The Washington Bridge and High Bridge over the Harlem River along the northern boundary of Manhattan, looking south
Ilargi: I saw the following headline last night:
"Japan Stimulus Plan May Spur Economy at 'Massive' Future Cost".
Right off the bat, I found myself wondering why Bloomberg, or any other news service, would say something like that about Japan, as a reaction to a new $150 billion "rising sun stimulus", and not about the US. All the more since before I saw it, I had already seen some fresh American budget deficit numbers and predictions. Here goes:
The US federal government posted a budget deficit of $192.27 billion in March. For the first six months of fiscal 2009, which started on October 1, 2008, the deficit was $956.80 billion. In the first half of the previous year, fiscal 2008, the deficit was $312.75 billion. In all of fiscal 2008, the shortfall was $454.80 billion, and that was already a record high. The Congressional Budget Office estimated on March 20 that the deficit will grow to $1.85 trillion this fiscal year, after projecting a $1.2 trillion deficit just two months prior. Over 50% extra in 2 months. In January 2008, the CBO still predicted a paltry $250 billion deficit for the year. See? That's what is known in the business as "growth potential".
If we go out on a limb just a little bit, we can pretty safely assume the CBO is off by 40% or more once again. After all, they always are. We get to that number by taking the March deficit and multiplying it by 12. That would add up to about $2.4 trillion. It's speculative, true, but it's also simply following a trendline. Don't be surprised if the deficit ends up between $2.5 and $3 trillion.The exact numbers are less important than the message. And what's more, don't forget that the CBO is habitually chided by the government for being too negative in the numbers it reports, which means "official" White House numbers will -as usual- be off by even wider margins. Of course, that’s nothing new, nor is it surprising in the least, but seeing how far off the CBO predictions are, it's difficult not to see US government numbers as meaningless, ridiculous, purely faith based and, in the end, intentionally false.
Nor are all these deficit numbers solely the result of out-of-control spending. There's also much less revenue coming in. Corporate tax receipts totaled $56.2 billion through March, vs $129.5 billion in the first half of fiscal 2008. And the trend is not promising. March corporate taxes totaled $3.39 billion, down from $32.57 billion in March 2008, down almost 90%. Individual income tax revenues are down 15% so far this fiscal year to $429.7 billion. A year ago, they stood at $503.5 billion. Next storm: all the people who will fall into lower tax brackets, bringing revenues down ever more and more.
And there's an additional problem waiting in the wings, one that might do more damage than anyone is prepared for: The U.S. government needs to roll over more than $2.5 trillion of outstanding sovereign debt coming due in 2009, even before it can issue any new debt, even though it will desperately need to do so in order to finance these ballooning deficits. The total number, if we add up old debt that needs to be rolled over, and new debt that's needed to finance new deficits, could well exceed $5 trillion.
To summarize: the deficit for the first half of fiscal 2009 is $956.80 billion, more than three times the $312.75 billion deficit for the first 6 months of fiscal 2008. The total shortfall for fiscal 2008 was $454.80 billion, while the CBO projection for fiscal 2009 is $1.85 trillion, or four times as much. Tax receipts, meanwhile, are down anywhere between 15% and 90%, depending on where you care to look.
So tell me again, why does Bloomberg single out Japan for a headline that includes the words "Massive' Future Cost"? If by "the future", we mean that stretch of time that starts tomorrow, the US is in for more agony and horror than anyone seems to -be willing to- realize. And that's just on the economic front. And no, it's not just the US that's faring poorly, but for the vast majority of Americans, that won't be much, if any, comfort.
I’ll leave you with some good strong quotes from Ned Hill, an economist in Cleveland I must admit I never heard of before, who addresses the car industry trouble, but who might as well have been talking about the demise of America as an empire:
• "If you go back to 1980 to 1982, with the upheavals in the steel, rubber, glass and auto industries, that really was the end of an economic era that started in the 1890s. This is the last movement in the symphony." [...]
• "It takes almost 20 years to rebuild your economy, and usually you waste five to six years because of denial."
US Posts $192.27 Billion Budget Deficit In March
The U.S. budget deficit closed in on $1 trillion just halfway through the fiscal year, driven by a recession that's sucked away tax revenues and sent millions of people scrambling for jobless benefits. The federal government posted a budget deficit of $192.27 billion in March, the sixth month of fiscal 2009, the Treasury Department said Friday. The government has run a deficit for six straight months. The last time that happened was October 2003 through March 2004. The record streak is May 1991 through March 1992. A survey of economists by Dow Jones Newswires forecast a March deficit of $150.0 billion. The Congressional Budget Office had estimated a deficit of $191 billion.
For the first six months of fiscal 2009, the budget shortfall totaled $956.80 billion. In the first six months of fiscal 2008, the government ran a deficit of $312.75 billion. In all of fiscal 2008, the government ran a deficit of $454.80 billion, which was a record high. Spending on government programs to rescue Wall Street and tax revenues shrunken by the economy's slump have helped boost the deficit into record turf in this fiscal year, which began Oct. 1, 2008. Gross spending on the Troubled Asset Relief Program was $2.89 billion for March - and $293.37 billion for the year to date. Another $46 billion went to Fannie Mae and Freddie Mac - $15.2 billion and $30.8 billion, respectively.
Also driving outlays and widening the deficit are traditional government programs to assist the jobless. The Labor Department's latest weekly report on state unemployment insurance benefits, released Thursday, noted another increase in continuing claims. Those claims - drawn by workers collecting benefits for more than one week in the week ended March 28 - surged 95,000 to 5,840,000, the highest level since the government started keeping track in 1967. March spending totaled $321.23 billion, compared to $227.03 billion in March 2008. Interest payments on the national debt were $19.93 billion, or 6% of total spending for the month. Defense spending ran at $51.674 billion. Veterans benefits were $4.354 billion. Social Security totaled $56.103 billion. Jobless benefit outlays were $10.6 billion.
In February, U.S. President Barack Obama signed a $787 billion package meant to spur an economy in a deep recession that began 16 months ago. The economic relief is seen inflating an already record deficit as the year progresses. The Treasury report Friday said it bought $17.38 billion in agency mortgage-backed securities during March; year to date, purchases totaled $119.20 billion. Treasury became the buyer of last resort for these bonds when it announced the takeover of Fannie Mae and Freddie Mac in early September. The bonds, guaranteed by Fannie and Freddie, play a critical role in the housing finance market. The yields on these bonds determine the mortgage rates that consumers pay on their home loans.
Year-to-date federal government spending totaled $1.95 trillion, compared to $1.46 trillion in the first six months of fiscal 2008. The monthly budget statement showed March federal government receipts totaled $128.96 billion, down from $178.82 billion a year earlier. Individual income-tax receipts totaled $41.23 billion, compared to $56.71 billion in March 2008. Corporate taxes totaled $3.39 billion, compared to $32.57 billion in March 2008. Recent government data showed corporate earnings after taxes fell 28% in the fourth quarter, a period including October-December 2008. Year-to-date federal government revenues totaled $989.83 trillion, compared to $1.15 trillion for the first six months of fiscal 2008. The Treasury said it plans to release budget data for April on May 12, 2009.
Widening Deficits: $1.8 Trillion In 2009
On March 20, 2009, the bipartisan Congressional Budget Office (CBO) released its latest forecast in an effort to take into account the impact of the recently released Obama budget. The verdict? A whopping $1.8 trillion deficit for 2009, approximately four times larger than the all-time record established in 2008 ($455 billion).
The concerns raised by this latest forecast are many:
Buried in the latest CBO forecast are numerous reasons to be alarmed, chief among them the authors’ admission that they have no idea what the future holds for the economy. They state:
- A mere two months ago, the CBO’s estimate for 2009 was "only" $1.2 trillion. They have already grossly underestimated a deficit that will most likely continue to balloon in the coming months.
- While the new administration:
- Has focused its attention on the spending side of the budget, it has paid little attention to the other side of the equation. What will happen when tax revenue comes in much lower than current projections?
- Even ignoring the likely expansion of the projected deficit, where will we get the $1.8 trillion needed to cover the CBO’s estimated deficit? Foreign investors? Higher taxes? Or that old standby, the printing presses?"Both the magnitude of the contractionary forces operating in the economy and the magnitude of the government’s actions to stabilize the financial system and stimulate economic growth are outside the range of recent experience. The forecast assumes that financial markets will begin to function more normally and that the housing market will stabilize by early next year. The possibility that financial markets might not stabilize represents a major source of downside risk to the forecast. "To cover themselves when their forecasts fall flat, the CBO members offer the following caveats:"Households’ and businesses’ confidence is also difficult to predict." andThese statements are somewhat disconcerting when we remember that in January 2008, it was this same CBO that predicted the U.S. government’s fiscal year deficit would be $250 billion. What did we end up with? A $455 billion deficit. They weren’t even close. What also worries us is that while the CBO clearly states that its forecast includes the impact of the currently approved programs, it fails to take into account any further bailouts of various industries, any new stimulus packages, or any additional programs proposed by the administration.
"CBO’s forecast incorporates the middle of the range of the agency’s estimates of ARRA’s impact on GDP and employment, that range is quite large."
While the current CBO forecast is the result of very scientific economic models put together by a multitude of experts, our economists at Casey Research question many of its basic assumptions by applying the same logic that allowed us – more than three years ago -- to correctly predict the subprime crisis and its expansion into a widespread financial disaster. We knew then that the models supporting the valuation of many derivatives were flawed, even as other analysts were claiming that real estate values were never going to decline and that securitization of subprime mortgages could magically eliminate default risk.
Applying this basic logic, let’s look at some of the core assumptions in the CBO forecast:
The Consumer Price Index is expected to drop from +3.8% in 2008 to -0.7% in 2009 (good news), while unemployment is projected to grow from 5.8% in 2008 to 8.8% in 2009 (it could be worse). The cost of borrowing record amounts of money will decline from 1.4% to 0.3% for the 3-month T-bill and from 3.7% to 2.9% for the 10-year T-bond (convenient). In The Casey Report our Chief Economist Bud Conrad compared data from the current recession with those of serious crises in the past. His conclusions? Although the impact of the current financial turmoil has been serious, we are nowhere near the average bottom experienced in other serious recessions. The unemployment rate is expected to bottom at 8.8% in 2009 (we are almost there), only two years after the start of the current recession. Unfortunately, history tells us that these forecasts may be far too optimistic. Looking at trends of the past, on average, unemployment peaked about four years after the start of a serious recession. In the worst case, the peak occurred 11 years after the start of the decline.
In addition, a rate of 8.8 % unemployment would look pretty good if compared to the figures in past crises. Historically, the average bottom was reached at 11%, while the worst-case scenario saw 27% unemployed. Currently, Gross Domestic Product has only contracted by 1.5% (conveniently, the CBO estimates the GDP’s contraction to bottom at precisely 1.5% in 2009 before expanding again in 2010). What does history tell us? In previous recessions, the GDP dropped by 9.3% on average and by 28% in the worst case. Based on its projected 1.5% reduction in the GDP, the CBO estimates that tax revenue will fall by as much as 13.4% (with part of this decline due to planned tax reductions for lower-income Americans). A more realistic, 5% reduction in GDP could have a far greater impact on revenue and cause a significant increase in the deficit.
To properly calculate the decrease in tax revenue, the following factors must also be considered:
- A 5% drop in GDP equates to a much greater drop in tax revenue. Tax receipts are based mainly on income, and most companies will see a far greater than 5% decline in net income for a 5% decline in sales;
- As incomes go down, many taxpayers will drop into lower brackets, thereby dropping the average tax rate collected;
- If businesses/individuals anticipate a decrease in income for the coming year, it can be expected that they will not pay their full quarterly payment obligations, instead taking the risk of estimating what their exact tax liability will be;
- Some taxpayers may be in such dire financial straits that they are unable to pay their taxes or quarterly estimates;
- After the losses accumulated in 2008, investors are unlikely to be paying much in the way of capital gains taxes for 2009 and probably for several years to come;
- The underground economy – signified by an increase in cash transactions not reported to tax authorities -- tends to thrive when recession hits. People have an extra incentive to save their precious dollars and are willing to take more risk, rather than hand over their money to the government. In the midst of the Great Depression, the 1931 federal tax revenues had fallen by 52% from their 1929 highs.
- While we do not expect anything that dramatic in 2009, it would not be unrealistic to see a 20% to 25% reduction in cash flow from tax collections this tax season. Such a drop would pose significant challenges given that spending commitments are off the charts and climbing. From September 2008 to January 2009, the monetary base more than doubled from $800 billion to $1.7 trillion, while M1 increased by 15%. Since then, the Fed has committed to buying an additional $300 billion in long-term Treasury bonds and to printing whatever it will take to jump-start the economy.
Is it reasonable to forecast zero inflation and historically low interest rates for this year and the foreseeable future?
While the credit freeze of the fall of 2008 triggered powerful deflationary forces, especially in commodities and real estate, we expect the impact of monetary expansion to have a measurable inflationary effect as early as the second half of 2009. The U.S. government needs to roll over $2,596 billion of outstanding Treasury bills and notes coming due in 2009 before it can add any new borrowing to finance the expected deficit. In previous years, foreign investors have invested most of their trade surpluses – to the tune of $200 billion to $500 billion per year – in Treasuries and agency debt. We cannot expect this trend to continue as we go forward, especially given that China, Japan, and the Middle East are experiencing a sharp decline in their exports and have indicated that they will have to support their own economies with massive stimulus packages. These actions will further reduce their propensity to buy U.S. debt.
The Treasury Department recently reported that in January 2009, international sales and purchase of U.S. assets showed a net outflow of $148 billion. This could be a sign that "the times, they are a-changin’." Assuming that foreign investments will not represent a large source of financing for the $4 trillion plus of U.S. Treasuries our government needs to sell this year, we will be forced to rely on domestic institutional and private investors. The problem here is that a great deal of institutional and private money has already fled from riskier categories of assets into lower-yielding Treasuries. If anything, these funds will be looking for higher-yielding investments as soon as possible.
In the absence of sizable increases in tax revenues, it is quite clear that the lion’s share of the planned sales of Treasuries in 2009 cannot be met by demand from the market. Either the Treasury will have to raise interest rates significantly, or the Fed will need to step in very aggressively to support the planned auctions. Our expectation is that both will happen. Auctions will fail and the Fed will step in. The market will react to more printing by anticipating inflation and demanding higher interest rates. Once the cycle starts, it will be very hard to pull interest rates back.
