Store in Halifax, North Carolina, advertising Coke, Dr. Pepper and patent medicines
Ilargi: Warren Buffett says stocks are the best investment, even as the economy has fallen off a cliff. In the process, he manages to boost the stock of his banks, US Bancorp and Wells Fargo, by some 15%. That should be a good payday for the stumbling oracle. It won't be for all the millions of investors who listen to his advice. Why anyone would listen to a man who's lost countless billions over the past year, it's beyond me. How do people think you get to be the world's richest man to begin with? Benevolence?
Marc Faber once was the sole owner of the Dr. Doom franchise. He sees the S&P 500 going all the way to below 500, but not before a spring rally first. I hope for many people, as in for all of you, that he's right. Stoneleigh sees a rally as well. Me, I see the possibility of things breaking down so hard and fast that the sucker-bear rally that would seem to make sense could be preempted altogether. If and when GM or Citi go down, "normal" expectations may well have to take a backseat. But as I said, I do hope we have some more time before the fall, when the Grim Piper will start sending around his bills for real.
New Dr. Doom wannabee Nouriel Roubini thinks the S&P won’t go much under 600. He gives me the impression, like many other voices, that he refuses to believe his own data. It's a very common phenomenon, people have images in their head that their worldview, no matter what the numbers tell them, is constructed around. It may satisfy them, but reality suffers in the process, as do the people who listen to them. I saw an interview with Canadian former MP Garth Turner the other day, and he was going strong at the beginning, but then strayed into territory that just made me laugh, advising people to buy homes and stocks, put money into pensions plans, overall a picture based on wishful thinking, and entirely unfounded.
So am I the real Dr. Doom? Nah, "doom" is nothing but an easily thrown around word that labels those who see things in a less rosy manner than the people who use it. I have a lot in common with Dmitry Orlov, when it comes to looking forward, and he calls the collapse of the USA inevitable. Is he a Dr. Doom as well? People who work in finance and economics, in whatever sense or shape, feel that they are the only ones who can seriously comment on the financial crisis and its fall-out. Orlov doesn't fit that image, and neither, as far as anyone knows, do I. Like the guilds in Europe's Middle Ages, economists, bankers, financial reporters and politicians, want to fence off their "field of expertise", and tell the rest of you what needs to be done, where the solutions can be found. And so far they succeed. No matter how often they are wrong, the incestuous little family parade just keeps on going.
Dmitry Orlov comes from a different angle. But he's seen the demise of the communist system from up close. Who's to say he's wrong when he says the US is doomed? Which of the economic pundits, which of the mass media's Dr. Doom's have any first-hand knowledge of what Orlov has lived through? None, would be my guess. Wouldn't that move their analysis towards a vision in which America can and will not fall apart? Just like they will not wish to ponder the demise of their own jobs, and the financial system that has provided them? So if that system does fall apart, are they the people to listen to, or would is be wiser to listen to Orlov?
I don't want to put myself anywhere in that discussion, I want to do what I do, and do it anonymously. And from that viewpoint, I see that the Asian Development Bank estimates that $50 trillion has vanished from the world's wealth in just one year. And that makes me think of Warren Buffett warning of inflation. Yeah, right, old man. I would personally stick with Bloomberg's estimate last year that the real lost global wealth number is closer to $60 trillion. The ADB says Global stock markets lost about $28.7 trillion in 2008, whereas Marketwatch last week put the losses in the US alone at over $11 trillion. Now, the US is large, but 40% of the total losses doesn't sound quite right.
It's still the same story we've been talking about all along. There's hundreds of trillions of dollars in outstanding and unsolved bets out there, and they will have to be settled, whether through payments or defaults. US taxpayer money disappearing into the pockets of global bankers can keep this process quiet for a while, and perhaps even long enough to have that spring rally, but it will have to unwind and unravel. The only thing that doesn't fit the profile is that when you lose insanely large bets, your kneecaps will be redesigned, while when bankers lose big, it's still your kneecaps that will get hurt, but this time by your own government. Something about that doesn't quite fit.
Global Financial Assets Lost $50 Trillion Last Year
The value of global financial assets including stocks, bonds and currencies probably fell by more than $50 trillion in 2008, equivalent to a year of world gross domestic product, according to an Asian Development Bank report. Asia excluding Japan probably lost about $9.6 trillion, while the Latin American region saw the value of financial assets drop by about $2.1 trillion, said Claudio Loser, a former International Monetary Fund director and the author of the report that was commissioned by the ADB. The report didn’t give a breakdown of asset declines in other regions.
"The loss of financial wealth is enormous, and the consequences for the economies of the world will unfortunately commensurate," said Loser, now the Latin American president of strategic advisory firm Centennial Group Inc.. "There are serious economic and political stumbling blocks that may well cause the recovery to be costly and slow to consolidate." Some of the world’s biggest financial companies including Lehman Brothers Holdings Inc. and Merrill Lynch & Co. have collapsed as banks and other financial institutions reported almost $1.2 trillion of losses and writedowns since the start of 2007. Global stock markets lost about $28.7 trillion in 2008, and another $6.6 trillion has been wiped from the value of world equities in 2009. "Poor macroeconomic and regulatory policies allowed the global economy to exceed its capacity to grow and contributed to a buildup in imbalances across asset and commodity markets," Loser said. "The previous sense of strength and invulnerability is now gone."
The global economy is likely to shrink for the first time since World War II, and trade will decline by the most in 80 years, the World Bank said yesterday. Its assessment is more pessimistic than an IMF report in January predicting 0.5 percent global growth this year. Developing nations will bear the brunt of the contraction and they will face a shortfall of between $270 billion and $700 billion to pay for imports and service debts, the Washington- based World Bank said. "This crisis is the first truly universal one in the history of humanity," former IMF Managing Director Michel Camdessus said at an ADB forum in Manila today. "No country escapes from it. It has not yet bottomed out."
Growth in 2009 may drop by half in developing and emerging countries, and a recovery in the global economy may only begin late this year or in early 2010, Loser said. Developing nations, which mostly escaped the earlier effects of the credit crisis, are facing more problems as the downturn worsens, the report said. "Emerging economies were initially able to absorb the initial impact of the crisis on account of the considerable progress in recent years in consolidating economic performance," Loser said. "This group of countries is experiencing mounting difficulties. Policy makers will thus need to find a balance between economic stimulus and financial stability."
Asia is likely to recover with "vibrant" growth once the crisis recedes in 2010, Manu Bhaskaran, the Singapore-based head of economic research at Centennial Group, said in a separate report for the ADB released today. South Asia’s growth prospects "remain good," he said. "Asia is mainly suffering a cyclical slowdown because of problems in the developed economies, it is not suffering a structural economic breakdown," Bhasakaran said. "There is no reason to think that the growth engines that have been unleashed in many parts of Asia are likely to weaken." Net capital flows to emerging markets may fall to $165 billion this year, from $470 billion in 2008 and a record $930 billion in 2007, Loser said, citing estimates from the Institute for International Finance. Net flows to emerging Asian economies may drop by 80 percent from the peak in 2007, he said. Protectionist measures by countries to prevent a deeper fallout from the global downturn won’t work, Loser said. "There is no room for denial or populist policies," Loser said. "Otherwise the crisis will become even deeper and harder to reverse."
Ilargi: Dmitry Orlov agrees with me on many points, in particular the need for governments today to provide for their citizens' basic needs, a topic I've often talked about here. Throwing in the term "sustainability" is something I would never do, though, that's for people who don't understand what it means. His comments on soldiers and prisoners in the US are dead on, as are the observations on "rebelling" populations.
'The collapse of America is unavoidable'
Obamavilles In America
In the depression of the1890s, the term for a breadline was a Cleveland Cafe, named after the Wall Street puppet who turned the government over to JP Morgan, London, and their cross of gold. In the 1930s, a shanty town was a Hooverville. In this depression, the wretched victims of foreclosure by Obama’s pals at Goldman Sachs, Citibank, and JP Morgan live and die in OBAMAVILLES. The arrogant elitist in the White House does not care.
Obama is presiding over a $10 trillion bank bailout, all money down a rat hole. Meanwhile, Obama’s so-called anti-foreclosure program is an incentive payment bonanza for predatory subprime lenders - the Angelo Mozillos of Countrywide and their ilk, who sold subprime Adjustable Rate Mortgages which should have been illegal all along.
Want to stop foreclosures? It’s easy: pass a law making foreclosure on any primary residence, family farm, or business a federal crime — for five years, or for the duration of the depression, whichever is longer. Put a family out on the street, shut down a farm, close a factory, and the banker goes to Leavenworth.
Start with the great foreclosers — Dimon of JP Morgan, Pandit the Bandit of Citibank, Lewis of Bank of America, Blankfein of Goldman Sachs, and the other zombie bankers. Don’t let them destroy Detroit, Toledo, Stockton, or any other American city. To get a recovery, wipe out the $1.5 quadrillion of financial derivatives like those of AIG, which have already cost US taxpayers $190 billion on the way to at least $400 billion. Outlaw the hedge fund hyenas that bid up the price of gas in 2008. Re-regulate financial and commodity markets, and bring back the uptick rule and the ban on naked shorts at the SEC.
And for families facing foreclosure, play for time by saying the magic words: "PRODUCE THE NOTE." To throw you out on the street, the banksters have to show the original piece of paper you signed. In many cases this has been securitized and sent to London or Zurich, and it may take months to find. The predators may even forget about you and go on to more gullible targets - like the dupes who still believe in the inherent justice and infallibility of the non-existent "free market."
Start a mass movement to wipe out the derivatives cancer and shut down the zombie banks
Depression Dynamic Takes Hold as World Trade, Banking System Revisit 1930s
The U.S. economy’s vital signs may not confirm a diagnosis of depression. The symptoms increasingly point to one. As in the Great Depression, world trade is collapsing, wealth is evaporating and the banking system is broken. Deflation is a growing threat as companies slash production, pay and prices. And leaders worldwide are having difficulty making headway in halting the self-perpetuating decline. "We are tracking 1929-1930," says Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley. The result: This contraction may leave a lasting imprint on the economy and society, just as the Depression did. In the wake of the devastation of the 1930s, Americans swore off stocks, husbanded their own resources and looked to the government for help.
Now, another generation might draw some of the same lessons from the deepest economic collapse of their lifetime. "This is going to scar the collective psyche," says Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania. "People will become much more conservative in borrowing, lending and investing." There’s no official definition of what qualifies as a depression. In the 1930s, the unemployment rate rose to 25 percent and the economy shrank by more than a quarter. No economist forecasts a return to the breadlines and shantytowns of that era, even as the economy gets closer to some of the metrics academics cite as constituting a depression, if not a "great" one.
Nobel Prize-winning economist Robert Barro defines a depression as a 10 percent fall in per-capita gross domestic product and consumption. The Harvard University professor sees roughly a 30 percent chance of that occurring now. Billionaire Warren Buffett said today the economy "has fallen off a cliff" and is unlikely to turn around soon. The Berkshire Hathaway Inc. Chief Executive Officer also said, in an interview with the CNBC television network, that efforts to stimulate recovery may lead to inflation higher than the 1970s. The economy contracted at a 6.2 percent annual rate in the last quarter of 2008 and will shrink at a 7 percent rate in the first three months of 2009, projects Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York.
Bradford DeLong, a former Treasury official who is now a professor at Berkeley, says a depression is a two-year period with unemployment at 10 percent or above. He says that’s possible, though not likely. The jobless rate rose to 8.1 percent in February, a 25-year high. Some industries are already in a depression, led by housing, where the decline accelerated in recent months as the credit crisis intensified. During the last four years, residential investment is down by 37 percent. That compares with an 80 percent drop in spending on home building from 1929 to 1932. "The past five months have been among the most difficult in U.S. economic history," Robert Toll, chief executive of Horsham, Pennsylvania-based Toll Brothers Inc., said Feb. 11, after the largest U.S. luxury homebuilder reported a 51 percent sales drop.
In the auto industry, U.S. sales have fallen 55 percent from their July 2005 peak. Production of cars and trucks plunged in January to an annual rate of 3.9 million, the lowest since the Federal Reserve began keeping records in 1967, and 67 percent below the January 2005 level. Things are so bad that auditors have questioned the ability of General Motors Corp., the biggest U.S. automaker, to continue as a going concern. U.S. motor vehicle output slumped 75 percent from 1929 to 1932, according to statistics in the book "American Automobile Workers 1900-1933," by Joyce Shaw Peterson. "We are in an automotive depression," said Efraim Levy, an equity analyst for Standard & Poor’s in New York. The financial-services industry has also been decimated. Since the crisis began in the middle of 2007, institutions worldwide have racked up $1.2 trillion in credit losses and writedowns. Announced job cuts have topped 280,000.
