Tower bridges, Fort Point Channel, Boston.
Spans for Northern Avenue, Congress Street and Summer Street.
Ilargi: Good luck with those record poll numbers for the first 100 days, America. And don't forget: keep talking to the hand. And if you happen to have a little moment in between drooling, ask yourself: who pays for the bank bail-outs? Remember, they need to be bailed out because they have debts so indecent they need to wear pants in public. And you think your president can pay off those debts?! He can't, not even now he's taken everything you own. You didn't own nearly enough before, and you owe nothing but debt today. Any appeals to transparency and the rule of law will be dealt with the way Ken Lewis tried today at the Bank of America shareholders meeting. He told that bunch of sore losers that he was mum on Merrill's losses because of "systemic risk". He did so just a shirt while after telling Andrew Cuomo it was because Paulson and Bernanke made him do it. Hey, who cares about the difference anymore? All we need to do is sit back and wait for Obama to start using terms like "systemic risk" and "national security". He will as soon as those numbers start dropping. For now, though, it's Lala Land all the way. US GDP drops even faster than Germany, and the street turns a "healthy profit". We must be stuck in Pleasantville, Land of Oz, and glued to the Truman Show. Say what you will, but the Obama campaign is one of the most outstanding sales jobs in history, fridges for Eskimo's territory. The economy tanks, and stocks rise. A politician robs his voters blind, and his ratings go through the roof. This is not a housing bubble or credit bubble we're witnessing, it's a reality bubble.
Why Congress Won't Investigate Wall Street
The famous Pecora Commission of 1933 and 1934 was one of the most successful congressional investigations of all time, an instance when oversight worked exactly as it should. The subject was the massively corrupt investment practices of the 1920s. In the course of its investigation, the Senate Banking Committee, which brought on as its counsel a former New York assistant district attorney named Ferdinand Pecora, heard testimony from the lords of finance that cemented public suspicion of Wall Street. Along the way, the investigations formed the rationale for the Glass-Steagall Act, the Securities Exchange Act, and other financial regulations of the Roosevelt era.
A new round of regulation is clearly in order these days, and a Pecora-style investigation seems like a good way to jolt the Obama administration into action. After all, the financial revelations of today bear a striking resemblance to those of 1933. In his own account of his investigation, Pecora described bond issues that were almost certainly worthless, but which 1920s bankers sold to uncomprehending investors anyway. He told of the bonuses which the bankers thereby won for themselves. He also told of the lucrative gifts banks gave to lawmakers from both political parties. And then he told of the banking industry's indignation at being made to account for itself. It regarded the outraged public, in Pecora's shorthand, as a "howling mob."
The idea of a new Pecora investigation is catching on, particularly, but not exclusively, on the left. It's probably not going to happen, though, in the comprehensive way that it should. The reason is that understanding our problems, this time around, would require our political leaders to examine themselves. The crisis today is not solely one of bank misbehavior. This is also about the failure of the regulators -- the Wall Street policemen who dozed peacefully as the crime of the century went off beneath the window. We have all heard the official explanation for this failure, that "the structure of our regulatory system is unnecessarily complex and fragmented," in the soothing words of Treasury Secretary Tim Geithner. But no proper Pecora would be satisfied with such piffle. The system was not only complex, it was compromised and corrupted and thoroughly rotten even in the spots where its mandate was simple.
After all, we have for decades been on a national crusade to slash red tape and stifle regulators. Over the years, federal agencies have been defunded, their workers have grown dispirited, their managers, drawn in many cases from antiregulatory organizations, have seemed to care far more about industry than the public. Consider in this connection the 2003 photograph, rapidly becoming an icon of the Bush years, in which James Gilleran, then the director of the Office of Thrift Supervision (it regulates savings and loan associations) can be seen in the company of several jolly bank industry lobbyists, holding a chainsaw to a pile of rule books. The picture not only tells us more about our current fix than would a thousand pages about overlapping jurisdictions; it also reminds us why we may never solve the problem of regulatory failure.
To do so, we would have to examine the apparent subversion of the regulatory system by the last administration. And that topic is supposedly off limits, since going there would open the door to endless partisan feuding. But it's not only Republicans who would feel the sting of embarrassment. Launching Pecora II would automatically raise this question: Whatever happened to the reforms put in place after the first go-round? Now a different picture comes to mind. It's Bill Clinton in November of 1999, surrounded by legislators of both parties, giving a shout-out to his brilliant Treasury Secretary Larry Summers, and signing the measure that overturned Glass-Steagall's separation of investment from commercial banking. Mr. Clinton is confident about what he is doing. He knows the lessons of history, he talks glibly about "the new information-age global economy" that was the idol of deep thinkers everywhere in those days.
"[T]he Glass-Steagall law is no longer appropriate to the economy in which we live," he says. "It worked pretty well for the industrial economy, which was highly organized, much more centralized, and much more nationalized than the one in which we operate today. But the world is very different." It turns out the world hadn't changed much after all. But the Democratic Party sure had. And while today's chastened Democrats might be ready to reregulate the banks, they are no more willing to scrutinize the bad ideas of the Clinton years than Republicans are the bad ideas of the Bush years. "We may now need to be reminded what Wall Street was like before Uncle Sam stationed a policeman at its corner," Pecora wrote in 1939, "lest, in time to come, some attempt be made to abolish that post." Well, the time did come. The attempt was made. And we could use that reminder today.
Durbin On Congress: The Banks "Own The Place"
So far this session, Sen. Dick Durbin has stood behind consumers like no other public official in Washington. He has served as the Senate Democrats' de facto point man on student aid reform, mortgage bankruptcy reform, usury reform, financial product safety, and consumer credit abuse. And around every corner, he's been met with resistance by banking industry lobbyists. In an interview with WJJG's Ray Hanania on Monday, the senior senator from Illinois stated outright that the banks "own" Capitol Hill.DURBIN: And the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place.
The ongoing negotiations about credit card reform legislation nicely illustrate Durbin's point. According to Hill sources, the U.S. House of Representatives is likely to vote on H.R. 627, otherwise known as the Credit Card Holders’ Bill of Rights Act, as early as Thursday. But it doesn't seem likely that the federal bill will be implemented quickly enough to help strapped consumers this year. For that, we can thank the banks. Last year, Rep. Carolyn Maloney (D-NY) proposed the bill of rights as a way to clean up this unregulated industry. The bill would stop credit card companies from raising interest rates on balances incurred under an old rate, would let consumers pay off loans with higher interest rates first, and would stop unfair late fees and “universal default” (the odious practice of raising interest rates on accounts in good standing when a borrower falls behind on other bills). While the bill eventually died in the Senate, Maloney reintroduced a similar version again this year and it has since passed the House Financial Services Committee.
But there's a catch. Originally, Maloney's bill required the banks to change their practices 90 days after passage. But a bipartisan group of lawmakers (including Rep. Luis Gutierrez, a recent thorn in the side of consumer groups) amended the bill earlier this month, pushing the effective date to either 12 months after passage or July 1, 2010. This had been a demand put forth by the financial services industry, which claimed that the changes would neccessitate countless hours to implement. Why is that important? The Federal Reserve passed new credit card rules in December that are scheduled to take hold in ... July 2010, rendering the Congressional legislation rather meaningless. When the Fed announced its changes, Democrats decried the extended timeline. But all it took was pressure from the banks to change their tune. And that will have a painful effect on consumers in the interim, as the Washington Independent's Mike Lillis writes:That spells bad news for credit card users, as banks in recent weeks have installed a series of fee and rate hikes to churn profits in a struggling economy. In many cases the increases come without any warning to consumers, and they often apply to balances accrued even before the hikes arrive. “Unfortunately the way the market place is working, [card users] could use more protection, not less,” said Graham Steele, an attorney at Public Citizen’s Congress Watch. “Consumers need relief now, and yet these bills are being weakened.”
Meanwhile, Durbin's bankruptcy reform bill is on course to be gutted by the Senate today, according to the Huffington Post's Ryan Grim. Just another example of Wall Street's outsized influence.
Congress passes $3.5 trillion budget plan
Split badly along party lines, Congress approved a five-year budget plan Wednesday that gives President Barack Obama a big leg up toward health care reform but could severely crimp the rest of his domestic agenda unless new savings and revenues are found. House Democrats lost 17 of their own members but easily prevailed 233-193 even without Republican support. Senate action followed on a mostly party line 53-43 vote just hours before Obama's evening White House press conference marking the end of his first 100 days in office. The victory sets the stage for a major battle this summer over healthcare reform in which Obama will have the added leverage of special budget procedures allowing him to circumvent the threat of a Republican filibuster in the Senate.
Democrats insist that it is still their intention to try to move forward without using this power, and Senate Finance and Health, Education and Labor Committees are each slated to begin their markups in June. If real progress is made, the hope is to avoid invoking the so-called "reconciliation" procedures, but the president and Democratic leaders badly wanted them as a backstop if no resolution is reached by Oct. 15. The complexity and cost of the healthcare issue make it a major test for the new president-both in term of policy but also how he chooses to use his power. The defection of Sen. Arlen Specter -a Pennsylvania Republican who announced Tuesday that he is switching to the Democrats-already puts the Democrats near the 60 vote threshold needed to break any Republican filibuster. But it is also a sensitive time when the White House fears overreaching and could use this window to reach out to Minority Leader Mitch McConnell (R-Ky.) to test his willingness to work more closely with the administration.
Obama can't ignore the big challenges ahead for himself in implementing the rest of the budget. In the new fiscal year beginning Oct. 1, it's anticipated total government spending will reach $3.55 trillion, of which about $1.2 trillion or better than a third would be deficit-financed. By 2014, federal outlays are projected to grow to $3.82 trillion, but Democrats are betting heavily than an improved economy will help them narrow the deficit to $523 billion or 14% of government expenditures. Nonetheless, the $523 billion target is still a huge sum by historic standards, and getting there a steep climb. For example the budget assumes between $173 billion and $208 billion in unspecified cuts from Obama's five-year requests for non-defense discretionary appropriations. That's close to 50% of the $400 billion in new funding the president is seeking.
Significantly less money is left on the table than Obama wanted for tax cuts, including his signature Make Work Pay credit to relieve the burden of payroll taxes on working class families. And the final compromise retreats from a House proposal to build into the budget adequate funds to cover annual Medicare reimbursement increases for physicians. "We have a rough road ahead," House Ways and Means Committee Chairman Charles Rangel told POLITICO of the scramble ahead to find the needed savings and revenues to meet the president's goals. And the New York quipped that he will be leaning heavily on his new "big brother" at the White House to help him find the money needed. "All I'm doing is taking one step at a time," Rangel said. "We've got our backs against the wall." "Frankly a couple of days ago I was very concerned. And then I said what the hell. I'm 79-years-old, I can't have a whole lot of crises. The only crisis I have right now is healthcare. I've got a big brother who shares this responsibility. His name is Barack Obama. He's younger than me, brighter than me, and more persuasive than me."