We continue to stand by our December forecast that the 2009 budget deficit is more likely to widen to levels between $2.5 and $3 trillion rather than the CBO’s $1.8 billion forecast. We also believe that inflation could start setting in as early as Q3 of 2009 and will accelerate sharply by 2010. Treasury rates will start climbing and the era of cheap money will end, making it harder for overleveraged consumers, businesses, and governments to service their debt. Monetary devaluation will be the only way for the U.S. government to shift the cost of irresponsible spending into the future. Our politicians are betting on the fact that this will happen after the next elections, thereby allowing them to continue to blame others for their reckless stewardship of the economy.
Japan Stimulus Plan May Spur Economy at 'Massive' Future Cost
Japan’s record 15.4 trillion ($153 billion) stimulus package may give a short-term boost to the nation’s economy, while leaving it saddled with a debt burden that will smother future growth, economists said. The plan unveiled yesterday by Prime Minister Taro Aso, who faces elections this year, is aimed at creating jobs in an economy heading for the worst recession since 1945. Equal to 3 percent of gross domestic product, the measures will add to debt that the OECD already forecasts will rise to 197 percent of gross domestic product next year. "The stimulus will probably prevent Japan from falling apart in the short term, but it will leave a massive bill for the future," said Hiromichi Shirakawa, chief economist at Credit Suisse Group AG in Tokyo.
"The package doesn’t do anything to promote a sustainable economic recovery."The plan does little to address the nation’s liabilities, give its aging citizens confidence in their pension system, or encourage them to spend some of their 1,400 trillion yen in financial assets, according to Kirby Daley, senior strategist at Newedge Group in Hong Kong. "The fiscal situation of the government is deteriorating faster than anyone imagined," Daley said in an interview with Bloomberg Television. The government needs to address its debt "so the Japanese consumer feels comfortable that their pension system is viable. They will then start to unlock those savings," he said.
Finance Minister Kaoru Yosano said the government will sell more than 10 trillion yen of debt to fund the spending on top of 33.3 trillion yen of bonds to be issued this fiscal year. That would take total liabilities to more than 800 trillion yen by March 2010, excluding short-term debt that the Organization for Economic Cooperation and Development uses to calculate its ratio. The debt burden will be borne by a shrinking population that will be hard pressed to keep the economy growing fast enough in years to come, said John Richards, head debt-market strategist for the Asia-Pacific region at Royal Bank of Scotland Plc in Tokyo. "The burden of this debt is going to be felt and it’s going to be much worse than people thought," Richards said. "It’s going to result in higher interest rates and slower growth than Japan can otherwise achieve."
Aso, 68, said the government will consider raising the consumption tax from the current 5 percent once the economy recovers "in order to not leave a huge debt to our children." Bond yields are already rising, climbing to the highest in almost five months on April 9 on speculation the supply of debt will keep increasing as the government tries to spend its way out of the recession. "Yields may rise as the government fails to give confidence that the stimulus package will improve jobs and consumption and boost tax revenue," said Kyohei Morita, chief economist at Barclays Capital in Tokyo. "Higher government bond yields may lead to higher borrowing costs for companies," stunting investment and economic growth, Morita said. Aso pledged to create up to 2 million jobs in the next three years and boost demand by between 40 trillion yen and 60 trillion yen by focusing on industries such as solar power, electric cars and energy-saving consumer electronics.
That compares with the 3.5 million jobs U.S. President Barack Obama pledged to save or create with his $787 billion stimulus package. The 25 trillion yen in total spending announced by Aso since he became prime minister in September is about 5 percent of GDP, a ratio comparable to the U.S. stimulus. "Aso is very optimistic" on that jobs creation number when you compare it with Obama’s plan, Daley said. "When you throw $150 billion at an economy in one year, you will see an effect. It will not be long term, nor sustainable." The Nikkei 225 Stock Average erased its losses for the year, climbing 2.5 percent for the week after details of the stimulus were leaked by ruling party officials. Economists said the plan would help moderate the economy’s deterioration later this year. "This new package likely will significantly boost domestic demand, mainly in private consumption and government investment, from the third quarter," said Masamichi Adachi, senior economist at JPMorgan Chase & Co. in Tokyo.
Analysts said that fixing the country’s long-term fiscal problems is the key to stimulating domestic consumption and weaning the country off its export dependence. Japan’s older generation is reluctant to spend after the government revealed two years ago that it had lost pension records for 50 million people, or more than a third of the entire population. Younger people are growing concerned that the system will have run out of money by the time they retire. A record 84 percent of Japanese are worried about retiring because they say they lack savings, an annual Bank of Japan survey showed in October. "What households and the elderly need to see in order for them to start spending money is evidence that they don’t have to worry about retirement," said Shirakawa at Credit Suisse. "The government isn’t providing any relief or convincing plans for the future. It’s all cheap talk by politicians.
Depositors' losses mount as 2 more banks fail to bring 2009 total to 23
Regulators shut down two banks Friday, with one of the failures apparently resulting in the largest loss to depositors since IndyMac Bank was shuttered last July. Friday's failures bring the total number of bank and thrift failures during 2009 to 23. The Colorado State Bank Commissioner shut down New Frontier Bank of Greeley, Colo. and named the FDIC receiver. The FDIC created the Deposit Insurance National Bank of Greeley, which was to operate for about 30 days, allowing New Frontier's depositors to move their insured balances to other institutions. About 10% of the bank's deposits were uninsured, creating potentially significant losses for the related depositors. Meanwhile, The North Carolina Commissioner of Banks shut down Cape Fear Bank of Wilmington, N.C. and appointed the Federal Deposit Insurance Corp. receiver.
The FDIC then arranged for First Federal Savings and Loan Association of Charleston (held by First Financial Holdings) to acquire all the deposits of the failed institution and most of its assets. Cape Fear Bank's holding company was Cape Fear Bank Corp. New Frontier Bank had total assets of $2.0 billion and total deposits of roughly $1.5 billion. Even in an environment where the FDIC had temporarily increased its regular deposit insurance limit for individuals to $250,000 and waived limits for non-interest-bearing checking accounts, approximately $150 million, or 10%, of the failed bank's deposits were uninsured. The FDIC apparently didn't find another institution willing to acquire New Frontier's deposits. Instead, it created a Deposit Insurance Bank to allow depositors to move their insured funds over the next 30 days. Deposit Insurance National Bank of Greeley will be administered by Bank of the West of San Francisco.
When a bank fails and uninsured deposits are not acquired by another institution, depositors become creditors to the FDIC receivership for amounts equal to their uninsured balances. Any money recovered from the receivership is called a "dividend." Sometimes the agency announces an "advance dividend," paying out an immediate percentage to uninsured depositors. When IndyMac Bank failed last July, there were $539.6 million in uninsured deposits, with an advance dividend of 50% paid out immediately on uninsured balances. No further dividends are being paid to IndyMac depositors, so the total loss to depositors is about $270 million. While some dividends may be paid to New Frontier's uninsured depositors, the $150 million total in uninsured deposits is staggering, considering the bank's deposits totaled only $1.5 billion. IndyMac had $19.1 billion in total deposits when it failed.
Although Colorado Bank Commissioner Fred Joseph's press release on New Frontier provided no reason for the closing, the FDIC had issued a cease and desist order to the institution on Dec. 2, requiring it to stop violations of regulations and law, as well as "unsafe and unsound" practices. The order required the institution to submit plans for raising capital and improving oversight of operations and required the removal of New Frontier's president and chief lending officer. According to published reports, the bank was making real estate loans that were far too large for an institution of its size. TheStreet.com Ratings had assigned New Frontier a D-minus rating based on Dec. 31, 2008 financial information, downgrading the rating from D-plus the previous quarter.
Cape Fear Bank had total assets of about $492 million and total deposits of $403 million. The FDIC entered into a loss-sharing agreement with First Federal S&LA of Charleston, whereby First Federal acquired all of Cape Fear Bank's deposits and $395 million in assets, with the FDIC sharing losses on certain asset pools. The agency didn't spell out what percentage of losses it would absorb. Cape Fear's eight offices were set to reopen Monday as branches of First Federal. While state regulators didn't issue a press release Friday on the bank failure, on Feb. 26 Cape Fear's holding company announced it had received cease and desist order resulting from an October 2008 FDIC examination of the bank. The order required the bank to increase its capital levels and the holding company's board to "increase its participation in the affairs of the bank." Both of these stipulations are pretty standard for regulatory orders issued to troubled community banks.
TheStreet.com Ratings had assigned Cape Fear Bank an E-minus (Very Weak) rating in March, based on Dec. 31, 2008 financial information. The institution's capital ratios had slipped below what is normally considered well-capitalized in the third quarter of 2008. At the end of the year, Cape Fear's tier 1 leverage ratio was 5.66% and its total risk-based capital ratio was 8.01%, barely above the 8% required for an institution to be considered adequately capitalized under ordinary regulatory requirements. Cape Fear Bank's losses mounted through 2008, as the institution was overwhelmed by losses in its construction loan portfolio. As we see with the failure of New Frontier Bank, there continue to be very serious risks to depositors, despite the FDIC's temporary increase of deposit insurance limits. The basic insurance limit of $250,000 on non-retirement balances is scheduled to revert to the $100,000 limit at the end of 2009. The waiver of insurance limits on non-interest-bearing checking accounts is also set to expire at the end of the year, with these balances reverting to their usual $100,000 limit.
While the FDIC has been able to find buyers for all deposits for most of the failed bank and thrifts during 2008 and 2009, there have been three failures in the past month in which the agency couldn't line up a buyer. It is also apparent that even in a crisis environment, the regulatory supervision process can be rather slow, as it took regulators four months to issue a cease and desist order to Cape Fear Bank after what must have been a pretty ugly examination. Another thing to consider is that even if your personal deposits are under FDIC insurance limits, you or someone you know are probably associated with a business, organization or government entity (such as a school district) with large deposits of somebody else's money in a local bank. In this environment, it is a very good idea to look into the health of your bank.
The Banksters Take A Page From Enron
Tragedy is turning into farce as the real intent of the bank rescue plan becomes apparent. Geithner and the banksters have adopted the playbook of a true fraud-and-deceit all-star: Enron.
No matter how cynical you get, it’s impossible to keep up. - Lily Tomlin
Somewhere along the continuum, there is a point at which tragedy turns into farce. I’m starting to think we may have passed that point with this whole TARP/TALF fiasco. From a comedy perspective, Turbo Timmy and his madcap schemes are the gift that keeps on giving. We’re scaling the heights of utter absurdity now... it’s like a Kurt Vonnegut novel come to life.
Just take this recent snippet from The Wall Street Journal, for instance: The Treasury Department, facing criticism over its bank-rescue program, said it may allow a broader group of private investors to purchase toxic securities... Last month, the Treasury said it would select fund managers based on certain criteria, including an ability to raise private capital and a minimum of $10 billion of eligible assets under management. On Monday, the Treasury said a proposal won't necessarily be disqualified if firms don't meet all the criteria. The Treasury added that it is particularly interested in program participation by small, minority- or woman-owned businesses.
Hmm. Okay, so let me get this straight. First they start out with an eligibility hurdle so ridiculous, it sounds like a leftover Dr. Evil catchphrase from the Austin Powers movie. "You must have ten BILLION dollars..." Then it hits them that gosh, ya know, that might have been a dumb idea. So in a stroke of belated genius, they decide to 1) disregard their own proposal criteria – not change it, but just ignore it, mind you – and 2) turn the bank rescue program into some kind of warm and fuzzy feel-good "help the little guy" exercise, like an SBA loan program writ large. Read the following in John Lovitz "liar" voice: We want to take all your money and give it to the banksters. No, wait. That sounds bad. We want to help the, ah, the billionaires. The poor, poor billionaires. No, wait – crap. That’s bad too. Here it is: We want to help minorities. Minorities and women. Yeah! Yeah, that’s the ticket...
The REALLY funny news, though, is that the PPIP (as it has been so christened) rescue plan now seems to be taking a page from one of the all-time greats of fraud and deceit. I have to take this opportunity to share one of my favorite nuggets, a little story that was making its way around trading desks circa 2002:Once there was a country bumpkin named Kenny – Kenny boy to his friends – and Kenny boy found himself in need of some money. Trouble was, he didn’t have a job and didn’t own a thing except a recently deceased pet goat. But Kenny boy was smart, and it didn’t take long for him to hatch a plan. Kenny boy called up all the farmers in the county and arranged a raffle for a blue-ribbon Holstein milking cow. On the day of the raffle, 100 farmers showed up and paid $50 per ticket, giving Kenny boy $5,000 to put in his pocket. Kenny boy drew the winning ticket and everybody went home. The next day, the raffle winner came by Kenny boy’s place to collect his prize. Kenny trotted out his expired pet. The farmer scratched his head and said "Son, that’s not a prize milking cow. That’s a dead goat." So Kenny boy gave the farmer his fifty dollars back.And as you might have guessed, Kenny boy’s last name was Lay and he grew up to found Enron. Ah, Enron. Remember those guys? The giant tilted "E," the ridiculous hubris, the bizarre commercials with the computerized "Why" voice... Classic stuff. Enron worked hard to rip off rubes like the public officials of the state of California, who didn’t realize that deregulating electricity markets without knowing how the game was played was the rough equivalent of dumping a bucket of chum into a shark tank. Enron also did all kinds of neat innovative things with "side pockets" and "special investment vehicles" and "off-balance-sheet partnerships," even going so far as to use really cool Star-Wars-themed names like "Death Star" and "Chewco."
In retrospect, who could have known that even as Enron was going down the tubes, our current crop of banksters were busy taking notes? I bring up Enron in light of new revelations that propel this whole rescue plan debacle to new heights of criminality and avarice.. Feast your eyes on this tidbit from a recent Financial Times piece, "Bail-out banks eye toxic asset buys":
US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals [emphasis mine] under the Treasury’s $1,000bn (£680bn) plan to revive the financial system. Spencer Bachus, the top Republican on the House financial services committee, vowed after being told of the plans by the FT to introduce legislation to stop financial institutions "gaming the system to reap taxpayer-subsidised windfalls." Mr. Bachus added it would mark "a new level of absurdity" if financial institutions were "colluding to swap assets at inflated prices using taxpayers’ dollars."