"You’ve had a major disruption of the financial system, just like the 1930s," says Mark Gertler, a New York University professor who collaborated on research about the Depression with Fed Chairman Ben S. Bernanke. In the 30s, more than 10,000 banks went bust. That disruption is making it hard for Bernanke and his fellow policy makers to get much traction in their efforts to stop the economic decline. Strapped with losses, banks are hoarding capital rather than lending. This type of breakdown happens only two or three times a century and can lead to a "downward vortex" in which weaknesses in the economy and the financial industry feed on each other and are difficult to break, Lawrence Summers, director of the White House’s National Economic Council, said Feb. 26. "It’s the kind of vicious cycle Franklin Roosevelt talked about," he told a forum in Arlington, Virginia.
Particularly worrying, says Stanford University professor Robert Hall, is the collapse of the jobs market. Over the past four months, payrolls have plunged 2.6 million. Summers has also voiced concern about a return of deflation, which wreaked havoc on the economy during the Great Depression. As wages fell back then, workers had a harder time paying their debts, aggravating the banking industry’s woes. In an echo of those troubles, GM, FedEx Corp. and casino company Wynn Resorts Ltd. are among businesses slashing pay for more than 100,000 workers as they cut costs to counter declining demand. There are other echoes. Since hitting a peak in October 2007, the Dow Jones Industrial Average has fallen 54 percent. Over a similar length of time -- from 1929 to 1931 -- the average fell 55 percent. It ultimately dropped 89 percent from its 1929 high before beginning to recover in mid-1932.
Combined with collapsing house prices, the free-fall in the stock market will destroy $23 trillion worth of U.S. wealth, reckons Lawrence Lindsey, a former senior White House official who now heads his own consulting company in Arlington, Virginia. Like the Great Depression, the current economic decline is global. The International Monetary Fund says this will be the first time since World War II that the U.S. and other industrial nations will suffer a simultaneous decline in their economies. Worldwide trade is falling fast as the credit crunch curbs financing for exporters and importers. The volume of merchandise trade plunged at an annual rate of 22 percent in the fourth quarter from the third, according to the CPB Netherlands Bureau for Economic Policy Analysis. The peak-to-trough decline from 1929 to 1932 was 35 percent, as countries slapped big tariffs on imports.
"We’re in a depression, and we need policy makers to make the right decisions to ensure that it does not become great," says Kevin H. O’Rourke, a professor at Trinity College in Dublin, who has studied the trade issue. Government officials, especially in the U.S., are moving more rapidly to tackle the turmoil than their counterparts did during the early years of the Great Depression. Bernanke has cut the benchmark interest rate to as low as zero, while President Barack Obama won congressional approval of a $787 billion stimulus package. Massachusetts Institute of Technology professor Peter Temin says the trouble is that the economy seems to be collapsing faster than policy makers are reacting. "They’ve only done enough to cushion the downturn," says Temin, author of the book "Lessons from the Great Depression." That leaves the U.S. -- and the rest of the world economy -- in danger of being mired in an extended period of little or no growth, much like that which afflicted Japan during the 1990s. Eichengreen says such an outcome would be equivalent to a depression. Whatever it’s called, the economy’s continuing deterioration will likely leave enduring marks. U.S. households are already rebuilding savings in response to the crisis. The savings rate rose to 5 percent in January, the highest in almost 14 years.
"They’re buying what they need, and they’re being very smart about how they spend their money," Myron Ullman, chief executive officer of Plano, Texas-based J.C. Penney Co., said on Feb. 20, after the third largest U.S. department-store chain forecast its first quarterly loss in almost five years. In a Feb. 27 memo, "The Return of the Frugal Consumer," Goldman Sachs economist Andrew Tilton projected a savings rate exceeding 8 percent by the end of 2010. Americans may also turn more conservative about where they keep their money. Merrill Lynch & Co. says U.S. bonds owned by individuals likely will account for 2 percent of households’ financial assets by 2013, up from 0.2 percent now. "We’re in the midst of a massive economic and financial crisis," former Fed Chairman Paul Volcker said at a Columbia University conference on Feb. 20. "We’re going to hear reverberations about this for a long time."
HSBC Plunges Record 24%, Punished by Late Trades
HSBC Holdings Plc plunged the most in at least 23 years in Hong Kong, driven to a 13-year low by last- minute trades and concern about deepening loan losses at its U.S. business. The shares fell 24 percent to HK$33 at the 4 p.m. close, the lowest since May 1995. HSBC, Europe’s largest bank, has lost 42 percent since announcing on March 2 that it will raise 12.5 billion pounds ($17.6 billion) in a rights offer at the equivalent of HK$28 apiece. Today’s plunge was exacerbated by trades in the final seconds of the daily closing auction, a process the city’s bourse has pledged to improve to reduce volatility and market manipulation. The shares had fallen 15 percent before the late trades amid worries over mounting loan losses in the U.S.
"People are not so animated on the outlook given their ongoing exposure to the U.S." lending business, said Warren Blight, a Hong Kong-based analyst at Fox-Pitt Kelton Asia Ltd. HSBC Chairman Stephen Green last week said the 2003 purchase of Illinois-based Household International, which led to billions of dollars of losses as the U.S. housing market collapsed, was a mistake. CLSA Asia-Pacific Markets analyst Daniel Tabbush, who in December correctly predicted HSBC would have to raise money, cut his target price for the stock by 32 percent to HK$28, citing the threat of swelling bad debts. "The Exchange is closely monitoring market conditions at any time, and if there are any irregularities we will report to the market regulator," Henry Law, a spokesman for Hong Kong Exchanges & Clearing Ltd., operator of the city’s stock exchange, said by phone today. He declined to comment on today’s trade.
The bourse on Feb. 13 said it will implement a 2 percent cap on price fluctuations during the 10-minute daily closing auctions to help battle market manipulation. The limit will take effect in the second quarter, Hong Kong Exchanges said at the time. JPMorgan Chase & Co. and Goldman Sachs Group Inc. are lead underwriters for HSBC’s stock sale. A group of Hong Kong tycoons, including billionaire Li Ka-shing, are underwriting at least $1.1 billion of the offering. Li "is very confident in HSBC," Winnie Cheong, a spokeswoman at Li’s flagship developer Cheung Kong (Holdings) Ltd., said by phone today "He will definitely underwrite the issue and will hold the shares for the long term." Li, Hong Kong’s richest man with a net worth of $16.2 billion according to Forbes Magazine, will underwrite about $300 million of HSBC’s offer, Cheong said on March 3.
"The market response is quite good so far toward the rights issue plan," Peter Wong, executive director of HSBC’s Hong Kong unit, told reporters in the city today. "Short-term volatility in share prices won’t impact it." London-based HSBC will stop making new loans at its U.S. unit, called HSBC Finance Corp., after reporting a 70 percent drop in full-year profit last week. Green said that with hindsight, he regretted the purchase of Household, which added almost 50 million U.S. clients, many with spotty credit histories. HSBC’s Hong Kong-traded shares have plummeted 79 percent since peaking at HK$153.50 in October 2007. During that time span, the subprime mortgage market collapse triggered the worst global recession since World War II.
Even as it was forced to tap investors for funds, HSBC has avoided the severity of losses that forced rivals Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc into taxpayer bailouts. Lloyds, the biggest U.K. bank by customers, last week ceded majority control to the government in exchange for a guarantee of risky assets. The bank was pushed to the brink of collapse by losses stemming from the October purchase of HBOS Plc, brokered by the U.K. government. Mortgage Competition HSBC last week reported a 2008 pretax loss of $15.5 billion from North American operations, compared with a profit of $91 million in 2007. The bank was forced to set aside about $53 billion over three years for bad loans, the majority stemming from the U.S. division.
Hang Seng Bank Ltd., a unit of HSBC and the biggest Hong Kong-based bank by market value, slid 6.1 percent to HK$69.10 in local trading. Hong Kong banks are lowering mortgage rates as competition intensifies, even though earnings are being squeezed by rising bad debt provisions and declining fee income, HSBC’s Wong said on March 6. The value of new mortgages granted in Hong Kong, which is in its first recession since 2003, fell for the sixth consecutive month in January as the city’s jobless rate rose by the most in a decade. "Investors are fearing more bad news will come out from the bank," said Castor Pang, strategist at Hong Kong-based Sun Hung Kai Securities Ltd. "They are also worried Hong Kong banks may have to keep lowering interest rates to boost lending."
New Fears as Credit Markets Tighten Up
The credit markets are seizing up again amid new anxieties about the global financial system. The fear and uncertainty that sent stocks to 12-year lows is now roiling the market for corporate bonds and loans, which have given back much of the gains they chalked up earlier in the year. Short-term credit markets are still performing better than they did last year thanks to government programs to buy commercial paper and guarantee short-term debt. But Libor, the London interbank offered rate, a common benchmark interest rate, has crept up over the past weeks, from 1.1% in mid-January to 1.3% on Friday, reflecting banks' concerns about being paid back for even short-term loans. It is still well below its peak of 4.8% last October.
This time around, the economy is slipping deeper into a recession, and bond investors worry the government's repeated modifications to its financial-rescue packages are undermining the very foundations of bond investing: the right of creditors to claim their assets first if a borrower defaults. Without this assurance, bonds of even the most stalwart institutions are much riskier to own. After what seemed like the beginning of a thawing of debt markets early in the year, sentiment has deteriorated, analysts say. The markets remain open only to the strongest companies. A rally in U.S. Treasury bonds last week reflects another bout of flight-to-quality buying. Junk bonds now yield 19 percentage points more than safe Treasury bonds, up from a 16-point spread in February, according to Merrill Lynch. The spread is still narrower than the 21-percentage-point premium reached last December, but any widening shows investors are becoming more fearful.
Part of the problem is that investors are still waiting for key details from the government about its plans to bolster U.S. banks and unfreeze the credit markets. After launching a $1 trillion program to kick-start consumer lending last week, the Obama administration is considering creating multiple investment funds to purchase bad loans and other distressed assets. The intent of the funds is to stabilize the prices of good assets and restore investor confidence. Without more clarity from the government on its bailout plans, the market could continue to drop, say analysts. That would further harm the economy and the institutions the government hopes to help, compounding its task of shoring up the financial system. "The credit markets are a mess because the economy is a mess," says Thomas Priore, chief executive of ICP Capital, a New York fixed-income investment firm. "There's fear out there that's driving down every asset class simultaneously. It illustrates a lack of investor confidence in the government's plan for fixing the financial infrastructure."
Bondholders have so far remained mostly unscathed by the intervention. But investors are now worried that if the crisis worsens, some of the government's efforts to salvage financial institutions such as American International Group Inc. and Citigroup Inc. could end up hurting the interests of debtholders. The concern is that further modifications of bailout plans could place the government's interests ahead of creditors. Though the government switched from holding Citigroup preferred shares to common shares in order to improve its capital base, putting taxpayers at greater risk, the move did little to ameliorate debtholder's worries. Many investors believe the government may change course again. The government's moves may also push down credit ratings of some securities, causing another wave of forced selling. That would further weigh on prices and increase the likelihood of pension funds, banks and insurance companies needing to take more write-downs. Investors say the prospect of such a scenario is deterring them from buying mortgage-backed securities and corporate bonds.
"The only way to invest is to guess at which way the winds in Washington are blowing, so capital is frozen," says Sean Dobson, chief executive officer at Amherst Holdings LLC, a mortgage-market trading and investment firm. Additional government aid to financial institutions hasn't prevented price declines among many of these companies' senior bonds. In a report over the weekend, analysts from J.P. Morgan Chase & Co. said they had expected government intervention to help protect the interests of bondholders at financial institutions. However, they noted that "in the extreme, losses can be so large that the political willpower to continue bailing out banks and insurance companies evaporates, forcing senior creditors to share in losses or producing other unorthodox outcomes."
At AIG, bonds of the insurance giant's subsidiaries last week traded at prices ranging from 38 cents on the dollar to around 81 cents, from more than 50 cents on the dollar a month ago, according to data from MarketAxess. As AIG's bailout package has swelled to over $170 billion from $85 billion last September, investors have grown worried that future restructurings could cause cash generated by AIG's units to be diverted to pay off the government before its bondholders, say analysts. Responding to such concerns in an earnings call last week, AIG's chief restructuring officer, Paula Reynolds, said, "There is no plan here to breach any covenants of the debt we have in place."
Long-term bonds of triple-A rated General Electric Co., which with its GE Capital Corp. unit is the largest U.S. corporate debt issuer, last week dropped to as low as 63.5 cents on the dollar as investors fretted about the possibility of not getting all their money back. GE's chief financial officer, Keith Sherin, tried to dispel those concerns last week, saying GE Capital will be profitable in the first quarter and full year and its capital position is strong. The bonds of Citigroup are trading at just over 70 cents on the dollar, despite its still-high single-A credit rating and government support. Such anomalies make it impossible to accurately determine the value of other bonds in the marketplace without any connection to a government bailout, say analysts and investors.
Traders last week saw multiple offers for blocks of securities for sale, known as "bid lists," circulating in the credit markets, as banks and brokers tried to sell chunks of structured bonds backed by mortgages and corporate debt. Big groups of sales suggest investors are desperate to unload their investments quickly, even if it means getting lower prices than if they waited. Some traders say they only trust securities that have the explicit backing of the government. Bonds issued earlier this year by Goldman Sachs Group Inc. and General Electric without the government's backing have dropped to 96 cents on the dollar and 73 cents on the dollar, respectively, in recent days. Their government-backed debt trades at or close to their full value of 100 cents on the dollar. The government has said it plans to expand its program to lend to investors to buy debt backed by mortgage loans that do not conform to government agency standards. But that market remains frozen.
