Corn planting in Jasper County, Iowa
Ilargi: As both Bill Black, in conversation with Bill Moyers, and Julian Delasantellis at Asia Times (no less interesting than Black) explain once more, at length, how insidious, widespread, and deeply embedded corruption and fraud have become in the White House-Wall Street revolving corridors over the past decade or two, we simultaneously learn that Larry Summers, one of the pivotal players in those corridors, has accepted $5.2 million from a hedge fund he is today supposed to regulate, as well as millions more in speaking engagements are the financial industry.
There were times when people like Summers were forced to step down in the face of such blatant potential conflicts of interest, but these days it's hard to escape the feeling that these activities have become so all-pervasive that none of the actors see much difference between themselves and their peers and colleagues.
And so the lines once drawn between what is legal and what is not, what is sound policy and what is abuse of power and trust, grow less transparent by the day. Of course you can't let a person who’s waiting for a big fat paycheck have a say in regulating the sender of that check. Or at least there was a time when that was considered out of the question. Times have changed. Nowadays, it has become the norm, and only a handful of people raise a voice of protest. By the time the main media catch up, if they ever will, the additional damage done to the interests of the people, financial and otherwise, will be huge. Several times annual GDP-size huge.
And when we look at that, who could still be surprised to see that AIG spends millions of dollars of your money on PR campaigns intended to persuade you that its present management team is not to blame for the litany of losses and illegal money transfers to Wall Street that we have witnessed so far? It's all in a day's job for a clique of insiders who are permitted to get away with ever more -borderline- criminal activities, aided and abetted by the people's chosen representatives. Indeed, they are emboldened by the lack of adversity they have encountered, apart from an overinflated hot-air hullaballoo over a few handfuls of bonuses.
I have condemned Obama's Rubin-Summers-Geithner team from the start, because it is made up of exactly the same people who under Cinton enforced and facilitated the erosion of those US laws that kept unbridled greed in check on Wall Street. They will never turn their back on those who gave them the power and status they presently enjoy. On the contrary, they will make sure more of the same is in the works. As long as they are in charge, there will never be any recovery in America, just more looting and pillaging. And no matter how popular Obama is today, he is very much to blame for allowing the plunder to continue.
It seems fitting, then, to take a look at the bear market rally, the biggest 4 week rally perhaps since the 1930's. Of course, financiers and the politicians on their payrolls will use it to declare that we have been saved, that the worst is over, and most of all that the trillions thrown into the black holes were well spent. Their control over the media guarantees that that message will be heard all over. And don't we all want to believe? Bernanke takes the lead in insisting that the stimulus has already started working (and for $12.8 trillion, you’d expect at least something). But if it were truly so, then Britain would have to see similar effects, since they took measures that were largely the same as the US, and sometimes even earlier.
Instead, this -and next- week's attempts by the UK government to prepare the population for an upcoming -behemoth- IMF loan for Britain raise strong suspicions that Gordon Brown et al indeed have no choice but to go the IMF route. And no matter how they try to soften the message and the impact, the shock will be immense. It also says a thing or two about Britain's perceived ability to raise money through the bond markets, whether it's because the Brits don't believe in the bond markets, or because the markets don’t believe in the Brits. WIll it be radically different for the US? Sure, US debt is more in demand. But don't let's forget that there is also a lot more supply. The future course of the stock markets, after the suckers have been cleaned out, will to a large extent depend on the balance between the supply and demand game in the bond markets, and Britain's recent experiences should at the very least be cause for reflection.
Hedge Fund Paid Summers $5.2 Million in Past Year
Top White House economic adviser Lawrence Summers received about $5.2 million over the past year in compensation from hedge fund D.E. Shaw, and also received hundreds of thousands of dollars in speaking fees from major financial institutions.A financial disclosure form released by the White House Friday afternoon shows that Mr. Summers made frequent appearances before Wall Street firms including J.P. Morgan, Citigroup, Goldman Sachs and Lehman Brothers. He also received significant income from Harvard University and from investments, the form shows.In total, Mr. Summers made a total of about 40 speaking appearances to financial sector firms and other places, with fees totaling about $2.77 million. Fees ranged from $10,000 for a Yale University speech to $135,000 for an appearance paid for by Goldman Sachs & Co.
The disclosure -- in a financial report that is required for federal office holders -- comes as Mr. Summers is involved in shaping the Obama administration's policy decisions on the financial meltdown as well as the broader recession. Among the many decisions the economic team has wrestled with has been whether to step up regulation of hedge funds, one of the most contentious subjects during a summit of world leaders this week. European nations pushed for tougher rules, while the Obama administration preferred a less stringent approach. Asked to comment, White House spokesman Ben LaBolt said that, "from the first days of the administration, we have bolstered accountability over banks" and made other rules changes so that "the influence of lobbyists is curbed, executive compensation is reined in, and firms are required to show how they will preserve or expand lending using government funds."
He added: "Dr. Summers has been at the forefront of this administration's work to shore up our nation's financial system and to put in place a regulatory framework that will strengthen the financial system and its oversight -- all in an effort to help the families across America who have paid a very steep price for risky decisions made by Wall Street executives." A White House official added that the speeches "long pre-date Summers's work as an official of the Obama administration or even the Obama transition. He was not an adviser to or an employee of the firms that paid him to speak."
Mr. Summers joined D.E. Shaw Group in late 2006 as a managing director. He helped develop strategies including new businesses and also helped evaluate investments for the New York firm, which oversees about $30 billion in assets, making it one of the biggest hedge-fund managers in the world. A D.E. Shaw spokeswoman couldn't be reached for comment. In at least one instance, Mr. Summers shed fees paid to him from a Wall Street firm that received federal funds. His form shows that he received a $45,000 speaking fee from Merrill Lynch on Nov. 12 -- about a week after Barack Obama won the election -- and that he donated the sum to charity. The White House official said that when Mr. Summers "became aware that Merrill Lynch would be accepting taxpayer funds through its merger with Bank of America, he attempted to cancel his appearance." The official added that "when he was unable, he elected to donate those funds to charity."
Mr. Summers also received significant income from Harvard University, where he served until 2006 as president, and from investments, his disclosure form shows. In addition to the Summers form, the White House released financial disclosure material for other top aides. David Axelrod, the president's top political advisor, reported in his form that he will get $3 million over the next five years from the sale of his two media consulting firms, ASK Public Strategies, LLC and AKP&D Message and Media. In addition, Mr. Axelrod took a salary of $896,776 last year from AKP&D and reported $651,914 in partnership income from the two companies. In total, Mr. Axelrod reported assets valued between $6.9 million and $9.5 million. Mr. Axelrod's clients were mostly political campaigns, including those of Rep. Patrick Kennedy, New York Attorney General Andrew Cuomo, and Chicago Mayor Richard M. Daley. He also reported receiving money from large corporations such as AT&T Inc., Comcast Corp. and the nuclear energy company Exelon Corp.
National Security Adviser James Jones reported $900,000 in salary and bonus from the U.S. Chamber of Commerce as well as director fees from a number of corporations. He received, for example, $330,000 from Boeing Corp. and $290,000 from Chevron Corp. Gregory Craig, White House Counsel, reported receiving a salary of $1.7 million last year from Williams & Connolly, the high-powered Washington law firm where he had been a partner since 1999. White House Social Secretary Desiree Rogers collected a $350,000 salary from Allstate Financial as president of the social networking division, as well as $150,000 in board fees from Equity Residential, a real estate investment trust in which she also holds at least $250,000 in stock. She also collected $20,000 in board fees from Blue Cross Blue Shield. Other assets reported in her checking account, stock investments, and mutual funds total at least $2 million.
Valerie Jarrett, assistant to the president for intergovernmental affairs, lists a $300,000 salary and $550,000 in deferred compensation from The Habitat Executive Services, Inc., in Chicago. Ms. Jarrett also disclosed payments of more than $346,000 for service on boards of directors that reflect her political ties, and work in Chicago real estate and community development. She was paid $76,000 last year for service as a director of Navigant Consulting, Inc. a Chicago-based global consulting group with governmental clients. She received $146,600 for service on the board of USG Corporation, a building materials manufacturer, and $58,000 to serve on the board of Rreef American REIT II, a real estate investment trust based in San Francisco. The Chicago Stock Exchange, Inc., paid her $34,444 to serve on its board.
Deputy National Security Advisor Tom Donilon earned $3.9 million as a partner at the law firm of O'Melveny & Myers LLP, where his clients include Citigroup, Inc., Goldman, Sachs & Co., and Obama fundraiser and heiress Penny Pritzker. Carol Browner, assistant to the president for energy and climate change, disclosed earnings of between $1 million and $5 million from lobbying firm Downey McGrath Group, Inc., where her husband, Thomas Downey, is a principal. She states $450,000 in "member distribution" income, plus retirement and other benefits from The Albright Group, a lobbying firm whose principals include former Secretary of State Madeline Albright. Some White House aides received considerably more modest compensation.
Director of Domestic Policy Council Melody Barnes reported modest retirement investments and $88,000 in income from her work on the Obama campaign and transition team, including $30,000 in consulting fees from Washington, D.C.-based firm The Raben Group. Director of the White House Office of Urban Affairs Adolfo Carrion reported no assets outside of his $160,000 salary earned as borough president of the Bronx and retirement funds for him and his wife. Patrick Gaspard, Director of the Office of Political Affairs, reported no assets aside from income of $198,000 combined from the SEIU International Union and Mr. Obama's presidential campaign. His listed liabilities are $10,000 to $15,000 in credit-card debt and $15,000 to $20,000 in student loan debt.
