally from its November low of 7,552.29 fell short of a 20 percent bull market gain, ending at 19.6 percent. "Obama should be listening to the stock market more than talking to it," said Kenneth Fisher, the billionaire chairman of Woodside, California-based Fisher Investments Inc., which oversees $22 billion. "He hasn’t gotten out of the gate well."
Bank of America sees grave harm from bonus reveal
Bank of America Corp (BAC.N) said it could suffer "grave harm" if it is forced to reveal data about an estimated $3.6 billion of bonuses paid to Merrill Lynch & Co officials in the days before the bank acquired the brokerage. In a petition filed late Wednesday in a New York state court in Manhattan, the bank urged Justice Bernard Fried to reject New York Attorney General Andrew Cuomo's demand for the data, which the bank believes should be kept confidential. Charlotte, North Carolina-based Bank of America bought Merrill on January 1, shortly after the bonuses were awarded. Bank of America said revealing the data could help rivals poach talent, prompt employees to leave because their privacy was violated, cause "internal dissension and consternation," increase security risks for bonus recipients, and give rivals a better idea of which businesses it considers most valuable.
Cuomo is investigating whether the bonuses violated securities laws. His office subpoenaed seven Merrill executives who got tens of millions of dollars of compensation in 2008, a person familiar with the probe said on Wednesday. Bank of America said neither the names nor the job titles of bonus recipients are relevant to Cuomo's probe or the public. "Disclosing such highly sensitive and confidential information to the public will cause grave harm and severe competitive disadvantage" to the bank, it said. Bank of America Chief Executive Kenneth Lewis and former Merrill Chief Executive John Thain have testified under subpoena about the bonuses. The names of some of Merrill's top earners were published Wednesday in The Wall Street Journal. Fried has scheduled a March 13 hearing on whether the bonus data can be disclosed. The judge is considering a separate request from a third party to broadcast the hearing.
Text of letter to Bank of America
March 5, 2009
O. Temple Sloan
Bank of America
100 N. Tryon Street
Charlotte, North Carolina 28255
Dear Mr. Sloan:
Recent events have fatally undermined investor confidence in Bank of America (BAC) Chairman and CEO Kenneth D. Lewis. With BAC’s share price now down 90% in 5 months, we call upon the BAC board of directors to immediately seek the resignation of Chairman and CEO Ken Lewis. Absent prompt action to remove Mr. Lewis, we will have no choice but to call upon BAC shareholders to join us at BAC’s upcoming annual meeting in voting against Mr. Lewis, Thomas Ryan, as chair of the Corporate Governance Committee responsible for CEO succession, and you as lead independent director.
A year ago, we communicated grave concerns with BAC’s failure to manage risk in a February 6, 2008 letter to three members of the board’s Asset Quality Committee. Absent a compelling explanation, we indicated our intent to oppose the directors’ re-election at BAC’s 2008 annual meeting. In response, you invited us to a meeting in Charlotte during which you assured us the board was diligent in its oversight of management and had already taken steps to substantially improve risk management. Based on these assurances, we did not oppose the election of any BAC directors.
The board, however, subsequently allowed Mr. Lewis to take outsized, reckless risks by acquiring Merrill Lynch in the midst of severe financial uncertainty. After hastily arranging the ill-considered acquisition, management then failed to disclose Merrill’s staggering fourth quarter losses prior to the shareholder vote on the merger. In addition, BAC’s senior management was reportedly aware of Merrill Lynch’s intent to distribute nearly $4 billion in bonuses at a time when Merrill Lynch was suffering heavy losses. It also appears that Mr. Lewis had the ability to prevent the payments under a previously undisclosed agreement.
Removing Mr. Lewis is now a necessary prerequisite to restoring BAC’s credibility with shareholders, regulators and the public. If the board fails to remove Mr. Lewis prior to filing its 2009 annual meeting proxy this month, we will urge shareholders to join us in opposing Mr. Lewis’ re-election and that of the independent directors most culpable for his continued employment. The CtW Investment Group works with pension funds sponsored by unions affiliated with Change to Win, a coalition of unions representing 6 million members, to enhance long-term shareholder value through active ownership. These funds, together with public pension funds in which CtW union members participate, are substantial long-term Bank of America shareholders.
At the time of our March 2008 meeting to discuss BAC’s risk management failures, BAC had lost approximately 30% of its market capitalization over the previous year, in significant part due to liquidity support agreements included in the terms of CDOs BAC had issued since 2005. At that meeting, we were assured by you and BAC’s risk management team that the company understood the mistakes it had made, and had already taken steps to substantially improve its risk management process going forward, including a commitment to seeking outside opinions concerning future developments in the financial markets.
Subsequent events suggest that neither the board nor management put adequate risk management practices in place: despite serious concerns with the Merrill acquisition voiced by numerous outside observers, the board supported Mr. Lewis’ gamble, with devastating results. Whereas BAC had entered the September-October meltdown in relatively strong shape compared to peer institutions - having lost only about 40% of its January 2007 market capitalization at the time Lehman Brothers collapsed - the board’s acquiescence to the Merrill Lynch acquisition has since precipitated a 90% fall in BAC’s share price.
Shareholders’ loss of confidence in BAC stems from the announcement on January 16 that Merrill Lynch had lost an additional $15.3 billion - and over $19 billion in shareholders’ equity - in the fourth quarter of 2008, essentially doubling its losses for the year. BAC shareholders could have avoided these devastating losses had BAC either exercised its rights under the Material Adverse Effects clause or disclosed the losses to its shareholders prior to our voting on the merger. Mr. Thain has reportedly indicated that BAC had ongoing access to Merrill Lynch’s daily profit and loss reports. Nevertheless, Mr. Lewis claims that he and his team were unaware of the scale of Merrill’s losses until after the December 5 shareholder vote. At that time, Mr. Lewis requested and received considerable further taxpayer support in the form of additional preferred equity and a partial guarantee of the value of approximately $118 billion in assets. But despite apparently recognizing the severity of Merrill’s condition and the damage a merger would do to BAC, Mr. Lewis neither informed shareholders of the scale of Merrill’s fourth quarter losses nor invoked BAC’s contractual rights under the merger agreement’s Material Adverse Effects clause.
More recently, shareholders have learned that at essentially the same time as the merger agreement, BAC and Merrill Lynch entered into a previously undisclosed agreement according to which Merrill was able to issue bonuses from a pool of approximately $5.8 billion, and that the bonuses "shall be determined by the company (Merrill) in consultation with the parent (Bank of America)." Indeed, it appears that BAC used its authority to influence Merrill’s bonus awards to reduce the size of the available pool from $5.8 billion to "under $4 billion." As a consequence of BAC’s failure to disallow bonus payments by Merrill Lynch, the company is now under investigation by the New York Attorney General.
These decisions have prompted shareholder litigation alleging breach of fiduciary duty. At minimum, they represent a failure of judgment on Mr. Lewis’ part. Any one of these actions alone would justify Mr. Lewis’ removal: he either knew the scale of Merrill’s losses and failed to inform shareholders of them, or he was grossly negligent in failing to keep abreast of Merrill’s deteriorating performance. Moreover, in allowing Merrill executives to extract $3.6 billion from the company even while BAC recorded over $15 billion in losses and was seeking further taxpayer support, Mr. Lewis endangered the solvency of BAC and severely tarnished its public image and reputation.