Mortgage bonds are also falling in value as the government reworks its plans to bail out homeowners. The new bill, called the Helping Families Save Their Homes in Bankruptcy Act, is intended to stem the tide of home foreclosures and reduce homeowners' debt by allowing bankruptcy judges to alter the terms of mortgage loans. The alterations mean some of the securities tied to those loans will suffer losses, and their ratings could be slashed. Bank of America Securities estimates the bill could affect holders of some $500 billion of mortgage securities who believed they were protected by holding the highest-rated portions of the bonds.
Some of these investors are now trying to unload their stakes in order to avoid massive losses or write-downs.
Germany at odds with U.S. over crisis
Germany may be at the heart of any European response to a weakening world economy, but Germany's heart is not in it. As world leaders gear up for a London summit meeting on April 2 where they are supposed to settle upon a coordinated response to the global economic crisis, conflict is brewing between Europeans who see tighter regulation of a skewed financial system as the main task ahead and Americans who are focused on the more immediate challenge of countering the acute dropoff in economic activity across the globe. The differences between Europe and the United States are most evident in Germany, where years of growth fueled by a mighty manufacturing base and a deep-seated suspicion of financial capitalism has spurred a powerful resistance to the Keynesian-style deficit-spending favored in Washington.
As the United States pushes to ensure that governments around the world are spending enough to replace the demand that has evaporated as U.S. consumers lead a global retrenchment, Germany is sticking to the relatively modest stimulus it has already approved. "The German approach is going to be 'let's wait on what we have already done,"' said Peter Bofinger, a professor of economics at the University of Würzburg and a critic of the government's reluctance to spend more. This weekend, finance ministers and central bankers from the Group of 20 industrialized nations and big emerging markets will meet in London to smooth the way for the summit of prime ministers and presidents in early April. On this side of the Atlantic, Chancellor Angela Merkel of Germany plans to huddle with President Nicolas Sarkozy of France on Thursday to formulate a European negotiating position. The next day, Merkel will retreat to the English countryside to meet with Prime Minister Gordon Brown of Britain.
But Merkel, who had been expected to follow Brown to Washington to meet with President Barack Obama in advance of the summit, has not yet announced any plans to do so. With France and Germany also somewhat at odds over how to respond to the economic crisis, the British-German entente has emerged as a new twist in international economic policy. When Germany tried to put hedge fund regulation on the agenda two years ago, Britain sided with the administration of George W. Bush in opposing the idea. But two weeks ago at a meeting in Berlin, Brown lined up alongside Merkel and Sarkozy in demanding close regulation of the financial sector. "These reforms, which I have been calling for some time and before the global meltdown, are crucial," Merkel said. "It is about introducing transparency into the system."
Merkel's government pushed through a €50 billion, or $63 billion, stimulus package in early January, but that still fell short of the demands from both outside the country and inside among a number of prominent economists to do more. Germany is not the only country in the world leery about cranking up spending. Japan is also watching its export machine falter, but a dysfunctional political system and already very high public debt levels limit the response there. In Germany, the lack of palpable effects of the economic crisis for ordinary Germans, along with a deep-seated mistrust of running up debt appears to be reinforcing the government's opposition to doing more, analysts said. And Germany is only now beginning to debate whether its export-heavy economic model might need to change in favor of greater demand at home.
Political developments have also left Merkel with little room to maneuver. With elections due in September she is loath to go on a massive spending spree; the opposition Free Democrats, which she hopes to lure into a conservative coalition after the election, will accuse her of trying to buy votes. Then there is the pressure from inside her own party, which is uneasy with bailouts and heavy spending. Some of the regional politicians broke silence over the past few days by criticizing Merkel's lack of clear leadership. There is broad support for thrift in Germany because of its history. Savings were wiped out by policies that created hyperinflation in the 1920s and left it with another worthless currency after World War II. Since then, German economic policy, across party lines, has been about assuring stability - even if that means accepting slower growth or higher unemployment.
Merkel's main argument is that if Germany, the biggest economy in Europe, were pushed to spend more to stimulate the economy, it might drag down the Continent over the long term by miring it in heavy debts that would require even higher taxes. That, German officials said, is something that the United States seldom appreciates.
At the same time, Germans warn, it would encourage more profligate countries - Greece, Italy and Spain are often mentioned in this context - from making the hard choices that brought the German budget nearly into balance before the crisis. "We did our homework," said Kurt Lauk, chairman of the economic council in Merkel's center-right Christian Democrats party. "That creates a bad mood of sorts within Europe."
On its face, Germany looks hard hit by the crisis, and the government expects the economy to contract by 2.25 percent in 2009, its worst showing in the post-war period.
Dig a little deeper, though, and the situation, to Germans anyway, looks less dire. German unemployment, reflecting fat orders to manufacturers and recent changes that made labor laws a bit more supple, has barely risen so far. In February it ticked up slightly to 7.9 percent. Still, with energy costs off their peaks of the summer, and food prices - a source of much complaint in Germany - also down, the mood among German consumers has remained surprisingly upbeat. That stands in sharp contrast to their U.S. and British counterparts. "The Germans have an economic crisis," said Wolfgang Twardawa, a consumer analyst at the research firm GfK, "but they don't have a financial crisis, and they certainly don't have a property crisis." Twardawa said he believed the German government would end up passing another stimulus plan, but only after national elections in September.
The idea that Germans need to spend more is also sensitive in Germany because it casts doubt on the viability of the country's economic model. After German unification in 1990, manufacturers in the country rapidly lost competitiveness as labor costs spiraled out of control and their products lost once-sterling reputations. They responded in the late 1990s with aggressive cost-cutting that included stringent limitations on wage increase, and a new generation of world-class products. The mixture made Germany the world's largest merchandise exporter - "export world champion," in the German press. But workers' wages stagnated and retailers in Germany suffered from weak demand. "For the Germans to turn around and say there is no point in stimulating domestic consumption because our economy is export-oriented makes no sense from their own perspective or a broader international one," said Simon Tilford, chief economist at the Center for European Reform in London. "The crisis has graphically exposed the limits of the German economy model."
U.S. Downturn Dragging World Into Recession
The world is falling into the first global recession since World War II as the crisis that started in the United States engulfs once-booming developing nations, confronting them with massive financial shortfalls that could turn back the clock on poverty reduction by years, the World Bank warned yesterday. The World Bank also cautioned that the cost of helping poorer nations in crisis would exceed the current financial resources of multilateral lenders. Such aid could prove critical to political stability as concerns mount over unrest in poorer nations, particularly in Eastern Europe, generated by their sharp reversal of fortunes as private investment evaporates and global trade collapses.
In its report, released ahead of a major summit of finance ministers in London this week, the World Bank called on developed nations struggling with their own economic routs to dedicate 0.7 percent of the money they spend on stimulus programs toward a new Vulnerability Fund to help developing countries. The report predicted that the global economy will shrink this year for the first time since the 1940s, reducing earlier estimates that emerging markets would propel the world to positive growth even as the United States, Europe and Japan tanked. The dire prediction underscored what many are calling a mounting crisis within a crisis, as the downturn that started in the wealthy nations of the West washes over developing countries through a pullback in investment, trade and credit. Despite the United States' position as the epicenter of the crisis, investors are flocking to U.S. Treasury bills and the dollar, squeezing developing nations out of global credit markets.
"We need to react in real time to a growing crisis that is hurting people in developing countries," World Bank President Robert B. Zoellick said in a statement. Action is needed by governments and multilateral lenders "to avoid social and political unrest," he said. The report said that 94 out of 116 developing countries have been hit by economic slowdowns. The World Bank projected that the economic crisis will push around 46 million people into poverty in 2009 through job and wage cuts, as well as declining flows of remittances, the money that foreign workers send to their families. Net private capital flows to emerging markets are plunging, set to fall to $165 billion this year -- or 17 percent of their 2007 levels. Falling demand in the West is sparking the sharpest drop in world trade in 80 years, sending sales of the products and commodities of poorer nations spiraling down, the report said.
That decline is touching off a wave of job losses. Cambodia has lost 30,000 jobs in the garment industry. In India, more than half a million jobs vanished in the last three months of 2008, including cuts in the gem, jewelry, auto and textile industries, according to the World Bank. As a result, the report estimates that at least 98 countries may have problems financing at least $268 billion in public and private debt this year. It noted a worsening in market conditions could raise that figure as high as $700 billion. Additionally, only one quarter of vulnerable developing countries, the World Bank said, have the ability to launch their own stimulus programs or to independently finance measures such as job-creation or safety-net programs.
To help them, multilateral lenders will need to dig deep. The World Bank remains well financed and is positioned to almost triple spending to $35 billion this year. But it warned the scope of the need in the developing world will exceed the combined ability of major multilateral lenders, and it called on governments in major nations and the private sector to pitch in more. For instance, its sister organization, the International Monetary Fund, recently received $100 billion more from Japan but is still asking more affluent nations to come up with an additional $150 billion to replenish its rapidly diminishing funds. While the World Bank aims to reduce global poverty largely through long-term projects in the developing world, the IMF is charged with offering bigger, more immediate bailouts to countries on the verge of economic collapse. The list of countries fitting that description has soared in recent months.
In November alone, the IMF parceled out $50 billion to nations in crisis -- the most the institution has ever spent in a single month. With more nations, particularly in Eastern Europe and Central Asia, facing serious trouble, the IMF is preparing to hand out tens of billions more. It is hoping to raise more funds from Western nations and other cash-rich countries such as China and those in the Middle East. The concern now, however, is that the scope of the crisis may be so vast that even an extra $150 billion may not enough. Some fear that nations in Western Europe such as Austria, Ireland and Spain -- believed to have graduated from IMF lifelines decades ago -- may soon require bailouts, taking funds that would have been spent on poorer nations. It could also prove difficult to raise more money from hard-hit countries including the United States and Britain, where politicians and citizens may decide that charity begins at home. "I'm worried about what happens when you see that a Greece or an Ireland that might need bailouts," said Simon Johnson, an MIT economics professor and former IMF chief economist. "Where is the money going to come from?"
A Rising Dollar Lifts the U.S. but Adds to the Crisis Abroad
As the world is seized with anxiety in the face of a spreading financial crisis, the one place having a considerably easier time attracting money is, perversely enough, the same place that started much of the trouble: the United States. American investors are ditching foreign ventures and bringing their dollars home, entrusting them to the supposed bedrock safety of United States government bonds. And China continues to buy staggering quantities of American debt. These actions are lifting the value of the dollar and providing the Obama administration with a crucial infusion of financing as it directs trillions of dollars toward rescuing banks and stimulating the economy, enabling the government to pay for these efforts without lifting interest rates.
And yet in a global economy crippled by a lack of confidence and capital, with lending and investment mechanisms dysfunctional from Milan to Manila, the tilt of money toward the United States appears to be exacerbating the crisis elsewhere. The pursuit of capital suddenly seems like a zero sum game. A dollar invested by foreign central banks and investors in American government bonds is a dollar that is not available to Eastern European countries desperately seeking to refinance debt. It is a dollar that cannot reach Africa, where many countries are struggling with the loss of aid and foreign investment. "Virtually all of the low-income countries are in very serious trouble," said Eswar Prasad, a former official at the International Monetary Fund and a senior fellow at the Brookings Institution, the liberal-leaning research organization in Washington.
He went on: "This is the third wave of the financial crisis. Low-income countries are getting hit very hard. The flow of private capital to the emerging market has dried up."
Private money invested in so-called emerging countries plunged from $928 billion in 2007 to $466 billion last year and is likely to fall to $165 billion this year, according to the Institute of International Finance. Not that the United States is enjoying a great influx of money. Globally, investors are holding tight to cash and extracting it as quickly as they can from risky ventures. In the United States, investments by foreigners have slowed markedly. But as Americans eschew foreign deals and keep their dollars at home, and as foreign central banks — especially China — buy Treasury bills, the United States is absorbing money that used to be scattered around the globe. And that is making money tighter elsewhere in the world.
The most immediate crisis appears to be in Eastern Europe, where investors borrowed exuberantly in foreign currencies — notably the euro and the Swiss franc — using those funds to build office towers and factories. Their debts are growing as their currencies decline in value, leading to bank losses and requiring government bailouts along with aid from the I.M.F.. Economists liken this episode to the financial crisis that assaulted much of Asia in the late 1990s. Then, as now, investors borrowed in foreign currencies. When investment left the region, local currencies plummeted, particularly in Thailand and Indonesia, setting off defaults and sowing job losses and poverty. "Eastern Europe looks incredibly similar to Asia in the 1990s," said Brad Setser, an economist at the Council on Foreign Relations in New York.