Harvard Derivatives Whiz Fired For Emailing Larry Summers About "Frightening" Trades?
Late update: Harvard spokesman John Longbrake called to emphasize that the university had conducted thorough investigations of all allegations about Harvard Management Company and point out the 13.8% annualized returns HMC delivered in the ten years that ended June 2008. In a separate development, we learned that Mack was scheduled to be the subject of a February 23 Newsweek story by Michael Hirsh that had been subsequently shelved. Hirsh declined to comment.
A former quantitative analyst at Harvard Management Company, the university's once-vaunted endowment manager, tells the Harvard Crimson she was fired for voicing concern to then-university president Larry Summers' chief of staff about the money manager's risky use of derivatives the traders didn't understand.
The episode dates back to 2002, when analyst Iris Mack, whose website identifies her as the second African American woman to earn a Harvard PhD. in applied math (and someone who likes primary colors) joined the much-venerated Harvard Management Company, which invests the university's then $18 billion endowment, to find what she termed a "frightening" state of affairs."The group I was working for had no background whatsoever to be working on [derivatives]," Mack says, adding that, to her knowledge, several of her colleagues were not licensed securities traders. "Sometimes the ways they handled even basic Black-Scholes models [widely used to price stock options] were puzzling."So Mack took inventory of the abuses -- high employee turnover, lax risk management practices and a "low level of productivity in the workplace" were among others, and detailed them in an email to Marne Levine, Summers' chief of staff and a Treasury staffer on the Obama Transition Team. (Summers was the only person to whom Meyers reported, and according to a recent Forbes story he personally ordered the university's biggest derivatives trade, a purchase of interest rate swaps that cost the university billions this year.)
A month after sending her email, Mack was fired after a meeting in which the endowment fund's then-chief furnished her the emails and castigated her for making "baseless accusations." She later sued for wrongful termination and settled out-of-court with the university. But she claims the practices "shocked" her, and -- the punchline is -- she had joined the company from Enron.
Which is also to say, lest you dismiss Mack as an opportunistic snitch capitalizing on Summers fateful opposition to regulating the derivatives that wreaked havoc on the financial system, she had a pretty valid reason to believe in the importance of whistleblowing."I'm not trying to pretend I'm omniscient or anything, but a lot of people who were quantitative traders, in the back of our minds, we knew a lot of these models were just that: guestimates," Mack says. "I have mixed feelings, on the one hand, I wasn't crazy, I knew what I was talking about. But maybe if more and more people had spoken up, the economy wouldn't be the way it is now."Mack is doing her part to affect change: she's a vociferous advocate of better math education for minorities and like FDIC chairman Sheila Bair, the writer of a children's book. It's called Mama Says Money Don't Grow On Trees (sequel idea: *...Unless You Are A Monstrously Overleveraged Bank With Access To The Federal Reserve Discount Window!).
If Mack's allegations are true Harvard certainly paid the price for its recklessness: Summers' swaps sowed the seeds for a financial disaster at HMC:It doesn't feel good to be borrowing at 6% while holding assets with negative returns. Harvard has oversize positions in emerging market stocks and private equity partnerships, both disaster areas in the past eight months. The one category that has done well since last June is conventional Treasury bonds, and Harvard appears to have owned little of these. As of its last public disclosure on this score, it had a modest 16% allocation to fixed income, consisting of 7% in inflation-indexed bonds, 4% in corporates and the rest in high-yield and foreign debt.Mack's boss at HMC, Jack Meyer, parted ways with the university in 2005. His bets were still paying off but his relationship with Summers had reportedly cooled -- among other things, over alumni outcry led by the university's Class of 1969 over the hedge fund-sized bonuses being awarded to employees of a supposed nonprofit. But if there's anything we've learned from the past year, gratuitous compensation and gratuitous risk go hand-in-hand.
For a long while Harvard's daring investment style was the envy of the endowment world. It made light bets in plain old stocks and bonds and went hell-for-leather into exotic and illiquid holdings: commodities, timberland, hedge funds, emerging market equities and private equity partnerships. The risky strategy paid off with market-beating results as long as the market was going up. But risk brings pain in a market crash. Although the full extent of the damage won't be known until Harvard releases the endowment numbers for June 30, 2009, the university is already working on the assumption that the portfolio will be down 30%, or $11 billion."The events of the last year show that the whole procedure of rewarding people so handsomely based on increases on paper value of the endowment was deeply flawed," says a spokesman for the [Class of 1969], which recently sent a letter to the Harvard president suggesting HMC staffers return $21 million of their latest bonuses. "Even now we don't really know how well it has done in the last ten years."
Bill Moyers talks to Bill Black about the fraud that pervades the financial industry and the Obama government
BILL MOYERS: Welcome to the Journal.
For months now, revelations of the wholesale greed and blatant transgressions of Wall Street have reminded us that "The Best Way to Rob a Bank Is to Own One." In fact, the man you're about to meet wrote a book with just that title. It was based upon his experience as a tough regulator during one of the darkest chapters in our financial history: the savings and loan scandal in the late 1980s.
WILLIAM K. BLACK: These numbers as large as they are, vastly understate the problem of fraud.
BILL MOYERS: Bill Black was in New York this week for a conference at the John Jay College of Criminal Justice where scholars and journalists gathered to ask the question, "How do they get away with it?" Well, no one has asked that question more often than Bill Black.
The former Director of the Institute for Fraud Prevention now teaches Economics and Law at the University of Missouri, Kansas City. During the savings and loan crisis, it was Black who accused then-house speaker Jim Wright and five US Senators, including John Glenn and John McCain, of doing favors for the S&L's in exchange for contributions and other perks. The senators got off with a slap on the wrist, but so enraged was one of those bankers, Charles Keating after whom the senate's so-called "Keating Five" were named he sent a memo that read, in part, "get Black kill him dead." Metaphorically, of course. Of course.
Now Black is focused on an even greater scandal, and he spares no one not even the President he worked hard to elect, Barack Obama. But his main targets are the Wall Street barons, heirs of an earlier generation whose scandalous rip-offs of wealth back in the 1930s earned them comparison to Al Capone and the mob, and the nickname "banksters."
Bill Black, welcome to the Journal.
WILLIAM K. BLACK: Thank you.
BILL MOYERS: I was taken with your candor at the conference here in New York to hear you say that this crisis we're going through, this economic and financial meltdown is driven by fraud. What's your definition of fraud?
WILLIAM K. BLACK: Fraud is deceit. And the essence of fraud is, "I create trust in you, and then I betray that trust, and get you to give me something of value." And as a result, there's no more effective acid against trust than fraud, especially fraud by top elites, and that's what we have.
BILL MOYERS: In your book, you make it clear that calculated dishonesty by people in charge is at the heart of most large corporate failures and scandals, including, of course, the S&L, but is that true? Is that what you're saying here, that it was in the boardrooms and the CEO offices where this fraud began?
WILLIAM K. BLACK: Absolutely.
BILL MOYERS: How did they do it? What do you mean?
WILLIAM K. BLACK: Well, the way that you do it is to make really bad loans, because they pay better. Then you grow extremely rapidly, in other words, you're a Ponzi-like scheme. And the third thing you do is we call it leverage. That just means borrowing a lot of money, and the combination creates a situation where you have guaranteed record profits in the early years. That makes you rich, through the bonuses that modern executive compensation has produced. It also makes it inevitable that there's going to be a disaster down the road.
BILL MOYERS: So you're suggesting, saying that CEOs of some of these banks and mortgage firms in order to increase their own personal income, deliberately set out to make bad loans?
WILLIAM K. BLACK: Yes.
BILL MOYERS: How do they get away with it? I mean, what about their own checks and balances in the company? What about their accounting divisions?
WILLIAM K. BLACK: All of those checks and balances report to the CEO, so if the CEO goes bad, all of the checks and balances are easily overcome. And the art form is not simply to defeat those internal controls, but to suborn them, to turn them into your greatest allies. And the bonus programs are exactly how you do that.
BILL MOYERS: If I wanted to go looking for the parties to this, with a good bird dog, where would you send me?
WILLIAM K. BLACK: Well, that's exactly what hasn't happened. We haven't looked, all right? The Bush Administration essentially got rid of regulation, so if nobody was looking, you were able to do this with impunity and that's exactly what happened. Where would you look? You'd look at the specialty lenders. The lenders that did almost all of their work in the sub-prime and what's called Alt-A, liars' loans.
BILL MOYERS: Yeah. Liars' loans--
WILLIAM K. BLACK: Liars' loans.
BILL MOYERS: Why did they call them liars' loans?
WILLIAM K. BLACK: Because they were liars' loans.
BILL MOYERS: And they knew it?
WILLIAM K. BLACK: They knew it. They knew that they were frauds.
WILLIAM K. BLACK: Liars' loans mean that we don't check. You tell us what your income is. You tell us what your job is. You tell us what your assets are, and we agree to believe you. We won't check on any of those things. And by the way, you get a better deal if you inflate your income and your job history and your assets.
BILL MOYERS: You think they really said that to borrowers?
WILLIAM K. BLACK: We know that they said that to borrowers. In fact, they were also called, in the trade, ninja loans.
BILL MOYERS: Ninja?
WILLIAM K. BLACK: Yeah, because no income verification, no job verification, no asset verification.
BILL MOYERS: You're talking about significant American companies.
WILLIAM K. BLACK: Huge! One company produced as many losses as the entire Savings and Loan debacle.
BILL MOYERS: Which company?
WILLIAM K. BLACK: IndyMac specialized in making liars' loans. In 2006 alone, it sold $80 billion dollars of liars' loans to other companies. $80 billion.