While we believe shareholders are entitled to a full explanation of what the board knew, when it knew it, and whether it approved of Mr. Lewis’ disastrous decisions, it is more important in our view that the board do what is necessary to restore investor confidence. Removing Mr. Lewis as Chairman and CEO is necessary first step in this challenging process.
Thank you for your timely consideration.
cc: Ken Lewis, Chairman, CEO, and President
Thomas Ryan, Chair Corporate Governance Committee
Wells Fargo Slashes Dividend By 85%
Calling it a "very difficult decision," Wells Fargo & Co. on Friday slashed its quarterly dividend 85%, to 5 cents a share from 34 cents, in an effort to save $5 billion and help the company pay back the government's recent investment in the firm. "The actions we're taking every day to build our company and to strengthen our balance sheet...are the right thing to do in any event for our shareholders, customers, and team members and these actions will help us repay the government's investment at the earliest practical date," Chief Executive Officer John Stumpf said in a press release. Wells received a $25 billion investment under the government's TARP program in October.
Wells also said Friday that its integration of Wachovia Corp is on track to achieve $5 billion in annual merger-related expense savings, and that it expects that total merger integration costs will be lower than originally projected. The payout reduction follows closely on the heels of an 85% dividend cut instituted by PNC Financial Services Group earlier this week, and cuts at other prominent blue chip firms like J.P., Morgan Chase and General Electric. Executives at many banks are feeling pressure to reconsider the defense of their companies' dividends as their stock prices fall and the market places a greater premium on capital preservation.
Stumpf also said that operating results for the first two months of the year are strong, and the firm continues to grow market share and generate new business.
"The Wachovia merger is proceeding as planned and is on track. We're on track to achieve $5 billion in annual merger-related expense savings which will be fully realized upon completion of the integration and we have already begun to realize these savings," the firm said. It said the costs of integrating Wachovia will be smaller than projected before, and that newly identified cost savings will cut 2009 expenses by about $ 2 billion.
Fed Assets Fall to $1.9 Trillion as Foreign-Currency Swaps Drop
The Federal Reserve’s loans, securities and other balance-sheet assets shrank by 0.8 percent to $1.9 trillion during the past week as dollar loans by foreign central banks fell. The Fed’s foreign-currency swaps with other central banks declined by $59.7 billion to $315.2 billion over the past week, the Fed said today in a weekly release. The total value of assets on the Fed’s consolidated balance sheet dropped by $14.8 billion from Feb. 25 to March 4. Fed Chairman Ben S. Bernanke has increased the central bank’s total assets by $1 trillion over the past year and indicated he may go further to revive credit and end the recession. In December, the Fed switched to using emergency credit programs as the main tool of monetary policy rather than changes in the main interest rate.
The Fed lowered the benchmark rate to a target range of zero to 0.25 percent in December. When the economy begins to recover, Fed officials say they will scale back lending, reduce balance- sheet assets and start raising interest rates again. The Fed set up the swap lines with central banks in Europe, the U.K. and other countries to lend dollar funds to banks in those areas. Lending to U.S. commercial banks through the Term Auction Facility increased by $45.6 billion to $493.1 billion. Short-term debt held by the Fed in its Commercial Paper Funding Facility fell in value by $1.32 billion to $240.3 billion. Discount-window lending to commercial banks rose to $66.7 billion as of yesterday from $65.6 billion a week earlier, the central bank said. Wall Street bond dealers pared their borrowings from the Fed to $23.6 billion yesterday from $25.2 billion last week.
Holdings of federal agency and mortgage-backed securities on the balance sheet were little changed. The Fed reported mortgage- backed securities holdings of $68.9 billion as of March 4, and federal agency securities of $38.2 billion. The central bank plans to purchase, by June, as much as $500 billion of mortgage-backed securities and $100 billion of debt from housing-finance companies Fannie Mae, Freddie Mac and Ginnie Mae. While net acquisitions of mortgage bonds have totaled $189.9 billion, the majority of the purchases have yet to close and appear on the Fed’s balance sheet. Credit to American International Group Inc., the insurer rescued by the government in September, rose to $85.1 billion from $81.3 billion, while the Fed’s loans to a program providing liquidity to the asset-backed commercial paper market and money- market funds fell to $8.09 billion from $9.98 billion.
The report doesn’t reflect the Fed’s Term Asset-Backed Securities Loan Facility, a new program to prop up loan markets for autos, credit cards, education and small businesses. The $200 billion program, backed with Treasury funds, will start disbursing funds March 25, the Fed and Treasury announced this week. A second phase will expand the TALF to $1 trillion and add other assets such as commercial mortgage-backed securities. The Fed said the M2 money supply declined by $5.7 billion in the week ended Feb. 23. That left M2 growing at an annual rate of 10 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.
The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds. During the latest reporting week, M1 declined by $13.4 billion. Over the past 52 weeks, M1 rose 15.2 percent. The Fed no longer publishes figures for M3.
Obama Says Rising Health Costs Are Threat to Economy
President Barack Obama said the burden of paying for health care in the U.S. threatens the foundation of the economy, and revamping the system is essential even in the midst of the recession. "The same soaring costs that are straining our families’ budgets are sinking our businesses and eating up our government’s budget too," the president told about 150 lawmakers, advocates and representatives from the health care, insurance and pharmaceutical industries at the White House. "That is why we cannot delay this discussion any longer."
Obama promised during his presidential campaign to make a health-care-system overhaul a top priority and the summit he convened today was being billed by the administration as a first step toward that goal. The issue has been divisive, and finding an answer that will keep costs down while also extending coverage to the estimated 46 million Americans without health insurance has eluded past presidents. Obama acknowledged the difficult road ahead, noting that former Theodore Roosevelt called for a national health insurance system almost a century ago.
"It’s a nice touch to get everyone together for discussions, but health care reform will quickly return to trench warfare for much of this year," Pete Davis, president of Davis Capital Investment Ideas in Washington, said in a note to clients today. Former President Bill Clinton’s health-care overhaul proposals sparked a contentious debate and were shot down after his administration presented Congress with a 1,300-page plan that lawmakers said had too little input from them. The lessons from that experience were included in the planning for today’s summit and in advancing the president’s health-care agenda, spokesman Robert Gibbs said yesterday. Obama will draft "some goals and principles" and leave details to Congress. "The president isn’t going to send a plan," Gibbs said.
Obama, in his remarks opening today’s forum, also said conditions are different than they were when Clinton was in office. "This time the call for reform is coming from the bottom up, from all across the spectrum" from doctors, nurses and patients to mayors, governors and members of Congress, he said. "We must address the crushing cost of health care this year, in this administration." National health-care expenses are projected to increase 5.5 percent to $2.5 trillion this year, after rising 6.1 percent in 2008, according to the Centers for Medicare and Medicaid Services. Family health-insurance premiums have climbed 58 percent since 2000, and the number of uninsured Americans reached 45.7 million in 2007, up 19 percent during the same period, according to the House Budget Committee.
