Rip Van Winkle Hotel, Sleepy Hollow, Catskill Mountains, New York
Ilargi: Now John Thain calls Ken Lewis a liar. Who called Hank Paulson a liar. Who called Bernanke a liar. Who is a liar. They all are. The end and the means. Their ends justify their means. I see people like Kunstler are back starting to try and see clever plans in Obama's approach too. More justified means. The country has ways of figuring out this kind of mess. It’s called the judicial system. And if Obama hasn't started a full-blown investigation into securities fraud yet concerning the lot of them, he's an accomplice, no matter what his means or his ends. It's not hard, it can start today. A president who doesn't live by and execute, the law, while having knowledge of criminal activity, is no president. I think people just simply can't stand to lose their dreams just yet, they wish to believe there will be change. And they figure that if they listen long enough they’ll find a way. Yeah, the darkness can be scary.
If I listened long enough to you
I'd find a way to believe that it's all true
Knowing that you lied straight faced while I cried
Still I look to find a reason to believe
Someone like you makes it hard to live
Without somebody else
Someone like you makes it easy to give
Never thinking of myself
If I gave you time to change my mind
I'd find a way to leave the past behind
Knowing that you lied straight faced while I cried
Still I look to find a reason to believe
Someone like you makes it hard to live
Without somebody else
Someone like you makes it easy to give
Never thinking of myself
If I gave you time to change my mind
I'd find a way to leave the past behind
Knowing that you lied straight faced while I cried
Still I look to find a reason to believe
One Nation Under Banks, With Justice for No One
The spectacle of Ben Bernanke and Henry Paulson running roughshod over Kenneth Lewis and his minions at Bank of America Corp. raises a pivotal question for all Americans: Is the U.S. a nation of laws, or a nation of banks? Let’s start by examining the facts disclosed last week in a letter by New York Attorney General Andrew Cuomo, while taking pains to present the actions of each player in this drama in the fairest possible light. Both Bernanke and Paulson in mid-December knew Bank of America was obliged by statute to publicly disclose the huge losses Merrill Lynch & Co. had racked up that month. You don’t get to be chairman of the Federal Reserve or, in Paulson’s case, secretary of the Treasury or head of Goldman Sachs Group Inc. without learning this basic tenet of U.S. securities laws.
Instead of making sure the public was fully informed of the losses before Bank of America completed its purchase of Merrill on Jan. 1, they did all they could to keep the secret safe. Neither Bernanke nor Paulson told the Securities and Exchange Commission, according to the letter Cuomo wrote to lawmakers and regulators. They didn’t tell Lewis or anyone else at Bank of America to do the right thing and obey the law. And while they promised Bank of America lots of money to keep it from calling off the deal, they were careful not to commit any of their agreements to writing for fear this would bind the government into disclosing them itself. It didn’t matter that investors were buying and selling billions of the banks’ shares without a clue that Merrill had lost more than $12 billion during the fourth quarter.
Bernanke and Paulson had a singular objective -- to get the Merrill deal done, on time -- even if that meant duping the stock market and threatening to fire Lewis as chief executive officer, along with the company’s board. The best that can be said about Bernanke and Paulson is that they believed the ends justified the means, and that preventing system-wide harm to the world’s financial markets took priority over strict adherence to the law. And yet, if you think they didn’t breach the public’s trust, ask yourself this: Knowing what we know now, how could you ever trust anything Bernanke says again? What about Paulson’s successor as Treasury secretary, Timothy Geithner, who at the time was still the president of the Federal Reserve Bank of New York? How could he have been out of the loop? Or was he playing the quiet role of boy wonder?
As for Lewis and the rest of Bank of America’s board, it’s a foregone conclusion that their word is now mud. The more honorable and legally appropriate path for them would have been to resign rather than participate in the cover-up. During his Feb. 26 sworn deposition, Lewis told lawyers for Cuomo’s office that “it wasn’t up to me,” to decide whether to disclose Merrill’s losses or Bank of America’s deal with the government. He said his decision not to disclose the information was based on direction from Paulson and Bernanke: “I was instructed that ‘We do not want a public disclosure.’” Even if Lewis’s account of what they said is true, though, it WAS up to him to make full disclosure. And it was up to a lot of other Bank of America officers and directors who failed in their duties, too. That doesn’t get Paulson and Bernanke off the hook. If they had wanted Bank of America to follow the law, they would have left no room for ambiguity.
All this puts the SEC and the rest of the government in a horrible spot. It is a matter of public record that the law wasn’t followed, thanks to Cuomo’s disclosures last week. And yet the agencies and policy makers responsible for enforcing the law are probably powerless to do anything about it. It would be nice to think that SEC Chairman Mary Schapiro might call for a sincere, thorough investigation. But there’s nothing in her professional background that suggests she has the spine or the nerve to take on a major financial institution, much less a former Treasury secretary or the sitting Fed chairman.
We probably won’t get any searching inquiries out of the banking industry’s elected overseers in Congress. Senate Banking Committee Chairman Christopher Dodd took V.I.P. loans from Countrywide Financial Corp., now a subsidiary of Bank of America. His counterpart in the House, Barney Frank, declared last July that Fannie Mae and Freddie Mac were “not in danger of going under,” about two months before they did. That leaves you and me, the American public, with the uncomfortable realization that we are slipping toward a state of lawlessness in this country, all in the name of saving our financial system by creating even bigger banks out of combinations of banks that were dangerously too big already. This doesn’t inspire confidence. It destroys it. We can have our freedom. Or we can have our systemically failure-prone financial institutions. We probably can’t have both.
Can a Rally Last on Diet of Junk?
Trash is king. The biggest winners since the stock market bounced off 12-year lows in early March have been the most beaten-down names, which, in the eyes of many investors, also have the riskiest outlooks. This winners list has been dominated by financial stocks, many of which have more than doubled in value in just a month and a half. While such a junk-stock rally after a massive selloff isn't unusual, some say the rebound is going to have to change in character to be led by higher-quality companies. Otherwise, it could falter amid continued economic weakness and earnings disappointments.
At the very least, the rally caught many investors flat-footed. It had been a widely held view that the best place to be whenever stocks recovered would be high-quality companies with the resources to tough out an extended difficult economic environment. Instead, the winners have been those with the shakiest fundamentals, such as high levels of debt or low return on equity. Despite missing the biggest gainers in the bounce, those with a "quality" focus say they are sticking with it. "By far and away the strength has been in financials and consumer" stocks, notes Neil Hokanson, a Solana Beach, Calif., adviser. "And when we look at the underpinnings in both of those areas we don't see any reason for that level of optimism."
Defying such skepticism, the stock market is holding on to most of the gains chalked up since March 9. In that time, the Dow Jones Industrial Average is up 23% and the Standard & Poor's 500-stock index has gained 28%. Financial stocks in the S&P 500 are up 76% and consumer-discretionary names, which include autos and restaurants, are up 43%. The gains in financials have been so outsized that they have led the overall S&P 500 higher even though they comprise a much smaller part of the index than in the past. Four of the five biggest contributors to the S&P 500 rally have been J.P. Morgan Chase, General Electric (with its big finance division), Wells Fargo and Bank of America. In contrast, technology stocks, which many investors have expected to lead a rally because of their generally strong balance sheets, are up 34%.
One reason for the bounce in financial and consumer stocks is that many had essentially been priced for extinction. But the aggressive steps by the Federal Reserve to pump cash into the financial system, along with other government efforts, have helped take those worst-case scenarios off the table. Meanwhile, on the economic front the catchphrase in the last few weeks has been "less bad," meaning that the pace of the economic decline is lessening. Another positive has been that first-quarter earnings are coming in a touch better than sharply reduced expectations, according to data from Thomson Reuters. Late last week, companies as varied as Ford, American Express, Amazon and Microsoft each came out with reports that investors found reason to cheer. With 35% of the companies in the S&P 500 having reported, first-quarter operating earnings are now expected to post a 35.3% decline, compared with the 36% drop expected on April 1.
However, analysts are continuing to reduce forecasts for the second quarter and the rest of the year. Until that trend reverses, some say, it will be hard for stocks to significantly extend the rally. For the quarter ending in June, earnings are now predicted to register a 33.7% drop, compared with a 31.7% decline expected at the start of the month. For the year, earnings are seen dropping 10.6%, compared with expectations for an 8.4% decline on April 1. Even as financial stocks have bounced, expectations for the group's earnings have eroded further. The consensus is for financials to post a 45% profit drop in the second quarter, five percentage points more than on April 1. The bounce in many financial stocks, however, has been dramatic. E*Trade Financial, for example, is up 319% since March 9, Citigroup is up 204%, and Huntington Bancshares is up 200%.
To some degree, such a snapback rally isn't unexpected. In 2003, following the last bear market, it was the stocks that had been crushed the most that were first to recover. "What's down the most will typically rally the most," says Frank Gretz, chief technical analyst at Shields & Co. Mr. Gretz notes, however, the striking disparity between the recent performance of industry-leading stocks such as Wal-Mart Stores and McDonald's compared with much smaller competitors. Wal-Mart is up just 0.8% since March 9 and McDonald's is up 3.8%. Meanwhile, Ross Stores is up 33% and P.F. Chang's China Bistro has nearly doubled. Matthew Rothman, global head of quantitative equity strategies at Barclays Capital, examined the 100 top-performing large stocks between March 10 and April 9, and found the most common attribute was that they were below $5 in price. They also tended to have relatively low levels of ownership among big institutional investors.
The bounce was "in extraordinarily dubious quality names," Mr. Rothman says. "These were names you would have had to have a lot of courage to be invested in" prior to the rebound, he says. Mr. Rothman says that on the one hand, there is evidence the junk-stock rally might have room to run. By his measures, stocks that rank low in quality have gotten cheaper lately, while quality stocks are starting to look expensive. But Mr. Rothman is in the camp that believes the rally isn't sustainable. Unlike in the last bear market, which was followed by a multiyear rally in beaten-down value stocks, he argues, the collapse of the credit bubble will make it more challenging for turnaround stories. Not everyone is skeptical, however. Shields's Mr. Gretz says that despite the lopsided nature of the stock rally, the rebound has been broad-based. "As long as most stocks are participating, that's the key to a rally's success," he says.
Money Doesn't Grow On Trees
After a sharp decline on Monday of last week, the market spent the remainder of the week recovering much of the loss. Overall, price/volume behavior continues to be uninspiring, leaving it still difficult to infer that investors have adopted a robust preference toward risk taking. The strongest characteristic of market action here is breadth (advances versus declines), but that also contributes to a variety of popular overbought indications, such as the number of stocks over their 50-day averages (which recently peaked above 80%, about where prior bull market rallies have tended to fail), and the McClellan oscillator and summation index, which are also fairly extended.
That's not to say that stocks have to decline here, but having failed so far to recruit much in the way of strong volume sponsorship, there is not much speculative merit to market risk, and only a modest amount of investment merit on the basis of valuations. Even if profit margins sustainably recover to above-average levels in the years ahead, stocks are priced to deliver probable total returns of about 10% annually over the coming decade. The idea that stocks are “once in a lifetime bargains” ignores the fact that this bear market began at strenuously overvalued levels on record profit margins – conditions that are not likely to return naturally in a deleveraging economy. Investors are taking the depth of the decline as a measure of the probable subsequent gain, but historically, the market doesn't work that way. There is little relation between the depth of a bear market and the strength of the subsequent bull.
A persistent element of hope in recent weeks has been the notion that bank operating earnings are “healthy.” To a large extent, this reflects the same sort of investing-on-hope that we saw during the dot-com bubble, the housing bubble, and other brief periods of delusion. The fact is that operating earnings look “healthy” because the only charge to earnings for credit losses is a discretionary “provision” that has been running behind actual defaults one quarter after another. Worse, last week, we learned that the Treasury actively encouraged fraudulent reporting from Bank of America, failing to disclose losses at Merrill Lynch to its shareholders when it was acquiring the company. The Wall Street Journal ran the following bit of testimony, under oath, from Bank of America head Ken Lewis:
As a result, instead of Merrill Lynch's bondholders taking a loss on their bonds, or swapping their debt for BofA equity, those bondholders will now be made whole for all of the losses that Merrill incurred, with 100% principal and interest, right alongside of the bondholders of BofA that are being protected. That's what these bureaucrats want during their stint in government service, that's how they advise our elected officials, and then their revolving door takes them right back to Wall Street. This thing is run by investment bankers and corporate bondholders for the benefit of investment bankers and corporate bondholders. Now, assuming that the government is able to persist in misusing public funds and abusing public trust in order to protect the bondholders of these institutions from losses, it's reasonable to ask: Could the banks eventually “earn their way out” of their losses over the longer-term?
- Lewis: I was instructed that “We do not want a public disclosure.”
- Q: Who said that to you?
- Lewis: Paulson…
- Q: Had it been up to you, would you (have) made the disclosure?
- Lewis: It wasn't up to me.
- Q: Had it been up to you.
- Lewis: It wasn't.
To answer that question, you have to think in terms of equilibrium. Even holding GDP constant, the earnings to recover the losses have to come from somewhere, which implies a redistribution away from where they were going before. Really, money doesn't grow on trees. We've got an economy running with outstanding debt of about 350% of GDP. Even a moderate percentage of that as loan losses will represent a significant share of GDP. To reallocate enough funds to fill that hole, we would have to keep deposit rates near zero, and corporate lending rates high, so that financial institutions would earn a persistently wide spread, or “net interest margin.” Over the short-term, that's what's been happening, so ironically, banks are more “profitable” today than they probably will ever be. Unfortunately, that “profitability” is an artifact of a) unsustainably wide net interest margins, and b) a failure to adequately book losses, at the encouragement of government bureaucrats.
Consider the economic landscape. Even before this earnings downturn, corporate profits were running at about 8% of GDP, a figure that was already based on unusually high profit margins. The personal savings rate was about zero, but has increased to about 4% as consumers have scaled back defensively. The U.S. government is running huge deficits, selling debt to foreigners in order to make the bondholders of mismanaged financial institutions whole. This will put a claim on our future national output and allow foreign owners to scoop up U.S. businesses in the years ahead. We are also running a large current account deficit (though somewhat smaller than in recent years thanks to a collapse in U.S. gross domestic investment).
In order for U.S. financial institutions to earn their way out of the losses, they will have to accrue and retain an amount on the order of 25% to 35% of GDP. If banks were able to sustainably charge high interest rates on loans and pay low interest rates on deposits, the earnings of the banks would come at a cost to corporate borrowers and private savers, who would earn very low returns on their savings. To accrue 25-35% of GDP to cover the debt losses, you would have to depress non-financial corporate profits and personal savings by about 25% for well over a decade.
So yes, we can indeed abuse the U.S. public in order to make the bondholders of U.S. financial institutions whole and protect them from any losses. This was the policy of the Bush Administration, and has tragically become the policy of the Obama Administration as well. By doing so, we will commit our future production to foreign hands, or we will commit about a quarter of U.S. non-financial profits and personal savings to these bondholders over the next decade. We can also allow bureaucrats to commit public funds that have not even been allocated by Congress, which is what we have done. We have all become dangerously de-sensitized the the sheer volume of money being tossed around here, and the potential for enormous fraud, misappropriation, cronyism, and misuse.