"Death Star" my foot... If this true, it makes the Enron chicanery of days past look positively Ewok-scaled in comparison. And most likely it is true... a few weeks prior to the FT exclusive, the New York Post reported that Citigroup and Bank of America had already begun using TARP funds – billions given to them by the government that they were supposed to use to make loans – to instead "aggressively scoop up" more of the very toxic assets that blew them up in the first place. The very idea that these banks could be buying up each other’s garbage – that they are even considering it – well, it just hurts my head, it’s so mind boggling. To understand why, let’s walk through a quick analogy.
Imagine, for a moment, that I have a beat-up old mini-fridge in the back of my garage. It has a coolant leak, it’s a little moldy, and it smells like stale beer, but I’m pretty sure it still works. Meanwhile, you happen to be in possession of a rusty old lawn mower. The blade is caked beyond recognition with fossilized grass clippings, the gunk that passes for oil has never been changed, and the thing takes twenty or thirty pulls to start... but you, too, are fairly certain your lawn mower "works." Now imagine that you and I make a deal. I will sell you my disgusting mini-fridge for the princely sum of a hundred thousand dollars. You, in turn, will sell me your ancient lawn mower for a hundred thousand dollars. I write a six-figure check out to you, and you write a six-figure check out to me. Nothing’s really happened, right? All we’ve done is swap two crap assets, neither one worth fifteen bucks in the real world, and furthermore swapped an identical large chunk of change ($100,000) between our respective bank accounts.
But hold on! Did I mention that we both employ highly creative accountants? Here’s the good news about our little swap. Thanks to our exchange, I can record a massive profit on my books... to the tune of $99,900, or whatever sum is left over above and beyond the book-entry carrying cost for my fridge. And you can do the same with your lawn mower. In the real world, the only thing that happened is junk got swapped with junk. In fantasy-land accounting world, however, you and I both just conjured up fantastic profits out of thin air. And it gets even better... did I mention that the government has generously granted me a non-recourse loan in order to provide the funds with which to buy your $100,000 lawn mower? I didn’t actually have to move $100K out of my bank account and into yours, because $93,000 of it was covered by government loan. The same privilege was extended to you, of course.
And of course the proceeds of my loan were sent to you as cash... and the proceeds of YOUR loan were sent to ME as cash... which means the wonderful taxpayer ponied up TWICE – to the tune of $186,000 – to fund our little phantom transaction with real dollars. See how great this is? We swap crap assets worth zilch, pretending they are actually worth $100,000... we record a massive profit on our books... and we collect real profit in the form of a $93,000 handout to both of us (the non-recourse loan). Of course, someone will eventually scratch their head (just like Kenny boy’s farmer) and say, "Hey. We don’t have anything worth $100,000 here. We’ve got a disgusting mini-fridge and a rusty lawn mower."
But by the time that happens, you and I will be in clover... and by definition we never had to pay back the loans anyway! Ain’t giant handouts grand? To understand what the banks plan to do under the guise of the PPIP "rescue plan" by way of swapping toxic assets with each other, simply replace "mini-fridge" and "lawn mower" in the above example with "toxic asset A" and "toxic asset B." Then up the scale from $100,000 to hundreds of billions – all the way up to a cool trillion maybe – and there you go. This is the fabulous Enron-style solution Turbo Timmy at the Treasury and Sheila Bair at the FDIC have laid out for us: "Death Star" and "Chewco" on steroids. They want to Enronize the whole damn financial system in an effort to save their connected masters (and grateful future employers) on Wall Street.
How the Toxic Asset Plan Will Magically Make Your Money Disappear
Under the Treasury Department's toxic asset proposal, the government puts in 85% of the investment in these assets through a loan given by the FDIC. The Treasury puts in another 7.5% of the money and the private investor contributes the final 7.5% This is a guaranteed way of transferring money from the American taxpayer to the private investors.
Let me show you how. Let's take two assets that the government and investors buy together, both at the purchase price of $100 million. Now, assume that one investment does great and goes up by 50% (to $150 million) and the other one does poorly and goes down by 50% (to $50 million). Well, the combined assets would still be worth $200 million, so the investors and the government should be exactly where they started, right? Nope. Look at the financial magic in this plan that makes the money disappear from the taxpayer and appear in the private investor's pocket.
In the investment that went down, since the private investor is part of the original 15% deposit, he actually gets wiped out when the loan cannot be paid back. That's really bad for the investor and he has lost his whole $7.5 million. This is the risk that Geithner is talking about to the private investor. The government on the other hand does not lose all of their money. They had put in $92.5 million, but now that's down to $50 million, so they lose $42.5 million. Unlike the private investor, they got something back. But they lost a lot more money.
Now, when you look at the investment that went up in value, the government has done well. They get 50% of the profits because they put in 50% of the deposit (the loan from the FDIC does not count toward divvying up the profit from these assets). So, the asset went up $50 million and the government gets $25 million in their pocket. But when you look at the private investor he has done even better. He gets the same $25 million for his 50%, except he only put in $7.5 million to begin with. Why does that matter? Because when you add up the profits and losses for both investments, something funny and tragic happens.
The private investor put in an initial $15 million in to the two assets. He lost $7.5 million in one and wound up with $32.5 million in the other (profit plus initial investment). So, he's at $17.5 million profit overall. The government on the other hand put in a combined $185 million into the two assets. They lost $42.5 million in one of them and made $25 million in another. Will you look at that? The government lost $17.5 million from the same exact investments with the same exact results. The $17.5 million magically got transferred from the government to the private investors.
Well, that's the magic of leverage. If you put in the great bulk of the money, you take the great bulk of the risk. If I put in a small amount of money but share equally in the rewards, then I make money while you lose money. Oh, one final thing. Do you know who the government is? That's us. The American taxpayer. This will literally be coming out of the taxes you pay on the money you work so hard for. This toxic asset plan will pick your pocket to pay off some of the richest people in America. If you think that makes sense, then you deserve to have your pocket picked. What's that about a fool and his money ...
When you're in, you're in
Feeling sorry for yourself? Struggling to get by? Wondering how you can get a bailout? Well, stop moping, because it's not too late! I may not have Suze Orman's verve or Billy Mays' voice. But I've discovered a revolutionary risk-free investment plan straight from those who brought us the economic meltdown. So in this column-fomercial, I won't waste your time with Ginsu knives or cash-for-timeshare schemes — I'm going to help make you rich beyond your wildest dreams! Look, we've all heard about Wall Street's losses. But you probably didn't hear about Corporate America's newest sure thing: a path to financial freedom far more reliable than any decent-paying job. It's something so old-fashioned that even amateur investors can understand it!
It's called graft — a surefire wealth creator that takes your investments, modifies laws, and delivers returns that the best stock trader could never dream of. This is the ShamWow of strategies, the Flowbee of economics, the Ronco of investing. Just look at the profits it generates! In the last decade, the financial industry's $5 billion investment in campaign contributions and lobbyists resulted in deregulation, which delivered trillions to executives. And when the bubble burst, there was another boatload of free money! By Bloomberg News' account, $12.8 trillion worth of taxpayer loans, grants and guarantees — all to Wall Street! But wait ... there's more!
The Associated Press this week reports that "companies that spent hundreds of millions lobbying successfully for a tax break enacted in 2004 got a 22,000-percent return on that investment" — $100 billion in all. That could be you! Of course, the secret is investing heavily in specific political stocks. For example, the banking industry recently paid Rahm Emanuel $16 million for about two years of work. That investment was recently paid back when, as President Obama's chief of staff, Emanuel led the January campaign to release another $350 billion in bank bailout funds. Turning a $16 million down payment into a $350 billion payout — that's huge! Likewise, Goldman Sachs hired former Senate aide Mark Patterson as one of its lobbyists — an investment that proved a huge winner when Patterson became the Treasury Department's chief of staff and the agency subsequently killed proposals to limit executive compensation at bailed-out banks. Cha-ching!
And the hedge fund industry paid economist Larry Summers $5.2 million in 2008 for part-time work — an investment that hit pay dirt when Summers became Obama's top economic aide and the administration resisted tough international hedge fund regulations that some G-20 countries wanted. Show me the money! That's right, the surest way to make big cash is not to invest in people with proven business experience or in valuable entrepreneurial ventures, but in blue-chip members of Permanent Washington — career politicos and bureaucrats who inevitably get back into positions of power and payback! Now I know you think that I sound like the guy in the question-mark suit and that my plan seems like a scam. But it's perfectly legal!
So how much would you pay for this kind of opportunity? $100 trillion? $50 trillion? What if I said you could get all this for just a few billion in pocket change? Because that's all it takes to start no-risk investing! It's that easy! Why let the corporate guys make all the money off government? Why waste time working for companies that make stuff when you can buy the one company that simply prints cash? Order now and try my product! It's not available in stores, but if you call within the next 15 minutes, we'll throw in free congressional and White House phone directories valued at $49.95! Operators are standing by!
Socialism has failed. Now capitalism is bankrupt. So what comes next?
The 20th century is well behind us, but we have not yet learned to live in the 21st, or at least to think in a way that fits it. That should not be as difficult as it seems, because the basic idea that dominated economics and politics in the last century has patently disappeared down the plughole of history. This was the way of thinking about modern industrial economies, or for that matter any economies, in terms of two mutually exclusive opposites: capitalism or socialism. We have lived through two practical attempts to realise these in their pure form: the centrally state-planned economies of the Soviet type and the totally unrestricted and uncontrolled free-market capitalist economy.
The first broke down in the 1980s, and the European communist political systems with it. The second is breaking down before our eyes in the greatest crisis of global capitalism since the 1930s. In some ways it is a greater crisis than in the 1930s, because the globalisation of the economy was not then as far advanced as it is today, and the crisis did not affect the planned economy of the Soviet Union. We don't yet know how grave and lasting the consequences of the present world crisis will be, but they certainly mark the end of the sort of free-market capitalism that captured the world and its governments in the years since Margaret Thatcher and President Reagan. Impotence therefore faces both those who believe in what amounts to a pure, stateless, market capitalism, a sort of international bourgeois anarchism, and those who believe in a planned socialism uncontaminated by private profit-seeking. Both are bankrupt.
The future, like the present and the past, belongs to mixed economies in which public and private are braided together in one way or another. But how? That is the problem for everybody today, but especially for people on the left. Nobody seriously thinks of returning to the socialist systems of the Soviet type - not only because of their political faults, but also because of the increasing sluggishness and inefficiency of their economies - though this should not lead us to underestimate their impressive social and educational achievements. On the other hand, until the global free market imploded last year, even the social-democratic or other moderate left parties in the rich countries of northern capitalism and Australasia had committed themselves more and more to the success of free-market capitalism.
Indeed, between the fall of the USSR and now I can think of no such party or leader denouncing capitalism as unacceptable. None were more committed to it than New Labour. In their economic policies both Tony Blair and (until October 2008) Gordon Brown could be described without real exaggeration as Thatcher in trousers. The same is true of the Democratic party in the US. The basic Labour idea since the 1950s was that socialism was unnecessary, because a capitalist system could be relied on to flourish and to generate more wealth than any other. All socialists had to do was to ensure its equitable distribution. But since the 1970s the accelerating surge of globalisation made it more and more difficult and fatally undermined the traditional basis of the Labour party's, and indeed any social-democratic party's, support and policies. Many in the 1980s agreed that if the ship of Labour was not to founder, which was a real possibility at the time, it would have to be refitted.
But it was not refitted. Under the impact of what it saw as the Thatcherite economic revival, New Labour since 1997 swallowed the ideology, or rather the theology, of global free-market fundamentalism whole. Britain deregulated its markets, sold its industries to the highest bidder, stopped making things to export (unlike Germany, France and Switzerland) and put its money on becoming the global centre of financial services and therefore a paradise for zillionaire money-launderers. That is why the impact of the world crisis on the pound and the British economy today is likely to be more catastrophic than on any other major western economy - and full recovery may well be harder. You may say that's all over now. We're free to return to the mixed economy. The old toolbox of Labour is available again - everything up to nationalisation - so let's just go and use the tools once again, which Labour should never have put away.
But that suggests we know what to do with them. We don't. For one thing, we don't know how to overcome the present crisis. None of the world's governments, central banks or international financial institutions know: they are all like a blind man trying to get out of a maze by tapping the walls with different kinds of sticks in the hope of finding the way out. For another, we underestimate how addicted governments and decision-makers still are to the free-market snorts that have made them feel so good for decades. Have we really got away from the assumption that private profit-making enterprise is always a better, because more efficient, way of doing things? That business organisation and accountancy should be the model even for public service, education and research? That the growing chasm between the super-rich and the rest doesn't matter that much, so long as everybody else (except the minority of the poor) is getting a bit better off? That what a country needs is under all circumstances maximum economic growth and commercial competitiveness? I don't think so.
But a progressive policy needs more than just a bigger break with the economic and moral assumptions of the past 30 years. It needs a return to the conviction that economic growth and the affluence it brings is a means and not an end. The end is what it does to the lives, life-chances and hopes of people. Look at London. Of course it matters to all of us that London's economy flourishes. But the test of the enormous wealth generated in patches of the capital is not that it contributed 20%-30% to Britain's GDP but how it affects the lives of the millions who live and work there. What kind of lives are available to them? Can they afford to live there? If they can't, it is not compensation that London is also a paradise for the ultra-rich. Can they get decently paid jobs or jobs at all? If they can't, don't brag about all those Michelin-starred restaurants and their self-dramatising chefs. Or schooling for children? Inadequate schools are not offset by the fact that London universities could field a football team of Nobel prize winners.
The test of a progressive policy is not private but public, not just rising income and consumption for individuals, but widening the opportunities and what Amartya Sen calls the "capabilities" of all through collective action. But that means, it must mean, public non-profit initiative, even if only in redistributing private accumulation. Public decisions aimed at collective social improvement from which all human lives should gain. That is the basis of progressive policy - not maximising economic growth and personal incomes. Nowhere will this be more important than in tackling the greatest problem facing us this century, the environmental crisis. Whatever ideological logo we choose for it, it will mean a major shift away from the free market and towards public action, a bigger shift than the British government has yet envisaged. And, given the acuteness of the economic crisis, probably a fairly rapid shift. Time is not on our side.