Obama closed the forum accompanied by Senator Edward Kennedy, who has pushed for health-care legislation in Congress. Kennedy is being treated for brain cancer and his entrance brought applause from the group. The Massachusetts senator said a solution to the rising cost of health care and covering for the uninsured long has eluded presidents and lawmakers. "This is the time for action," Kennedy, chairman of Senate Health, Educations, Labor and Pensions Committee, said. "I’m looking forward to being a foot-soldier in this undertaking, and this time we will not fail." Obama highlighted some of the comments made by participants during smaller sessions, including Republican lawmakers, that he said showed there is "a clear consensus that the need for health-care reform is here and now."
Obama laid out eight principles to govern the overhaul, including a reduction of health-care costs; a guarantee that Americans can choose health insurance, including plans offered by their employers; improvement in the quality and safety of care and a requirement that the overhaul be paid for with spending cuts elsewhere. "The status quo is the one option that is not on the table," Obama said at the beginning of the session. The group the administration brought together today includes lawmakers from both parties as well as stakeholders such as General Mills Inc. Chairman and Chief Executive Officer Ken Powell, former Representative Billy Tauzin, president of the Pharmaceutical Research and Manufacturers Association, as well as union representatives and health-care advocacy groups.
Democratic leaders in Congress say they want to have a health-care overhaul package ready for consideration by August. Senator Max Baucus, a Montana Democrat and chairman of the Finance Committee, and House Energy and Commerce Chairman Henry Waxman, a California Democrat, told reporters this week in separate forums they would have a package ready for floor votes before lawmakers leave for their August recess. That would give Republicans and Democrats about four months to agree how to reshape medical coverage, including whether government programs or private insurance should cover more Americans. Obama said he wanted the goal to be met by the end of this year. Baucus said that the health-care overhaul legislation wouldn’t add to the deficit. "It will be paid for," he told reporters on March 3. Waxman said he plans to start hearings on March 10. Both lawmakers attended the White House summit.
Two officials seasoned in health policy will ultimately be guiding the health-care agenda: Kansas Governor Kathleen Sebelius was chosen March 2 be secretary of health and human services, and former Clinton administration health aide Nancy-Ann DeParle was selected to head Obama’s new White House Office for Health Reform. Obama’s fiscal 2010 budget calls for a restructuring of federal priorities, including a $634 billion fund to overhaul the country’s health care system, funded partly by tax increases taking effect in 2011. Increased levies would apply to families making more than $250,000, and on oil and gas firms, companies that do businesses overseas and hedge funds and other private equity firms.
Top Treasury Candidates Pull Out
Two candidates for top jobs at the Treasury have withdrawn their names from consideration, complicating efforts by Treasury Secretary Tim Geithner to staff his department at a time of economic crisis, according to people familiar with the matter. Annette Nazareth, who was expected to be tapped as deputy Treasury secretary, and Caroline Atkinson, who was being considered to oversee international affairs, have both taken their names out of the running, these people said. Ms. Atkinson's name was withdrawn weeks ago and Ms. Nazareth withdrew several days ago. Across the administration, several potential candidates have been blocked by the Obama administration's tough rules about who it will hire. In addition, the White House increased the rigor of its vetting process after tax problems threatened Mr. Geithner's confirmation and scuttled that of former Sen. Tom Daschle.
The withdrawals aren't confined to the Treasury. Susan Tierney recently withdrew her name from consideration for the job of deputy secretary of energy for what a person close to her said were family reasons. Jane Garvey recently withdrew from consideration for the deputy secretary post at the Department of Transportation, according to people familiar with the matter. People familiar with the matter said Ms. Nazareth and Ms. Atkinson withdrew in part because of the long vetting process, which had dragged on for weeks and included several rounds of intense questioning. Treasury has identified and is vetting other people for top slots, including H. Rodgin Cohen, chairman of top law firm Sullivan & Cromwell LLP and an adviser to virtually every firm on Wall Street, for the deputy secretary position, two people familiar with the matter said. Mr. Cohen declined to comment.
A Treasury spokesman said: "The Treasury Department is following the normal vetting process for nominees. With more than 50 political appointees already hard at work, the department is ahead of staffing levels from previous administrations....Any rumors of vetting problems or delays in the process are simply not true." Ms. Nazareth's ability to get the job may have been complicated by her previous role at the Securities and Exchange Commission, where she ran the division with oversight of financial markets, including what were once the nation's investment banks. Some on Wall Street had raised concerns in the Senate over Ms. Nazareth's role as the founder of the SEC's Consolidated Supervised Entities program, which was created in 2004 to coax global investment banks to voluntarily submit to regulation, according to people familiar with the matter.
The five major investment banks no longer exist. They have either been acquired, filed for bankruptcy protection or reorganized as regulated banks. Many people cite their ill-advised bets on the mortgage market as one cause of the financial crisis. The program was abandoned in September 2008 after then-SEC Chairman Christopher Cox declared it "fundamentally flawed from the beginning." Ms. Nazareth's role in creating the program had come to the attention of the Senate Finance Committee. Because her nomination hadn't been formalized, any effort to delve into her role in the failed regulatory regime never got beyond the early stages. The withdrawals come amid growing concern about the lack of staff at Treasury as it tries to grapple with an unrelenting financial crisis. Mr. Geithner is the only official to be nominated, let alone confirmed.
Paul Volcker, an economic adviser to President Barack Obama, recently called the lack of staff "shameful" and said Mr. Geithner "shouldn't be sitting there alone." Treasury actually has more staff than many other agencies and departments. Mr. Geithner is relying on a series of counselors and several holdovers from the administration of former Treasury Secretary Henry Paulson. Previous administrations have taken time to build out their Treasury staffs but the delay at Mr. Geithner's Treasury comes at a precarious time, as the administration tries to revamp the $700 billion bank bailout and rewrite the rules for financial regulation. The Obama administration has recently ratcheted up its scrutiny of potential nominees. Lawyers have been poring over several years of potential Treasury appointees' tax returns and other financial and personal information, such as the legal status of household help. Mr. Obama curtailed the ability of lobbyists to work in the administration. The Treasury also wants to avoid hiring anyone with ties to a bank that received bailout aid.
Fault Found in Takeover of Banks
The Office of the Comptroller of the Currency was slow to mandate changes at a pair of banks that were taken over by the government in July, the Treasury Department's Office of Inspector General said in a report. The OCC was faulted for its supervision of First National Bank of Nevada and First Heritage Bank, both of which were owned by First National Bank Holding Co. of Scottsdale, Ariz. Despite identifying various problems over a number of years, the federal regulator didn't act quickly enough to make sure the banks changed their behavior, the report concluded. "We believe that OCC did not issue formal enforcement action for any of the banks in a timely manner, and was not aggressive enough in its supervision of the banks in light of their weak management practices," the inspector general's office said in the report, which is dated Feb. 27. First National and First Heritage were taken over by the government last July, at an estimated cost of $862 million to the Federal Deposit Insurance Corp.'s insurance fund.