What we cannot do is create all of this out of thin air. Understand that the money that the government is throwing around represents a transfer of wealth from an unwitting public to the bondholders of mismanaged financial corporations, even while foreclosures continue. Even if the Fed buys up the Treasuries being issued, and thereby “monetizes” the debt, that increase in government liabilities will mean a long-term erosion in the purchasing power of people on relatively fixed incomes. To a large extent, the funds to defend these bondholders will come by allowing U.S. businesses and our future production to be controlled by foreigners. You'll watch the analysts on the financial news channels celebrate the acquisition of U.S. businesses by foreign buyers as if it represents something good.
It's frustrating, but we are wasting trillions of dollars that could bring enormous relief of suffering, knowledge, productivity, and innovation in order to defend bondholders of mismanaged financials, and nobody cares because hey, at least the stock market is rallying. If one thing is clear from the last decade, it is that investors have no concern about the ultimate cost of the wreckage as long as they can get a rally going over the short run. For my part, I remain convinced that without serious efforts at foreclosure abatement (ideally via property appreciation rights), mortgage losses will begin to creep higher later this year, surging in mid-2010, remaining high through 2011, and peaking in early 2012. To believe that we are through with this crisis or the associated losses is to completely ignore the overhang of mortgage resets that still remain from the final years of the housing bubble.
Goldman Sachs Boosts Risk-Taking at Fastest Pace on Wall Street
Goldman Sachs Group Inc., unbowed by the securities industry’s worst year since the Great Depression, increased its trading bets at the fastest rate on Wall Street. Goldman Sachs’s so-called value-at-risk, the amount the New York-based bank estimates it could lose from trading in a day, jumped 22 percent to $240 million in the first quarter, twice what Morgan Stanley stands to lose, company reports show. VaR climbed 2.8 percent in the same period at JPMorgan Chase & Co. and dropped 14 percent at Credit Suisse Group AG. Offense beat defense in the first three months of 2009 as Goldman Sachs reported record revenue of $9.4 billion, dwarfing Morgan Stanley’s $3.04 billion. Since Goldman Sachs and Morgan Stanley, the two biggest U.S. securities firms, converted into banks in September, Morgan Stanley Chief Executive Officer John J. Mack has reduced proprietary trading and principal investing to focus on the firm’s role as a financial adviser and broker.
“What stands out to me isn’t so much that Goldman had a blow-out quarter, it’s that Morgan Stanley had a disappointing quarter,” said Jeffery Harte, an analyst at Sandler O’Neill & Partners LP in Chicago, who has a “hold” rating on both firms. Morgan Stanley posted a $177 million loss in the first quarter and slashed its dividend by 81 percent after real estate and debt-related writedowns. By contrast, Goldman Sachs, led by Chief Executive Officer Lloyd C. Blankfein, reported better- than-estimated earnings of $1.81 billion in the same period. “Morgan may have it right for 2010, but for the first quarter of 2009 that wasn’t the right answer,” said Peter Sorrentino, a senior fund manager at Cincinnati-based Huntington Asset Advisors Inc., which oversees about $13.3 billion and owns Goldman Sachs shares. “Goldman saw the moment completely differently. They saw the opportunity, saw the pricing and realized this isn’t going to last forever.”
Goldman Sachs wasn’t alone. New York-based JPMorgan generated a record $4.9 billion of fixed-income revenue, and profits at Citigroup Inc. and Credit Suisse, based in Zurich, were helped by trading revenue that exceeded analysts’ estimates. Deutsche Bank AG, Germany’s biggest bank, may report record trading when it discloses first-quarter earnings tomorrow, people with knowledge of the situation said last week. VaR is just one measure banks use to try to gauge losses. It isn’t designed to capture the risk of rare and extreme losses. For that reason, some critics such as Nassim Taleb, author of the “The Black Swan,” say the metric is inadequate. Wall Street made money in the first quarter from traditionally unprofitable corporate loans and trades for their customers, as the gap between what banks pay to buy fixed-income securities and what they sell them for, the so-called bid-ask spread, almost doubled.
“Spreads are way up,” JPMorgan CEO Jamie Dimon told analysts April 16 after the biggest U.S. bank by market value reported a 10 percent drop in first-quarter net income. The past three months represent “a historically high quarter, and if you were looking at it, it’s not reasonable to expect it to continue at that level,” said the 53-year-old Dimon. Credit Suisse Chief Executive Officer Brady W. Dougan, 49, said last week that taking fewer chances to lose money “remains a key area of focus” for the biggest Swiss bank by market value. Barclays Plc President Robert Diamond, who runs the London-based bank’s securities unit, said in an April 15 interview that he’s “reasonably optimistic” as he looks ahead. “It has been quite a while since we’ve seen analysts talk about revenue as opposed to writedowns and balance-sheet risks,” said Diamond, 57.
Goldman Sachs sold $5 billion of stock on April 14, and Blankfein, 54, pledged to use the proceeds to help repay the $10 billion that the firm received last year under the Troubled Asset Relief Program. Morgan Stanley also got $10 billion. Mack, 64, told employees on March 30 that 2009 would be a “difficult” year and said “it’s the wrong time” to return the money. New York-based Morgan Stanley then said last week it would “consider” repayment. The firms can’t make refunds until after they learn the results of stress tests conducted by banking regulators to determine which of the 19 largest U.S. banks needs more capital to help weather adverse economic conditions. The assessments may be made public as soon as May 4. Goldman Sachs and Morgan Stanley are the fifth- and sixth-largest banks by assets. “Both companies would like to find a way to give back the TARP capital, but I think Goldman has been a little more vocal about that, a little more aggressive in going to the market and raising capital,” said Nick Sheumack, an investment banker at Keefe Bruyette & Woods Inc. in New York who advises securities firms and asset-management companies.
Morgan Stanley Chief Financial Officer Colm Kelleher, 51, said on a conference call with analysts and investors last week that weaker-than-expected fixed-income trading revenue of $1.3 billion, or $2.3 billion excluding writedowns related to the firm’s improved creditworthiness, was “about risk appetite.” “We will take risk when we think the risk-adjusted return appetite warrants that,” Kelleher said. Goldman Sachs CFO David Viniar, 53, told analysts on April 14 that his firm took advantage of a reduced number of competitors to charge more for executing trades, even in some of the most liquid securities. The bank booked $6.56 billion of fixed-income trading revenue, 34 percent more than its previous record and five times Morgan Stanley’s. “The vast majority of all our risk-taking is on behalf of clients,” said Goldman Sachs spokesman Lucas van Praag.
Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York, said Morgan Stanley hampered its traders from participating as so-called counterparties in even safer, liquid markets because of efforts to reduce balance-sheet assets. That limited the financing that the firm could provide to customers, he said. “Fixed-income traders without the ability to provide customer financing and with limited use of balance sheet are unable to take advantage of even favorable market conditions,” Hintz wrote in an April 23 report. Total assets climbed 5 percent at Goldman Sachs to $925 billion in the four months ended March 31, while Morgan Stanley’s assets dropped 5 percent to $626 billion. Morgan Stanley’s conservative stance may stem from its need to win over investors. The firm’s stocks and bonds are priced at a discount to Goldman Sachs’s. Morgan Stanley shares dropped below $10 in October and still trade at less than the firm’s $27.32 book value. Goldman Sachs’s stock never fell below $50 and trades above the company’s $98.82 book value.
“If you think back to last fall, Morgan was in a much more precarious situation than Goldman Sachs,” said Roger Freeman, an analyst at Barclays Capital in New York who worked for Lehman Brothers Holdings Inc. when it went bankrupt last year. “It’s perfectly understandable that there’s shock there.” Lehman’s collapse led investors to lose confidence in Wall Street. Goldman Sachs’s $4 billion of senior unsecured bonds maturing in April 2018 traded as low as 77 percent of face value on Sept. 16, the day after the bankruptcy. Morgan Stanley’s $4.5 billion of senior unsecured bonds maturing in April 2018 plunged to 61 percent of face value on Oct. 10, according to trades of more than $1 million on NASD’s Trace system. The two companies responded by converting to bank holding companies to win government financing support. Both qualified for $10 billion injections from the U.S. Treasury in October.
Goldman Sachs and Morgan Stanley bonds have since recovered. Goldman Sachs’s April 2018 senior unsecured notes traded at 93 cents on the dollar last week, and Morgan Stanley’s were 95 cents on the dollar, according to Trace. The cost of insuring against a default on Morgan Stanley’s bonds is still higher than for Goldman Sachs. Morgan Stanley’s credit-default swaps traded on April 24 at 3.65 percent, compared with 2.38 percent for Goldman Sachs. The difference means it costs $127,000 more each year to protect $10 million of Morgan Stanley debt than to insure the debt of Goldman Sachs. While both companies are able to issue debt with a guarantee from the government, Goldman Sachs sold $2 billion of 10-year notes in January without a guarantee to test market confidence. Morgan Stanley hasn’t tried to do that yet, and CFO Kelleher said the firm is waiting until the market is receptive.
The 24-member KBW Bank Index has declined 22 percent this year, compared with Goldman Sachs’s 44 percent advance in New York Stock Exchange composite trading and Morgan Stanley’s 37 percent increase. New York-based Citigroup slumped 52 percent in the same period, and JPMorgan climbed 5.9 percent. Goldman Sachs and Morgan Stanley said last year that they intended to build their base of deposits. Morgan Stanley’s deposits rose 67 percent to $60 billion at the end of March. Goldman Sachs, which had deposits of $27.6 billion at the end of November, didn’t disclose a figure for the end of March. Blankfein has shown no inclination to change the business model that helped Goldman Sachs set industry records for earnings and pay in 2006 and 2007. “Nothing that happened this year altered the core of what Goldman Sachs is,” Blankfein told investors at a Nov. 11 conference in New York. “We won’t stop doing the things that made us a leading investment bank.” Trading is such an integral part of Goldman Sachs’s culture that Blankfein has no choice, Huntington’s Sorrentino said.
“Goldman is Goldman because they’ve done that,” he said. “If they can get paid to take a risk, they’ll take it. You don’t get paid for doing safe stuff.” First-quarter revenue-per-employee and compensation figures bear that out. At Goldman Sachs, each of the firm’s 27,898 employees brought in, on average, $338,017 in revenue, compared with $68,760 apiece for Morgan Stanley’s 44,241 employees, according to data compiled by Bloomberg. Compensation and benefits at Goldman Sachs totaled $4.71 billion in the quarter, an average of $168,829 per employee, compared with $2.08 billion at Morgan Stanley, or $47,060 for each person. Mack began pulling out of businesses that used a lot of the company’s capital in November, reducing proprietary trading, principal investments, mortgage origination and the prime brokerage division that caters to hedge funds. “They’re just trying to get to where the puck is going to be, whereas Goldman just said, ‘No, we’re still playing the game we’ve always played,’” Sorrentino said.
IMF says national deficits to remain sky-high
Budget deficits across the industrialised world will remain sky-high next year in spite of reduced spending on fiscal stimulus packages, the International Monetary Fund warned on Sunday. It said the Group of 20 leading economies taken together would run a budget deficit of 6.5 per cent next year compared with 6.6 per cent in 2009. The huge deficits owe more to weakness in the world’s big economies than to discretionary spending on stimulus packages, which is set to decline in 2010. Staff at the US Federal Reserve estimate that the ideal interest rate for the US economy under current conditions is minus 5 per cent, according to an internal analysis prepared for its last policy meeting. The IMF said on Sunday the UK deficit would rise from 9.8 per cent of gross domestic product this year to 10.9 per cent next, while the deficit in Japan would increase to 9.6 per cent of GDP.
It predicted that the US deficit would inch lower, but to a still high 8.8 per cent of GDP. The biggest deterioration would come in Germany, the IMF forecast, with the deficit jumping from 4.7 per cent of GDP to 6.1 per cent. The deficit will also move higher in France, to 6.5 per cent of GDP. The IMF budget forecasts came after three days of meetings of world finance ministers and ?central bank governors in Washington. In a statement, the Group of Seven industrialised nations said “some signs of stabilisation are emerging” in the world economy. However, US and UK officials worry that continental European nations might backslide on the stimulus, while French and German officials fear the US and UK could backslide on regulation.
Thain Fires Back at Bank of America
John Thain figured seven months ago that he was just one rung down the corporate ladder from becoming chief executive of the largest consumer bank in the U.S. Now, he is trying to climb back from the professional disaster that followed. In an effort to restore his sullied reputation, the 53-year-old Mr. Thain is striking back at Bank of America Corp. He claims the bank lied about its role in the giant bonuses and losses at Merrill Lynch & Co. that cost Mr. Thain his job in January, after Bank of America bought the troubled brokerage. "Getting fired is one thing. But nobody has the right to say things that they know aren't true," said Mr. Thain, who had been Merrill's chief executive, during one of a series of interviews with The Wall Street Journal.
Charlotte, N.C.-based Bank of America has stated publicly that the decision to pay bonuses to Merrill employees in December rather than in January, when they usually go out, was solely Mr. Thain's. News of the $3.62 billion in bonuses sparked a public outcry, badly damaging Mr. Thain's reputation. But Mr. Thain says that he and Bank of America Chief Executive Kenneth Lewis agreed in writing that the bonuses could be paid before Bank of America's acquisition of Merrill closed, which led to the early payments. "The suggestion Bank of America was not heavily involved in this process, and that I alone made these decisions, is simply not true," he says. Bank of America has painted a different picture than Mr. Thain's of critical decisions that were made last fall. It has cast him as the person responsible for distributing billions of dollars of bonus money despite Merrill's huge losses. Before Mr. Thain's recent discussions with the Journal, he had refrained from commenting in depth.
Bank of America declined to respond in detail to Mr. Thain's remarks. The company "stands by statements it has made," spokesman Robert Stickler wrote in an email. "These issues have been previously extensively reported by the news media. We believe it is time to move on. We wish Mr. Thain well in his future endeavors." Nevertheless, the issue is likely to surface again at Bank of America's annual meeting on Wednesday, when shareholders will have a chance to question management about the controversial acquisition, which involved emergency government funding. In testimony disclosed last week, Mr. Lewis said he felt pressured by government officials to complete the deal and to remain silent about his concerns about mounting losses at Merrill. Mr. Thain's decision to tell his side of the story comes three months after he was asked to resign by Mr. Lewis in a meeting that lasted just a few minutes. "Until he came to ask me to resign, there was never an indication from him that he had any concerns," says Mr. Thain.