Social Security's Surplus Disappearing Fast in Downturn
Federal budget worrywarts (myself included) have been fretting for years about the arrival of the Dread Fiscal Year 2017, when Social Security was projected to start becoming a drag on federal finances. Well, no need to worry about 2017 any more. Thanks to the worst economic downturn since the 1930s, the moment of reckoning is already almost here: According to both the budget proposed by the White House in February and projections issued by the Congressional Budget Office (CBO) in March, Social Security benefits ($659 billion, according to the CBO) will exceed payroll taxes ($653 billion) in fiscal 2009 for the first time since 1984.
Payroll tax receipts generally hold up much better in recessions than income taxes, but job losses have been so severe that the CBO expects them to decline slightly from 2008, while benefits rise almost 9% because of cost-of-living adjustments and the beginnings of the baby boomer retirement wave. If you count the $17 billion in income taxes expected to be paid on Social Security benefits, the system will still manage to provide a slight surplus for federal coffers in fiscal 2009. But from 2010 through 2012 there are small projected deficits, and after heading back into the black from 2013 to 2015 the program will become a growing drain on federal finances after that, projects the CBO.
Back in 1983, when Social Security last faced deficits, Congress approved a set of Social Security reforms that included a graduated hike in the payroll tax and an increase in the retirement age. Thanks to those changes, payroll tax receipts surpassed benefits in 1985, and the system has been operating at a surplus ever since. The money has been invested in Treasury securities that the Social Security system is supposed to live off in the future. But in the meantime it has provided a significant boost to the federal bottom line for almost 25 years. No more.
Blogger Paul Lukasiak noticed this sudden change in Social Security's fortunes back in February and economist Kevin Hassett caught on in March, but it has otherwise attracted little notice. There's been some media coverage since then of Social Security's declining revenues, but none clearly makes the point that Social Security is about to cease playing its decades-old role as subsidizer of the rest of the federal government. This is partly because officially Social Security is still running a substantial surplus, and will be throughout the next decade, according to the CBO. A key source of that surplus, though, is interest payments on federal debt held by the Social Security trust fund.
It's money that Social Security has definitely earned, but it's coming out of the rest of the federal budget. Same goes for employer contributions to Social Security for federal employees, which also boost the program's bottom line but not the government's. A better reason for the lack of attention paid to the disappearance of Social Security's surplus may be that it's starting to seem like small change. My earlier worry about 2017 was that the country was going to have to find a way — through raising taxes or cutting spending — to make up for the $100 billion or so that Social Security had been handing over to the rest of the federal government annually.
Now, with a budget deficit projected at $1.8 trillion this year, we've got far bigger fiscal issues to worry about. That still leaves the question of Social Security's long-term financing needs, which will be reassessed soon in the system's annual trustees' report. But a couple of years of below-expected payroll tax receipts shouldn't dramatically change that forecast — and whatever long-run deficits the trustees project for Social Security will pale beside those expected for sister program Medicare.
Goldman Sachs Share Sale to Repay Treasury Could Pressure Rival Banks
Goldman Sachs Group Inc., by selling stock to help it repay $10 billion to the U.S. Treasury, may pressure competitors to follow suit or appear dependent on government support, analysts said. The company, scheduled to report earnings April 14, is considering announcing the share sale as early as next week, the Wall Street Journal reported yesterday, citing unidentified people familiar with the matter. Lucas van Praag, a spokesman for New York-based Goldman Sachs, declined to comment. A 47 percent gain for the company’s stock price this year and a return to profitability in the first quarter may help Chief Executive Officer Lloyd Blankfein raise new money, analysts said. That might let Goldman Sachs, the sixth-biggest bank, return the cash received in October from the Treasury’s Troubled Asset Relief Program and shake off compensation and hiring restrictions imposed on banks that took the U.S. aid.
"It’s in Goldman’s best interest to be free from the TARP," said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. "But just because it’s best for Goldman Sachs, doesn’t mean their repayment is in the best interests of the broader U.S. economy." Goldman Sachs’ repayment may lead banks "to race each other to access a very weak equity market and to write their checks to the Treasury," Hintz said by e-mail yesterday. "This could set off new credit concerns about the banks that can’t repay and could set back the recovery of the credit markets." Citigroup Inc., the third-largest U.S. bank, has tumbled 55 percent in New York Stock Exchange composite trading this year and is expected by analysts to report a sixth consecutive quarterly loss. Bank of America Corp., the largest U.S. bank by assets, has dropped 32 percent this year and analysts estimate it will report a first-quarter profit.
Morgan Stanley CEO John Mack, whose firm is expected by analysts to report a first-quarter loss when it reports earnings a week after Goldman, said last month he opposes any move by banks to return TARP money right now. Morgan Stanley, which has gained 58 percent in New York trading this year, was the second- biggest U.S. securities firm after Goldman before they both converted to banks in September to access Federal Reserve lending programs. "As much as we would like to give the money back and just focus on not having government involvement, being totally a public entity, we think, and I think, that it’s the wrong time to do it now," he told employees on a March 30 conference call. The Federal Reserve is reviewing the financial condition of 19 U.S. banks in a so-called stress test to determine whether any need to raise more capital or require extra aid to help absorb losses from further deterioration of the economy.
The 19 banks, which include Goldman Sachs as well as Citigroup, Bank of America and Morgan Stanley, have been told not to talk about the tests so the government can release the results in an orderly fashion later in the month, according to people familiar with the matter. "The top 10 TARP-funded banks will start being differentiated as to those that can shed the TARP and those that cannot," said Roy Smith, a finance professor at New York University’s Stern School of Business and a former Goldman Sachs partner. A share sale by Goldman "makes the gap more pronounced and more obvious." Even without Goldman Sachs’s share sale, any banks that don’t pass the stress test "will find it very difficult to tap private money," said Isabel Schauerte, an analyst at Boston- based financial research and consulting firm Celent. "They are visibly marked as the bottom -- a message that doesn’t go down well with the many investors that have burnt their fingers."
Goldman Sachs, the world’s biggest and most profitable securities firm before becoming a bank, was among nine financial institutions that shared $125 billion in the first payments from the Treasury’s $700 billion TARP. David Viniar, Goldman Sachs’ chief financial officer, said in February that the bank would like to repay the money because "operating our business without the government capital would be an easier thing to do." Earlier this week, Blankfein said that banks have "not a choice, but an obligation to taxpayers" to repay the government money as soon as they can without jeopardizing their business. An $787 billion economic stimulus law signed in February included a provision that prohibits cash bonus payments to the top five executives and the 20 highest-paid employees at banks that receive at least $500 million of bailout funds. Bankers can still get stock bonuses, although those are restricted until their employees prepay the bailout funds.
"Goldman is extremely eager to shake off the restrictions and scrutiny that come along with TARP," said Celent’s Schauerte. "A return of taxpayer funds would manifest the bank’s restored strength and set it apart from the pack -- just as in better times." Goldman Sachs raised $5.75 billion from a common stock offering at $123 each in September that started right after Warren Buffett’s Berkshire Hathaway Inc. bought $5 billion of preferred stock in the company. Goldman Sachs shares jumped 8.4 percent April 9 to close at $124.33, its highest since Oct. 3, amid a rally in bank stocks. The rally was sparked by Wells Fargo & Co., in which Berkshire is also a large investor, saying that it expects to report record first-quarter earnings. "It shouldn’t be beyond anybody’s imagination for them to be able to raise $5 billion or $6 billion through a new raise," said NYU’s Smith. "Remember Goldman Sachs raised $5 billion in a capital raise in September -- it was a much worse time and they raised it at a price level which is not far from where the stock is now." If Goldman Sachs’s first-quarter earnings match or exceed expectations, "it would make a lot of strategic sense to announce share sales in concert with releasing earnings," said Celent’s Schauerte.
Why the Lifeline for the Life Insurers?
by Elizabeth MacDonald
Shares in life insurers have soared higher in trading on news they may get a government bailout via TARP capital injections. Hartford Financial, Genworth Financial, Lincoln National, Prudential Financial, all have stayed steadily in the green. But why should US taxpayer dollars, which were supposed to be used to help banks, be used to bail out insurers that are regulated by the states, which enjoy the economic benefits of their business? What next, mutual fund companies? Why should US taxpayers bail out life insurers who routinely lobby state regulators to weaken their capital reserve requirements, and who have their policies backed by state insurance guarantee associations? The world didn’t collapse when a major life insurance company, Executive Life, folded in 1991.
A TARP bailout for the insurers is yet another controversial move by the government. Yes, according to their industry lobby group, the life insurers own about a fifth of all corporate debt, and are the single largest owner of corporate debt in the country, so keeping insurers afloat helps defrost credit markets that have been priced for the ice age. Yes, Americans own lots of life insurance policies and variable annuities that the insurers sold, which are retirement investments that guarantee minimum returns regardless of stock market drops. But despite the fact that TARP was meant to bail out bank that pose a "systemic risk" to the economy, the bailout of the life insurers is a pre-emptive rescue, none of them face bankruptcy for now. Also, the corporate bond market is coming back, and many variable annuities are not due and owing for ten years or more.
And their bailout tosses spotlights on an important issue–the backdoor way into TARP, which is meant to rescue banks. That is, companies can try to qualify for TARP taxpayer money by buying thrifts or industrial loan companies, outfits that basically process loans and credit cards (see the column "The United States of Bailouts".) And why should US taxpayers bail out insurers that are regulated by the states, which enjoy the economic benefits of their business? Here’s what Fox News analyst Jim Farrell has to say about this:
- First, insurance companies are regulated by state authorities. The state authorities have already determined that they are not willing to provide financial assistance to these insurance companies. If the states are not willing to do so, why should the federal government?
* The life insurance sought nationwide capital relief from the National Association of Insurance Commissioners (the life insurance companies wanted to hold fewer assets as a reserve against policy claims than provided for under state laws). The NAIC declined to give the insurance companies this blanket relief.
- Second, the states where these entities are headquartered receive tremendous financial benefits from these entities. Why should some states reap the benefits, but the costs be shared by all federal taxpayers?
* According to testimony on March 17, 2009 to the Senate Banking Committee by The Illinois Director of Insurance (Michael T. McRaith) on behalf of the National Association of Insurance Commissioners "States derive $17.5 billion in taxes and fees from insurers, with approximately eight percent (8%) used to support regulation and the remainder supporting State general funds."
- Third, the Illinois Director of Insurance recently assured Congress that it was "unlikely" that any insurance company was "too big to fail"
* In his March 17, 2009 testimony to the Senate Banking Committee, Director McRaith stated: - "Given that the US has the world’s most vibrant and competitive insurance marketplace, it is unlikely that any one insurer is "too big to fail." If an insurer were to fail, regardless of size, State-based guaranty funds would protect existing policyholders and pay claims. McRaith continued: "As history demonstrates, competition and capacity allow other insurers to fill marketplace voids left by the failed insurer. States also operate residual markets to cover those unable to obtain an offer of insurance in the conventional market. Therefore, even a major insurer failure, while traumatic in terms of job displacement and, perhaps, for shareholders, will generally not impose systemic risk."
- Fourth, some states (and in at least one case clouded by a potential conflict of interest) have relaxed the reserve requirements for select insurance companies. This means that these insurance regulators made it more likely that, in the event of a failure, the insurance company would not have sufficient funds to honor existing policy-holder claims. Why should all taxpayers pay for decisions made by individual state regulators (especially if they had the potential of being clouded by a conflict of interest)?
* Hartford Financial Services Group, an insurer that is apparently asking for a federal handout, got almost $1 billion in reserve relief from a state regulator who is a former executive at the company, according to Bloomberg. Hartford, which lost $2.75 billion last year, got the relief from a state regulator who is a former executive at the company, Bloomberg says. Connecticut Insurance Commissioner Thomas Sullivan rebuffed a Feb. 10 request by the Consumer Federation of America and the Center for Economic Justice to recuse himself from matters involving his former employer, Bloomberg reports. He approved a change in accounting standards that reduces the amount of money Hartford must hold for customer obligations by about $987 million. The insurer announced the action in a regulatory filing today, Bloomberg says.
* In addition, NewYork’s insurance director Eric Dinallo gave MetLife–another federal bailout requester–a reserve benefit of about $1.8 billion. MetLife Inc., the biggest U.S. life insurer, said in December the change would give the firm a benefit of about $1.8 billion. Regulators in Iowa and Ohio have signaled they may provide relief, Bloomberg says.
- Fifth, just as the FDIC provided guarantees for bank accounts and thus obviated the need of the federal government to provide TARP funds to failing smaller financial institutions (and these institutions were allowed to fail), state guarantee programs and state-mandated insurance reserve requirements provide similar assurance that policyholders will be generally protected.
- Insurers have their policies backed by state insurance guarantee associations.
- The total amount of money available every year to pay policyholders in states’ insurance guaranty funds is $8.8 billion, according to the National Organization of Life & Health Insurance Guaranty Associations.
- No state’s insurance guaranty fund has ever been wiped out.
- In addition, the world did not end when a multi-billion dollar insurance company failed in California in 1991. When Executive Life Insurance Company failed in 1991, 277,320 of the approximately 299,967 policies (85%) were 100% covered, with the remaining 15% of policyholders receiving between 79% and 89% of their policy’s value.
- Sixth, the root of the problem is variable insurance products sold by these companies that contained a guaranteed return provision. Meaning, they sold annuities that guaranteed a minimum return to investors. But why bail out companies who sold a risky product and also investors who knowingly took this risk?
* Investors in these products knew (or should have known) that: (1) annuities are not life insurance - they are contracts between the purchaser of the annuity and the issuing insurance company; (2) annuities are not insured by the FDIC or any federal government agency; and (3) like mutual funds, these products carried a risk that they may decrease in value or even lose all value.
* The Dow Jones Industrial Average is down about 45% since its peak in October 2007, and most mutual funds have experienced similar declines. The federal government is not bailing out mutual funds to "make whole" investors in these vehicles because the investors took the risk that their value may go either up or down.
- Seventh, in order to qualify for TARP funds, insurance companies bought banks or thrifts. These insurance companies are now looking to leverage a "small" purchase to a large TARP handout.
* Hartford Financial Services Group Inc. infused $20 million into a troubled Florida thrift (Federal Trust Corp.) to qualify for TARP funds. Hartford wants to use this $20 million investment to get access to $1.1 billion to $3.4 billion through TARP.