BILL MOYERS: And was this happening exclusively in this sub-prime mortgage business?
WILLIAM K. BLACK: No, and that's a big part of the story as well. Even prime loans began to have non-verification. Even Ronald Reagan, you know, said, "Trust, but verify." They just gutted the verification process. We know that will produce enormous fraud, under economic theory, criminology theory, and two thousand years of life experience.
BILL MOYERS: Is it possible that these complex instruments were deliberately created so swindlers could exploit them?
WILLIAM K. BLACK: Oh, absolutely. This stuff, the exotic stuff that you're talking about was created out of things like liars' loans, that were known to be extraordinarily bad. And now it was getting triple-A ratings. Now a triple-A rating is supposed to mean there is zero credit risk. So you take something that not only has significant, it has crushing risk. That's why it's toxic. And you create this fiction that it has zero risk. That itself, of course, is a fraudulent exercise. And again, there was nobody looking, during the Bush years. So finally, only a year ago, we started to have a Congressional investigation of some of these rating agencies, and it's scandalous what came out. What we know now is that the rating agencies never looked at a single loan file. When they finally did look, after the markets had completely collapsed, they found, and I'm quoting Fitch, the smallest of the rating agencies, "the results were disconcerting, in that there was the appearance of fraud in nearly every file we examined."
BILL MOYERS: So if your assumption is correct, your evidence is sound, the bank, the lending company, created a fraud. And the ratings agency that is supposed to test the value of these assets knowingly entered into the fraud. Both parties are committing fraud by intention.
WILLIAM K. BLACK: Right, and the investment banker that we call it pooling puts together these bad mortgages, these liars' loans, and creates the toxic waste of these derivatives. All of them do that. And then they sell it to the world and the world just thinks because it has a triple-A rating it must actually be safe. Well, instead, there are 60 and 80 percent losses on these things, because of course they, in reality, are toxic waste.
BILL MOYERS: You're describing what Bernie Madoff did to a limited number of people. But you're saying it's systemic, a systemic Ponzi scheme.
WILLIAM K. BLACK: Oh, Bernie was a piker. He doesn't even get into the front ranks of a Ponzi scheme...
BILL MOYERS: But you're saying our system became a Ponzi scheme.
WILLIAM K. BLACK: Our system...
BILL MOYERS: Our financial system...
WILLIAM K. BLACK: Became a Ponzi scheme. Everybody was buying a pig in the poke. But they were buying a pig in the poke with a pretty pink ribbon, and the pink ribbon said, "Triple-A."
BILL MOYERS: Is there a law against liars' loans?
WILLIAM K. BLACK: Not directly, but there, of course, many laws against fraud, and liars' loans are fraudulent.
BILL MOYERS: Because...
WILLIAM K. BLACK: Because they're not going to be repaid and because they had false representations. They involve deceit, which is the essence of fraud.
BILL MOYERS: Why is it so hard to prosecute? Why hasn't anyone been brought to justice over this?
WILLIAM K. BLACK: Because they didn't even begin to investigate the major lenders until the market had actually collapsed, which is completely contrary to what we did successfully in the Savings and Loan crisis, right? Even while the institutions were reporting they were the most profitable savings and loan in America, we knew they were frauds. And we were moving to close them down. Here, the Justice Department, even though it very appropriately warned, in 2004, that there was an epidemic...
BILL MOYERS: Who did?
WILLIAM K. BLACK: The FBI publicly warned, in September 2004 that there was an epidemic of mortgage fraud, that if it was allowed to continue it would produce a crisis at least as large as the Savings and Loan debacle. And that they were going to make sure that they didn't let that happen. So what goes wrong? After 9/11, the attacks, the Justice Department transfers 500 white-collar specialists in the FBI to national terrorism. Well, we can all understand that. But then, the Bush administration refused to replace the missing 500 agents. So even today, again, as you say, this crisis is 1000 times worse, perhaps, certainly 100 times worse, than the Savings and Loan crisis. There are one-fifth as many FBI agents as worked the Savings and Loan crisis.
BILL MOYERS: You talk about the Bush administration. Of course, there's that famous photograph of some of the regulators in 2003, who come to a press conference with a chainsaw suggesting that they're going to slash, cut business loose from regulation, right?
WILLIAM K. BLACK: Well, they succeeded. And in that picture, by the way, the other three of the other guys with pruning shears are the...
BILL MOYERS: That's right.
WILLIAM K. BLACK: They're the trade representatives. They're the lobbyists for the bankers. And everybody's grinning. The government's working together with the industry to destroy regulation. Well, we now know what happens when you destroy regulation. You get the biggest financial calamity of anybody under the age of 80.
BILL MOYERS: But I can point you to statements by Larry Summers, who was then Bill Clinton's Secretary of the Treasury, or the other Clinton Secretary of the Treasury, Rubin. I can point you to suspects in both parties, right?
WILLIAM K. BLACK: There were two really big things, under the Clinton administration. One, they got rid of the law that came out of the real-world disasters of the Great Depression. We learned a lot of things in the Great Depression. And one is we had to separate what's called commercial banking from investment banking. That's the Glass-Steagall law. But we thought we were much smarter, supposedly. So we got rid of that law, and that was bipartisan. And the other thing is we passed a law, because there was a very good regulator, Brooksley Born, that everybody should know about and probably doesn't. She tried to do the right thing to regulate one of these exotic derivatives that you're talking about. We call them C.D.F.S. And Summers, Rubin, and Phil Gramm came together to say not only will we block this particular regulation. We will pass a law that says you can't regulate. And it's this type of derivative that is most involved in the AIG scandal. AIG all by itself, cost the same as the entire Savings and Loan debacle.
BILL MOYERS: What did AIG contribute? What did they do wrong?
WILLIAM K. BLACK: They made bad loans. Their type of loan was to sell a guarantee, right? And they charged a lot of fees up front. So, they booked a lot of income. Paid enormous bonuses. The bonuses we're thinking about now, they're much smaller than these bonuses that were also the product of accounting fraud. And they got very, very rich. But, of course, then they had guaranteed this toxic waste. These liars' loans. Well, we've just gone through why those toxic waste, those liars' loans, are going to have enormous losses. And so, you have to pay the guarantee on those enormous losses. And you go bankrupt. Except that you don't in the modern world, because you've come to the United States, and the taxpayers play the fool. Under Secretary Geithner and under Secretary Paulson before him... we took $5 billion dollars, for example, in U.S. taxpayer money. And sent it to a huge Swiss Bank called UBS. At the same time that that bank was defrauding the taxpayers of America. And we were bringing a criminal case against them. We eventually get them to pay a $780 million fine, but wait, we gave them $5 billion. So, the taxpayers of America paid the fine of a Swiss Bank. And why are we bailing out somebody who that is defrauding us?
BILL MOYERS: And why...
WILLIAM K. BLACK: How mad is this?
BILL MOYERS: What is your explanation for why the bankers who created this mess are still calling the shots?
WILLIAM K. BLACK: Well, that, especially after what's just happened at G.M., that's... it's scandalous.
BILL MOYERS: Why are they firing the president of G.M. and not firing the head of all these banks that are involved?
WILLIAM K. BLACK: There are two reasons. One, they're much closer to the bankers. These are people from the banking industry. And they have a lot more sympathy. In fact, they're outright hostile to autoworkers, as you can see. They want to bash all of their contracts. But when they get to banking, they say, ???contracts, sacred.' But the other element of your question is we don't want to change the bankers, because if we do, if we put honest people in, who didn't cause the problem, their first job would be to find the scope of the problem. And that would destroy the cover up.
BILL MOYERS: The cover up?
WILLIAM K. BLACK: Sure. The cover up.
BILL MOYERS: That's a serious charge.
WILLIAM K. BLACK: Of course.
BILL MOYERS: Who's covering up?
WILLIAM K. BLACK: Geithner is charging, is covering up. Just like Paulson did before him. Geithner is publicly saying that it's going to take $2 trillion a trillion is a thousand billion $2 trillion taxpayer dollars to deal with this problem. But they're allowing all the banks to report that they're not only solvent, but fully capitalized. Both statements can't be true. It can't be that they need $2 trillion, because they have masses losses, and that they're fine.
These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed, not because...
BILL MOYERS: What do you mean?
WILLIAM K. BLACK: Well, Geithner has, was one of our nation's top regulators, during the entire subprime scandal, that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig in the poke stuff happened under him. So, in his phrase about legacy assets. Well he's a failed legacy regulator.
BILL MOYERS: But he denies that he was a regulator. Let me show you some of his testimony before Congress. Take a look at this.
TIMOTHY GEITHNER:I've never been a regulator, for better or worse. And I think you're right to say that we have to be very skeptical that regulation can solve all of these problems. We have parts of our system that are overwhelmed by regulation.
Overwhelmed by regulation! It wasn't the absence of regulation that was the problem, it was despite the presence of regulation you've got huge risks that build up.
WILLIAM K. BLACK: Well, he may be right that he never regulated, but his job was to regulate. That was his mission statement.
BILL MOYERS: As?
WILLIAM K. BLACK: As president of the Federal Reserve Bank of New York, which is responsible for regulating most of the largest bank holding companies in America. And he's completely wrong that we had too much regulation in some of these areas. I mean, he gives no details, obviously. But that's just plain wrong.
BILL MOYERS: How is this happening? I mean why is it happening?
WILLIAM K. BLACK: Until you get the facts, it's harder to blow all this up. And, of course, the entire strategy is to keep people from getting the facts.
BILL MOYERS: What facts?