The affair made him a lightning rod for public ire over greed on Wall Street. Suddenly, he was unemployed after a 30-year career that included three years as president of Goldman Sachs Group Inc., another four running the New York Stock Exchange, and, since December 2007, the top job at Merrill. At first, he spent hours scanning the Internet for coverage of his downfall. Shortly after his ouster, Mr. Thain and his wife were invited to dinner by John Reed, the former Citicorp Inc. chairman and CEO, who had recruited Mr. Thain to the NYSE. Mr. Reed suggested the 21 Club, a well-known Manhattan restaurant frequented by Wall Street executives. "He just wanted to be off the radar," says Mr. Reed. Instead, the two couples went to a low-key French restaurant in Greenwich Village. Mr. Thain, a former mortgage-bond trader and electrical-engineering student, "was shell-shocked," Mr. Reed says. "He was very stoic and uptight....He had to relax and say, 'This is crummy, and this is going to hurt,' and just accept it. At the time, he just tried to pretend nothing had happened."
Since then, Mr. Thain says, he has gotten used to being stopped on the street by strangers. Most thank him, he says, for saving Merrill by agreeing in September to sell it in a deal then valued at $50 billion -- a rapid-fire bid to avoid the kind of collapse that led Lehman Brothers Holdings Inc. to seek bankruptcy protection. Others tell him he is just another greedy Wall Street executive. When Mr. Thain left Goldman after almost 25 years to run the Big Board, he said at the time that it was his chance "to be CEO." Now he spends his time networking and says he is optimistic that he will get another chance to run a publicly traded company. He still puts on a suit nearly every day, although he no longer has an office to go to. As long as the Bank of America mess is hanging over his head, it may be difficult for Mr. Thain to land another CEO job, despite accomplishments ranging from helping lead Goldman through the events of Sept. 11 to the modernization of the NYSE.
"Right now, John is radioactive," says Mr. Reed, who nine years ago lost a showdown with Sanford Weill to run Citigroup Inc. "I would guess any company with a public board would have a hard time hiring him. Bank of America made him the poster boy for bad practices." In a Journal interview, Mr. Thain said that when he arrived at Merrill, "I viewed it as a five- to seven-year opportunity. I felt it would take two years to work out the bad assets." He admits to some mistakes. He lobbied last year for a multimillion dollar bonus from the Merrill board, although in the end he asked for no bonus. In 2007, he spent more than $1.2 million renovating his office and two surrounding conference rooms at the firm's lower Manhattan headquarters. One room had been used as a gym by his predecessor, Stan O'Neal, who was forced out after big bets on mortgage-backed securities backfired. Mr. Thain reimbursed Merrill after the renovation became public.
Initially, Mr. Thain had hoped to keep Merrill independent. He was encouraged by other top Merrill executives to pursue a deal. The sale was hammered out rapidly over the weekend of Sept. 13 and 14. "No one knows for sure if Merrill would have survived the week that followed, but the risk was too high not to do something," says Mr. Thain. "Ken Lewis and I didn't know each other well, but we agreed on a vision and the strategic value of the deal," he says. "I knew the deal meant I wouldn't be CEO." Mr. Thain says Mr. Lewis subsequently had assured him he was a leading candidate to eventually succeed him as CEO. Then, he says, Mr. Lewis set out to make him the scapegoat for problems related to the Merrill takeover. Mr. Thain says the bank's statements have left the impression he was hiding information. "What bothers me is I was trying to do the right thing for Merrill's shareholders, employees and clients," he says. "I want to set the record straight."
Four days after his ouster, Mr. Thain emailed a small group of Merrill executives. He wrote that he was "completely transparent" about fourth-quarter losses, which eventually totaled $15.84 billion. He told CNBC in an interview that his ouster "was a surprise to me." Then he went silent. At the time, people close to Bank of America suggested that Mr. Thain had left the bank in the dark about Merrill's deteriorating financial condition, and had left on a ski vacation in December. Bank of America said it had "no authority" to tell Merrill what to do about compensation, and that Mr. Thain "decided" to pay bonuses in December rather than in January, as is customary.
But the merger agreement signed by Messrs. Lewis and Thain includes a nonpublic document, viewed by the Journal, which shows that Merrill was allowed to pay out the employee bonuses before the takeover was completed. The bonus pool was capped at $5.8 billion, and both men agreed to pay 60% in cash and 40% in stock, the document indicates. The two companies later set a deal-completion date of Jan. 1, which meant the bonuses could be paid in December or earlier. Bank of America's spokesman says the merger agreement "allows for the bonus payments to be paid, but does not require it." According to the merger documents, many other compensation decisions at Merrill were to be made "in consultation" with Bank of America officials. Bank of America approved paying a portion of the bonuses in Bank of America stock and was involved in setting compensation for a number of Merrill executives, people involved in the matter say.
Within days of the takeover announcement, Bank of America's transition team arrived at Merrill to begin figuring out how to combine the two companies. About 200 employees set up on one floor of Merrill's headquarters, and Bank of America Chief Accounting Officer Neil Cotty moved into an office on the 32nd floor. The group became involved in nearly every aspect of Merrill's operations, with dozens of Bank of America employees tracking Merrill's financial condition on a daily basis, according to people who work at the firm. In October, Bank of America announced that Mr. Thain had agreed to become president of the combined company's global banking, securities and wealth-management business once the acquisition was completed. A bank spokesman said there had been "no commitment about succession in Mr. Thain's decision to stay." Mr. Thain says that in late September, over a dinner in Charlotte, Mr. Lewis told him he was the only real candidate in line to succeed him.
By the end of November, Merrill's losses were ballooning because of deteriorating market conditions and write-downs on various mortgage-related investments. Still, the daily emails sent to executives at both companies summarizing the deal's status said "status green," according to Mr. Thain, signaling that the takeover was on track. In early December, the compensation committee of Merrill's board agreed to a bonus pool of $3.62 billion. On Dec. 11, Bank of America asked Merrill to increase the amount of cash to 70%, according to a letter reviewed by the Journal. The two companies agreed that the stock portion of Merrill's bonuses would be paid in early January. Mr. Thain says the documents prove that Bank of America was actively involved in compensation decisions.
Some Bank of America executives have said that Mr. Lewis lost confidence in Mr. Thain when Mr. Lewis learned of the losses from the transition team. Mr. Lewis flew to Washington on Dec. 17 to tell federal regulators that he was considering abandoning the takeover. Two days later, Mr. Thain left for vacation in Vail, Colo., unaware that the regulatory showdown had happened. Messrs. Thain and Lewis both have said that Mr. Thain didn't find out until Jan. 5. Mr. Thain disputes that he was out of touch during his vacation and says he wasn't the only top executive who was away from the office. "There was no change in my availability," he says, adding that he was in daily contact with his office on a variety of issues. While getting off a ski lift, he says, he bumped into Mr. Cotty, Bank of America's chief accounting officer. Mr. Lewis himself spent several days at Reynolds Plantation, a Ritz-Carlton hotel in rural Georgia, hotel records show.
On Jan. 16, Bank of America announced the massive fourth-quarter loss at Merrill and disclosed that the government had backed the Merrill deal with $20 billion in additional aid and protection against losses on $118 billion in troubled assets. Bank of America has said that the deterioration of Merrill's assets was much larger than it expected. That triggered tough questions for Mr. Lewis about the deal and his leadership. Six days later, Mr. Thain says, he was stunned by a Financial Times article that reported Merrill had "accelerated" bonus payments in order to pay them before the takeover was completed. The article quoted a Bank of America spokesman saying that Mr. Thain had "decided" to speed up the payments. Bank of America "was informed of his decision," the spokesman said. Mr. Thain says he wasn't given a chance to review Bank of America's statement, but that he would have strongly objected to it. On the morning the article was published, Mr. Lewis flew to New York to ask for Mr. Thain's resignation. News of Mr. Thain's office renovations was reported on CNBC while Mr. Lewis was en route.
"The board blames you for the fourth quarter, and this is not going to work out," Mr. Lewis told Mr. Thain, according to Mr. Thain. Bank of America has said Mr. Thain agreed to resign. Mr. Thain says he views it as a firing. Since the deal closed on Jan. 1, almost all of Merrill's top executives, including President Gregory Fleming and Robert McCann, head of Merrill's giant brokerage force, have left. "It is unfortunate so many good people from Merrill Lynch have left," says Mr. Thain. Bank of America has continued to try to distance itself from the controversial decisions about bonus payments. "They were a public company until the first of the year," Mr. Lewis told Congress in February. "They had a separate board, separate compensation committee, and we had no authority to tell them what to do, just urged them what to do." Last week's first-quarter results at Bank of America offered Mr. Thain a bit of vindication. Excluding certain merger costs, Merrill had a profit of $3.7 billion, representing nearly 90% of Bank of America's overall net income for the quarter.
Fed study puts ideal US interest rate at -5%
The ideal interest rate for the US economy in current conditions would be minus 5 per cent, according to internal analysis prepared for the Federal Reserve’s last policy meeting. The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation. A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5 per cent. Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. They suggested that the Fed should expand its asset purchases by even more than the $1,150bn (€885bn, £788bn) increase policymakers authorised at the last meeting, which included $300bn of Treasury purchases. The assessment that the US central bank needs to provide stimulus equivalent to a substantially negative interest rate is unlikely to have changed ahead of this week’s policy meeting.
The Fed is not likely to embark on any substantial new programmes at this meeting, in large part because it will not have downgraded its economic forecasts since the last meeting. Indeed, Fed officials may see the risks to the economy as a little more balanced than they were in March, though policymakers probably still see these risks as overall weighted to the downside. This could set the stage for a more detailed discussion of the framework that will ultimately govern the Fed’s exit strategy. There is, though, a small but intriguing possibility that the Fed could follow the Bank of Canada in setting out an explicit timeframe over which it expects to keep short-term rates at virtually zero. While this novel strategy is likely to at least provoke debate within the US central bank, which has shown itself willing to adopt measures first deployed elsewhere, many policymakers would probably be wary of adopting the Canadian approach, following their own unsatisfactory experience in providing guidance on interest rates after the dotcom bubble burst. Others may feel the Canadian approach would be ineffective as it may not be seen as credibly binding the central bank’s future decisions.
Still, many Fed officials expect they may well keep rates near zero for another 18 months to two years and some might see value in making this more explicit. Ben Bernanke, chairman, sees the massive expansion of bank reserves caused by the Fed’s unconventional operations as already providing a way to assure the market that the Fed will not be in a position to raise rates for quite some time to come. The last meeting saw the Fed buy long-term treasuries for the first time in decades. The large initial impact of the move on markets is no longer visible, but officials think the policy was reasonably successful. Previous staff analysis suggested the $300bn purchase would reduce the yield on 10-year treasuries by 25-35 basis points, and officials think the rate today is about this much lower than it would have been if they had not started buying. Further purchases are possible, particularly if the Fed again downgrades its economic forecasts. The staff analysis comparing unconventional operations to interest rate cuts suggests more might be needed anyway. However, policymakers are likely to watch how financial conditions respond to the already-authorised interventions before deciding whether to step up much further.
'I Am Dr. Realist'
Most other economists rolled their eyes when Nouriel Roubini warned in a September 2006 speech to the International Monetary Fund that the global bubble was going to burst. They nicknamed him "Dr. Doom"—and then the hard times hit. As finance ministers and central bankers from the world's major economic powers gather in Washington this weekend, they might consider listening to what Roubini has to say now. The New York University professor told NEWSWEEK's Lally Weymouth why he sees more trouble ahead and what the recovery will look like. Excerpts:
Weymouth: What do you believe is happening to the economy today?
Roubini: The rate of economic contraction you have seen in the last two quarters—6 percent annualized—is going to slow down. The optimists are already talking about the "green shoots" of spring, about economic activity becoming positive. [They say] we will have positive growth in the third quarter, and in the fourth quarter we will grow 2 percent over the previous quarter. They expect that next year, growth will go back to above 2 percent. Compared with this optimistic consensus, I believe that the rate of economic contraction is going to slow from minus 6 percent in the last two quarters to minus 2 percent by the fourth quarter. Next year, I believe that the growth rate is going to be 0.5 percent for the U.S. average. Even if we are technically out of a recession, we are going to feel like we are in a recession. The bottom of the economy is not going to be in three months, but rather toward the beginning or middle of next year.
So you are still Dr. Doom?
No, I am not Dr. Doom. I am Dr. Realist. I don't believe we are going to end up in a near depression. Six months ago I was more worried about an L-shaped near depression. Today, after the very aggressive policy actions taken by the U.S. and other countries, the risk of that near-depression L has been reduced from 30 percent to 15 or 20 percent. We are instead in the middle of a U.
You think the Obama administration is on the right track?
I have to give credit to the administration. Within 30 days of coming to power, they did an $800 billion stimulus package, a new program to deal with mortgages and foreclosures, and also a bank plan that when Treasury Secretary Tim Geithner came with details, made the markets rally sharply. Each one of these three programs has some flaws. The fiscal stimulus could have been more front-loaded. For the mortgages, eventually you are going to need a reduction of the face-value principal of the mortgages. And on the banks, I believe after the stress tests it is going to be obvious that even some of the largest banks are so fundamentally in trouble that you cannot buy their toxic assets. You need to take over these banks on a temporary basis, clean them up and then sell them back to the private sector.
You have to nationalize these banks?
Yes. If you do not like the dirty N word, you can call it a "temporary takeover."
How about the deficit the banks are building up?
In the short term I am supportive of it, because if we didn't have these fiscal deficits, the recession would become a depression. On the other side, I do agree that this is not a free lunch. We are going to add trillions of dollars to our public debt, which is going to go from 40 to 80 percent of the GDP. There are only a few ways in which you can finance that extra public debt. If you rule out default and a capital levy on wealth, you either have the "inflation tax" or you have to painfully cut spending or raise taxes, and either one is not going to be politically palatable.
What is going to fuel the next growth cycle?
That is a difficult question. The periods of high growth in the United States in the last 25 years have been characterized by an asset and credit bubble. Whatever the future growth is going to be, this time around it needs to be sustainable and not bubble-prone because we are running out of bubbles to create. We had the real-estate [bubble], tech bubble, housing bubble, hedge-fund bubble, private-equity bubble, commodities bubble, even the art bubble—and they are all bursting.
What makes you different from the other economists?
We think usually that crowds—on average—can be wiser than individuals. In this case, most people got it wrong because whenever we are in an irrational, exuberant bubble, people fail to think correctly.
Do you believe this is a bear-market rally or do you think it is the market anticipating an economic recovery?
As we reach newer lows, we may be closer to a level of the market that is fundamentally right. A year ago we were not as close to a true bottom. Today we are closer to it. As we become closer to the bottom of the economy, the stock market looks ahead and sees the light at the end of the tunnel and rallies. In spite of these caveats, I would argue that even the latest market rally is a bear-market rally.
Do you worry about China getting tired of holding our bonds?
In the short run, China has no option but to accumulate more reserves and dollar reserves. Why? Because if they stop doing that, their currency would appreciate sharply while their exports are plunging. So in the short run, they are going to keep on accumulating. But I have seen a huge number of new initiatives in the last month that suggest [the Chinese] are pushing for the yuan to become an international currency and a reserve currency. They are doing bilateral deals with countries like Argentina and half a dozen others in yuan, not in dollars.
They are moving away from the dollar?
Yes, slowly they will. First they have to establish their own currency as an international currency. That will take years, but already in a month they have done more than in the last 10 years.