Jobless rates rise in all US metro areas in March
Unemployment rates rose in all of the nation's largest metropolitan areas for the third straight month in March, with Indiana's Elkhart-Goshen once again logging the biggest gain. The Labor Department reported Wednesday all 372 metropolitan areas tracked saw jobless rates move higher last month from a year earlier. Elkhart-Goshen's rate soared to 18.8 percent, a 13 percentage-point increase. That was the fourth-highest jobless rate in the country. The Indiana region has been hammered by layoffs in the recreational vehicle industry. RV makers Monaco Coach Corp. Keystone RV Co. and Pilgrim International have sliced hundreds of jobs. The jobless rate jumped to 17 percent in Bend, Ore., a 9.2 percentage-point rise and the second-biggest monthly gainer. Bend for years has been the center of the central Oregon real estate and construction boom, largely fueled by retirees from California.
Many of them bought vacation or retirement homes in high-end rural developments called destination resorts, which the state began allowing in 1984 as an exception to land use laws that otherwise aim to preserve rural land from development. The credit crunch and falling home prices have made it harder for retirees to cash out of their existing homes. Part of the area also features easy access to skiing, mountain biking, hunting, fishing and golf. But as unemployment rises, state analysts have cited weakness in the service and entertainment sectors. Roger Lee, executive director of the nonprofit Economic Development for Central Oregon, said losses in construction jobs have battered the area, with the impact rippling through retail and service sectors. The region's unemployment rate also has been affected by a growth in the labor force. State officials believe that is due to spouses going back into the job market to keep households afloat and retirees returning to work to supplement damaged retirement savings accounts.
Rounding out the top three was North Carolina's Hickory-Lenoir-Morganton, which saw its unemployment rate rise to 15.4 percent last month, an increase of 9.1 percentage points. That region has been especially hard hit by heavy layoffs in manufacturing amid a recession that is nearing a record as the longest in the post World War II period. El Centro, Calif., continued to claim the highest unemployment rate — 25.1 percent. The jobless rate there is notoriously high because there are so many unemployed seasonal agriculture workers. Following close behind were Merced, Calif., with a jobless rate of 20.4 percent, and Yuba City, Calif., at 19.5 percent. The national unemployment rate soared to 8.5 percent, a quarter-century high, in March.
Companies have seen their sales and profits hurt by the recession. They have been laying off workers and taking other cost-cutting steps to survive the downturn, which began in December 2007. Many economists believe employers will stay in cost-cutting mode even if the recession ends this year, as some hope. The nationwide unemployment rate could top 10 percent early next year before it starts to slowly drift downward. Companies won't feel inclined to boost hiring until they are confident any economic recovery has staying power. More layoffs were announced this week. Textron Inc. said it will expand layoffs, eliminating 8,300 jobs, or 20 percent, of its global work force as the recession weakens demand for corporate planes. The maker of Cessna planes, Bell helicopters and turf-maintenance equipment earlier this year said it would reduce its work force by 6,200 jobs, or 15 percent, mostly at Wichita, Kansas-based Cessna.
Elsewhere, General Motors Corp. laid out a massive restructuring plan that includes cutting 21,000 U.S. factory jobs by next year. Clear Channel Communications Inc., the largest owner of U.S. radio stations, said it's cutting 590 jobs in its second round of mass layoffs this year. And bearings and specialty steels maker Timken Co. indicated it will cut about 4,000 more jobs by the end of this year after earlier suggesting about 3,000 jobs already had been targeted In Wednesday's metro unemployment report, the government said 18 regions registered jobless rates of at least 15 percent. Meanwhile, 15 regions had rates below 5 percent. They include: Ames, Iowa; Houma-Bayou-Cane-Thibodaux, La.; Iowa, City, Iowa; Manhattan, Kansas; and Lubbock, Texas. Both Iowa City, home of the University of Iowa, and Houma-Bayou-Cane-Thibodaux had the lowest unemployment rates at 3.6 percent each. The Louisiana region, with about 200,000 residents, is located on the coast and serves as a vital support area for the offshore petroleum industry in the Gulf of Mexico. Because of deepwater drilling in the Gulf, where projects take years to complete and bring to production, there has been little short-term effect from low energy prices.
Visa's Net Income Jumps 71%
Visa Inc.'s fiscal second-quarter net income surged 71% amid a prior-year litigation provision as results topped analysts' expectations despite falling consumer spending. Visa and its chief rival, MasterCard Inc., are insulated from credit woes arising from increasing delinquencies because they don't lend to consumers. They make money from the fees they charge banks to process card payments on the plastic these banks issue. But as the recession has deepened, consumer spending has slowed, eating into the fees the processors earn from transactions.
For the quarter ended March 31, Visa reported net income of $536 million, or 71 cents per Class A share, up from $314 million, or 39 cents per Class A share, a year earlier. Excluding items such as the litigation reserve, earnings rose to 73 cents from 52 cents. Revenue climbed 13% to $1.65 billion. Analysts' latest estimates were for per-share earnings of 64 cents on revenue of $1.61 billion, according to a poll by Thomson Reuters. Payments volume, representing spending on Visa cards, dipped 1% as a drop in the U.S. more than offset gains elsewhere.
The number of Visa-branded cards grew 8% world-wide to more than 1.7 billion while the number of transactions processed on its network climbed 9%. Visa's data on payments volume and transactions lag a quarter. Therefore, the payments and transactions volumes reported in the fiscal second quarter are as of the end of December. Visa reiterated its earnings and reduced revenue forecast for 2009 and 2010 while boosting its operation-margin targets for the years. MasterCard reports results Friday. American Express Co. last week said customers reduced spending by 16% in the first quarter, sending the company's quarterly net income down 56%. Unlike other card companies, which either issue plastic or process the transactions, American Express does both.
Bank of America CEO Lewis Loses Chairman Title
Bank of America Corp.'s shareholders voted in historic fashion on Wednesday to strip chief executive Ken Lewis of his title as chairman, demonstrating just how precarious Lewis's hold on his other job - chief executive - has become. The shareholder resolution, which requires Bank of America to appoint a separate chairman and chief executive, marks the first binding shareholder resolution to pass at a S&P 500-member firm, according to RiskMetrics Group. The resolution passed with 50.34% of the vote. The margin was so razor-thin that Bank of America recounted the votes and announced the results hours after its annual meeting, which the firm held Wednesday in its hometown of Charlotte, N.C.
Following the vote's tally, Bank of America's board huddled and elected Dr. Walter Massey as the bank's chairman, officially removing Lewis from the role. Lewis will retain the titles of president and chief executive. "The board unanimously expressed its support for Lewis to continue in that role," the bank said in a statement. Earlier in the day at the annual meeting, as bank officials worked to tally - and re-tally - the votes, Lewis defended the bank's much-criticized purchases of Countrywide Financial Corp. and Merrill Lynch & Co. His decision to go forward with the Merrill deal has fueled anger among shareholders, who have accused Lewis of failing to disclose crucial information about Merrill's condition ahead of the deal's closing. Shares in Bank of America closed up 6.5% at $8.68.
Even though Lewis is no longer the bank's chairman, he's likely to face continued sharp scrutiny over negotiations he had with government officials in December, when he and bank regulators kept quiet about the quickly crumbling condition of Merrill Lynch. Lewis later told New York Attorney General Andrew Cuomo that former Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke had stiff-armed him into not disclosing Merrill's condition to shareholders, even though Bank of America would soon close its purchase of Merrill.
But that explanation failed to appease some large shareholders, who turned out to be crucial to the outcome of Wednesday's vote. CtW Investment Group, as well as a mammoth California pension fund, said ahead of the vote that they would vote against Lewis. Against that backdrop, Lewis continued his defense on Wednesday, telling shareholders that Bank of America's board didn't have a legal duty to disclose to shareholders that the federal government had pressed Bank of America to follow through on its deal to buy Merrill Lynch. Lewis had told Paulson in mid-December that he would seek to kill the deal because of Merrill's condition.
Tim Geithner Finally Gets Some Good Press
This week People will come out with their annual "50 Most Beautiful People" list. Breast-cancer survivor Christina Applegate is on the cover, and inside, young heartthrobs like Dev Patel, Robert Pattinson, Channing Tatum, and Zac Efron fill out the rest of the list. Michelle Obama is even on the list! She's in a section called "Barack's Beauties," along with Chief of Staff Rahm Emanuel, Social Secretary Desirée Rogers, and — wait a minute. Tim Geithner is on the list, too! We totally forgot that he was hot! (Probably because he's always making that face.) Now that we think about it, this might just be the only positive press we've read about him in months. Let this be a lesson to all of you who wasted your high-school days listening to those nerds who were jealous of your popularity — when all else fails, you really can fall back on your looks.
Fed Keeps Purchase Targets Unchanged in Sign Worst of Recession Has Passed
The Federal Reserve refrained from increasing purchases of Treasuries and mortgage securities, signaling the worst of the recession may be over. “The economy has continued to contract, though the pace of contraction appears to be somewhat slower,” the Fed’s Open Market Committee said in a statement after a two-day meeting in Washington. “Household spending has shown signs of stabilizing, but remains constrained by ongoing job losses, lower housing wealth and tight credit.” Chairman Ben S. Bernanke is watching for signs of a slowing contraction as the Fed’s loans and bond purchases reduce the cost of credit for households and businesses. Consumer spending rebounded in the first quarter, while the slump in housing and inventories pushed the economy to its worst performance in five decades, the Commerce Department reported earlier today.
“The committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets,” the Fed statement said. Bonds fell after the Fed failed to commit to increase its buying of long-term Treasuries. The yield on the benchmark 10- year note jumped to 3.11 percent at 2:22 p.m. in New York, from 3.02 percent late yesterday. The Standard & Poor’s 500 Index remained higher at 875.11, a gain of 2.4 percent from yesterday. The FOMC kept the federal funds rate target at a range of zero to 0.25 percent for the third straight meeting and repeated its intentions to keep the target rate low. Today’s decision was unanimous. At the previous FOMC meeting in March, policy makers agreed to buy $300 billion of long-term Treasury debt within six months while increasing purchases of mortgage-backed securities to $1.25 trillion this year from $500 billion and doubling purchases of housing-agency debt to $200 billion.
The Fed panel said the economy “is likely to remain weak for a time,” and officials expect “a gradual resumption of sustainable growth in a context of price stability.” Former Fed Chairman Paul Volcker said the U.S. economy is “leveling off at a low level” and doesn’t need a second fiscal stimulus package. Still, the economy is functioning only by “the grace of government intervention” and “we’re in for a long slog” before a recovery takes hold, Volcker said on Bloomberg Television’s “Conversations with Judy Woodruff” airing this weekend. He is head of President Barack Obama’s Economic Recovery Advisory Board.
