Hamburger stand at the Buckeye Lake amusement park near Columbus.
"Buckeye Lake is the weekend and summer months resort for all of central Ohio. Its patrons are clerks, Columbus politicians, laborers, businessmen, droves of high school and college students. The rich occupy one side of the lake, the rest rent cottages on the other side. It has an evil reputation and an evil smell. It has furnished Columbus and the neighboring small towns and cities with dancing, cottaging, swimming, etc. for several generations. This is the most unsavory place the photographer ran across in Ohio."
Ilargi: I was thinking on this lovely sunny Sunday that we've all here, me first of all, been so pre-occupied with financial bubbles, all the way from the 1930's to tech stocks to housing, that we have been completely overlooking the fact we have recently entered a new bubble, one that risks having an even more profound effect on our lives than the previous ones. While I‘m tempted to call it a credit bubble, and that name would be correct, I’ll choose another one, just to avoid confusion. We are in a credibility bubble. And it's about to pop.
I've been saying for months that what the media insists on labeling a financial crisis has long since turned into a full-blown political one. Along with many, if not most, I was naive enough for a short while to think a change of presidency could or would make a difference, that the political crisis might be averted and we could focus on finance alone. But that's not true, is it, that hasn't happened?! Obama may appeal on a personal level to different, and more, people than W43, but if you look at financial policies, and especially at what's going on with the Wall Street-Washington relationship, i.e. bail-outs, nothing seems to have changed as far as I can see since Inauguration Day. Ben Bernanke is a constant factor, and his tone hasn't altered, and while Paulson has been replaced with Geithner, there's little doubt that the interests served by both administrations have remained the same. The influence of Goldman Sachs on policy making looms large in the thinking public's eye by now, but that serves a bit too much, if you ask me, to divert attention away from the likes of JPMorgan, Morgan Stanley, Ban of America, Citigroup and others. And let's not get started on Lockheed and Cargill et al.
In the past few weeks, the Sunday talkshow scene has been full of Larry Summers and his ilk. Today, Rahm Emanuel is pushed forward. The reason for the change is that the message is catching on that things are bottoming out and getting better, with green shoots and blue skies replacing red ink. The PR spin is working, and the boys and girls know it; the polling machinery works full speed overtime. In their view, it's getting to be time to reel in the big catch. BusinessWeek ran a piece this week that claimed resets of optionARM and Alt-A loans are being delayed, which in their view is a good sign, somehow signaling a recovery. Over the past 10 days, a chorus of government and banking voices have been cheering success stories, and people are so hungry for anything green, they'll bit into anything that color. Including mold and fungus, apparently.
But, even when you consider the trickery (to use a nice term) involved in government stats across the board, if you read a bit beyond headlines, all numbers bar none are atrocious. Of course some fall a bit less steeply for a while than they did before $12.8 trillion was injected into the sick ward. Mind you, Citi got $45 billion in direct funding, plus another X billion through AIG and A deity of your choice-only knows how much through the funds the Fed refuses to reveal, and Citi still needed a set of utterly bizarre accounting tricks to eke out a $1.6 billion profit, which turned out to stand only if its legal obligations were ignored. Do you understand how bad that picture is? It's not just the Neverland Ranch type acid-induced "new" Federal Accounting Standards that come into play, Citi was given all the tools it could dream of and them some, and its stock lost 9% in one day because the investment scene didn't buy into the look-at-the-hand schtick.
The present administration, only 12-weeks old, doesn't just do nothing to unravel the mysterious cheating practices in the financial world, and neither does it just allow the mystery to stay alive. No, it actively encourages the creation of more of the same, and more of more, it uses your money to ensure that the sleight of hand that's driving you into debt can continue and prevail, meaning you yourself pay to keep alive those practices that will drive you into the poorhouse, if need be at gunpoint.
The odds that the people at large will wake up anytime soon are negligible. Financial markets at large are not that gullible though. I wouldn't be surprised if this week or next they'll start popping the credibility bubble. And while I'd be sort of sorry to see Obama fail, I think it's far more important to have policies based on reality instead of acid, and for a president to communicate with his voters honestly, not in a hologram. Or a bubble.
China seeks oversight of reserve currency issuers
Chinese Premier Wen Jiabao called for more surveillance of countries that issue major reserve currencies, according to published reports Saturday. Wen did not specify the United States in his remarks at the Boao Forum for Asia in China's Hainan Province. But Chinese officials have recently expressed their concern about their country's investments in dollar-denominated assets. "We should advance reform of the international financial system, increase the representation and voice of emerging markets and developing countries, strengthen surveillance of the macro-economic policies of major reserve currency issuing economies, and develop a more diversified international monetary system," Wen said, according to China's official Xinhua news agency. Wen told the conference that China's economy was faring "better than expected."
China said last week that its economy grew at an annual rate of 6.1% in the first quarter, a slowdown from 6.8% in the fourth quarter of 2008. Wen said China would seek to expand currency swap agreements that are seen as a step toward eventually making the yuan more of a global reserve asset. "We should give full play to bilateral currency swap agreements and will study expanding currency swaps in scale and to more countries," Wen was quoted as saying. China's central bank has signed six such swap deals since late 2008, totaling 650 billion yuan ($95 billion). China will set up a $10 billion cooperation fund to support infrastructure projects in countries in the Association of Southeast Asian Nations, Wen said. The plan was announced earlier this month by Chinese Foreign Minister Yang Jiechi. Asean's other member countries are Thailand, Malaysia, the Philippines, Singapore, Brunei, Vietnam, and Indonesia.
"We should make greater efforts to promote free trade and expand intra-regional trade," Wen said, according to Xinhua. "We should accommodate each other's concern to the greatest extent possible, build consensus and establish a regional reserve pool as early as possible so as to better protect our region from financial risks," Wen reportedly said. Also at the Boao Forum, Zhou Xiaochuan, head of the People's Bank of China, said at a panel discussion that the International Monetary Fund failed to give alarm or diagnosis, let alone remedies when problems occurred in developed countries, according to Xinhua. "International financial institutions need reform, and have many weak points," said Zhou. He added that the combination of international and regional organizations such as the Asian Development Bank would be a good option, Xinhua said. Zhou reportedly said he understood that it might be harder for the IMF, a global organization, to make decisions.
Last month, Zhou proposed the creation a new international reserve currency in an essay published on the central bank's Web site. Zhou suggested that the IMF's Special Drawing Right (SDR) should be given a greater role. The SDR is an international reserve asset, created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system. Its value is based on a basket of key international currencies. "The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies," Zhou wrote in the essay.
Also at the Boao Forum, the chairman of China's sovereign wealth fund said that the fund plans to expand its international investments this year, including those in European nations it shunned after they set limits on its investments. China Investment Corp. Chairman Lou Jiwei said that due to financial protectionism limiting his fund's stakes and voting rights, it "didn't invest a single cent in Europe," according to a report in the Wall Street Journal. But since last year, Lou said, "there has been a change," and "Europe is now very welcoming to us, and isn't talking about such conditions any more." The newspaper report cited Lou as saying, "People suddenly look at us as a lovable force."
Why We Should Banish Larry Summers From Public Life
I vote to banish Larry Summers. Not from the planet. That wouldn't be nice. Just from public life. The criticisms of President Obama's chief economic adviser are well known. He's too close to Wall Street. And he's a frightful bully, of both people and countries. Still, we're told we shouldn't care about such minor infractions. Why? Because Summers is brilliant, and the world needs his big brain. And this brings us to a central and often overlooked cause of the global financial crisis: Brain Bubbles. This is the process wherein the intelligence of an inarguably intelligent person is inflated and valued beyond all reason, creating a dangerous accumulation of unhedged risk. Larry Summers is the biggest Brain Bubble we've got.
Brain Bubbles start with an innocuous "whiz kid" moniker in undergrad, which later escalates to "wunderkind." Next comes the requisite foray as an economic adviser to a small crisis-wracked country, where the kid is declared a "savior." By 30, our Bubble Boy is tenured and officially a "genius." By 40, he's a "guru," by 50 an "oracle." After a few drinks: "messiah." The superhuman powers bestowed upon these men -- and yes, they are all men -- shield them from the scrutiny that might have prevented the current crisis. Alan Greenspan's Brain Bubble allowed him to put the economy at great risk: When he made no sense, people assumed that it was their own fault. Brain Bubbles also formed the key argument Greenspan and Summers used to explain why lawmakers couldn't regulate the derivatives market: The wizards on Wall Street were too brilliant, their models too complex, for mere mortals to understand.
Back in 1991, Summers argued that the subject of economics was no longer up for debate: The answers had all been found by men like him. "The laws of economics are like the laws of engineering," he said. "One set of laws works everywhere." Summers subsequently laid out those laws as the three "-ations": privatization, stabilization and liberalization. Some "kinds of ideas," he explained a few years later in a PBS interview, have already become too "passé" for discussion. Like "the idea that a huge spending program is the way to stimulate the economy." And that's the problem with Larry. For all his appeals to absolute truths, he has been spectacularly wrong again and again. He was wrong about not regulating derivatives. Wrong when he helped kill Depression-era banking laws, turning banks into too-big-to-fail welfare monsters.
And as he helps devise ever more complex tricks and spends ever more taxpayer dollars to keep the financial casino running, he remains wrong today. Word is that Summers's current post may be a pit stop on the way to the big prize, Federal Reserve chairman. That means he could actually make "maestro."
Mr. President, please: Pop this bubble before it's too late.
U.S. can avoid bank nationalizations: Rahm Emanuel
The Obama administration thinks it can avoid nationalizing U.S. banks that are currently under scrutiny to see how well they would fare if the recession were worse than expected, the White House said on Sunday. "I think we will be able to avoid that," White House Chief of Staff Rahm Emanuel said on ABC's "This Week with George Stephanopoulos." He added that bank nationalization was "not the goal" of the administration.
Emanuel, however, cautioned he had not seen the results of "stress tests" on 19 lenders whose balance sheets are being scrutinized by regulators. They include Citigroup Inc., Wells Fargo & Co.and Bank of America. The findings will be used to determine who may need more government capital. Officials have said they will take care that the test results do not damage the banks' reputations, but they are expected to give some stark orders on how the banks should rebuild as a result of the financial crisis.
Geithner sees no new banking crisis
U.S. Treasury Secretary Timothy Geithner does not see a second wave of banking collapses and the government is ready to support capital-raising when needed, a Japanese newspaper said on Sunday. In an interview with the Asahi Shimbun newspaper, Geithner was quoted as saying U.S. authorities were making sure there was steady funding and that banks were able to meet commitments. "So in some ways what we're saying is we're going to backstop the amount of capital-raising that's necessary," he was quoted as saying in an English text of the interview.
"And again, a lot of that will come from the market, ultimately. But where it doesn't we'll make sure we provide it." In an attempt to assess banks' capital needs, the U.S. government is testing how they would fare under more adverse economic conditions than are expected. The results are due at the end of April. Once the "stress tests" are finalized and the capital needs are determined, banks will have six months to raise capital in the private market or could take an infusion of government funds. Geithner was also quoted as saying the Group of Seven of rich nations and the Group of 20, which also includes emerging economies such as China and India, were "very complementary forums."
Geithner will host both a G7 finance ministers meeting and a G20 ministerial session on April 24 in Washington. He told the Asahi that China had played a role in stabilizing the global financial crisis, and added that Beijing was committed to a more flexible currency regime over time. "China's exchange rate appreciated quite substantially in real terms," he was quoted as saying. "China's accumulation of foreign reserves has slowed and they are putting in place economic policies that will encourage domestic demand and growth."