* This will allow the insurance company to remain largely outside of federal oversight, but still get federal funds.
* Both Morgan Stanley and Goldman Sachs fully transitioned to bank holding companies to get access to TARP funds. So did American Express, CIT Group
Banks aim to rebuild investor confidence
US banks are looking to capitalise on strong first-quarter results and the end of the government "stress tests" to raise capital and rebuild investor confidence in the battered sector. Goldman Sachs is finalising a plan to raise billions of dollars in the capital markets, a step that could pave the way for it to repay $10bn in government cash. Successfully raising the funds could satisfy what has become an unofficial condition of being allowed to repay government loans, as government officials have told banks that they also need to demonstrate that they have solid investor support. Goldman had around $111bn of cash and cash-equivalent securities in December.
The plans to repay the bail-out money soon may be threatening to banks still in need of help – a list that could include Citigroup or Bank of America – as it would draw a distinct line between healthy and unhealthy institutions. The bank’s plans come as Goldman prepares to kick off the first-quarter reporting season on Tuesday and after five consecutive weeks of rallying stock markets have left Goldman shares at their highest level since October. Goldman declined to comment. The bank has said for several months that it would like to repay the government funds, but institutions need permission from regulators. Obtaining this permission depends on the tests of their financial health.
US banks are set to report one of their best quarters since the beginning of the crisis but investors will be trying to predict how banks might have fared in the stress tests. The tests – which will determine whether banks such as Citi and BofA need more taxpayer funds – are set to finish in the next week. Investors raised expectations after Wells Fargo stunned the market on Thursday by forecasting record quarterly profits of around $3bn driven by strong results in its mortgage unit. The Wells news triggered a strong rally in banks’ shares. Goldman’s results come amid investor hopes that reduced competition has allowed banks to charge more for their services. "But, ultimately, the sector will have to demonstrate the rebound is sustainable," said a senior Wall Street executive.
What Is Obama’s Plan For The Banks?
What is the Obama administration up to with the banks? That’s been the question flying around the Web the last two days. Naturally, there’s no shortage of answers. Henry Blodget at Clusterstock suggests that they may be paralyzed with fear of causing another Lehman type meltdown or more disturbingly that they are in the back pocket of the industry. That was the conclusion of Jonathan Weil in his opinion piece at Blooomberg yesterday. Though to be fair to Weil he also suggested that it could be a fear of causing a panic or even a lack of manpower that is holding the administration back. In either case, both Blodgett and Weill feel that the administration has to do something or it risks losing control of public opinion. Today’s reports that the government has essentially ordered the banks undergoing the stress tests to not talk about the results only adds to the intrigue.
In fact, the stress tests may turn out to have been one of the dumber political moves of the crisis. Any credibility they may have had was mostly lost when the standards were revealed to be much too moderate and then eventually destroyed when it was announced that no bank would fail and that no details would be released. It may have made sense at some midnight meeting of a bunch of technocrats but anyone with a scintilla of political sense could forecast the disaster it’s growing into. The Obama people didn’t get where they are by being politically tone deaf and they aren’t stupid. They also know that the longer they let this drag on the more it becomes their problem, if it isn’t already. So why are they dragging their feet? Realistically, there are only three or four giant financial institutions that at the worst have to be dealt with. If any of the big regionals are unable to muddle through, their insolvency would be difficult but not overwhelming. Below them the problems are manageable for the FDIC.
Assuming that the administration isn’t delusional or a captive of Wall Street a couple of other possibilities occur to me. One, is a derivative of the paralyzed by fear theory. In this scenario, the losses are so big and the required resources to solve the problem so overwhelming that the administration cannot bring itself to admit to the situation. The sheer magnitude of the resources that need to be brought to bear on the problem is overwhelming them. In effect, the fix eats up all the money that can prudently be tapped from the economy.
The second is that the complexity of taking over several of the large institutions is so daunting that the administration is still trying to figure it out. In this case, they may have decided to keep some on life support while they write the playbook with, say a Citi restructuring. Something along the lines of Weill’s manpower argument. There is always the chance that everyone, including me, is just borrowing trouble. The situation may be not nearly so dire as many think and indeed muddling through not only the best policy but workable as well. Let’s hope that is the case.
Citi investors urged to oust directors
A leading proxy advisory group has recommended that shareholders vote against re-electing half the board of Citigroup, including the bank’s chairman, Richard Parsons, because of the directors’ failure to maintain risk controls and hold the line on executive pay. Glass Lewis advised shareholders to withhold votes from seven of Citigroup’s 14-member board: Michael Armstrong, the former chief executive of AT&T; Alain Belda, the chairman of Alcoa; John Deutch, the former director of the Central Intelligence Agency; Andrew Liveris, the chief executive of Dow Chemical; Anne Mulcahy, the chief executive of Xerox, and Judith Rodin, the president of the Rockefeller Foundation.
RiskMetrics, another proxy adviser, recommended voting against the re-election of four directors: Mr Armstrong, Mr Belda, Mr Deutch and Ms Mulcahy. Proxy groups are influential because many institutional investors, especially index funds, rely on their recommendations in voting. RiskMetrics said: "The [Citigroup] audit committee and board have chronically failed to address the company’s risk management and compliance issues. This poor oversight in conjunction with the company’s continued asset expansion . . . contributed to its current state, compelling the government to provide the company with four instances of extraordinary government assistance."
Citigroup in recent months appointed Mr Parsons as independent chairman, and replaced four outgoing directors with new ones, after pledging to focus more on risk management. Citigroup said: "Citi’s board of directors has diligently carried out its responsibilities during one of the most severe market downturns in decades. The board also rotated committee chairs and members in July 2008. There is no basis for any recommendations against directors." However, RiskMetrics said Citigroup’s steps were "reactive" and taken at the behest of regulators, not shareholders. "Given the depth of the company’s problems, the board may require a fresh start to rebuild its credibility with shareholders. Therefore, we recommend shareholders vote against the current and former leaders of the audit committee," it said.
Glass Lewis gave Citigroup an "F" grade for its pay practices. It said: "It paid more than its peers, but performed worse than its peers". The group also pointed to the bank’s need for capital infusions, saying directors needed to be held accountable. A union group, the American Federation of State, County and Municipal Employees (Afscme) has campaigning against the re-election of six current and former members of the audit committee, saying they failed to manage risk properly. Citigroup’s largest investors are index fund managers, such as State Street, Barclays Global Investors and Vanguard, which cannot sell their stakes even if they disapprove of the company’s actions. However, these funds can vote against the re-election of directors.
Treasury Has About $100 Billion Left to Spend From TARP
Two new independent reports peg available resources in the government’s Troubled Asset Relief Program at just over $100 billion -- with one report saying the Treasury still has more than $370 billion in unspent TARP cash on hand. The amount is important: Analysts and lawmakers are questioning whether the government will have enough TARP funding to finish stabilizing the financial system -- especially after results from the government’s bank "stress tests" are released later this month; the results may require the Treasury to invest more capital in banks. Treasury also may need to spend more for auto makers, life insurance companies and other industries that comes knocking on its door for help. "I don't think you can tell if it's enough to finish the job because they don't think we know how big the job is," said Karen Petrou, managing partner of Federal Financial Analytics, a research firm in Washington, D.C. "The [government] stress tests for the top 20 banks are still incomplete and then once we get those results, we still aren't sure what Treasury’s going to do with them."
Treasury Secretary Timothy Geithner said two weeks ago that there was "roughly $135 billion" in remaining TARP resources. But the two new reports -- one from the Financial Services Roundtable and the other from the TARP Congressional Oversight Panel -- agree there is $109.5 billion in uncommitted TARP funds. Congress authorized $700 billion for TARP last fall. According to the FSR, Treasury has allocated $667.5 billion to announced TARP programs, has committed to spending about $590 billion so far under those programs and has actually disbursed -- cut checks for -- about $329 billion. The largest TARP programs are its bank capital investment program ($250 billion allocated, though applications recently ended at requests for $218 billion) and its new program to purchase toxic assets in the financial system in partnership with private investors ($100 billion allocated). Flipping the FSR numbers to see what is left of the original $700 billion in TARP authority, FSR says there is $32.5 billion in unallocated authority, $109.5 billion left uncommitted to specific spending and about $371 billion in undisbursed TARP cash.
Treasury makes one assumption in estimating remaining TARP resources that the FSR and oversight panel do not: The department expects some banks that received TARP investments will pay back $25 billion soon -- a "conservative estimate," a Treasury spokesperson says. Goldman Sachs (GS: 124.69, 9.661, 8.4%), for one, has said it plans to repay its $10 billion in TARP funding by the end of the year. Assuming the $25 billion in funds are repaid, unallocated TARP resources would total $134.5 billion, the approximate figure cited by Geithner. "It gives us -- and this is very important -- substantial resources to move ahead with this broad-based suite of initiatives to help get the financial system back in the business of providing credit," Geithner said in an interview March 29 on ABC’s "This Week."
But that outlook is not certain. Whether the unallocated TARP money is $109.5 billion or $134.5 billion, most of whatever remains is committed to existing TARP programs. Meantime, auto companies are seeking another $22 billion in TARP loans; life insurance companies have applied for $20 billion in TARP capital, sources say, and there are other potential applicants for TARP funding. "Mortgage insurance companies are critical to home ownership -- we won't see new borrowers in a mortgage market pickup until something is done for the mortgage insurers," Petrou said. And "municipalities need help."
The Administration proposed a $750 billion placeholder in its budget for an additional TARP funding request to Congress at some point, if needed. But because of voter anger over bank bailouts, Petrou and others doubt Congress will approve any new TARP funding anytime soon -- if at all. "Getting Congress to approve yet more money in this program is impossible," Petrou said. Treasury "is either going to have to come up with Plan B, which would be another program that will recognize these political obstacles, or they're going to have to figure out way, I hope, through [government] guarantees and maybe some other innovative structures to make the [existing] $700 billion work as hard as it can." In its analysis, the FSR also said banks that received TARP investments have paid the Treasury $1.7 billion in dividends through March 31.
Delinquency Rate Rises on FHA-Backed Loans
Home mortgages insured over the past two years by the Federal Housing Administration are falling into delinquency at a faster rate, adding to risks that could prompt the agency to request an infusion of taxpayer funds. Nearly 10.2% of borrowers who took out FHA-backed loans in the first quarter of 2008 had missed at least two consecutive monthly payments within the first 10 months. That was up from 2007, when 9.4% of FHA-based borrowers missed payments within the first 10 months. Analysts often track loans made in a particular year, or "vintage," to better gauge the future performance of the entire portfolio. About 12.3% of loans made in 2007 were seriously delinquent -- 90 days or more late -- in February 2009, for example, including 4% that were in foreclosure or bankruptcy. The 2007 delinquencies helped to boost the overall delinquency rate on FHA-backed loans in February 2009 to 7.46% from 6.16% a year earlier.
Loans that are 60-days delinquent aren't necessarily headed to foreclosure, and the FHA has robust loss-mitigation programs. FHA officials say nearly 10% of those 60-day delinquencies end up in foreclosure, compared with a 27% rate for private-sector loans. But the rising default rate nonetheless illustrates the challenges that face the agency as it becomes one of the last backers of mortgages with low down payments. Top officials of the Department of Housing and Urban Development told lawmakers earlier this month that the FHA, a self-funded government agency, is weighing whether it will need to ask for taxpayer money for the first time in its 75-year history. Officials say job losses and broader economic deterioration that have made borrowers more vulnerable are primarily responsible for the rising defaults. But loans with seller-funded down payments, which have higher default rates, were "clearly adding to the overall losses," said William Apgar, a senior adviser to HUD Secretary Shaun Donovan.
Congress ended the seller-funded down-payment program last fall. Loans made in 2007 with seller-funded down-payments were 60% to 70% more likely to have a 60-day default than loans made without the 100% financing, Mr. Apgar said. HUD officials told Congress that down-payment assistance programs accounted for 30% of all FHA foreclosures but just 12% of all loans. Defaults have also jumped in certain markets where loan caps limited the FHA's reach until Congress increased the limits last year. Florida accounted for 14 of the 50 markets with the highest FHA default rates at the end of 2008, up from two in 2007. In West Palm Beach, defaults nearly doubled to 10.7% in December, from 5.5% a year earlier. FHA lending there has increased by one-third. HUD officials said they are evaluating the performance of loans in markets into which the agency recently expanded.
During the housing boom, the FHA never loosened its mortgage standards and it requires fully documented incomes for 30-year fixed-rate loans. The FHA's delinquency rate at the end of February remained below the 7.88% delinquency rate reported by the Mortgage Bankers Association at the end of the fourth quarter of 2008. Despite the rising defaults, the FHA sees some bright spots in its recent vintages. Rates of 30- and 60-day delinquencies for 2007 loans fell in January and February, which could indicate that serious delinquencies and foreclosures will peak this year. Officials also say the average credit score of borrowers has increased. The collapse of the subprime-mortgage market in 2007 swelled the volume of loans headed to the FHA, which insures lenders against the risk of defaults on loans that meet their standards. FHA-insured loans are available to borrowers who make down payments as low as 3.5%. The FHA's share of the U.S. mortgage market rose to nearly a third of all loans originated in the fourth quarter of 2008, from about 2% in 2006, according to Inside Mortgage Finance, a trade publication.
Subsidizing Failure In Washington
Imagine you went to get your driver’s license. You studied up on your state’s requirements. You learned the rules of the road. You practiced driving in your neighborhood under the watchful eyes of your mom or dad. And then when you went to the DMV, you passed the written and driving tests with flying colors. Now imagine that you ran into someone in the waiting room who conceded he hit the sauce before coming in. You watched him flub the written test. Then you heard he crashed into the curb twice during his driving test — and spent most of the ride hitting on his instructor. You’d expect to get your license — and you’d expect the other guy to fail, or maybe even get hauled off to jail. But in Washington, D.C. these days, that’s not how it works. Everybody passes! It’s like some perverse Lake Wobegon world, where everyone is above average (or treated that way). And it should have you, me, and every other American taxpayer fuming.