The Fed’s strategy appears to be easing credit for banks, corporations and households. The three-month London interbank offered rate, or Libor, for dollars fell to 1.03 percent today, the lowest level since June 2003, the British Bankers’ Association said. The TED spread, the difference between what the Treasury and banks pay to borrow dollars for three months, has narrowed to 0.91 percentage point, from as high as 4.64 percentage points on Oct. 10. Companies have raised a record $468 billion in U.S. bond sales this year. The average cost of a 30-year fixed-rate mortgage fell to 4.80 percent last week, down from 6.03 percent a year ago, according to data from Freddie Mac. The Fed released its decision hours after the government reported the U.S. economy contracted at a 6.1 percent annual pace in the first quarter, reflecting declines in housing and a record slump in inventories. The economy contracted at a 6.3 percent annual rate in the last three months of 2008.
Bernanke said in an interview with CBS’s “60 Minutes” program that aired March 15 that the Fed’s efforts so far had brought down mortgage rates, among evidence of “green shoots” in some markets. A month later, the Fed chief gave a speech saying there were signs that the “sharp decline” in the economy was slowing, indicating a potential “first step” toward a recovery. His outlook is partly supported today by a 2.2 percent gain in consumer spending in the first quarter, the most in two years. Consumer spending accounts for 70 percent of the economy. Officials cut the benchmark lending rate to as low as zero in December and switched to using direct bond purchases and loans to support credit markets. “The Fed is following an extraordinarily expansionary policy,” William Poole, a senior fellow at the Cato Institute in Washington and former president of the St. Louis Fed, said before policy makers issued their statement. “There is I think accumulating evidence that we may not be all that far from a bottom” of the contraction. Poole spoke in an interview with Bloomberg Radio.
The public won’t get full details on whether Fed officials adjusted their outlooks until May 20, when the central bank releases minutes of this week’s meeting. That report will include a new round of quarterly economic projections of growth, inflation and unemployment from the Fed’s five governors and 12 district-bank presidents on the FOMC. Policy makers have lowered their projections for 2009 gross domestic product several times, forecasting in January an average range of contraction of 1.3 percent to 0.5 percent. A year ago, officials foresaw growth this year ranging from 2.1 percent to 2.7 percent. The recession that began in December 2007, triggered by the housing collapse and credit crisis, has wiped out 5.1 million jobs from the U.S. economy, pushing the unemployment rate to a quarter-century high of 8.5 percent.
“There’s been lots of talk about ‘green shoots,’” Robert Eisenbeis, a former Atlanta Fed research director who is now chief monetary economist for Vineland, New Jersey-based Cumberland Advisors, said before today’s meeting concluded. “You can find a lot of dead leaves too.” Even so, economists expect the annual pace of the contraction to slow in the second quarter to about 2 percent, the median estimate in a Bloomberg News survey. That should pick up to a 0.4 percent annual growth rate in the third quarter, according to the same survey, conducted March 30 to April 8. Reports last week showed that orders for U.S. durable goods in March fell less than forecast and sales of new houses were higher than projected. Separately, about 140 Fed staff members are coordinating capital tests on the 19 largest banks to assure they can continue to lend if the economy worsens. Results of the exams are scheduled for release the week of May 4. Bernanke said in an April 14 speech in Atlanta that the U.S. “will not have a sustainable recovery” without a stabilization of the financial system and credit markets.
Let's Hold Obama to His Promise of Transparency
President Barack Obama has promised a full accounting online of where his $787 stimulus package is spent and to expose to public ridicule anyone caught wasting taxpayer money. At a White House news conference in March, the president put it this way: "If we see money being misspent, we're going to put a stop to it, and we will call it out and we will publicize it." Unfortunately, the president's deeds don't match his words. True transparency requires putting specific details of every government expenditure online, where citizens can review them and spot wasteful spending. Several states are already doing just that and finding that citizens and taxpayer groups make great watchdogs. In Missouri last August, the nonpartisan National Taxpayers Union (NTU), discovered more than $2.4 million spent for questionable purposes over the past eight years, including purchases from bakeries, beauty salons and women's lingerie stores.
Thanks to NTU and Missouri's willingness to put its expenses out for public review, we know that state officials spent $15,482.57 at Ann's Bra Shop in St. Louis (expenses listed as "professional services" and "clothing supplies"). Government employees also spent more than $1.6 million at coffee shops, $387,210.14 at framing stores, $278,053.46 at florists and nurseries, and $70,849.02 at bakeries. Other dubious expenditures included $936.75 spent at The Corsage Shop in New Madrid, Mo., and $3,010 at the Westside Barber Shop (the disclosure forms didn't indicate which of the several in the state).
After receiving thousands of letters from unhappy state residents, Republican Gov. Matt Blunt asked the state's Office of Administration in August to review the expenditures. "This is exactly what we expected and envisioned when we created the MAP [Missouri Accountability Portal]," Mr. Blunt said in a statement. "Transparency and openness help root out wasteful spending and we welcome this scrutiny." The bra-shop purchases turned out to be legitimate (they were for female prisoners). However, the uproar that followed the disclosure put lawmakers on notice that the public was paying attention and put the fear into them that voters would punish them if they allowed tax dollars to pay for floral bouquets, beauty treatments and caffeine fixes for bureaucrats. This watchdog process is apparently what the president has in mind for Recovery.gov, a Web site the administration set up to publish reports on stimulus spending.
But these reports will offer very little insight into where our tax dollars are going. Why? Because the stimulus package only requires states and cities to disclose project-level expenses. We will know that New York will spend $5.9 million on repaving 34 miles of roads in Westchester and Rockland counties, but not how much of our tax dollars went to, say, Starbucks for workers on the project. The federal government will disclose how much it gives to a state, and the state must report how it distributed those funds to a private company or to local government. But there's no requirement to disclose where the money actually ends up. And there won't be any real data on the Web site for a year. There will be plenty of potential for corsages and caffeine. Americans need a much clearer picture of their stimulus dollars at work. Who got what? What did they buy? And for how much? That's the only information that will let taxpayers know if they're getting ripped off.
This last point is crucial. Congress isn't requiring stimulus contracts to be competitively bid. Transparency -- and the public pressure it brings -- is the best remedy left for cutting waste. If Mr. Obama means what he says about transparency, he must get governors, mayors, city executives and grantees to account for every stimulus dime spent. And he must do it now -- not in a year. Without those details, we can only assume the worst.
Chrysler creditors reportedly resist recent offer
While Chrysler LLC has made some big strides toward a deal to slash its hefty debt burden, the automaker still appears to be teetering on the edge of bankruptcy ahead of Thursday's deadline to prove its viability. But a group of banks holding about 70% of Chrysler's debt, including J.P. Morgan, Morgan Stanley and Goldman Sachs, have agreed in principle to accept $2 billion in cash for $6.9 billion in secured debt, the Detroit News reported Wednesday. A senior Obama administration official confirmed a deal a day earlier without going into specifics. The exchange would be a crucial step in Chrysler's avoiding bankruptcy and could also help it finalize a partnership with Italy's Fiat. But some of the 46 banks in total that hold Chrysler debt are reportedly resisting the offer.
Without having them all step up, "it would still be necessary for Chrysler to go through what we call our 'surgical bankruptcy' -- 30-day type of process -- in order to in effect drag along any banks that choose not to participate," an anonymous source told the Detroit News. A Chrysler spokesperson declined to comment as did an administration official, who responded to reports that President Barack Obama is planning to announce Chrysler's bankruptcy on Thursday by saying talks could push late into the evening. "We have maintained that negotiations could run up to the deadline which has always been 11:59 PM on the 30th," the official said. Erich Merkle, an independent auto analyst in Grand Rapids, Mich. isn't convinced that a bankruptcy, which could be much messier than some may believe, is looming.
"It's difficult to know what's really going on with all this high-stakes poker," he said. "But given everything that's happened this week, I just can't see the government pushing Chrysler into bankruptcy, which could eventually lead to liquidation." Merkle also said he believes rival General Motors Corp. will manage to stay afloat outside of the bankruptcy courts. GM announced Monday that it would offer 225 shares of common stock for each $1,000 of debt in an exchange that CEO Fritz Henderson said would determine whether the automaker succumbs to bankruptcy. GM faces a deadline to prove its ability to survive outside of bankruptcy at the end of next month.
Chrysler, Fiat: Back from the Brink?
An agreement with big banks may keep Chrysler out of bankruptcy court, but several smaller debt holders remain to be wooed. Italian automaker Fiat moved much closer to a deal with Chrysler on Apr. 28 that will blend the two companies' operations and likely keep Chrysler out of bankruptcy court. The breakthrough came when a committee representing bank and private equity lenders that hold 75% of Chrysler's $6.9 billion in debt agreed with the White House auto industry task force and Chrysler owner Cerberus Capital Partners to take just $2 billion of what it's owed, along with 5% of the company's equity. The automaker is still not safe from Chapter 11, though. A group of smaller banks that collectively hold 25% of the debt also need to be brought into line. The White House is looking for at least 90% participation by the lending banks before providing more government financing that will keep the automaker out of bankruptcy.
Unless the White House extends its deadline, the wooing process needs to conclude by Apr. 30. One executive working with the debt holders says that smaller banks are complaining that the big banks, who were recipients of Troubled Asset Relief Program (TARP) bailout funds, succumbed to political pressure, striking a weaker deal than what they had been negotiating for. On Mar. 30, President Obama said his task force concluded that Chrysler could not continue as an independent entity, and that the U.S. Treasury would not extend any more loans to Chrysler past that Apr. 30 deadline unless it struck a deal with another automaker, its unions, and lenders, and showed financial viability. Debt holders have been complaining that the United Auto Workers were getting much better terms from the White House, and they have been holding out for a better deal.
On Sunday, the UAW struck an agreement that gives the union's Voluntary Employee Benefit Assn. (VEBA) health-care trust fund $4.5 billion in Chrysler stock, or about 55% of the fund's total financial backing. A VEBA representative will also hold a seat on Chrysler's board of directors. A Treasury official indicated that the ongoing negotiations definitely boosted the odds in favor of Chrysler steering clear of bankruptcy court. "The agreement from Chrysler's principal banks is an exceptional accomplishment in line with the President's firm commitment that all stakeholders sacrifice to make this deal succeed," the official said. While Obama Administration officials have talked tough about forcing both Chrysler and General Motors (GM) into bankruptcy in the last month, there is also a desire to avoid it. "Actual Chapter 11 brings a lot of unknowns for how the consumer will react," says independent marketing consultant Dennis Keene. "Especially now, having hit what we think is the bottom of sales and consumer confidence, Chapter 11 would be a setback for everyone."