Bankers Turn Off Campaign Cash Spigot
Bank Employee Donations Down 97 Percent From First Quarter 2007
Since the financial industry bailouts began, Wall Street and Washington have never looked closer. But as the recession deepens and banks grow to resent the stigma associated with taxpayer aid, an unexpected chill is occurring: Bank employees are slamming their checkbooks shut. Individual executives and workers at the 10 biggest beneficiaries of the TARP bailout donated slightly more than $31,000 to congressional campaigns and party committees during the first quarter of this year, according to a Washington Independent analysis of campaign finance reports filed with the Federal Election Commission. Moreover, the total donations from employees at the top five banks receiving TARP capital – Detroit automakers were excluded – is less than three percent of what they were during a similar period in the 2008 election cycle.
The bleak economy is undoubtedly a factor in the drop, but it appears that lawmakers as well as bankers are in agreement with the CEO of JP Morgan Chase, who quipped recently that the bailout was a “scarlet letter” he could not wait to shed. Citigroup employees, for example, were the TARP’s second-largest congressional donors so far this year, contributing $5,450. But that number represents just 5 percent of the employee giving that occurred in the first quarter of the election cycle that just ended, when Citigroup employees gave $128,405 to lawmakers’ campaigns and party committees. “Members of Congress really don’t want to get in the press taking money from Bank of America right after they doled out money to Bank of America,” said Craig Holman, legislative representative for Public Citizen’s Congress Watch. “And that’s perfectly understandable.”
Indeed, several senior Democrats – including Senate Banking Committee Chairman Chris Dodd (D-Conn.) and Finance Committee Chairman Max Baucus (D-Mont.) – already have forsworn campaign contributions from the political action committees, known as PACs, of banks receiving TARP assistance. But apart from House Financial Services Committee Chairman Barney Frank (D-Mass.), lawmakers have avoided any ban on donations from individual bank executives. And with good reason; even campaign finance watchdogs see no problem with the employees of TARP participants exercising their constitutional right to give to congressional campaigns. Still, the bottom has fallen out of the boom in election-season largess from bank workers. The largest amount of donations coming from a single TARP beneficiary during the first three months of this year was the $6,100 given by employees at Morgan Stanley (see chart).
That number is decidedly off-pace from the contribution rate at Morgan during the 2008 election, when employees gave $910,400 to congressional candidates and party committees alone – excluding donations to presidential campaigns and the company PAC. The donation data analyzed by The Washington Independent excludes money given to 2008 presidential campaigns, state- and county-level political committees, and company PACs – although PAC donations from bailed-out banks also are down by about one-third for the first quarter of 2009, according to Holman. Winnowing out those three types of donations allows for a specific look at how bailed-out bank employees view members of Congress this year. “You could see that there would be a logic[al reason], with the government playing such a large role in their sector, for them to be giving a fair amount of money,” observed Meredith McGehee, policy director at the Campaign Legal Center.
So why are bank workers shrugging at the Capitol Hill money chase? Perhaps, McGehee replied, for the same reason that most ordinary Americans wouldn’t give to their favorite member of Congress: they’re strapped for cash. “These are people that made lots and lots of money” in the past, she said. “[Now] those who have not lost their jobs fear they will, and in this case the desire to spend their own money on political contributions is not so great.” Rising economic insecurity on Wall Street, where lost financial-industry jobs are already estimated at more than 20,000, is one possible reason for the slide in donations. Another is the “scarlet letter” factor, as JP Morgan CEO Jamie Dimon put it to reporters earlier this month (not long after he jokingly presented Treasury Secretary Tim Geithner with a fake check repaying his bank’s bailout money).
As the personal lives of bailed-out executives attract more scrutiny from the media and more frustration from the public, even mid-level bank workers may be fearful of undue attention paid to their political giving patterns. After furious lawmakers castigated AIG CEO Edward Liddy over the company’s $450 million bonus payouts, AIG employees began receiving threats of strangulation with piano wire and violence against their children. “A lot of it has to do with keeping a low profile, not becoming a target of AIG-type speculation,” reasoned Bill Allison, senior fellow at the non-profit Sunlight Foundation. “If you give now, you may be putting a big neon light over your head.” In fact, AIG offers a stark picture of the plunge in personal giving by bailed-out bank employees. No donations were reported from within the troubled firm’s ranks during the first quarter of 2009, compared with more than $226,000 in congressional contributions from AIG workers during the 2008 election season.
The same pattern is visible at Merrill Lynch and Wachovia, which were both bought by competitors last year in shotgun marriages orchestrated by the government. Despite the banks’ escape from imminent bankruptcy, donations from employees remain notably low. Wachovia workers and executives sent $2,520 to Capitol Hill campaigns during the first quarter of this year, or less than 1 percent of the company’s $368,200 in individual donations ahead of last year’s election. An even bigger drop occurred at Merrill, where workers and executives have given $3,250 to campaigns so far this year after pouring $93,600 into congressional coffers during the same period in the 2008 election cycle – when their total giving topped $976,200. But the downturn in contributions from bank executives and workers should not be mistaken for a diminishment in Wall Street’s long-term influence. The current lull also may be driven by the financial industry’s acceptance of newly heightened regulations as a foregone conclusion, while other industries gear up to fend off still-uncertain government involvement.
“I’m not sure there’s quite the same [volume of] talk of rewriting the rules that there is in health care,” Allison, of the Sunlight Foundation, said. “The bank battle is more midstream.” Even the most outspoken inter-office critic of the bailout — AIG vice-president Jake DeSantis, who wrote a New York Times op-ed defending his performance — is a lapsed campaign donor. DeSantis gave $2,100 to Dodd at the very beginning of the 2008 election, after donating the same amount to ex-Rep. Nancy Johnson (R-CT) during the 2006 cycle. This year, FEC reports show that he gave nothing.
Bargaining fails to break deadlock over IMF
Cracks have opened up in the united front maintained by the leading world economies in trying to combat the global recession. Tensions flared at talks between finance ministers over how to carry through key elements of the pact sealed at this month’s London summit of the Group of 20 nations. Despite intense bargaining throughout the weekend, ministers gathered in Washington failed to agree on how to raise the full $500 billion (£340 billion) in extra funding for the International Monetary Fund pledged by the G20 three weeks ago. The IMF’s ruling International Monetary and Financial Committee (IMFC) trumpeted as a “key achievement” success in securing $250 billion to double the fund’s available finance for crisis loans. But while more than $300 billion of the $500 billion target sum has now been pledged, countries were still at odds over who should provide the remaining money promised by the G20, and by what means.
A split also erupted between the United States and Europe over a call by Washington for a far-reaching shake-up of the IMF that would give a much bigger say in its operations to emerging market countries, led by China, at the expense of Europe. There were more divisions, too, over the pace at which extraordinary fiscal and monetary measures to fight the world slump should start to be unwound once recovery takes hold. The most serious differences came over the urgent efforts to raise the extra funding for the IMF. The US continued to lead attempts to persuade more countries to make one-off crisis contributions to the fund’s coffers or boost their existing commitments. Talks were under way to expand the select group of countries that can be called on to provide extra money to the IMF under its so-called “new arrangements to borrow”. But the weekend meeting ended without a deal. China, Brazil and India led developing nations in forcing through measures under which the IMF will sell bonds on world markets to raise additional funding as an alternative to some countries offering it longer-term loans.
Along with other emerging market nations, China is reluctant to make bigger financial commitments to the IMF without being allowed a much greater part in decision-making at the fund and its sister body the World Bank. The emerging powers argue that they are under-represented in the two organisations under “quotas” that set their voting power as well as how much they pay in, and are demanding more say in return for any extra cash. With Washington keen to spread the burden of financing the IMF, Tim Geithner, the US Treasury Secretary, issued a strong call at the weekend for a reordering of power in the fund. “This is essential for strengthening the IMF’s legitimacy, ensuring that it remains at the centre of the international monetary system,” Mr Geithner said. “Much bolder action is required to realign quotas towards dynamic emerging-market economies.” Guido Mantega, the Brazilian Finance Minister, underlined the pressure for change. “The IMF has repented from many of its past sins, but it still has to address the original sin — its democratic deficit,” he said.
European countries that would have to sacrifice voting power to make way for emerging powers signalled their opposition to rapid change. “For the moment the representation around the table is attractive,” Didier Reynders, the Belgian Finance Minister, said. “European countries are having to finance the fund very strongly.” Mr Geithner suggested cutting the size of the IMF board to 22, from the present 24, by 2010 and to 20 by 2012, while preserving the existing number of seats for emerging market and developing nations. A 20-member IMF board would have global legitimacy, having been internationally agreed, and could be made to line up with membership of the G20, which, while powerful, lacks formal legitimacy. Dominique Strauss-Kahn, the IMF’s managing director, said, meanwhile, that other divisions had surfaced between countries over how quickly government borrowing and ultra-low interest rates to boost economies should be returned to more normal levels as the crisis abated. “At some point, we need to prepare the exit strategy from the stimulus process,” he said.
Bernanke Warming Prompts Record Company Debt Sales
Wherever you look, Federal Reserve Chairman Ben S. Bernanke’s efforts to repair global credit markets are showing signs of working. The Libor-OIS premium that indicates banks’ reluctance to lend to each other fell to 0.85 percentage point today, the lowest level since before Lehman Brothers Holdings Inc. collapsed in September, according to data compiled by Bloomberg. Companies have raised a record $468 billion in U.S. bond sales this year. Prices of the most senior portions of mortgage bonds backed by prime U.S. jumbo loans have climbed 24 percent in the past five weeks, according to London-based Barclays Capital. Investor confidence in financial markets is returning after the U.S. government and the Fed agreed to spend, lend or commit $12.8 trillion to end the longest recession since the Great Depression. Finance chiefs from the Group of Seven predicted in Washington on April 24 that the world economy will start to rebound later this year.
“Every place where the Fed has acted aggressively, we’ve seen a meaningful improvement,” said Laurence Meyer, a Fed governor from 1996 to 2002 and now vice chairman of consulting firm Macroeconomic Advisers LLC in St. Louis. The central bank’s balance sheet expanded by $1.3 trillion to $2.2 trillion since August as the Fed purchased everything from corporate commercial paper to bonds backed by consumer payments on mortgages and car loans. Bernanke also agreed to buy $1.15 trillion of Treasuries and mortgage-backed bonds to keep borrowing rates from rising after cutting the target interest rate for overnight loans between banks to a range of zero to 0.25 percent in December from 5.25 percent in 2007. Banks are lending to each other again, after credit dried up in August 2007 when losses from subprime mortgages left financial institutions with securities and financial contracts they couldn’t value. They froze when Lehman filed for the biggest bankruptcy in history on Sept. 15.
The TED spread measuring the difference between the London interbank offered rate for three-month dollar loans and the Treasury bill rate rose as high as 4.64 percentage points Oct. 10. It was 96 basis points today. Libor had dropped for 20 straight days, to 1.05 percent, the lowest since June 2003. That’s the longest streak since it fell 22 days starting Oct. 13, when central banks around the world offered as much dollar funding as required. “The short-term markets are in much better shape because the U.S. government has done a lot to help,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which holds $90 billion in fixed-income assets. Libor, calculated by the British Bankers’ Association, helps determine borrowing costs on about $360 trillion of financial agreements ranging from home mortgages to corporate bonds, according to the Bank for International Settlements in Basel, Switzerland.
The difference between Libor and the expected average federal funds rate over the next three months -- the Libor-OIS spread -- surged to 3.64 percentage points the same day as the TED spread jumped. The gap averaged about 0.11 percentage point from the start of the decade to mid-2007. The spread narrowed to the least since Sept. 12 as Credit Suisse Group AG, Goldman Sachs Group Inc., Citigroup Inc. and JPMorgan Chase & Co. posted first-quarter results this month that beat analysts’ forecasts. Improvement in Libor-OIS “is an indication that the money markets are healing,” said Thomas Girard, who helps oversee $115 billion in fixed income assets for New York Life Investment Management in New York. “It’s moving in the right direction.”
While markets are healing, the Libor-OIS is nowhere near what former Fed Chairman Alan Greenspan would call “normal.” In June, he said that the spread was the best way to tell when lending returned to health, which would be when the gap was about 25 basis points, or 0.25 percentage point. Consumer credit costs are still high by historical standards compared with what banks pay to borrow, an obstacle Bernanke says must be overcome to fix the economy. “Restoring the flow of credit to households and businesses is essential if we are to see, as I expect, the gradual resumption of sustainable economic growth,” he said April 3.
The rate on 30-year fixed mortgages averages 1.92 percentage points more than what it costs the U.S. government to borrow for 10 years as measured by yields on Treasury notes. While that’s down from 3.07 percent on Dec. 19, which was the highest level since 1986, according to Bloomberg data, it’s still above the average of 1.75 percentage points in the decade before the credit crisis began. Writedowns and losses of the securities total $1.34 trillion, according to data compiled by Bloomberg. More than 60 U.S. financial institutions have failed over the past two years. Financial regulators may force some of the largest U.S. banks to raise capital or conserve cash after accounting for assets held off their balance sheets after releasing results of so-called stress tests on the 19 largest institutions April 24. Federal Reserve Bank of San Francisco President Janet Yellen signaled this month that the central bank and the government helped create the market distress when they allowed Lehman to collapse, saying the firm was “too big to fail” and its bankruptcy caused a “quantum” jump in the magnitude of the financial crisis.
The U.S. economy is expected to contract. Gross domestic product will shrink 2 percent this quarter, after dropping 5 percent in the first quarter, according to the median forecast of 59 analysts in a Bloomberg News survey. Prices of some assets may have risen too fast, given the outlook for the economy. Bonds rated CCC returned 24 percent since bottoming on March 9, according to JPMorgan Chase & Co. analysts led by Peter Acciavatti. “The appearance of stabilization in some economic data should be viewed in the context that almost all segments of the U.S. economy remain at very depressed levels,” the analysts said in a report dated April 24. “At the end of the day, if the economy stabilizes at a very low level, this is not enough for many highly leveraged companies to see enough improvement in earnings to prevent a restructuring.”
Investors are taking comfort from signs that the U.S. economy is stabilizing after contracting 6.3 percent in the final quarter of 2008. Combined sales of existing and new homes have hovered at an annual pace of 5 million since November and construction of single-family houses was little changed in March for a third month. Retail sales rose an average 1 percent in the first two months of the year after declining in each of the previous six months. Consumer confidence measures increased from historic lows, and factory surveys, including indexes by the New York and Philadelphia Fed banks, have shown a slower rate of decline in April. “The economy right now is in a healing process,” said Jonathan Basile, an economist at Credit Suisse in New York. “We’re stabilizing first. The rebound comes later.”