The inspector general's report blamed the failure of the firms on losses from their commercial real-estate loan portfolios, as well as inadequate risk management. The gaps in oversight of the banks were the subject of a page-one article in The Wall Street Journal in October. Comptroller of the Currency John Dugan, in a letter accompanying the inspector general's report, didn't dispute the findings. "We agree that, based on our experience with these two banks, it is appropriate to take additional measures to reinforce certain expectations and requirements to our examining staff," Mr. Dugan wrote in the letter. Sixteen banks have failed so far this year, and banks are collapsing at a much faster pace than the 12 that were seized by regulators in the fourth quarter of 2008. A total of 25 FDIC-insured financial institutions failed last year.
Coping with Portfolio Panic
How investors—and besieged financial planners—are coping with portfolio pain. They used to bring concerns about their children or their marriages. But increasingly parishioners are also telling Glen VanderKloot, a Lutheran minister in Springfield, Ill., about their financial worries, and that puts him in the unusual position of dispensing investment advice. Sometimes he quotes scripture—"I will not be shaken"—and sometimes Warren Buffett. Explains VanderKloot: "He says now is the time to buy." It's hard to stay calm in the face of the market's volatility and the constant drumbeat of recession, unemployment, bills to pay, and bailouts. A recent American Psychological Assn. survey found that 8 out of 10 Americans cite money and the economy as their top sources of stress.
These worries are taking a physical and psychological toll, and people are dealing with them in ways ranging from the self-improving (more exercise) to the soporific (late-night viewings of Judge Judy). Doctors see recession anxiety in many forms. Manhattan dentist Kenneth Berger says he's treating more patients for stress-related teeth grinding, while periodontist Neal Lehrman has noticed an increased number of Wall Streeters inadvertently channeling aggression through their toothbrushes to their gums. For Serena Ehrlich, 39, of Santa Monica, Calif., the challenge of launching her document database company, Docstoc, in a recession while caring for aging parents has led to a painful bout of ulcerative colitis after four years of remission. "If this economy doesn't get better, my guts are going to kill me," Ehrlich says.
Likewise, since the subprime crisis hit last summer, Thomas, a managing director at a financial services giant who prefers that his last name not be used, has lost his appetite—and with it, 30 pounds from his already lanky frame. To combat his increased stress, he's running 30 to 40 miles a week and training for marathons. Still, he's grinding his teeth, battling insomnia and anxiety attacks, and fighting with his spouse about finances. Money matters are a source of conflict for couples even in the best of times. With the market meltdown, tensions have amped up even further. Kathleen Gurney, a Sarasota (Fla.) psychologist who counsels patients about money, has a client in her late 40s who is fighting with her husband because she wants to sell their stocks and put the money in cash. She anxiously watches financial news all day while her spouse works late to avoid the constant arguing.
Gurney advised the woman to turn off the TV and take an investing class at a community college. "I told her to familiarize herself with the language of investing so she'll feel like she has more control," Gurney says. "Then maybe there's a place they can compromise." Indeed, many doctors and counselors say activities that distract from your problems and restore self-confidence are the best way to fight stress. That approach has worked for Tobias Levkovich, chief equity strategist at Citigroup, whose psyche has been damaged by layoffs and what he describes as "the crushing weight of wealth lost in the equity markets." He recommended financial stocks in 2008. No wonder he gained 30 pounds eating barbecued potato chips, fried foods, and other junk late at night. Instead of rushing into a crash diet, though, Levkovich, 47, got motivated by asking Citigroup colleagues to sponsor a Biggest Loser-style contest last fall. In the dollar-per-pound challenge, he lost 27 pounds while raising $17,000 for the Food Bank for New York City. He has since dropped an additional 13 pounds.
Distracting the mind can also help the many people whose stress manifests in sleep-related issues. Karen Hochman obsesses over everything from meeting payroll and paying taxes to business development at her New York City specialty food Webzine The Nibble. "I don't stress out during the day because I work 15 to 18 hours and have no time to unravel," says Hochman, who is "fortysomething." But she wakes up at 3 a.m., her mind racing. The only thing that can lull her back to sleep is the absurdity of the TV show Judge Judy, which she records. "Even though so many of the charges and defenses are beyond reason and the people lie through their teeth, there is still a voice of sanity at the front of the courtroom," Hochman says. "At least justice prevails, in small doses, on TV. There is order in the universe, and I can sleep again."
Opel should consider insolvency, German minister says
Opel, the troubled European unit of carmaker General Motors, should seriously consider insolvency rather than seeking a government bail-out, a German minister said on Friday. "We must grasp that a modern insolvency law is a better way to overcome such a crisis than the state taking taking a stake," Wolfgang Schaeuble, interior minister, told newspaper Handelsblatt. "Our modern insolvency law is not set on the destruction but on the preservation of economic assets. The public perception is that insolvency is akin to going bust or bankrupt. But that is wrong," he added.
Mr Schaeuble’s remarks are a radical departure from previous government rhetoric, which has hinted that credit guarantees are Berlin’s preferred measure to help Opel, if necessary. German officials are due to hold talks in the chancellery on Friday with top GM executives including Fritz Henderson, chief operating officer, and Carl-Peter Forster, president of GM Europe. They are expected to pressure GM to put forward a more comprehensive rescue concept. The carmaker is seeking €3.3bn in state support but European leaders have struggled to disguise their annoyance with management’s current rescue proposal. Peer Steinbrueck, finance minister, bemoaned on Thursday that GM’s restructuring plan for Opel "so far isn’t a reliable basis for a decision".
This frustration was echoed by Günter Verheugen, European Union industry commissioner, who complained about a lack of transparency on key issues and proposed a meeting of industry ministers from countries that had an interest in GM’s future. GM has warned that without aid from several states it could run out of cash as early as next month, endangering up to 300,000 jobs, including suppliers. Friday’s talks may be complicated by a report that GM has given up some of Opel’s patents as collateral for aid from the US government. German tabloid Bild said the admission was contained in a 217-page report prepared by GM for the German government. Opel could not be reached for comment on Friday.
Mercedes-Benz February Car Sales Down 25%
Due to the ongoing downturn on almost all markets and the upcoming model changeover for the high-volume E-Class series, Mercedes-Benz Cars sold a total of 72,200 vehicles (February 2008: 96,800) worldwide in February, Daimler AG said Friday. The division has sold 134,500 (January-February 2008: 187,200) Mercedes-Benz, AMG, smart, and Maybach brand vehicles to date this year, or minus 28%. Mercedes-Benz sold 63,600 vehicles in February 2009 (February 2008: 88,000 units). This represents a 28% decline from the February 2008 mark, which was the brand's all-time sales record for the month of February
Smart delivered 8,600 vehicles (February 2008: 8,800 units) to customers worldwide last month, or minus 2%. Smart is now in the third year of its lifecycle. The smart fortwo has been available in the U.S. since one year now, and in February customers purchased 1,400 (February 2008: 1,100) of the innovative two-seater which is an increase of 29%. Klaus Maier, Executive Vice President Sales and Marketing Mercedes-Benz Cars: "In recent weeks we've been observing a growing interest among German customers in our new passenger cars and our one year old pre-owned vehicles. In February, sales of the smart fortwo in Germany increased by 28%. What's more, there was a substantial increase in orders for the A- and B-Class. The demand for our one year old pre-owned vehicles has also been developing very positively since the beginning of the year, with double-digit growth rates."
