Pennsylvania Avenue and 15th Street, Washington DC
"'General' Rosalie Jones and her suffrage 'army' marched triumphantly into the Capital shortly before noon yesterday, through the Capitol grounds and down Pennsylvania avenue, with an escort of local enthusiasts and citizens which fairly choked the streets and delayed traffic. It was one of the most remarkable street demonstrations ever seen here"
Ilargi: The world of hallucinations in a few short lines:
G20: The promised amount gets bigger as the day progresses. It stands at about $1.2 trillion as I write this. Everybody will wear the happy face masks, brag of how hard they worked and claim unexpected successes. Tomorrow, back home, they'll take off their faces and start preparing for a world in which treaties can no longer be made or if they are, trusted. That's what the leaders take away from the meeting. Not the markets though: happy masks all over on the floors. Check your wallets. And any way, how come the Dow is up when:
U3: Unemployment numbers keep on rising fast. Continuing claims are at their highest since records began in 1967, new claims since 1982. Seeing the stock exchanges as somehow reflecting the state of the real world was always shaky; it's a load of nothing now. Down the line, however, the real world will reflect nigh perfectly in the exchanges. To delay that point, lawmakers and the banking industry, in their Siamase unison, have pushed so long and so hard that the:
FASB: Accounting Standards Board today decided to squash mark-to-market regulations, which will allow for more and worse mark-to-toilet-paper lies at Goldman et al, as well as at:
AIG: In a report published today, The Institutional Risk Analyst states that AIG has been a doomed Ponzi scheme for years, at least since the day they started getting involved in Credit Default Swaps, but if you look closer, for much longer. Geithner and Bernanke's claims that the swaps are valid and legal paper, says the report, are either proof of gross incompetence or worse. All payments of taxpayer money made to Wall Street banks through AIG's rescue programs will have to be recalled by the bankruptcy court that will have to deal with AIG eventually. Will that happen, or will AIG last long enough to participate, at the behest of the banks, in the:
PPIP: Geithner's Public Private Investment Plan requires that those firms that would like to play a substantial role, i.e. that wish to share in the 20-25% returns the plan promises, will have to hold at least $10 billion in toxic assets on their own balance sheets. In other words, only the biggest losers need apply. That would be Goldman, Citi, JPMorgan and perhaps the largest hedge funds like Blackrock. Oh, and it would also include:
PIMCO: Which is willing to suffer a 20% profit for the common good, re: the recovery of the US economy. So why are you so ungrateful? Wake up, it’s dream world out there. If you want reality, just go look at your own bank account. Or your pension fund, the value of your home.
US Initial Jobless Claims Highest Since 1982 At 669,000, Continuing Claims Reach 5.73 Million Record
The number of Americans filing unemployment claims unexpectedly rose last week to the highest level since 1982 and those staying on benefit rolls jumped to a record as companies kept cutting jobs to trim costs. Initial jobless claims swelled by 12,000 to 669,000 in the week ended March 28, topping 600,000 for a ninth straight time, after a revised 657,000 the prior week, the Labor Department said today in Washington. The number of people staying on benefit rolls soared in the prior week to 5.73 million. Another Labor Department report tomorrow may show the jobless rate in March rose to the highest in more than 25 years, reinforcing concerns that the economy will continue to bleed jobs as companies reduce output.
Less employment and slowing incomes may thwart a rebound in consumer spending, setting back prospects for an economic turnaround in the second half of 2009. "It is difficult to sustain any rebound in consumer spending when you have such sharp declines in employment," said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. "It’s getting harder to get a job once you lose it." The Labor Department tomorrow may say the jobless rate last month climbed to 8.5 percent, the highest level since 1983, according to the median forecast in a Bloomberg survey. Payrolls probably fell by 660,000 workers, bringing total job losses since the downturn began to about 5 million.
Initial claims were estimated to fall to 650,000 from 652,000 initially reported for the prior week, according to the median projection of 43 economists in a Bloomberg News survey. Estimates ranged from 630,000 to 682,000. Stock index futures trimmed earlier gains following the report, while Treasury securities held losses. The Standard & Poor’s 500 futures contract was up 1.9 percent at 824.8 at 9:12 a.m. in New York, after having been up as much as 2.5 percent earlier. The four-week moving average of initial claims, a less volatile measure, rose to 656,750 from 650,250, today’s report showed. Continuing claims were the highest since records began in 1967, rising from 5.57 million.
The unemployment rate among people eligible for benefits, which tends to track the jobless rate, increased to 4.3 percent in the week ended March 21, the highest since 1983, from 4.2 percent. These data are reported with a one-week lag. Twenty-four states and territories reported an increase in new claims for the week ended March 21, while 29 reported a decrease. Initial jobless claims reflect weekly firings and tend to rise as job growth, measured by the monthly non-farm payrolls report, slows. Companies cut an estimated 742,000 workers in March, the most since records began in 2001, according to figures released yesterday by ADP Employer Services. Also yesterday, Challenger, Gray & Christmas Inc. reported that job cuts announced by U.S. employers nearly tripled in March from a year earlier.
Cardinal Health Inc. reported its clinical and medical products businesses, which are to be spun off later this year as CareFusion Corp., will reduce their global workforce by about 800 over six months and shed an additional 500 positions through normal attrition and not filling open roles. The moves are "necessary to help offset current economic conditions," Chief Executive Officer Kerry Clark said in a March 31 statement. Tyson Foods Inc., the largest U.S.-based meat producer, last week said it will close a processed-meats plant in Oklahoma and cut 580 jobs to move production to other locations. The economy contracted at a 6.3 percent pace in the fourth quarter, the worst performance since 1982, and should the recession continue through the end of April it will be the longest in seven decades. Still, recent reports show February retail sales fell less than expected and consumer purchases gained in the first two months of the year. Home sales and durable-goods orders also both rose unexpectedly in February.
G-20 Will Channel $1.1 Trillion in Aid to Ease Recession Pain
World leaders neared an agreement to tighten rules on financial markets, crack down on tax havens and channel more cash to the International Monetary Fund as they narrowed differences over how to fight the deepest global recession since World War II. "You’ll see a substantive and ambitious outcome, serious moves and steps put in place to accelerate our recovery from this recession," U.K. Business Secretary Peter Mandelson said today in a Bloomberg Television interview. Leaders of the Group of 20 nations gathered today in London a day after German Chancellor Angela Merkel and French President Nicolas Sarkozy sparred with President Barack Obama and British Prime Minister Gordon Brown over how to avoid repeating the financial market collapse that caused the recession.
At the top of the agenda is a regulatory framework to rein in risky trading practices and executive pay. The leaders also moved toward compromise on naming tax havens and how far to go in overseeing hedge funds. "I don’t think President Sarkozy will be disappointed," said Mandelson. Brown will announce the summit’s conclusions today at 3:30 p.m. The summit marks a "unique chance" to "thoroughly" change the financial system, Merkel, who faces elections in September, said at a news conference in London yesterday. "That’s why we’re being a bit tough." Officials signalled they will endorse $500 billion in new cash for the IMF, bringing its resources to $750 billion. They also moved closer to Brown’s goal of providing $100 billion in credit lines to support trade after Japan pledged $22 billion.
"I am very confident that we will significantly increase the IMF resources," U.K. Chancellor Alistair Darling said in a Bloomberg Television interview. "People have talked about doubling and perhaps we can go further than that. We want to make sure the IMF has as much money as it need and critically that it can intervene earlier." U.S. Treasury Secretary Timothy Geithner wants to bring hedge funds, private-equity firms and derivatives markets under federal supervision for the first time. A new systemic-risk regulator would have power to force companies to increase their capital or cut their borrowing, and authorities would be able to seize them if they came unstuck.
"There is a very strong consensus for broader, stronger, higher standards so the world never faces a crisis like this again," Geithner said in a Bloomberg Television interview yesterday. "The approach that all these countries are going to come together and support is that we agree on higher common standards for oversight." Protests continued today after demonstrations yesterday in London’s financial district. Activists clashed with police outside the Bank of England and broke into a Royal Bank of Scotland Group Plc branch. Police in riot gear, on horseback and with dogs moved in to surround members of the crowd that smashed at RBS, which is now mostly-owned by the U.K. government.Sarkozy said yesterday the summit draft doesn’t do enough to attack tax cheats and there must also be a "global decision" to crack down on traders’ bonuses. Another concern of the euro-area’s biggest countries was that not enough hedge funds will be subjected to oversight.