WILLIAM K. BLACK: The facts about how bad the condition of the banks is. So, as long as I keep the old CEO who caused the problems, is he going to go vigorously around finding the problems? Finding the frauds?
BILL MOYERS: You--
WILLIAM K. BLACK: Taking away people's bonuses?
BILL MOYERS: To hear you say this is unusual because you supported Barack Obama, during the campaign. But you're seeming disillusioned now.
WILLIAM K. BLACK: Well, certainly in the financial sphere, I am. I think, first, the policies are substantively bad. Second, I think they completely lack integrity. Third, they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they're refusing to obey the law.
BILL MOYERS: In other words, they could have closed these banks without nationalizing them?
WILLIAM K. BLACK: Well, you do a receivership. No one -- Ronald Reagan did receiverships. Nobody called it nationalization.
BILL MOYERS: And that's a law?
WILLIAM K. BLACK: That's the law.
BILL MOYERS: So, Paulson could have done this? Geithner could do this?
WILLIAM K. BLACK: Not could. Was mandated--
BILL MOYERS: By the law.
WILLIAM K. BLACK: By the law.
BILL MOYERS: This law, you're talking about.
WILLIAM K. BLACK: Yes.
BILL MOYERS: What the reason they give for not doing it?
WILLIAM K. BLACK: They ignore it. And nobody calls them on it.
BILL MOYERS: Well, where's Congress? Where's the press? Where--
WILLIAM K. BLACK: Well, where's the Pecora investigation?
BILL MOYERS: The what?
WILLIAM K. BLACK: The Pecora investigation. The Great Depression, we said, "Hey, we have to learn the facts. What caused this disaster, so that we can take steps, like pass the Glass-Steagall law, that will prevent future disasters?" Where's our investigation?
What would happen if after a plane crashes, we said, "Oh, we don't want to look in the past. We want to be forward looking. Many people might have been, you know, we don't want to pass blame. No. We have a nonpartisan, skilled inquiry. We spend lots of money on, get really bright people. And we find out, to the best of our ability, what caused every single major plane crash in America. And because of that, aviation has an extraordinarily good safety record. We ought to follow the same policies in the financial sphere. We have to find out what caused the disasters, or we will keep reliving them. And here, we've got a double tragedy. It isn't just that we are failing to learn from the mistakes of the past. We're failing to learn from the successes of the past.
BILL MOYERS: What do you mean?
WILLIAM K. BLACK: In the Savings and Loan debacle, we developed excellent ways for dealing with the frauds, and for dealing with the failed institutions. And for 15 years after the Savings and Loan crisis, didn't matter which party was in power, the U.S. Treasury Secretary would fly over to Tokyo and tell the Japanese, "You ought to do things the way we did in the Savings and Loan crisis, because it worked really well. Instead you're covering up the bank losses, because you know, you say you need confidence. And so, we have to lie to the people to create confidence. And it doesn't work. You will cause your recession to continue and continue." And the Japanese call it the lost decade. That was the result. So, now we get in trouble, and what do we do? We adopt the Japanese approach of lying about the assets. And you know what? It's working just as well as it did in Japan.
BILL MOYERS: Yeah. Are you saying that Timothy Geithner, the Secretary of the Treasury, and others in the administration, with the banks, are engaged in a cover up to keep us from knowing what went wrong?
WILLIAM K. BLACK: Absolutely.
BILL MOYERS: You are.
WILLIAM K. BLACK: Absolutely, because they are scared to death. All right? They're scared to death of a collapse. They're afraid that if they admit the truth, that many of the large banks are insolvent. They think Americans are a bunch of cowards, and that we'll run screaming to the exits. And we won't rely on deposit insurance. And, by the way, you can rely on deposit insurance. And it's foolishness. All right? Now, it may be worse than that. You can impute more cynical motives. But I think they are sincerely just panicked about, "We just can't let the big banks fail." That's wrong.
BILL MOYERS: But what might happen, at this point, if in fact they keep from us the true health of the banks?
WILLIAM K. BLACK: Well, then the banks will, as they did in Japan, either stay enormously weak, or Treasury will be forced to increasingly absurd giveaways of taxpayer money. We've seen how horrific AIG -- and remember, they kept secrets from everyone.
BILL MOYERS: A.I.G. did?
WILLIAM K. BLACK: What we're doing with -- no, Treasury and both administrations. The Bush administration and now the Obama administration kept secret from us what was being done with AIG. AIG was being used secretly to bail out favored banks like UBS and like Goldman Sachs. Secretary Paulson's firm, that he had come from being CEO. It got the largest amount of money. $12.9 billion. And they didn't want us to know that. And it was only Congressional pressure, and not Congressional pressure, by the way, on Geithner, but Congressional pressure on AIG.
Where Congress said, "We will not give you a single penny more unless we know who received the money." And, you know, when he was Treasury Secretary, Paulson created a recommendation group to tell Treasury what they ought to do with AIG. And he put Goldman Sachs on it.
BILL MOYERS: Even though Goldman Sachs had a big vested stake.
WILLIAM K. BLACK: Massive stake. And even though he had just been CEO of Goldman Sachs before becoming Treasury Secretary. Now, in most stages in American history, that would be a scandal of such proportions that he wouldn't be allowed in civilized society.
BILL MOYERS: Yeah, like a conflict of interest, it seems.
WILLIAM K. BLACK: Massive conflict of interests.
BILL MOYERS: So, how did he get away with it?
WILLIAM K. BLACK: I don't know whether we've lost our capability of outrage. Or whether the cover up has been so successful that people just don't have the facts to react to it.
BILL MOYERS: Who's going to get the facts?
WILLIAM K. BLACK: We need some chairmen or chairwomen--
BILL MOYERS: In Congress.
WILLIAM K. BLACK: --in Congress, to hold the necessary hearings. And we can blast this out. But if you leave the failed CEOs in place, it isn't just that they're terrible business people, though they are. It isn't just that they lack integrity, though they do. Because they were engaged in these frauds. But they're not going to disclose the truth about the assets.
BILL MOYERS: And we have to know that, in order to know what?
WILLIAM K. BLACK: To know everything. To know who committed the frauds. Whose bonuses we should recover. How much the assets are worth. How much they should be sold for. Is the bank insolvent, such that we should resolve it in this way? It's the predicate, right? You need to know the facts to make intelligent decisions. And they're deliberately leaving in place the people that caused the problem, because they don't want the facts. And this is not new. The Reagan Administration's central priority, at all times, during the Savings and Loan crisis, was covering up the losses.
BILL MOYERS: So, you're saying that people in power, political power, and financial power, act in concert when their own behinds are in the ringer, right?
WILLIAM K. BLACK: That's right. And it's particularly a crisis that brings this out, because then the class of the banker says, "You've got to keep the information away from the public or everything will collapse. If they understand how bad it is, they'll run for the exits."
BILL MOYERS: Yeah, and this week in New York, at this conference, you described this as more than a financial crisis. You called it a moral crisis.
WILLIAM K. BLACK: Yes.
BILL MOYERS: Why?
WILLIAM K. BLACK: Because it is a fundamental lack of integrity. But also because, if you look back at crises, an economist who is also a presidential appointee, as a regulator in the Savings and Loan industry, right here in New York, Larry White, wrote a book about the Savings and Loan crisis. And he said, you know, one of the most interesting questions is why so few people engaged in fraud? Because objectively, you could have gotten away with it. But only about ten percent of the CEOs, engaged in fraud. So, 90 percent of them were restrained by ethics and integrity. So, far more than law or by F.B.I. agents, it's our integrity that often prevents the greatest abuses. And what we had in this crisis, instead of the Savings and Loan, is the most elite institutions in America engaging or facilitating fraud.
BILL MOYERS: This wound that you say has been inflicted on American life. The loss of worker's income. And security and pensions and future happened, because of the misconduct of a relatively few, very well-heeled people, in very well-decorated corporate suites, right?
WILLIAM K. BLACK: Right.
BILL MOYERS: It was relatively a handful of people.
WILLIAM K. BLACK: And their ideologies, which swept away regulation. So, in the example, regulation means that cheaters don't prosper. So, instead of being bad for capitalism, it's what saves capitalism. "Honest purveyors prosper" is what we want. And you need regulation and law enforcement to be able to do this. The tragedy of this crisis is it didn't need to happen at all.
BILL MOYERS: When you wake in the middle of the night, thinking about your work, what do you make of that? What do you tell yourself?
WILLIAM K. BLACK: There's a saying that we took great comfort in. It's actually by the Dutch, who were fighting this impossible war for independence against what was then the most powerful nation in the world, Spain. And their motto was, "It is not necessary to hope in order to persevere."
Now, going forward, get rid of the people that have caused the problems. That's a pretty straightforward thing, as well. Why would we keep CEOs and CFOs and other senior officers, that caused the problems? That's facially nuts. That's our current system.
So stop that current system. We're hiding the losses, instead of trying to find out the real losses. Stop that, because you need good information to make good decisions, right? Follow what works instead of what's failed. Start appointing people who have records of success, instead of records of failure. That would be another nice place to start. There are lots of things we can do. Even today, as late as it is. Even though they've had a terrible start to the administration. They could change, and they could change within weeks. And by the way, the folks who are the better regulators, they paid their taxes. So, you can get them through the vetting process a lot quicker.
BILL MOYERS: William Black, thank you very much for being with me on the Journal.
WILLIAM K. BLACK: Thank you so much.