In one key regard, this crisis is more problematic: In the 1990s, the rest of the global economy was growing vigorously. Once danger abated, Asian countries were able to resume growth by selling goods to the United States, Europe, Japan and China. Indeed, the very plunge in currencies that precipitated the crisis also provided a fix, making Thai, Malaysian, Indonesian and Korean goods that much cheaper on world markets. This time, as many low-income countries again see their currencies fall, they are confronting a world beset by recession, in which demand for their products is weak and falling. In a report released Sunday, the World Bank predicted that the global economy would shrink in 2009 for the first time in more than half a century and forecast that global trade would decline for the first time since the early 1980s.
"Depreciation isn’t enough now to offset the global contraction," said Mr. Setser, noting that export powers like Japan, Korea, Taiwan and Brazil have had rapid declines in sales in recent months. "Everybody’s looking vulnerable. All commodity exporters are potentially subject to currency crises." Fears are growing that a much broader group of countries will plunge into trouble. Mr. Prasad’s list of potential danger zones includes Vietnam, the Philippines, Malaysia and Indonesia, as well as Pakistan and Ecuador. In the Asian financial crisis, countries at the center of the storm were particularly vulnerable because the values of their currencies were mostly pegged to the dollar. Once central banks ran out of dollars to exchange for their own currencies, they lost their ability to influence the exchange rate. As a result, their currencies fell, turning already large debts into impossible debts.
Many more countries now allow their currencies to float with the whims of the market, removing this grim chain of events. Still, as economic activity slows and banks are stuck with larger losses, the damage could swell beyond the ability of governments to finance bailouts, said Kenneth S. Rogoff, a former chief economist at the I.M.F. and now a professor at Harvard. "Debt collapses are going to wreak havoc with exchange rates," Mr. Rogoff predicted. "A lot of countries in Europe are already on the brink of default." Only two years ago, many analysts were suggesting that the I.M.F. — created more than 60 years ago to rescue countries in financial distress — no longer had a clear reason to exist. Now, the fund is scrambling for contributions from developed nations to bolster its $350 billion war chest. Mr. Setser suggested it needed $1 trillion for all that might yet unfold.
Because worries are deeper nearly everywhere else, the United States and the dollar have essentially benefited from the worldwide panic. In the last year, the dollar has risen 13 percent against major foreign currencies after adjusting for inflation, according to Federal Reserve data. Foreign holdings of Treasury bills rose by $456 billion in 2008. "It’s a huge safe haven effect," said William R. Cline, a senior fellow at the Peterson Institute for International Economics in Washington. "The basic assumption that people are making is that the U.S. government will never default on its debt." As the dominant flavor of money used in business worldwide, the dollar has once again been affirmed as the global reserve currency.
Only last year, some analysts said that as the American economy sagged, foreign central banks would be reluctant to sink national savings into the dollar. That has been soundly debunked. In ordinary times, the rise of the dollar would provoke American worries that it would crimp exports by making goods more expensive on world markets. But for American policy makers, what matters now is attracting enough buyers of American debt to finance the rescue plans, and if the dollar must rise along the way, that is a cost worth paying. "The fact that we can still borrow at lower interest rates is saving us from much more severe adjustments," Mr. Rogoff said. "We’re really still staring down an abyss."
An L of a recession – reform is the way out
The US is dragging its feet over the financial sector. The European Union is doing the same, as well as failing to adopt policies that could shield it from an increasingly probable speculative attack. And judging by the state of preparations, the forthcoming Group of 20 summit is going to be a disaster. So it looks like it is going to be an L – not a V or a U. I mean an L-shaped recession, one that starts with a steep decline, followed by very low growth for many years. In a V-type recession, the recovery is instant. In a U-type, it comes eventually. My guess is that we are currently somewhere in the middle of the vertical bit of the L, but it is the horizontal bit that is the scariest. History never repeats itself exactly, but we know from economic history that financial crises are surprisingly similar. This looks like Japan all over. Without financial restructuring, the economy is not going to recover. And Japan was lucky. It was surrounded by a booming global economy.
The best way to fight such a disaster is to restructure the banking system and provide short-term economic stimulus through monetary and fiscal policy. Speaking at a recent Aspen Italia conference in Rome, Martin Feldstein, a former economic adviser to Ronald Reagan and president of the National Bureau of Economic Research, estimated that US consumer spending would fall by $500bn (€395m, £355bn) annually, and construction spending by $250bn. Against this combined annual $750bn shortfall, the current stimulus package is woefully inadequate. In other words: we are looking at an L. An L-shaped recession will make the adjustment of balance sheets even more painful. Unemployment will continue to rise. House prices will keep on falling. US consumers and banks will spend the next five or more years deleveraging, getting their respective balance sheets back in order. In that period, the US current-account deficit will fall sharply, as will that of the UK, Spain and several central and eastern European countries. This process can take a long time, and in an L-shaped recession it takes longer.
But the effect is also brutal on the rest of the world. The fall in current-account deficits will be partially compensated for by lower surpluses from oil and gas exporters, such as Middle Eastern countries and Russia. But the bulk of the adjustment would be borne by the world’s largest exporters: Germany, China and Japan. Globally, current-account deficits and surpluses add up to zero – minus some statistical reporting errors. You can do the maths. If the US stops buying German cars, Germany will eventually stop making them. If we had a simple U-shaped recession, we would still have a painful recession in Germany and Japan, for example. But under a U-shaped scenario, both countries would be among the first to benefit from the recovery.
In an L-shaped recession, however, recession gives way to depression, despite the fact that both countries thought they had done their "homework". If nobody can afford to run a large deficit for a long time – which is what an L recession effectively implies – the economic models of Germany and Japan will no longer work. Germany had a current-account surplus of more than 7 per cent last year. It is the world’s largest exporter. Exports constitute about 41 per cent of national gross domestic product – an extraordinary number, given the size of the country. So what should these countries do? The right policy response would be to reduce the dependency on exports and undertake structural reforms that facilitate the shift towards non-tradable goods. These are not the same type of structural reforms as those of the past, involving cost-cutting and improving competitiveness. This is about flexibility and mobility.
Unfortunately, the opposite is happening. Germany is clinging to its export model like a drug addict. An example is the debate about the future of Opel, the European car manufacturing subsidiary of General Motors. Opel is unlikely to survive without help from the government. The proponents of a state bail-out of Opel argue that the company is systemically relevant. This argument is obviously wrong. There can be systemically relevant banks, but there can be no systemically relevant carmakers. But the answer is also revealing. What it means is that Opel is systemically relevant for the country’s export-oriented model. The bail-out adherents are clinging to an industrial structure that has no hope of survival in an L-shaped world.
To her credit, Angela Merkel, the German chancellor, seems reluctant to agree to the bail-out, as is her party. But pre-election politics will make a bail-out of some sort likely. It is terrible economics. The problem is not even the waste of taxpayers’ money. Combined with French car subsidies, such a decision will contribute to massive overcapacity in the sector and will slow down the economy’s adjustment to the export shock. We are nowhere near a solution to the crisis. After committing errors of omission, global leaders are now producing errors of commission. The Americans dream about a return to a world of credit finance consumption while the Germans dream about assembly lines. In an L-shaped world, these are nightmares.
Marc Faber Says Government Actions Will Spur Spring Rally
Government spending will spur gains in the Standard & Poor’s 500 Index after it fell 56 percent from an October 2007 record, investor Marc Faber said. "Equities could rally between here and the end of April," Faber said in an interview with Bloomberg Television. "The government’s efforts will fail to boost economic activity. They can boost stocks. Stocks have adjusted meaningfully." Faber said that although the S&P 500 may drop 27 percent to below 500 before the bear market ends, investors will make money over the next 10 years.
Congress last month enacted President Barack Obama’s $787 billion package of tax cuts and spending on roads, bridges and public buildings. His 2010 budget indicated the government may devote another $750 billion to a financial rescue after an initial $700 billion. The S&P 500 dropped 56 percent from an Oct. 9, 2007, record, dragged down by $1.2 trillion in losses at financial firms worldwide from the collapse of the subprime mortgage market. The benchmark for American equities lost 38 percent last year, its biggest annual decline since 1937.
Industrial commodities are more attractive than gold, Faber said, after bullion rallied 6.3 percent this year, compared with a 9.1 percent decline for the Reuters/Jefferies CRB Index of 19 materials. Faber, the publisher of the Gloom, Boom & Doom report, advised buying gold at the start of its eight-year rally, when it traded for less than $300 an ounce. The metal topped $1,000 last year and traded at $932.78 an ounce today. He also told investors to bail out of U.S. stocks a week before the so-called Black Monday crash in 1987, according to his Web site.
Roubini Says S&P 500 May Drop to 600 as Recession Intensifies
The Standard & Poor’s 500 Index is likely to drop to 600 or lower this year as the global recession intensifies, said Nouriel Roubini, the New York University professor who predicted the financial crisis. His forecast represents a 12 percent retreat from the March 6 closing level for the benchmark index for U.S. stocks. His estimate assumes companies in the S&P 500 will report profit of $50 a share this year and investors will pay 12 times that for equities. "My main scenario is that it’s highly likely it goes to 600 or below," Roubini said today in an interview at the Chicago Board Options Exchange Risk Management Conference in Dana Point, California.
A level of "500 is less likely, but there is some possibility you get there." The S&P 500 has dropped 25 percent to 680.04 in 2009, its worst start to a year, following a 38 percent decline in 2008 that was the steepest annual retreat since 1937. "Even if you do everything right with fiscal and monetary policy, we’re still going to be in a recession through the end of this year and into next year," Roubini said earlier during his speech at the options-industry conference. "The recession train left the station over a year ago, and it’s going to continue."
Warren Buffett says economy fell off a cliff
Billionaire Warren Buffett said the economy has "fallen off a cliff" over the past six months and consumers have changed their habits in remarkable ways.
Buffett said Monday during a live appearance on CNBC that current economic turmoil has basically followed the worst-case scenario he envisioned. "It's fallen off a cliff," Buffett said. "Not only has the economy slowed down a lot, but people have really changed their habits like I haven't seen." Buffett said the changes are reflected in the results of Berkshire Hathaway Inc.'s subsidiaries. He said Berkshire's jewelry companies have suffered, but more people have been willing to switch to Geico to save money on car insurance.
He predicted that unemployment will likely climb a lot higher before the recession is done, but he also reiterated his optimistic long-term view: "Everything will be all right. We do have the greatest economic machine that's ever been created." Fear and confusion have been driving consumer and investor behavior in recent months, Buffett said. The nation's leaders need to clear up the confusion before anyone will become more confident, and he said all 535 members of Congress should stop the partisan bickering about solutions. Buffett said he believes patriotic Republicans and Democrats will realize the nation is engaged in an economic war. "What is required is a commander in chief that's looked at like a commander in chief in a time of war," Buffett said.
A little over a week ago, Buffett released his annual letter to shareholders describing the worst of his 44 years at the helm of Berkshire. The Omaha, Neb.-based company reported sharply lower profit because of its largely unrealized $7.5 billion investment and derivative losses. Overall, Berkshire's 2008 profit of $4.99 billion, or $3,224 per Class A share, was down 62 percent from $13.21 billion, or $8,548 per share, in 2007. Berkshire's fourth-quarter numbers were even worse. Buffett's company reported net income of $117 million, or $76 per share, down 96 percent from $2.95 billion, or $1,904 per share, a year earlier. Buffett said he doesn't regret writing an editorial last fall encouraging people to buy U.S. stocks, but he joked that in hindsight he wishes he'd waited a few months to publish the piece. Since that editorial appeared on Oct. 17, the Dow Jones industrial average has fallen from 8,852.22 to close at 6,626.94 on Friday.
Buffett stands by his overall advice that over time owning stocks will be better than so-called safe investments. "Overall, equities are going to do far better than U.S. government bonds at these prices," he said. Buffett said he doesn't regret investing $8 billion of Berkshire's money in investment bank Goldman Sachs Group Inc. and conglomerate General Electric Co. last fall. Both companies gave Berkshire preferred shares paying 10 percent interest that Buffett said he doesn't think he could get now. Berkshire owns a diverse mix of more than 60 companies, including insurance, furniture, carpet, jewelry, restaurants and utility businesses. And it has major investments in such companies as Wells Fargo & Co. and Coca-Cola Co.
Buffett Buffs Up His Banks
Warren Buffett offered a plug for Wells Fargo and US Bancorp., two of biggest losers in Berkshire Hathaway's equity portfolio In an interview with CNBC Monday, Buffett suggested that Wells Fargo could earn over $4 a share "in a few years" and said that prospects for Wells Fargo and US Bancorp "three years out are better than ever. They will come out fine." Buffett said that Wells Fargo's earnings power, before provision for loan losses, is $40 billion in a few years, and that provisions could run at $10 billion to $12 billion. This suggests about $28 billion in earnings power before taxes, or about $4.30 a share. This estimate is in line with Street estimate of Wells' earnings power in 2011 or 2012 in a more normal economic and credit environment. Buffett said his estimate didn't come from management. Wells Fargo is expected to earn $1 to $1.50 a share this year.