The recession has worsened since the G-20 leaders last met in November in Washington. The Organization for Economic Cooperation and Development said in Paris that the economy of its 30 members will contract 4.3 percent this year and predicted unemployment in the Group of Seven will reach 36 million late next year. The World Bank lowered its growth forecast for developing countries this year by more than half to 2.1 percent. "The only thing I wish for is that all the presidents gathered here have the maturity to understand the every day that passes without a solution to the crisis, more people are going to suffer," Brazilian President Luiz Inacio Lula da Silva told reporters after arriving in London. G-20 members are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, South Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the U.S., the U.K. and the European Union. Officials from Spain and the Netherlands are also present.
Medvedev Resurrects Replacing Dollar as Reserve Currency
So much for that fresh start. Barely 24 hours after announcing that Russia and the United States would cooperate on a host of long-simmering issues, Russia President Dmitri A. Medvedev re-proposed a Russian idea that the United States had thought it had batted away: starting a new basket of strong regional currencies to replace the dollar as the world’s reserve currency.
In a speech before leaders here at the Group of 20 summit, Mr. Medvedev said that the countries most responsible for the global economic crisis (read: the United States) are not taking their fair share of the burden for “macroeconomic policies” needed to fix the problem.“On this basis we conclude that it would be wise to support the creation of strong regional currencies and to use them as the basis for a new reserve currency,” Mr. Medvedev said. “One could also consider partially backing this currency with gold.” This is not the first time Russia has brought up the idea of replacing the dollar—it floated the idea two weeks ago, and was followed by an essay by a Chinese economic official who said the same thing.
But Obama administration officials quickly poured water over the proposal, and it had seemed that the issue was deadafter G20 officials said they would not be taking up the proposal at the summit. Mr. Medvedev, however, brought it up anyway. “It is not our goal to destroy existing institutions or to weaken the dollar, pound or euro,” he said, according to a translation of a speech provided by an adviser to the Russian government. “We are simply calling for a joint assessment of how the global currency system can most favorable by developed for the sake of the global economy.”
Geithner’s Non-Recourse Gift That Keeps on Giving to Bill Gross
Treasury Secretary Timothy Geithner’s plan to rid banks and markets of devalued assets may be a boon for Pacific Investment Management Co.’s Bill Gross. The plan may reward investors with 20 percent annual returns on "really toxic" mortgages bought at 45 cents on the dollar by allowing them to borrow six times their moneywith "non-recourse" government-backed debt , New York-based Credit Suisse Group AG analysts Carl Lantz and Dominic Konstam wrote in a March 27 report. That loan would be worth 15 cents to an investor seeking the same return who can’t use borrowed money.
Geithner’s Public-Private Investment Program, or PPIP, promises to boost prices enough to encourage banks, insurers and hedge funds to sell their mortgage holdings, freeing them to make loans while creating a potential windfall for investors. Federal Reserve Chairman Ben S. Bernanke said March 20 that "credit market dysfunction" is countering efforts to fix the economy. "One of the challenges has been that leverage has really been pulled away from the system and as a result the kinds of returns investors are looking for haven’t really been available," said Ken Hackel, head of fixed-income strategy at RBS Securities in Greenwich, Connecticut. RBS is one of the 16 primary dealers that are obligated to bid at the Treasury’s auctions of government debt and which trade with the Fed.
Since Geithner unveiled the plan on March 23, Pacific Investment, or Pimco, which manages the world’s biggest bond fund, and New York-based BlackRock Inc., the largest publicly traded U.S. asset manager, said they may be interested in participating in PPIP. Others include New York-based Apollo Global Management LLC, the private-equity firm run by Leon Black, and Los Angeles-based Colony Capital LLC, which has invested more than $39 billion since it was founded in 1991. "This is perhaps the first win/win/win policy to be put on the table," Gross, co-chief investment officer of Newport Beach, California-based Pimco, said in an e-mailed statement last week.
Geithner’s plan may already be working. Top-rated commercial-mortgage bonds rose 5.6 percent since March 20 to about 79 cents on the dollar on average, according to Merrill Lynch & Co. indexes. The most-senior class of benchmark 2005 securities backed by fixed-rate Alt-A home loans, or those ranked between prime and subprime, increased about 12 percent to 54 cents as of March 31, according to Deutsche Bank AG. Geithner’s plan encourages investors to buy as much as $1 trillion of real-estate assets by using $75 billion to $100 billion provided by the Treasury and government loans. The goal of the Fed and the Treasury since September has been to cleanse banks of troubled assets.
The Treasury would match the money asset managers raise to join them in public-private funds. The Federal Deposit Insurance Corp. would guarantee borrowing offered to funds buying loans, while the Treasury and Fed would offer financing to mortgage- securities buyers. The Fed loans may be made available to investors that are not part of the public-private funds. "Institutional investors, especially the largest, want to be able to put more leverage into trades so they can get higher returns for their efforts," said David Castillo, a senior trader of structured-finance bonds at Further Lane Securities in San Francisco. "On paper the concept is wonderful, though I’m of the opinion most banks still won’t be able to sell."
Analysts at JPMorgan Chase & Co., Barclays Plc and Deutsche Bank AG also say they don’t expect banks to sell many loans into the program because accounting rules mean they generally carry the debt at face value. That suggests they would record a loss when selling the assets, eroding their capital. The credit markets began to seize up in 2007 as losses on subprime mortgages mounted. Since then, the world’s largest financial institutions have taken $1.3 trillion in losses and writedowns, according to Bloomberg data. Gross domestic product shrank 6.3 percent in the fourth quarter, the most since 1982, as banks reined in lending. The government and Fed have spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year, to stem the longest recession since the 1930s, Bloomberg data show.
"Widening credit spreads, more-restrictive lending standards and credit market dysfunction are working against the monetary easing and leading to tighter financial conditions," Bernanke said March 20, addressing the Independent Community Bankers of America’s national convention in Phoenix. The Treasury’s role in buying securities with private investors raises the risk the government would interfere with the businesses of its partners, said Jim Shallcross, who oversees about $14 billion in bonds as director of portfolio management at McLean, Virginia-based Declaration Management & Research LLC. Representative Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee, said in an April 1 interview that the distribution of half of the profits to the investor "does bother me."
"But even beyond that, what bothers me even more is it’s taxpayer money," Bachus said. "What you are doing is artificially inflating the price of those assets because at the present prices the financial institutions won’t sell them." Geithner signaled he’d oppose any attempt to claw back profits from investors participating in the program. Investors and banks "need to have confidence that the rules of the game are going to be clear, consistently applied in the future," he said in an April 1 Bloomberg Television interview in London.
Nobel prize-winning economists Paul Krugman, a professor at Princeton University in Princeton, New Jersey, and Joseph Stiglitz, a professor at the Business School of Columbia University in New York, blasted Geithner’s plan for putting the taxpayer on the hook for losses with what they say is little likelihood of success. "The Geithner plan works only if and when the taxpayer loses big time," Stiglitz wrote in the New York Times this week. "With the government absorbing the losses, the market doesn’t care if the banks are ‘cheating’ them by selling their lousiest assets, because the government bears the cost." Krugman wrote in the Times last month that "Obama is squandering his credibility" with the plan.
While the government’s takeovers of failed savings and loans in the late 1980s and early 1990s cost taxpayers and let private investors gain, it succeeded in ending the crisis. The Resolution Trust Corp. recovered almost $400 billion from asset sales, short of their book value of $452 billion, the agency’s executives said on the day it was shut down on 1995. The government cost of the bailout totaled about $90 billion. "There was a lot of concern that they were selling the assets too quickly and too cheaply," said Raghuram Rajan, the former chief economist of the International Monetary Fund in Washington who’s now a professor at the University of Chicago. "There was a lot of second guessing, but it worked."