The UAW has agreed to cuts in wages, overtime pay opportunities, vacation days, and to the elimination of the so-called Jobs Bank, which continued to pay workers after they were terminated. Retirees will also lose their dental and vision insurance coverage. UAW President Ron Gettelfinger couldn't be reached for comment on Apr. 28. But in a letter to members he said, "We fought to maintain our wages, our health care, and our jobs. … In the face of adversity, we secured new product guarantees, and we negotiated new opportunities for UAW involvement in future business decisions." Part of the agreements call for Fiat to build a small car in the U.S. with union workers. They also specify engines that will be made available to Chrysler and built in the U.S., assuring that some future Chrysler models will continue to be built domestically.
"The UAW is under a great deal of pressure, but the deal they struck was very necessary," said Canadian Auto Workers President Ken Lewenza. The CAW cut a deal with Chrysler last weekend. "The unions have done a great deal to make this deal happen." What Chrysler looks like after Fiat begins retooling the company remains to be seen. The Jeep brand is widely considered to be the most valuable asset. Part of the plan calls for Fiat to distribute Jeep models through its European and South American network, which could quickly enhance the company's sales. The two companies also have been exploring whether they can take some existing Fiat vehicles and rapidly modify them to be sold as Dodges and Chryslers in the U.S. Of course, all those plans depend on Chrysler, its banks, and the White House crossing the finish line.
Chrysler Bankruptcy, Fiat Alliance to Be Announced by Obama Tomorrow
President Barack Obama aims to announce tomorrow that Chrysler LLC will be placed into Chapter 11 bankruptcy, leading to an alliance with Italian automaker Fiat SpA, people involved in the matter said. Administration officials are still resolving outstanding issues, and the plan isn’t finished yet, said one of the people, who declined to be named because discussions are private. As part of ongoing negotiations, the U.S. Treasury raised its offer to Chrysler’s lenders, offering them $2.25 billion in cash to forgive $6.9 billion in secured debt, two other people familiar with the matter said. The previous offer had been for $2 billion in cash. Any bankruptcy filing could come as soon as tomorrow, people familiar with that matter said.
Chrysler’s best assets would be sold to a new entity that would have an ownership structure similar to that envisioned in an out-of-court deal between the Auburn Hills, Michigan-based automaker and Fiat, based in Turin, Italy, the people said. The Italian company would become a 20 percent owner of Chrysler, and a union retiree health-care trust fund would own 55 percent, with the rest of the company staying in the government’s hands initially, the people said. Chrysler has made progress in out-of-court restructuring, including reaching labor deals with the United Auto Workers union and Canadian Auto Workers on new contracts. Chief Executive Officer Bob Nardelli said today in a memo to employees that the company is waiting to hear whether its 46 lenders will agree to take cash to wipe out $6.9 billion in secured debt.
One issue remaining is the U.S. government’s effort to combine Chrysler Financial and GMAC LLC, the lending units affiliated with Chrysler and General Motors Corp. The idea is to ensure that Chrysler has a well-capitalized credit arm, as required by Obama’s automotive task force, said people familiar with the situation. Sheila Bair, chairman of the Federal Deposit Insurance Corp., has expressed concern that such a combination would involve her agency guaranteeing its debt, according to two people familiar with her views. Bair is reluctant to be drawn into bailing out auto-finance companies to the potential detriment of the FDIC’s deposit insurance fund, according to the people, who asked not to be identified because the discussions are private..
Bankruptcy: The Hip New Corporate Trend
Chapter 11 bankruptcy filings: all the cool kids are doing it. The world of restructuring and bankruptcy slumbered along for years. Then Lehman Brothers Holdings came along in September 2008 with the largest bankruptcy filing in history, easily eclipsing that of former energy trader Enron. Now it seems hardly a day goes by without a big, well-known company teetering on the edge of or actually seeking the protection of Chapter 11 of the U.S. Bankruptcy Code: Lyondell USA, Circuit City, Sharper Image, General Motors and Chrysler, the list goes on. Steve Smith is the global head of restructuring and global head of leveraged finance for UBS Investment Bank, whose clients include Fiat in its negotiations with Chrysler, Charter Communications, Young Broadcasting and ION media. Deal Journal spoke with him to get an overview of the world of restructuring U.S. companies.
Deal Journal: What are the big issues now in the world of restructuring?
Steve Smith: One of the key points in all the cases, is how do you finance the pending bankruptcy and how do you finance the exit? The aspect of this cycle that has changed is that the troubles of the financing world have spilled over so completely into bankruptcy that it’s very challenging. The lack of debtor-in-possession financing [which takes companies through the Chapter 11 process] and the lack of exit financing continue to be front and center. The creative solutions we’re seeing center around what we’re seeing in DIP financing. We’re seeing rollups in DIPs [where previous lenders to the company put in new money] or a disproportionate rollup, where the lenders who have the most exposure put in more money.
DJ: We have seen such giant bankruptcies or near-bankruptcies, with fresh records being set for size: Lehman, GM, Chrysler.
Smith: Yes. Partly it is the severity of the downturn, where you have companies that you don’t think would have filed for bankruptcy. The other thing is the number of very large companies that had been very highly levered going into this bankruptcy cycle.
DJ: Perhaps as a consequence of that, Deal Journal has heard more about the struggle to create “bespoke” bankruptcies that are individually tailored to the companies involved. Do you think there still is a general playbook?
Smith: I think it is true that these things are without precedents for size or complexity. Anyone who has an idea how to restructure Chrysler or General Motors, given the union and the legacy contracts, the scale of the restructuring they need, there is nothing to compare those to. For that matter, there’s no comparison in the scale of a Lehman Brothers, the complexity of the contracts and the number parties involved. I think Lehman Brothers will exceed the Enron of the last cycle by orders of magnitude because there are so many parties.
DJ: UBS, like all banks, has to think about how it will use its balance sheet to help in the restructuring of its clients. Is that a center of your business?
Smith: I would say that we continue to look to put money in DIP loans that have attractive risk-reward characteristics, although those opportunities are difficult to find, and we have the appetite where we can put our capital to work.
DJ: Is there a limit to how much you will put in?
Smith: Effectively, no. There’s a practical limit in today’s world, where $1 billion to $2 billion becomes the limit to capital-raising. We would look to take that in conjunction with other lenders.
DJ: You would share even $1 billion to $2 billion?
Smith: Absolutely. There was $3 billion of money put into Lyondell, and a number of lenders came together for that.
DJ: You run both leveraged finance, which raises capital for junk-rated companies, and restructuring. Is there any connection between those two businesses?
Smith: I certainly think there’s a bigger connection between leveraged finance and the restructuring world than ever before. Companies that might have been new-issue entities before are now looking for restructuring advice or financing. New-issue entities [in the context of leveraged finance] would be typically strategic acquisitions, Verizon-type of acquisitions where you have one investment-grade business acquiring another business and getting a bridge loan and financing.
DJ: Both Chrysler and GM have been discussed as a testing point for so-called 363 sales, which are acquisitions done in bankruptcy court.
Smith: We are spending a lot of time at UBS advising buyers in 363 sales or organizing that activity. It’s more advantageous to sell a big part of a company through a 363 as opposed to reorganizing the company. With the restricted financing market, we’re not seeing 363s that are taking much more creative capital structures because you can see 363 transactions that include rollover debt or other financing provided by stakeholders.
DJ: With all of the bankruptcies of auto-parts suppliers in the past, are we any closer to knowing how to restructure the auto industry?
Smith: I think we know how to restructure it. I think we’re struggling to make businesses that make sense in today’s world. I don’t think it’s a restructuring matter of converting debt into equity. Part of this problem is the scale of what’s happening here. You look at GM, and the amount of pension liabilities and debt are just massive. It is unprecedented.
Fixing bankrupt systems is just the beginning
by Martin Wolf
Can we afford to fix our financial systems? The answer is yes. We cannot afford not to fix them. The big question is rather how best to do so. But fixing the financial system, while essential, is not enough. The International Monetary Fund’s latest Global Financial Stability Report provides a cogent and sobering analysis of the state of the financial system. The staff have raised their estimates of the writedowns to close to $4,400bn (€3,368bn, £3,015bn). This is partly because the report includes estimates of writedowns on European and Japanese assets, at $1,193bn and $149bn, respectively, and on emerging markets assets held by banks in mature economies, at $340bn. It is also because writedowns on assets originating in the US have jumped to $2,712bn, from $1,405bn last October and a mere $945bn last April. To put this in context, the writedowns estimated by the IMF are equal to 37 years of official development assistance at its 2008 level. Estimated writedowns on US and European assets, largely held by institutions located in these regions, also come to 13 per cent of the aggregate gross domestic product.
The IMF estimates the additional equity requirements of the banks as well. It starts from total reported writedowns up to the end of 2008, which come to $510bn in the US, $154bn in the eurozone and $110bn in the UK. The capital raised to the end of 2008 is, again, $391bn in the US, $243bn in the eurozone and $110bn in the UK. But the IMF estimates additional writedowns in 2009 and 2010 at $550bn in the US, $750bn in the eurozone and $200bn in the UK. Against this, it estimates net retained earnings at $300bn in the US, $600bn in the eurozone and $175bn in the UK. The IMF points out that the ratio of total common equity to total assets – a measure investors burned by more sophisticated risk-adjusted ratios increasingly trust – was 3.7 per cent in the US at the end of 2008, but 2.5 per cent in the eurozone and 2.1 per cent in the UK. The IMF concludes that the extra equity needed to reduce leverage to 17 to 1 (or common equity to 6 per cent of total assets) would be $500bn in the US, $725bn in the eurozone and $250bn in the UK. For a 25 to 1 leverage, the required infusion would be $275bn in the US, $375bn in the eurozone and $125bn in the UK.
In current dire circumstances, the chances of raising such sums from markets are zero. Part of the reason is that they could still prove to be too little. After all, the IMF’s estimates of the potential writedowns on US assets alone have grown nearly three-fold in just one year. It would not be surprising if they rose again. Yet these are not the only sums required. Governments have so far provided up to $8,900bn in financing for banks, via lending facilities, asset purchase schemes and guarantees. But this is less than a third of their financing needs. On the assumption that deposits grow in line with nominal GDP, the IMF estimates that the “refinancing gap” of the banks – the rollover of short-term wholesale funding, plus maturing long-term debt – will rise from $20,700bn in late 2008 to $25,600bn in late 2011, or a little over 60 per cent of their total assets (see chart below). This looks like a recipe for huge shrinkage in balance sheets. Moreover, even these sums ignore the disappearance of securitised lending via the so-called “shadow banking system”, which was particularly important in the US.
The IMF also provides new estimates of the ultimate fiscal costs of rescue efforts (see chart below). At the high end are the US and the UK, at 13 per cent and 9 per cent of GDP, respectively. Elsewhere, costs are far lower. These, happily, are affordable sums. Indeed, compared with the recession’s impact on public debt, they look quite manageable. True, costs are likely to end up higher. But the overwhelming likelihood remains that the fiscal costs of deep recessions are substantially greater than those of rescuing finance. Refusing to rescue financial systems because it looks too expensive is a classic case of being “penny wise, pound foolish”. A better reason for refusing to bail out banks is its dire effect on incentives. The alternative must then be bankruptcy. Jeremy Bulow of Stanford University and Paul Klemperer of Oxford University have advanced a scheme that would do this neatly.