Born again - and again
by Julian Delasantellis
It may seem tame considering what has come since, but Henry Levin's 1960 teen romantic comedy Where the Boys Are was fairly revolutionary for its time. Hewing to the still mostly standard Hollywood formula of showcasing the limb-grinding adventures of attractive hormone-sodden young satyrs before, in the last reel, showing the said same fulfillment of these desires devastating their lives, the movie tells the tale of two college co-eds, Merritt (Dolores Hart) and Melanie (Yvette Mimieux) on spring break in Fort Lauderdale, Florida. Merritt hesitates on taking the penultimate step in the game of what she calls "backseat bingo" in order to win the heart of a special beau; Melanie fairly explicitly affirms (for the time, anyway) that she intends to show no such restraint.
Of course, it ends very badly for Melanie. Lured to a party at a roadside motel where she believes that her new boyfriend will be present along with other desirable young Ivy League "Yalies", she is next seen wandering aimlessly in the middle of a busy highway, hair and clothes disheveled - as the then movie morals code would not allow the word that described her obvious violation to be explicitly uttered, the audience was left to draw the obvious inference as to the terrible price she paid for her licentiousness. She gets hit by a car; in the hospital, she confesses the worst part of her sin to Merritt. "They weren't even Yalies!" she sobs.
Thirty eight years later, in 1998, US Commodity Futures Trading Commission chairwoman Brooksley Born, in seeking to uphold the integrity of the financial system, was similarly accosted. However, in contrast to poor Melanie, the gang that attacked her possessed just about the highest imaginable academic pedigrees. They were the then deputy secretary of the Treasury (and now the chair of President Barack Obama's National Economic Council) Laurence Summers (BA Massachusetts Institute of Technology, Phd Harvard); Federal Reserve Board chairman Alan Greenspan (BA, MA Columbia, Phd New York University); and the leader of the gang, Treasury secretary Robert Rubin (BA Harvard, LLB Yale - yes! he was even a Yalie). After the attack on chairwoman Born, the gang carelessly hopped into their souped-up hot rod and proceeded to further make the preparations for their rich-kid, thrill-kill firebombing of the world financial system we see occurring today.
If you ever have the misfortune to be locked in a history seminar listening to the instructor drone on and on about how America in the interwar period withdrew from the world to focus on itself, isolationism, and just plain irrelevancies, it would not be impudent to raise your hand and ask "But just which interwar period are you talking about, Herr doktor professor?"
The common perception would be that the period being referred to was the 1918-1941 period between America's experience in the first and second world wars. But now there's another interwar period - the 12 years between the 1989 fall of the Berlin Wall, which represented the end of the Cold War, and the attacks of September 11, 2001, which essentially marked the beginning of the so-called "War on Terror". As Derek Chollet and James Goldgeier put it in their new book From 11/9 to 9/11- America Between the Wars... in one respect, however, the 1990s were indeed a "holiday." The end of the Cold War made many Americans and their leaders believe the world had become more benign and, therefore, of less concern. The three Presidential campaigns of that era - in 1992, 1996, and 2000 - spent little time on foreign policy issues. The mainstream media closed overseas bureaus and reduced the newsprint and airtime spent on events abroad. Instead of looking outward, Americans looked in - obsessed with oddities such as the OJ Simpson trial and hopes fueled by the booming stock market. In many respects, these years were self indulgent ones. David Halberstam called them "a time of trivial pursuits."
Gordon W Prange's 1982 book At Dawn We Slept tells the tale of an America blissfully unaware of the true nature of the world threats facing it as the world fell into war and the Japanese prepared the attack on Pearl Harbor; if America was sleeping in 1941, in the late 1990s it was in a permanent haze of total blitzed zonk generated by the world's most-prescribed sleeping pill, Halcion, and very much enjoying it as it gazed wistfully at its plastic Kabbalah bracelet and nodded off some more.
It was the same in economics and financial policy. Francis Fukuyama declared the "End of History", meaning that the central operative principle to be learned from the fall of state socialism was that the government which governed least governed best. Bill Clinton, noting the electoral disasters that befell leftist Democratic presidential nominees Walter Mondale and Michael Dukakis in 1984 and 1988, pointedly ran in 1992 with the blessing of the party's centrist Democratic Leadership Council. Following the electoral drubbing received by the party in 1994 after the public rejected his vision of a government-run healthcare system, his innate centrist instincts were brought even more to the fore. Proposals and bureaucrats advocating income redistribution and/or antagonistic stances towards business and finance would be banished to academia.
Since the administration's poll fortunes (not to mention its members' actual fortunes) rose so closely in tandem with the stock market, no "enemy of the people" would be allowed to advocate policies that might kill, or even mildly irritate, the golden goose. The Democratic economic policy secretariat might be more favorably inclined to more gender and/or racial diversity than the Republicans they replaced, and the art on their walls might be more Jackson Pollock and Mark Rothko than Frederic Remington and LeRoy Niemen; otherwise, their views were basically identical.
That pattern held at the US Commodity Futures Trading Commission (CFTC), the government agency charged with regulating and monitoring the frequently very topsy-turvy world of commodity and financial futures markets and trading. Clinton had appointed Mary Schapiro as his first CFTC chair in 1993 - she had been a member of the Securities and Exchange Commission ( SEC) from the Ronald Reagan-George Bush Snr era (and is now Obama's choice to lead the SEC). Clinton then in 1996 appointed Washington corporate lawyer Brooksley Born as his second choice to chair the CFTC. As an associate with the uber-connected law firm of Arnold and Porter, the Clinton gang must have thought they had made an outstanding choice - another female face as a sop to the feminist component of the base, but one trustworthy enough not to shake the pro-business and markets applecart being plied by the adults upstairs. Well, one out of two isn't bad.
One thing that the Clinton gang must have overlooked in making sure that Ms Born wasn't the financial regulation equivalent of the actor and drag queen Ru Paul was that her self-described most memorable case while at Arnold and Porter was litigation arising out of the failed attempt by the Hunt Brothers to corner the market in silver as the inflationary spike of the 1970s flamed out in 1979 and 1980. In a 2003 interview in Washington Lawyer, Born noted that she personally witnessed the case "causing great damage to traders when the price [of silver] went up and then again when it collapsed". "That's nice," the Clinton official who vetted her must have tut-tutted. "The press wants to know, what color will your credenza be." In early 1998, she pulled something out of that credenza. They sure noticed her upstairs then.
Traditionally, the CFTC's mandate and purview extended no further than commodity options and futures traded on recognized and established commodity exchanges, such as the Chicago Board of Trade or the New York Mercantile Exchange. In her interview, Born explains how she witnessed the development of futures-like contract instruments traded away from the exchanges, so-called over the counter (OTC) derivatives, and how it troubled her."One major issue was the enormous growth of over-the-counter derivatives. OTC derivatives had been legally permitted for the first time in 1993 ... This allowed the growth of a business that is now (2003-2007 estimates for this market put its notional value at over US$500 trillion) estimated at over a $100 trillion annually in terms of the notional value of contracts worldwide. [Federal Reserve chairman] Alan Greenspan had said that the growth of this market was the most significant development in the financial markets of the 1990s. The market was virtually unregulated and many, many times as big as the trading on the futures exchanges ... The commission had kept some nominal authority over this market, but there were no mechanisms for enforcing the rules. For example, antifraud rules were retained, but no reporting was required. The market was completely opaque. Neither the commission nor any other federal regulator knew what was going on in that market! Also, there had been a number of major problems in the market, including the near collapse of Barings Bank until it was taken over by ING
... I became enormously concerned about OTC derivatives and thought the market was a nightmare waiting to happen ... I was particularly concerned that there was no transparency. No federal regulator knew what kind of position firms like Long-Term Capital Management [LTCM] and Enron had in the derivatives markets. "These instruments can be used to reduce economic risk, and they are certainly very valuable and useful economic instruments, but they can also create enormous risks, as they did at Enron and Long-Term Capital Management. Warren Buffett has recently called them financial weapons of mass destruction. I became concerned about it once I got to the commission and began to learn about the OTC market. The more I learned, the more I realized we didn't know. I realized there was a tremendous potential danger to the markets in the United States and to the international economy."
Yeah, yeah kid - go play outside. But it was her next move that really got the alarm bells ringing up in the suites of the Ivy Leaguers who had Clinton's ear. This related to LCTM, the Greenwich, Connecticut hedge fund whose September 1998 insolvency necessitated an emergency rescue package by the Federal Reserve to prevent the entire world financial system from being dragged down along with it. "About three months before we knew about Long-Term Capital Management, the commission came out with a concept release in the Federal Register asking for input from the industry and other interested people concerning the need for more oversight of the over-the-counter derivatives market."
Of course, these were the days of the American Republic's powerful ruling First Triumvirate - Rubin, Greenspan and Summers - the trio that Time Magazine would soon anoint as "The Committee to Save the World." Back in April 1998, however, all they were doing was keeping the US economy, and more importantly its stock market, humming along at crowd-pleasing and poll-boosting numbers. Early that April, the Dow Jones Industrial Average topped 9,000 for the first time, nearly tripling in just over three years. The woman who was really giving Clinton conniption fits then was not Born but Monica Lewinsky, and by not getting the financial industry mad, by keeping the stock market hopping, Clinton, correctly it turns out, felt that he could defeat the real threat the Lewinsky scandal posed to his presidency. Therefore, one woman , Born, was not going to be allowed to sidetrack his defense against the threat posed by another - Lewinsky.
The roadside motel party came on April 21, 1998 - except that the location was changed to Rubin's oak-paneled conference room at the Treasury. Rubin had found out what Born was about to propose, and the former co-chairman of Goldman Sachs would have none of it. Formally, it was a meeting of the President's Working Group on Financial Markets, with Rubin, Greenspan and SEC chairman Arthur Levitt going three to one against Born.