The odds of Geithner’s programs succeeding would be low if the financing offered was "recourse," Credit Suisse’s Lantz and Konstam said. That would require the funds to pay back the government funds with their own money if the value of the assets fell below the amount of the loans. With recourse loans, the type of "toxic" mortgages identified by the Credit Suisse analysts, which have a hypothetical 40 percent annual default probability and only 10 percent expected recoveries, would be worth only 19.7 cents. The type of loans that may be sold, New York-based Citigroup Inc. analyst Darrell Wheeler said in a March 27 report, include $93 billion of commercial mortgages that are probably carried on the books of banks at 65 cents to 75 cents on the dollar because they were meant to be packaged into bonds.
Unlike Geithner’s plan for loans, the public-private funds for securities will be limited initially to only five managers, such as Pimco and BlackRock, already overseeing $10 billion of the assets targeted. That program will buy securities from holders of toxic assets other than banks. "There it’s probably going to work -- for five people," said Dan Castro, chief risk officer at hedge fund Huxley Capital Management in New York. "You’re selecting a very small group of large guys and giving them all the advantages." By providing loans, the government may allow investors to more than double their potential profits. The most-senior class of a 2007 Goldman Sachs Group Inc. commercial-mortgage bond traded at 69.6 cents on the dollar on March 27, offering a yield of 12 percent, according to report that day from Bank of America Corp. analysts Roger Lehman and Julia Tcherkassova in New York.
If the Fed provides a five-year non-recourse loan and requires an investor to put up only 85 percent of the cost of the securities, then that investor could "walk away" when the loan expires and still have earned 25 percent returns, Lehman and Tcherkassova wrote. That assumes losses on the underlying loans don’t exceed 30 percent. That type of bond has risen more than 10 cents on the dollar since the plan was announced, according to Wheeler. The amount of leverage available under the Fed’s program hasn’t been announced. The FDIC program will offer as much as six times the money raised by the private-public funds from individuals and the Treasury. ‘We intend to participate and do our part to serve clients as well as promote economic recovery,’’ Pimco’s Gross said in the e-mail.
FASB Eases Fair-Value Rules Amid Pressure From Lawmakers, Financial Firms
The Financial Accounting Standards Board, pressured by U.S. lawmakers and financial companies, voted to relax fair-value rules that Citigroup Inc. and Wells Fargo & Co. say don’t work when markets are inactive.The changes approved today to fair-value, also known as mark-to-market, allow companies to use "significant" judgment in valuing assets to reduce writedowns on certain investments, including mortgage-backed securities. Accounting analysts say the measure, which can be applied to first-quarter results, may boost banks’ net income by 20 percent or more. FASB approved the changes during a meeting in Norwalk, Connecticut.
House Financial Services Committee members pressed FASB Chairman Robert Herz at a March 12 hearing to revise fair-value, which requires banks to mark assets each quarter to reflect market prices, saying the rule unfairly punished financial companies. FASB’s proposals, made four days later, spurred criticism from investor advocates and accounting-industry groups, which say fair-value forces companies to disclose their true financial health. Blackstone Group LP Chairman Stephen Schwarzman, the American Bankers Association and 65 lawmakers in the House of Representatives urged that fair-value accounting, mandated by FASB, be suspended last September. William Isaac, chairman of the Federal Deposit Insurance Corp. from 1981 to 1985, has called fair value "extremely and needlessly destructive" and "a major cause" of the credit crisis. Robert Rubin, the former Citigroup Inc. senior counselor and Treasury secretary, said Jan. 27 the rule has done "a great deal of damage."
Fair-value "provides the kind of transparency essential to restoring public confidence in U.S. markets," former Securities and Exchange Commission Chairman Arthur Levitt said in an interview yesterday. Levitt is co-chairman, along with former SEC head William Donaldson, of the Investors’ Working Group, a non-partisan panel formed to recommend improvements to regulation of U.S. financial markets. Other members of the group, which met in New York yesterday, include Brooksley Born, former chairman of the Commodity Futures Trading Commission, and Bill Miller, chief investment officer of Legg Mason Capital Management Inc. "The group is deeply concerned about the apparent FASB succumbing to political pressures, which prevent U.S. investors from understanding the true obligations of U.S. financial institutions," Levitt said. Levitt is a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.
Fair-value requires companies to set values on most securities each quarter based on market prices. Wells Fargo and other banks argue the rule doesn’t make sense when trading has dried up because it forces companies to write down assets to fire-sale prices. By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s changes could raise bank industry earnings by 20 percent, according to Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York. Companies weighed down by mortgage-backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus.
Test Of Unity For The ECB
As the Group of 20 world leaders struggled to thrash out a communique later on Thursday, the European Central Bank's governing council was discussing future borrowing rates for the euro zone. The central bank was expected to lower interest rates by up to 50 basis points to 1.0% later that afternoon, its lowest level in its history, to reflect rapid deterioration of the euro zone economy. The market will also be looking for any hints of quantitative easing for Europe. Ongoing disagreements between the ECB's governing council might make it difficult for the bank to put on a display of unity at its closely-watched press conference, over what it plans to do next. "This will be a very difficult meeting," said BNP Paribas analyst Dominic Bryant. "Discussions at the governing council are ongoing and there is no united view, some believe that 50 basis points is too steep, some want to go down the route of credit and quantitative easing."
One issue at stake: the gap between Europe's refinancing benchmark rate and the overnight deposit rate. The ECB might cut both by 50 basis points, taking the overnight deposit rate down to zero, which some members aren't keen on. But cutting the benchmark rate by 50 basis and the deposit rate by 25 basis would narrow the gap between the two. The ECB had actually taken the decision to widen the gap in January, by cutting the deposit rate more than the benchmark lending rate in an effort to discourage banks from hoarding reserves. (See "ECB To Banks: Sharing Is Caring.") Narrowing the gap between the two would therefore be seen as a change in that policy of discouraging banks from saving, and could be a step that members aren't too eager to take. This could well mean both being cut by just 25 basis points--which would be a big disappointment for the market.
The market will also be looking out for any hints on whether the central bank plans to introduce "unorthodox" measures such as quantitative easing, flooding the market with money by buying debt from banks to increase their capital reserves, a move undertaken by Britain and the United States. Here too the ECB's governing council is in disagreement. President Jean Claude Trichet is one who fears it could trigger higher inflation. A lack of unity or clear vision of what to do next is likely to be taken badly by the market, as recent indicators have pointed to deflation, and further contraction being on the cards. Euro zone inflation for March fell to 0.6%--an all time low--and BNP Paribas estimates that the figure could go negative by the summer.
Euro area unemployment is rising too, to an unexpected 8.5% in February, according to data released on Wednesday. The market rose ahead of the decision, with the Dow Jones Eurostoxx 50 rising 3.3%, while the euro gained 0.3%, to $1.3283, from $1.3249 the day before. The euro has been gaining against the dollar and the pound after the quantitative and credit easing measures have increased, but this in itself could prove a liability, making it harder for many of the export-orientated euro member states such as Germany to bounce back.
China to Boost Yuan Swaps, Payments on Dollar Concern
China’s leaders, increasingly concerned about the nation’s $740 billion of U.S. Treasuries, are making it easier for trading partners and consumers to do business in yuan. The People’s Bank of China has agreed to provide 650 billion yuan ($95 billion) to Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea through so-called currency- swaps. More such arrangements are being planned so importers can avoid paying for Chinese goods with dollars, the central bank said. In Hong Kong, which has pegged the currency to its U.S. counterpart since 1983, stores from Park’n Shop supermarkets to jewelers accept yuan.
Chinese officials are using the Group of 20 meeting, which begins today in London, to call for reducing the dollar’s role and the creation of a new global reserve currency. Premier Wen Jiabao has said he’s concerned that a weaker greenback will erode the value of China’s Treasuries as the U.S. tries to spend its way out of the longest recession since the 1930s. "China has learned from this financial crisis that we must reduce reliance on the dollar and promote the yuan as a regional or international currency," Zhang Ming, secretary general of the international finance research center at the Chinese Academy of Social Sciences said in a March 31 interview in Beijing. "We need to shield our economy from any more turmoil in the U.S."