Ilargi: Well, I stil hope Mankiw is joking. If not, he's a real dumb piece of meat, and having him continue teaching economics at Harvard is a scary thought. I don’t think he's joking.
It May Be Time for the Fed to Go Negative
With unemployment rising and the financial system in shambles, it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. But I’m not talking about attitude. I‘m talking about numbers. Let’s start with the basics: What is the best way for an economy to escape a recession? Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services — and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.
The problem today, it seems, is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools, such as buying longer-term debt securities, to get the economy going again. But the efficacy of those tools is uncertain, and there are risks associated with them. In many ways today, the Fed is in uncharted waters. So why shouldn’t the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent? At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand. The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less.
Unless, that is, we figure out a way to make holding money less attractive. At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. (I will let the student remain anonymous. In case he ever wants to pursue a career as a central banker, having his name associated with this idea probably won’t help.) Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent. That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.
The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea of a carrying tax on money. With banks now holding substantial excess reserves, Gesell’s concern about cash hoarding suddenly seems very modern. If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.
Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations. Ben S. Bernanke, the Fed chairman, is the perfect person to make this commitment to higher inflation. Mr. Bernanke has long been an advocate of inflation targeting. In the past, advocates of inflation targeting have stressed the need to keep inflation from getting out of hand. But in the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative.
The idea of negative interest rates may strike some people as absurd, the concoction of some impractical theorist. Perhaps it is. But remember this: Early mathematicians thought that the idea of negative numbers was absurd. Today, these numbers are commonplace. Even children can be taught that some problems (such as 2x + 6 = 0) have no solution unless you are ready to invoke negative numbers. Maybe some economic problems require the same trick.
N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President George W. Bush.
Fed’s Kohn, Dudley Defend Size, Scope of Emergency Loan Plans
Two of the Federal Reserve’s top policy makers defended the Fed’s emergency lending, saying the programs won’t cause an inflationary surge or create “significant” risk for taxpayers. Vice Chairman Donald Kohn, speaking yesterday in Nashville, Tennessee, said the Fed has loaned to “sound” borrowers and plans to disclose more about such credit. New York Fed Bank President William Dudley, speaking at the same conference, said he’s “not worried at all that” a doubling in the central bank’s balance sheet to $2.19 trillion will spur inflation. Policy makers are pursing an unprecedented strategy to revive the economy by providing credit to companies other than banks and cutting the main interest rate to as low as zero. The Fed plans to buy as much as $1.25 trillion in agency mortgage- backed securities this year and is providing financing for securities backed by loans to consumers and small businesses.
The increased credit has provoked concerns prices will surge. Central bank officials are “dramatically underplaying the risks and liability side of the balance sheet,” former St. Louis Fed President William Poole said in an interview at the conference. “We are very vulnerable to an inflation explosion,” said Poole, a senior economic adviser to Merk Investments LLC in Palo Alto, California.
Former Fed Chairman Paul Volcker said Congress will probably review the authority granted to the Fed following the expansion in its assets. “I don’t think the political system will tolerate the degree of activity that the Federal Reserve, in conjunction with the Treasury, has taken,” Volcker, head of President Barack Obama’s Economic Recovery Advisory Board, said in remarks to the conference at Vanderbilt University.
U.S. lawmakers from both political parties, including House Financial Services Committee Chairman Barney Frank, have expressed concern in recent months that the central bank has overstepped its authority by providing emergency credit. “I think for better or for worse we are at a point where the Federal Reserve Act, after all that has been happening in the last year or more, is going to be reviewed,” Volcker said. Central bank officials are “underestimating the political forces they’re going to face once the recovery starts,” said Poole, a contributor to Bloomberg News. Fed Vice Chairman Kohn said in his speech “intense scrutiny” of the central bank’s emergency programs is “natural and appropriate.” Still, such attention “should not lead to a fundamental change in our place within our democracy,” he said. “And I believe it will not.”
While the central bank may be channeling credit to some markets more than others, “we are not taking significant credit risk that might end up being absorbed by the taxpayer,” Kohn said. “For almost all the loans made by the Federal Reserve, we look first to sound borrowers for repayment and then to underlying collateral.” Kohn made an exception for financial institutions such as Bear Stearns Cos. and insurer American International Group Inc. that would cause widespread disruption in markets should they fail. Such companies would “probably have higher credit risk,” he said. Kohn said the Fed would disclose more details on its loans and borrowers involved in central bank programs “in coming weeks.” The Fed’s refusal to provide such information prompted a lawsuit by Bloomberg News in November and criticism from U.S. Republican Senator Richard Shelby of Alabama and other lawmakers.
“Understandably, given the sharp increase in loans to new institutions and markets, the public is naturally interested in our lending practices,” the vice chairman said. Dudley said he sees no legitimate reason for rising “investor anxiety” that participation in the $1 trillion Term Asset-Backed Securities Loan Facility will provoke government scrutiny. The TALF, aimed at supporting financing of loans to credit card borrowers, students, car buyers and small businesses, is off to a “slow start,” Dudley said, recording just $6.4 billion in loans. Investors have shied from joining some emergency credit programs after lawmakers criticized the compensation practices of financial companies that accepted taxpayer funds to shore up capital, Dudley said. “My own view is that these fears are misplaced,” Dudley said. He said TALF is “completely a Federal Reserve program and operation,” and that government funds would only be used to protect the Fed against a credit risk such as a default.
Treasuries fell for a fourth week as better-than-expected earnings at banks including Goldman Sachs Group Inc. and JP Morgan Chase & Co. bolstered speculation the longest recession in the postwar era may be easing. The yield on the 10-year note rose two basis points this week, or 0.02 percentage point, to 2.95 percent. In an unusual public exchange between a current and former U.S. central banker, Volcker asked Kohn to explain the merits of a 2 percent inflation goal, instead of a 1 percent or 3 percent objective. “By aiming at 2, you have a little more room on nominal interest rates, a little more room to react to an adverse shock to the economy or better odds of stabilizing the economy,” Kohn said. “By being clearer about our objective about what we consider price stability, we will have armed ourselves to lean against tendencies for inflation to rise,” Kohn said. The vice chairman also said that he doesn’t expect deflation, or a consistent decline in consumer prices, over the next five years, while not ruling out the possibility. The Fed’s credit programs “have helped ease financial conditions, though they can’t address all the problems in financial markets,” Kohn said. “The situation in financial markets and the economy would have been far worse if the Federal Reserve hadn’t taken the actions.”
Two Fed officials face grilling from Volcker
Two top Federal Reserve officials faced some tough questioning on their policy on inflation on Saturday, from none other than the inflation-taming former Fed chief Paul Volcker. Fed Vice Chairman Donald Kohn and New York Fed President William Dudley, speaking at a conference at Vanderbilt University, said they were not worried the central bank's unorthodox policies to battle the recession would set the stage for runaway inflation down the road. They then opened the floor to questions. Volcker, sitting in the audience of an event to honor former Fed governor Dewey Daane on his 90th birthday, grilled Kohn on how the Fed can consider an inflation target of 2 percent consistent with a goal of price stability.
"Why 2 percent? I don't get it," Volcker, who led the Fed from 1979 to 1987 and is now a senior economic adviser to President Barack Obama, said. "If 2 percent is the best inflation rate, and the economic recovery lags, does it become 3 percent?" Volcker is best known for stamping out inflation during his tenure as Fed chairman by dramatically raising interest rates. Kohn responded that a policy aimed toward an inflation rate of 2 percent, rather than something lower, gives the U.S. central bank more breathing room when it faces economic shocks. "If we had been at 1 percent inflation, then interest rates would have already been lower when the shock hit," Kohn said.
"Your problem is does 2 percent become 3 percent or 4?" he said to Volcker, adding that that hasn't been the case for other central banks that have an inflation target. "But I'm not going to convince you, am I?" Kohn told the imposing 6-foot, 7-inch Volcker, who was sitting in the front row. Dudley, meanwhile, faced questions by Volcker on his remarks that the Fed could pay interest on reserves so that banks keep more reserve funds at the central bank as a way to drain liquidity when the economy improves. "Explain this to me," Volcker said. After Dudley responded that the Fed can manage monetary policy with excess reserves in the banking system, Volcker said: "Now I'm even more confused."
Volcker Says Fed’s Authority Probably to Be Reviewed
Former Federal Reserve Chairman Paul Volcker said Congress will probably review the authority granted to the Fed following emergency credit programs doubling the central bank’s balance sheet to $2.19 trillion. “I don’t think the political system will tolerate the degree of activity that the Federal Reserve, in conjunction with the Treasury, has taken,” Volcker, head of President Barack Obama’s Economic Recovery Advisory Board, said today at a conference at Vanderbilt University in Nashville, Tennessee. U.S. lawmakers from both political parties have expressed concern in recent months that the central bank has overstepped its authority by creating several emergency credit programs aimed at reviving lending and ending the recession.
“I think for better or for worse we are at a point where the Federal Reserve Act, after all that has been happening in the last year or more, is going to be reviewed,” Volcker said. Under the act the central bank may in “unusual and exigent circumstances” lend to “any individual, partnership, or corporation” as long as the loans are secured “to the satisfaction” of the Fed. Lawmakers including House Financial Services Committee Chairman Barney Frank have said Congress should consider revising the Depression-era emergency provision. The central bank has been using such powers “with great abandon,” Frank, a Massachusetts Democrat, told reporters in January. “Ultimately we have to do something about this statute.” Volcker didn’t predict the future powers of the central bank.
“It’ll be very interesting to see what the role of the Federal Reserve will be,” Volcker said. The possibilities “range all the way from giving the Federal Reserve more supervisory and regulatory responsibility to largely taking away” those powers. Volcker dismissed concerns the U.S. has entered a depression while saying a recovery will be slow. “It’s hard to see that we’re going to have a very rapid recovery,” he said. “We are in a great recession, for sure.” Gross domestic product fell at a 5 percent annual pace last quarter and will drop at a 2 percent rate in the following three months, according to the median estimate in a Bloomberg News survey earlier this month. The unemployment rate climbed to a 25-year high of 8.5 percent in March, from 8.1 percent the previous month. The U.S. has lost about 5.1 million jobs since the recession started in December 2007.
Fed’s Lockhart: Commercial Real Estate Trouble Risk to Economy
The latest big threat to economic recovery in the U.S., the commercial property market, could be the next target of an expanded special lending program from the central bank, Dennis Lockhart, president of the Atlanta Federal Reserve Bank, said Saturday. “On our watch list this year as a risk to the [economic] outlook is continuing worsening in the commercial real estate sector,” Mr. Lockhart said. The central banker was speaking at a conference on financial policy hosted by Vanderbilt University’s Owen Graduate School of Management to honor former Fed Governor Dewey Daane. Fed policymakers are still considering whether to include sponsorship for commercial property loans under its Term Asset-Backed Securities Loan Facility, or TALF, Mr. Lockhart said, adding that there’s been no official decision. “The details haven’t been fully worked out,” he said.
Lockhart is currently a voting member on the Fed committee that deliberates the bank’s policy actions. At the last meeting, March 18, the committee announced a new plan to buy $300 billion in longer-term Treasurys and expand by $750 billion the size of lending programs aimed at reducing mortgage rates. The TALF program, which can accommodate around $1 trillion of support for the asset-backed markets that support consumer and business lending, has only just gotten underway, to a tepid reception from investors. The commercial real estate market has suffered on a variety of fronts, from rising unemployment in the corporate sector to a drop in business travel that’s depriving hotels of guests. As a result, Mr. Lockhart said, there’s a real risk of a spike in delinquencies and failure to refinance the roughly $400 billion of commercial real estate loans coming due this year.