There are a lot of bad banks out there. A LOT. As Martin [Weiss] explained earlier this week in his special presentation: "The debt crisis is much greater than the government has reported, according to the white paper. The FDIC’s "Problem List" of troubled banks includes 252 institutions with assets of $159 billion. The updated review by Weiss Research, however, shows that 1,816 banks and thrifts are at risk of failure, with total assets of $4.67 trillion, compared to 1,568 institutions, with $2.32 trillion in total assets in the prior quarter." But there are also literally THOUSANDS of institutions that are NOT at an elevated risk of failure. They did NOT take on excessive, stupid risk in the derivatives market. They did NOT make a bunch of crappy residential and commercial mortgage loans. They did NOT buy a bunch of esoteric, hard-to-value securities in an attempt to juice up the yields they earned on their portfolios. The same goes for the insurance industry …
We just learned this week that life insurers have joined the seemingly endless line of companies seeking — and getting — government-funded bailouts. The Treasury Department is going to infuse capital into life insurance firms that are organized as bank holding companies or that own a thrift subsidiary. Many of those firms have seen their share prices plummet and their investment portfolios come under pressure. But you know what? For every poorly run insurer that took on too much risk in their investments and charged too little in premiums, there’s another firm that’s in much better shape. They did the exact opposite of their careless competitors. Logic would tell you the best approach is simple …
Nurses and doctors in the ER — or medics under fire during wartime — perform a vital function. Triage. They figure out which patients have the best chance of survival, and they focus their efforts on them. Those who are unfortunately a lost cause are kept as comfortable as possible until they pass on. That’s precisely what Washington SHOULD be doing with financial firms! Policymakers should be figuring out which institutions are too weak to survive, then euthanizing them. More specifically, they should deny them bailout money … let them fail … then let stronger competitors pick over their carcasses. If need be, bolster those stronger companies with aid so that the entire system doesn’t come crashing down.
But again and again, Washington is doing precisely the opposite. Officials are raining money down on any and all comers. Banks and insurers that are on the ropes because they took on too much risk are getting money willy-nilly. Heck, you could argue that some of the biggest risk-takers (Citigroup Inc., anyone?) are getting the biggest share of the bailout money. It’s just like giving a driver’s license to the drunk guy who failed his test and sending him out the door to do even more damage on the road. The banking industry "stress test" is a perfect example of this ridiculous approach. The results of the tests are being compiled now, and we should have some details in the next couple of weeks. You would expect that if any of the institutions failed, they’d get taken out — forced into receivership, carved up, or otherwise dealt with in a prompt manner.
But policymakers are planning to do the exact OPPOSITE! They’ve said that if any institution fails the test, they’ll be given several months to raise money. If that effort fails, they’ll be given an injection of taxpayer-funded capital. Does this make any sense to you? Because it sure as heck doesn’t to me. It’s another blatant sop to the financial industry, just like the caving in on the mark-to-market standards and the subsidy-packed plan that gives away the store to fund managers who buy toxic assets from banks (both of which I talked about in last week’s Money and Markets column). There IS a better way to go about this process without letting the world economy and the entire financial system collapse. We provided details in our recent white paper. It’s high time the folks in Washington start paying attention — because it’s OUR money they’re handing out like Halloween candy.
Job cuts needed to stop NYC bankruptcy: Mayor Bloomberg
Sweeping layoffs of government employees are needed to prevent New York going bankrupt, Mayor Michael Bloomberg said Thursday. Bloomberg, who is in tense negotiations with municipal workers' unions, said an extra 7,000 jobs would have to go unless major reductions are made in employee benefits. "We cannot continue. Our pension costs and health care costs for our employees are going to bankrupt this city," he said in comments broadcast on NY1 television. Bloomberg, running for a third mayoral term at the end of this year, said that proposals from unions so far were "nowhere near what is adequate."
The possible job cuts, first announced Wednesday, would be on top of 1,300 already proposed and another 8,000 that could be axed through attrition. Department heads have until Monday to propose cuts and Bloomberg must present the city budget by the end of the month. The city is barred by law from running deficits. The recession and the Wall Street crisis have knocked a huge hole in city finances that traditionally relied heavily on taxes from financial companies. The budget office on Wednesday said that 7,000 extra job cuts would allow the city to cut a further 350 million dollars in expenditure.
Obama breaks war funding promise
STEVE CHIOTAKIS: President Obama's economic team is about to take in a lot of information at the White House this morning. Treasury Secretary Tim Geithner, Federal Reserve Chairman Ben Bernanke and FDIC Chairwoman Sheila Bair, among others, will be talking about stabilizing the financial sector -- including those bank stress tests, unemployment numbers and mortgage refinancing. The administration also sent an $83 billion war supplemental to Congress, hoping for a speedy response. Marketplace's Steve Henn joins us now from Washington. Steve, I thought the president said he wouldn't use "supplemental funding requests" anymore?
STEVE HENN: That's right -- Obama promised that he would fund the war in the normal budget process, and the Democrats made the same promise back in 2007 when they took over Congress. They couldn't keep it, and the White House is now saying this is absolutely the last time they'll do this, but they were forced to because the wars are only funded through about the first few months of this year. So the Pentagon's set to run out of money.
CHIOTAKIS: So what does the supplemental include, then?
HENN: Most of the funding goes to the wars in Iraq and Afghanistan. The big change here is that you're beginning to see a shift in resources from Iraq toward Afghanistan. Iraq still makes up the lion's share of the money, but more is going to operations along the Afghan-Pakistani border.
CHIOTAKIS: And the president wants to pass this by Memorial Day. What are the chances of that happening?
HENN: Well, I, you know I think the administration and the Pentagon really wants this to be passed quickly, and they've also asked Congress not to sort of lard down this emergency appropriation package with special projects or weapons systems that they like. That's gonna be tough, though -- as you know, Secretary Gates unveiled his budget, and he wielded an axe to some of Congress' favorite weapons systems. So the F-22 is slated cuts, the stealth destroyer's slated for cuts, and congressional advocates of all those programs are going to look at this emergency appropriation as perhaps another chance to push through funding for their beloved projects for at least another few months.
Volcker Assumes Smaller-Than-Expected Role With Obama
As an early supporter of Barack Obama, Paul Volcker gave the young presidential candidate gravitas and advice. He frequently sat by Mr. Obama's side at key economic events, and started carrying a cellphone for the first time, just to be able to brainstorm with the candidate from the campaign trail. In the Obama White House, the role of the 81-year-old former chairman of the Federal Reserve has been more limited. The one-time central banker has been put in charge of a presidential advisory board that hasn't yet had a formal meeting. It has been nearly a month since he has seen Mr. Obama. Mr. Volcker hasn't been a main player in key decisions handling the global financial crisis.
Treasury Secretary Timothy Geithner unveiled the administration's plans for handling troubled financial institutions and the housing crisis without seeking input from Mr. Volcker, associates say. "Paul was surprised" at the failure to consult him, particularly on issues of financial rescue after his dominant role in resolving financial crises in the 1980s, says one person who has spoken to Mr. Volcker recently. On the eve of one announcement, a Wall Street executive ran into Mr. Volcker at a cocktail party and asked what he expected from the Treasury secretary's imminent announcement. "I have no idea what Tim's going to say," he responded, according to somebody there.
A Treasury spokeswoman said Mr. Volcker was "briefed" on all plans, including the latest one addressing banks' toxic assets. A White House spokeswoman said that Mr. Volcker "is a valued economic adviser to the president and the administration." She said that his "advice on issues including regulatory reform and financial stability are invaluable to the administration." Mr. Volcker, who recently had a pacemaker implanted in what he told friends was a "trivial procedure," said in a brief telephone interview Wednesday that he has no complaints about his role. "How they use me is up to them," Mr. Volcker said. "I'm conflicted about wanting to go fishing and being responsive....I might get busier than I want to be." He declined to comment about specific areas where he was or wasn't consulted.
When Mr. Obama announced the blue-ribbon advisory group on Feb. 6, he praised Mr. Volcker as "one of the world's foremost economic policy experts." With big names like General Electric Co. Chief Executive Jeffrey Immelt, the group, Mr. Obama said, would provide "voices to come from beyond the Washington echo chamber...." At a ceremony in the White House's East Room, the president added that the group would "meet regularly" with him. So far, the full group hasn't met. "The whole organizational side of this has been a nightmare," Mr. Volcker says. A White House spokeswoman says it will hold its first quarterly meeting in mid-May. In the meantime, Mr. Volcker and his members have divided themselves into subgroups such as financial regulation, employment growth and housing, and are holding conference calls, two members say.
When Mr. Volcker was in town earlier this week, he met with Mr. Geithner, Lawrence Summers, the chief White House economic adviser, and Christina Romer, the chairwoman of the Council of Economic Advisers, to discuss financial regulation. A key ally for Mr. Volcker inside the White House is Austan Goolsbee, the chief economist of his panel, and a member of the council. The pair grew close during the campaign when Mr. Goolsbee, Mr. Obama's chief economic adviser, worked to bring in Mr. Volcker after he indicated his support for the underdog candidate. Mr. Goolsbee says he talks with Mr. Volcker three or four times a week and helps get his views to the president and to senior administration officials. The task force, and particularly Mr. Volcker's input, "is meant to serve a role akin to an economic version of the president's BlackBerry," Mr. Goolsbee says. Messrs. Volcker and Goolsbee also send periodic memos to the president on the issues.
Mr. Volcker's advice hasn't always been heeded. The former Fed chairman urged the administration to "slow down" its push for regulatory changes. "Paul thought it was important to take enough time to fill holes in the regulatory framework and not get caught up in the current atmosphere," says former Securities and Exchange Commission Chairman William Donaldson, who's on the Volcker panel. When a former Fed official, attorney John Walker, recently met Mr. Volcker, Mr. Walker told him the administration "isn't getting the best use of you." Mr. Volcker shrugged it off, saying he's comfortable with his role. Mr. Walker says Mr. Volcker added: "I'm 81 years old."
GM, Chrysler Ratings Are Cut by S&P as Deadlines Loom
General Motors Corp. and Chrysler LLC had ratings cut on some of their debt by Standard & Poor’s as the automakers face government deadlines to restructure or file for bankruptcy. GM’s $4.5 billion senior secured revolving credit facility was reduced to CCC- from CCC, or nine grades below investment quality, S&P said today in a statement. S&P dropped its recovery rating to 2 from 1, saying lenders may recoup 70 percent to 90 percent in a default by Detroit-based GM. "The lowering of the rating on the revolving credit facility reflects our view of persistently weaker demand for light vehicles in North America," said Greg Maddock, an S&P analyst. Assets backing the debt also are declining, he said.
S&P’s actions underscored doubts about whether the companies, propped up with $17.4 billion in federal loans, can meet President Barack Obama’s directives to shrink debt, chop labor costs and revamp operations. They risk losing their U.S. aid and be pushed into government-ordered bankruptcies. The downgrades for GM, the biggest U.S. automaker, and No. 3 Chrysler didn’t include the possibility of further government funding, S&P said. Obama’s auto task force said it would help finance GM until the end of May and Chrysler until April 30.
Likelihood of Default GM’s corporate-credit rating was left unchanged at CC, which S&P said reflected "our view of the likelihood that GM will default -- through either a bankruptcy or a distressed debt exchange."
Chrysler’s senior secured first-lien term loan due 2013 was lowered to CC from CCC, and a senior secured second-lien term loan due 2014 was reduced to C from CC, or 11 grades below investment quality. S&P reduced its recovery rating to 4 from 1, projecting lenders could get back 30 percent to 50 percent in a default by closely held Chrysler. GM and Chrysler are both working to reduce debt and labor expenses. GM is meeting this week and next with a team from the U.S. Treasury to craft a revised plan to save the company. Lenders for Auburn Hills, Michigan-based Chrysler are holding meetings and exchanging proposals with the Treasury to cut the carmaker’s debt, people familiar with the situation have said
Chrysler Likely Broken Up If Bankruptcy Filed
Standard & Poor's Ratings Service became the most recent official organization to raise the specter of bankruptcy at General Motors Corp. and Chrysler LLC, cutting ratings on their secured debt. The warning comes the day after word of a new hard-ball offer for unsecured bondholders at GM, and highlights the fact that the clock for both companies is ticking. GM has until the end of May to strike a deal with stakeholders; Chrysler has until the end of April. Bankruptcy experts have called a filing by the two companies likely, and both companies and their stakeholders have been actively preparing for that eventuality.
The ratings firm warned that large parts of Chrysler likely would be broken up and sold off if it files for bankruptcy protection and that second-lien loan holders should expect payouts of 10% or less. First-lien loan holders can expect payments of 30% to 50%. The market appears to have already priced in worse possibilities. Chrysler's first-lien loans were trading at 15 cents/18 cents when the market closed Thursday, according to a hedge-fund trader who is active in the name. The first-lien loans are held mostly by big banks, led by Goldman Sachs Group Inc. and JPMorgan Chase & Co., the trader said. Bank loans secured by assets have historically returned more than 90%. S&P said a bankruptcy filing would likely occur around the end of April or soon after if Chrysler is unable to finalize an agreement with Italy's Fiat SpA, win concessions from its main labor union and secured lenders, or otherwise satisfying the Obama administration.
The prognosis for GM's secured debt holders was far better; they can expect payments of 70% to 90% in event of default on the revolving loan, S&P said, compared with the current market price of 33-1/2 cents/36-1/2 cents. S&P added that term-loan holders could get between 90 cents on the dollar and par, well above where the bond trades now at 45 cents/47 cents. However, the agency said its estimates exclude the possibility of debtor-in-possession financing - the loans to get a company through the bankruptcy process - which would come before any other claims. The ratings agency made the comments Friday as it lowered its issue-level ratings on Chrysler's senior secured first-lien term loan due 2013 one notch to CC from CCC. The latest view reflects S&P's view of a likelihood of default, either from a bankruptcy or a distressed-debt exchange. At the same time, it lowered its issue rating on the company's secured second-lien term loan due 2014 to C.