Wells Fargo shares are up 1.06, or 12.31%, to 9.67 Monday morning, helped by the Buffett comments but still are down 68% this year. Berkshire owned 304 million shares of Wells Fargo at year-end. US Bancorp shares are up 88 cents, or 10%, at 9.70 but are down 66% this year. Meanwhile, Berkshire's A shares are off 795, to 72,4000, a drop of 1.09%. The B shares (BRKB) are down 27, or 1.16%, to 2300. Buffett said Wells Fargo and US Bancorp are earning "enormous" spreads in part because of "bargain-rate money." He said the biggest risk with both institutions is that the government forces them to sell equity at depressed prices, diluting existing holders.
Wells Fargo last week cut its quarterly dividend to five cents a share from 34 cents in a bid to boost its capital. The move will provide about $5 billion annually of additional common equity. There has been concern that the bank's tangible common equity ratio, which stood at 2.86% at year-end, is too low. Most regional banks have ratios of 4% or more and many think regulators are starting to target a ratio of about 4%. There has been concern on Wall Street that Wells Fargo may have to raise common equity, diluting existing holders. Wells Fargo argues that its common equity ratio is understated because it has significantly marked down mortgages that it acquired as part of its deal to buy Wachovia in late 2008.
Fed Reiterates No Losses Seen on Rescues of AIG, Bear Stearns
The Federal Reserve reiterated it doesn’t expect U.S. taxpayer losses on the rescues of American International Group Inc. and Bear Stearns Cos. even after declines in assets the central bank acquired from the companies. The Fed made the statements Feb. 25 in its second bimonthly report to Congress on the central bank’s use of emergency-lending authority. The report was posted on the Fed’s Web site today. The periodic reports are required under a provision of the $700 billion financial-rescue legislation passed in October.
The Fed agreed in March 2008 to take on a $30 billion portfolio of "less liquid" assets to spur the purchase of Bear Stearns by JPMorgan Chase & Co. While the portfolio’s value has since declined to $25.9 billion, the Fed doesn’t expect a "net loss" to itself or taxpayers in part because the securities can be sold over a 10-year period to repay a $28.8 billion Fed loan. With AIG, the insurer bailed out in September, the central bank expects "full repayment by AIG of all of its Federal Reserve borrowing," the Fed said. The report doesn’t reflect changes to the AIG rescue announced March 2, including $30 billion in fresh capital from the Treasury. The modifications give the Fed rights to the cash flow from tens of thousands of life insurance policies, valued at about $8.5 billion.
The revisions bring total taxpayer aid to about $160 billion, which also includes a $40 billion investment from the Treasury’s Troubled Asset Relief Program. The Fed said in the Feb. 25 report it doesn’t foresee losses in part because of the "substantial assets and operations supporting repayment" by AIG. The company said in a Feb. 26 presentation to regulators that failing to save AIG again could cripple money-market funds, force European banks to raise capital, cause competing life insurers to fail and wipe out the taxpayers’ stake in the firm.
Summers calls for boost to demand
Barack Obama’s top economic adviser has urged world leaders to pump more public money into the economy in a co-ordinated effort to boost demand and lift the world out of recession. In an interview with the Financial Times, Lawrence Summers said the urgent need for a short-term increase in spending by governments temporarily overrode the longer-term goal of tackling the global imbalances many economists believe caused the financial crisis. The US administration had no choice but to take strong public action to "save the market system from its own excesses", he said.
His comments, ahead of next month’s crunch G20 summit in London, make it clear that the US administration wants industrialised nations to share responsibility for engineering a global demand-led recovery and does not believe this burden should fall on China alone. "The old global imbalances agenda was more demand in China, less demand in America. Nobody thinks that is the right agenda now," said Mr Summers. "There’s no place that should be reducing its contribution to global demand right now. It is really the universal demand agenda."
While the US and other western nations should return to living within their means in the medium term, everyone should raise spending sharply now. "The right macro-economic focus for the G20 is on global demand and the world needs more global demand," said Mr Summers. Widely seen as being among the most pro-market voices in the White House, having been Bill Clinton’s last Treasury secretary in the 1990s, Mr Summers said the view that the market was inherently self-stabilising had been "dealt a fatal blow". At a time when the Republican critique of Washington’s aggressive response to the crisis is growing more trenchant, Mr Summers made an unapologetic case for government intervention.
"This notion that the economy is self-stabilising is usually right but it is wrong a few times a century. And this is one of those times: there’s a need for extraordinary public action at those times." Mr Summers’ influence in the White House is central, particularly given the difficult start to the tenure of Tim Geithner, Treasury secretary, whose nomination was overshadowed by the revelation that he failed to pay more than $34,000 dollars of taxes on time. He put up a robust defence of the administration’s focus on tackling historically high rates of inequality in the US. But he insisted the underlying aim should be to restore the capitalist market system to health.
Task Force Visits Detroit As Deadline Looms on Aid
President Barack Obama's auto team will spend Monday at the Detroit home of the Big Three as the administration begins to narrow its options for helping the reeling auto sector. The field trip wraps up nearly three weeks of fact gathering by the team since General Motors Corp. and Chrysler LLC submitted their rescue plans to the Treasury Department in the hopes of winning billions more in government loans. Ford Motor Co. is not seeking government aid. Top Treasury Department advisers Steven Rattner and Ron Bloom, who are leading the auto task force, plan to use the day in Detroit to clarify an array of lingering questions surrounding the companies' rescue plans, which many analysts have criticized as overly optimistic. The team will also meet with the United Auto Workers union to discuss its willingness for deep compromises over wages, staff cutbacks and funding for its retiree health plan.
While in Detroit the auto team plans to tour production and engineering facilities and to test drive the Chevy Volt, GM's electric car that is the centerpiece of its technology push. The visits will feature the GM Technical Center and the Chrysler Dodge Truck Center. The team will then hold discussions with GM and Chrysler officials, as well as top representatives from the UAW. The weeks ahead are filled with peril for both the White House and the auto makers as administration officials face a March 31 deadline for deciding whether to give the companies nearly $22 billion more in federal assistance. Political pressure is mounting against an open-ended bailout of GM and Chrysler, with strong support in many quarters for the companies to reorganize through bankruptcy. But with the nation's unemployment rate now over 8%, President Obama and his team are wary of undermining the UAW and sending another economic shockwave through the heart of the country's industrial belt.
The last few weeks have served as a crash course for the Obama auto advisers, none of whom have past experience in the car industry. Mr. Bloom came to the Treasury after years advising the United Steelworkers union, while Mr. Rattner left a lucrative career as a financier and co-founder of the private-equity firm Quadrangle Group. The sector's woes are worsening rapidly, stirring concern that the administration may have to decide before March 31 whether to offer credit assistance to the country's wobbly auto dealers and parts suppliers. Car sales in the U.S plunged by more than 40% in February. GM took a major step Sunday toward securing up to $5 billion in aid from Canada after winning concessions on wages, pension payments and health care from the Canadian Auto Workers union. The CAW was forced to the bargaining table after the Canadian government said it would not help GM without union concessions and GM threatened to pull its operations out of the country without a deal.
GM executives are fighting to persuade the auto task force that reorganization outside of bankruptcy is the ideal path. Even though these executives are confident they could survive a short, pre-arranged bankruptcy filing, they argue such a move would be risky because of the danger customers and business partners would lose faith with the company. In discussions with the auto panel, members of GM's bondholder committee and UAW representatives have argued against the bankruptcy. Instead, the three parties are looking to restructure tens of billions in health-care obligations and unsecured debt before March 31. Support for a court-led reorganization is building among Republicans on Capitol Hill. Arizona Sen. John McCain said on Fox News Sunday that "the best thing" for General Motors would be to reorganize through Chapter 11 bankruptcy so the company could "come out of it a stronger, better, leaner and more competitive automotive industry." Since first appealing to Congress late last year for about $18 billion in bridge loans, the automaker's condition has deteriorated amid plunging sales. GM's auditors on Thursday raised concerns in the company's annual report about GM's ability to survive shy of bankruptcy.
AIG Warned U.S. Failure Would Cripple World's Banks, Money Funds, Insurers
American International Group Inc. appealed for its fourth U.S. rescue by telling regulators the company’s collapse could cripple money-market funds, force European banks to raise capital, cause competing life insurers to fail and wipe out the taxpayers’ stake in the firm. AIG needed immediate help from the Federal Reserve and Treasury to prevent a "catastrophic" collapse that would be worse for markets than the demise last year of Lehman Brothers Holdings Inc., according to a 21-page draft AIG presentation dated Feb. 26, labeled as "strictly confidential" and circulated among federal and state regulators. "What happens to AIG has the potential to trigger a cascading set of further failures which cannot be stopped except by extraordinary means," said the presentation by New York-based AIG. "Insurance is the oxygen of the free enterprise system. Without the promise of protection against life’s adversities, the fundamentals of capitalism are undermined."
Regulators revised AIG’s bailout last week to ease loan terms and extend $30 billion in fresh capital after the firm posted a $61.7 billion fourth-quarter loss, the worst in U.S. corporate history. Lawmakers are reluctant to give more support beyond the package already in place, worth about $160 billion, because they say regulators haven’t given enough detail about how the funds are being used or when the bailouts will end. The Fed is "asking for an open-ended check" and is "not going to get" it, Senator Robert Menendez, a New Jersey Democrat, said last week in Congressional hearings. AIG warned of turmoil around the globe if the government allowed the insurer to fail, adding "it is questionable whether the economy could tolerate another shock to the system that a failure of AIG would produce."
The value of the U.S. dollar might fall, Treasury borrowing costs could rise and the agency would face "doubts about the ability of the U.S. to support its banking system," according to the presentation, parts of which were reported earlier by the New York Times. Under the scenarios sketched by AIG, European banks that bought credit-default swaps might need to raise $10 billion in capital and could face rating downgrades. Life insurance customers, their faith shaken in the industry, would redeem some of their $19 trillion in U.S. policies, overwhelming firms already weakened by the credit crisis, AIG said. The $38 billion in support provided by the firm to money- market funds would be in jeopardy, AIG said, possibly forcing some to "break the buck." The term refers to a money fund that suffers losses so large that it must pay investors less than the traditional $1-a-share value that gives the short-term funds their reputation for safety.
Outside the U.S., where AIG operates in more than 140 countries, a collapse could lead to the "immediate seizure" of its businesses by regulators and could impair "the entire insurance industry within certain regions," the presentation said, which added that its conclusions were "speculative" and a matter of judgment. "Who knows if what they’re saying is true?" said Phillip Phan, professor of management at the Johns Hopkins Carey Business School in Baltimore. "A lot of it sounds like conjecture, that if AIG collapses the rest of the industry will, too. It’s a way of creating a crisis atmosphere and the sense you have to respond quickly." AIG’s latest rescue package includes equity, new credit and lower interest rates on existing loans designed to keep it in business. Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner have said the government must prop up AIG to avoid damaging the financial system.
Fed spokeswoman Michelle Smith said the central bank "came to its conclusions based on our own analysis." Christina Pretto, an AIG spokeswoman and Isaac Baker of the Treasury didn’t immediately have a comment. Billionaire Warren Buffett, appearing on CNBC today, said the bailout of "quasi-financial" firms like AIG was necessary, even if everyone dislikes what had to be done to salvage it. New York Insurance Superintendent Eric Dinallo said at a March 5 hearing he’d received the presentation. The document doesn’t say which other companies have benefited from AIG’s repeated rescues. Goldman Sachs Group Inc. and Deutsche Bank AG were among at least two dozen financial institutions that were paid $50 billion from the bailout funds received by AIG, the Wall Street Journal reported, citing a confidential document and people familiar with the matter whom it didn’t identify.
Goldman and Deutsche got about $6 billion each between September and December, the Journal said. Merrill Lynch & Co., Societe Generale SA, Morgan Stanley, Royal Bank of Scotland Group Plc and HSBC Holdings Plc were other counterparties that also received payments, the newspaper said, citing the document. AIG’s presentation said that without more U.S. help, investment losses would mean "AIG will not be able to repay its obligations" and that cash previously provided by the U.S., which controls a 79.9 percent stake in the insurer, could be lost. Chief Executive Officer Edward Liddy, who took over the top job in September, has vowed that AIG will repay all of its debts to taxpayers.
At AIG itself, failure could have led to dismissals from its workforce of 116,000, the document said. At that level, the staff is unchanged from the end of 2007 before AIG’s bailout. The global credit crunch has led to at least 284,000 job cuts at the rest of the world’s financial companies, according to Bloomberg data. The insurer’s first bailout package, crafted last September, later grew to $150 billion. After failing to sell enough subsidiaries to repay the government, AIG had to turn to U.S. taxpayers again. The company may need more support if financial markets don’t improve, the Treasury and Federal Reserve said last week in a joint statement.
Cuomo, Frank Demand Merrill, Bank of America Bonus Data
New York Attorney General Andrew Cuomo and U.S. Representative Barney Frank demanded Bank of America Corp. immediately disclose 2008 bonus data for all Merrill Lynch & Co. and Bank of America employees who received $1 million or more. Cuomo and Frank, a Democrat from Massachusetts who’s chairman of the U.S. House Financial Services Committee, made their demand in a March 9 letter to Bank of America chairman Kenneth D. Lewis that said his refusal to reveal compensation information "fuels distrust and cynicism." Cuomo has been examining executive pay at banks that received money from the U.S. Treasury’s Troubled Asset Relief Program. Merrill and Charlotte, North Carolina-based Bank of America have received about $45 billion. Bank of America bought Merrill on Jan. 1.