Don't Bank on It
The Amazing Randi. We'd never heard of the chap until last week, when we were indulging in an old habit that began way back when we were a copy boy (the journalistic equivalent of a galley slave) and took to passing some of the grudgingly little downtime allotted to us poring over the obituaries. Our interest was not born solely of innate ghoulishness, but nurtured also by the fact that an obit provides a highly compressed and often fascinating biography of those noteworthy souls who have recently departed from the ranks of the quick. In this instance, the subject was not the Amazing Randi, but John Maddox, a British editor of considerable renown who transfigured a stuffy magazine named Nature into a scintillating science journal. Mr. Maddox, by all description an unflaggingly imaginative and energetic editor broadly versed in the sciences, was graced with a flair for the unorthodox and a sharp nose for bamboozle.
Back in the late 1980s, he published a piece by a French doctor claiming remarkable qualities for an antibody he had studied, but only on the condition that an independent group of investigators chosen by Mr. Maddox monitor the doctor's experiments. Among the investigators he chose was the Amazing Randi (né James Randi), a professional magician whose knowledge of science may have been limited but whose knowledge of hocus-pocus was peerless. The poor doctor's goose was cooked. Mr. Maddox's engaging inspiration got us to thinking, gee, wouldn't it be great to have an Amazing Randi handy to help uncover the voodoo that has caused investors virtually en masse to suspend disbelief. We're referring, of course, to their marvelously revived tendency to slip on their rose-colored glasses, which for so long had been gathering dust on the shelf, when viewing corporate fortunes or the economy at large.
Take for example, dear old Goldman Sachs , which has enjoyed a mighty burst of enthusiasm among Street folk that has sent its shares sprinting to the vanguard of this smashing stock-market rally; an enthusiasm, moreover, that has spilled over to other banks and their financial kin. No argument, the firm has handsomely outperformed its few surviving rivals, none of which is blessed with Goldman's deft trading skills or tight Washington connections. Goldie reported earnings of $1.8 billion for the first quarter. In doing so, it got a lucky boost from its switch from a fiscal year ending November to a calendar year. The shift came in response to statutory fiat, as part of Goldman's change to a commercial bank, a prerequisite to gaining eligibility for all those lovely billions in loans and guarantees the government has been showering on banks.
That $1.8 billion in March-quarter profits was a heap more than its analytical followers expected, and, as intimated, a sparkling demonstration of Goldman's vaunted trading agility (from what we can gather, it made a bundle in part by timely shorting bonds). The switch in its fiscal year took December out of the first quarter and made it an isolated, stand-alone month, relegated to an inconspicuous assemblage of bleak figures far in the rear of the company's 12-page earnings release. As it happens, Goldman lost some $780 million in December, a tidy sum that obviously would have taken a lot of the gloss off its reported first-quarter performance. And, who knows, it might have even drained some of the zing that the surprisingly good results lent the stock.
But, in any case, the very next day, the spoilsport credit watchers at Standard & Poor's threw a bit of cold water on the shares by venturing that, in light of the soggy economy and unsettled capital markets, it would be "premature to conclude that a sustained turnaround" by Goldman was necessarily in the cards. The financial sector, as even the most cursory spectator of the investment scene doubtless is aware, has provided the crucial spark to this powerful bear-market rally. And, in particular, the return from the very edge of the abyss by the banks in the opening months of this year has revived fast-swelling bullish sentiment. The question naturally arises: How did the banks, so many of which seemed to be slouching toward extinction, get their act together to the point where they were in the black in January and February?
In search of an answer, we turned up an intriguing explanation for this magical metamorphosis by Zero Hedge, a savvy and punchy blog focusing on things financial. Not to keep you in suspense, Zero Hedge fingers AIG , that repository of financial ills and insatiable consumer of taxpayer pittances, as the agent of the banks' miraculous recovery. But not quite the way you might think. As Zero Hedge explains, AIG, desperate to hit up the Treasury for more moola, decided to throw in the towel and unwind its considerable portfolio of default-credit protection. In the process, the badly impaired insurer, unwittingly or not, "gifted the major bank counterparties with trades which were egregiously profitable to the banks." This would largely explain, according to Zero Hedge, why a number of major banks actually, as they claimed, were profitable in January and February.
But the profits, it is quick to point out, are of the one-shot variety, and, ultimately, they entailed a transfer of money from taxpayers to banks, with AIG acting as intermediary. Lacking any deep familiarity with the arcana of credit swaps and the like, we can't swear to the accuracy of this analysis. But shy of conjuring up the Amazing Randi and have him unveil the truth, it strikes us as plausible -- and easily as persuasive as many of the various explanations we have come across for the surprising and rather mysterious turn for the better by the banks. If by chance it proves out, it just might act as a sobering influence, and not just on the financial sector. Frankly, we're as bored with this bear market as anyone. And we fully understand, after a year of brutal pummeling, the frantic hopefulness with which investors respond to the inevitable bounce, especially when it's as robust as this one has been. And we understand, too, their eagerness to grasp at the flimsiest hint of recovery and to strain to put a good face on every twist and turn of the economy, no matter how ugly. But we fear -- as some tunesmith crooned long ago -- wishing won't make it so.
There's nothing obviously wrong when investors, confronted by what seems to be a sold-out market and tired of sitting on their hands, decide to take a fling on a bear-market rally. And it certainly has been rewarding for virtually anyone who a month or so ago did just that. But an awful lot of folks don't have the time, the discipline, the nimbleness or the spare cash for that sort of hit-and-run investing. And the danger resides in being carried away by a momentary spate of quick gains and turning a blind eye to the riskiness of the market, which now is a heck of a lot greater, if only because the advance has carried price/earnings ratios to elevated levels -- something above 20 on the Standard & Poor's 500 -- or to the critical negatives in the economy.
David Rosenberg of Bank of America/Merrill Lynch (we can't believe we said the whole thing) last week offered some worthwhile observations on the stock market and the economic landscape that just happen to buttress our own reservations. He points out that the two groups that paced the sharp upswing were financials and consumer cyclicals, in which there are, respectively, net short positions of 5 billion and 2.7 billion shares. Which strongly suggests that not an insignificant part of the rally has been provided by shorts running for cover. He also points out that the Russell 2000 small-cap index is up 36% since the March low, and has outperformed the S&P by some 980 basis points. As David says, "the last time it pulled such a massive rabbit out of the hat" was in the stretch from late November to early January, and the major averages proceeded to make new lows two months later.
Another amber light he spots is investor confidence. Over the past five weeks, he reports, Rasmussen, which takes a daily reading, has seen its investor-confidence index surge 32 points, an unprecedented climb in so short a span. This could be, he suspects, a "fly in the ointment for a sustained equity-market rally." David has four markers that will signal to him that the economy is finally making the turn and starting an extended expansion. The first is home prices. The second is the personal-savings rate. Marker No. 3 is the debt-service ratio, and No. 4 is the ratio of the coincident-to-lagging indicators of the Conference Board. Aggregating those four markers, he calculates that we are roughly 44% of the way through the adjustment process. That is a tick up from where we were last month. However, the improvement, he laments, has been very modest and very slow.
We should add that he also stresses that it's critical for both the economy and the market that payrolls stop shrinking. All the talk about jobless claims "stabilizing" is so much poppycock, he snorts. That number of claims, he notes, is still consistent with monthly payroll losses of around 700,000. As with industrial production, which is also in a vicious slump, employment must stop falling before a recession typically ends. "Call us when claims fall below 400,000," he says, which is his estimate of "the cut-off for payroll expansion/contraction." Until then, he warns, "the recession will remain a reality. Rallies will be brief, no matter how violent, and green shoots are a forecast with a very wide error term attached to it."
Mortgage industry changes throw new hurdles in borrowers' way
Mortgage rates and house prices are down -- which sounds great for buyers and refinancers. But mortgage industry underwriting and appraisal changes taking effect this month are putting new hurdles in the way of borrowers and loan officers. Take Fannie Mae's and Freddie Mac's add-on fees for loans purchased after April 1. In some cases, applicants are being hit with extra fees of 3% to 5% because of the type of property they want to buy or refinance, their credit scores or the size of their down payment. Some major lenders who sell loans to Fannie and Freddie are going further -- tightening underwriting rules beyond what either corporation requires. For example, as of April 6, Wells Fargo, one of the country's largest mortgage originators, imposed a new minimum FICO credit score of 720 -- up from the previous 620 -- on all conventional loans purchased through its wholesale system that have less than a 20% down payment.
It also began requiring a total debt-to-income ratio maximum of 41% -- down from the previous 45%. Fannie Mae now has a mandatory fee of three-quarters of a percentage point on all condominium loans, no matter how high the applicant's credit score. For a once-popular interest-only condo loan with a 20% down payment and a borrower credit score of 690, Fannie imposes the following ratcheted sequence of add-ons: one-quarter of a percentage point as an "adverse market" fee; 1.5% for the below-optimal credit score; three-quarters of a percentage point for the interest-only payment feature; and the same because the property is a condo. The total comes to 3.25% extra, which can be paid upfront or rolled into the loan.
On top of these extra fees, borrowers are now starting to get hit with two sets of cost-raising appraisal rule changes. Fannie and Freddie have begun requiring all appraisers to complete an extra "market condition" report that includes detailed statistical analyses of local sales and pricing trends -- above and beyond the regular appraisal data. Many appraisers are charging an extra $45 to $50 for the time required to complete the form. Home buyers and refinancers can expect to pay the higher fees. On top of that, beginning May 1, Fannie and Freddie are refusing to fund loans with appraisals that do not follow a set of new rules known as the Home Valuation Code of Conduct. Among the procedural changes: Mortgage brokers no longer can order appraisals directly, but instead must allow lenders or investors to use third-party "appraisal management companies" to assign the job to appraisers in their networks.
How does that affect the consumer? Consider the notification one Connecticut brokerage firm recently received from a major lending partner: Starting April 15, all good faith estimates provided to applicants must indicate a flat $455 charge for appraisals arranged through the appraisal management company. The broker previously charged $325. Consumers will now have to pay the appraisal fee upfront -- before any inspection or valuation is completed -- using a credit card, debit card or electronic fund transfer. What happens if the appraisal comes in low and the applicants can't qualify for the refi or purchase program they sought? Tough luck: They'll have just two choices: Pay another $455 for a second appraisal -- with no assurance that it will solve the problem -- or cancel the application. Jeff Lipes, president of Family Choice Mortgage Corp., which serves the Hartford, Conn., area, said the net effect of the underwriting, credit score and pricing changes was to "squeeze some people who are creditworthy by any reasonable standard out of the market."
For instance, as a result of the restrictions on condos, Lipes says "whenever we hear the word 'condo' [from an applicant], we shiver" because the deck is stacked against them. Even for prime borrowers with 800 FICO scores and 50% down payments, Lipes said, "I can't tell them that we're certain we can get you a mortgage." A welter of recent rule changes from Fannie Mae has made some condo units in projects with commercial tenants or high percentages of investor units almost impossible to refinance. In Naples, Fla., John Calabria, president of Bancmortgage Corp., said, "It has become such a nightmare to lend money" because of the layers of add-on fees, higher mandatory down payments and FICO scores. One high-income client sought to put down 25% ($200,000) to buy an $800,000 condo as a second home but couldn't because the minimum down payment on such a unit is now 30%. "That's ridiculous," Calabria said. "Some of this just doesn't make sense."