Rubin laid out his, or, more accurately, the financial industry's concerns. "So, you're not going to do anything, right?" Rubin, according to a report of the meeting published recently in the Washington Post. Born was non-committal. The Rubin gang thought that they had gotten the message across. In that, couldn't have been more wrong. Born called and raised. In the May 7, 1998, CFTC press release that introduced the initiative to the world, Born described her thinking, taking special note that, as had become sine qua non in Washington policymaking then and now, no monied sacred oxen would be gored.The Commission believes it is appropriate to review its regulatory approach to OTC derivatives. The goal of this re-examination is to assist it in determining how best to maintain adequate regulatory safeguards without impairing the ability of the OTC derivatives market to grow and the ability of US entities to remain competitive in the global financial marketplace. In that context, the Commission is open both to evidence in support of broadening its existing exemptions and to evidence of the need for additional safeguards.
Thus, the concept release identifies a broad range of issues in order to stimulate public discussion and elicit informed analysis. The Commission seeks to draw on the knowledge and expertise of a broad spectrum of interested parties, including OTC derivatives dealers, end-users of derivatives, other industry participants, other regulatory authorities, and academicians. The Commission emphasized that it is mindful of the industry's need to retain flexibility permitting growth and innovation, as well as the need for legal certainty.
The release does not in any way alter the current status of any instrument or transaction under the Commodity Exchange Act. All currently applicable exemptions, interpretations and policy statements issued by the Commission remain in effect, and market participants may continue to rely on them. Any proposed regulatory modifications resulting from the concept release would be subject to rulemaking procedures, including public comment, and any changes that imposed new regulatory obligations or restrictions would be applied prospectively only.
Probably the only way this could have been made less threatening to the derivatives industry would have been if traders had been offered lollipops and freshly made ice-cream sundaes, but, still, the industry was outraged, and they knew exactly what to do. If the attack by the executive branch's most senior economic managers wasn't enough to silence this impudent upstart, this blowsy tart, the legislature was always on hand to do the industry's bidding for a price. At a July 30, 1998, meeting of the Senate Committee on Agriculture, Nutrition and Forestry, Born was forced to undergo another violation, this time before a packed hearing room of financial industry lobbyists, publicists, and other mouths for hire gathered to witness the ritual. Then deputy secretary of the Treasury Lawrence Summers led off.Mr Chairman, the OTC derivatives market has grown from nothing to become a highly lucrative industry of major international importance. It is reasonable to consider whether it is necessary to make changes in how this market is regulated. But there is currently no clear consensus in the government or in the private sector concerning any possible additional regulation for this market. And there is certainly no consensus that the CFTC currently has the legal authority to regulate this market or raise questions about possible regulation of this market in the future.
Then Federal Reserve chairman Greenspan. Back in 1998, the masses listened intently to each magnificent inflection of every brilliant syllable the great oracle uttered, for people literally believed that the prophet cum savior had the ability to spin gold from dross. Only now, 10-plus years later, do we realize that his true skills could be more accurately described as being just the opposite. Not only did Greenspan oppose the expansion of CFTC jurisdiction to OTC derivatives; he even wanted it scaled back for standard, exchange-based futures trading.The Federal Reserve believes that the fact that OTC markets function so effectively without the benefits of the CEA [the 1936 Commodity Exchange Act, which authorized the CFTC] provides a strong argument for development of a less burdensome regulatory regime for financial derivatives traded on futures exchanges. To reiterate, the existing regulatory framework for futures trading was designed in the 1920s and 1930s for the trading of grain futures by the general public. Like OTC derivatives, exchange-traded financial derivatives generally are not as susceptible to manipulation and are traded predominantly by professional counterparties.
Next up, SEC chairman Levitt. The former president of the American Stock Exchange was certainly not bullish on Brooksley Born.The CFTC's concept release raises important policy questions that should not be addressed by the CFTC alone, but rather require the attention of Congress, members of the financial regulatory community, and interested industry participants. In that spirit, perhaps Levitt would have advocated death-row inmates write the laws for capital punishment, as they certainly could be termed "interested industry participants".
A couple more flayings from industry executives, and the obvious lack of sympathy shown by the committee chairman, Republican Richard Lugar, to her positions, and Born began to wilt. Not only was Rubin's Treasury blocking her initiative to expand CFTC's jurisdiction further into OTC derivatives, it was authoring legislation to strip what little authority the CFTC had in the sector away from it. Born tried to counterattack.The legislative proposal offered by the Treasury Department raises serious concerns. The Treasury proposal would severely limit the CFTC's ability to fulfill its oversight responsibilities with regard to OTC derivatives transactions within its statutory authority, would result in a substantial change in the CEA, and would potentially leave the American public without federal protection in the event of an emergency in the OTC derivatives market. No justification has been offered for these sweeping changes in OTC derivatives regulation. Indeed, the Treasury proposal does not appear to be based on any principled concern about the need for a coordinated approach to the OTC derivatives market, since it aims to restrict only the activities of the CFTC.
Lugar wanted Born to drop her proposal, threatening her with writing new laws into statute limiting the CFTC's jurisdiction. Born was willing to entertain a temporary moratorium to allow the bureaucracy time to attempt to unify behind a common position, but, for the sharks circling around her, that was just her blood in the water. Not even the September LTCM crisis, which seemed to prove her point about the dangers of derivatives, changed any minds among her critics. "Yes," there was a crisis, they sniffed, but Uncle Alan fixed everything, so why can't we go back to making more money? Still, Born tilted at windmills. Appearing before the House Banking Committee, Born warned of animmediate and pressing need to address whether there are unacceptable regulatory gaps ... This episode should serve as a wake-up call about the unknown risks that the over-the-counter derivatives market may pose to the US economy and to financial stability around the world.
It would all be for naught, for lined up against Born's integrity and vision were the entire government/financial complex shuttling in and out of positions in Bill Clinton's administration. Congress passed the six-month hold on CFTC's regulatory authority, making it permanent in 1999. During those six months what little legislative support for tighter restrictions collapsed. Born resigned from the CFTC in the spring of 1999.
During those last 18 months of Bill Clinton's administration, as the old fox celebrated his escape from the baying hounds of impeachment, he basically put "For Sale" signs on his entire economic policy. In November 1999, Congress passed, and Clinton signed, the Gramm-Leach-Billey Act, repealing the 1933 Glass Steagall Act, which had previously maintained explicit corporate firewalls between investment and commercial banking. That led to a wave of financial system mergers and agglomerations that was the first step in the creation of the giant "too big to fail" wounded banking behemoths that so trouble our world today. Then, in the closing hours of his administration came the president's signature on the 2000 Commodity Futures Modernization Act, which, as if it were possible, put up an even bigger "NO TRESPASSING" sign in-between the CFTC and OTC derivatives.
In all these legislative deregulatory efforts championed by Rubin's Treasury et al, the legislation was shepherded through the Congress not by a northeastern elite school Democratic liberal, but by ultra-conservative Texas Republican Phil Gramm, with his Phd from the University of Georgia. Gramm called the Glass-Steagall repeal an event that "will keep our markets modern, efficient and innovative, and it guarantees that the United States will maintain its global dominance of financial markets". Did the Clinton team ever question the ideological incongruity of this ill-fated alliance? Probably not; this only concerned the people's welfare in the economy; it wasn't as if they had to share their box with him at the Metropolitan Opera or something.
The rest, as they say, is history, and not very pleasant history at that. In the dark alleys of some greed-soaked imaginations of Wall Street quantitative analysts, OTC derivatives conducted a witches' sabbath with the existing mortgage finance industry. This created a home financing framework that would circumvent Fannie Mae and Freddie Mac, the government's two existing real-estate finance institutions that, for the most part, had kept American housing on an even keel for over 60 years. The new paradigm was, instead of selling mortgage loans to Fannie and Freddie, the mortgage paper would be rolled out into ever and ever more-leveraged rounds of collateralized debt obligations (CDOs). The CDOs were insured not by the government, but by unregulated credit default swaps (CDS) of which no one in authority or anywhere else ever knew the full extent or quantity, nor knew who was carrying the counterparty risk on the other side of the trade.
The tide of liquidity let loose by this scheme, sometimes called the "shadow banking system", blew the real-estate bubble all the way out to the subprime mortgage borrowers, but when real-estate prices drove so far away from reality that they couldn't even see cloud cuckoo land in the rear-view mirror anymore, the real-estate market cracked and the whole edifice of the sorcerer's apprentice was thrown into reverse. CDOs and other mortgage-backed securities suddenly acquired a new, far less complimentary title - that of "toxic banking assets". It was AIG's central role in the CDS market that drove it into the arms of the government; as for the rest of the OTC derivatives that Brooksley Born warned of, no type of even the lightest regulation was ever applied to them. There are only estimates of just how many more are out there waiting to fail, or how many more will fail with each successive leg down in real-estate values.
But when you're out walking in the financial forest, with each crash you hear signifying another hollowed-out shell of a once-great financial institution toppling over under the crushing weight of its own incompetence and hubris, that sound tells you that once again Born is being proved correct. The rapidly dwindling cult of defenders of The Committee to Save the World claim that hindsight is always 20/20: "If we knew now what we knew then - etc, etc." But the real problem was not that they could not see, but they would not hear. Brooksley Born's foresight was perfect; it was the tin ears possessed by those whom she warned that were the problem.