The letter is the latest salvo in Cuomo’s battle with Lewis over the individualized bonus data. In the letter, Cuomo and Frank say Merrill’s $3.6 billion in bonuses and Bank of America’s $3.3 billion should be made public. "Taxpayers who are footing the bill obviously demand accountability and want to know who received these funds and why," the letter said. Scott Silvestri, a spokesman for Bank of America, had no immediate comment about the latest letter. In a court filing last week, Bank of America said it would suffer "grave and irreparable harm" if the Merrill employees and their bonuses were publicly identified.
Cleveland's Commercial Property Delinquencies Signal Coming U.S. Declines
Cleveland and Detroit lead the U.S. in commercial mortgage delinquencies, a sign the housing crisis that brought down Wall Street is spreading beyond the residential market. Office, retail, apartment and industrial properties with mortgage payments 60 days late or more rose to 3.93 percent as of March in the Cleveland area and to 3.75 percent in the Detroit area, according to data compiled by Bloomberg. The North American commercial property delinquency rate is 1.1 percent, according to Standard & Poor’s. "There is really no part of the country being spared," said Robert Bach, chief economist at Santa Ana, California-based broker Grubb & Ellis Co. "Cleveland and Detroit are just the first to feel the stress. They’re the canaries in the coal mine."
The second year of the U.S. recession is reducing demand for commercial real estate after prices hit a record in 2007. The slump in housing and rising unemployment will probably take a toll on retail and office landlords, Bach said. Loans secured by properties that were written assuming rental growth have been unable to meet targets, leading to increased defaults. The delinquency rate for North American commercial real estate loans in mortgage backed securities may triple in 2009 as loans default, Standard & Poor’s credit analyst Eric Thompson said in a Feb. 17 statement. Once-booming housing markets such as Phoenix and Las Vegas are likely next at risk, said Bach. The Phoenix area had the second-highest percentage of 30-day late commercial real estate loan payments among the largest 26 metro areas in the U.S. as of this month, Bloomberg data show.
The owner of the 40-story Tower at Erieview in downtown Cleveland gave notice it would miss a Nov. 1 debt-service payment on a $44.2 million loan because of capital expenses and declining occupancy, according to a Feb. 9 statement by Standard & Poor’s. Payments on the loan, which was packaged with other commercial real estate loans and sold to investors by Bear Stearns Cos., have resumed and the New York-based rating company "expects a minimal loss upon the completion of the workout." JPMorgan Chase & Co., the largest U.S. bank by market value, bought Bear Stearns in a forced sale last year. The property is on a list of distressed assets compiled by research service Real Capital Analytics. Cleveland’s office vacancy rate was 14.8 percent in 2008 and is forecast to rise to 20.4 percent in 2010, according to CBRE Econometric Advisors, part of CB Richard Ellis Group Inc., the largest U.S. commercial real estate broker. A rate above 20 percent would be the highest since 1991, according to Jon Southard, principal at CBRE Econometric.
Cleveland’s unemployment rate was 7.1 percent in December. Ohio’s unemployment rate was 8.8 percent in January as the state lost 214,600 non-farm jobs, including 90,600 in manufacturing and 12,000 in financial services. The Tampa, Florida, area was third in late payments at 2.9 percent in March, according to Bloomberg data. The Pittsburgh region was No. 4 at 2.7 percent and the Riverside, California metropolitan area was fifth at 2.6 percent. For the 26 largest metropolitan areas in the U.S., Bloomberg data covers 32,859 properties that back loans packaged into commercial mortgage- backed securities. In Detroit, iStar Financial Inc. a New York-based financing company, took control of One Detroit Center in 2007 from Houston- based developer Hines as occupancy fell in the tallest office building in Michigan.
The 1-million-square-foot tower’s vacancy rate is 40 percent, according to Real Capital. Detroit’s economy has been hard-hit by job losses in the automobile and auto-parts industries. The area’s office vacancy rate was 22 percent in 2008 and is forecast to rise to 29.2 percent in 2010, which would tie it with Phoenix for the highest rate in the U.S., according to CBRE Econometric Advisors. "There just is no demand," said Jeffrey Bell, a first vice president and broker who specializes in downtown Detroit for Los Angeles-based CB Richard Ellis. Unemployment in the Detroit area was 10.6 percent in December, the highest of 49 metropolitan areas with a 2000 U.S. Census Bureau population of 1 million or more, according to the U.S. Bureau of Labor Statistics. The Detroit area’s foreclosure rate led the U.S. in 2007 and Cleveland was sixth, according to RealtyTrac Inc., an Irvine, California-based seller of default data. By 2008, Detroit had fallen to 10th, and Cleveland tumbled to 24th.
Retail developments across the U.S. from California to Florida are also being hurt as consumers pare spending, leading to loan defaults. A $125.2 million loan backed by the Promenade Shops at Dos Lagos, a more than 350,000-square-foot retail development in Corona, California, in the Riverside region, is in default and payments are four months late, according to Bloomberg data. The shopping center includes a Coach Inc. luxury goods store and clothing retailer Eddie Bauer Inc., according to the development’s Web site. Josh Poag, chief executive officer for the project’s developer, Poag & McEwen Lifestyle Centers, based in Memphis, declined to comment. The Riverside area’s economy is being hurt by rising home foreclosures and surging unemployment. The Riverside-San Bernardino region had the third-highest foreclosure rate in the U.S. in 2008, up from fourth in 2007, according to RealtyTrac. Unemployment was 10.1 percent in December, according to the Bureau of Labor Statistics. The U.S. unemployment rate was 8.1 percent in February.
Tampa’s foreclosure rate was 23rd in 2007 and rose to 13th in 2008. Phoenix was 22nd in 2007 and rose to 5th in 2008. In Maple Heights, Ohio, a suburb southeast of Cleveland where the estimated population was about 24,000 in 2006, times are tough at Southgate USA, a 765,448-square-foot shopping center that’s in foreclosure, according to Bloomberg data. "There’s been a lot of vacancies here at Southgate for a very long time," said Arlene Orlando, the owner of Mining Company Jeweler Gold and Diamond Exchange, a jewelry store that has been in business for 21 years. "The customer base over here is dwindling very quickly." Southgate USA is 39 percent vacant, according to Bloomberg data. A $25.5 million loan backed by the shopping center, with a $21.9 million balance, was bundled with other loans in a commercial mortgage backed security and sold to investors by JPMorgan. A Value City Furniture store, one of the anchors of the mall, shut down, Orlando said. A message left with Southgate USA wasn’t immediately returned. Orlando said she’s never seen business this bad. "This is by far the worst," Orlando said.
Japan's External Deficit Is Worst On Record
Japan Inc. once appeared smart for having investing abroad. Now that those investments have stopped sending profits home, the country’s current account is going into the red. The country registered a January current account deficit of 172.8 billion yen ($1.8 billion), the Ministry of Finance reported Monday. That was the poorest showing ever for the world’s second-largest economy, a trade behemoth. The income surplus component of the current account dropped by 31.5% from the previous year, as falling interest rates abroad and weak profits meant that investments overseas were no longer as lucrative.
As the global economic picture gets gloomier, overseas ventures, into which Japan’s corporate cash flowed in rosier times, are faltering. The yen’s stubborn strength, hovering just below 100 to the dollar, has crippled exports, hurting the country’s biggest companies. Automakers like Toyota Motor, Nissan Motor and Honda Motor have been hard hit, as have consumer electronics manufacturers like Canon, Sony and Toshiba. Japan was a latecomer to the global recession, but the economy has been catching up rapidly to the rest of the beleaguered world. The Nikkei 225 average hit its lowest point in a quarter century on Monday, down 87.07 points, or 1.2%, at 7,086.03. Businesses’ capital expenditures are down, unemployment is rising and public confidence in Prime Minister Taro Aso’s government is at a worrisome low.
The embarrassing resignation last month of Finance Minister Shoichi Nakagawa after an evidently drunken performance at a G-7 summit was just another punch line in the litany of bad humor that is pervading Japan. There is no plan B for Japanese corporate investment strategies. "Given this current turmoil, firms cannot do anything," said Akira Maekawa, senior economist at UBS in Tokyo. "There’s no better place for them to put money." Maekawa expected the current account to return to surplus in February and March but cautioned that the bottom is not in sight: "The global economy’s in very bad shape, so those investments turn out to be miserable."
More bad news: Domestic demand, long considered undernourished in this thrift-conscious nation, is unlikely to pick up the slack. The sleek boutiques that chic foreign luxury purveyors like Louis Vuitton, Tiffany and Gucci built for Tokyo’s moneyed class are largely empty now. Japanese consumers are too scared of losing their jobs to spend freely, now that the era of lifetime employment at big firms is ending. As they did during the 1990’s "Lost Decade," however, budget-minded consumers may be hurting the economy--and ultimately their own finances--even more.
Overvalued euro set to plunge 'within months'
Spread betting companies have reported a huge wave of short euro trades in the last two weeks, leading to speculation that a significant correction in the currency will come in the next few months. Investors take out short trades when they expect a currency to fall. In recent days, futures traders in the US have significantly increased their bets that the euro will fall against the dollar. Data released by the Washington-based Commodity Futures Trading Commission on Friday showed that the "net short position" of trades against the euro by hedge funds and speculators almost doubled in the week to March 3 to 19,431 contracts from 10,081 contracts a week earlier. "Quite a significant correction in the euro is coming in the next few months.
The European Central Bank (ECB) is behind the curve in getting to grips with its economic problems," said David Buik of BGC Partners. He added that the eurozone entered recession later than other economies, but policy-makers had been too slow to act, putting the currency at risk. The global recession means that the euro is facing its strongest test since its launch a decade ago as the less productive countries such as Spain, Greece and Italy have failed to match the efficiency of some of Europe's faster growing economies. Last week the ECB cut interest rates to a record low of 1.5pc and further rate cuts are expected. The ECB now expects that the eurozone economy will contract between 2.2pc – 3.2pc this year, after previously forecasting a fall of zero – 1pc. The pound closed at €1.11 on Friday. The UK has reduced interest rates to 0.5pc to combat the severe slowdown and rates in the US are zero-0.25pc. China, Australia and Japan have also made cuts as they try to prop up their faltering economies.
European lending rates fall as banks pass on ECB cuts
Eurozone businesses and consumers are seeing steep drops in interest rates on their borrowings in a clear sign that banks are passing on cuts announced by the European Central Bank. The significant falls in interest rates on mortgages and lending to business reported on Monday by the ECB support the claim last week by Jean-Claude Trichet, ECB president, that "the transmission mechanism of monetary policy is not significantly hampered". Since last October, the ECB has slashed official borrowing costs by 275 basis points to 1.5 per cent, the lowest since the launch of the euro in 1999. But the ECB has stopped short of embarking on the sort of emergency "credit easing" or "quantitative easing" measures unveiled by the US Federal Reserve or the Bank of England. Instead, the ECB has pointed to the success it has had in bringing down market interest rates since the collapse of Lehman Brothers investment bank last September by supplying banks with unlimited amounts of liquidity at fixed interest rates. Last week, it announced that unlimited-liquidity provision would continue until at least next year.
Julian Callow, European economist at Barclays Capital, said: "The key agent of transmission in the euro area economy is the banking sector. This is different to the US and UK where the securities markets are also very important for financing the non-financial private sector." The ECB would take comfort, he argued, from the fact that "official rates set by the governing council do impact with a reasonably linear relationship over time on the rates that banks charge to make new loans." According to the ECB’s latest statistics, the interest rate on floating-rate mortgages and those with rates fixed for a year or less fell by 70 basis points in January to an average of 4.39 per cent. Loans to businesses on similar terms fell by 65 basis points to 4.73 per cent. In mid-January, the ECB cut its main interest rate by 50 basis points, and another 50 basis point cut was announced last week – the effects of which have still to feed through.
Record Bond Sales in Europe Reduce Reliance on Bank Loans
European companies are selling bonds at the fastest pace on record, even with relative borrowing costs at all-time highs, to get ahead of a deluge of government debt and to reduce reliance on banks. Companies led by Electricite de France SA, the world’s biggest utility, Siemens AG, Europe’s largest engineering company, and Vivendi SA, France’s biggest media company, raised 258 billion euros ($324 billion) in the first two months of 2009, more than double the 110.4 billion euros in the year- earlier period. Executives say they are raising more than they need rather than compete with European governments selling an unprecedented amount of debt this year -- more than $800 billion -- to pay for their economic stimulus packages.