Separately, S&P lowered its issue-level ratings on GM's $4.5 billion senior secured revolving credit facility to CCC-, one notch above the company's CC corporate credit rating, but kept the rating on its term loan. S&P said the rating on the GM credit facility was lowered due to concerns about persistently weaker demand for light vehicles in North America, as well as declining pools of assets securing the facility. The corporate credit rating for each company remained unchanged at CC. The economic downturn and a shift in the market away from sport-utility vehicles have hurt GM, Chrysler and Ford Motor Co. (F). Restructuring plans from GM and Chrysler have come under increased scrutiny from the administration. Late last month, President Obama gave Chrysler just a month to wrap up a partnership with Fiat. GM most recently asked for an additional $16.6 billion capital infusion as Chrysler sought $6 billion. They have already received $13.4 billion and $4 billion, respective
U.S. Squeezes Auto Creditors
The federal government is taking an increasingly hard line with the creditors of General Motors Corp. and Chrysler LLC, trying to squeeze billions of dollars in concessions out of banks, bondholders and others. In both cases, the U.S. is directly and not-so-directly managing negotiations for the car companies as they prepare for what could be Chapter 11 bankruptcy filings. Chrysler has been told by the Treasury Department to get a deal done with creditors by the end of April, while GM has until the end of May. A Treasury spokeswoman declined to comment on dealings with GM and Chrysler debtholders. GM's restructuring could play out in one of two ways. It could successfully negotiate cost-cutting concessions with unions and bondholders so it can become viable outside of bankruptcy. Or, in the more likely scenario, it will reorganize by filing for Chapter 11, said people familiar with the situation.
The Treasury Department is pushing GM to offer its bondholders, who are owed $29 billion, a small portion of shares in the company. That's a sharp cut from a bond-exchange offer GM made two weeks ago, which included about $8.5 billion in cash and new debt in the company as well as 90% of GM's stock, said people familiar with the terms. The Treasury, which has pumped $13.4 billion into GM to keep it afloat, believed the earlier plan was too generous to bondholders, said people familiar with the matter. The new debt-exchange offer, which could be presented as soon as next week, is sure to face strong resistance from bondholders. But the offer may be a last chance at avoiding bankruptcy, which GM worries would be more expensive and disruptive than an out-of-court solution.
President Barack Obama's auto task force, meantime, has made it "crystal clear" that its members think a managed, or "prepackaged," bankruptcy is GM's best option, but it is letting GM pursue the out-of-court option for now, said people familiar with the matter. Many of GM's bigger bondholders prefer to negotiate outside of court, said people involved, but have been frustrated by a lack of engagement by the government and GM. These bondholders also are raising concerns that the bankruptcy revamp GM is considering may be unfair to investors and unions, said these people. The plan would split the company into a "New GM" containing its desirable assets, such as Chevrolet and Cadillac, and an "Old GM" holding troubled brands such as Saturn and the auto giant's union health-care liabilities. Treasury officials, many of whom are now working on GM's restructuring from an office in Detroit, plan to meet in coming days with a committee representing GM's bondholders.
The bondholders likely will struggle to figure out how to value the latest debt-exchange offer, said a person familiar with the matter, because it isn't clear what the government will do about the $13.4 billion it has lent GM. In a bankruptcy scenario, the government could reduce its debt in the company by transferring some or all of it to the "Old GM," said this person. If the government agreed to reduce its debt outside of bankruptcy, that likely would make GM shares worth more. That could sweeten the new bond-exchange offer. Such a move also could make the United Auto Workers union more favorable to a new health-care deal with GM, another requirement of the Treasury. The UAW has been largely unwilling to negotiate with GM until it sees what concessions will be made by bondholders and others. The standoff between bondholders and the UAW underscores the difficulty surrounding GM's attempt to reorganize without the coercion of bankruptcy. Key players in the Obama administration are pointing to the lack of progress as a reason that bankruptcy could be unavoidable.
At Chrysler, the U.S. wants banks and investors who control its bank debt to give up about 85% of the nearly $7 billion they are owed. In bankruptcies, such senior secured lenders typically get most of their money back. Some senior lenders believe they would get more than 70 cents for each dollar of their secured loans if Chrysler is broken up and sold under bankruptcy, said people familiar with the talks. Other lenders don't have an exact number nailed down and are awaiting detailed figures from the auto maker on its assets. All of the 40-plus lenders and investors are nonetheless incensed by the last Treasury offer: that they accept about 15 cents per dollar of face value of their loans. Secured lenders -- those whose loans are backed by the rights to Chrysler assets should the company default -- haven't made a counteroffer to the Treasury, but one is forthcoming, say these people.
The lenders have now added the hedge fund Elliott Management to their negotiating team, which also includes Chrysler's four largest bank debtholders: J.P. Morgan Chase & Co., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley. Those four banks hold about $4.3 billion of the bank debt, said people familiar with the situation. Elliott Management is also a large holder of Chrysler bank debt, which it bought on the secondary market. In a statement Thursday, a steering committee representing secured lenders, including the four big banks and Elliott Management, said: "We are engaged in ongoing discussions with the U.S. Treasury and Chrysler, and continue to work diligently toward achieving a thoughtful solution prior to the April 30th deadline." The lenders' steering committee held a conference call with lenders on Monday to update them on the Treasury offer, which one Chrysler debtholder called "ugly, really a pretty low starting point."
Chrysler, which is controlled by Cerberus Capital Management LP, has estimated that if it liquidates, the amount its senior secured lenders would see is between 11 cents and 43 cents on the dollar, according to the viability plan it submitted to the government in February. With Chrysler bank debt trading at around 12 cents on the dollar, the government view has been, "Why offer more than 15 cents?" said a person involved in the talks. But some of the senior secured lenders think that is a low-ball estimate and say recoveries could reach 70 cents on the dollar in liquidation, said another person familiar with the talks. Chrysler said in its February plan that the company had identified $1 billion worth of noncore assets that could be sold and had sold $700 million of those assets, such as its California design center.
In addition, the lenders say there is value in Chrysler's Jeep brand. Aside from vehicle sales, the brand generates $500 million a year in royalty revenue for use of its name on everything from bicycles to strollers. It is the value of Chrysler in liquidation that prompted some of the secured lenders to buy the company's debt. These lenders are distressed-asset buyers and hedge funds that haven't received federal assistance. But the largest portion of the company's debt is held by banks that have received federal aid, including J.P. Morgan, Citigroup, Goldman Sachs and Morgan Stanley. Michigan Gov. Jennifer Granholm and one of the state's congressmen have suggested lenders that received funds under the Troubled Asset Relief Program should have to write off their debt to ensure the future of Chrysler.
Trading and Living in a Cesspool of Lies
What seems to spook people now is the possibility that everybody in charge of everything is a fraud or a crook. Legitimacy has left the system…James Howard Kuntsler, Legitimacy Dwindles
There is a contagious epidemic of lies spreading all over the world, and it starts with rot at the highest levels of government. We are drowning in a cesspool of lies. All you have to do is open your eyes and ears. The litany of lies is everywhere. Even those who are doing everything possible to lead lives of radical honesty will slip and catch themselves in a lie. Maybe it’s a "little white lie" or something that is euphemistically called an "error of omission" or a "slip of the tongue." Nonetheless, a lie is a lie. Why do people lie? Because they can. We start lying at around age 4-5 when we gain the power and awareness of language. The first lies we tell as children are not malicious, rather they are tests of the degree to which we can manipulate our environment. Eventually, children learn that lying can be used to get what they want or get out of trouble. Everyone lies a little. How many times today have you told a lie? Right now, I might be lying to you about lying.
So we have the little liars and then we have the big liars. These are people who are compelled to lie about almost everything. They lie to protect themselves, make themselves look good, gain financial, sexual or social rewards, avoid punishment or manipulate others. Manipulation is a huge motivation for these big liars. In the extreme, such individuals are given vague descriptions like "pathological liar" or actual psychiatric DSM-IV diagnoses (Antisocial Personality Disorder, Borderline Personality Disorder, etc). How neatly official. Big Deal. They now have a name and a label, but if their lips are moving, they’re lying. Period. One lie leads to another and another until there is no way to distinguish the truth from the lie.
Lying wears people out. Lying causes stress and stress kills. Lying puts people into a prison cell of their own making. There is no freedom, rather more and more need to keep boxing themselves further into the corner of their lying brain box. I assure you that once you have been "played" by a compulsive liar, you will never be the same person. If you want to feel the depths of total frustration and absolute crazy-making, then get intimately involved with a big time liar. The internal rot that plagues a family, culture or country begins at the top and like an unleashed deluge of contaminated rotting sewage, trickles downward. We all know that politicians lie. After all, the origin of the word politics might as well be from poly (many) and tics (small blood-sucking insects). It is a foregone conclusion that those in poli-tics will lie to us to get what they want from us and to further their own agendas.
Take the financial markets, for example. My inbox is polluted with crap. I make it a point to stay on over 25 mailing lists of hocus-pocus newsletter services that offer unlimited riches (without your doing any work of course!) by trading this or that Holy Grail indicator or magical formula that has just been discovered and will turn your $1,000 to $1,000,000 in less than a year. Right. Sure. Please give us all a break here. Marketing to groups of people who are addicted to money (that means just about everyone in the world) is easy. All the "neuromarketers" have to do is to appeal to the dopamine-driven rat brain areas. Just the thought of making money through these "revolutionary instant cash machines" produces dopamine and "lights up" the pleasure centers of your brain.
The interesting aspect of this is that the most effective way to sell is to lie. Oh, no! Can that possibly be true? In order to sell you something, people have to lie to you? It doesn’t have to be a whole lie; it can be a partial lie. So how do you know what part of it is a lie and what part isn’t? You don’t and you likely never will until after it’s too late and your money is long gone. They are there to get your money, and they will do everything possible to separate you from your hard-earned cash. There are some very powerful hammerhead sharks lurking around every corner and doing every sneaky deal imaginable to convince you to buy something; anything. Come on in, the water’s fine, so just keep buying. There is no danger here---none at all! Everything is just wonderful, so keep buying these worthless pieces of paper.
There appears to be no limit to the sneaky slimy cesspool of deception that runs through the financial markets and our society. As the social mood continues to darken, and our currency spirals downward, the rot and stench will increase. Desperate people do desperate things and it’s all about separating you from your money. My bonus report published today for subscribers begins a series on how not to be scammed by gypsies tramps and thieves. There is nothing underneath the glitz. There are no invisible golden threads. The emperor is naked. It is a sham that will devour and steal from you until it has the greed has gorged itself and moved on to the next victim and the next and the next.
Please, everyone who is reading this: Open your eyes; do not allow yourself to be led down some garden path that appears lush with trees and flowers, but ends up in the vast wasteland of wiping out your life savings and stealing what is left of your sanity. Beware of false prophets, hypesters and crooks. Your rat brain is always out to get you, and the scam artists know exactly where your rat brain lives. Use your rational brain to override the rat brain impulses and allow yourself time to measure and judge with logic and reason. Beware and be careful. Verify. Believe in a Higher Power, but remember to lock your car.
One of the saddest lessons of history is this: If we've been bamboozled long enough, we tend to reject any evidence of the bamboozle. The bamboozle has captured us. Once you give a charlatan power over you, you almost never get it back…Carl Sagan
A Game of Credit Cost Smoke at Mirrors at Wells Fargo?
Wells Fargo & Co. managed to bring some holiday cheer into financial markets Wednesday, just ahead of the Easter holiday, with its pronouncement that it expects to post a record quarterly net income of $3 billion — or 55 cents per share — when it officially reports Q1 2009 earnings later this month. But more than a few voices are already questioning the results, warning that this quarter’s big gain is more likely to be a flash in the pan than a market turning point.
In particular, Wells Fargo reported that they will absorb just $3.3 billion in charge-offs on bad loans for the quarter, and just $4.6 billion in loss provision expense; both numbers are well below most analyst estimates, and are the primary reason Wells will report earnings trumping earlier Street estimates.
“The shocker was that they only had only $3.3 billion [in] charge offs,” said Whitney Tilson of hedge fund manager T2 Partners, in a CNBC interview Wednesday afternoon. “It’s weird, because in Q4 Wachovia and Wells Fargo together had $6.1 billion in charge-offs, and then in a quarter in which things were terrible, those charge offs fell by 50 percent … They’re going to have a lot of losses over the next couple of years, [and] anyone baselining at $3.3 billion in charge offs per quarter is crazy.”
Know what else is weird? That Tilson is still long Wells Fargo, after hearing all of that.
CNBC’s Fast Money crew was quick to gloat over the positive results for WFC on air Wednesday, however, poking fun at FBR Capital Markets analyst Paul Miller, who had recently been a guest and recommended shorting Wells Fargo stock over the bank’s exposure to souring loans. “He [Miller] wasn’t wrong, he was 27 percent early,” cracked Jeff Macke of Minyanville.com and a regular Fast Money panelist, referring to the bounce in WFC’s shares in Wednesday trading.
Of course, one day of trading does not a trend make. We believe that credit quality materially deteriorated in the first quarter, and that Wells Fargo is under-reserving for expected future losses,” FBR’s Miller wrote in a Wednesday research brief. “We reiterate our Underperform rating.” More questions from Miller: “[W]e remain cautious based on what we don’t know. Most importantly, what happened to nonperforming loans and what would have been net charge-offs excluding purchase accounting adjustments? What are the trends in WFC’s Option ARM portfolio? Did the company write up the MSR and what was the new capitalized cost of servicing? Was there any benefit from an increase in level 3 assets given recent accounting guidance?”
If the Fast Money crew had any desire to do basic analysis before running their collective mouths, they might have been able to pull up this chart — which should speak volumes about the value of skepticism here:
This shows the ratio of loan loss reserves/total loans at the four major U.S. banks still standing. Wells Fargo is in white. Notice anything? You know, like which bank is comparatively weakest on reserving activity against its loan book?
This chart doesn’t include updated Q1 numbers for Wells, as the bank did not provide an updated loan total on Wednesday — meaning it doesn’t include Wachovia. Historically, Wells has justified its lower reserves by maintaining a comparatively higher-quality loan book; can the same argument really be made now? With Wachovia’s option ARMs lurking? Because there’s an ugly truth about credit costs: they come home to roost eventually, irrespective of any games played with loss reserves in the interim.
What Next For Banks?
The case for keeping banks in something close to their current structure begins to take shape. It’s not about traditional claims that big banks are more efficient, or Lloyd Blankfein’s argument that this is the only way to encourage risk-taking, or even the House Financial Services Committee view that immediate resumption of credit flows is essential for preserving jobs. Rather, the argument is: those opposed to banks and bankers are angry populists who, if unchecked, would do great damage. Bankers should therefore agree to some mild reforms and more socially acceptable behavior in the short-run; in return, the centrists who control economic policymaking will protect them against the building backlash. This is a version of Jamie Dimon’s line: "if you let them vilify us too much, the economic recovery will be greatly delayed."