Valuable banking functions of each institution would be split off into a new “bridge” bank, leaving liabilities (apart from deposits) in the old bank. Creditors left behind would be given equity in the new bank. Governments could “top up” some creditors beyond this level, without making all creditors whole, as now. Respectable opinion assumes that it would be best to provide full bail-outs of creditors in systemically important institutions. The rationale for this is that it is the only way to eliminate further panic. The objection is not the fiscal cost. It is that a limited number of large, complex and “too-big-to-fail” institutions would then emerge. Their creditors would naturally believe they were lending to governments. This would be a recipe for yet bigger catastrophes in future years. Yet imposing large losses on creditors is indeed risky. It would probably have to be done simultaneously everywhere. Only after it was obvious that surviving banks were sound would anybody be willing to lend to them without guarantees. Even worse than this choice between grim alternatives is the fact that the path to recovery is likely to be slow, whichever is chosen.
As the latest World Economic Outlook notes in an important chapter, recessions that follow financial crises are unusually severe. So, too, are globally synchronised recessions. But now we are living through a globally synchronised recession that coincides with a huge financial crisis that emanates from the core countries of the world economy, particularly the US. This is a recipe for a long recession and a weak recovery. Whatever is done about the financial system, “deleveraging” is the order of the day (see chart). The UK’s position in this looks dire. But that of the US looks quite bad, too, even compared with that of Japan in the 1990s. For better or worse, the authorities have decided to bail out their financial systems with taxpayer money. Almost all the affected countries should be able to afford to do this, at least on the IMF’s numbers. So now, having made the fundamental decision to prevent bankruptcy, they must return their financial systems to health as swiftly as they possibly can. Even so, that will prove to be a necessary, not a sufficient, condition for a return to robust economic health. The overhang of debt makes deleveraging inevitable. But it has hardly begun. Those who hope for a swift return to what they thought normal two years ago are deluded.
Volcker Says Economy 'Leveling Off,' No Need for More Stimulus
The U.S. economy is “leveling off at a low level” and doesn’t need a second fiscal stimulus package, said former Federal Reserve Chairman Paul Volcker, one of President Barack Obama’s top economic advisers. Volcker, head of Obama’s Economic Recovery Advisory Board, said the 6.1 percent decline in first-quarter gross domestic product reported by the government today was “expected.” More recent data show the contraction in housing, business spending and inventories has slowed, and stimulus spending is only just beginning to hit the economy, he said. Still, the economy is functioning only by “the grace of government intervention” and “we’re in for a long slog” before a recovery takes hold, Volcker said on Bloomberg Television’s “Conversations with Judy Woodruff” airing this weekend. Government help will continue, and the administration won’t let any banks fail, he said.
“I’m not here to tell you the economy is going to recover very strongly in the short run,” Volcker said. “There is reason to believe that it should be leveling off, at a low level.” While Volcker suggested the economy may not need a second stimulus, he said growth isn’t likely to pick up markedly for several years. What he calls the “Great Recession” differs from previous contractions because it’s global in scale and because the financial system has broken down. “I do not think there are grounds for great optimism,” Volcker said. “It is going to take a while, I think, to have a strong recovery.”
That will keep the government involved in the financial system, and the administration will provide the capital needed to keep banks afloat, he said.
“There’s a visible commitment by the government to support these so-called systemically important institutions at this point,” said Volcker, 81, who served at the Fed’s helm from 1979 to 1987. “So they’re not going to go under in the sense of ceasing operations or even interrupting operations. It’s a question of how much support they’re going to need.” The administration’s plans to help private investors remove distressed assets from banks’ balance sheets will work “to some extent,” Volcker said. “How quickly we deal with the system that is, as I say, still in intensive care, is the question.” Treasury Secretary Timothy Geithner’s Public-Private Investment Program, or PPIP, encourages investors to buy as much as $1 trillion of real-estate assets by using $75 billion to $100 billion provided by the Treasury and government loans.
Volcker expressed concern about the expansion of the Fed’s balance sheet as central bankers attempt to ease credit conditions. “The Federal Reserve is going beyond the traditional role of central banks here or abroad,” Volcker said. “At some point it’s reasonable to ask should this particular institution, with its independence very well protected, be allocating so much of what is essentially government money.” Still, Volcker had praise for Fed chief Ben S. Bernanke. “He’s sitting down there doing a great job,” said Volcker, who declined to speculate on whether Obama will reappoint Bernanke when his term as chairman ends in 2010. “It’s not a situation where any of this problem reflects shortcomings on Mr. Bernanke’s part.” Volcker agreed with economists who say the expansion of the Fed’s balance sheet, to more than $2.2 trillion as of last week, might pose an inflation danger at some point. “The inflation problem, which should be a real threat for the future, is not right on the doorstep,” he said. “But two or three years from now that may be the critical problem, how that’s handled. Because, given what the Federal Reserve has been doing, it’s going to be harder to retrace their steps, so to speak, than it ordinarily would be.”
US Lawmakers Want Answers On Bank of America Issue
U.S. lawmakers continue to seek answers about whether the Treasury Department and Federal Reserve pressured Bank of America Corp. CEO Ken Lewis to not publicly raise questions about the bank's deal to buy Merrill Lynch & Co. Wednesday, Rep. Spencer Bachus of Alabama, the ranking Republican on the House Financial Services Committee, called for hearings into "possible violations of the securities laws." Bachus, citing a Wall Street Journal story about Lewis' testimony before New York's attorney general earlier this year, said he was concerned that material information was not provided to Bank of America shareholders.
The call was the latest from lawmakers concerned about Lewis' suggestion that then Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke may have counseled Bank of America to withhold certain details about the bank's purchase of the investment bank. Rep. Dennis Kucinich, D-Ohio, who chairs a House Oversight and Government Reform subcommittee on domestic policy, has already requested the Fed and Treasury provide documents dealing with the negotiations with Bank of America. Both are expected to comply with the request, and future hearings in front of Kucinich's committee are expected. "The implications of Mr. Lewis' testimony, if accurate, are extremely serious, " Kucinich said in a letter sent last week to Bernanke.
Time for Bank Creditors to Share the Pain?
The big debate about President Obama’s financial rescue plan has centered on whether he’s been right to avoid nationalizing the country’s biggest banks. But there is another, more pressing question about the plan that has received considerably less attention. After the Federal Reserve’s stress tests identify the country’s sickest banks next week, who will bear responsibility for shoring up their balance sheets? Will it be solely the government? Or will the government force institutions that lent money to sick banks in better times — their creditors — to take a hit by forgiving some of the loans?
Timothy F. Geithner, the Treasury secretary, and other officials are reluctant to force losses, often called haircuts, on banks. They worry that haircuts could create a cascade, in which some of the creditors that take losses become insolvent, while creditors of healthier banks begin wondering whether they will be subject to future haircuts. In the ensuing panic, financial markets could freeze up, as they did last fall. But relying on the government alone to shore up the banks brings risks, too. In the long term, it could leave taxpayers with an enormous bill. In the short term, it could destroy the already thin political support for the rescue plan.
Recently — and, I’d argue, fortunately — the Obama administration seems to have become more open to the idea of encouraging loan forgiveness in certain situations. Beyond those situations, officials hope that no others are needed. Yet that may turn out to be wishful thinking. The Treasury Department has only about $130 billion remaining in its Troubled Asset Relief Program, or TARP, fund. By comparison, American banks are probably facing an additional $1 trillion in losses over the next two years, the International Monetary Fund projects. The gap between those numbers means that the debate over haircuts could be with us for a while.
The case against haircuts starts with Lehman Brothers. When Lehman collapsed into bankruptcy on the night of Sept. 14, its creditors were left with billions of dollars in loans to Lehman they would never recover. Needing to conserve capital and fearful that other firms might collapse soon, they largely stopped lending. “That’s when this crisis took a quantum leap up in terms of seriousness,” as Janet Yellen, the president of the San Francisco Fed, recently said. So imagine that on Monday, when releasing the results of its stress tests, the Fed says that several banks need more money to survive a deep recession. Assuming private investors are not willing to put it up, the government will then have two options. It can increase the banks’ assets, by giving them more taxpayer money in exchange for an even greater ownership stake. Or the government can reduce the banks’ debts, by using its influence to encourage, or even demand, loan forgiveness.
Debt reduction, in exchange for an equity stake, is a standard strategy for dealing with failing companies. It’s what the Obama administration is trying to do with Chrysler’s and G.M.’s creditors. Under the tentative deal worked out on Tuesday, Chrysler’s creditors would receive about 28 cents in stock for every dollar of loans they forgave. But banks aren’t like other companies. Like it or not, they are the heart of the credit system and thus the economy. No matter what happens to Chrysler’s creditors, Honda won’t stop making cars, and people won’t stop buying them. Imposing losses on Bank of America’s creditors, though, has the potential to freeze the financial markets.
One sign that such concerns are legitimate is the fact that they’re shared by some economists who saw the financial crisis coming well before Fed officials or Mr. Obama’s current advisers. At a Fed conference in 2005, Raghuram Rajan — then the director of research at the I.M.F. and now a University of Chicago professor — criticized Alan Greenspan for turning a blind eye to risk (and was in turn criticized by Lawrence H. Summers, now Mr. Obama’s lead economic adviser). Today, Mr. Rajan says that haircuts really do have the potential to make some financial firms insolvent and cause worldwide problems. Yet he also says that the government should study whether it can sensibly impose any losses on creditors, rather than unquestioningly accepting Wall Street’s self-interested view that haircuts would be bad for the economy. “We constantly have to question the arguments the Street puts forward,” he said, “and ask whether they are really these holy cows who can’t be touched.”
Ever so gradually, the administration may be moving toward this more skeptical position. In February, the Treasury began twisting the arms of some holders of Citigroup preferred stock to get them to convert it into common stock. (Preferred stock, despite its name, is something between a loan and stock.) The credit markets hiccupped, but quickly returned to their previous state. In the wake of the stress tests, the Fed and the administration may well push for more conversions along these lines. The trickier issue is what to do with holders of so-called subordinate debt. In the spectrum of investments, subordinate debt is considered safer than preferred stock and tends to be subject to haircuts only when a company slides toward bankruptcy. Pushing a bank to the brink of bankruptcy would raise the specter of Lehman Brothers. Now, some debtholders may be fearful enough of bankruptcy that they would willingly accept haircuts, figuring they are better than the alternative. On “Meet the Press” on April 19, Mr. Summers said one option for increasing the banks’ capital was “asset liability swaps,” by which he meant a voluntary exchange of loan forgiveness for equity.