The yuan has risen 21 percent to 6.8349 per dollar since the central bank scrapped a fixed exchange rate in July 2005. China has limited its advance to 2.7 percent in the past year as a stronger currency made the nation’s exports less competitive at a time when the economy is growing at the slowest pace in seven years. Gross domestic product will expand 6.5 percent in 2009, from 9 percent last year, according to the World Bank. Wen said on March 13 that China, the world’s biggest holder of foreign exchange reserves, wants guarantees for the safety of its U.S. assets. The Fed last month announced a $1.15 trillion plan to buy Treasuries and mortgage-related bonds, boosting supply of the currency.
Anxiety increased in the past year because the dollar’s gains were driven in part by investors fleeing riskier assets after the bankruptcy of Lehman Brothers Holdings Inc. in September froze credit markets. The PBOC said March 31 its swaps were designed to help developing nations running short of dollars "cope with the current crisis." The Dollar Index, which the ICE uses to track the greenback against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, rallied 18 percent in the past year. It dropped 2.9 percent last month as the Fed started buying Treasuries. The yuan’s 12-month non-deliverable forwards rose 3.7 percent from a month earlier to 6.75, showing traders expect the currency to appreciate, according to data compiled by Bloomberg.
PBOC Governor Zhou Xiaochuan asked the International Monetary Fund on March 23 to expand the use of so-called Special Drawing Rights, which are valued against a basket of currencies, and move toward a "super-sovereign reserve currency." G-20 members Russia and Indonesia supported the proposal, which would reduce the volatility of reserves. China and its Asian allies will adopt a "mild approach" on the plan to avoid driving down the value of U.S. investments, said Lee Chi Hun, deputy director at Korea Centre for International Finance, a Seoul-based government research agency. "A rapid collapse in the dollar system will cause damage to those who hold the most dollar assets," said Lee. The proposal is "a strong warning for the U.S. to protect the value of Chinese assets," he said.
The dollar made up 64 percent of the world’s $6.71 trillion foreign-exchange reserves at the end of last year, down from 64.4 percent in September and 72.7 percent in June 2001, IMF data shows. The yuan can’t be a reserve currency because it isn’t fully convertible. "It’s very premature to think the U.S. dollar can be replaced," said Diane Lin, a Sydney-based fund manager at Pengana Capital, which oversees about $1.9 billion. "The Chinese yuan will eventually become a convertible currency internationally. But we are talking about a timeframe of over five years." China, the world’s second-largest exporter after Germany, according to the World Trade Organization, is turning to other strategies to reduce its dependence on the U.S. currency.
Bank of China Ltd., the nation’s largest foreign-exchange lender, has started trials for the yuan settlement program in Shanghai and Hong Kong, President Li Lihui said in Beijing last month. While China allowed the currency to be used for trading goods and services in December 1996, it had to be converted before cross-border payments were made. Controls on buying or selling yuan for investment are also being eased. The government said on Dec. 9 it will triple the amount of domestic securities that overseas funds can buy under the qualified foreign institutional investors program to $30 billion, without giving a timeframe. "The next step will probably be to allow use of yuan in trade with more regions or nations," said Chan Wing Kee, managing director of Hong Kong-based Yangtzekiang Garment Ltd., which makes GAP and Levi’s clothes. "I’m pretty sure the yuan has more potential to strengthen than the dollar, the euro, the pound and the yen."
Indonesian companies will be able to buy Chinese goods using yuan for the first time after last month’s 100 billion yuan currency swap, Bank Indonesia Deputy Governor Hartadi Sarwono said yesterday in Jakarta. "Importers don’t need to use dollars and they can directly pay their import bills with yuan," Sarwono said. "This will reduce pressure in the dollar market and help stabilize the foreign-exchange rate." Hong Kong banks have been able to accept yuan deposits since 2004 and stores have increasingly welcomed payment in China’s currency since 2003, when a relaxation of visa controls led to a surge in the number of mainlanders visiting the city. "A lot of tourists were bringing nothing but cash for purchases so we had to adapt as retailers," said Caroline Mak, chairman of the Hong Kong Retail Management Association. "Watch, even jewelry shops, they all take yuan now."
U.K. Evades 'Horror Show' as 30-Year Gilt Demand Exceeds Supply
The U.K. sold all 2.25 billion pounds ($3.3 billion) of 30-year bonds today, the longest-dated securities offered since the Treasury was unable to find enough buyers at an auction of 40-year debt last week. Thirty-year gilts extended declines after the auction, which had 1.59 times as many bids as securities offered, the U.K.’s Debt Management Office said today. Last week, an auction of 1.75 billion pounds of bonds due in 2049 received bids for 93 percent of the securities sold. "This will be a relief for the Debt Management Office after last week’s horror show," said Orlando Green, a fixed- income strategist in London at Calyon, the investment-banking division of Credit Agricole SA. "Demand was sufficient enough for them."
Today’s sale was the first since the failed auction on March 25 of debt that is outside the maturity range targeted for purchase by the Bank of England in its so-called quantitative easing program. Today’s bid-to-cover ratio compares with 1.48 the last time the Treasury sold the September 2039 securities on March 4. The yield on the 4.25 percent security was two basis points higher at 4.19 percent as of 12:34 p.m. in London. Gilts with maturities of 10 years or less earned investors 2 percent this year, including reinvested interest, according to Merrill Lynch & Co.’s U.K. Gilts, 1-10 Years Index. Debt due in 25 years or more lost 7.2 percent. Investors bid for 1.63 billion pounds of the 1.75 billion pounds of the 40-year bonds auctioned last week.
Robert Stheeman, chief executive officer of the Debt Management Office, which oversees auctions on behalf of the Treasury, said demand fell short partly because of the central bank’s asset-purchase program, which left yields "not all that attractive" to pension funds, the traditional buyers of longer-dated debt. The government won’t sell any bonds maturing later than 2030 in the next two months except for those indexed to the rate of inflation, the debt agency said March 31. The Treasury will sell so-called linkers due as late as 2047. The Debt Management Office said March 18 it may also hire banks to sell long-dated conventional and index-linked gilts. Governments around the world are selling record amounts of debt to fund stimulus programs and bank bailouts amid the worst economic slump since the Great Depression.
U.K. Prime Minister Gordon Brown’s government plans to sell as much as 147.9 billion pounds in the fiscal year ending March 31, 2010, after targeting a record 146.4 billion pounds in the year ended March 31. The Bank of England cut Britain’s benchmark interest rate to an all-time low of 0.5 percent on March 5 and said it would start buying government and corporate bonds to lower borrowing costs and revive growth. The British economy contracted 1.6 percent in the fourth quarter, the most since 1980. Central bank Governor Mervyn King, who said in testimony to lawmakers in London on March 24 the government should be "cautious about going further in using discretionary measures" to expand deficits, said he expects a similar contraction in the first three months of 2009. Germany is planning to sell a record 346 billion euros ($457 billion) of bonds this year, while U.S. sales will almost triple to a record $2.5 trillion, according to a Goldman Sachs Group Inc. forecast.
Obama Weighs Buyout Rage Against Future of Iconic Auto Union
President Barack Obama, confronting growing public outrage against bailouts, is taking a hard line with the United Auto Workers, the union that supported his election and whose future now hangs in the balance. The UAW, once a pre-eminent U.S. labor organization, is in retreat along with U.S. automakers. It is a quarter the size it was at its peak of 1.5 million members in 1979, when its political clout helped Chrysler Corp. get a then-unprecedented $1.2 billion federal bailout. Now Obama is pushing the union, which already has given up job-security programs and some compensation, to take more concessions within 60 days or General Motors Corp. could face bankruptcy. His auto task force warned the cost of GM’s pensions and retiree health care will "grow to unsustainable levels."
"The president is showing labor a little tough love," said David Cole chairman of the Center of Automotive Research in Ann Arbor, Michigan. "He took away the idea from labor that ‘Barack will take care of us, no matter what.’" Instead, Obama, facing growing public resentment over bailouts following the $165 million in bonuses awarded employees of American International Group Inc., is putting the same pressure on the UAW as he is on GM’s bondholders. A March 23 survey by auto researcher R.L. Polk & Co. found 62 percent of Americans oppose additional government aid for GM and Chrysler LLC. In 1980, Chrysler Corp., as it was known then, was granted more than $1 billion in loan guarantees and paid the loans back in 1983.