The Treasury yield curve measuring the difference between two- and 10-year yields is expanding, a signal investors expect growth and inflation to quicken. The spread widened to 2.05 percentage points on April 24, within one basis point of the biggest gap since Nov. 24. The curve averaged below zero in 2006 and the first half of 2007 as investors correctly forecast a recession. “Time starts to heal things in this business, especially when you have a yield curve that is very steep,” said Donald Galante, chief investment officer and senior vice president of fixed income at MF Global Ltd. in New York, which provides trading execution and clearing services. Investors are gaining confidence in companies, demanding an extra 6.9 percentage points in yield on average to corporate bonds instead of Treasuries, down from 8.96 percentage points in December, according to Merrill Lynch & Co.’s U.S. Corporate and High Yield index. That represents an average annual savings for companies of about $20 million on each $1 billion of bonds sold.
Bond sales by companies with investment-grade credit ratings are 33 percent ahead of the same period in 2007, when they issued the most ever, Bloomberg data show. Securities rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s are considered below investment grade. “There is a lot of money moving into the corporate bond space,” said Greg Haendel, who helps oversee $6.2 billion as a money manager at Transamerica Investment Management in Los Angeles. “The fixed-income markets will be an indicator on the way back up.” Yields on top-rated securities backed by auto loans and credit card payments have narrowed as much as 4.35 percentage points relative to benchmark interest rates since hitting record highs in late November, according to JPMorgan data. The average rate on auto loans is 2.67 percentage points above one-month Libor. While that is more than the average of 1.84 percentage points over the past decade, it’s down from about 8 percent in December.
Prices of the most-senior class of “prime-jumbo” mortgage securities climbed about 15 cents on the dollar to about 78 cents in the five-week period ended April 23, according to Barclays Capital.
The average rate on a jumbo mortgage, which is bigger than the types of loans that Fannie Mae or Freddie Mac buy, fell to 6.34 percent last week from 7.65 percent in October, according to Bankrate.com. Non-jumbo rates average 4.80 percent, the lowest level since the 1970s, Freddie Mac data show. Investors are also buying bonds backed by loans on office buildings, shopping malls and apartment buildings after Treasury Secretary Timothy Geithner announced a plan on March 23 to encourage investors to buy as much as $1 trillion of real-estate assets by using $75 billion to $100 billion from the Treasury and government loans in an effort to cleanse banks of troubled assets.
The yield spread on AAA debt backed by commercial mortgages has narrowed 3.63 percentage points from about 8.5 percentage points since March 20, Bank of America Corp. data show.
Stocks rallied, Treasuries tumbled and gold fell as credit markets advanced. The MSCI World Index of stocks in developed economies rose 8.9 percent so far this month after tumbling 25 percent at the start of the year. Treasuries posted their worst first quarter since 1999, losing 1.4 percent, including reinvested interest, according to Merrill Lynch’s U.S. Treasury Master Index. The gauge is down another 1.5 percent in April. Gold, which reached $1,007.70 an ounce, closed at $913.40 on April 24. “All these policy actions are removing the downside tail risk and the markets are responding in kind,” said Kenneth Volpert, who oversees $180 billion in taxable bonds for Vanguard Group in Malvern, Pennsylvania. “It doesn’t mean everything is great again. We still have a tough road ahead.”
Put It on My O-Card
On the list of villains of the economic crisis, credit card companies are rising faster than their own rates. So after President Obama met Thursday with CEOs from Visa, Mastercard, and American Express, he stated his disapproval loud and clear. "The days of any-time, any-reason rate hikes and late-fee traps have to end," he said. Meanwhile, the House passed a "Credit Cardholders' Bill of Rights" that would limit unfair lending practices. The Senate version is even harsher—it would prohibit interest rate hikes for no reason and would put restrictions on marketing cards to people under 21. There may even be a provision for hanging CEOs by their thumbs.
But instead of cracking down on companies that treat their customers poorly, why doesn't the government just offer a credit card of its own? After all, government regulation may help, but it's unlikely to solve the problems of the credit industry—namely, spiraling interest rates coupled with rising defaults. Obama likes to talk about constructive alternatives. Why not offer an O-card? With his face on it? The idea isn't crazy. In Germany and France and Iceland and India, state-owned banks issue credit cards. One difference between those lenders and private banks is that interest rates are lower, since profit isn't the state's chief goal. (Europeans also have a different relationship with credit cards, using them to make routine payments rather than rack up debt.) Government-issued credit cards could also help consumers avoid those small but numerous charges that add up over time, from ATM fees to annual fees to interchange fees.
Nor does the notion freak out economists. "It's not something I'd be sitting here and saying" in normal circumstances, says Tahira K. Hira, a professor of finance at Iowa State University. "But some of the rates are so astronomically high, it's becoming impossible to manage for individuals." Phillip Uhlmann of Tufts University says, "I think a government system might offer a cleaner type of business, more easily understood by consumers." Wait, what are we saying? Surely we don't want the government lending directly to individuals. That way lies socialism. Maybe so, but we're already there. Think of all the different things the state finances. It backs home mortgages through quasi-government-owned Fannie Mae and Freddie Mac. It offers student loans through its direct-loan program, providing billions of dollars to help kids pay for college. Uncle Sam will even chip in to help you buy a car—it gave auto financer GMAC a $5 billion bailout last December.
If we're already backing loans for the three biggest life expenses—homes, college, and cars—what's missing? Consumer and business credit. Consumer spending accounts for almost 70 percent of GDP. The average American household carries $8,700 in credit card debt. And just as the financial crisis swallowed the housing market, it seems to be eyeing the credit card industry. Purchases are way down. Credit card companies are slashing credit limits. Others are offering special deals: If you're the wrong kind of customer, American Express will give you $300 to close your account. Creating a government-sponsored lending agency—a Fannie Mae for credit cards—would rein the whole system in. For one thing, it would offer lower rates than the usual 18 percent. The government could charge, say, 8 percent interest and still turn a profit.
It would include none of the usual hidden fees or surprise charges. (In 2007, penalty fees were $7.5 billion, cash advance fees were $5.6 billion, annual fees were $4.6 billion, and interchange fees were $23.6 billion.) And while the credit card industry spent $34 billion on marketing in 2007, the government would avoid that expense entirely. The card would theoretically be accepted everywhere, because merchants would know Obama is good for it. The caveat: You'd have to be supercreditworthy to get a card. The government doesn't want to have borrowers behind on payments; if they defaulted, taxpayers would have to pick up the tab. (Fannie Mae and Freddie Mac had higher standards than other lenders, too.) But that would be preferable to the current system, which punishes people for even minor slip-ups, like paying at the wrong time of day or buying stuff at the wrong store.
One way to attract borrowers would be to link the credit cards to a cause—like an affinity program, but for government. Every time you buy something, a small percentage would go to wind-farm construction, say, or clean-coal research, or school computers. The government could also do something creative like dipping into the Social Security money pool. If it lent that money to creditworthy Americans, it could make a killing. There is a risk that a public credit card would undercut the competition. It would by definition have a triple-A rating, since the government could guarantee its own loans, while other lenders would be in the low single-As at best. The state therefore couldn't be too cavalier about wooing customers from other companies. It would also have to avoid freeloaders who don't intend to pay back their government-backed loans. But a little competition would be a good thing, since it would force companies to re-examine their lending practices. And instead of straight regulation, this would be—you listening, Newt?—a market-based solution.
GM To Cut 21,000 Hourly Jobs, Eliminate Pontiac Brand
General Motors Corp. said Monday it will cut 21,000 hourly jobs and eliminate its Pontiac brand by the end of next year as part of a stepped-up restructuring plan. The auto maker will also start an exchange offer for $27 billion of its unsecured public notes as the company looks to become viable, saying a successful exchange offer would allow it to stay out of bankruptcy court.
GM, which is surviving on federal loans, is racing to restructure by June 1 under close watch of the Obama administration. "The objective here is not to just survive but to come up with an operating plan that will allow us to win," Chief Executive Fritz Henderson said Monday. The U.S. Treasury will extend an additional $11.6 billion to GM, in addition to $15.4 billion in existing loans. The government will forgive half the debt in exchange for equity in a restructured GM.
Henderson said earlier this month the White House had demanded "faster, deeper" cost cutting. Under the latest viability plan, GM's fourth iteration, the company will idle one additional factory and look to eliminate 500 additional dealers. Other reductions will come sooner than initially planned. GM said it expects to further reduce salaried employee headcount as well, but did not specify a number. The company said it will focus on four core brands in the U.S. - Chevrolet, Cadillac, Buick and GMC - as it looks to make fewer different models and focus on product development programs. Production of the Pontiac brand will end by next year. "You have a strategy that wins or you have to stop," Henderson said. "We didn't have a strategy that allowed us to win with the Pontiac brand." It will also restructure its U.S. dealer organization, reducing its U.S. dealer count by more than 40% by the end of next year, a reduction of 500 more dealers four years sooner than its earlier viability plan.
Under the exchange program, the company is offering to exchange 225 common shares for each $1,000 principal amount of outstanding notes. The stock closed Friday at $1.69 a share and shares were recently up 11% at $1.87 in premarket trading. Today's bond exchange filing represents an important step in GM's effort to restructure its company, President Barack Obama's automotive task force said in a statement. The interim plan that GM laid out in this filing reflects the work GM has done since March 30 to chart a new path to financial viability. "We will continue to work with GM's management as it refines and finalizes this plan and with all of GM's stakeholders to help GM restructure consistent with the President's commitment to a strong, vibrant American auto industry," the statement said.
The exchange will commence only if 90% of bondholders agree to the terms. Under the plan, if GM fails to get adequate participation, it will file for bankruptcy protection. The company added that negotiations regarding contract changes with the United Auto Workers union are still ongoing. Chrysler LLC, which is also seeking more U.S. government aid, announced Sunday that it reached a tentative agreement with the UAW and won a ratification vote from the Canadian Auto Workers allowing the auto maker to cut hourly compensation by C$19 an hour. Chrysler, the third largest U.S. auto maker, is also seeking concessions from its debt holders and must sign a merger deal with Italian auto maker Fiat SpA. All of these moves must be completed by April 30.
Chrysler woes could batter Michigan
No state has more riding on the line than Michigan when it comes to whether Chrysler LLC lives or dies. "The epicenter of Chrysler's operations is southeast Michigan," said Sophia Koropeckyj, managing director for Moody's Economy.com. This is crunch time for many Michigan business owners and households. The automaker known for its minivans and dubbed as "beleaguered" during its 1979 bailout battles now has until Thursday to craft a solid plan to partner with Italian automaker Fiat SpA or it could be forced into bankruptcy. "We're really getting close to the wire," said Erich Merkle, an auto industry analyst in Grand Rapids.
As of February, Chrysler had 8,500 salaried employees in Michigan and 13,800 hourly workers in Michigan. Those numbers include active workers and workers on layoff, according to Sean McAlinden, chief economist for the Ann Arbor-based Center for Automotive Research. Five other states in the Midwest have solid Chrysler stakes: Ohio, Indiana, Illinois, Wisconsin and Missouri. Right now, some speculate about a stronger possibility that no deal would be reached between Fiat and Chrysler. Others have speculated that Chrysler could seek bankruptcy protection -- and do a Fiat deal. "Unfortunately, I think it's closer to a bankruptcy situation," Merkle said. "It's always a bit of a coin toss." Michigan needs to hold its collective breath and hope Chrysler does not hit the bankruptcy liquidation button. The state could be in better shape if Chrysler finds a way to keep some factories and office cubicles running.
Even with a deal, experts warn that more jobs will be lost as the Detroit Three continue restructuring. "It's either going to be a small negative or a larger negative," said Comerica's chief economist, Dana Johnson. Even if Chrysler does not disappear, Moody's Economy.com is forecasting that about 260,000 jobs would be lost in Michigan between the end of 2008 and mid-2010. If Chrysler has to liquidate, the estimate goes up to 315,000 jobs lost. If General Motors Corp. were to disappear and sell off assets, the estimate goes up to 360,000 jobs lost between late 2008 and mid-2010. At the end of 2008, Michigan had nearly 4.1 million jobs. Michigan faces even tougher challenges. Other states, including Ohio and Indiana, have facilities run by foreign automakers. Johnson forecasts that Michigan's jobless rate could hit 14.5% to 15% by year-end or early next year, up from 12.6% in March.
Detroit Would Prefer Any Auto Bankruptcy to Be Handled Locally
Detroit, which could lose an automaker to bankruptcy, hopes to console itself with a big piece of the legal action. The bankruptcy court in the Motor City is making itself as attractive as possible should General Motors or Chrysler file for Chapter 11 protection, and it appears to be in the running. At stake may be crucial decisions on how employees and others will fare in a restructuring. And the depressed Michigan economy could also benefit from all the hotel and restaurant revenue brought in by out-of-town lawyers, researchers, journalists and their support teams. The established forums for big corporate cases are in Delaware, where many businesses are incorporated, and New York. The two locations have been home to six of the 10 biggest bankruptcy filings, including Lehman Brothers, Washington Mutual, WorldCom and Enron, according to BankruptcyData.com.
By contrast, Detroit’s biggest bankruptcy case was by a 1994 filing by F&M Distributors, a retailer with $328 million in assets, a few zeroes shy of the assets held by General Motors. Big companies in Detroit have mostly opted to part with their hometown. When the Delphi Corporation, an auto parts supplier once part of G.M., filed for bankruptcy protection in 2005, it went to New York. The Kmart Corporation took its bankruptcy hearing to Chicago in 2002. With the Treasury Department directing Chrysler to prepare to file for bankruptcy protection as early as this week as part of a deal to sell assets to Fiat, and with G.M. operating under a June 1 deadline to come up with a viable plan or file bankruptcy itself, location choices could be made quickly.
Detroit’s six bankruptcy judges have adopted a rule that could appeal to both the automakers’ management and the Obama administration. They will allow the chief bankruptcy judge to pick who will oversee a giant corporate filing, rather than leaving the selection to chance. Last week, Michigan’s attorney general sent G.M. a letter urging it not to go out of state. “I am gravely concerned about the impact of any bankruptcy filing in a jurisdiction outside Michigan,” Mike Cox, the attorney general, wrote in a letter to G.M.’s chief executive. Because the company’s headquarters, many of its plants and hundreds of thousands of current and former employees are in Michigan, Mr. Cox continued, “any potential bankruptcy filing outside the state of Michigan seems bizarre.”
The choice of courthouse can have serious implications for interested parties, said David A. Skeel, a law professor at the University of Pennsylvania. The law varies from jurisdiction to jurisdiction, and judges in some places may be more or less sympathetic to the bankrupt company, its creditors, its employees and other affected groups. By deciding in December that the chief judge could pick who would hear a G.M. case — or a Chrysler case, for that matter, or any other “very large, complex case of national significance” — Detroit’s six judges created the opportunity for the selection of a specific judge with particular views. Previously, cases were assigned at random. Given the likely controversy over any G.M. reorganization plan, bondholders and other creditors may be worried about the prospect of facing a judge chosen because he is friendly to the company and the administration instead of their interests.