The government’s main role would be to force existing equity holders to offer the swaps to creditors. Equity holders often oppose such swaps because their own stake is diluted. But government regulators could insist that the offer be made and then allow debtholders to accept or reject it. If the offer were, say, 60 cents on the dollar and the market price of the debt only 50 cents, the creditors might accept. If steps like these, along with TARP, are enough to repair the financial system, haircuts won’t be needed. If not, the only remaining options will be more taxpayer money, more haircuts or both. We already know what the bankers will say about haircuts, regardless of how carefully they’re devised: that they’ll end up hurting the rest of us. Remember, though, they said the same thing about stronger financial regulation, and they turned out to be spectacularly wrong. Stronger regulation would indeed have hurt many bankers. It would have benefited the rest of us.
This month, I interviewed Mr. Obama for a Q. and A. to be published Sunday in The New York Times Magazine, and I asked him why his economic inner circle was dominated by protégés of Robert Rubin. These protégés, like Mr. Geithner and Mr. Summers, are deeply thoughtful people, just as Mr. Rubin is. But in retrospect, they all gave too much deference to Wall Street. Mr. Obama replied that his economic team also included people from outside the Rubin circle, which is certainly true. Still, Mr. Geithner and Mr. Summers remain the dominant forces in the team. When they — and the president — consider Wall Street’s warnings about haircuts, I hope they also consider its track record. Lately, taxpayers haven’t done very well when they’ve listened to Wall Street’s advice.
European economic confidence bounces back
European business and consumer confidence bounced back in April for the first time in nearly two years, the European Commission said Wednesday. The EU executive said its monthly survey of companies and shoppers across the European Union and in the 16 countries that share the euro showed more optimism for the first time since May 2007, rising from record lows. It said there was "a clear improvement in sentiment in industry and among consumers" in both regions. But EU and euro-zone construction companies were more downbeat than last month and euro retailers were also more pessimistic, not matching optimism from all EU retailers.
A separate survey of industry managers also rose for the first time since May 2008 but is still at a very low level and points to shrinking output for March, it said. Industry is also warning that it has cut back capacity to the lowest levels since 1990 -- to 71 percent in the EU and 70.5 percent in the euro area -- and expects to reduce investment by around a fifth this year. The economic sentiment indicator measuring confidence from consumers and different business sectors rose to 63.9 in April from 60.4 in March for the entire 27-state European Union. For the smaller euro area, the indicator rose to 67.2 this month from 64.7 last month.
Among larger countries, Italy, Britain, the Netherlands, Spain and Poland saw "significant increases in sentiment" with far smaller pickups in France and Germany. A survey of financial services -- not included in the overall figure -- also improved markedly, the EU said. Overall, business managers saw a better situation ahead and said they expected more demand for their services -- the first time they saw an improvement since October. Industry said they expected more new orders in the next three months. The business climate indicator -- which focuses on industry managers -- also increased in April to minus 3.33 from minus 3.49 in March.
The EU added a note of caution by saying sentiment was still at a very low level and pointed to another year-on-year contraction in industrial output in March, following a record fall in February. "It also suggests that annual industrial production growth will remain clearly subdued in April," it said. Managers' expectations of export orders continues to worsen, it said. A survey of industrial investment showed that managers in most EU nations also expect a sharp decrease in investment this year, saying it could drop 18 percent in the EU and by 20 percent in the euro zone. A fall 2008 survey had predicted only a 5-percent drop for both areas.
European Lending Declines in March as ECB's 'Deflation Problem' Worsens
Lending to euro-region companies and households declined for a second month in March, extending the worst drop since records began 18 years ago and threatening to exacerbate a recession. Loans fell 0.2 percent from February, when they declined 0.1 percent, the European Central Bank said in Frankfurt today. While a separate report showed banks expect to tighten credit standards less forcefully in the second quarter, the European Commission said consumers now expect prices to fall for the first time since at least 1990. “The hard lending data shows that the ECB is facing a deflation problem and will have to act more aggressively,” said James Nixon, an economist at Societe Generale SA in London and a former ECB forecaster. “Unfortunately, the Governing Council will probably latch on to the more positive bank survey and do a lot less than is necessary in the current environment.”
The ECB, which has lowered its benchmark interest rate by 3 percentage points since early October to a record-low 1.25 percent, is under pressure to indicate what other measures it can use to stem Europe’s worst recession since World War II. While some reports indicate the downturn may be easing, a contraction in lending may hinder any recovery by curbing the amount of money available for investment and spending. Spain’s central bank said today its economy shrank by the most since at least 1970 in the first quarter and the commission reported that capacity utilization by European companies was the lowest since 1990. Loans to the private sector grew at the lowest annual rate on record, expanding 3.2 percent in March from a year earlier, the ECB said. “Bank credit volumes are clearly being squeezed by the double whammy of tighter supply and weaker demand,” said Martin van Vliet, senior economist at ING Groep NV in Amsterdam. “Euro-zone money and credit data for March will reinforce pressure on the ECB.”
At the same time, European stocks and the euro rose today as companies from Siemens AG to Sanofi-Aventis SA reported earnings that beat analysts’ estimates, stoking optimism that the outlook is improving. The European Commission said that confidence in the economic outlook increased for the first time in 11 months in April, and the German government forecast the region’s largest economy will return to growth next year. The Dow Jones Stoxx 600 Index of European shares added 0.9 percent, trimming its 2009 decline to 1.5 percent. The euro strengthened 0.9 percent to $1.3263. ECB policy makers convene for their next rate-setting meeting in Frankfurt on May 7. President Jean-Claude Trichet has indicated the bank will cut its benchmark rate again and promised to announce new non-standard measures combat the crisis. So far, the ECB has resisted following the Federal Reserve and Bank of England, which have cut their key policy rates to close to zero and started pumping money into their economies by buying government and corporate debt.
The ECB has focused on trying to revive bank lending by offering financial institutions as much cash as they want against eligible collateral for up to six months. Some policy makers have suggested the ECB may soon start lending banks money for longer periods. In a report on its bank lending survey, the ECB also said that the net percentage of banks expecting credit standards for companies to tighten in the second quarter fell to 28 percent from 47 percent in the first three months of the year. After today’s data, “the bank will no doubt feel justified in pursing the monetary course already embarked on,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt. “It can be expected to decide at the next council meeting to lower the refinancing rate to 1 percent and extend the maturity periods for tender operations, but not to announce an outright purchase of securities on the secondary market in the current climate.” The ECB also said today that M3 money-supply growth, which its uses as a gauge of future inflation, slowed to 5.1 from 5.8 percent in February.
Fortis shareholders approve sale to BNP Paribas
Shareholders of Fortis approved the sale of assets to France's BNP Paribas on Tuesday, bringing the controversial carve-up of the group closer to conclusion after last year's rescue. After a debate that descended into chaos with investors throwing shoes and coins at the chairman, 72.99 percent of shares voted in favour of BNP's purchase of a 75 percent stake in Fortis Bank, the Belgian banking business currently in state hands. A majority of votes at a second meeting in the Dutch city of Utrecht on Wednesday will be required for the deal to be approved. The outcome there should be very similar given that shareholders can vote at both meetings. Under the deal BNP Paribas will take the majority stake in Fortis Bank to make it the euro zone's largest deposit holder through its push into Belgium and Luxembourg. It will also indirectly buy a 25 percent stake in Fortis Insurance Belgium from Fortis Holding for 1.375 billion euros. BNP Paribas's shares were down 2.8 percent at 37.16 euros on Tuesday. Fortis shares were suspended. "For BNP it doesn't change that much. It was already priced into the stock," said GSD Gestion fund manager Christophe Gautier. "BNP shares are more affected by what's happening in the broader banking sector."
The Belgian government said it was happy with the result, and looked forward to another shareholders vote in Utrecht tomorrow to conclude the deal. "After that, we'll put everything in place to consolidate the future of Fortis Bank," Belgian prime minister Herman Van Rompuy said in a statement. The protracted saga led to the collapse of the Belgian government in December, a series of legal battles and a several heated shareholders meetings, one of which was stalled by a bout of wrestling. Fortis, stretched by its 24 billion euro purchase of the Dutch business of ABN Amro in 2007, was carved up by Belgium, the Netherlands and Luxembourg in October after an 11.2 billion-euro cash injection failed to calm investors. Tuesday's meeting was suspended twice after shareholders vented their anger over the ABN deal's top-of-the-market price just before market crash, which caused destroyed life savings. Fortis's Dutch activities are held by the Dutch state.
Shares in Fortis, once considered an essential part of every prudent Belgian investor's portfolio, have fallen to below 2 euros from almost 30 euros before it's ill-fated ABN Amro bid. Investors opposed to the deal, such as those represented by lawyer Mischael Modrikamen and activist investor group Deminor, say that BNP is not a saviour but an assets stripper. They believe shareholders would be best served if Belgium returned Fortis Bank in exchange for a stake in Fortis. The legal battle continued until just hours before the deal. Rebel investors wanted voting rights for some 170 million shares to be removed from the vote on the sale to BNP, arguing that Fortis had not made clear who owned these shares. A Belgian court rejected the request on Tuesday morning. Modrikamen has said he plans further legal action. "I am particularly shocked by what we have witnessed, he said. "We will now examine options and clearly suspension of this decision is one of the options that we have.
4,820 CalPers Retirees Receive Annual Pensions In Excess Of $100,000
We have a lot to worry about these days. We’re worried that we may lose our jobs, that we may lose our healthcare insurance and that we won’t have sufficient retirement savings. We realize that without jobs we can’t make our mortgage payments; we know that our homes have dropped in value resulting in little or no equity, so we can’t afford to stay in or sell our homes. In California there is one lucky group that doesn’t have those worries: state and local government retirees. As of May, 2008, there were 4,820 CalPERS retirees receiving annual pensions in excess of $100,000. That didn’t include government retirees in 80 other plans in California—judges, UC, STRS, charter cities, and 1937 Act counties. About half of these retirees were public safety workers: cops, firefighters, prison guards. The remaining half includes former city managers, assistant managers, county executives, district attorneys, engineers, finance officers, personnel directors, computer scientists, and physicists.
Since May 2008, more than 120 new retirees have joined the “$100,000 Club” – each month - every month. That’s been going on for the last 12 months – more than 1,500 have joined that well-paid retirement group ; this rate of increase will accelerate as droves of retired public safety workers who are now in the $90,000 to $100,000 range receive annual cost of living increases. Led by labor unions, this group has profited tremendously. When the dot com boom artificially inflated stock prices (giving pension funds surplus assets) those union representatives convinced former Senator Deborah Ortiz to carry SB 400 to give pension fund surpluses to government workers by increasing retirement benefits while lowering retirement ages. When real estate values exploded, developers’ fees, property taxes and sales taxes increased and labor negotiators demanded that those higher revenues be spent on higher worker salaries. The combination of generous formulas, lower retirement ages, and higher salaries (used in new formulas) means that career cops, among others, now receive pensions that exceed their final year’s wage, and for more years in retirement than they ever worked.