There are numerous metrics I and other writers have repeatedly cited that illustrate the growing role and centrality in the US economy of the financial services sector. In the New York Times, Gretchen Morgensen noted that, in 2007, there were more financial engineers, those who put together all the CDS and CDOs and OTC derivatives, than there were actual physical engineers, people who actually made stuff, employed in the US. My favorite metric was that, as the financial services sector topped out in that last giddy summer of 2007, it represented about 21% of the market-based weighting of the S&P 500, but over 40% of its earnings.
America, a nation steeped in Christianity down to its grain, apparently failed to apply the Golden Rule to this circumstance - that he who has the gold makes the rules. In allowing the continuation of a political system driven by money, it became virtually inevitable that, once the financial industry took over the country's economic system, it would only have to go just a bit further to take over the political system as well.
When it did, it virtually assured the eventual creation of the maladies we see today - a general population straining under the weight of the collapse of the once-booming, now-busted banking system that once financed much of its basic necessitates, with the elite and mid-level of the financial system luxuriating behind the physical security of the high walls of its gated communities, and the economic security of the equally formidable legal ramparts that protect its rapacious bonus arrangements.
In an article in the May edition of the Atlantic, Simon Johnson, former International Monetary Fund official and current professor of finance at Massachusetts Institute of Technology, writes of what he calls "the quiet coup", finance's takeover of the American polity.In its depth and suddenness, the US economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn't be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn't roll over their debt did, in fact, become unable to pay.Johnson's policy prescription in this matter seems to have the big financial oligarchs broken up into much smaller operating entities; the assumption there seems to be that they would then be collecting commensurately less monopoly rent that could be used to buy the political system.
This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the US financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people. But there's a deeper and more disturbing similarity: elite business interests - financiers, in the case of the US - played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse.
More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Maybe. Maybe not. There's the old story of a thoroughly drunk (and married) Winston Churchill stumbling up to an attractive woman at a party.
"Madam, will you sleep with me for five million pounds?"
"Would you sleep with me for one pound?"
"Of course not, what kind of woman do you think I am?"
"Madam, we've already established what kind of woman you are," said Churchill. "Now we're just negotiating the price."
AIG's PR Blitz
So as we reported yesterday, longtime AIG CEO Hank Greenberg went before Congress and placed the blame for the firm's collapse squarely on the execs who took over after he left in 2005 -- including on the crew currently at the helm, who Greeenberg said should be replaced. But we've been struck by the ferocity of AIG's response to Greenberg, who's been skirmishing with the firm pretty much since he stepped down. Despite its awkward position as a ward of the state -- not to mention as the prime corporate face of the greed and recklessness that caused the financial crisis -- AIG has mounted an aggressive public-relations counter-offensive.
AIG spokesman Mark Herr told the Associated Press: "Mr. Greenberg is again trying to re-write history in order to distance himself from the Financial Products group he personally created and oversaw. The fact is that, under his watch, guaranteed compensation arrangements for (Financial Products group) employees were put in place." And AIG put out a statement saying:Hank Greenberg continues to deny his role in allowing Financial Products to write the multi-sector credit default swaps which sowed the seeds for AIG's troubles.
.... [Greenberg] refuses to acknowledge that he approved entry into the credit default swap business, approved more than $40 billion of swaps written on (debt obligations) containing sub-prime loans, and didn't hedge or put up reserves against them.......
The claim that he could have hedged the entire book, or forced counter-parties to renegotiate collateral provisions, is not grounded in reality. It is also at odds with the fact that under his tenure none of these trades was ever hedged.
And in a press release that accompained a four-page dossier attacking Greenberg, put out preemptively the night before Greenberg's testimony, AIG added:Given that Hank Greenberg led AIG into the credit default swap business, has repeatedly refused to testify under oath about a transaction he initiated when he was still AIG's CEO, and is being investigated by the SEC and the Justice Department, we don't understand how he can be viewed as having any credibility on any AIG issue.
According to Pro Publica, the dossier was entitled "The Greenberg Legacy." The news site reports:The first section includes 11 bullet points that recap history of the Financial Products division and Greenberg's role in originating it. Greenberg has tried to distance himself from the unit, which lost billions selling a form of insurance on toxic mortgage securities. The next section deals with "Mr. Greenberg's Ouster." It recounts Greenberg's decision to "take the Fifth" when confronted by questions from investigators examining securities fraud by the company.
And in a Washington Post op-ed last month, current CEO Ed Liddy sounded a similar theme:Mistakes were made at AIG, and on a scale that few could have imagined possible. The most egregious of those began in 1987, when the company strayed from its core insurance competencies to launch a credit-default-swaps portfolio, which eventually became subject to massive collateral calls that created a liquidity crisis for AIG.
Indeed, the pushback has so been so aggressive that it brings to mind the news from last month that the toppled insurance giant has four PR firms on its payroll. And two of those firms, Hill & Knowlton, and Mark Penn's Burson-Marsteller, are high-priced experts at shaping Washington opinion. Penn has written that his firm's work for AIG "is all about helping this company handle the massive volume of media, government and employee interest in their situation." But Dick Grove, a veteran PR man who has worked with both Burson-Marsteller and Hill & Knowlton, told TPMmuckraker that AIG is likely paying a pretty penny for those services. Based on his experience doing such work, said Grove, "you're gonna have a whole lot of meetings," for which the spin-meisters would charge hourly fees, "like a taxi meter going berserk."
Grove said he thinks AIG's willingness to spend big bucks on shaping its image in Washington is misguided -- especially since it's taxpayer money. Instead, given the current environment, it should simply make itself available to the media and answer questions as openly and honestly as possible. It's also worth noting that AIG's line of attack has dovetailed with that of committee Republicans. The day before AIG put out its statement attacking Greenberg's credibility and pointing out that he's under federal investigation, Rep. Darrell Issa, the committee's ranking GOPer, sent a letter to committee chair Ed Towns, obtained by TPMmuckraker, that likewise noted the federal investigations and expressed "concern about the credibility of our witness."
Ilargi: The worst is over, the bottom is in sight, we've located the problem? Look at a number of graphs and judge for yourself.
Biggest 4-Week Bull Market Since 1933
DOW and S&P up 25% since March 9th--the biggest 4-week rally since 1933. Still sure you didn't miss the bottom?
Ilargi: So, bottom, anyone? Graphs often tell good stories. First, an old favorite, Dow Jones bear rallies in the Great Depression period.
Ilargi: And then some recent ones from Doug Short:
click graphs to enlarge
Doug Short's Graphs
Beware the bear market bounce
The bullish momentum for global equities, which started a month ago, has extended into the first days of April. But the pace of the rally has made many investors worried that the claws of yet another bear trap are being sharpened. "We're not out of the woods by any stretch of the imagination," said Andrew Milligan, head of global strategy for Standard Life Investments. "One only has to look at the pace of rising unemployment and what that entails for corporate profits in 2010 to remain cautious about the equity market." Major bear markets for stocks, such as 1973-1974 or the decade-long bear market of the 1930s, were periods of extended rallies that ultimately failed. A bear market rally is often short lived and explosive.
Since leading markets fell to new lows for this cycle early in March, the bounce back has been led by financials, which had borne the brunt of selling pressure in February. This suggested that the rise in stocks during March was largely due to what is known as "short-covering" - where market bears who had bet on stocks to go down by borrowing and then selling them take their profits by buying the stock back at the lower price. When stocks fell sharply on Monday, it was mainly attributed to indications from the US government that it would not stand in the way of a bankruptcy filing for General Motors. It appeared that the March rally was in danger of following the path set by the so-called Santa Claus rally that began last November and which faltered at the start of the year.
Instead, stocks resumed rising for much of this week. The S&P 500, London's FTSE 100 and Japan's Nikkei 225 index posted their first positive month of the year. March was the FTSE Eurofirst 300's first positive month since last August. This week, Hong Kong, Australia and the Nasdaq Composite entered positive territory for the year. In spite of declines yesterday, after sharp job losses in March, the S&P 500 was on course for its fourth consecutive weekly gain. A run of weekly gains this long has not been recorded since the market peaked in October 2007. Equities' bullish performance was helped by signs that the pace of the decline in some global economic indicators was easing. Accounting rule changes for US banks and the marking of their distressed assets helped extend the rally for the S&P financials index, up 50 per cent from its low last month.
Another source of support came when world leaders at the G20 meeting in London pledged $1,000bn to the International Monetary Fund to cushion the global recession for emerging markets. Indeed, emerging markets have been leading the charge in 2009. Moscow is up 19 per cent for the year, Shanghai has jumped 33 per cent and Brazil has rallied about 16 per cent. This type of leadership is worrying some analysts. "In general, sustainable post-bubble rallies are not led by those stocks which are the bubble darlings," says James Montier, strategist at Société Générale. "The prominence of emerging markets, mining and financials in the recent rally gives me pause for thought. Especially when neither emerging markets nor mining are at bargain basement levels of valuation."
At its current level, the S&P has rallied 23 per cent from its March low, a little less than the 25 per cent rally from its November low. The FTSE 100 bounced 23 per cent from its low in November and has risen some 15 per cent in the current rally. Japan's Nikkei 225 index has gained 24 per cent in the past few weeks, better than its 20 per cent rally from November to January, but less than its 33 per cent bounce last October. Ashraf Laidi, chief market strategist at CMC Markets, says that past major bear markets, including two separate bear markets during the Depression of the 1930s and the dotcom bust of 2000, ran for three years. "Such analysis suggests a bottom may not be reached until autumn 2010," he said. Making the valuation case for some markets is also difficult say analysts. "Valuations are cheap, but they are not as cheap as seen in past," said Mr Milligan, noting that the price-earnings ratios for the FTSE fell below 5 in the 1973-74 bear market.