Professor Skeel said that the Third Circuit, which includes Delaware, had an established court opinion that makes it harder to redo a collective bargaining agreement, a likely sticking point in a G.M. case. “That makes Delaware a little less attractive” to the company, Professor Skeel said. On the other hand, he said, the Detroit court is a bit of a “wild card,” having given few signals in substantial cases there of how it would resolve complex issues. Judges in any jurisdiction would want a crack at overseeing a G.M. reorganization, said Douglas G. Baird, a law professor at the University of Chicago. “It’s like climbing Mount Everest,” he said, of the sense of accomplishment that could come from all the hard work. G.M. is not tipping its hand. Greg Martin, a company spokesman, responded to the letter from the Michigan attorney general by saying that the company remained focused on restructuring outside of bankruptcy.
“However, if GM is not able to complete the actions required, it will have no other alternative than to pursue an in-court restructuring, and we would be prepared to do so,” Mr. Martin said in an e-mail message. “The filing location would be just one of many factors we would need to take into account.” Still, courthouse clerks in Detroit are buzzing, and security guards are bracing themselves. In a meeting this month, clerks throughout the Detroit federal court system were told there was no indication whether or when G.M. might file its case in Detroit, according to a clerk who attended but declined to give her name. They were also told that the court would probably get several days’ notice that a filing was imminent.
Even if they cancel later, companies make an appointment to drop off boxes of legal documents in a major bankruptcy case. There would be practical challenges to a filing in Detroit. For one thing, there is not a lot of space. The federal bankruptcy court is housed in a 27-story office building at 211 West Fort Street, across from the federal courthouse that also is home to a branch of the federal Sixth Circuit Court of Appeals. The bankruptcy court rooms, on its upper floors, have floor to ceiling windows with sweeping views of downtown Detroit, the Detroit River and Windsor, Ontario, beyond. The courtrooms have adjacent work rooms for use by lawyers — but probably not enough to handle the hordes that would want them for the nation’s largest bankruptcy filing.
Japan revises growth forecasts sharply lower
The government cut its forecast for Japan’s economy to shrink 3.3 per cent in the year to next March instead of its previous estimate of zero growth on Monday as the world’s second largest economy remains in the grip of the worst recession since World War Two. The government also sharply lowered forecasts for industrial output and exports, which have been the main drag to the economy. Tokyo now sees industrial production falling 23.4 per cent in the current fiscal year against the previous forecast of a 4.8 per cent drop, and exports slipping 27.6 per cent compared with a 3.2 per cent fall expected earlier. The outlook takes into account a record Y15,400bn ($158.5bn) stimulus the government unveiled in early April which it hopes will help raise economic activity by 1.9 percentage points.
Kaoru Yosano, finance minister, has instructed Cabinet Office, the government’s main economic research and policy agency, to review its economic forecast released in January, citing a rapid deterioration in economic conditions. The forecast is used as the basis for various policy decisions, including compiling budget plans. The Cabinet Office said downside risks remain. ”High uncertainties remain over the outlook for the stabilisation of the global financial system as well as the economy,” the Cabinet Office said in a report. ”Developments in job conditions need to be carefully watched,” it said. The new forecast sees the unemployment rate rising to 5.2 per cent against the earlier estimate of 4.7 per cent, as a sharp drop in production in light of tumbling exports dealt a severe blow to manufacturing jobs. The government also cut forecasts for corporate capital investment for fiscal 2009-10 to a fall of 14.1 per cent from the earlier forecast of 4.2 per cent.
Although a rising jobless rate bodes ill for consumption, Cabinet Office lowered forecasts for private consumption only slightly to a 0.3 per cent rise from the earlier estimate of a 0.4 per cent rise, counting on a positive impact from the stimulus steps. The Cabinet Office estimates the stimulus package, which adds to previous economic steps amounting to Y12,000bn since the breakout of the economic crisis, will push up private spending by 0.7 percentage points. But as consumers tighten their purse strings and corporate demand falls, fears are growing that deflation is setting in again. The overall consumer price index is expected to fall 1.3 per cent in fiscal 2009, a bigger fall than a 0.4 per cent decline forecast in January. Japan’s overall CPI fell 0.1 per cent in February from a year earlier, marking the first year-on-year fall since September 2007. The March figures are due out on Friday.
The new forecast also included a revised real GDP estimate of a 3.1 per cent contraction in the fiscal year ended on March 31, down sharply from the earlier estimate of a 0.8 per cent contraction.
The new forecast is based on an assumption that the January-March quarter would show an annualised contraction of around 14 per cent. If realised, it would be the worst contraction since comparable data started in 1955. Preliminary figures for first-quarter GDP are due out on May 20. The Bank of Japan is also to release its twice-yearly outlook report for the economy and prices on Thursday. The central bank currently forecasts two years of falling prices. The International Monetary Fund last week doubled its forecast contraction for Japan to a slide of 6.2 per cent in calendar 2009 but this will be heavily influenced by a sharp contraction expected for the first quarter, which the fiscal year forecasts do not include.
Eurozone banking needs a co-ordinated strategy
The most shocking news from last week's excellent Global Financial Stability Report from the International Monetary Fund was not the headline estimate of total bad assets. That number stands at $4,100bn (2,800bn, 3,000bn) and will almost certainly be revised upwards. Much more shocking was that the lion's share of these assets belong to European, not North American, banks. Of the total $4,100bn, the global banking system accounts for $2,800bn. Of that, a little over half $1,426bn is sitting in European banks, while US banks account for only $1,050bn. Even worse, European banks have written down much less than American ones. According to Reuters, the US and European banking and insurance sector has so far written down $740bn. More than 70 per cent of the write-downs come from the US. The eurozone's share has been an appalling 14 per cent. Another statistic from the IMF report: to recapitalise the banking system to reach capital ratios that prevailed in the mid-1990s, capital injections of $275bn would be required for US banks, and a whopping $500bn for European banks.
You get the picture. All these data tell us that Europe has both the biggest problem and has made the least progress. And since recessions associated with financial crises last longer than ordinary recessions, as the economic literature on financial crises suggests, the eurozone has a big problem. The IMF says that even if the right policies are implemented at the right time the recovery will be slow and painful, because deleveraging takes its time. But if the right policies are not implemented, the recovery will take much longer. The latest economic projections by German economic institutes are consistent with the IMF's pessimistic analysis. The problem is not only that the German economy will shrink by some 6 per cent this year. The real issue is that there is no projected recovery even by the end of 2010. We are looking at economic stagnation that could last several years.
So whatever legitimate criticism we may have of the Geithner/Summers plan for the US banking rescue, both in terms of its effectiveness and fairness, the situation is a lot worse in Europe. For example, the German bank rescue plan, details of which will become known next month, will almost certainly remain a voluntary scheme. There will be no stress test to determine whether a bank should be forced to accept new capital. Of course, this plan is clearly better than nothing. But it is not going to solve the problem of an under-capitalised banking sector. Unlike the Geithner/Summers plan, it does not even pretend to do so. Yet the core problem with the European policy response, both in terms of bank rescues and stimulus packages, is a failure to co-ordinate across national borders. Last week's spat between Axel Weber, the president of the Bundesbank, and the European Commission, over whether banks in receipt of government aid should unwind "foreign" European operations, highlights the problem that a single market does not work when all the policy decisions in a crisis are taken at national level.
As Lord Turner, chairman of the UK's Financial Services Authority, rightly said about the future of European banking: "Faced with the reality we either need more European co-ordination or more national powers, more Europe or less Europe we can't stay where we are." The IMF has noted that unilateral government action to support the domestic financial sector can easily turn into financial protectionism. This is happening right now in the eurozone where governments have enacted policies that make public support conditional on maintaining domestic lending, thereby crowding out foreign-owned competitors. Europe's macroeconomic response suffers from the same fundamental problem. Uncoordinated national stimulus programmes have ended up both ineffective and protectionist such as Germany's infrastructure investments or French subsidies for the car sector. When only uncoordinated national stimulus plans are on offer, the benefits are drowned by negative externalities. On those grounds, I would oppose another round of national programmes. What the eurozone needs is a co-ordinated European stimulus.
Our Great Recession constitutes a seminal crisis for Europe's internal market and its single currency. It still has the potential to strengthen both. If the eurozone were to enact policies to fix the banking sector and support growth, if it facilitated eurozone accession to central and east European countries (and the UK), and if it started to think about issuing a joint European bond, the euro could emerge strengthened from this crisis both in terms of its exchange rate against the dollar, and its significance as a global currency. At this moment, however, that optimistic scenario is not very likely. European leaders are by and large an intellectually complacent lot. They have never paid sufficient attention to the spillovers of national policies in a single market under a single currency during a crisis. By pursuing what they mistakenly perceive to be policies in their short-term national interest, they not only damage the long-term prospects of the eurozone, but they ultimately end up damaging themselves. They are all under the illusion that they have a national strategy. But adding it all up, there is no joint strategy. I suspect that this ugly drama will play out the full five acts, in classic European style. And we are not even halfway through. Not even close.
Ilargi: Howard Archer at IHS is a nothing with zero credibility. So he's quoted 100 times a week by journalists looking for the balance required through "fair" reporting. But what's so fair about quoting someone who's always and consistently wrong? When does ”fair” reporting become just plain bad reporting?
UK mortgage approvals fall 25.3%
Hopes of a revival in Britain's battered housing market were undermined today by data showing the number of mortgages approved for house purchase fell by 25.3 per cent in the 12 months to March. Figures from the British Bankers Association (BBA) showed 26,097 mortgages were approved in March, down from 34,920 a year ago. The number approved was down 7 per cent on the previous month. Until March the figures had shown modest rises for three months. David Dooks, director of statistics at the BBA, said the figures showed it would be "unrealistic to expect the mortgage market to recover in a steady and consistent way in the current economic environment". Other recent data has given hope that an end was in sight to the slump in the housing market. Figures from the Council of Mortgage Lenders (CML) last week revealed that 24,300 mortgages were secured in February, up from 23,400 a month earlier.
A recent Hometrack survey revealed that house prices fell at a reduced rate of 0.3 per cent month-on-month in April while the number of house sales agreed that month rose by nearly 15 per cent. Howard Archer, chief UK and European economist of IHS Global Insight, said that despite the March relapse revealed by today's BBA figures, the overall evidence was that housing market activity had "very likely passed its worst point, helped by the substantial fall in house prices from their 2007 peak levels and markedly reduced mortgage rates." The BBA figures, he said, suggested that "the most likely scenario is the pick-up ...will be both very gradual and prone to relapses given still very poor economic fundamentals and relatively tight credit conditions."
Factors including soaring unemployment, muted wage growth and a suspicion that house prices still have some way to fall, would continue to weigh down the housing market for some time to come, he said. Property groups fear that the chances of a pick-up in market activity could be damaged by plans by Lord Turner of Ecchinswell, chairman of the Financial Services Authority, to outlaw super-sized mortgages. Lord Turner suggested in his review into the banking crisis in March that the size of mortgages offered by the banks could be capped. A paper to be published in September will further explore the idea which is aimed at drawing a line under the reckless lending to homebuyers, typified by Northern Rock's offer, at the height of the boom, of 125 per cent mortgages.
The New Angst at the Heart of Germany
The economic meltdown has rattled the confidence of the skilled workers at the heart of the German economic and social model. But they are unlikely to take to the streets -- at least for the time being. Germany has long been overshadowed by warnings that a crisis was looming. But now it's here. Politicians, business leaders, experts and trade union leaders sit around the table in the Chancellery. The only thing they know is that no one knows what to do. No one will be left unaffected by these troubled times. Germany's economy is set to shrink by 5, maybe 7, percent and the number of unemployed will increase by at least another 1 million. For the first time since World War II, Germany's middle class has been shaken to the core. It is not those with low-income jobs, like retail workers in discount stores or carers for old people, who are at greatest risk. Instead, it is those working in the highly productive industries at the heart of the German economic model who face the full force of the downturn.
It is engineering companies in the German state of Baden-Württemberg and medical technology firms in Bavaria which are seeing their orders slump by 50 or 60 percent. At risk are the jobs created following the approach known as "flexible specialization," which aims to enable firms to be in a position to adjust quickly to a changing market environment. German companies have seen a real revolution over the last 15 years as a result of the flexible specialization approach and the "total quality management" philosophy. These are the same skilled workers in the middle of German society who demonstrated, all across the country, how the challenges of globalization can be met. Now fear is spreading through these value-added industries. Families which were always convinced that success was based on hard work are suddenly getting the feeling that they are caught in a downward spiral from which they cannot escape by themselves. Maybe these people won't actually lose their own jobs, but their previously secure belief that the social welfare net was something for other people has been shaken to its core. The crisis has undermined the strong sense of self-confidence which used to be exuded by the social classes at the core of the modern German economic model.
Such workers never felt dependent on economic stimulus plans or tax relief. For them, their own efforts were proof that German industry is synonymous with quality. They could confidently ignore whatever was decided by those in power in Bonn or Berlin, safe in their conviction that the effects would be felt elsewhere. Berthold Huber, the head of the powerful IG Metall union, knows that these people do not tend towards "social unrest." That is something for the proletariat, not the highly specialized German skilled worker. What is currently happening to those people, the people at the heart of the German economic model, needs to be taken seriously in a different way. Most of them know it is futile to get angry at those responsible for the crisis. What is much more important is strengthening their resolve to stand firm until the worst is over. These people are ready to weather the storm. They are ready to show those slick men with their striped shirts and Anglo-Saxon business buzzwords what they are capable of, even in a time of crisis. And they are ready to do that, not as cunning freeloaders, but as a self-confident community that never loses its sense of perspective -- even when the government in Berlin is at a complete loss.
Russia May Seek World Bank Loan as Sovereign Wealth Fund Becomes Exhausted
Russia plans to borrow money on the international market next year and may arrange loans from the World Bank to help cover its budget shortfall, Finance Minister Alexei Kudrin said. Banks and pension funds are likely to be the chief buyers of Russian bonds, Kudrin said today in an interview broadcast on the state television channel Vesti. Russia’s budget deficit may be wider than the government’s estimate of 7.4 percent of gross domestic product, Kudrin said in Washington on April 24. “It’s too early to speak about the market and about pricing,” Kudrin said in comments broadcast on Vesti. “It depends on how we cope with this difficult year before the future bond issue.”
The government expects revenue to drop by 30 percent this year as the economy enters its first recession in a decade. Russia may borrow $5 billion next year in the government’s first international bond sale since the 1998 default, Arkady Dvorkovich, President Dmitry Medvedev’s top economic adviser, said on April 14. The Russian government may also seek “billions of dollars” over the coming years from the World Bank, Kudrin said. The country’s Reserve Fund, one of its two sovereign wealth funds, may be exhausted by the end of this year, he said. The fund will be replenished if oil prices stay above $50 a barrel, according to Kudrin.
Plan to monitor all internet use
Communications firms are being asked to record all internet contacts between people as part of a modernisation in UK police surveillance tactics. The home secretary scrapped plans for a database but wants details to be held and organised for security services. The new system would track all e-mails, phone calls and internet use, including visits to social network sites. Ministers say police need new tools to fight crime but opposition MPs and campaigners have raised privacy fears. Announcing a consultation on a new strategy for communications data and its use in law enforcement, Jacqui Smith said there would be no single government-run database.