"He has no choice but to be equally tough on labor and the bondholders," said Cole. "He’s put them both in a cage with the government and said if they don’t come up with a deal in 60 days, he’ll let the lions in," referring to bankruptcy. In Chapter 11, a judge could tear up labor contracts with benefits the UAW has built over 73 years. The pre-arranged bankruptcy the president is said to expect could be used to protect the union, said labor professor Gary Chaison of Clark University in Worcester, Massachusetts. "Obama will use his influence to protect workers in the way the collective bargaining agreement is rewritten," he said. At Ford Motor Co., which is not seeking federal aid, the union on March 9 accepted concessions that put labor costs on a path toward parity with Japanese rival Toyota Motor Corp. UAW members once enjoyed wages and benefits that pushed labor costs to $74 an hour. Ford said its new deal brings its labor costs down to $50 an hour by 2011, slightly more than Toyota’s $48.
Obama indicated he wants more labor cuts -- without giving targets -- from GM and Chrysler, which has 30 days to complete an alliance with Italy’s Fiat SpA or lose its U.S. government support. GM has received $13.4 billion in aid compared with $4 billion for Chrysler, and the two are seeking as much as $21.6 billion more. The administration has raised the prospect of putting GM through a so-called quick rinse bankruptcy of as few as 30 days if there aren’t more givebacks from labor, lenders and dealers. "This is not consistent with the rhetoric that ‘Bankruptcy is the last resort and we’re out to protect the workers’," said auto analyst Brian Johnson of Barclays Capital in Chicago. "Improvements in liquidity for GM will come out of the UAW."
The UAW’s role in the auto bailout had been seen as pivotal. There are 132,600 active members at GM, Ford and Chrysler. With another 550,000 retirees and surviving spouses, the union has more influence with Obama than the automakers, said Sean McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Michigan. Spokesmen for GM, Ford and Chrysler declined comment. "We cannot have a strong middle class without a strong labor movement," Obama told an AFL-CIO conference March 3. Unions spent $52 million to help elect Obama, including $5 million from the UAW, according to OpenSecrets.org, a Washington-based organization that tracks campaign spending. On Monday, Obama took a tougher tone in putting the onus on the UAW and the companies to justify further taxpayer support.
"What we are asking is difficult," he said in a speech in the White House. "It will require hard choices by companies. It will require unions and workers who have already made painful concessions to make even more. Only then can we ask American taxpayers who have already put up so much of their hard-earned money to once more invest in a revitalized auto industry." UAW officials remain supportive of the president. They view his tough talk and bankruptcy threats as posturing to put more pressure on the bondholders to forgive debts, said a person familiar with the view of UAW leadership. When the economy recovers and Obama is under less political pressure, the UAW plans to ask him for billions in federal funding for a retiree health-care trust, said the person who asked not to be identified revealing internal union discussions.
"There’s light-years of improvement in terms of Washington’s understanding of the importance of manufacturing," compared with the Bush administration, UAW Vice President Bob King said in a March 18 interview. "There is still a problem of discrimination against the blue-collar worker versus the white- collar worker. They are putting the auto industry through 27 hurdles and hoops before doing anything for them." Congressional Republicans are ready to criticize Obama for showing any favoritism to the union. Senator Richard Shelby, an Alabama Republican who advocates bankruptcy for GM, told Bloomberg TV March 31 the UAW would not help. "The UAW, I do not think will ever give enough concessions to let the company be viable again," he said.
To reverse the union movement’s long decline, labor leaders have been counting on Obama’s support for national health care and easier rules for organizing workers, said David Green, UAW local president at a GM factory in Lordstown, Ohio. Obama has already signaled his support for so-called card- check legislation that will allow unions to organize employers once a majority of workers have signed cards requesting one. Currently, companies have the right to require a secret ballot before recognizing a union. The UAW continues to contract as a deepening recession and tight credit markets drive U.S. auto sales to the lowest level in at least 16 years. The Detroit Three are offering buyouts to more than 100,000 workers, a quarter of the UAW’s remaining membership. GM said March 26 that 7,500 hourly employees accepted. The UAW is "trying to protect its relevancy at a time when the worst-case scenario is happening," said Chaison, the labor professor.
Workers say they hope to avoid sacrificing more pay and benefits. "It was a hard pill to swallow to give up all this stuff, but it was something that needed to be done," said Anderson Robinson Jr., president of a Michigan UAW local representing about 3,500 workers at two Ford factories. "I told my members if we don’t pass this, we could all be out of a job." Had the UAW agreed in December to make those concessions, an aid package "would have overwhelmingly received bipartisan support," Tennessee Republican Senator Bob Corker said last month, instead of failing in the Senate. To soften the blow of auto-job losses, Obama on March 30 appointed Edward Montgomery, a former deputy labor secretary, as director of recovery for auto communities and workers, to help with retraining and economic development in communities with auto factories. "The president has laid out that he understands the situation, that it’s not the fault of the workers," he said yesterday in Lansing, Michigan.
The UAW’s membership fell from 1.5 million in 1979 to 431,000 at the end of 2008, according to an annual report the union filed with the Labor Department March 30. The UAW failed to organize the wholly owned U.S. factories of the Japanese automakers such as Toyota, which kept the union at bay by paying similar hourly wages and locating factories in southern states with little organized labor. That left the UAW’s fate tied to the U.S. automakers. GM, Ford and Chrysler account for 44.5 percent of this year’s sales, down from 70 percent of the U.S. auto market a decade ago. Now Obama, a self-professed friend to labor, has subordinated the interests of the UAW and GM to those of the taxpayer. The future of each institution depends on them meeting the president’s new list of difficult demands. "If Obama gives Detroit the money, the UAW will still have a heartbeat," said McAlinden, a former UAW member. "If he doesn’t, he’ll bring down the curtain on industrial unionism."
Chrysler’s Dispute With Supplier Closes Second Ontario Plant
Chrysler LLC, under a 30-day deadline from the U.S. government to restructure, stopped production at a second Ontario factory because of a dispute with an auto parts supplier. The Brampton, Ontario, plant makes the Chrysler 300, Dodge Challenger and Charger, said Max Gates, a Chrysler spokesman, in an interview today. Chrysler idled its minivan plant in Windsor yesterday because of the parts shortage caused by the dispute. The parts shortage could ripple through many of the Auburn Hills, Michigan-based company’s factories unless it’s resolved, Gates said. He declined to identify the supplier or describe the nature of the dispute.
Bank of Canada May Buy Corporate Debt to Spur Growth as Rates Near Zero
Bank of Canada Governor Mark Carney, who won support from Prime Minister Stephen Harper to implement extraordinary monetary measures, is likely to say policy makers are ready to buy commercial paper and other corporate debt to spur the economy, and create new money to pay for it. Carney, who has almost run out of room to cut interest rates, said he’ll detail rules on April 23 for how so-called quantitative and credit easing policies would work. They may include plans for purchases of corporate debt, including commercial paper, if needed to boost the economy.
While Canadian banks have avoided credit losses that triggered bailouts and nationalizations in other Group of Seven countries, slower lending helped push the economy into its first recession since 1992. Buying commercial paper is a good way to boost demand without taking much risk, said former Bank of Canada Governor David Dodge in a March 13 interview. "If they have to come in and be willing to buy some regular commercial paper, well that’s not the end of the world," said Dodge, who retired in January 2008. Purchases of longer-term corporate bonds may be less likely, he said, because "that’s a pretty difficult thing for a central bank to do, to go very far out on the risk curve."
Carney said in a March 14 interview that buying assets is "absolutely the providence of the central bank," and purchasing non-government securities is a possibility. Finance Minister Jim Flaherty said in a separate interview he’s studying ways to shore up the commercial paper market. Central banks in the U.S., U.K. and Japan have made asset purchases a monetary policy focus after cutting rates close to zero. Under quantitative or credit easing, those purchases could be paid for using new money created by the central bank. Tougher conditions for borrowers have pinched companies that use commercial paper for expenses such as payrolls.