In the U.S., despite the difficult market conditions, Mercedes-Benz sold 14,200 passenger cars in February (February 2008: 18,600, or minus 24%), more than any other premium brand. Contributing to the result was the fact that the GLK got off to a good start. Sales of pre-owned vehicles also developed positively in the U.S., with 5,800 units sold (February 2008: 4,500), amounting to an increase of 28%. In China, Mercedes-Benz is maintaining its position as the fastest- growing premium brand. In February, sales in China increased by 17% to 3,000 units (February 2008: 2,500). The B-Class has been available in China since January, and the smart fortwo will celebrate its market launch there this year.
China’s 2009 Rebound Is Pure Fantasy
The idea that China can grow strongly as the world unravels is a fantasy. Ditto for the view that China is going to save the global economy. China is already slowing, of course. The third-biggest economy grew 6.8 percent in the last quarter of 2008. Such growth sounds like heaven just about everywhere else. Yet for an economy at China’s level of development, one that zoomed along at a 13 percent pace in 2007, it’s hell. Premier Wen Jiabao was wrong to err on the side of caution yesterday when he delivered the Chinese equivalent of the U.S. State of the Union address. He said the country’s 8 percent growth target is within reach, indicating an additional stimulus package isn’t needed. It’s a bad call, and Wen is likely to regret it as 2009 unfolds.
Markets are sensing as much. On Wednesday, stocks around the globe soared on hopes that at least one major economy would skirt disaster. Markets came back to Earth yesterday after China quelled stimulus speculation. As the global meltdown deepens, it probably means the export demand that drives China won’t return until well into 2010. Here are five reasons a Chinese rebound in 2009 may not pan out:
1. World growth is collapsing. This isn’t hyperbole, but a sobering fact. The International Monetary Fund can’t downgrade its global growth estimates fast enough as the credit crisis overwhelms economies as diverse as Ireland, Japan, the United Arab Emirates and the U.S. Asian governments are increasing spending to soften the blow from falling asset prices, consumer spending and manufacturing. The European Central Bank is struggling to keep up with the region’s plunging economy. The trillions of dollars of wealth being lost as markets plummet are depleting public coffers and damaging consumer psychology. It’s not a good environment for any government hoping for a revival in global demand.
2. China’s key customer is in hiding, indefinitely. Just when you thought conditions in the $14 trillion U.S. economy couldn’t get any worse, they "deteriorated further" in almost all corners of the country over the last two months, the Federal Reserve said in its regional business survey. Wang Hanmin, a sales manager at Yixing Bochangyuan Garments Co. in Jiangsu province, spoke for many this week when he said exporters are facing a "life and death" crisis. Exporters are so worried that they are calling on the government to weaken the yuan after the biggest slump in overseas sales in more than a decade. One thing is for sure: The U.S. consumer isn’t about to help China out of this dilemma.
3. A lack of tools. It’s important to remember that the 4 trillion yuan ($585 billion) spending plan unveiled in November was more spin than reality. Much of it wasn’t new, but a tally of existing spending efforts. They were never going to boost a $3.3 trillion economy anyway. China’s almost $2 trillion of currency reserves would seem to give the nation considerable policy latitude. Yet China’s vast economy lacks the financial infrastructure to get the bang it needs from its stimulus in yuan. Would building more roads, bridges and dams do the trick? "Eight percent GDP doesn’t really tell you anything about job creation," says Stephen Green, Shanghai-based head of research for China at Standard Chartered Plc. "Many of these projects are not particularly job-intensive." The spending will help, but such projects didn’t propel growth as hoped over the last 30 years. Exports did.
4. All those U.S. Treasuries. Financing loads of new projects could prove dicey, even for cash-rich China. Any move to draw down $696 billion of U.S. government debt could leave China with major losses and prolong the U.S. recession. That leaves domestic lending institutions. If China wants to avoid a Japan-like bad-loan crisis, or something far worse, it has to be careful about massive public-works projects with questionable economic benefits. Of course, there’s the "official" gross-domestic-product figure, and then there’s the real situation in the most populous nation. The double-digit drops in exports among China’s biggest trading partners in Asia show how bad things are getting. Offsetting those trends won’t be easy and it won’t be cheap.
5. Rebalancing takes time. Just as the U.S. needs to become a nation of savers, China needs more consumers. That’s a destabilizing, decade-long process that requires the creation of national safety nets and more education and health-care spending. Making that transition would be a big enough challenge with a healthy world economy. Doing it while Group of Seven members are in recession and developing Asia is slowing rapidly will prove extraordinarily difficult.
Wen wasn’t exaggerating yesterday when he said China faces its "most difficult" year of the past 30. How much China’s export collapse is hurting can been seen in the 20 million migrant workers who are suddenly unemployed. The risk of social unrest is higher than at any time since 1989, the year of the Tiananmen Square protests. China’s top-down system has worked extraordinarily well in recent years. It’s still a stretch to think the country can turn its economy upside down in this ever-worsening environment. Wen says China needs to "reverse the economic slide as soon as possible." Too bad officials in Beijing think their work is largely done. It’s not, no matter what the official spin is.
ECB board member warns on zero interest rates
Slashing interest rates to zero can cause serious damage to an economy, a senior European Central Bank policymaker has warned, highlighting the bank’s wariness about cutting eurozone borrowing costs much below the latest historic low. Lorenzo Bini Smaghi, an ECB executive board member, argued that reducing interest rates too far at a time when deflation remained unlikely would be "like giving antibiotics for any cough". The medicine would be inappropriate and could "weaken the body and facilitate the attack of the real bacteria, when they finally come later on." He also urged policymakers to "learn from the experience of the last decade" – in which low interest rates set by the US Federal Reserve had fuelled a housing bubble. "The crisis that we are currently in is the result of the bursting of that bubble," Mr Bini Smaghi said in a speech at Ancona university in Italy.
The ECB cut its main interest rate this week by half a percentage point to 1.5 per cent, the lowest since the launch of the euro in 1999, after revising its forecasts to take a sharply gloomier view on continental Europe’s recession. It also revised downwards markedly its forecasts for eurozone inflation this year and next, which it expected undershoot by a wide margin its target of an annual rate "below but close" to 2 per cent. However, the Bank of England and US Federal Reserve have cut official interest rates much closer to zero. Jean-Claude Trichet, ECB president, did not rule out completely the possibility of eurozone deflation – persistent and general falls in prices that result in significant economic damage. But he described the risk as "very, very meagre," given European price and wage rigidities in continental Europe’s economies. In his speech, Mr Bini Smaghi argued that cutting interest rates to zero would be justified "if the economy is really on the verge of persistent deflation" but, if it was not, acting "just to insure against the worst case scenario can have deleterious effects in both the short and long term."
Among the possible dangers was of consumers or investors assuming the central bank "knows more than the private sector about deflationary risks," which would change expectations about likely price trends and increase the probability of deflation emerging. Central banks could also find it difficult to raise interest rates once they had reached a very low level, Mr Bini Smaghi argued, and when rates did rise, holders of long-term assets would be hit by a capital loss, which would hit the economy. Investors might be more inclined to invest in long-term risky assets if cuts in interest rates stopped at a higher level, he suggested. "It might seem paradoxical, but a policy of persistently low interest rates might be more credible at a slightly higher level of interest rate than at zero."