These guaranteed generous pensions come at a terrible price. Even before the stock market crash, unsustainable pension and retiree health costs forced the City of Vallejo to declare bankruptcy. The state, cities, and counties were struggling to pay pension costs before the market crash. Today they are ill equipped to take on any new spending as they brace for much higher pension plan contributions in 2010 - just when the market crash in pension funds will fully impact their budgets. It’s ironic that we are seeing layoffs of active police and firefighters in order to pay benefits for retirees. Have we lost our common sense? What can we do to stop this increasingly unsustainable outflow of funds? A 2nd tier of benefits must be provided to new government workers that scales their pensions back to reasonable levels for all new government workers .
Benefits should be uniform for miscellaneous workers and safety workers no matter if they work for a city, the state, or a special district. Just like social security, the benefits should be portable, so when a worker transfers to another agency, his retirement benefit continues without a break in service. But folks at the Capitol are loathe to even entertain this idea. In an attempt to stop the coming train wreck, Governor Schwarzenegger created the Post Employment Benefit Commission in 2007 to study the problem and make recommendations to handle it. That final report concluded, “With respect to funding these critical benefits, it is important to emphasize that each public agency in California faces different funding constraints, personnel needs, and organizational purposes. A one-size-fits-all approach is neither appropriate nor practical.” Nonsense! Tell that to the Social Security Administration, Federal Employee Retirement System, and almost all other states that have uniform benefits for all government workers.
Others ask, “If agencies have the ability to scale back benefits for new workers, why is legislation necessary to force everyone to adopt lower, uniform formulas?” It is next to impossible to scale back benefits, even for new employees, because unions fight fiercely against these attempts. When the Governor was forced to furlough workers to cut costs this year, he was compelled by unions to make pension contributions based on full salaries. Unions consider pensions inviolable. Pete Wilson successfully rolled back pension formulas for new workers when he was governor, but that was years before unions rose to the power they enjoy today. Some cities are going through their 2nd round of increases. If nothing is done, eventually all government employers will have adopted the highest formula allowed. History proves employers grant pension increases in bad times as well as good times. We must stop this nonsense at the ballot box.
Ilargi: Heck, let's include this drivel, so you can see what level of publication Barron's is.
Fed Fights a Record Global Bank Run
The Federal Reserve has been roundly castigated in some quarters -- even former high officials of the central bank -- for its aggressive and unprecedented steps to combat the credit crisis. But data just released by the Bank for International Settlements suggest that, if anything, the expansionary measures taken by the Fed (and in concert with the Treasury Department) were dwarfed by the record contraction in the global banking system brought on by the crisis. According to the BIS, which acts as a central bank for central banks, total bank claims shrank by $1.8 trillion in the fourth quarter, or 5.4%, to $31 trillion. This was the largest decline ever recorded.
In other words, there never was a global run on the banking system such as the one seen in the final three months of 2008, which followed the bankruptcy of Lehman Brothers and the near-collapse of American International Group (ticker: AIG) in September. The numbers serve to confirm the extent of the tsunami that swept through the world's financial system. As the balance sheets of the global banking system threatened to shrink like a dying star and create an economic black hole that could suck in the world's economy, central banks and treasuries around the world responded in kind. In the U.S., the Fed doubled the size of its balance sheet, to about $2 trillion from $900 billion in the fourth quarter, and is in the process of adding another $1.15 trillion to its assets through the purchase of Treasury and U.S. agency obligations and mortgage-backed securities. Meanwhile, the federal government established the Troubled Asset Relief Program to pump $700 billion into the banking system.
Meanwhile, authorities abroad have established similar programs, notably in the U.K. Central banks from Japan to Canada have embarked on similar "quantitative easing" plans, effectively printing money to offset the credit contraction that has taken place in unprecedented proportion. Unlike in the 1930s, when central banks actually aided and abetted the collapse of the banking system, today's leaders responded to the unprecedented crisis in the fourth quarter with equally unprecedented force. Yet, Fed officials find themselves uncharacteristically on the defensive for their actions, even from former, highly respected officials of the central bank. As with former presidents, retired Fed officials generally have followed the protocol of not criticizing their successors.
Former Fed Chairman Paul Volcker, who saw through the fight against inflation in the late 1970s and early 1980s against fierce opposition from all quarters, has not been so reticent of late. While he kept mum during the term of his direct successor, Alan Greenspan, he has taken to task the Bernanke Fed, as well as the Treasury, for their aggressive counter-attacks against the credit crisis. "I don't think the political system will tolerate the degree of activity that the Federal Reserve, in conjunction with the Treasury, has taken," Volcker said at a symposium on monetary policy in Nashville, Tenn., last week. Similarly, Bloomberg News quoted William Poole, the monetarist former president of the St. Louis Fed, as complaining that the central bank's actions threaten inflation.
Fed officials are "dramatically underplaying the risks and the liability side of the balance sheet," said the economist who now is a consultant to an investment group. Yet, the effects of the shrinkage of the private banking system's balance sheet are unequivocally evident. It's now history that fourth-quarter gross domestic product shriveled at a 6.3% annual rate. What's become apparent is that the real output of the finance industry shrank last year at nearly twice the previous record rate of decline, according to JPMorgan Chase (JPM) economist Michael Feroli. Real output in the finance industry fell 3.0% in 2008, compared to the previous record of a 1.6% decline in 1958. Because finance looms much larger in the economy, last year's contraction shaved a hefty 0.24% from GDP, compared to just 0.05% in 1958.
From 1997 to 2000, finance typically kicked about 0.5 percentage points to GDP growth, Feroli notes. In 2008, only construction and manufacturing detracted as much or more than finance from GDP, 0.24% and 0.32%, respectively. Construction and manufacturing are directly affected by the collapse in credit, so the financial travails extend far beyond Wall Street. Now, however, policy makers are accused of being too solicitous of Wall Street. To be sure, banks, including the I-banks, have benefited from the actions of the Fed and the Treasury. But that is separate from the question of the macroeconomic impact of their actions. Those who contend that the expansion of central bank balance sheets is inflationary ignore the contraction of balance sheets in the banking system, as well as the so-called shadow banking system of assets and liabilities not recorded on banks' books.
This analysis is very different from arguments that appeal to the "output gap," the difference between the economy's potential output and actual production. That analysis effectively says that high unemployment will hold down wages and prices, which manifestly did not happen in the staflationary 'Seventies. Inflation, as Milton Friedman taught, is always and everywhere a monetary phenomenon. Yet the current central-bank expansion is offsetting the contraction in the banking system -- which Friedman criticized the Fed for failing to do in the 1930s. The new BIS data bear out the justification for the Fed's actions, notwithstanding the critics' claims.
Green shoots: grounds for cautious pessimism
by Willem Buiter
I am not going to use this opportunity to deepen the gloom by exploring at length the possible consequences of a worldwide pandemic of a virulent form of swine flu. Just a few depressing words will have to suffice. From an economic perspective, a flu pandemic amounts to at least a temporary reduction in the effective supply of labour. If flu-related mortality is high, there will be a permanent reduction in labour supply. The dependency ratio rises (temporarily or permanently, depending on whether mortality increases). Trade and travel are interrupted. A flu pandemic therefore represents an adverse supply shock. Notional consumption demand need not decline materially, but effective consumption demand may well be depressed if many would-be shoppers cannot reach the sellers of goods and services or arrange for delivery. Investment is bound to suffer.
A flu pandemic therefore also represents an adverse shock to aggregate demand. It is bad news on both the demand and supply side. It will however, impact favourably on global warming. Now you know. In what follows I will analyse global economic prospects on the assumption that there will not be a global swine flu pandemic. The real economy downturn in the US is about 1,5 years old; the UK recession has been with us for at least three quarters; the rest of Europe, Japan and most emerging markets and developing countries have juvenile recessions, barely a couple of quarters old.
As regards the overdeveloped world, or at least the North Atlantic part of it, the odds are that this contraction of real economic activity will be deeper and last longer than other post-war recessions. The reason is that other post-war recessions were either the results of central banks murdering a boom that threatened price stability or of an exogenous oil price increase (Opec I and II). Following both types of downturns, the financial system (markets, banks and other systemically important institutions) were, on balance, in good shape (cyclically adjusted!). Banks suffered as a result of the decline in demand for external financing by households and non-financial enterprises caused by the recession, and from the increase in arrears, defaults and other delinquencies that come with an economy-wide slowdown. But the capacity of the system for providing intermediation services and external financing for households and non-financial enterprises was typically in reasonable shape.
Not so today. The crossborder North-Atlantic financial system had collapsed before the downturn in the real economy got going in earnest. Indeed, the financial collapse was the primary cause of the recession in the USA, the UK, Iceland and most of the rest of Western Europe. We know from the studies of Reinhart and Rogoff and of Laeven and Valencia that real economy contractions that follow a financial crisis tend to be both longer and deeper than those that don’t. Specifically, following deep financial crises, the unemployment rate rises an average of 7 percentage points over the down phase of cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, and the duration of the GDP downturn averages around 2 years.
US real GDP growth was -0.2 percent in 2007, Q4 (on the previous quarter), but became positive again the next two quarters (0.9 percent growth in 2008Q1 and 2.8 percent in 2008 Q2). Since then, growth has been negative, with -0.5 percent in 2008Q3 and -6.3% in 2008Q4. The Reinhart-Rogoff downturns are measured from previous peak GDP, which was 2008Q2. If the US conforms to the average of the post-World War II serious financial crisis countries studied by Reinhart and Rogoff, negative GDP growth would persist until 2010Q2. Growth after that would be slow and hesitant. The 2008Q2 level of GDP would be regained at the earliest around the middle of 2012. Unemployment would still be far above the 2008Q2 level at that time.
There is little reason to assume the US will do better than the average achieved post-world war II. Its room for discretionary fiscal stimuli has been more than exhausted. Almost two years have been wasted since the beginning of the financial crisis as regards getting past toxic assets off the balance sheets of the banks. The US regulators and Treasury have put the interests of the unsecured creditors of the banking system ahead of those of current and future tax payers and beneficiaries of public spending. Worse than that, by failing to come up with the required amount of up-front fiscal resources to clean the balance sheets of the zombie banks, recapitalise the banks and, where necessary, guarantee new lending and borrowing, the US authorities have relegated most of the banking system to a state of limbo in which far too little new lending to the real economy is undertaken. The sloth-like speed of the stress tests and the six months grace period granted banks deemed short of capital to come up with new capital on their own, contribute further to my sense that the authorities in the US are doing everything they can to make sure that the US gets as close as possible to emulating Japan’s lost decade.