The value of paper outstanding fell to C$88.4 billion ($69.9 billion) in January from C$124.7 billion a year earlier, a 29 percent decline, according to Bank of Canada figures. The yield on one-month paper is 55 basis points above the central bank’s key rate, compared with the average of 9 points since 2000. Buying securities to revive Canada’s economy instead of supporting credit markets would represent a new focus for monetary policy. Carney said yesterday after a speech in Yellowknife, Northwest Territories, that publishing guidelines this month doesn’t mean using extraordinary policies is "preordained." He didn’t give specifics when asked about what securities might be involved in quantitative or credit easing.
Policy makers are already purchasing assets to help credit markets work better. The Bank of Canada is using purchase and resale agreements to buy securities for up to three months, and then returning them to investors. The government is buying up to C$125 billion of mortgages for five years and plans to purchase up to C$12 billion of asset-backed securities. The bank is most likely to adopt quantitative or credit easing by lengthening the term of repurchase agreements to as much as two years, said Michael Gregory, senior economist at BMO Capital Markets in Toronto. "They really don’t have to do anything new, they can just tweak their existing arrangements," Gregory said. Moving to a two-year term would fill a "hole" in how banks raise money, he said. "I suspect that they would provide some support for asset backed commercial paper," he said.
The Bank of Canada chopped its benchmark overnight lending rate to a record 0.5 percent March 3, and said the rate would remain there or lower until the economy begins to grow strongly. The overnight rate probably can’t go below 0.25 percent because that would make the rate the Bank of Canada offers on overnight deposits it accepts from commercial banks less than zero, said Eric Lascelles, chief economics and rates strategist at TD Securities in Toronto. A benchmark rate too close to zero would also disrupt returns on money-market funds that charge management fees of about 0.50 percent, he said. The Bank of Canada will probably buy corporate debt and government bonds and create money to pay for them, Lascelles said. "That is one of the areas of the Canadian market that is still broken," he said
David Laidler, a former visiting economist at the Bank of Canada and author of several books on monetary policy, said "getting the cash into circulation is the most important thing." "They are about there, that’s my reading," Laidler said in an interview March 10. Purchasing government bonds to finance deficits may be the best way to boost demand, Laidler said, because it lets fiscal and monetary policies work together. Government bond purchases can help lower yields on corporate debt, fostering new loans to create demand and ward off deflation. "I’m sure they are hoping like hell that they don’t have to" adopt emergency policies, said Richard Harris, an economics professor at Simon Fraser University in Vancouver. "I don’t think anybody expects quantitative easing to produce positive growth numbers, we’re really talking about moderating a very severe downturn and preventing deflation."
Ilargi: If there's any money left, they'd be among the lucky few in the world
'Baltic States Should Let Citizens Tap Pensions'
Estonia, Latvia and Lithuania should let their citizens tap contributions to private pension funds to prevent households going bankrupt and revive demand, said Karsten Staehr, a professor of public finance in Tallinn. "The reduced pension saving meant for a distant future seems a small cost when compared to the cost of personal bankruptcy, distressed sale of property, etc.," Staehr wrote on the RGE Monitor, an economic research company in New York. The increased demand could help boost the economies, he said.
The Baltic states are facing their worst economic crisis since regaining independence from the Soviet Union in the early 1990s, after a credit fueled boom turned to bust. The three countries already have plans to allow citizens to reduce mandatory contributions to the second pillar pension, which is managed by privately run pension funds, according to Staehr. "It seems most appropriate to make the withdrawal voluntary and to tax the withdrawn sum relatively lightly," he said. The Baltic states divide their pension systems into three pillars, with the first paying out pensions on current contributions. The second pillar is a compulsory savings program run by private funds, while the third pillar comprises private pension savings with a preferential tax treatment.
The disadvantage to allowing withdrawals from the second pillar would be that the private pension funds would lose business, and should withdrawals become widespread the funded pension systems’ future "could be up in the air," he said. Baltic consumers are slashing spending as their economies slump into recession. Estonian retail sales fell an annual 18 percent in February, Latvia’s retail sales dropped 25 percent and Lithuanian retail sales slumped 32 percent, in the same month. Estonia’s and Latvia’s gross domestic product will probably shrink 12 percent this year, and Lithuania, the biggest of the three, may contract 9 percent, SEB said yesterday in its Eastern European Outlook report. The economies will also contract next year, it said.
Latvia was forced to turn to a group led by the International Monetary Fund and the European Commission for a 7.5 billion ($10 billion) loan after it took over its second biggest bank and its economy shrunk 10.3 percent in the fourth quarter. Estonia, which ran budget surpluses from 2002-2007, says it does not need IMF aid, while Lithuania, which is cutting public wages and the budget, says it won’t rule out seeking international assistance.
Latvia Missed IMF Payment After Failing to Cut Budget
Latvia didn’t receive a transfer of about 200 million euros ($265 million) from the International Monetary Fund last month after it failed to push through budget cuts, a spokeswoman for Prime Minister Valdis Dombrovskis said. The Washington-based fund’s payment wasn’t transferred because the previous government didn’t cut the budget in line with a 7.5 billion-euro bailout agreement from a group led by the IMF and European Commission, Liga Krapane, the Premier’s spokeswoman, said in a telephone interview today. Another payment of about 1 billion euros from the European Commission, due in June, won’t be transferred until the budget deficit is narrowed to about 5 percent of gross domestic product, Krapane said.
"This episode increases the probability that the new government will stick to the agreed terms of the loan," said Annika Lindblad, an analyst at Nordea Markets, in an e-mail. Latvia’s OMX Riga Index was little changed as of 12:38 p.m. local time. That compares with a 4.1 percent gain in the Dow Jones EURO STOXX 50 Index. Credit-default swaps linked to Latvia rose 70 basis points today to 920.9 basis points, according to CMA Datavision in London. The budget cuts, which are planned for June, may rise as high as 750 million lati ($1.4 billion), according to the central bank. Dombrovksis said the IMF is not ready to finance a "much bigger" budget deficit than 5 percent of GDP, according to an interview with Dienas Bizness today.
The five-party coalition government, which took over after the administration of Ivars Godmanis collapsed on Feb. 20, will have to negotiate budget cuts ahead of municipal and European parliament elections scheduled for June 6. The country faces bankruptcy in June if subsequent installments of its international loan are delayed because of the government’s failure to push through budget cuts, Dombrovskis said in a March 9 interview. "Dombrovskis’s comments will have to be seen in a political context as he will want to make it 100 percent clear to the coalition partners in the government that if extreme fiscal tightening is not passed very soon, the Latvian government will simply run out of money," said Lars Christensen, chief analyst at Danske Bank A/S in Copenhagen, in an e-mailed note. Credit-default swaps, conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point equals $1,000 on a swap protecting $10 million of debt.
Earth population 'exceeds limits'
There are already too many people living on Planet Earth, according to one of most influential science advisors in the US government. Nina Fedoroff told the BBC One Planet programme that humans had exceeded the Earth's "limits of sustainability". Dr Fedoroff has been the science and technology advisor to the US secretary of state since 2007, initially working with Condoleezza Rice. Under the new Obama administration, she now advises Hillary Clinton. "We need to continue to decrease the growth rate of the global population; the planet can't support many more people," Dr Fedoroff said, stressing the need for humans to become much better at managing "wild lands", and in particular water supplies.
Pressed on whether she thought the world population was simply too high, Dr Fedoroff replied: "There are probably already too many people on the planet." A National Medal of Science laureate (America's highest science award), the professor of molecular biology believes part of that better land management must include the use of genetically modified foods. "We have six-and-a-half-billion people on the planet, going rapidly towards seven. "We're going to need a lot of inventiveness about how we use water and grow crops," she told the BBC. "We accept exactly the same technology (as GM food) in medicine, and yet in producing food we want to go back to the 19th Century."