Jobless put new slant on stress tests
Rising unemployment is prompting US authorities to consider taking a tougher stance in judging the results of bank stress tests, a development that ultimately could force leading financial groups to hold more capital. The stress test process is intended to ensure that the big US banks have enough equity capital to comfortably survive a recession that is worse than officials presently expect – a so-called “adverse scenario”. When the stress tests were revealed two months ago, the authorities defined the adverse scenario as one in which unemployment rose gradually to peak at 10.4 per cent in late 2010. But, since the announcement was made, unemployment has risen much more quickly than was expected, even under the “adverse scenario”.
The Federal Reserve and a number of other economic forecasters also revised down their estimates for growth over the next two years. The upshot is that the likelihood of unemployment reaching 10.4 per cent looks higher than it did at the onset of the exercise. The authorities believe it is too late to revisit the assumptions underpinning the stress tests. However, it is not too late for them to decide to interpret the implications for capital more stringently. The Treasury declined to comment. Making such an adjustment would help arguments against claims by critics such as Nouriel Roubini, chairman of RGE Monitor, who wrote on his blog: “The stress test results are meaningless as actual data are already running worse than the worst case scenario.”
The authorities have not yet made a final decision on changing the way the tests will be interpreted. Even if officials do lean in this direction, it may never be visible because they did not specify in advance any precise formula relating stress test outcomes to required bank capital. Moreover, signs of economic recovery could persuade policymakers to disregard the rapid recent rise in unemployment on the grounds that it might revert to the less alarming trajectory they originally expected. Policymakers also believe that other assumptions in the test still reflect a worse-than-expected outcome. Nonetheless, unemployment is an important driver of loan defaults.
At the same time, administration officials are pressing wary banks and regulators to agree to disclose summary details of the stress test assessment of each bank’s assets. They believe that this information would help markets evaluate the financial health of each bank as well as reinforce the credibility of the stress test exercise. They do not think that even weaker banks could benefit from hiding the results from the market since investors would probably fear the worst. However, they want to avoid a disorderly situation in which the stronger banks advertise the results of their stress tests while weaker banks resist doing so. This could further stigmatise the weaker banks and lead to an additional loss of confidence.
Corporate Bonds Are Selling, if There’s a Safety Net
Are the credit markets showing some signs of revival? At first glance, it appears that the answer is yes, at least for high-quality corporate borrowers. The volume of investment-grade corporate bonds issued in Europe and Asia in the first three months of this year was the highest ever for any quarter, while in the United States the total fell just short of the record. But that glance is deceiving. Corporate bond markets around the world are functioning in large part because of government guarantees. Eight months ago, before the collapse of Lehman Brothers and the rescue of the American International Group, the idea of a government-guaranteed corporate bond would have seemed contrary to basic capitalist principles. Now, such bonds account for a substantial share of corporate bond issuance, generally by banks and other financial companies.
The accompanying charts show the volume of new bond issues and new syndicated bank loans, by quarter, going back to 2005, in the United States, Europe and Asia, as reported by Thomson Reuters. Even without the guarantees by governments, the issuing of corporate bonds did pick up from the low levels of late 2008. But syndicated loans — loans made by banks and then sold off to other banks and financial institutions — have shown much less recovery among investment-grade issuers. And for riskier borrowers, there is little sign of an ability to borrow. The volume of leveraged loans — syndicated loans issued to less creditworthy corporate borrowers — continues to decline around the world. And the high-yield, or junk bond, market has only started to recover in the United States and remains moribund elsewhere.
It could be seen as a disappointment that the $500 billion in government-guaranteed loans issued around the world in the last half year have not done more to spur bank lending. But the syndicated loan markets continue to suffer because whole classes of buyers have vanished. Such loans were previously packaged into collateralized loan obligations, or C.L.O.’s, which were then sold as securities that could be rated as high quality even though the underlying loans were not. That business has blown up, and, increasingly, banks are making only those loans that they, or other banks, are willing to keep on their own balance sheets.
In the United States, the total volume of leveraged loans and junk bonds issued over the last six months was $70 billion. That figure is one-tenth the size of the figure for the first six months of 2007, before the subprime mortgage crisis in the United States began to shut down the supply of money for risky loans. The declines are smaller in Europe and Asia, but the volume of risky loans never grew as large in those markets. A resumption of functioning corporate credit markets would be a strong indication that the credit crisis was receding. But the fact that the current growth in lending is largely a function of government guarantees shows that the credit markets remain far from healthy, even if they are larger than they were in late 2008, when the panic was most intense. “Credit markets are materially better, but not normal,” Bruce Kasman, the chief economist of JPMorgan Chase, said this week at the Hyman P. Minsky conference of the Levy Economics Institute of Bard College.
Goodbye Bland Affluence
A small sign of the times: USA Today this week ran an article about a Michigan family that, under financial pressure, decided to give up credit cards, satellite television, high-tech toys and restaurant dining, to live on a 40-acre farm and become more self-sufficient. The Wojtowicz family—36-year-old Patrick, his wife Melissa, 37, and their 15-year-old daughter Gabrielle—have become, in the words of reporter Judy Keen, "21st century homesteaders," raising pigs and chickens, planning a garden and installing a wood furnace. Mr. Wojtowicz was a truck driver frustrated by long hauls that kept him away from his family, and worried about a shrinking salary. His wife was self-employed and worked at home. They worked hard and had things but, Mr. Wojtowicz said, there was a "void." "We started analyzing what it was that we were really missing. We were missing being around each other." So he gave up his job and now works the land his father left him near Alma, Mich. His economic plan was pretty simple: "As long as we can keep decreasing our bills we can keep making less money."
The paper weirdly headlined them "economic survivalists," which perhaps reflected an assumption that anyone who leaves a conventional, material-driven life for something more physically rigorous but emotionally coherent is by definition making a political statement. But it didn't look political from the story they told. They didn't look like people trying to figure out how to survive as much as people trying to figure out how to live. The picture that accompanied the article showed a happy family playing Scrabble with a friend. Their story hit a nerve. There was a lively comment thread on the paper's Web site, with more than 300 people writing in. "They look pretty happy to me," said a commenter. "My husband and I are making some of the same decisions." Another: "I don't know if this is so much survivalism as a return to common sense." Another: "The more stuff you own the harder you have to work to maintain it."
To some degree the Wojtowicz story sounded like the future, or the future as a lot of people are hoping it will be: pared down, more natural, more stable, less full of enervating overstimulation, of what Walker Percy called the "trivial magic" of modern times. The article offered data suggesting the Wojtowiczes are part of a recent trend. People are gardening more if you go by the sales of vegetable seeds and transplants, up 30% over last year at the country's largest seed company. Sales of canning and preserving products are also up. Companies that make sewing products say more people are learning to sew. I have a friend in Manhattan who took to surfing the Web over the past six months looking for small- and farm towns in which to live. The general manager of a national real-estate company told USA Today that more customers want to "live simply in a less-expensive place." Some of this—the desire to live less expensively, and perhaps with greater simplicity—seems to key off what I am seeing in Manhattan, a place still generally with more grievances than grief, and with a greater imagination about how badly things are going to go than how bad it is right now. Many think that no matter how much money is sloshing through the system from Washington, creating waves that lead to upticks, the recession is really a depression.
We won't "come out of it," as the phrase goes, for five or seven years, because the downturn is systemic, global, and because the old esprit is gone. The baby boomers who for 40 years, from 1968 through 2008, did the grunt work of the great abundance—work was always a long-haul trip for them, they were the first in the office in 1975 and are the last to leave the office to this day—know the era they built is over, that something new is beginning, something more subdued and altogether more mysterious. The old markers of success—money, status, power—will not quite apply as they have. They watch and work as the future emerges. In New York some signs of that future are obvious: fewer cars, less traffic, less of the old busy hum of the economic beehive. New York will, literally, get dimmer. Its magical bright-light nighttime skyline will glitter less as fewer companies inhabit the skyscrapers and put on the lights that make the city glow.
A prediction: By 2010 the mayor, in a variation on broken-window theory, will quietly enact a bright-light theory, demanding that developers leave the lights on whether there are tenants in the buildings or not, lest the world stand on a rise in New Jersey and get the impression no one's here and nobody cares. The New York of the years 1750 to 2008—a city that existed for money and for all the arts and delights and beauties money brings—is for the first time going to struggle with questions about its reason for being. This will cause profound dislocations. For a good while the young will continue to flock in, for cheaper rents. Artists will still want to gather with artists—you cannot pick up the Metropolitan Museum and put it in Alma, Mich. But there will be a certain diminution in the assumption of superiority on which New York has long run, and been allowed, by America, to run.
More predictions. The cities and suburbs of America are about to get rougher-looking. This will not be all bad. There will be a certain authenticity chic. Storefronts, pristine buildings—all will spend less on upkeep, and gleam less. So will humans. People will be allowed to grow old again. There will be a certain liberation in this. There will be fewer facelifts and browlifts, less Botox, less dyed hair among both men and women. They will look more like people used to look, before perfection came in. Middle-aged bodies will be thicker and softer, with more maternal and paternal give. There will be fewer gyms and fewer trainers, but more walking. Gym machines produced the pumped and cut look. They won't be so affordable now.
Hollywood will take the cue. During the depression, stars such as Clark Gable were supposed to look like normal men. Physical perfection would have distanced them from their audience. Now leading men are made of megamuscles, exaggerated versions of their audience. That will change. The new home fashion will be spare. This will be the return of an old WASP style: the good, frayed carpet; dogs that look like dogs and not a hairdo in a teacup, as miniature dogs back from the canine boutique do now. A friend, noting what has and will continue to happen with car sales, said America will look like Havana—old cars and faded grandeur. It won't. It will look like 1970, only without the bell-bottoms and excessive hirsuteness. More families will have to live together. More people will drink more regularly. Secret smoking will make a comeback as part of a return to simple pleasures. People will slow down. Mainstream religion will come back. Walker Percy again: Bland affluence breeds fundamentalism. Bland affluence is over.
Leading economists urge full nationalisation of Ireland's banks
A group of leading economists is urging the Irish government to ditch its "bad bank" plan in favour of a temporary nationalisation of the financial sector. In an opinion piece in The Irish Times, 20 of Ireland's leading academic economists argue that the government has got it badly wrong. "In normal circumstances, none of us would recommend a nationalised banking system," they wrote. "However, these are far from normal times, and we believe that in the current circumstances nationalisation has become the best option to the government. "Furthermore, we explicitly recommend nationalisation only as a temporary measure. Once cleaned up, recapitalised, reorganised with new managerial structures, and potentially rebranded, we recommend that the banks be returned to private ownership."
The news came as Moody's credit ratings agency warned it could cut Ireland's triple-A rating within the next three months as the country's debt levels are set to soar. Standard & Poor's and Fitch, the other two major ratings agencies, have already downgraded their ratings on Ireland's sovereign debt. Moody's said: "Should Moody's come to the view that Ireland will emerge from the crisis with relatively weak growth prospects and a much higher debt burden for the foreseeable future, Ireland would be downgraded to the mid to high Aa rating range." Ireland's historically low debt levels could surge to 100% or more of GDP next year, compared with 41% last year, under the government's plans to cleanse the banking sector of bad property loans.