What limited bank lending takes place is often at high interest rates, and is funded at government-subsidised rates (about $340bn worth of borrowing by banks has so far been guaranteed by the state). These tax-payer-engineered high spreads on limited new lending, plus the welcome transfusion of taxpayers’ money through AIG paying off its counterparties at 100 cents on the dollar gave a useful boost to many banks’ Q1 profits. Add to that the under-provisioning by many banks for new loan losses, plus the new latitude granted by the FASB to banks wishing to window-dress the depressed mark-to-market value of some of their securities, plus the wonderful accounting convention that permits banks to count as revenue reductions in the market value of their traded debt caused by a loss of market confidence in their creditworthiness, and the banking profitability green shoot is visibly wilting on the vine.
Disguising the new damage done to the banks’ loan book by the contraction of the real economy will become harder as time passes. By the end of the year, I expect that the combination of the stress tests and the reluctant revelation of new bad loans may bring us to the point that even the authorities can no longer shrink from restructuring the insolvent components of the banking system by forcing the unsecured creditors to swap their debt and other claims for equity. Only then can the banking system as a whole begin to function normally again - one hopes under very different rules of the regulatory game.
The inventory cycle
The inventory cycle is short and sharp. Statistically, inventory accumulation and decumulation often account for more than 100 percent of the business cycle. This is unlikely to be the case in the current cycle. Final demand (private consumption, private fixed investment, exports and government spending on goods and services) is contributing to the downturn and will have to turn around to achieve a sustained recovery. With financial intermediation in tatters, external finance for would-be financial deficit units, households or firms, will be hard to find and expensive. Most households have suffered massive losses of financial wealth and will want to restore their financial health by saving more. Other final demand components are also unlikely to become buoyant in a sustained manner anytime soon. Private fixed investment is likely to be week for the next couple of years because of prevailing excess capacity and limited availability and high cost of external funds. US export growth inn unlikely to be a major source of demand.
Government spending will grow quite rapidly, but the dire fiscal condition of the Federal government effectively precludes further discretionary expansionary fiscal measures. Federal government deficits significantly larger than those envisaged here would unnerve the financial markets and trigger a buyers’ strike in the US Treasury debt markets, either because of a fear of default (quite unlikely) or because of a fear of large-scale irreversible future monetisation and inflation (quite likely). I know it’s not priced in the long-term US government bond yields yet, but this would not be the first time financial markets have been wildly irrational in recent years - so just you wait.
Asset price stabilisation
House prices continue to fall. While house price changes don’t have an aggregate wealth effect, they do affect the capacity of households to borrow, because property, unlike human capital, makes rather good collateral. Until house prices stabilise, it is hard to see consumption reviving. Even with the recent (in my view premature) recovery in the US equity markets, stock market wealth in the US has come down spectacularly from its previous peak, and is now, in real terms, at about its 1996/1997 level. Talk of a lost decade…
In Europe, the UK is in many ways the US with a half-year lag. The size of its banking sector relative to the economy and to the fiscal capacity of the government and the absence of global reserve currency status for sterling makes the UK more vulnerable than the US to a triple crisis - banking, exchange rate and sovereign debt. The ability of the UK authorities to raise future taxes or slash public spending is, however, likely to be greater than that of the US, whose political system is polarised to the point of paralysis. The US, like the UK, is therefore at risk of a ‘sudden stop’ (an unwillingness of anyone to fund the sovereign and an unwillingness of the rest of the world to fund either the private or public sectors of the US), as long as US political infantilism, especially in the US Congress, guarantees a veto for any sensible (or even just arithmetically feasible) proposal for solving the scary fiscal unsustainability problem of the US.
The rest of Western Europe is dead in the water. The ECB is paralysed, partly by fear of the zero lower bound on interest rates among some of its Governing Council, partly because of the absence of a ‘fiscal Europe’, capable of recapitalising the ECB/Eurosystem should it suffer a serious capital loss as a result of private sector credit exposure incurred as a result of its monetary, liquidity enhancing and credit enhancing operations. Countries that have fiscal credibility and could do more as regards Keynesian fiscal stimuli, like Germany and France, refuse to do so. The recession in Western Europe started about a year after that in the US. It will last at least as much longer. The banking system of Western Europe (ex-UK) has been even more reluctant than that of the US and the UK in owning up to the disastrous state of its balance sheet. At least €500bn additional capital will be required to keep the continental West-European banking system on its feet. More will be required if it is to actually start lending in earnest again.
I don’t understand the Japanese economy. Never have. Probably never will. Will they be a locomotive for the rest of the world? Everything’s possible but not everything’s likely. Japan’s public debt to GDP ratio is 180% of GDP and rising. Yet even long-term rates on nominal public debt remain very low. The main reason is, I believe, that while the Japanese state runs a massive financial deficit, the Japanese private sector runs an even more massive financial surplus. The consolidated financial position of the country has been one of persistent current account surpluses. Private financial wealth is huge and the net international investment position of the country is a large positive number. (Italy has a milder version of the same configuration of private and public saving and borrowing propensities).
So if the markets believe that the Japanese political system is and will be capable of achieving, sooner or later, the large resource transfer from the private sector to the public sector that is required to make the public finances sustainable, the overall financial position (flows and stocks) of the country is what matters. And these consolidated national flows and stocks still look pretty good. This in contrast to the US and the UK, where looming fiscal deficits combine with low private saving propensities to create enduring doubt about fiscal sustainability. As regards Italy, I am less than fully confident that the Italian tax payer/beneficiary of public spending will do as (s)he is told by the nation’s fiscal authorities, now or in the future.
The prospects of the emerging markets depend, first, on their dependence on external demand, second, on their dependence on external finance and, third, on the scope for expansionary domestic demand management and the ability of the authorities to use it intelligently and flexibly. No emerging markets suffered the destruction of their banking systems prior to going into recession. Their contractions are the result of the external transmission of the north-Atlantic financial crisis and contraction, through trade linkages, through deteriorating terms of trade (especially for commodity producers), through falling remittances, through the financial markets and through the parent banks of foreign-owned local subsidiaries and branches restricting the availability of re-financing and new funding to their local subsidiaries and branches.
The emerging markets that are best poised to enjoy a speedy recovery (following a V-shaped recession) are those that do not depend excessively on external finance and on external demand. China certainly fits the bill as regards lack of dependence on external finance. Like many other emerging markets that suffered through the Asian and Russian crises of 1997-1998 or observed it closely, China self-insured against an interruption of external financing flows by building up massive liquid foreign exchange reserves. Chinese reserves today even exceed those of Japan. India, Brazil, Korea, Malaysia, Singapore and Taiwan also built up large foreign exchange reserves.
China does not fit the bill, however, as a candidate for a sustained early recovery because of its external trade dependency. Growth in demand for its exports will not revive anytime soon. The country is not large enough to pull itself up by its own boot straps, unless it achieves a radical restructuring of its production and a shift in the composition of final demand away from exports and towards domestic final demand. China recognises this and has thrown the kitchen sink at the problem. Although it is hard to understand the exact size of the fiscal stimulus it has provided, there is no doubt that this stimulus was large. Interest rates have been cut. Credit growth, including bank lending to state enterprises and to construction has exploded. The problem with this approach is that the composition of the demand stimulus and production boost is completely wrong. The government has simply done more of whatever it was doing in the past: increased investment in the production of exportable goods and heavy industry (metals and chemicals), increased production of semi-finished manufactured goods and increased investment in infrastructure. The inevitable result of this investment boom will be increased excess capacity in exportables and unprecedented environmental destruction.
China is missing a huge opportunity. Its short-run imperative (boost demand through a fiscal stimulus) coincide with its long-run imperative (reduce the national saving rate and the external current account surplus). This stands in sharp contrast to the US and the UK, where the short-run imperative (boost demand through a fiscal stimulus) conflicts 180 degrees with its long-run imperative (save more and reduce the external current account deficit). China saves too much in the household sector, the corporate sector (especially the state enterprises) and the public sector. It badly needs an unfunded pay-as-you go social security retirement scheme to boost consumption by the old. China’s fiscal position is such that the country could introduce the benefit (pension) part of the social security scheme for a number of years without having the social security tax in place!
China’s rapidly greying population and the one-child policy mean that, without a credible, universal, publicly funded social security retirement scheme, it is individually rational to save like crazy, because neither the state nor your children will be able to look after you in old age. Another way to boost public consumption (and reduce household saving), is to guarantee decent quality medical care for all regardless of ability to pay. Saving to pay for private tuition for one’s (only) child is another important driver of private saving in China. Providing better quality public education could free private resources for consumption.
But a boost to consumption demand (private and public) of this nature requires a matching change in the structure of production towards consumer goods and services and away from heavy industry. China hasn’t even begun to address this shift of demand towards non-traded goods and imports and of production towards consumer goods and services. Even if its ultra-old-school demand stimulus does not get killed (yet) by environmental constraints (clean fresh water, clean air, clean soil etc.), it will certainly be killed by mismatch constraints as the country adds massively to its capacity to supply goods nobody wants. The green shoots we may be seeing in China will therefore not endure unless the country manages, very rapidly, a radical change in the composition of its production and consumption. That is possible, but not likely.
A country like India - much less dependent than China on external demand but rather more dependent on external finance - could also recover rather soon, and in a more sustainable way, especially if it finds a way to further stimulate domestic saving. But its weight in the world economy is slight - not enough to be a locomotive, not even the little engine that could. Other emerging markets, like Brazil, have been hit hard by the global downturn and by the freezing up of key financial markets despite being net foreign creditors and running external surpluses prior to the crisis. Brazilian corporates were heavily exposed to the international financial markets, often at short maturities. While the central bank, thanks to its large foreign exchange reserves, was capable of preventing large-scale defaults, the financial squeeze on Brazil’s corporations, plus the terms of trade shock and the decline in export demand has caused the country’s industrial production to fall off a cliff. One would expect it to be able to recover sooner than the US or Western Europe, if it can direct demand towards domestic sources.
Eastern Europe (including the CIS) is the most dramatic victim of the made-in-Wall-Street/City-of-London/Zurich crisis. Virtually all countries in the region were heavily dependent on external financing and on foreign trade. Some, especially in the CIS, are major commodity exporters. Western banks are often the parent banks of the local branches and subsidiaries. As the barbarians threatened Rome, headquarters withdrew the Legions from the provinces. Parent banks are ruthlessly cutting the access to funds of their subsidiaries and branches in CEE. No help will come anytime soon, with the members of the old EU barely capable of keeping their own trousers up.
The only reasonably convincing evidence of ‘green shoots’ comes from China. That, however, is unlikely to be sustainable, as it is very much the result of a ‘same-as-it-ever-was’ package of fiscal, monetary and credit policy measures by the Chinese authorities. The export- and heavy-industry led expansion they have successfully engineered is the way of the past. It will go nowhere, unless China transforms the composition of both production and demand in the directions that are unavoidable (and also desirable) for a country at its level of economic development. Apart from China, the only green shoots I have seen were in the salad bar of the hotel I am staying at.