Dr Fedoroff, who wrote a book about GM Foods in 2004, believes critics of genetically modified maize, corn and rice are living in bygone times. "We wouldn't think of going to our doctor and saying 'Treat me the way doctors treated people in the 19th Century', and yet that's what we're demanding in food production." In a wide ranging interview, Dr Fedoroff was asked if the US accepted its responsibility to reduce emissions of carbon dioxide, the gas thought to be driving human-induced climate change. "Yes, and going forward, we just have to be more realistic about our contribution and decrease it - and I think you'll see that happening." And asked if America would sign up to legally binding targets on carbon emissions - something the world's biggest economy has been reluctant to do in the past - the professor was equally clear. "I think we'll have to do that eventually - and the sooner the better."
THE MOST POPULOUS NATIONS
China - 1.33bn
India - 1.16bn
USA - 306m
Indonesia - 230m
Brazil - 191m
Ilargi: A crucial article from Chris Whalen's The Institutional Risk Analyst for all those who'd like to get a more in-depth understanding of just how corrupt our financial systems, and the people operating in them, are. I put it at the bottom because of the length.
Before Credit Default Swaps, There Was Reinsurance
AIG has been a doomed Ponzi scheme for years
"What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?"
CFO MagazineJune 1, 2005
"In the regulatory world, a 'side letter' is perhaps the most insidious and destructive weapon in the white-collar criminal's arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless."
For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps ("CDS") contracts and other types of "high beta" risks, business lines that are highly correlated with the financial markets.
In our interview with Robert Arvanitis last year, "'Bailout: It's About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis', September 29, 2008," we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other "high beta" risks, at least from our perspective.
In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments.
One of the first things we learned about the insurance world is that the concept of "shifting risk" for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm's entry into the CDS market.
In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG's foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.
As with the phony reinsurance contracts that AIG and other insurers wrote for decades, when AIG wrote hundreds of billions of dollars in CDS contracts, neither AIG nor the counterparties believed that the CDS would ever be paid. Indeed, one source with personal knowledge of the matter suggests that there may be emails and actual side letters between AIG and its counterparties that could prove conclusively that AIG never intended to pay out on any of its CDS contracts. The significance of this for the US bailout of AIG is profound. If our surmise is correct, the position of Feb Chairman Ben Bernanke and Treasury Secretary Tim Geithner that the AIG credit default contracts are "valid legal contracts" is ridiculous and reveals a level of ignorance by the Fed and Treasury about the true goings on inside AIG and the reinsurance industry that is truly staggering.
Does Reinsurance + Side Letters = CDS?
One of the most widespread means of risk shifting is reinsurance, the act of paying an insurer to offset the risk on the books of a second insurer. This may sound pretty routine and plain vanilla, but what most people don't know is that often times when insurers would write reinsurance contracts with one another, they would enter into "side letters" whereby the parties would agree that the reinsurance contract was essentially a canard, a form of window dressing to make a company, bank or another insurer look better on paper, but where the seller of protection had no intention of ever paying out on the contract.
Let's say that an insurer needs to enhance its capital surplus by $100 million in order to meet regulatory capital requirements. They can enter into what appears to be a completely legitimate form of reinsurance contract, an agreement that appears to transfer the liability to the reinsurer. By doing so, the "ceding company" - an insurance company that transfers a risk to a reinsurance company - gets to drop that $100 million in liability and its regulatory surplus increases by $100 million.
The reinsurer assuming the risk does actually put up the $100 million in liability, but with the knowledge that they will never have to actually pay out on the contract. This is good for the reinsurer because they are paid a fee for this transaction, but it is bad for the ceding company, the insurer with the capital shortfall, because the transaction is actually a sham, a fraud meant to deceive regulators, counterparties and investors into thinking that the insurer has adequate capital. Typically the fee is 6% per year or what is called a "loan fee" in the insurance industry.
When it operates in this fashion, the whole reinsurance industry could be described as a "surplus rental" proposition, whereby an insurer literally loans another insurer capital in the form of risk cover, but with a secret understanding in the form of a side letter that the loan will be reversed without any recourse to the seller of protection. You give me $6 million in cash today, and I will give you a promise that we both know I will never honor. Does this sound familiar? What our contacts in the insurance industry describe is almost a precise description of the CDS market, albeit one that evolved in the reinsurance industry literally decades ago and has been the cause of numerous insurance insolvencies and losses to insured parties. Or to put it another way, maybe the inspiration for the CDS market - at least within AIG and other insurers -- evolved from the reinsurance market over the past two decades.
As best as we can tell, the questionable practice of using side letters to mask the economic and business reality of reinsurance transactions started in the mid-1980s and continued until the middle of the current decade. This timeline just happens to track the creation and evolution of the OTC derivatives markets. In particular, the move by AIG into the CDS market coincides with the increased awareness of and attention to the use of side letters by insurance regulators and members of the state and federal law enforcement community. Keep in mind that what we are talking about here are not questionable risk management policies but acts of deliberate and criminal fraud, acts that often result in jail time for those involved. As one senior forensic accountant who has practiced in the insurance sector for three decades told The IRA:
"In every major criminal fraud case in which I have worked, at the center of the investigation were these side letters. It was always very strange to me that on-site investigators and law enforcement officials consistently found that these side letters were being used to mask the true financial condition of an insurer, and yet none of the state regulators, the National Association of Insurance Commissioners (NAIC), nor federal law enforcement authorities ever publicly mentioned the practice. They certainly did not act like the use of side letters was a commonplace thing, but it was widespread in the industry."
It is important to understand that a side letter is a secret agreement, a document that is often hidden from internal and external auditors, regulators and even senior management of insurers and reinsurers. We doubt, for example, that Warren Buffet or Hank Greenberg knew the details of side letters, but they should have. Just as a rogue CDS trader at a large bank like Societe General (NYSE:SGE) might seek to hide losing trades, the underwriters of insurers would use sham transactions and side letters to enhance the revenue of the insurer, but without disclosing the true nature of the transaction.
There are two basic problems with side letters. First, they are a criminal act, a fraud that usually carries the full weight of an "A" felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided.
As the use of these secret side letters began to become more and more prevalent in the insurance industry, and these secret side deals were literally being stacked on top of one another at firms like AIG, the SEC began to investigate. And they began to find instances of fraud and to crack down on the practice. One of the first cases to come to the surface involved AIG helping Brightpoint (NASDAQ:CELL) commit accounting fraud, a case that eventually led the SEC to fine AIG $10 million in 2003.
Wayne M. Carlin, Regional Director of the SEC's Northeast Regional Office, said of the settlements: "In this case, AIG worked hand in hand with CELL personnel to custom-design a purported insurance policy that allowed CELL to overstate its earnings by a staggering 61 percent. This transaction was simply a 'round-trip' of cash from CELL to AIG and back to CELL. By disguising the money as 'insurance,' AIG enabled CELL to spread over several years a loss that should have been recognized immediately."
Another case involved PNC Financial (NYSE:PNC), which used various contracts with AIG to hide certain assets from regulators, even though the transaction amounted to the "rental" of capital and not a true risk transfer. As the SEC noted in a 2004 statement: "The Commission's action arises out of the conduct of Defendant AIG, primarily through its wholly owned subsidiary AIG Financial Products Corp. ("AIG-FP"), (collectively referred to as "AIG") in developing, marketing, and entering into transactions that purported to enable a public company to remove certain assets from its balance sheet." Click here to see the SEC statement regarding the AIG transactions with PNC.
The SEC statement reads in part: "In its Complaint, filed in the United States District Court for the District of Columbia, the Commission alleged that from at least March 2001 through January 2002, Defendant AIG, primarily through AIG-FP, developed a product called a Contributed Guaranteed Alternative Investment Trust Security ("C-GAITS"), marketed that product to several public companies, and ultimately entered into three C-GAITS transactions with one such company, The PNC Financial Services Group, Inc. ("PNC"). For a fee, AIG offered to establish a special purpose entity ("SPE") to which the counter-party would transfer troubled or other potentially volatile assets. AIG represented that, under generally accepted accounting principles ("GAAP"), the SPE would not be consolidated on the counter-party's financial statements. The counter-party thus would be able to avoid charges to its income statement resulting from declines in the value of the assets transferred to the SPE. The transaction that AIG developed and marketed, however, did not satisfy the requirements of GAAP for nonconsolidation of SPEs."