"The conditions were ideal at the start of the year, and my analysis was that longer-dated bonds would go up later in the year as governments pile in to borrow," Daniel Camus, chief financial officer of EDF, said in an interview. "I covered the essentials for the year." The company sold 7.9 billion euros in bonds in January. Companies are selling bonds at a time when premiums have risen to the highest on record amid a worldwide credit crunch because of $1.2 trillion in writedowns and credit losses at financial companies after the U.S. subprime mortgage market collapsed in 2007. They are reducing their reliance on banks, many of which, from Citigroup Inc. to Royal Bank of Scotland Group Plc of Edinburgh, sought government bailouts.
"We wanted to rebalance our debt away from bank loans," Philippe Capron, CFO of Vivendi, which in January sold 1.4 billion euros of 7.75 percent bonds, said in an interview. "Who knows what shape the banks are going to be in, what their policy on loans is going to be. We didn’t want to be totally at the mercy of the banks." Vivendi’s banks include RBS and Brussels-based Fortis, both of which are now state-controlled after getting government aid. European companies accounted for more than half of global corporate bond sales in the first two months. Although premiums relative to comparable government debt remain at record highs, cuts in interest rates by central banks to revive the world economy have kept overall borrowing costs low. The European Central Bank last week slashed its benchmark interest rate to a record 1.5 percent and signaled other cuts may be in store.
"It’s the right time to issue bonds," said Munich-based Siemens’s CFO Joe Kaeser. "I assume that we’re going to be flooded with government bonds in the next few months." Just last week, euro-region governments sold 18.4 billion euros of bonds, more than three times the weekly average of the past three years of 5.8 billion euros. European governments committed 1.2 trillion euros in bank aid and about 200 billion euros in economic-stimulus plans. The U.S. package rises to $9.7 trillion once all measures to address the financial crisis are thrown in, Bloomberg estimates show. The subprime crisis and the resultant collapse in housing, coupled with the steep drop in equity prices worldwide, wiped out more than $40 trillion of wealth, equivalent to two-thirds of last year’s global gross domestic product, former Federal Reserve Chairman Alan Greenspan said last month.
It also curbed companies’ access to the debt market. Vivendi was unable to sell bonds in September, Capron said. "The market was totally closed," he said. "It wasn’t a question of rates being too high, there just wasn’t a market." When it sold bonds in January, Vivendi paid 500 basis points more than it would have on a bank loan, Capron said. "The higher interest rate will cost us 50 million euros this year, but it’s like an insurance for us," he said. Paris-based EDF sold bonds to replace bank loans for the 12.5 billion-pound ($18 billion) purchase of British Energy, even though there was no need to roll over any of the debt for two years, Camus said. The average interest rate on the bank loans was 7 percent. He replaced it with euros borrowed at 5.1 percent and dollars at 6.9 percent, over six years.
Siemens’s Kaeser raised 4 billion euros last month, more than the 2 billion euros of bonds he’d intended to sell, as demand drove down the rates he had to pay.
Siemens’s four-year bonds were priced to yield 158 basis points more than the benchmark swap rate, down from initial price guidance of 170 basis points. The spread on the eight-year bonds was cut 10 basis points to 200. Financial markets show investors continue to shun riskier assets. The MSCI World Index of stocks has plummeted more than 50 percent in the past year. Although the three-month euro Libor-OIS spread, a gauge of bank reluctance to lend, has narrowed to 48 basis points, the average over the last five years was 34 basis points. The extra yield investors demand to hold high-grade company bonds rather than government debt hit a high of 442 basis points on March 5, according to Merrill Lynch & Co.’s Investment-Grade Corporate Bond Index. It was on average at 47 basis points in the first half of 2007.
"The corporates need funding and investors want their bonds," said Suki Mann, a credit strategist at Societe Generale SA in London. "Government yields are too low and equities are too volatile, so everyone is looking at the corporate bond market. Each month is a record, and utilities and telecoms will continue to drive the market." On March 2, TeliaSonera AB, Sweden’s largest telephone company, sold 550 million euros of five-year bonds. Madrid-based Telefonica SA, Europe’s second-biggest phone company, is considering selling 500 million euros of bonds in pounds, Cinco Dias reported March 4. Schneider Electric SA, the world’s biggest maker of circuit breakers, sold 750 million euros in four-year bonds in January although it didn’t need all that money, says CFO Pierre Bouchut. "This way I have ample liquidity and I don’t have to be nervous for the coming year," he says. "For the next three years I have cash or unused credit lines totaling 3 billion euros. We can absorb any shock. I was concerned there might be tight liquidity in the market later in the year."
Schneider’s 6.75 percent bonds were priced at 435 basis points more than similar-maturity German government debt. After hitting a six-year high at 4.68 percent last June, German 10- year government bonds fell to 2.97 percent, near a record low. Patrice Durand, CFO of Thales SA, Europe’s largest defense- electronics company, told a similar story. "We didn’t totally need the money but we saw it as insurance," he said. "In these sorts of times, you want a cushion so that later you aren’t forced to borrow at much worse rates." Thales sold 275 million euros in bonds at 333 basis points more than German government bonds. Roche Holding AG, Switzerland’s biggest drugmaker, issued the largest euro-denominated fixed-rate bond deal ever last month, to help fund its hostile bid for Genentech Inc.
UK 10-year gilts hit 20-year low, pound slides
UK 10-year gilt yields slid to the lowest level in at least 20 years and the pound fell as bank shares tumbled and policymakers prepared to buy government bonds to inject cash into the recession-trapped economy. Yields on gilts maturing from five years to 30 years dropped after Lloyds Banking Group ceded control to the government and HSBC sank as much as 14pc in London trading. The Bank of England said March 5 it plans to spend £75bn buying corporate debt and government assets that have between five and 25 years to mature. "This banking-nationalization talk is keeping banking stocks well depressed and that’s supportive for gilts," said Orlando Green, a fixed-income strategist in London at Calyon, the investment-banking unit of France’s Credit Agricole SA.
"The five- to 25-year part of the curve is going to be well supported given that quantitative easing is going to be centering around the 10-year region." The 10-year gilt yield dropped as much as 11 basis points to 2.95pc, the lowest level since Bloomberg began tracking the data in 1989. The security yielded 3.02pc as of 12:46 p.m. in London. The 4.5pc note due in March 2019 rose 0.45, or £4.50 per £1,000 face value, to 112.73. The yield on the security posted its biggest two-day drop since at least 1989 at the end of last week after policy makers also cut the main interest rate on March 5 to 0.50pc, the lowest level in the bank’s 315-year history. The UK is the first country to start so-called quantitative easing since Japan tried to stimulate its economy in the 1990s by printing money. The Bank of England may spend as much as £65bn on government securities in the next three months and about £10bn on company bonds, according to RBC Capital Markets.
Policy makers "expect the corporate-paper facility to see no more than £10bn-£25bn of bonds delivered to them," John Wraith, head of sterling interest-rate strategy at RBC Capital Markets in London, wrote in a March 6 note. "This implies £60bn to £65bn of gilt purchases over the next three months." Investors should bet on the difference in yield, or spread, between two- and seven-year U.K. government notes narrowing to as little as 75 basis points as the Bank of England starts buying gilts, RBC said on Monday. The FTSE 350 Banks Index fell 8.1pc and the FTSE 100 Index dropped 1.6pc. Futures on the Dow Jones Industrial Average declined 1.9pc. "Banking stocks in the U.K. are under pressure today," said Steven Barrow, head of G-10 currency research at Standard Bank in London. "That backdrop is negative for sterling." The pound dropped 2.3pc to $1.3769 as of 12:55 p.m. in London. It weakened 1.6pc to 91.22p per euro, depreciating to 91p for the first time since January 29.
Vauxhall 'in terrible trouble', says Mandelson
The global automotive industry faces a crunch week as insolvency looms for a number of the industry's key players. Lord Mandelson will come under pressure from UK-based car makers as they seek access to a promised £2.3bn in government support, which was originally announced in January. Yesterday the Business Secretary conceded that Vauxhall was in "terrible trouble" and said that he planned to work with Germany to try to save the European subsidiaries of General Motors. A crisis seminar will be held this week at the Department for Business, Enterprise & Regulatory Reform (BERR) where industry leaders are expected to discover the terms of access to the Government-backed assistance.
On February 27 the European Commission approved government plans to unlock £1.3bn of loans from the European Investment Bank for car manufacturers and major suppliers, as well as up to £1bn of further loans guaranteed by the UK taxpayer. However, the Government has yet to release any funds. Vauxhall-owner GM Europe and Jaguar Land Rover, which is owned by India's Tata, are expected to be at the head of the queue for assistance. Speaking at the Geneva Motor Show last week, GM's senior European executive, Carl-Peter Foster, said that Vauxhall factories in the UK may need to close if they do not get access to government money. Vauxhall employs 3,300 people at Ellesmere Port and Luton and hundreds of jobs depend on what happens to its UK dealerships. However, the bulk of European bailout money will be required at GM's Opel unit in Germany.
Opel has now hired three law firms to advise on restructuring and insolvency options, according to a spokesman for GM Europe. Baker & McKenzie and Clifford Chance have been hired by GM Europe and German law firm Wellensiek will be advising the Opel unit. Mr Foster was in Berlin over the weekend holding top level talks with Angela Merkel's government. In the US on Thursday, trading in the shares of US car component manufacturer Visteon were suspended as they were trading at just 2 cents a share. The company is expected to file for Chapter 11 protection from bankruptcy as soon as tomorrow, when a $16m (£11.4m) interest payment is due.
Ilargi: Ambrose Evans-Pritchard keeps on trying to suggest that Britain is not as bad as it is. Declaring his love for Gordon Brown is merely the next step, as despair sets in.
Thanks to the Bank it's a crisis; in the eurozone it's a total catastrophe
The Bank of England may have averted a catastrophe. If ever there was a time when this country needed its own monetary authorities – acting with wartime urgency – this is the moment. Those nations with fossilised or timid central banks clinging to outdated ideologies are not so lucky. Even less lucky are those such as Spain and Ireland that have surrendered policy to a body that is deaf to their pleas and constitutionally obliged to ignore the welfare of their particular societies. They face crucifixion. Spain's agony is already well advanced. Industrial output has fallen 24pc. Some 352,000 people have lost their jobs in two months. BBVA expects unemployment to reach 20pc next year, touching 4.5m. Premier Jose Luis Zapatero can do nothing as long as Spain remains in monetary union. He cannot devalue to claw back 30pc in lost labour competitiveness against EMU's German bloc, or take emergency steps to slow the property crash. In an odd lapse last week – perhaps a slip – he advised Spaniards that the best thing to do in these dark times was to ****.
Yes, it is dangerous for the Bank of England to buy up a third of all long-dated gilts. But it would be even more dangerous to allow deflation to run its course in an economy where debt levels have reached such extremes. Debt and deflation are a deadly mix. The errors that led to our current predicament are well-known. A small army of economists – Austrians, Monetarists, and Keynesians – warned that central banks were playing with fire by fixing the price of credit too low and ignoring asset bubbles. The $6.7 trillion in reserve accumulation by China, Japan, and the petro-powers drove bond yields too low for safety. Credit signals were gravely distorted. In Britain, Gordon Brown poured petrol on the fire by pushing the fiscal deficit to 3pc of GDP at the top of the cycle. Wretched man. However much we rage at Sir Fred or Citi-wrecker Chuck Prince, let us not forget that this crisis was confected by governments. To blame the free market is to miss the bigger point. But I digress. We are now faced with the post-debt wreckage. The task at hand is to hold our societies together as best we can. One dreads to think what would have happened if the Hoover-Brüning nostalgics had succeeded in blocking every remedy.
As it is we have seen industrial production collapse in every region. The drops in January were: Japan (-31pc), Korea (-26pc), Russia (-16pc), Brazil (-15pc), Italy (-14pc), Germany (-12pc). Falls that took two years from late 1929 have been compressed into five months. Those who say this is nothing like the Great Depression are complacent. Household debt is higher today, and UK banks are in worse shape. (No bank of size failed in the British Empire during the slump). Britain's economy contracted by 5.6pc from peak to trough in the early 1930s (Eichengreen). Some put the figure at nearer 8pc. We may surpass that this time. America suffered worse. Real GDP fell 28pc. But the worst occurred in the second leg, after the heinous policy blunders of late 1931. Reading contemporary accounts, it is clear that hardly anybody – not even Keynes or Fisher – realised that the world was slipping into a depression during the first 18 months. Nobel laureate Paul Krugman says the Fed has been as far behind the curve today as it was then, given the faster pace of collapse. It is bizarre that Ben Bernanke has not started to buy US Treasuries a full three months after he floated the idea, despite a yield rise of 80 basis points.
He has been stymied by the hawks. Kansas chief Thomas Hoenig said last week that the top priority is to drain liquidity before recovery later this year sets off inflation. Well, Mr Hoenig said last May that inflation psychology was gaining a hold "not seen since the 1970s and early 1980s" with a risk that inflation would become "embedded in the economy." The price spike broke within weeks. If his model was wrong then, why is it right now? As for the ECB, it has not reached the starting line. Jean-Claude Trichet insists that there is no danger of deflation in Europe. What is the weather like on his planet, asked Mr Krugman. The ECB has cut rates to 1.5pc, but since they need to be minus 1pc on the Taylor Rule, this leaves the breach as wide as ever. The Bundesbank is blocking any serious move towards quantitative easing. Given that Germany's economy is imploding (Deutsche Bank sees 5pc contraction this year) one wonders if the Bundesbank would be less hawkish if the D-mark still existed. Even their hard-money brothers at Switzerland's SNB are cash printers these days. So has monetary policy in euroland been paralysed by squabbles at a calamitous moment, blighting every member state? Almost certainly. I'll take the Old Lady of Threadneedle Street any day, warts and all.