Last week Dublin announced what will be the first nationwide "bad bank" plan in Europe since the financial crisis started two years ago, with the creation of an asset management agency to take over toxic property loans with a book value of up to €90bn (£79.5bn). The government has said it will buy the loans at a substantial discount, and Dublin could end up taking majority stakes in some lenders to boost their capital ratios. The group of economists said the government was grossly underestimating the scale of losses at the country's banks and could end up overpaying for land and development portfolios. "We see nationalisation as being the inevitable consequence of a required recapitalisation of the banks done on terms that are fair for the taxpayer," they said.
"With €90bn in loans to be purchased, the consequences to the taxpayer of overpaying for bad assets by 10% to 30% are truly appalling. To put these figures in perspective, the effect in a full year of the budget measures taken last week was to save the exchequer €5bn," the economists said. Last week, Dublin unveiled its second emergency budget in six months, but even with a slew of tax hikes and some spending cuts, it is still facing a shortfall this year and next equivalent to 10.75% of GDP, which is more than three times the EU's limit. At Moody's a senior analyst, Dietmar Hornung, said that his firm's warning on Ireland's sovereign rating "reflects the severe economic adjustment taking place in Ireland, which threatens to undermine the country's low-tax, financial services-driven economic model. Ireland has lost both economic and government financial strength relative to its AAA peers over the past year."
Tumble in house prices pushes 900,000 UK borrowers into negative equity
Plunging house prices have forced 900,000 mortgage borrowers into negative equity, the Council of Mortgage Lenders (CML) said last night. The figure is equivalent to 13 per cent of those who took out a mortgage between April 2005 and the end of last year. Three in four have an average shortfall of between £6,000 and £8,000, but nearly a quarter of a million borrowers have a shortfall close to £20,000. A further 13,000 homeowners are in negative equity by £37,000. Homeowners in the North are worst affected, with 70,000, or 9.2 per cent of owner-occupied homes in the region, now in negative equity. About 150,000 homeowners in the South East owe more on their property than it is worth, but this amounts to only 5.7 per cent of all households in the region. Homeowners in Scotland are among the least likely to be in negative equity, with only 1 per cent of borrowers affected.
The CML, which represents 98 per cent of mortgage lenders, said that a further 1.1 million borrowers have seen their equity stake in their home whittled down to less than 10 per cent, making it difficult for them to get a competitive fixed-term mortgage deal when their present home loan ends. House prices have fallen by nearly 20 per cent since the market peaked in autumn 2007, leaving 900,000 homeowners owing more money on their property than it is worth, the CML said. The CML said that the size of the problem was still less than in the housing market crash of the early 1990s, when 1.5 million people were left in negative equity. Although it has issued no forecast of how many people may be in negative equity before the housing market recovers, the CML said that recent “alarming” estimates by Gfk NOP, the research group, that 5 million people are at risk of negative equity by the end of the year seemed “implausible”.
Borrowers in negative equity who need to move house or cannot keep up with their repayments must sell their home at a loss and then strive to repay the outstanding sum to their lender. The CML said: “For borrowers, there is little practical difference between negative and low positive equity. The effect of both is to make mortgage credit difficult to obtain, and moves less easy to complete.” Banks have cut sharply the amount that they lend to those with modest deposits in the wake of the credit crunch. Homeowners with a 5 per cent deposit must pay about 7 per cent interest for a two-year fixed-rate mortgage, while borrowers with a 40 per cent deposit will pay only 4 per cent interest, new figures from Moneyfacts, the price comparison website, show.
However, the recent sharp cuts in base rate by the Bank of England are making life easier for many borrowers because they can switch to their lender's relatively cheap standard variable rate when their mortgage deal ends. There are fears that unemployment, which recently soared to a 12-year high of more than 2 million people, will spiral to above 3 million in the coming year, forcing more borrowers into financial difficulties. There are about 11.7 million mortgages in the United Kingdom and there are 18 million owner-occupied households, official figures show.
London to Lose 290.000 Jobs on Bank, Building Cuts
London’s workforce will shrink by 290,000 jobs through 2011 because of cuts in financial services and construction, the city’s economics department said. The number of jobs in the city will fall to 4.4 million in 2011 from 4.69 million at the end of 2008, said Greater London Authority Economics in an e-mailed report today. The economics agency cut its forecast since a report six months ago.
London, which has outpaced the U.K.’s economic growth for most of the last decade, has been buffeted by falling house prices and the decline in global financial markets. The drop in employment this year will be the first in London since 2004. The U.K capital’s “exposure to financial services poses risks for the London economy should the downturn in this sector prove prolonged, which appears possible,” the agency said.
Around 500,000 people were employed in financial services jobs in London last year. Only hotels and catering and public services will increase employment in the next three years, the agency said. Jobs in transportation, manufacturing and construction also will decline. London’s economy will shrink this year and next before growing by 1.7 percent in 2011, the agency said. The city’s economy has expanded in each of the previous six years. The U.K. economy is shrinking at the fastest pace since 1980. Unemployment jumped the most since 1971 in February, with claims for jobless benefits rising 138,400 in the month to 1.39 million, the Office for National Statistics said March 18.
Alistair Darling: slump to end this year
Alistair Darling will say in this week’s budget that the recession should end this year, with a worse-than-forecast contraction in the economy in 2009 replaced by growth next year.
The chancellor will also attempt to mend fences with business by introducing measures to help firms cope with the recession, including an extension of provisions to allow them to carry back losses for up to three years and defer tax payments. Direct action to boost investment by temporarily increasing capital allowances — which has been pushed hard by the Engineering Employers’ Federation and other bodies — is also under consideration. Other likely measures include a public list of tax cheats to be published by HM Revenue & Customs, and the appointment of a mediator between banks and small businesses. Darling will also say he is considering a medium-term move to rein in the public-sector deficit through tax increases and spending cuts.
Preparations for the budget, which continued this weekend, were overshadowed by the death yesterday of Eddie George, former governor of the Bank of England. Lord George, 70, ran the Bank from 1993 to 2003. Darling will say on Wednesday he is looking beyond the recession to “investing in the recovery”. The chancellor will reveal, however, that he expects the economy to shrink by about 3.5% this year compared with his prediction of a 0.75%-1.25% drop in his November pre-budget report. He will also insist that the economy is on track for recovery. While most independent economists see the economy as flat or slightly down in 2010, Darling will predict a rise of about 1%, arguing that the recession should be over by the end of the year.
Treasury officials say that while last November’s pre-budget report was about stabilising the economy at a time when the banking system was deep in crisis, the budget will be about building the recovery, in line with the pledges made at the G20 summit in London this month. As well as giving a boost to cash flow and investment, its measures will focus on employment, investing in broadband and other digital technology, and green incentives. Markets will focus on what Darling has to say about cutting public borrowing, now set to hit between £170 billion and £180 billion this year, up from a predicted £118 billion in November. Officials say that the budget will include medium-term “fiscal consolidation” measures for raising tax and cutting public spending. The chancellor will not propose any immediate measures to curb the deficit but set out what officials describe as a medium-term “direction of travel” to cut borrowing. “We can’t ignore the fact that you need to do something when the budget deficit is more than 10% of GDP,” said one official.
The Ernst & Young Item Club’s eve-of-budget forecast, using the Treasury’s model of the economy, predicts a similar outcome this year to that expected to be unveiled by Darling, with a 3.5% drop in gross domestic product this year. However, it expects only a muted performance next year, with GDP slipping by 0.1%, gloomier than Treasury predictions. Even so, the Item Club believes that next year Britain will pick up sooner than other leading economies, largely thanks to sterling’s big drop over the past year, which will boost exports. Both output and interest rates will rise as other countries remain in the doldrums, it says. Manufacturing output will drop 10% this year but recover by 3.3% in 2010. “If you are looking at 2010 we are going to be first out,” said Peter Spencer, Item’s chief economic adviser. “The signs are positive that the monetary policy committee’s aggressive tactics are working. The credit crunch may finally be easing and with it will come the beginning of the end of the recession.”
The government’s efforts to stabilise the banking system, together with better news from financial markets, give cause for optimism that the worst is behind us, the report says. The Item forecast warns, though, that despite signs of optimism, there is plenty of pain to come, with 900,000 job losses this year and a further 500,000 next, pushing unemployment up from just over 2m now to 3.4m by the end of 2010. Inflation will remain very weak, it says, with retail price inflation negative by 3.5% in the autumn. It also warns that public borrowing will stay high, hitting £180 billion this year and remaining above £150 billion for the following two years, saying “an unambiguous medium-term plan” will be needed for returning them to good health.
North Sea Protection: U.K. Oil Industry Seeks Aid
The U.K. oil industry is pressing for big tax breaks in next week's government budget, warning that dozens of small oil companies operating in the North Sea will go bust without help, which in turn could accelerate a decline in U.K. oil and gas production. The warnings come as smaller players in the industry reel from low crude prices, high costs and shrinking credit. Many are cutting investment and drilling fewer wells. But with the U.K. facing a grim economic outlook and a growing budget deficit, it's unlikely the government will go further than a minor tax change announced in November.
Malcolm Webb, head of Oil & Gas U.K., a trade association, said exploration on the U.K. Continental Shelf "could effectively collapse" unless the government introduces "targeted incentives" for the industry. Oil companies want Britain to follow the lead of Norway, whose tax system encourages oil exploration. Although its overall tax rate is higher, oil companies get tax breaks on exploration costs. In a letter to Treasury chief Alistair Darling, Mr. Webb said capital investment could otherwise be halved to £2.5 billion ($3.75 billion) in 2010. Mr. Darling unveiled a "value allowance" that would reduce the tax rate for small, technically challenging fields in his November pre-budget report. But Oil & Gas U.K. says it should be broadened to all new developments.
"We're saying cut us some slack, without having to put your hand in your pocket," Mr. Webb said. All "decisions on the budget will be announced [April 22]," a Treasury spokesman said. For decades, the North Sea has been one of the world's great sources of oil and gas, providing a critical complement to the Middle East. Some 39 billion barrels of oil equivalent have been produced from North Sea fields since the early 1970s. An estimated 25 billion barrels remain to be recovered. But the basin is maturing rapidly, and output has been declining since 1999. New discoveries are miniscule compared to the big finds of its heyday and are harder to develop. Some of the world's biggest oil companies, such as BP PLC and Royal Dutch Shell, have reduced their exposure to the North Sea and have shifted their focus to places like Canada and offshore Angola.
The U.K. government has opted to lure smaller players with low-cost licenses. But many of these independents have seen their access to debt and equity dry up. At the same time, the price of oil, down around $100 a barrel from the record set of last summer, has made some projects uneconomical. Of the 176 companies that hold U.K. petroleum licences, 105 are neither producing oil or gas nor have fields under development, according to energy consultancy Hannon Westwood. Without cash flow to finance operations, "they will disappear," said Chris Bulley, a partner at Hannon Westwood. Already, the number of exploration wells drilled in the first three months of this year fell 78%, compared with the same period a year earlier, according to accountancy firm Deloitte. A big factor was financial turmoil at Canada's Oilexco Inc., which had been one of the most active explorers in the North Sea. Oilexco's North Sea unit was placed under administration in January. The unit was bought by Premier Oil PLC last month.
GAO team wins approval for fake medical product
Fictitious review board also OK'd in screening probe
Government investigators looking into lax screening of medical research said yesterday they easily won approval from a private independent review board of a fake product to be used in medical testing on human subjects. The Government Accountability Office also said it was able to register with the Health and Human Services Department a fictitious institutional review board, a panel of doctors and scientists that must approve any medical drug or device to be used in federally funded testing on humans. The president of this fake board was a dog named Trooper. The GAO said its investigation showed the system "is vulnerable to unethical manipulation, particularly by companies or individuals who intend to abuse the system or to commit fraud."