In both cases, AIG was engaged in transactions that were meant not to reduce risk, but to hide the true nature of the risk in these companies from investors, regulators and the consumers who rely on these institutions for services. Keep in mind that while the SEC did act to address these issues, the parties involved received light punishments when you consider that these are all felonies that arguably would call for criminal prosecution for fraud, securities fraud, conspiracy and racketeering, among other things. Indeed, this is one of those rare cases where we believe AIG itself, as a corporate person, should be subject to criminal prosecution and liquidation.
Birds of a Feather: AIG & GenRe
Click here to see a June 6, 2005 press release from the SEC detailing criminal charges against John Houldsworth, a former senior executive of General Re Corporation ("GenRe"), a subsidiary of Berkshire Hathaway (NYSE:BRKA), for his role in aiding and abetting American International Group, Inc. in committing securities fraud.
The SEC noted: "In its complaint filed today in federal court in Manhattan, the Commission alleged that Houldsworth and others helped AIG structure two sham reinsurance transactions that had as their only purpose to allow AIG to add a total of $500 million in phony loss reserves to its balance sheet in the fourth quarter of 2000 and the first quarter of 2001. The transactions were initiated by AIG to quell criticism by analysts concerning a reduction in the company's loss reserves in the third quarter of 2000."
But the involvement of the BRKA unit GenRe in the AIG mess was not the first time that GenRe had been involved in the questionable use of reinsurance contracts and side letters. Click here to see an example of a side letter that was made public in a civil litigation in Australia a decade ago. The faxed letter, which bears the ID number from the Australian Court, is from an insurance broker in London to Mr. Ajit Jain, a businessman who currently heads several reinsurance businesses for BRKA, regarding a reinsurance contract for FAI Insurance, an affiliate of HIH Insurance.
Notice that the letter states plainly the intent of the transaction is to bolster the apparent capital of FAI. Notice too that several times in the letter, the statement is made that "no claim will be made before the commutation date," which may be interpreted as being a warranty by the insured that no claims shall be made under the reinsurance policy. By no coincidence, HIH and FAI collapsed in a $5.3 billion dollar fiasco that ranks as Australia's biggest ever corporate failure. Click here to read a March 9, 2009 article from The Age, one of Australia's leading business publications, regarding the collapse of HIH and FAI.
In 2003, an insurer named Reciprocal of America ("ROA") was seized by regulators and law enforcement officials. An investigation ensued for 3 years. According to civil lawsuits filed in the matter, GenRe provided finite insurance to ROA in order to make the troubled insurer look more solvent than it was in reality. Several regulators and law enforcement officials involved in that case tell The IRA that the ROA failure forced insurers like AIG and Gen Re to start looking for new ways to "cook the books" because the long-time practice of side letters was starting to come under real scrutiny.
"These reinsurance deals made ROA look better than it really was," one investigator with direct knowledge of the ROA matter tells The IRA. "They went into the ROA home office in VA with the state insurance regulators and law enforcement, and directed the employees away from the computers and records. During that three-year investigation, GenRe learned that local regulators and forensic examiners had put everything together and that we now understood the way the game was played. I believe the players in the industry realized that that they had to change the way in which they cooked the books. A sleight- of-hand trick that had worked for 25 years under the radar of regulators and investors was now revealed."
Several senior officials of ROA eventually were prosecuted, convicted of criminal fraud and imprisoned, but DOJ officials under the Bush Administration reportedly blocked prosecution of the actual managers and underwriters of ROA who were involved in these sham transactions, this even though state officials and federal prosecutors in VA were anxious to proceed with additional prosecutions.
AIG: From Reinsurance to CDS
While some reinsurers are large, well-capitalized entities that generally avoid these pitfalls, AIG was already a troubled company when it began to write more and more of these risk-shifting transactions more than a decade ago. It is easy to promise the moon when people think that they can deliver, but because AIG and their clients saw how easy it was to fool regulators and investors, the practice grew and most regulators did absolutely nothing to curtail the practice.
It was easy for AIG to become addicted to the use of side letters. The firm, which had already encountered serious financial problems in 2000-2001, reportedly saw the side letters as a way to mint free money and thereby help the insurer to look stronger than it really was. AIG not only helped banks and other companies distort and obfuscate their financial condition, but AIG was supplementing its income by writing more and more of these reinsurance deals and mitigating their perceived exposure via side letters.
A key figure in AIG's reinsurance schemes, according to several observers, was Joseph Cassano, head of AIG-FP. Whereas the traditional use of side letters was in reinsurance transactions between insurers, in the case of both CELL and PNC neither was an insurer! And in both cases, AIG used sham deals to make two non-insurers, including a regulated bank holding company, look better by manipulating their financial statements. Falsifying the financial statements of a bank or bank holding company is an felony.
AIG-FP was simply doing for non-insurers what was common practice inside the secretive precincts of the insurance world. The SEC did investigate and they did finally obtain a deferred prosecution agreement with AIG, which was buried in the settlement with then-New York AG Elliott Spitzer.
The key thing to understand is that if you look at many of these reinsurance contracts between ROA and Gen Re, they look perfect. They appear to transfer risk and seem to be completely in order. But, if you don't get to see the secret agreement, the side letter that basically says that the reinsurance contract is a form of window dressing, then you cannot understand the full implications of the transaction, the reinsurance agreement. Not, several experts speculate, can you understand why AIG decided to migrate away from reinsurance and side letters and into CDS as a mechanism for falsifying the balance sheets and earnings of non-insurers.
Several observers believe that at some point in the 2002-2004 period, Cassano and his colleagues at AIG began to realize that state insurance regulators and the FBI where on to the reinsurance/side letter scam. A number of experts had been speaking and writing about the issue within the accounting and fraud communities, and this attention apparently made AIG move most of its shell game into the world of CDS. By no coincidence, at around this time side letters began to disappear in the insurance industry, suggesting to many observers that the industry finally realized that the jig was up.
It appears to us that, seeing the heightened attention from regulators and federal law enforcement agencies such as the FBI on side letters, AIG began to move its shell game to the CDS markets, where it could continue to falsify the balance sheets and income statements of non-insurers all over the world, including banks and other financial institutions.
AIG's Cassano even managed to hide the activity in a bank subsidiary of AIG based in London and under the nominal supervision of the Office of Thrift Supervision in the US, this it is suggested to hide this ongoing activity from US insurance regulators. Even though AIG had been investigated and sanctioned by the SEC, Cassano and his colleagues at AIG apparently were recalcitrant and continued to build the CDS pyramid inside AIG, a financial pyramid that is now collapsing. The rest, as they say is history.
Now you know why the Fed and EU officials are so terrified about an AIG liquidation, because it will result in heavy losses to or even the insolvency of banks and other corporations around the globe. Notice that while German Chancellor Angela Merkel has been posturing and throwing barbs at President Obama, French President Nicolas Sarkozy has been conciliatory toward the US.
But for the bailout of AIG, you see, President Sarkozy would have been forced to bailout SGE for a second time in two years. So long as the Fed and Treasury can subsidize AIG's mounting operating losses, the EU will be spared a financial bloodbath. But this situation is unlikely to remain stable for long with members of the Congress demanding an investigation of the past bailout, a process that can only result in bankruptcy for AIG.
Are the CDS Contracts of AIG Really Valid?
The key point is that neither the public, the Fed nor the Treasury seem to understand is that the CDS contracts written by AIG with these various non-insurers around the world were shams - with no correlation between "fees" paid and the risk assumed. These were not valid contracts as Fed Chairman Ben Bernanke, Treasury Secretary Geithner and Economic policy guru Larry Summers claim, but rather acts of criminal fraud meant to manipulate the capital positions and earnings of financial companies around the world.
Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple. Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing.
Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG's operations.
(Editor's note: Officials of BRKA and GenRe did not respond to telephonic and email requests by The IRA seeking comment on this article. An official of AIG did respond but was not willing to comment on-the-record for this report. We shall be happy to publish any written comments that BRKA, AIG or GenRe have on this article.