UK unemployment 'to hit 3.2 million'
Unemployment will hit 3.2 million as the economy shrinks by even more than had been feared, business leaders at the British Chambers of Commerce have predicted. The BCC report also warns that painful tax rises and spending cuts will soon be required to start paying off the huge debts the Government is running up. Official unemployment figures are rising and currently stand at 2 million, but in its latest economic report, the BCC says that the peak will be much higher. Some 3.2 million people will be out of work by the second half of 2010, the BCC says. That is just over one in ten of the workforce. Overall, the UK economy will contract 3.7 per cent in 2008/09, the BCC says. IN 1992-93, the peak of the last recession, GDP fell by 2.5 per cent. Though stark, that is not the bleakest forecast the economy. The Bank of England has predicted that over the entire recession, the UK economy could shrink by 4 per cent or even more.
The BCC report also piles added pressure on Alistair Darling to use his Budget in April to set out plans for a severe squeeze on public spending in the years after the recession. The Chancellor is borrowing huge amounts from the bond markets to finance short-term tax cuts and accelerated public spending during the downturn. In his pre-Budget report last year, the Chancellor set out plans to borrow an extra £500 billion over five years, taking the national debt above £1 trillion for the first time. The Treasury's current forcecasts are for borrowing of £118 billion in 2009/10 and £105 billion the year after. The BCC says that borrowing will actually be higher, £143 billion -- equal to 10 per cent of GDP -- in 2009/10, and £158 billion the following year. Even on the Government's figures, the national debt is set to go above £1 trillion for the first time. The BCC says that Labour's borrowing will mean any future government will have no choice but to rein in spending and increase its tax revenues. "These figures signal a very serious budgetary position, which will have to be addressed vigorously as soon as the present recession ends," the BCC report says.
With polls pointing to a Conservative victory at the next general election, senior Tories are increasingly trying to prepare public opinion for unpopular measures on tax and spending. George Osborne, the shadow chancellor, last week warned that a Tory government will inherit the worst public finances since the Second World War and warned that radical changes in public services will be required. And Steve Bundred, chief executive of the Audit Commission, which scrutinses public services, has warned of an "Armageddon scenario" where international investors are no longer willing to lend the UK government as much money as the Treasury wants to borrow. Mr Darling's pre-Budget report last year signalled much tighter spending and higher taxes from 2011. But the April statement is likely to go much further and could outline deep real-terms cuts in Government spending in the years ahead. "Government borrowing is unacceptably large. Rising budget deficits are essential in the near future, in order to alleviate and eventually end the recession, but the critical need to significantly reduce borrowing after the recession ends will inevitably dampen UK growth prospects for a considerable period," said David Kern, chief economist at the BCC. "Producing a credible plan to reduce Government debt and borrowing over the medium-term is a key condition to maintaining the UK's international credit rating and the confidence of the markets."
Iceland nationalizes last remaining big bank
The global financial crisis on Monday claimed a clean sweep of Iceland’s largest banks after Straumur-Burdaras, the last of the big four to remain standing, finally succumbed to the pressure and was nationalised. "In spite of its strong capital position and the support of funding banks, Straumur believes its liquidity position is no longer strong enough to sustain activities," the bank said in a statement. Straumur’s demise marks the end of a five-month fight to stay alive after all three of Iceland’s largest banks – Glitnir, Landsbanki and Kaupthing – collapsed in the space of a week in October last year. Straumur had consistently tried to reassure the market that it remained relatively well capitalised, that its operations could return to being profitable and its loan book would eventually shrug off growing provisions to become sustainable.
It had announced a plan to sell a third of its assets and managed to obtain additional financing worth €133m, despite reporting a €576m loss in the fourth quarter of the year. But the combination of a collapse of global liquidity and the continued absence of confidence in Icelandic banks eventually made it impossible for the bank to fund its ongoing operations. According to a statement from the Icelandic government, all deposits of Icelandic commercial banks are fully secured. Straumur is a licensed commercial bank and is a member of The Depositors’ and Investors’ Guarantee Fund. Iceland’s Financial Supervisory Authority suspended the bank’s board and appointed a committee to run the bank. William Fall, a former senior executive at Bank of America, who joined the bank in 2007, has resigned.
Teathers, Straumur’s UK brokerage arm, was not trading Monday as employees waited for direction from the new Straumur management in Iceland. The London Stock Exchange is reviewing its status as a nomad. This marks the second time Teathers employees have been left in the lurch by an Icelandic collapse. Last autumn, Teathers went into administration when its then-parent Landsbanki was nationalised. Straumur bought the Teathers name and hired about half of the staff. Straumur also has operations in Iceland, Denmark, Sweden, Finland, Poland and the Czech Republic.
Ilargi: A really excellent guest post at Nakedcapitalism.com by OptionArmageddon’s Rolfe Winkler.
More Debt Won't Rescue the Great American Ponzi
Policy-makers not only misunderstand the economic crisis, they continue to underestimate it. Consequently, solutions to date have not only failed to "fix" anything, they have made the problem worse. The problem isn't falling asset prices, it's not rising foreclosures, it's too much debt. With an assist from mark-to-market accounting,* too much debt inflated the asset bubble in the first place. Yves has it exactly right that the only "solution" to this crisis is price discovery, to allow asset prices to fall to whatever level they need to in order for markets to clear. This is bad news for over-levered balance sheets, but there's nothing else to be done.
And yet American policy-makers appear convinced that more debt can rescue an economy already drowning in it. If we can just keep the leverage party going, all will be well. $787 billion to fund "stimulus," another $9 trillion committed to guarantee bad debts, 0% interest rates and quantitative easing to drive more lending, new off balance sheet vehicles to hide from the public the toxic assets they've absorbed. All of it to be funded with debt, most of it the responsibility of taxpayers.
If I may offer just one reason this will all fail: rising interest rates. Interest rates need only revert to their historical median in order to hammer asset values, and balance sheets, into oblivion.
A simple present value calculation suggests that house prices could fall another 30% if mortgage rates get back to 8%.** Enough to wipe out a 20% downpayment made today and still leave the buyer upside down on his mortgage. Given the pile of Treasurys the Obama administration plans to dump on the market, it seems logical to assume interest rates are headed up.
Some might argue that deleveraging is SO violent that a couple years of "stimulus" and other debt-financed rescue measures are needed to cushion the blow. Unfortunately, any positive impact is likely to be offset by upward pressure on interest rates. Perhaps the Fed can monetize a lot more debt. But that will have its own negative consequences.
Picture it if you will: the economy stabilizes, money flows out of Treasurys, which drives interest rates back to normal. Asset values that had appeared to stabilize fall again. More writedowns ensue, more balance sheets turn up insolvent. The debt deflation conflagration ignites again, burning up what's left of the economy.
If our experience to date has taught us anything it should be that kicking losses up to bigger balance sheets solves nothing. Losses have to be taken. The balance sheets on which they reside will end up insolvent. Why compound our problems by piling up more debt and concentrating all of it on the public's balance sheet? Is American arrogance so great that we believe our Treasury and our currency will survive the trillions of $ worth of losses and stimulus we've already agreed to fund? To borrow Martin Wolf's wonderfully evocative phrase, we are a python that has swallowed a hippopotamus.
At the end of the day, flushing more debt through the system is the only lever policy-makers know how to pull. Lower interest rates, quantitative easing, deficit spending, it's all the same. It's all borrowing against future income. Each time we bump up against recession, we borrow a bit more to keep the economy going. With garden variety recessions, this can work. Everyone wants the good times to continue, so no one demands debts be paid back. Creditors accept more IOUs and economic "growth" continues apace. If it sounds like Bernie Madoff's Ponzi scheme, that's because it is.
Each time Bernie's scam got a few too many investor withdrawals, he'd simply plug the hole by raising more investor cash. The guys at Fairfield Greenwich were making so much in fees, they were happy to funnel more his way. But at a certain point, Ponzis get too big. There simply aren't enough new investors to pay off older ones. In the aggregate, the same is true for Western economies. Their debt loads are now so huge, they are simply unpayable.
Naturally, policy-makers sound just like Ponzi-schemers: Just give us a little more cash to get us through this rough patch and everything will be copacetic. Ben Bernkanke at the National Press Club alluded to the famous quote by St. Augustine: "Oh Lord, give me chastity, but do not give it yet." President Obama convened his "fiscal responsibility" summit days after passing the stimulus bill and days before proposing huge increases in health care spending.
So the question becomes, can we keep our Ponzi going? Or has it grown too large? Have we reached the moment when, like the Depression, there's just no escaping the great unwind?
There has been much protest from economists that whatever economic funk we find ourselves in presently, it's not as severe as the Depression. One data point suggesting otherwise is Household Debt vs. GDP. A favorite example of mine, though, was the chart at right featured in the Congressional Oversight Panel's January report. (Click to enlarge)
The COP's chart downplays our current crisis by comparing the number of failed banks during the Depression with the number today. But the number of bank failures misses the point. The banking system is far more concentrated today. What makes our current banking crisis totally unprecedented is the size of bank failures relative to the overall economy. A better way to compare the two crises is to look at deposits in failed banks relative to GDP. (click to enlarge)
As you can see, I've taken the liberty of adjusting FDIC's figure for 2008. This chart includes the $2.0 trillion worth of deposits at BofA, Citi, and Wachovia as of September 30, 2008.***
Last year WaMu was the only ultra-large bank that officially "failed" according to FDIC. But in the absence of government intervention, it's likely the entire U.S. banking system would have gone under. Certainly the "failed" list would now include Citi, BofA and Wachovia.
Adding these three banks to the list still understates the scale of the crisis. Can anyone seriously argue that Chase and Wells would have survived the year in the absence of taxpayer largess?
What about non-deposit taking financials? AIG, Fannie, Freddie, Goldman Sachs, Morgan Stanley, GE and---at some point soon---a few of the Federal Home Loan Banks. Then there's the insurance industry. With leverage worse than the banking system's and balance sheets chock-full 'o toxic assets, it too owes its survival to TARP cash and publicly-subsidized lending.
Also FDIC's Deposit Insurance Fund. The $19 billion it has in reserve is but a drop in the bucket compared to the $5 trillion worth of deposits and bank debt it now "guarantees." Naturally, the Fund needs replenishing.
Public and private pension systems are drastically underfunded. California is on the verge of bankruptcy. The unfunded liabilities for Medicare and Social Security are north of $50 trillion.
European economies face even more oppressive debt loads.
The great Ponzi scheme that is the Western World's economy has grown so big there's simply no "fixing" it. Flushing more debt through the system would be like giving Madoff a few billion to tide him over. Or like adding another floor to the Tower of Babel. To what end? The collapse is already here. The question is: How much do we want it to hurt?
Using the public's purse to finance "confidence" in a system that is already kaput may delay the Day of Reckoning, sure, but at the cost of multiplying our losses. Perhaps fantastically.
Bottom line....We can bankrupt ourselves propping up a system that is collapsing anyway, or we can dig ourselves out of debt, if not with higher interest rates then certainly with fiscal austerity. That would be a hard sell to the American people, I know. But deep down, Summers and Geithner know it is the right thing to do. It is, after all, the prescription they wrote for emerging markets facing financial crises.
It's long past time we took our own medicine. If we don't take it voluntarily, the bond market will stuff it down our throat anyway.
*As asset values increased, so did the value of collateral to support new lending. More lending inflated asset prices, increasing the value of collateral yet again, encouraging still more lending. Since house prices never fall, everyone imagined this cycle could continue ad infinitum. And even if they didn't, no one was going to get in the way. Too much money was being made. I wonder: did any of the current critics of MTM's pro-cyclicality complain on the way up?
**Imagine mortgage rates jump from 5% to 8% tomorrow, with no corresponding increase in buyers' incomes. A representative consumer has $3,000 to spend on housing today and tomorrow. Increasing interest rates 300 bps drastically reduces the principal value of the loan he can support with that monthly payment. (Admittedly, this is a simplistic way of looking at house prices. But it serves to demonstrate asset price sensitivity to interest rates.)
Now increase the interest rate to 8% while holding other variables constant.
- Monthly payment = $3,000, # of mortgage payments = 360 (30 years * 12 months = 360), future value of mortgage balance = $0, IntRate = 5% over 12 months or .42% per period, Present value of asset = $558k
***Caveat: to the extent government intervention allowed insolvent financials to survive the S&L crisis, they wouldn't be included in this list.
- payment = $3,000, # of payments = 360, Future Value = $0, IntRate = 8% over 12 months or .67% per period, Present Value = $409k
- 409/558 - 1 = -27%