But she also said that "doing nothing" in the face of a communications revolution was not an option. The Home Office will instead ask communications companies - from internet service providers to mobile phone networks - to extend the range of information they currently hold on their subscribers and organise it so that it can be better used by the police, MI5 and other public bodies investigating crime and terrorism. Ministers say they estimate the project will cost £2bn to set up, which includes some compensation to the communications industry for the work it may be asked to do. "Communications data is an essential tool for law enforcement agencies to track murderers, paedophiles, save lives and tackle crime," Ms Smith said.
"Advances in communications mean that there are ever more sophisticated ways to communicate and we need to ensure that we keep up with the technology being used by those who seek to do us harm. "It is essential that the police and other crime fighting agencies have the tools they need to do their job, However to be clear, there are absolutely no plans for a single central store." Communication service providers (CSPs) will be asked to record internet contacts between people, but not the content, similar to the existing arrangements to log telephone contacts. But, recognising that the internet has changed the way people talk, the CSPs will also be asked to record some third party data or information partly based overseas, such as visits to an online chatroom and social network sites like Facebook or Twitter.
Security services could then seek to examine this data along with information which links it to specific devices, such as a mobile phone, home computer or other device, as part of investigations into criminal suspects. The plan expands a voluntary arrangement under which CSPs allow security services to access some data which they already hold. The security services already deploy advanced techniques to monitor telephone conversations or intercept other communications, but this is not used in criminal trials. Ms Smith said that while the new system could record a visit to a social network, it would not record personal and private information such as photos or messages posted to a page.
"What we are talking about is who is at one end [of a communication] and who is at the other - and how they are communicating," she said. Existing legal safeguards under the Regulation of Investigatory Powers Act would continue to apply. Requests to see the data would require top level authorisation within a public body such as a police force. The Home Office is running a separate consultation on limiting the number of public authorities that can access sensitive information or carry out covert surveillance. Liberal Democrat home affairs spokesman Chris Huhne said: "I am pleased that the Government has climbed down from the Big Brother plan for a centralised database of all our emails and phone calls.
"However, any legislation that requires individual communications providers to keep data on who called whom and when will need strong safeguards on access. "It is simply not that easy to separate the bare details of a call from its content. What if a leading business person is ringing Alcoholics Anonymous, or a politician's partner is arranging to hire a porn video? "There has to be a careful balance between investigative powers and the right to privacy." Shadow home secretary Chris Grayling said: "The big problem is that the government has built a culture of surveillance which goes far beyond counter terrorism and serious crime. Too many parts of Government have too many powers to snoop on innocent people and that's really got to change.
"It is good that the home secretary appears to have listened to Conservative warnings about big brother databases. Now that she has finally admitted that the public don't want their details held by the State in one place, perhaps she will look at other areas in which the Government is trying to do precisely that." Guy Herbert of campaign group NO2ID said: "Just a week after the home secretary announced a public consultation on some trivial trimming of local authority surveillance, we have this: a proposal for powers more intrusive than any police state in history. "Ministers are making a distinction between content and communications data into sound-bite of the year. But it is spurious. "Officials from dozens of departments and quangos could know what you read online, and who all your friends are, who you emailed, when, and where you were when you did so - all without a warrant." The consultation runs until 20 July 2009.
Northern Lights caused by electrical tornadoes, scientists discover
The secrets of the Northern Lights, one of the world's greatest natural spectacles, have been unlocked by scientists. The ghostly displays that illuminate the skies above the Arctic have inspired myths and captivated onlookers for centuries, but now researchers have discovered more about how they are created. The lights, also known as Aurora Borealis, are generated when electrical tornadoes hurtle towards Earth and come into contact with the ionosphere, one of the upper layers of the atmosphere. These tornadoes, spinning at more than a million miles an hour, are produced by vast clouds of solar particles. They gather 40,000 miles above the planet's surface, releasing whirlwinds when they become destabilised by the strength of their own electrical charge. Astronomers have long known that the lights are created when streams of particles from the sun – known as solar winds – come into contact with the Earth's magnetic field.
But a team including Professor Karl-Heinz Glassmeier of the Institute for Geophysics and Extraterrestrial Physics in Braunschweig, Germany, has now established how the field traps the particles on the planet's sun-facing "day" side, before deflecting them to the "night" side, where they gather in clouds and then dive towards the surface. The researchers used five Nasa satellites sent up as part of the Themis programme to monitor the Northern Lights - and their equivalents at the south pole - to produce the first images of these tornadoes, and discussed their findings at a European Geosciences Union meeting in Vienna last week. "The Themis satellites have given us our first opportunity to see the process that generates the aurorae in three dimensions and show just what spectacularly powerful events they are," Prof Glassmeier said.
Geithner, as Member and Overseer, Forged Ties to Finance Club
Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked. Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele Davis, then an assistant Treasury secretary. The proposal quickly died amid protests that it was politically untenable because it could put taxpayers on the hook for trillions of dollars. “People thought, ‘Wow, that’s kind of out there,’ ” said John C. Dugan, the comptroller of the currency, who heard about the idea afterward. Mr. Geithner says, “I don’t remember a serious discussion on that proposal then.”
But in the 10 months since then, the government has in many ways embraced his blue-sky prescription. Step by step, through an array of new programs, the Federal Reserve and Treasury have assumed an unprecedented role in the banking system, using unprecedented amounts of taxpayer money, to try to save the nation’s financiers from their own mistakes. And more often than not, Mr. Geithner has been a leading architect of those bailouts, the activist at the head of the pack. He was the federal regulator most willing to “push the envelope,” said H. Rodgin Cohen, a prominent Wall Street lawyer who spoke frequently with Mr. Geithner. Today, Mr. Geithner is Treasury secretary, and as he seeks to rebuild the nation’s fractured financial system with more taxpayer assistance and a regulatory overhaul, he finds himself a locus of discontent. Even as banks complain that the government has attached too many intrusive strings to its financial assistance, a range of critics — lawmakers, economists and even former Federal Reserve colleagues — say that the bailout Mr. Geithner has played such a central role in fashioning is overly generous to the financial industry at taxpayer expense.
An examination of Mr. Geithner’s five years as president of the New York Fed, an era of unbridled and ultimately disastrous risk-taking by the financial industry, shows that he forged unusually close relationships with executives of Wall Street’s giant financial institutions. His actions, as a regulator and later a bailout king, often aligned with the industry’s interests and desires, according to interviews with financiers, regulators and analysts and a review of Federal Reserve records. In a pair of recent interviews and an exchange of e-mail messages, Mr. Geithner defended his record, saying that from very early on, he was “a consistently dark voice about the potential risks ahead, and a principal source of initiatives designed to make the system stronger” before the markets started to collapse. Mr. Geithner said his actions in the bailout were motivated solely by a desire to help businesses and consumers. But in a financial crisis, he added, “the government has to take risk, and we are going to be doing things which ultimately — in order to get the credit flowing again — are going to benefit the institutions that are at the core of the problem.”
The New York Fed is, by custom and design, clubby and opaque. It is charged with curbing banks’ risky impulses, yet its president is selected by and reports to a board dominated by the chief executives of some of those same banks. Traditionally, the New York Fed president’s intelligence-gathering role has involved routine consultation with financiers, though Mr. Geithner’s recent predecessors generally did not meet with them unless senior aides were also present, according to the bank’s former general counsel. By those standards, Mr. Geithner’s reliance on bankers, hedge fund managers and others to assess the market’s health — and provide guidance once it faltered — stood out. His calendars from 2007 and 2008 show that those interactions were a mix of the professional and the private. He ate lunch with senior executives from Citigroup, Goldman Sachs and Morgan Stanley at the Four Seasons restaurant or in their corporate dining rooms. He attended casual dinners at the homes of executives like Jamie Dimon, a member of the New York Fed board and the chief of JPMorgan Chase.
Mr. Geithner was particularly close to executives of Citigroup, the largest bank under his supervision. Robert E. Rubin, a senior Citi executive and a former Treasury secretary, was Mr. Geithner’s mentor from his years in the Clinton administration, and the two kept in close touch in New York. Mr. Geithner met frequently with Sanford I. Weill, one of Citi’s largest individual shareholders and its former chairman, serving on the board of a charity Mr. Weill led. As the bank was entering a financial tailspin, Mr. Weill approached Mr. Geithner about taking over as Citi’s chief executive. But for all his ties to Citi, Mr. Geithner repeatedly missed or overlooked signs that the bank — along with the rest of the financial system — was falling apart. When he did spot trouble, analysts say, his responses were too measured, or too late. In 2005, for instance, Mr. Geithner raised questions about how well Wall Street was tracking its trading of complex financial products known as derivatives, yet he pressed reforms only at the margins. Problems with the risky and opaque derivatives market later amplified the economic crisis.
As late as 2007, Mr. Geithner advocated measures that government studies said would have allowed banks to lower their reserves. When the crisis hit, banks were vulnerable because their financial cushion was too thin to protect against large losses. In fashioning the bailout, his drive to use taxpayer money to backstop faltering firms overrode concerns that such a strategy would encourage more risk-taking in the future. In one bailout instance, Mr. Geithner fought a proposal to levy fees on banks that would help protect taxpayers against losses. The bailout has left the Fed holding a vast portfolio of troubled securities. To manage them, Mr. Geithner gave three no-bid contracts to BlackRock, an asset-management firm with deep ties to the New York Fed. To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a critic of the bailout, Mr. Geithner’s actions suggest that he came to share Wall Street’s regulatory philosophy and world view. “I don’t think that Tim Geithner was motivated by anything other than concern to get the financial system working again,” Mr. Stiglitz said. “But I think that mindsets can be shaped by people you associate with, and you come to think that what’s good for Wall Street is good for America.”
In this case, he added, that “led to a bailout that was designed to try to get a lot of money to Wall Street, to share the largesse with other market participants, but that had deeply obvious flaws in that it put at risk the American taxpayer unnecessarily.” But Ben S. Bernanke, the chairman of the Federal Reserve, said in an interview that Mr. Geithner’s Wall Street relationships made him “invaluable” as they worked together to steer the country through crisis. “He spoke frequently to many, many different players and kept his finger on the pulse of the situation,” Mr. Bernanke said. “He was the point person for me in many cases and with many individual firms so that we were prepared for any kind of emergency.” A revolving door has long connected Wall Street and the New York Fed. Mr. Geithner’s predecessors, E. Gerald Corrigan and William J. McDonough, wound up as investment-bank executives. The current president, William C. Dudley, came from Goldman Sachs. Mr. Geithner followed a different route. An expert in international finance, he served under both Clinton-era Treasury secretaries, Mr. Rubin and Lawrence H. Summers. He impressed them with his handling of foreign financial crises in the late 1990s before landing a top job at the International Monetary Fund.
When the New York Fed was looking for a new president, both former secretaries were advisers to the bank’s search committee and supported Mr. Geithner’s candidacy. Mr. Rubin’s seal of approval carried particular weight because he was by then a senior official at Citigroup. Mr. Weill, Citigroup’s architect, was a member of the New York Fed board when Mr. Geithner arrived. “He had a baby face,” Mr. Weill recalled. “He didn’t have a lot of experience in dealing with the industry.” But, he added, “He quickly earned the respect of just about everyone I know. His knowledge, his willingness to listen to people.” At the age of 42, Mr. Geithner took charge of a bank with enormous influence over the American economy. Sitting like a fortress in the heart of Manhattan’s financial district, the New York Fed is, by dint of the city’s position as a world financial center, the most powerful of the 12 regional banks that make up the Federal Reserve system. The Federal Reserve was created after a banking crisis nearly a century ago to manage the money supply through interest-rate policy, oversee the safety and soundness of the banking system and act as lender of last resort in times of trouble. The Fed relies on its regional banks, like the New York Fed, to carry out its policies and monitor certain banks in their areas.
The regional reserve banks are unusual entities. They are private and their shares are owned by financial institutions the bank oversees. Their net income is paid to the Treasury. At the New York Fed, top executives of global financial giants fill many seats on the board. In recent years, board members have included the chief executives of Citigroup and JPMorgan Chase, as well as top officials of Lehman Brothers and industrial companies like General Electric. In theory, having financiers on the New York Fed’s board should help the president be Washington’s eyes and ears on Wall Street. But critics, including some current and former Federal Reserve officials, say the New York Fed is often more of a Wall Street mouthpiece than a cop. Willem H. Buiter, a professor at the London School of Economics and Political Science who caused a stir at a Fed retreat last year with a paper concluding that the Federal Reserve had been co-opted by the financial industry, said the structure ensured that “Wall Street gets what it wants” in its New York president: “A safe pair of hands, someone who is bright, intelligent, hard-working, but not someone who intends to reform the system root and branch.”
Mr. Geithner took office during one of the headiest bull markets ever. Yet his most important task, he said in an interview, was to prepare banks for “the storm that we thought was going to come.” In his first speech as president in March 2004, he advised bankers to “build a sufficient cushion against adversity.” Early on, he also spoke frequently about the risk posed by the explosion of derivatives, unregulated insurancelike products that many companies use to hedge their bets. But Mr. Geithner acknowledges that “even with all the things that we took the initiative to do, I didn’t think we achieved enough.” Derivatives were not an altogether new issue for him, since the Clinton Treasury Department had battled efforts to regulate the multitrillion-dollar market. As Mr. Geithner shaped his own approach, records and interviews show, he consulted veterans of that fight at Treasury, including Lewis A. Sachs, a close friend and tennis partner who managed a hedge fund. Mr. Geithner pushed the industry to keep better records of derivative deals, a measure that experts credit with mitigating the chaos once firms began to topple. But he stopped short of pressing for comprehensive regulation and disclosure of derivatives trading and even publicly endorsed their potential to damp risk.
Nouriel Roubini, a professor of economics at the Stern School of Business at New York University, who made early predictions of the crisis, said Mr. Geithner deserved credit for trying, especially given that the Fed chairman at the time, Alan Greenspan, was singing the praises of derivatives. Even as Mr. Geithner was counseling banks to take precautions against adversity, some economists were arguing that easy credit was feeding a more obvious problem: a housing bubble. Despite those warnings, a report released by the New York Fed in 2004 called predictions of gloom “flawed” and “unpersuasive.” And as lending standards evaporated and the housing boom reached full throttle, banks plunged ever deeper into risky mortgage-backed securities and derivatives. The nitty-gritty task of monitoring such risk-taking is done by 25 examiners at each large bank. Mr. Geithner reviewed his examiners’ reports, but since they are not public, it is hard to fully assess the New York Fed’s actions during that period.
Mr. Geithner said many of the New York Fed’s supervisory actions could not be disclosed because of confidentiality issues. As a result, he added, “I realize I am vulnerable to a different narrative in that context.” The ultimate tool at Mr. Geithner’s disposal for reining in unsafe practices was to recommend that the Board of Governors of the Fed publicly rebuke a bank with penalties or cease and desist orders. Under his watch, only three such actions were taken against big domestic banks; none came after 2006, when banks’ lending practices were at their worst. Perhaps the central regulatory challenge for Mr. Geithner was Citigroup. Cobbled together by Mr. Weill through a series of pell-mell acquisitions into the world’s largest bank, Citigroup reached into every corner of the financial world: credit cards, auto loans, trading, investment banking, as well as mortgage securities and derivatives. But it was plagued by mismanagement and wayward banking practices. In 2004, the New York Fed levied a $70 million penalty against Citigroup over the bank’s lending practices. The next year, the New York Fed barred Citigroup from further acquisitions after the bank was involved in trading irregularities and questions about its operations. The New York Fed lifted that restriction in 2006, citing the company’s “significant progress” in carrying out risk-control measures.