Representative Bart Stupak, a Michigan Democrat and chairman of the House Energy and Commerce Committee's oversight and investigations panel, said the findings "raise serious questions" about both the specific board that approved the fake product and "the entire system for approving experimental testing on human beings." Officials from HHS and the Food and Drug Administration assured lawmakers there were substantial protections in place to ensure that testing is done in a responsible and ethical manner. The review board that fell for the GAO ruse, Coast IRB LLC, of Colorado Springs, charged that the GAO violated federal and state criminal laws by falsely representing itself to be a medical device company and forging a medical license.
"We got hoodwinked," said Daniel Dueber, Coast IRB's chief executive. "You didn't get hoodwinked," Stupak replied. "You took the bait - hook, line, and sinker." According to the GAO, two independent review boards rejected the fake medical protocol, which called for a full liter of a fictitious product to be poured into a woman's stomach after surgery. An employee of one called it "junk" while a board member of another said it was the "riskiest thing I've ever seen on this board." But Coast IRB approved it unanimously and minutes of the meeting obtained by GAO showed that board members thought the bogus protocol was "probably very safe." Stupak also questioned whether the investigation revealed a tendency of "IRB shopping," where clinical researchers choose the review boards based on how quickly and inexpensively they approve studies.
The GAO said it also registered its own fictitious IRB with HHS using an online registration form. It ran ads for its "HHS-approved" IRB with emphasis on the speed of its review process. A research coordinator who responded to the ads said it was because of the low price and quick turnaround time. Dr. Jerry Menikoff, director of HHS's Office for Human Research Protections, told lawmakers the registration process does not mean the HHS is giving a stamp of approval to a review board. "Right now we think we have a well-functioning system," he said, adding that there was room for improvement.
The Tower of Basel: Secretive Plans for the Issuing of a Global Currency
In an April 7 article in The London Telegraph titled “The G20 Moves the World a Step Closer to
a Global Currency,” Ambrose Evans-Pritchard wrote:
“A single clause in Point 19 of the communiqué issued by the G20 leaders amounts to revolution in the global financial order.
“‘We have agreed to support a general SDR allocation which will inject $250bn (£170bn) into the world economy and increase global liquidity,’ it said. SDRs are Special Drawing Rights, a synthetic paper currency issued by the International Monetary Fund that has lain dormant for half a century.
“In effect, the G20 leaders have activated the IMF’s power to create money and begin global ‘quantitative easing’. In doing so, they are putting a de facto world currency into play. It is outside the control of any sovereign body. Conspiracy theorists will love it.”
Indeed they will. The article is subtitled, “The world is a step closer to a global currency, backed by a global central bank, running monetary policy for all humanity.” Which naturally raises the question, who or what will serve as this global central bank, cloaked with the power to issue the global currency and police monetary policy for all humanity? When the world’s central bankers met in Washington last September, they discussed what body might be in a position to serve in that awesome and fearful role. A former governor of the Bank of England stated:
“[T]he answer might already be staring us in the face, in the form of the Bank for International Settlements (BIS). . . . The IMF tends to couch its warnings about economic problems in very diplomatic language, but the BIS is more independent and much better placed to deal with this if it is given the power to do so.”1
And if the vision of a global currency outside government control does not set off conspiracy theorists, putting the BIS in charge of it surely will. The BIS has been scandal-ridden ever since it was branded with pro-Nazi leanings in the 1930s. Founded in Basel, Switzerland, in 1930, the BIS has been called “the most exclusive, secretive, and powerful supranational club in the world.” Charles Higham wrote in his book Trading with the Enemy that by the late 1930s, the BIS had assumed an openly pro-Nazi bias, a theme that was expanded on in a BBC Timewatch film titled “Banking with Hitler” broadcast in 1998.2 In 1944, the American government backed a resolution at the Bretton-Woods Conference calling for the liquidation of the BIS, following Czech accusations that it was laundering gold stolen by the Nazis from occupied Europe; but the central bankers succeeded in quietly snuffing out the American resolution.3
Modest beginnings, BIS Office, Hotel Savoy-Univers, Basel
First Annual General Meeting, 1931
In Tragedy and Hope: A History of the World in Our Time (1966), Dr. Carroll Quigley revealed the key role played in global finance by the BIS behind the scenes. Dr. Quigley was Professor of History at Georgetown University, where he was President Bill Clinton’s mentor. He was also an insider, groomed by the powerful clique he called “the international bankers.” His credibility is heightened by the fact that he actually espoused their goals. He wrote:
“I know of the operations of this network because I have studied it for twenty years and was permitted for two years, in the early 1960's, to examine its papers and secret records. I have no aversion to it or to most of its aims and have, for much of my life, been close to it and to many of its instruments. . . . [I]n general my chief difference of opinion is that it wishes to remain unknown, and I believe its role in history is significant enough to be known.”
Quigley wrote of this international banking network:
“[T]he powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences. The apex of the system was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world’s central banks which were themselves private corporations.”
The key to their success, said Quigley, was that the international bankers would control and manipulate the money system of a nation while letting it appear to be controlled by the government. The statement echoed one made in the eighteenth century by the patriarch of what would become the most powerful banking dynasty in the world. Mayer Amschel Bauer Rothschild famously said in 1791:
“Allow me to issue and control a nation’s currency, and I care not who makes its laws.”
Mayer’s five sons were sent to the major capitals of Europe – London, Paris, Vienna, Berlin and Naples – with the mission of establishing a banking system that would be outside government control. The economic and political systems of nations would be controlled not by citizens but by bankers, for the benefit of bankers. Eventually, a privately-owned “central bank” was established in nearly every country; and this central banking system has now gained control over the economies of the world. Central banks have the authority to print money in their respective countries, and it is from these banks that governments must borrow money to pay their debts and fund their operations. The result is a global economy in which not only industry but government itself runs on “credit” (or debt) created by a banking monopoly headed by a network of private central banks; and at the top of this network is the BIS, the “central bank of central banks” in Basel.
Behind the Curtain
For many years the BIS kept a very low profile, operating behind the scenes in an abandoned hotel. It was here that decisions were reached to devalue or defend currencies, fix the price of gold, regulate offshore banking, and raise or lower short-term interest rates. In 1977, however, the BIS gave up its anonymity in exchange for more efficient headquarters. The new building has been described as “an eighteen story-high circular skyscraper that rises above the medieval city like some misplaced nuclear reactor.” It quickly became known as the “Tower of Basel.” Today the BIS has governmental immunity, pays no taxes, and has its own private police force.4 It is, as Mayer Rothschild envisioned, above the law.
The BIS is now composed of 55 member nations, but the club that meets regularly in Basel is a much smaller group; and even within it, there is a hierarchy. In a 1983 article in Harper’s Magazine called “Ruling the World of Money,” Edward Jay Epstein wrote that where the real business gets done is in “a sort of inner club made up of the half dozen or so powerful central bankers who find themselves more or less in the same monetary boat” – those from Germany, the United States, Switzerland, Italy, Japan and England. Epstein said:
“The prime value, which also seems to demarcate the inner club from the rest of the BIS members, is the firm belief that central banks should act independently of their home governments. . . . A second and closely related belief of the inner club is that politicians should not be trusted to decide the fate of the international monetary system.”
In 1974, the Basel Committee on Banking Supervision was created by the central bank Governors of the Group of Ten nations (now expanded to twenty). The BIS provides the twelve-member Secretariat for the Committee. The Committee, in turn, sets the rules for banking globally, including capital requirements and reserve controls. In a 2003 article titled “The Bank for International Settlements Calls for Global Currency,” Joan Veon wrote:
“The BIS is where all of the world’s central banks meet to analyze the global economy and determine what course of action they will take next to put more money in their pockets, since they control the amount of money in circulation and how much interest they are going to charge governments and banks for borrowing from them. . . .
“When you understand that the BIS pulls the strings of the world’s monetary system, you then understand that they have the ability to create a financial boom or bust in a country. If that country is not doing what the money lenders want, then all they have to do is sell its currency.”5
The Controversial Basel Accords
The power of the BIS to make or break economies was demonstrated in 1988, when it issued a Basel Accord raising bank capital requirements from 6% to 8%. By then, Japan had emerged as the world’s largest creditor; but Japan’s banks were less well capitalized than other major international banks. Raising the capital requirement forced them to cut back on lending, creating a recession in Japan like that suffered in the U.S. today. Property prices fell and loans went into default as the security for them shriveled up. A downward spiral followed, ending with the total bankruptcy of the banks. The banks had to be nationalized, although that word was not used in order to avoid criticism.6
Among other collateral damage produced by the Basel Accords was a spate of suicides among Indian farmers unable to get loans. The BIS capital adequacy standards required loans to private borrowers to be “risk-weighted,” with the degree of risk determined by private rating agencies; and farmers and small business owners could not afford the agencies’ fees. Banks therefore assigned 100 percent risk to the loans, and then resisted extending credit to these “high-risk” borrowers because more capital was required to cover the loans. When the conscience of the nation was aroused by the Indian suicides, the government, lamenting the neglect of farmers by commercial banks, established a policy of ending the “financial exclusion” of the weak; but this step had little real effect on lending practices, due largely to the strictures imposed by the BIS from abroad.7
Similar complaints have come from Korea. An article in the December 12, 2008 Korea Times titled “BIS Calls Trigger Vicious Cycle” described how Korean entrepreneurs with good collateral cannot get operational loans from Korean banks, at a time when the economic downturn requires increased investment and easier credit:
“‘The Bank of Korea has provided more than 35 trillion won to banks since September when the global financial crisis went full throttle,’ said a Seoul analyst, who declined to be named. ‘But the effect is not seen at all with the banks keeping the liquidity in their safes. They simply don’t lend and one of the biggest reasons is to keep the BIS ratio high enough to survive,’ he said. . . .
“Chang Ha-joon, an economics professor at Cambridge University, concurs with the analyst. ‘What banks do for their own interests, or to improve the BIS ratio, is against the interests of the whole society. This is a bad idea,’ Chang said in a recent telephone interview with Korea Times.”
In a May 2002 article in The Asia Times titled “Global Economy: The BIS vs. National Banks,” economist Henry C K Liu observed that the Basel Accords have forced national banking systems “to march to the same tune, designed to serve the needs of highly sophisticated global financial markets, regardless of the developmental needs of their national economies.” He wrote:
“[N]ational banking systems are suddenly thrown into the rigid arms of the Basel Capital Accord sponsored by the Bank of International Settlement (BIS), or to face the penalty of usurious risk premium in securing international interbank loans. . . . National policies suddenly are subjected to profit incentives of private financial institutions, all members of a hierarchical system controlled and directed from the money center banks in New York. The result is to force national banking systems to privatize . . . .
“BIS regulations serve only the single purpose of strengthening the international private banking system, even at the peril of national economies. . . . The IMF and the international banks regulated by the BIS are a team: the international banks lend recklessly to borrowers in emerging economies to create a foreign currency debt crisis, the IMF arrives as a carrier of monetary virus in the name of sound monetary policy, then the international banks come as vulture investors in the name of financial rescue to acquire national banks deemed capital inadequate and insolvent by the BIS.”
Ironically, noted Liu, developing countries with their own natural resources did not actually need the foreign investment that trapped them in debt to outsiders:
“Applying the State Theory of Money [which assumes that a sovereign nation has the power to issue its own money], any government can fund with its own currency all its domestic developmental needs to maintain full employment without inflation.”