Two yawns for the Bank of England today
by WIllem Buiter
The Bank of England today cut Bank Rate by 50 basis points to 0.50% and announced the start of its quantitative easing (QE) operations. Although no major damage was done through these decisions, both measures are disappointing and put the Bank further behind the curve. What’s wrong with a zero Bank Rate?
Why 50 basis points off Bank Rate rather than the MPC swallowing deeply and setting Bank Rate at zero immediately? The answer given in the statement released today by the MPC was that "… the Committee also noted that a very low level of Bank Rate could have counter-productive effects on the operation of some financial markets and on the lending capacity of the banking system. " That statement is kvatsch. If banks (or other financial institutions) have locked themselves into contracts that cause losses when Bank Rate gets very close to zero, say because the rates paid by banks to their creditors are constrained not to be negative, then a zero Bank Rate would be unpleasant for these banks. They will just have to grin and bear the losses as regards their existing contracts and make sure not to include the offending clauses in any new contracts. It is as easy technically to pay negative deposit rates as positive deposit rates. Depositors threatening to hold their wealth in the form of coin and currency should be told to do so. The inconvenience and risk of holding and storing physical coin and bank notes would soon become apparent.
The Bank’s own money market operations might have to be changed when Bank Rate hits zero, although this is not obvious, as long as the Bank is willing to pay negative interest on deposits held with it by commercial banks and building societies in excess of the average agreed at the beginning of the reserve maintenance period. For those who like this kind of thing, here is the Bank’s own short summary of objectives and methods for its money market operations. The two objectives are:
• (i) To implement monetary policy by maintaining overnight market interest rates in line with Bank Rate, so that there is a flat risk-free money market yield curve to the next MPC decision date, and there is very little day-to-day or intraday volatility in market interest rates at maturities out to that horizon.
• (ii) To reduce the cost of of disruption to the liquidity and payment services supplied by commercial banks. The Bank does this by balancing the provision of liquidity insurance against the costs of creating incentives for banks to take greater risks, and subject to the need to avoid taking risk onto its balance sheet."
The methods are described as follows:
"The framework has four main elements:
Reserves-averaging scheme. Eligible UK banks and building societies undertake to hold target balances (reserves) at the Bank on average over maintenance periods running from one MPC decision date until the next. If an average balance is within a range around the target, the balance is remunerated at Bank Rate.
Operational Standing Facilities. Operational standing deposit and (collateralised) lending facilities are available to eligible UK banks and building societies. They may be used on demand. In normal circumstances, the lending / deposit rates are 25bp higher than Bank Rate and 25bp below Bank Rate respectively.
A Discount Window Facility. This is a facility to provide liquidity insurance to the banking system. Eligible banks and building societies may borrow gilts, for up to 30 days, against a wide range of collateral in return for a fee, which will vary with the collateral used and the total size of borrowings.
OMOs. Open market operations (OMOs) are used to provide to the banking system the amount of central bank money needed to enable reserve-scheme members, in aggregate, to achieve their reserves targets. OMOs comprise short-term repos at Bank Rate, long-term repos at market rates determined in variable-rate tenders and outright purchases of high-quality bonds. "
So the Bank could implement its existing procedures with a zero Bank Rate and a minus 25 basis points operational standing deposit facility rate. Instead of persisting in its current inefficient and ineffective methods of overnight (collateralised) lending and deposit taking - an expression of the wish to control both price and quantity of overnight reserves - it would be much simpler (and more likely to satisfy objective (i) above) to abolish the reserve averaging scheme and to narrow the spread between the rates on the two Operational Standing Facilities (the operational standing collateralised lending facility and the operational standing deposit facility) to zero from its current value of 50 basis points. The Bank would be ready, during a reserve maintenance period, to lend overnight (collateralised) any amount, 24/7, at Bank Rate and to accept any amount of overnight deposits, 24/7, at Bank Rate. The Bank has moved half-way towards this sensible procedure by eliminating the 25 basis points penalty for holding deposits. That makes it even harder to understand why, given the atrocious condition of the British economy and the near-certainty that the inflation target will be undershot in the second half of the year (barring a collapse of sterling), Bank Rate was not cut to zero today. It may not help much, but it won’t hurt.
Are gilt rates too high? The Bank also announced that it would engage in up to £75 bn worth of financial asset purchases in the first instance (the Chancellor hinted at an eventual total of £150 bn), financed with higher bank reserves at the Bank of England. Such reserves count as part of the monetary base, M0. The assets to be purchased include both high-grade corporate securities and medium-to long-term gilts (maturities between 5 and 25 years). Under the Asset Purchase Facility announced earlier (which is included in totay’s totals), the counterpart on the Bank of England’s purchases of up to £50 bn of private securities are Treasury deposits with the Bank of England. These don’t count as part of base money. The Bank would buy the private securities, increasing commercial bank reserves with the central bank. The Treasury would sell Treasury bills, mopping up (sterlising) the increase in bank reserves and deposit the receipts from the Treasury Bill sale with the central bank. With sterlisation, the private sector ends up holding Treasury Bills rather than deposits with the central bank. Not much of a difference, really, as Treasury bills are highly liquid and can be repoed at the central bank.
But why does the Bank of England wish to purchase mainly medium-term and long-term Treasury bonds (gilts)? There are no asset market anomalies in the gilt market that make such purchases desirable. The gilts markets have remained liquid throughout. Medium- and long-term rates are not abnormally high. If anything they are uncomfortably low for such institutional investors as pension funds and insurance companies. Temporary monetisation of government gilt sales may become sensible in months to come, as the government deficit explodes, but it is not a priority at all at this moment. 5-year gits today yield 2.26 percent, 10-year gilts 3.30 percent, 20-year gilts 4.31 percent and 30-year gilts 4.20 percent. Assuming the Bank of England will achieve the inflation target of 2.0 percent on average over the next 10-, 20- and 30-year horizon, these rates don’t look at all high. If anything, I would like to see them rather higher. The anomalies are to be found in the cost and availability of private funds. Corporate bond spreads over sovereigns are unusually wide. Interbank spreads over the OIS rate are low compared to the cardiac arrest period that followed the demise of Lehman, the (first) rescue of AIG and the initial rejection of the TARP, but high by any other metric. Other credit risk spreads and liquidity spreads continue to suggest disfunctional private markets. The effective way to address these anomalies is to intervene in these disfunctional markets directly, by purchasing private securities and by engaging in unsecured lending (in the interbank market and elsewhere). Instead the Bank decides to focus on buying masses of public sector instruments for which yields are, if anything, too low.