There are three problems with this argument: it is wrong, it won’t work, and it doesn’t move the reform process at all in the right direction. The "center vs. the pitchforks" idea fundamentally misconstrues the current debate. This is not about angry left or right against the center. It’s about centrist technocrat (close to current big finance) vs. centrist technocrat (suspicious of big finance; economists, lawyers, nonfinancial business, and - most interestingly - current/former finance, other than the biggest of the big, particularly people with experience in emerging markets.) Just as an example, a broad range of entirely centrist people (including in and around the IMF; former Treasury; you’d be amazed) are expressing support for the ideas in our Atlantic article. People on the left are, not surprisingly, also in line with this view; but we’re also hearing convergent thoughts from some on the right - many who emphasize improving the environment for entrepreneurship don’t see big finance as their friend. So far, the only person who called to complain works for an "oligarch."
You might think the "anti-pitchfork" strategy might work, particularly as it has in the past (e.g., in the early Clinton years). The problem for this strategy now is not just the fragile state of banks - by itself this can be ignored for a long while through forbearance, behind a smokescreen of complicated schemes with confusing acronyms - but the ways in which the markets they created now operate. Just as global financial liberalization created the potential for capital to move violently across countries and greatly facilitated speculative attacks on currencies, so financial deregulation within the United States has made it possible for capital markets to attack - or, in less colorful terms, go short or place massive negative bets on - the credit of big banks and, in the latest developments, the ability of the government to bailout/rescue banks.
The latest credit default spreads data for the largest banks show a speculative run underway. As the system stabilizes, it becomes more plausible that a single big bank will fail or be rescued in a way that involves large losses for creditors. This would like trigger further speculative attacks on other banks, much as the shorting of countries’ obligations spread from Thailand to Indonesia, Malaysia and then to Korea in fall 1997. The government’s own policies are facilitating these attacks, because as the Fed and Treasury make progress towards easing credit conditions, this makes it easier and cheaper for large hedge funds and others to take large short positions. And keep in mind the underlying loss of confidence is self-fulfilling: as you lose confidence, you want to go short, and selling the credit causes further loss of confidence - and banks are forced out of business.
The government’s entirely reasonable and long overdue request for a resolution authority will set up runs on that authority. If the authority is not granted, the runs will be on the government’s low and failing ability to save banks - given that the trust of Congress has been lost and no more cash for bailouts is likely forthcoming (presumably until there are large further shock waves or until Goldman Sachs itself is on the line.) The continuing pressure on banks has nothing to do with populism and everything to do with the internal contradictions of the house of cards they built. Now they will scramble to limit short selling or find other emergency measures that will protect their credit. Such partial fixes would do nothing to stop the underlying deterioration of their credit; think about how countries facing currency attacks throw up futile defenses, try to change the rules, and squander their reserves on the way down.
You can see where this is going, but do not cheer. The likely result will be misery for many and further financial chaos around the world. The big issue is of course the financial sector reform process. Some of my colleagues expressed great satisfaction with the progress made by the G20. But progressing down a blind alley is not something to be pleased about. I have yet to hear a single responsible official in any industrial country state what is obvious to most technocrats who are not currently officials: anything too big to fail is too big to exist. If the bankers were just stupid, as suggested by David Brooks, then regulatory fixes might make some sense. But we know that bankers are smart, so it is their organizations that became stupid. What is the economic and political power structure that made it possible for such stupid organizations to become so large relative to the economy? Answer this and you address what we need to do going forward.
At a high profile conference in the run-up to this crisis, someone destined to become a leading official in the Obama Administration responded to a sensible technocratic critique of the financial system’s incentive structure (from the IMF, no less) by calling it "Luddite". By all accounts, this is the prevailing attitude in today’s White House. But the right metaphor is not breaking productive machines, or peasants with pitchforks, or even the poor vs. the rich. It’s as if the organizations running the nuclear power industry had shown themselves to be stupid and profoundly dangerous. You might wish to abolish nuclear power, but that is not a realistic option; storming power plants makes no sense; and the industry has captured all regulators ever sent after them. The technocratic options are simple, (1) assume a better regulator, of a kind that has never existed on this face of this earth, (2) make banks smaller, less powerful, and much more boring.
Making Banking Boring
Thirty-plus years ago, when I was a graduate student in economics, only the least ambitious of my classmates sought careers in the financial world. Even then, investment banks paid more than teaching or public service — but not that much more, and anyway, everyone knew that banking was, well, boring. In the years that followed, of course, banking became anything but boring. Wheeling and dealing flourished, and pay scales in finance shot up, drawing in many of the nation’s best and brightest young people (O.K., I’m not so sure about the "best" part). And we were assured that our supersized financial sector was the key to prosperity. Instead, however, finance turned into the monster that ate the world economy.
Recently, the economists Thomas Philippon and Ariell Reshef circulated a paper that could have been titled "The Rise and Fall of Boring Banking" (it’s actually titled "Wages and Human Capital in the U.S. Financial Industry, 1909-2006"). They show that banking in America has gone through three eras over the past century. Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some of which later turned out to have been based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929. During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.
The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative for those who ran it. Banking became boring, partly because bankers were so conservative about lending: Household debt, which had fallen sharply as a percentage of G.D.P. during the Depression and World War II, stayed far below pre-1930s levels. Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans. After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.
As these changes took place, finance again became a high-paying career — spectacularly high-paying for those who built new financial empires. Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age. Needless to say, the new superstars believed that they had earned their wealth. "I think that the results our company had, which is where the great majority of my wealth came from, justified what I got," said Sanford Weill in 2007, a year after he had retired from Citigroup. And many economists agreed. Only a few people warned that this supercharged financial system might come to a bad end. Perhaps the most notable Cassandra was Raghuram Rajan of the University of Chicago, a former chief economist at the International Monetary Fund, who argued at a 2005 conference that the rapid growth of finance had increased the risk of a "catastrophic meltdown." But other participants in the conference, including Lawrence Summers, now the head of the National Economic Council, ridiculed Mr. Rajan’s concerns. And the meltdown came.
Much of the seeming success of the financial industry has now been revealed as an illusion. (Citigroup stock has lost more than 90 percent of its value since Mr. Weill congratulated himself.) Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry. But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again. Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress. Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.
How to Make the Bank Asset Plan Work
Four legal concerns to address.
The government has finally figured out how to get us out of a credit crisis caused by leverage and securitization: more leverage and securitization. Under the Public Private Investment Program (PPIP) unveiled last month, the Treasury plans to partner with private investors to purchase "legacy" (formerly known as "toxic") loans and securities from banks, with leverage guaranteed by the FDIC (for loan purchases) or provided by the Federal Reserve or Treasury (for securities purchases). The aim of the PPIP is to put a price on illiquid assets, which will enable banks to sell those assets, make new loans, and raise new capital. Once that occurs, the spigots of securitization will be reopened and consumer credit will be expanded. PPIP, in short, aims to conscript private money into public service.
It's a combustible combination, and it will only work if, for investors, the anticipated financial rewards outweigh the potential legal risks. Do they? On the financial side, a valuation riddle has dogged efforts to jump-start credit markets since passage of the Troubled Asset Relief Program last year. Selling legacy assets at too low a price would only wipe out needed bank capital. But selling those assets at too high a price would force taxpayers to pay more than they should. The PPIP aims to solve this riddle by focusing on leverage rather than prices. Leverage allows investors to earn a higher rate of return on an asset than they might have otherwise. Or in this case, to earn the same return on higher-priced assets with leverage as they earn on lower-priced assets without leverage.
For example, with leverage an investor can get the same return on a loan he buys at 60 cents on the dollar as he does on a loan he buys without leverage for 40 cents on the dollar. Moreover, under PPIP the leverage will be nonrecourse, so an investor's loss will be limited to his investment. PPIP, therefore, appears to offer a compelling financial opportunity. But the legal picture is more complicated. Private fund managers and government agencies have fundamentally different purposes, obligations and constituencies. Fund managers have a fiduciary duty to their funds and investors; government agencies generally exist to serve the public interest. If PPIP is to succeed it needs to effectively reconcile these divergent purposes. Specifically, hedge-fund managers and other investors have at least four legal concerns that must be addressed.
First, they are concerned about the consistency and reliability of the government as an investment partner. The Treasury announced the PPIP on March 23. A few days later, Treasury Secretary Timothy Geithner outlined new proposed regulations for hedge funds. The Treasury also noted that it will manage PPIP investments "in the public interest." Both unnerved fund managers who are worried about conflicts between public and private interests. Second, in the wake of the bonus flap and resulting congressional proposals to tax Wall Street bonuses at punitive rates, investors are concerned that any gains they get from the PPIP will be stripped away via taxation. Third, the FDIC has promised to maintain "rigorous oversight" of the formation, funding and operation of Public-Private Investment Funds (PPIFs). Investors need to know whether the FDIC's oversight role will compromise their decision-making autonomy.
Finally, there are tax considerations. Domestic investors worry that Treasury will require PPIFs to be structured as tax-inefficient vehicles. Non-U.S. investors worry that the activities of PPIFs -- especially loan servicing -- will be construed as a U.S. trade or business, thus subjecting them to U.S. taxation. By addressing these concerns, the Treasury, the FDIC and the Fed can calm the worries of investors, enhance participation and increase the likelihood of success of the PPIP. Specifically, with respect to the first two issues, the government can offer participating funds reasonable exemptions from any future regulation or tax that would otherwise hit them because of their participation in the PPIP. On the third issue, the FDIC can soothe concerns by issuing detailed and binding guidance on its oversight rights.
And on the fourth issue, the Treasury can permit PPIFs to be structured as pass-through entities, and the IRS can confirm that the activities of PPIFs will not be considered a U.S. trade or business. This will encourage offshore investors to pour money into PPIFs without fear that doing so will subject them to U.S. taxes. The PPIP is not perfect -- no government program is. But it is the most financially plausible proposal to date for resolving the legacy asset problem. To increase the likelihood of participation by private investors, the government should leverage its demonstrated financial creativity by providing additional legal certainty.
Midwest auto industry: Tough times ahead for towns across region
In tattered and gray industrial towns across the Midwest, no one knows exactly where the ax will swing next. But there is no doubt the forced downsizing of General Motors and Chrysler, which will begin to take shape in the coming weeks, will fundamentally change the quality of life in communities and the region for years to come. Even if both automakers survive, economists say, they will be smaller and will pay lower wages and benefits. More communities will lose production and parts plants, and the states that have relied heavily on those manufacturing jobs—especially Michigan, Indiana and Ohio — will take a big hit that, economists warn, will take years and perhaps decades to overcome. "If you go back to 1980 to 1982, with the upheavals in the steel, rubber, glass and auto industries, that really was the end of an economic era that started in the 1890s," said Ned Hill, an economist at Cleveland State University. "This is the last movement in the symphony."
While the American auto industry played a large role in creating the modern Midwest a century ago, its unraveling has exposed the region's economic over-reliance on vehicle manufacturing. In recent decades, the demise of specialized manufacturing—shoes in Missouri, TV picture tubes in Indiana and Ohio, glass in Toledo and rubber in Akron—sent many towns and cities reeling from the loss of jobs. On a larger scale, Chicago, northwest Indiana and northeast Ohio suffered from Big Steel's slide more than 25 years ago. But the auto industry has a much broader footprint in the region, with about two dozen assembly plants of General Motors, Chrysler and Ford in the Midwest and many hundreds of parts suppliers peppered about, according to the Federal Reserve Bank of Chicago.
"Every job in the auto industry usually can be responsible for five to six jobs in general throughout the entire economy," said Jerry Conover, director of the Indiana Business Research Center at Indiana University. "The direct and indirect effect of all of this means a lot less money circulating through the cash registers in these states." The details of the downsizing are being discussed as GM faces a deadline at the end of May to satisfy the government's requirements for federal assistance. Chrysler has until the end of April to work out a merger deal with Italian carmaker Fiat. Those private discussions have fed rumors of plant closings around the Midwest and across the nation. Bankruptcy is an option for both automakers. How bad would it be if one or more of the Detroit automakers failed?
In perhaps the most dire forecast, the Center for Automotive Research in Ann Arbor, Mich., said the 2009 job loss would be nearly 2.5 million if there were a 50 percent cut in operations at the Big Three. Personal income would drop by $276 billion, the report forecast. That, Hill noted, assumes the lost auto production would not be picked up by other automakers, including Honda and Toyota, which have production facilities in the Midwest. Still, even under less pessimistic projections, pain will be spread around the region as jobs are slashed and pay, health-care and retirement benefits are scaled back, Hill predicted. "The unfortunate thing is you've got a large number of small- to mid-size communities dependent on this income," Hill said. "What's happening now will put the industrial Midwest at a bigger disadvantage."
The domestic auto industry has been shrinking since the 1980s, and some of the cities affected by that decline provide a bleak view of what may be in store for others as the industry continues to contract. For generations, Anderson, Ind., was a major parts supplier for GM, but most of those operations have been gradually shut down over the past 25 years. Anderson, which has struggled to regain its economic footing, is defined by a disproportionate number of senior residents, steady job losses and wages at less than 75 percent of the U.S. average, according to a report from STATS Indiana. In nearby Muncie, Ind., another city that supplied GM, the last of the major suppliers is scheduled to complete its shutdown later this year. The average wage has dropped in Muncie, which is making a painful transition from a well-paying manufacturing economy to one dominated by health care and Ball State University.
"It takes decades to make the adjustment," said Roy Budd, executive director of Energize-East Central Indiana, a non-profit economic development group. "I think we've trough-ed out and are on the upswing. But it takes a lot of time. We didn't get into it overnight and won't get out of it overnight." The economic crisis has made Michigan, once one of the more prosperous states, a net population loser, with 109,000 more people moving out last year than moved in, according to census data. Among the obstacles for the region to recover, Conover said, is the relatively low percentage of college graduates in these states. The national average of people with a bachelor's degree or more is 27.5 percent, according to the Census Bureau. The percentages in Michigan, Ohio and Indiana are 24.7, 24.1 and 22.1, respectively. The questions of how, and indeed whether, GM and Chrysler survive will begin to be answered in a few weeks, and then any affected communities will begin the adjustment to life without their biggest breadwinner. "This is pretty devastating stuff," Hill said. "It takes almost 20 years to rebuild your economy, and usually you waste five to six years because of denial."