When governments fall into the trap of accepting loans in foreign currencies, however, they become “debtor nations” subject to IMF and BIS regulation. They are forced to divert their production to exports, just to earn the foreign currency necessary to pay the interest on their loans. National banks deemed “capital inadequate” have to deal with strictures comparable to the “conditionalities” imposed by the IMF on debtor nations: “escalating capital requirement, loan writeoffs and liquidation, and restructuring through selloffs, layoffs, downsizing, cost-cutting and freeze on capital spending.” Liu wrote:
“Reversing the logic that a sound banking system should lead to full employment and developmental growth, BIS regulations demand high unemployment and developmental degradation in national economies as the fair price for a sound global private banking system.”
The Last Domino to Fall
While banks in developing nations were being penalized for falling short of the BIS capital requirements, large international banks managed to escape the rules, although they actually carried enormous risk because of their derivative exposure. The mega-banks succeeded in avoiding the Basel rules by separating the “risk” of default out from the loans and selling it off to investors, using a form of derivative known as “credit default swaps.”
BIS Tower Building, Basel
Botta 1 Building, Basel
However, it was not in the game plan that U.S. banks should escape the BIS net. When they managed to sidestep the first Basel Accord, a second set of rules was imposed known as Basel II. The new rules were established in 2004, but they were not levied on U.S. banks until November 2007, the month after the Dow passed 14,000 to reach its all-time high. It has been all downhill from there. Basel II had the same effect on U.S. banks that Basel I had on Japanese banks: they have been struggling ever since to survive.8
Basel II requires banks to adjust the value of their marketable securities to the “market price” of the security, a rule called “mark to market.”9 The rule has theoretical merit, but the problem is timing: it was imposed ex post facto, after the banks already had the hard-to-market assets on their books. Lenders that had been considered sufficiently well capitalized to make new loans suddenly found they were insolvent. At least, they would have been insolvent if they had tried to sell their assets, an assumption required by the new rule. Financial analyst John Berlau complained:
“The crisis is often called a ‘market failure,’ and the term ‘mark-to-market’ seems to reinforce that. But the mark-to-market rules are profoundly anti-market and hinder the free-market function of price discovery. . . . In this case, the accounting rules fail to allow the market players to hold on to an asset if they don’t like what the market is currently fetching, an important market action that affects price discovery in areas from agriculture to antiques.”10
Imposing the mark-to-market rule on U.S. banks caused an instant credit freeze, which proceeded to take down the economies not only of the U.S. but of countries worldwide. In early April 2009, the mark-to-market rule was finally softened by the U.S. Financial Accounting Standards Board (FASB); but critics said the modification did not go far enough, and it was done in response to pressure from politicians and bankers, not out of any fundamental change of heart or policies by the BIS.
And that is where the conspiracy theorists come in. Why did the BIS not retract or at least modify Basel II after seeing the devastation it had caused? Why did it sit idly by as the global economy came crashing down? Was the goal to create so much economic havoc that the world would rush with relief into the waiting arms of the BIS with its privately-created global currency? The plot thickens . . . .
On the front lines of the U.S. meltdown
It’s just before 11 a.m., and a small group of men in scuffed sneakers and blue jeans have assembled on the courthouse steps in Stockton, Calif. They’re here for what’s become a familiar ritual in U.S. cities hit hard by falling house prices: the foreclosure auction. At the peak of the housing bubble, Stockton was one of the most frenzied real estate markets in the country. Now, with many of those homes in foreclosure, the bidding wars have turned surreal. An auctioneer steps out of the courthouse, and with little fanfare starts to read out the details of several foreclosed homes. For a while there are no takers. Then he gets to a house in the nearby town of Manteca—opening price: $99,870.08. “Two more pennies,” says one bidder in a muscle shirt. Another man steps forward: “Plus a penny.” It goes on like this, the two bidders anteing up copper Lincolns for a home that, four years ago, might easily have fetched $40,000 above the asking price. “Going once, twice, third and final time. Property is sold at $99,870 and 13 cents.”
In a country that’s always done things bigger—bigger booms, bigger bubbles, bigger busts—California stands apart. Few other places saw real estate mania reach such feverish heights. Fewer still have seen their fortunes plunge to such abject lows that the decision over whether to buy a house comes down to five cents. With the world’s eighth-largest economy brought to its knees, Maclean’s took a road trip through one of the hardest-hit parts of California: the region encircling the San Francisco Bay Area. It’s a ring of misery, where unemployment is nearing 20 per cent in some counties. In cities like Stockton, one in 60 houses are in some state of foreclosure. With shopaholic Californians hunkering down, retailers are shutting their doors, from exclusive boutiques to outlet malls in soccer mom enclaves like Elk Grove. One city, Vallejo, unable to pay its bills, has given up and declared bankruptcy. More are expected to follow. Even Silicon Valley, California’s most resilient region and its best hope to lead a recovery, is struggling. California has always been a barometer for the rest of the country. As the Golden State goes, so goes the United States. Now everyone is waiting to see whether the California dream can be resurrected. “People are watching California closely because what happens here is seen as an indicator of what will happen elsewhere,” says Alex Whalley, an economist who teaches at the University of California-Merced. “California is the leading edge of what’s to come.”
The city of Merced sits some 200 km southeast of San Francisco, and a lifetime away from the glitter and restlessness of coastal California. But those two worlds have come together in this dusty corner of a farmer’s fleld in mid-March. The Governator is here, and he’s brought cash to upgrade a nearby freeway overpass. It’s been six years since Arnold Schwarzenegger gave up acting to take top billing in the state legislature. And as he speaks, a trucker passing by on the highway spots him and honks. “We will be pumping in as much money and pumping out as much money as we can,” he says, punching the air with his giant fist and sounding not unlike Hans and Franz from that old Saturday Night Live sketch. “We will rebuild this area and create as many infrastructure projects as possible.” That’s because, like everywhere else in this recession, “infrastructure” is a code word for jobs, and jobs are something Merced desperately needs.
The latest figures released last week are startling. In February, unemployment in Merced (pop. 80,000) hit 19.9 per cent, double the national average and well above California’s already high rate of 10.5 per cent (only Michigan has been harder hit). During the housing boom, half of all new jobs in California were tied to real estate, and Merced was no different. With the housing collapse, thousands of construction jobs have dried up. The region relies heavily on agriculture, but a three-year drought has crippled the sector—in February, Schwarzenegger declared a state of emergency because of the water shortage. Several retailers in the city, such as Linens N’ Things and Circuit City, but also local building supply stores, have closed. Quebecor World, the Montreal-based printing company that sought bankruptcy protection last year, operates a plant here that has laid off staff. Ellie Wooten, the 75-year-old mayor of Merced, recently warned it might close altogether. “Merced was a sleepy little town that nobody had ever heard of,” says Whalley, a Canadian from London, Ont., who moved to Merced at the peak of the boom to work at the university. “Now everybody knows it as the centre of the bust.”
The first thing that’s striking upon arriving is that this doesn’t look like a city in the grips of a crisis. You expect to see rows of boarded-up stores and despondent souls roaming the streets. Instead, downtown Merced is quite charming. There’s a lineup at the Starbucks on Main Street. And the streets are full of cars. But head north of Yosemite Avenue, which once served as the outer limits for the town, and the full scale of America’s woes hits you head-on. Large signs that advertise housing developments with names like Windsong and Riverstone point instead to overgrown grassy fields. Roads have been built and light standards put in place, but most of the lots are empty. Where you’d expect to see rows of cookie-cutter homes, there are just small clusters of houses scattered awkwardly across the landscape. Sometimes work crews simply put down their hammers and walked away, leaving behind wood-frame skeletons to bleach in the sun. In the evening you can stand on the divider of a freshly paved four-lane road for 15 minutes and not see a soul. When a woman finally does come along with her dog, she says that some people have walked away from their homes and left town. She and her husband are still holding on, but “it’s scary.” They owe $135,000 more than their house is worth.
Every mania has a foundation, and in Merced it was anticipation over the new university, which opened its doors in 2005. While crews worked on the campus eight kilometres north of town, developers scrambled to fill in the cow pastures in between with homes. Many believed that overnight, Merced would be transformed into a thriving university town. The city was also touted as an emerging commuter city for the Bay Area. Speculators, mostly from San Francisco, snapped up the new homes, driving prices up 50 per cent between 2002 and 2004. But eventually, reality set in, even as new developments were being mapped out. With just 2,500 students, the university is not much larger than a high school at this point, though it’s expected to grow. What’s more, it’s a daunting three-hour drive past grain elevators to get to San Fran. Whalley recalls the mood as the bubble began to burst. “Sales started to slow down but the line was, ‘It’s only temporary, there won’t be a decline, at worst prices will just flat-line,’ ” he says. “It’s kind of what you hear in Canada right now.” At the peak in 2005 the median house price in Merced was $382,000. Today it’s just $105,500.
There was another glaring flaw built into Merced’s real estate equation that no one seemed to ask about. Who in this town could possibly afford these McMansions? At the peak of the market it took an income of $120,000 to buy a home in Merced, according to the Center for Housing Policy. Yet, Merced has always had a problem with high unemployment. The median income is barely $35,000 a year. That suggests the majority of people who were buying then were out-of-town speculators or locals who had no hope of actually repaying their mortgages. A few blocks up the road from where Schwarzenegger held his press conference, Michelle Allison, program manager at the county employment office, spreads half a dozen menial job postings out on a table in front of her—much of what’s on offer at the moment. An increasing number of the people coming in for help are flight attendants, teachers and business owners. Yet the going rate for the few jobs available is just US$8 an hour. “It’s frustrating because we’re getting them all trained and ready to work, but for what?” she says. “There’s nothing out there.”
Anthony Jones, an army veteran who’d worked steadily for two decades, has hit a wall. It’s been a year since he lost his $31,000-a-year job at a struggling grocery chain, and in that time he’s applied to dozens of employers, with no success. “I feel like I’m starting all over again at 50,” he says. He remains optimistic that the government’s stimulus programs will jump-start the local economy. But the fact is, it could take months for that to take effect, leaving few options for those who can’t find work in the meantime. Allison herself is all too aware of that. Her job ends next month. “I’m looking for work outside of California,” she says. Michael Blower never quite knows what to expect when he enters a foreclosed home in Stockton. The real estate agent is often the first person into a house after the bank has seized it. In one home he found an abandoned antique piano. In another house all the walls had been kicked in, possibly by vandals but more likely by the previous owners before they left. And when he opened a dishwasher recently, it was crawling with cockroaches and rats. So when he walks into a two-storey house on the edge of Stockton and sees shattered glass everywhere, he’s not particularly surprised. A football-sized rock sits in the middle of the kitchen floor. Blower will have to call a contractor to replace the glass, but he knows it will probably just get smashed again. “We’ve got at least another couple of years of this,” he says.
The title of Foreclosure Capital of America tends to shift with each month of new data, but Stockton is almost always in one of the top five spots. Starting in 2003, people began to flee rising house prices in the Bay Area for bedroom communities like Stockton, but that only served to drive up property values here, too. As buyers got squeezed out of the market, banks peddled more and more subprime loans to entice them back in. At the height of the bubble, when the average house price reached $358,000, the vast majority of home sales in the city were bought with subprime mortgages. This explains why homeowners here have been hit so hard by the wave of foreclosures. Stockton house prices have plunged by about 62 per cent to an average of just $137,000. This has left whole neighbourhoods “underwater”—meaning homeowners owe more than their houses are worth. According to Zillow, a market research firm, an estimated 96 per cent of all homes in Stockton bought in 2006 are underwater.