A defense of the Bank’s approach to QE could be that what matters is not the asset side of the Bank’s balance sheet but the liability side. The Bank wants to increase the stock of base money. Private assets are in limited supply, so the quickest way to increase the stock of base money is to purchase gilts. But why would an increase in the stock of base money help the provision of credit to the private sector by banks? Will banks, unless the spread anomalies are reduced and the fear and loathing that pervade the financial markets vanish, actually be induced to engage in more risky lending to households and non-financial enterprises simply because they hold more reserves with the central bank? I doubt that additional bank reserves will be burning holes in the pockets of the bankers. It is certainly not helpful from the point of view of getting the banks to use the additional reserves they hold to boost their lending, that the Bank of England has reduced the opportunity cost to commercial banks of holding large reserves, by eliminating the 25 basis points penalty on the operational standing deposit facility. A while ago, the ECB, faced with the problem that commercial banks took the liquidity it injected into the market and redeposited it with the Eurosystem rather than lending it out or using it to purchase private secutiries, raised the penalty on ‘excess deposits’ from 25 basis points to 100 basis points (the total ‘corridor’ between the ECB’s overnight lending rate and its overnight borrowing rate is now 200 basis points, as opposed to 25 basis points for the Bank of England) . But the Bank of England today moved in the opposite direction. Strange indeed. So two yawns for the Bank of England today. Could do better.
Record rise in gilts as Bank of England 'starts printing presses'
Gilts saw their biggest one-day jump in memory after the Bank of England signalled it was embarking on a policy of money creation for the first time. The Bank cut interest rates by half a percentage point and committed to spending £150bn of newly created central bank money on corporate and government bonds. The news sent shockwaves through Britain's capital markets. Although most economists had expected the rate cut, which leaves borrowing costs at an effective zero of 0.5pc, the scale and speed of the plan to pump extra cash into the economy took traders by surprise. The Bank plans to spend £50bn of the money it creates on corporate debt and the remaining sum on government bonds.
The sheer scale of the operation is illustrated by the fact that the entire corporate bond and commercial paper market in the UK is worth only £57.5bn, while the amount of gilt-edged government debt eligible for the Bank's auctions totals £250bn. The Bank initially intends to spend £75bn on the operation, with the remaining amount likely to be committed as and when the Monetary Policy Committee judges necessary. As the news sank in, Bank's Governor Mervyn King conceded that further interest rate cuts were "very unlikely". With investors piling into gilts in anticipation of the auctions, the first of which is next Wednesday, gilt prices jumped by the biggest amount for at least 17 years, with some declaring it the most dramatic day in UK government debt in history. A rise in gilt prices pushes yields lower.
"For gilt yields to move by 30 basis points in a month is a big move," said Philip Shaw, of Investec. "For it to move that much in a day must be pretty much unprecedented." The 10-year benchmark gilt yield dropped by 32 basis points to 3.32pc. John Wraith, head of sterling rate strategy at RBC Capital Markets, said the fall was "massive but not surprising" given the aggressive nature of the Bank's plans. The Bank will buy up various amounts of debt in twice-weekly auctions over the coming months. The first aims to spend about £2bn on gilts. The decision means the UK is now officially engaged with quantitative easing, where the central bank attempts directly to influence the amount of money flowing through the economy by printing it – albeit electronically.
The Bank is embarking on this policy to stop the economy – already in the deepest recession since the 1980s – from tipping into depression. Despite recapitalisation of the banking system, unemployment is rising and consumer confidence collapsing as the crisis spreads from into the broader economy. The Bank's action is a more aggressive stance than the one adopted by the US Federal Reserve. The initial £75bn sum represents about 5.4pc of gross domestic product in Britain, whereas the Fed has pumped around $670bn (£474bn) into the system, or 4.7pc of GDP.
Printing money: an easy guide to quantitative easing
The 'unconventional tools' that the Bank of England will use to fight the financial crisis. Interest rates are now as close as they can get to zero without causing malfunctions in the financial system. In this new world, with the Bank of England shorn of its main tool for influencing the economy, the policymakers in Threadneedle Street have to turn to unconventional tools. Some have been tried before with differing degrees of success. But whatever the tool, the objective is clear: to keep Britain from dipping any deeper into recession and becoming trapped in a debt-driven deflation and depression, as the US was in the 1930s.
With no room to cut rates, the Bank must instead turn to direct means of influencing the money supply. This is important. The nominal growth rate of an economy can be no greater than the speed at which money is growing, and flowing around the economy. This famous economic equation – the quantity theory of money – lies behind the Bank's decision to create £150bn of money. Whether it will succeed is another question, but Thursday's announcement means it has thrown its weight behind this new policy of quantitative easing with more weight and vigour than any other central bank in history.
THE BANK OF ENGLAND'S EMERGENCY WEAPONS
How does it work?The Bank lends out money in return for collateral – usually government or company debt – to instill confidence in the market and provide cash with which to trade. It has been doing this for over a year through its Special Liquidity Scheme and its successor.
Pros: The system does not meddle directly with monetary policy – so does not interfere with interest rate decisions – and it directly ensures that banks' balance sheets are kept above water.
Cons: Although it addresses liquidity problems – ie. when financial institutions don't have enough cash to hand – it does not solve the credit crunch, in which banks are unwilling to lend cash at all.
Does it work? To an extent. It has ensured strains on the financial markets have eased in comparison with the early days of the crisis, but the amount banks are willing to lend remains extremely low.
Buying company debt
How does it work? The Bank buys, rather than lends against, the assets of private investors, be they pension funds, insurance groups or banks. The assets are most likely commercial paper (short-term company debt) and corporate bonds. It pays for the money from a pot of cash raised by the Government through issuing gilts – in other words without increasing the amount of cash in the system. This is what the Bank has attempted to do through the Asset Purchase Facility, and is what the Federal Reserve is doing in the US.
Pros: If successful, it gets to the heart of the matter, reducing the cost of credit for companies and lubricating the capital markets for companies. Because the purchases are funded by the Government it is not particularly inflationary.
Cons: It has proved very difficult for the Bank to get hold of the right type of commercial debt (in other words at a good price, and a type that won't default). Pay too little and you will leave the taxpayer facing a big bill in the coming years.
Does it work? To an extent. The Fed has bought billions of dollars worth of corporate debt, but with little impact on commercial bond spreads.
Buying gilts (Government debt)
How does it work? The Bank buys government debt off investors and banks rather than corporate debt. This is something the Bank had authorised by the Treasury yesterday. The aim is to bring longer-term interest rates down, ensuring that companies and lenders cut their own rates.
Pros: Gilts are gilt-edged, and so have very little chance of defaulting (and if the UK Government has defaulted that is a whole other kettle of fish to worry about) and there are plenty of them around, so are easy to buy.
Cons: It does not make any direct difference to companies' cost of borrowing, instead pushing down government interest rates: nice, but not the heart of the matter.
Does it work? Yes, if by that you mean getting long-term interest rates down. The Japanese did it in the past, but it has not yet been tried by the Fed.
Creating money to buy assets
How does it work? The Bank buys assets off private investors but funds those purchases by creating money (literally, with the push of a button; metaphorically, with printing presses). This is what the Government has now approved. The aim is to increase the amount of money in the economy, which will in turn increase either economic growth, inflation, or a combination of the two.
Pros: The UK faces a possible spate of debt deflation, and there are few more powerful weapons for a central bank to use than its printing presses. It can also aim to kill two birds with one stone and cut the cost of borrowing for companies by making cash more plentiful. With interest rates at zero, there are few other more powerful tools the Bank can employ.
Cons: In normal times, such a policy is potentially highly inflationary. There is every chance the Bank is unconsciously laying the ground for an uncontrollable wave of inflation in the future. Deflation is the big enemy at present but the threat may be overblown, and printing money – quantitative easing – will create a mess of unparalleled proportions to clear up afterwards.