In fact, risk was rising to dangerous levels at Citigroup as the bank dove deeper into mortgage-backed securities. Throughout the spring and summer of 2007, as subprime lenders began to fail and government officials reassured the public that the problems were contained, Mr. Geithner met repeatedly with members of Citigroup’s management, records show. From mid-May to mid-June alone, he met over breakfast with Charles O. Prince, the company’s chief executive at the time, traveled to Citigroup headquarters in Midtown Manhattan to meet with Lewis B. Kaden, the company’s vice chairman, and had coffee with Thomas G. Maheras, who ran some of the bank’s biggest trading operations. (Mr. Maheras’s unit would later be roundly criticized for taking many of the risks that led Citigroup aground.) His calendar shows that during that period he also had breakfast with Mr. Rubin. But in his conversations with Mr. Rubin, Mr. Geithner said, he did not discuss bank matters. “I did not do supervision with Bob Rubin,” he said. Any intelligence Mr. Geithner gathered in his meetings does not appear to have prepared him for the severity of the problems at Citigroup and beyond. In a May 15, 2007, speech to the Federal Reserve Bank of Atlanta, Mr. Geithner praised the strength of the nation’s top financial institutions, saying that innovations like derivatives had “improved the capacity to measure and manage risk” and declaring that “the larger global financial institutions are generally stronger in terms of capital relative to risk.”
Two days later, interviews and records show, he lobbied behind the scenes for a plan that a government study said could lead banks to reduce the amount of capital they kept on hand. While waiting for a breakfast meeting with Mr. Weill at the Four Seasons Hotel in Manhattan, Mr. Geithner phoned Mr. Dugan, the comptroller of the currency, according to both men’s calendars. Both Citigroup and JPMorgan Chase were pushing for the new standards, which they said would make them more competitive. Records show that earlier that week, Mr. Geithner had discussed the issue with JPMorgan’s chief, Mr. Dimon. At the Federal Deposit Insurance Corporation, which insures bank deposits, the chairwoman, Sheila C. Bair, argued that the new standards were tantamount to letting the banks set their own capital levels. Taxpayers, she warned, could be left “holding the bag” in a downturn. But Mr. Geithner believed that the standards would make the banks more sensitive to risk, Mr. Dugan recalled. The standards were adopted but have yet to go into effect.
Callum McCarthy, a former top British financial regulator, said regulators worldwide should have focused instead on how undercapitalized banks already were. “The problem is that people in banks overestimated their ability to manage risk, and we believed them.” By the fall of 2007, that was becoming clear. Citigroup alone would eventually require $45 billion in direct taxpayer assistance to stay afloat. On Nov. 5, 2007, Mr. Prince stepped down as Citigroup’s chief in the wake of multibillion-dollar mortgage write-downs. Mr. Rubin was named chairman, and the search for a new chief executive began. Mr. Weill had a perfect candidate: Mr. Geithner. The two men had remained close. That past January, Mr. Geithner had joined the board of the National Academy Foundation, a nonprofit organization founded by Mr. Weill to help inner-city high school students prepare for the work force. “I was a little worried about the implications,” Mr. Geithner said, but added that he had accepted the unpaid post only after Mr. Weill had stepped down as Citigroup’s chairman, and because it was a good cause that the Fed already supported.
Although Mr. Geithner was a headliner with Mr. Prince at a 2004 fundraiser that generated $1.1 million for the foundation, he said he did not raise money for the group once on the board. He attended regular foundation meetings at Mr. Weill’s Midtown Manhattan office. In addition to charity business, Mr. Weill said, the two men often spoke about what was happening at Citigroup. “It would be logical,” he said. On Nov. 6 and 7, 2007, as Mr. Geithner’s bank examiners scrambled to assess Citigroup’s problems, the two men spoke twice, records show, once for a half-hour on the phone and once for an hourlong meeting in Mr. Weill’s office, followed by a National Academy Foundation cocktail reception. Mr. Geithner also went to Citigroup headquarters for a lunch with Mr. Rubin on Nov. 16 and met with Mr. Prince on Dec. 4, records show. Mr. Geithner acknowledged in an interview that Mr. Weill had spoken with him about the Citigroup job. But he immediately rejected the idea, he said, because he did not think he was right for the job. “I told him I was not the right choice,” Mr. Geithner said, adding that he then spoke to “one other board member to confirm after the fact that it did not make sense.” According to New York Fed officials, Mr. Geithner informed the reserve bank’s lawyers about the exchange with Mr. Weill, and they told him to recuse himself from Citigroup business until the matter was resolved.
Mr. Geithner said he “would never put myself in a position where my actions were influenced by a personal relationship.” Other chief financial regulators at the Federal Deposit Insurance Company and the Securities and Exchange Commission say they keep officials from institutions they supervise at arm’s length, to avoid even the appearance of a conflict. While the New York Fed’s rules do not prevent its president from holding such one-on-one meetings, that was not the general practice of Mr. Geithner’s recent predecessors, said Ernest T. Patrikis, a former general counsel and chief operating officer at the New York Fed. “Typically, there would be senior staff there to protect against disputes in the future as to the nature of the conversations,” he said. As Mr. Geithner sees it, most of the institutions hit hardest by the crisis were not under his jurisdiction — some foreign banks, mortgage companies and brokerage firms. But he acknowledges that “the thing I feel somewhat burdened by is that I didn’t attempt to try to change the rules of the game on capital requirements early on,” which could have left banks in better shape to weather the storm. By last fall, it was too late. The government, with Mr. Geithner playing a lead role alongside Mr. Bernanke and Mr. Paulson, scurried to rescue the financial system from collapse. As the Fed became the biggest vehicle for the bailout, its balance sheet more than doubled, from $900 billion in October 2007 to more than $2 trillion today.
“I couldn’t have cared less about Wall Street, but we faced a crisis that was going to cause enormous damage to the economy,” Mr. Geithner said. The first to fall was Bear Stearns, which had bet heavily on mortgages and by mid-March was tottering. Mr. Geithner and Mr. Paulson persuaded JPMorgan Chase to take over Bear. But to complete the deal, JPMorgan insisted that the government buy $29 billion in risky securities owned by Bear. Some officials at the Federal Reserve feared encouraging risky behavior by bailing out an investment house that did not even fall under its umbrella. To Mr. Geithner’s supporters, that he prevailed in the case of Bear and other bailout decisions is testament to his leadership. “He was a leader in trying to come up with an aggressive set of policies so that it wouldn’t get completely out of control,” said Philipp Hildebrand, a top official at the Swiss National Bank who has worked with Mr. Geithner to coordinate an international response to the worldwide financial crisis. But others are less enthusiastic. William Poole, president of the Federal Reserve Bank of St. Louis until March 2008, said that the Fed, by effectively creating money out of thin air, not only runs the risk of “massive inflation” but has also done an end-run around Congressional power to control spending. Many of the programs “ought to be legislated and shouldn’t be in the Federal Reserve at all,” he contended.
In making the Bear deal, the New York Fed agreed to accept Bear’s own calculation of the value of assets acquired with taxpayer money, even though those values were almost certain to decline as the economy deteriorated. Although Fed officials argue that they can hold onto those assets until they increase in value, to date taxpayers have lost $3.4 billion. Even these losses are probably understated, given how the Federal Reserve priced the holdings, said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. “You can assume that it has used magical thinking in valuing these assets,” she said. Mr. Geithner played a pivotal role in the next bailout, which was even bigger — that of the American International Group, the insurance giant whose derivatives business had brought it to the brink of collapse in September. He also went to bat for Goldman Sachs, one of the insurer’s biggest trading partners. As A.I.G. bordered on bankruptcy, Mr. Geithner pressed first for a private sector solution. A.I.G. needed $60 billion to meet payments on insurance contracts it had written to protect customers against debt defaults. A.I.G.’s chief executive at the time, Robert B. Willumstad, said he had hired bankers at JPMorgan to help it raise capital. Goldman Sachs had jockeyed for the job as well, but because the investment bank was one of A.I.G.’s biggest trading partners, Mr. Willumstad rejected the idea. The potential conflicts of interest, he believed, were too great. Nevertheless, on Monday, Sept. 15, Mr. Geithner pushed A.I.G. to bring Goldman onto its team to raise capital, Mr. Willumstad said.
Mr. Geithner and Mr. Corrigan, a Goldman managing director, were close, speaking frequently and sometimes lunching together at Goldman headquarters. On that day, the company’s chief executive, Lloyd C. Blankfein, was at the New York Fed. A Goldman spokesman said, “We don’t believe anyone at Goldman Sachs asked Mr. Geithner to include the firm in the assignment.” Mr. Geithner said he had suggested Goldman get involved because the situation was chaotic and “time was running out.” But A.I.G.’s search for capital was fruitless. By late Tuesday afternoon, the government would step in with an $85 billion loan, the first installment of a bailout that now stands at $182 billion. As part of the bailout, A.I.G.’s trading partners, including Goldman, were compensated fully for money owed to them by A.I.G. Analysts say the New York Fed should have pressed A.I.G.’s trading partners to take a deep discount on what they were owed. But Mr. Geithner said he had no bargaining power because he was unwilling to threaten A.I.G.’s trading partners with a bankruptcy by the insurer for fear of further destabilizing the system. A recent report on the A.I.G. bailout by the Government Accountability Office found that taxpayers may never get their money back.
Over Columbus Day weekend last fall, with the market gripped by fear and banks refusing to lend to one another, a somber group gathered in an ornate conference room across from Mr. Paulson’s office at the Treasury. Mr. Paulson, Mr. Bernanke, Ms. Bair and others listened as Mr. Geithner made his pitch, according to four participants. Mr. Geithner, in the words of one participant, was “hell bent” on a plan to use the Federal Deposit Insurance Corporation to guarantee debt issued by bank holding companies. It was a variation on Mr. Geithner’s once-unthinkable plan to have the government guarantee all bank debt. The idea of putting the government behind debt issued by banking and investment companies was a momentous shift, an assistant Treasury secretary, David G. Nason, argued. Mr. Geithner wanted to give the banks the guarantee free, saying in a recent interview that he felt that charging them would be “counterproductive.” But Ms. Bair worried that her agency — and ultimately taxpayers — would be left vulnerable in the event of a default. Mr. Geithner’s program was enacted and to date has guaranteed $340 billion in loans to banks. But Ms. Bair prevailed on taking fees for the guarantees, and the government so far has collected $7 billion. Mr. Geithner has also faced scrutiny over how well taxpayers were served by his handling of another aspect of the bailout: three no-bid contracts the New York Fed awarded to BlackRock, a money management firm, to oversee troubled assets acquired by the bank.
BlackRock was well known to the Fed. Mr. Geithner socialized with Ralph L. Schlosstein, who founded the company and remains a large shareholder, and has dined at his Manhattan home. Peter R. Fisher, who was a senior official at the New York Fed until 2001, is a managing director at BlackRock. Mr. Schlosstein said that while he and Mr. Geithner spoke frequently, BlackRock’s work for the Fed never came up. “Conversations with Tim were appropriately a one-way street. He’d call you and pepper you with a bunch of questions and say thank you very much and hang up,” he said. “My experience with Tim is that he makes those kinds of decisions 100 percent based on capability and zero about relationships.” For months, New York Fed officials declined to make public details of the contract, which has become a flash point with some lawmakers who say the Fed’s handling of the bailout is too secretive. New York Fed officials initially said in interviews that they could not disclose the fees because they had agreed with BlackRock to keep them confidential in exchange for a discount. The contract terms they subsequently disclosed to The New York Times show that the contract is worth at least $71.3 million over three years. While that rate is largely in keeping with comparable fees for such services, analysts say it is hardly discounted.
Mr. Geithner said he hired BlackRock because he needed its expertise during the Bear Stearns-JPMorgan negotiations. He said most of the other likely candidates had conflicts, and he had little time to shop around. Indeed, the deal was cut so quickly that they worked out the fees only after the firm was hired. But since then, the New York Fed has given two more no-bid contracts to BlackRock related to the A.I.G. bailout, angering a number of BlackRock’s competitors. The fees on those contracts remain confidential. As Mr. Geithner runs the Treasury and administration officials signal more bailout money may be needed, the specter of bailouts past haunts his efforts. He recently weathered a firestorm over retention payments to A.I.G. executives made possible in part by language inserted in the administration’s stimulus package at the Treasury Department’s insistence. And his new efforts to restart the financial industry suggest the same philosophy that guided Mr. Geithner’s Fed years. According to a recent report by the inspector general monitoring the bailout, Neil M. Barofsky, Mr. Geithner’s plan to underwrite investors willing to buy the risky mortgage-backed securities still weighing down banks’ books is a boon for private equity and hedge funds but exposes taxpayers to “potential unfairness” by shifting the burden to them.
The top echelon of the Treasury Department is a common destination for financiers, and Mr. Geithner has also recruited aides from Wall Street, some from firms that were at the heart of the crisis. For instance, his chief of staff, Mark A. Patterson, is a former lobbyist for Goldman Sachs, and one of his top counselors is Lewis S. Alexander, a former chief economist at Citigroup. A bill sent recently by the Treasury to Capitol Hill would give the Obama administration extensive new powers to inject money into or seize systemically important firms in danger of failure. It was drafted in large measure by Davis Polk & Wardwell, a law firm that represents many banks and the financial industry’s lobbying group. Mr. Geithner also hired Davis Polk to represent the New York Fed during the A.I.G. bailout. Treasury officials say they inadvertently used a copy of Davis Polk’s draft sent to them by the Federal Reserve as a template for their own bill, with the result that the proposed legislation Treasury sent to Capitol Hill bore the law firm’s computer footprints. And they point to several significant changes to that draft that “better protect the taxpayer,” in the words of Andrew Williams, a Treasury spokesman.
But others say important provisions in the original industry bill remain. Most significant, the bill does not require that any government rescue of a troubled firm be done at the lowest possible cost, as is required by the F.D.I.C. when it takes over a failed bank. Treasury officials said that is because they would use the rescue powers only in rare and extreme cases that might require flexibility. Karen Shaw Petrou, managing director of the Washington research firm Federal Financial Analytics, said it essentially gives Treasury “a blank check.” One year and two administrations into the bailout, Mr. Geithner is perhaps the single person most identified with the enormous checks the government has written. At every turn, he is being second-guessed about the rescues’ costs and results. But he remains firm in his belief that failure to act would have been much more costly. “All financial crises are a fight over how much losses the government ultimately takes on,” he said. And every decision “requires we balance how to achieve the most benefits in terms of improving confidence and the flow of credit at the least risk to taxpayers.”