As a result of all this, Stockton’s real estate market has a zoo-like quality to it. It was here, after all, that the phenomenon of the foreclosure tour first emerged. On weekdays, minibuses prowl the streets, shuttling buyers from foreclosed property to foreclosed property. The world of real estate reality TV, which whipped buyers into a frenzy during the bubble, has tuned in to the trend. When a new show called Deals on the Bus was launched in January, naturally Stockton was the first stop. Prettying up neighbourhoods so they look enticing to passersby has become an industry unto itself. Nothing screams empty home like a sunburned front lawn, so landscapers spray dead lawns with green biodegradable paint to give properties that lived-in look.
Watching all this from their rental house are Daniel and Dorothy Martin. He’s 91. She’s 77. But their age didn’t help them avoid being evicted from their home in February. If anything, it made matters worse. Dorothy is deeply religious. Before sitting down for an interview, she first requests that everyone join hands while she leads a prayer, asking that peoples’ eyes be opened to the troubles so many homeowners are facing. But she quickly admits to having less than charitable thoughts toward the mortgage brokers who forced her out of her home. “I’m a Christian woman, but I felt like breaking the windows and splattering the walls with paint before we left,” she says. “I kept asking ‘Why us?’ We didn’t do anything. Why should we be thrown out on the street?” Over the years the Martins have owned seven homes from Ohio to California. When they moved to Stockton four years ago to be close to their grandchildren, they bought a home with an $85,000 down payment. Both of them are retired, but their fixed income of $3,700 a month more than covered the $1,600 monthly payments. Then last year the Martins were notified that their payments, like those of so many other Americans who took out adjustable-rate mortgages, were about to skyrocket and would gobble up almost their entire income. They tried to renegotiate, but were told that until they defaulted, the bank couldn’t help. When they did stop making payments, they learned that the bank they’d been speaking with no longer owned their mortgage. (Their daughter, Gail Sullivan, later learned the Martins’ mortgage had been sold and resold five times.) In February, the Martins received a “notice to quit.” The sheriff’s office posted it to their front door. But by then they’d already moved out. “We left a lot of love in that house,” she says.
Despite all that’s happened, Dorothy remains hopeful everything will work out for them. She’s also thankful the couple have a roof over their heads and food on the table, unlike so many others. A quick visit to the Stockton food bank shows the extent of the problem. A long line of people coils up to the door. According to Kristine Gibson, a manager at the food bank, demand is up 25 per cent over last year, and rising. She says the people coming in today for food baskets include a lot more middle-class families. She can tell by their nicer cars. If there’s a silver lining in Stockton’s housing crisis, it’s that affordability has meant a return to some semblance of normalcy in the housing market. Blower says half of the people he sees buying homes today are investors, while the other half are first-timers who wisely sat out the bubble and saved their money. “There are a lot of couples who thought they’d never be able to buy a house three years ago who suddenly can today,” he says. “I’m seeing a lot of all-cash offers from them.”
Still, the damage has been done, and the repercussions will continue to be felt for a long time. In recent months many banks have abided by a moratorium on foreclosures, but that is about to end. The result, says Blower, will be hundreds of additional properties dumped onto the market. But as everyone knows now, America’s recession has spread far beyond the world of residential real estate. As Wiley Chandler, who anted up the winning penny at the Stockton courthouse, puts it, “Everybody had money, everybody was refinancing their houses. Little guys, big guys, they were all spending it on everything. And now nobody is spending nothing.” Nowhere is that more apparent than the commercial wastelands forming around Sacramento. When Oprah Winfrey aired a segment on a tent city full of homeless people in Sacramento in late February, it touched off an international media storm. Here, in the capital of California, was one of the most glaring symbols of the recession. Since then, reporters from every continent have flocked to the sprawling site, set beneath power lines and next to an almond factory. The fact is, though, most of the residents here, like Rico Morales, the self-proclaimed mayor of the tent city, have been homeless for years. “This is my home, it’s not a mansion, but it’s organized,” he says, adding that he’s been homeless since he was 13. “When the mayor [of Sacramento, former top NBA-player Kevin Johnson] gets off work, he wants to go home, have a coffee, watch some TV. We’d like the same thing, but unfortunately we can’t.”
But while the sudden media attention given to Sacramento’s tent city has shone a much-needed light on the long-term problems of homelessness in America, there’s another U.S. crisis playing out that could prove far more crippling to the global economy. And signs of it are evident 20 km south of Sacramento, in the city of Elk Grove. In 2005, the U.S. Census Bureau crowned Elk Grove the fastest-growing city in America—although, astonishingly, until 2000 it didn’t even officially exist. In just one year, the population exploded by 12 per cent to 112,000. With home builders racing to erect whole new subdivisions overnight, their counterparts in the world of commercial real estate launched a tidal wave of new strip mall and office building projects for the growing population to shop and work in. Today, if you drive a few minutes into the countryside, you can see where that wave broke. A skeleton of steel beams and aluminum roofing rises out of the weeds, the remnant of a highly touted 130-acre shopping mall (the owner of the project, General Growth Properties, is one of America’s largest developers, but is struggling to stave off bankruptcy). Several car dealerships have gone bust, luring gangs who tag them with graffiti. Whole strip malls sit empty. A cook at a Chinese restaurant sits outside smoking a cigarette during lunch hour because there are no customers to feed. “People aren’t going out to eat anymore,” he says. Several restaurants, such as Chili’s, have closed. The commercial vacancy rate in Elk Grove and other cities around Sacramento has topped 30 per cent. Analysts expect it to rise further.
It is, of course, a similar story all across the state. In Silicon Valley, the area to the south of San Francisco dominated by the technology sector, offices within blocks of the massive Google campus are crying for tenants. Even the most exclusive shopping districts in California are struggling. From Rodeo Drive to Melrose Place, luxury boutiques that just a year ago were considered “recession-proof” have closed. Tracey Ross, whose eponymous boutique in West Hollywood served celebrities like Kate Hudson, shut down her store in January. “When wealthy customers who can afford to pay retail are getting 80 per cent off at Saks, it makes it impossible for smaller boutiques to compete,” she said at the time. What does it matter if the world has a few less J.Crews or Bed, Bath & Beyonds? Many experts say commercial real estate is the next domino to fall as a result of the U.S. recession. If it does, those banks and institutional investors that managed to dodge the housing crash, including those based in Canada, could face even more staggering losses.
Consider the nondescript three-storey red brick office building a half-hour up the highway from Elk Grove in the city of Roseville. It’s the kind of structure that crowds most business parks. But, said one mortgage banker in Sacramento who asked not to be named, the giant Quebec pension fund, Caisse de dépôt et placement du Québec, could face millions of dollars in losses on this one building alone. Through its real estate financing subsidiary CWCapital, which manages US$11 billion in assets, the caisse is exposed to the high-risk portions of a US$10.5-million securitized loan on the property. But the banker says a third of the building sits empty and the developer has stopped making loan payments. Given the tumbling value of commercial property in the region, he estimates the building is worth half the loan amount. “They [the caisse] don’t know what’s coming,” says the banker.
For a while it looked like the California dream had turned into a permanent nightmare. For months this past winter, legislators grappled with how to plug a massive US$42-billion hole in the state’s finances for the year. Some 20,000 public sector jobs were on the chopping block. Billions in personal income-tax refunds, welfare payments and student grants were put on hold. In short, California was going broke. Last December, Gov. Schwarzenegger did what he’s had to do a lot of lately. He declared a state of emergency, this one fiscal. In the end, the state passed a budget involving US$13 billion in new taxes and US$15 billion in spending cuts. Schwarzenegger, meanwhile, may be popular in the rest of the country, but in California his approval rating is in free fall. But if the state managed to temporarily plug its fiscal hole, in Vallejo the dam has broken wide open. Last year, this scenic city 53 km north of San Francisco declared bankruptcy. “We’re out of money,” says Stephanie Gomes, a city council member.
Since the late 1970s, when anti-tax advocates introduced a state ballot measure called Proposition 13 that capped property taxes, cities in California have increasingly relied on new home construction and commercial development fees to feed their revenue needs. Now, with the foreclosure crisis and businesses closing, that money has dried up. But even as cities like Vallejo are having a hard time finding new revenue, they are also suffering the after-effects of a massive spending spree. Spending on public sector salaries in particular has skyrocketed. According to Gomes, a leader in the fight to fix Vallejo’s financial mess, 26 employees each earned more than US$250,000 last year, most of them firefighters. The city’s unfunded liabilities, meaning the money it must eventually pay out to cover employees’ health and retirement benefits, total more than US$200 million. As a result, Vallejo has had to slash services. The number of police positions has been cut to 116 from 150, while two fire stations have been closed and another two are at risk. “People are hurting, they’re losing their jobs, losing their homes, yet we’re looking at a US$13-million shortfall,” says Gomes. “We can’t go and ask people for more money until we get our own house in order.”
Some fear other cities may tumble into the bankruptcy pit. Several small towns outside the Bay Area, such as Rio Vista and Isleton, are said to be at risk. “There’s not much else cities can do,” says Lynn LoPucki, a professor of bankruptcy law at UCLA School of Law, “other than sell off city hall to pay down their debts.” If Vallejo represents the worst-case scenario for California, then Silicon Valley remains its greatest hope. If the state can regain its past glory, the bets are that the turnaround will start here. No one’s saying the tech hub has escaped the recession unscathed. The foreclosure crisis has touched cities like San Jose and Palo Alto. Unemployment in the region has also hit 9.4 per cent. Giants like Hewlett-Packard, Microsoft and even Google have announced layoffs. At a Starbucks near the Google campus in Mountain View, several customers update their resumés on laptops. One of them, Michelle, moved to the area three years ago from back east and quickly landed a job as an office administrator at a small tech start-up. The company recently shut down. “Anyone who tells you Silicon Valley will avoid the recession doesn’t know what they’re talking about,” she says.
Still, the region is proving more resilient than other parts of the state. A big reason for that was the carnage of the dot-com crash in 2000, which left the tech sector much leaner. “There are microcosms of economic viability in California, and Silicon Valley is one of them, because we already had our crash and depression,” says Patti Wilson, a career adviser. While companies have been laying off workers, they’re still hiring new ones, replacing poor performers with better talent. And Silicon Valley continues to attract the lion’s share of the world’s venture capital. Yet even Wilson is hedging her bets. She was born in Canada but has lived and worked in the Bay Area’s tech sector most of her life. Her plan is to move back to Canada part-time. She says that decision is driven partly by the economic crisis, but also her unhappiness with the state of politics in the U.S. “This is a very troubled time,” she says. “There’s no early remedy for the challenges facing the United States. This will be long-term, pervasive and debilitating.”
Back in Merced, there are signs of hope. Wal-Mart plans to open a distribution centre in the city, which would bring hundreds of jobs. The housing market, meanwhile, seems to be slowly regaining its footing. It’s early evening and Roberta Flanagan, an 84-year-old real estate agent in the business since the 1960s, has thrown a party for her clients, complete with 100 lb. of corned beef. Standing in the crowded room, you wouldn’t know there’s a recession going on outside. A steady stream of people comes in through the door. Many have taken the opportunity of the housing crash to buy homes they couldn’t afford before. “A whole generation just got a hard lesson in life,” says Flanagan. “Good old common sense is going to come out of this. Is there a future? You bet.” Such optimism in itself is not going to be enough to fuel a recovery, even if it were shared by the rest of state. But when the economy does turn around, California will likely be at the forefront of the rebound. It’s just that, with unemployment rising and damage from the foreclosure crisis still unfolding, it could be some time before that happens.