Does it work? Yes and no. The only other time it has been used is by the Bank of Japan. As Japan is still trapped in stagnation, many say it failed. However, there is evidence the Japanese experience would have been worse had it not taken these measures. Some also argue that the BoJ was too slow to start quantitative easing.
The helicopter drop
How does it work? The bank prints money, piles it inside a helicopter, takes to the skies and scatters the cash across the nation. Suddenly, every family is richer – provided they get to the cash in time and have sharp enough elbows. This technically amounts to a tax rebate for everyone funded by money creation, and was christened a "helicopter drop" of money by economist Milton Friedman. In his eyes it was the most dramatic way for the central bank to get money out into the streets.
Pros: This instantly gets money into people's hands and, with any luck, gets them spending it in the high street. Those who don't spend can use it to pay off debt, which isn't such a bad thing either.
Cons: It is so radical a policy it might scare away international investors from the UK. It displays a disregard for controlling inflation that could also send sterling plunging. It will summon up even more vivid comparisons with Zimbabwe and Weimar Germany.
Does it work? It has never been properly tried before. The Japanese and Koreans have experimented with issuing vouchers to their citizens in the hope of encouraging them to spend but these were – importantly – not funded with created money. Fed Chairman Ben Bernanke is convinced, however, that in desperandum it would pump up a deflated economy.
UK stake in Lloyds set to hit 70%
Lloyds Banking Group is close to a deal to insure around £250bn of toxic assets that could see the taxpayers' stake in the bank rise to 70pc, the Financial Times reported. Alistair Darling, the Chancellor, has agreed an outline deal to insure bad loans in return for non-voting shares, according the newspaper. Most of the toxic assets will come from HBOS, the mortgage lender Lloyds bought last autumn in a rescue deal. HBOS, which aggressively lent to businesses and homeowners during the boom, last month shocked shareholders by reporting a pre-tax loss of £11bn for 2008. The deal is part of the Treasury's taxpayer-backed Asset Protection Scheme to insure banks' riskiest assets against further losses, and the Treasury and the bank have been negotiating for a week.
The government’s £4bn in preference shares could be converted into ordinary shares, according to the FT. Preference shares are expensive, carrying an interest payment of 12pc, which costs Lloyds £480m a year. Shares in Lloyds climbed more than 5pc to 43.2p in early trading. They've plunged 90pc in the past 12 months. If these are converted into ordinary shares it would take the taxpayer’s voting stake in Lloyds from 43pc to around 60pc. However, because the insurance scheme will be paid for in non-voting shares, the government’s stake will rise to about 70pc. The Lloyds board has resisted handing over direct voting control to the state. The Financial Times reported that the bank insisted on Thursday night that negotiations were continuing, but added that it may conclude it has little choice.
"There are still extensive negotiations and the Lloyds board still has to get their head around this and agree to it," a source told the paper, adding there is a 60pc chance of a deal being struck on Friday. Last week, RBS announced it was putting £325bn of assets into the government’s asset insurance scheme, where the bank agreed to pay a "first loss" on bad loans while the taxpayer agreed to underwrite 90pc of remaining losses. The government could end up with an economic stake of 95pc. The deal would further anger Lloyds shareholders who are already upset with chairman Sir Victor Blank and chief executive Eric Daniels for the problems that have resulted from buying HBOS.
Ireland May Lose Its AAA Credit Rating, Fitch Says
Ireland may lose its AAA debt rating because of a slump in government tax revenue, Fitch Ratings said. The country’s top credit classification was put on "watch negative," Fitch said in a statement from London today. Ireland received the top rating from Fitch in 1998. The government needs to find as much as 4.5 billion euros ($5.7 billion) through spending cuts and tax increases if it’s to prevent the budget deficit from swelling beyond 9.5 percent of gross domestic product, Finance Minister Brian Lenihan said two days ago. Tax revenue plunged 24 percent in the first two months of the year, the government said March 3.
"The rating action reflects recent disappointing news on government revenue performance, which points to very sharp declines in tax receipts across the board in January and February," Fitch analysts Chris Pryce and Douglas Renwick in London said in today’s statement. The cost of insuring against a default on Irish sovereign debt rose, with credit-default swaps on the government’s debt climbing to 367.5, from 365.8, according to CMA Datavision prices. They reached a record 396 basis points on Feb. 17. The yield difference, or spread, between 10-year Irish and German bonds widened to 268 basis points, from 256 points yesterday. It averaged 16 basis points in the past five years. Standard & Poor’s cut its outlook on Ireland’s AAA rating in January, citing the government’s growing budget deficit. The economy may shrink as much as 7 percent in 2009, Davy, the country’s largest securities firm, said in a report this week.
More hotels are facing foreclosure, bankruptcy
When it opened on Waikiki in 1964, The Ilikai was the first luxury high-rise hotel in Hawaii. The oceanfront property also gained fame for appearing in the opening credits of the 1960s TV series Hawaii Five-O. But a rough economy has the landmark condo hotel facing possible closure if it can't find a buyer. A large portion of its hotel units — a majority of its rooms are privately owned condos — was forced into foreclosure after its owner failed to repay a loan due. "Many (customers) won't notice the difference in service," says court-appointed commissioner George Van Buren. "It's unlikely that it'll close." Still, he couldn't "give an unqualified assurance" that it will remain open. The U.S. hotel industry is bracing for more foreclosures or bankruptcies this year as owners increasingly fail to pay back maturing loans or fall behind on payments.Until now, hotels have been spared from waves of foreclosures that have rocked the housing market.
But that could change this year, says Los Angeles hotel attorney Jim Butler. "It's like a water balloon and someone forgot to turn off the water. But it hasn't burst yet." Occupancy and revenue are expected to plummet this year. About 36% of full-service U.S. hotels will lack the cash flow needed to pay their monthly mortgages in 2009 vs. 21% in 2008, says Mark Woodworth of PKF Hospitality Research. Though it's rare for hotels in foreclosure to shut down completely, since debtors still want operating incomes, they are increasingly cutting back on services to save money. That means fewer restaurants will remain open and room-service hours will be cut. There will be longer wait times at the front desk and fewer bellhops working in the lobby.
Among other large hotels that have undergone foreclosure or under notice for foreclosure: Renaissance Grand & Suites Hotel in St. Louis, and W Hotel and InterContinental Montelucia Resort, both in Scottsdale, Ariz. Owners of Ritz-Carlton Lake Las Vegas, Sheraton Downtown Orlando and The Tropicana in Las Vegas have filed for bankruptcy. MGM Mirage said this month that it "might not be able to stay in compliance" with a loan, which could lead to default. Hotel operators generally insist that it's business as usual at distressed hotels. Many hotels have a "non-disturbance" clause in their contracts with their brands to retain certain standards, says hotel consultant Richard Warnick. "But in bankruptcy, courts can void management contracts."
Warnick advises customers to try to book at hotels that have "been around a while." "The newer they are, the more likely they're in trouble." Bob Eaton of PKF Capital adds that customers should read contracts carefully when paying deposits for weddings or large meetings since customers are generally considered unsecured creditors and are last in line for repayment in bankruptcy.