In contrast, valuations for Japanese stocks look very appealing, said Mr Montier. "The entire Japanese market is trading below book value," he said. "Rather than running with the bubble redux, I prefer to hunt for opportunities where maximum pessimism is more blatant and the herd shuns the opportunities." The current rally in stocks has not been accompanied by a significant improvement in corporate credit. Indeed, the corporate default cycle is on course to peak this year and instability could agitate equity markets, as was the case in 2002. A significant headwind for equities also looms in the form of first-quarter earnings and guidance for the rest of the year to be revealed by companies later this month. Nicholas Colas, chief market strategist at BNY ConvergEx, said: "The past few weeks have been an ideal time for a rally, but the prospect of [the] earnings season will cap the market gains for now. "Whether you are bullish or bearish, you have to be concerned about earnings and company guidance for the rest of the year."
Credit Woes Hit Home
A credit-card crunch is squelching the dreams of entrepreneurs. For two years, Jack Diamond used his Bank of America small-business credit card to finance his plants-and-aquatics nursery business in Tampa, Fla. He would use the credit card to purchase plants, then pay down his balance after he sold lilies, pond plants and aquatic fertilizer to customers. Last September, Bank of America Corp. cut the $46,000 credit line on his card to $27,200, just a few hundred dollars above his current balance. He couldn't buy the plants, seeds and equipment he needed for his spring selling season. He laid off six of his eight employees. "I'm almost living paycheck to paycheck," says Mr. Diamond, 55 years old, who is considering filing for business bankruptcy.
Even as wobbly banks tighten up on consumer credit cards, they are also cracking down on small-business owners by slashing their credit lines, closing accounts and raising interest rates. A recent Federal Reserve survey found that about two-thirds of banks' loan officers reported that they tightened terms for business loans in recent months. Meanwhile the National Small Business Association, a trade group, said 69% of 250 surveyed small-business members faced worse terms on their cards, such as higher interest rates, in the second half of last year. Banks have reason to get tough. In a bad economy, small businesses are usually among the first victims. Credit-card issuers have seen a surge in charge-offs, or debts no longer expected to be paid, over the past year as small businesses fail.
But the credit-card squeeze couldn't come at a worse moment for the estimated 27.2 million small-business owners who have long been one of the growth engines of the economy. Many, especially start-ups, don't have the track record or size to qualify for traditional bank loans. Even many established small-business owners use credit cards to pay salaries or buy inventory. "People are using their credit cards to keep the businesses going, so when that dries up, the businesses go," says Jeanne Marie Cella, an attorney in Media, Pa., who has seen a significant increase in small-business owners filing for bankruptcy. Indeed, the crackdown on business credit cards is happening just as the federal government scrambles to free up credit for small businesses by raising federal loan guarantees and reducing fees on certain Small Business Administration loans. In an attempt to get credit flowing again, the Treasury said it would buy up securities backed by SBA loans. Meanwhile, politicians in Congress are asking the Treasury to use more bailout funds to guarantee bank lines of credit for small businesses.
Until recently, credit-card issuers avidly courted small-business owners. Visa Inc., American Express Co., MasterCard Inc. and Discover Financial Services had an estimated 29 million business credit cards in circulation in 2008, up from just five million in 2000, according to the Nilson Report. Spending on the cards rose to $296.3 billion from about $70.4 billion over the same period. Banks began moving into small-business credit cards in the mid- to late-1990s following the creation of credit-scoring models. One factor was a 1995 study by Fair Isaac Corp. and Robert Morris Associates, a trade group for loan officers and credit-risk managers, analyzing the performance of business loans.
The study surprised bankers. It found that a small business's cash flow and financial statements bore little correlation with how the owner would pay his or her bills. A much stronger predictor was the business owner's personal credit score. The banks concluded they could safely issue business credit cards to proprietors with good credit records even if the underlying business didn't appear to justify a loan. "The credit-card industry noticed that study and that's when they started marketing business credit cards," says Robert Lahm, a professor of entrepreneurship at Western Carolina University. "Credit cards have become probably the most common small-business loan product."
Peggy Durant of Clearfield, Pa., took advantage of various personal and business cards' promotional offers to finance her and her husband's small businesses over the past decade, which include a bed and breakfast, residential and commercial rental projects and a solo law practice. After J.P. Morgan Chase & Co.'s Chase Card Services in January raised the minimum payments on one of her cards, Ms. Durant decided to take out a first mortgage on one of her rental properties and open a business line of credit with her local bank to help pay off other credit-card balances and reserve a cash cushion in case more banks followed suit. "It has created a sense of anxiety and made us do things differently than we would have," says Ms. Durant, 60. "That money is no longer there to use." Credit-card issuers, naturally, see a different picture. The rate of business bankruptcy filings has outpaced consumer bankruptcy filings over the past 12 to 15 months. Average charge-offs for businesses with at least one charge-off jumped to nearly $11,000 from a little above $7,000 over the same period, according to data from Equifax Inc.'s commercial-business group.
Faced with rising losses, financial-services firms last year began scaling back credit lines, products and marketing to small businesses. In January, American Express discontinued its business line of credit and capital line program. Capital One Financial Corp. stopped offering small-business closed-end loans last year. Citigroup Inc. discontinued one of its business credit cards, the Citi Business Premier Pass card, late last year. Advanta Corp., which mainly offers small-business credit cards, raised rates on many last year. Financial-services firms say they are trying to control their risk in the current environment. "The line reductions that might be made reflect concern about overall debt load relative to one's financial position in this environment," said Tom Sclafani, a spokesman for American Express. He declined to comment on individual customers.
Steve Brumer of Suwanee, Ga., says he has been squeezing his own customers since American Express cut the credit line on his business credit card to $20,000 from $65,000 and pared another line of credit that it later closed. In the past, Mr. Brumer, who sells wireless equipment to businesses, would typically give customers up to 30 days to pay their bills, since he would be able to rely on the cards' credit lines to fund his working capital in the meantime. Now, "I don't issue any lines of credit to any customers. It is all cash or all wire funds transfers for everything," says the 53-year-old. Some small-business owners find their business-card problems spilling into their personal lives. Because the business owners usually agree to be guarantors for the cards, any delinquencies or other adverse actions are usually reported to their personal credit files, making it harder to get personal loans.
Kristie Jakeman of Jensen Beach, Fla., saw her credit score fall to 680 from 740 in January after Advanta started reporting her business credit card to credit bureaus as delinquent. Her troubles began last summer after Advanta moved to raise her 7.99% interest rate to 9.9% in September, then to 21.9% in October. She complained to the company and says it promised to lower her rate but didn't. She continues to fight to have the charges reversed. The higher payments made it harder to keep up, and she says she finally decided not to make her December payments until the company agreed to work with her. Advanta raised her rate to 33%. A spokesman for Advanta declined to comment. Because of the drop in her credit score, Ms. Jakeman, 42, who runs a racehorse-management business and a company that develops nutritional supplements for animals, says she was turned down for a small-business loan. She is now looking for a business line of credit, which has a much lower credit limit. "We're back to a $50,000 line of credit, which severely limits our growth. I'm certainly not going to go out and hire people."
Treasuries Slide as Traders Focus on Record U.S. Debt Supply
Treasury notes dropped for a second week as investor concern about record U.S. borrowing overshadowed the first debt buybacks by the Federal Reserve since the 1960s. U.S. securities fell 1.7 percent in 2009, according to Merrill Lynch & Co.’s U.S. Treasury Master index, as the government issued debt to help revive the economy and service the budget deficit. It will sell an estimated $59 billion in notes April 7-9. The U.S. needs to borrow $3.25 trillion this fiscal year, including sales to replace maturing securities, Goldman Sachs Group Inc. estimated. “The bond market has significant supply-demand issues,” said John Spinello, chief technical strategist in New York at Jefferies Group Inc., a brokerage for institutional investors.
“As much as one wants to believe the buyback of $300 billion over six months is going to prevent rates from going higher, all it will do is slow down the process.” The benchmark 10-year note’s yield rose 13 basis points, or 0.13 percentage point, to 2.90 percent, according to BGCantor Market Data. The 2.75 percent security due in February 2019 tumbled 1 1/8, or $11.25 per $1,000 face amount, to 98 3/4. The yield has remained in a range of 2.14 percent to 3.05 percent this year after sliding to a record low of 2.04 percent on Dec. 18. It averaged 4.25 percent for the past five years. Thirty-year bond yields increased eight basis points to 3.69 percent after declining five basis points to 3.61 percent in the five days ended March 27.
The central bank, which announced March 18 it would purchase up to $300 billion in Treasuries to help lower consumer borrowing rates, has acquired $31.05 billion in U.S. debt through five buyback operations. It plans two so-called coupon passes next week and three the following week. Treasuries extended losses yesterday after Fed Chairman Ben S. Bernanke said in a speech in Charlotte, North Carolina, the central bank must retain the flexibility to withdraw the record amounts of credit it injected into the economy to keep inflation in check when the crisis abates.
“This is a very significant issue because it focuses people’s attention on the fact that the Fed is going to have to sell the assets it bought at some point, so that will push rates higher,” said Ajay Rajadhyaksha, head of U.S. fixed-income strategy in New York at Barclays Capital Inc., one of 16 primary dealers that trade with the central bank. The Treasury is scheduled to sell $6 billion in 10-year inflation-indexed notes on April 7. It is also likely to auction $35 billion in three-year notes at its April 8 sale and $18 billion in a reopening of 10-year notes the following day, according to Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm. The Treasury will announce the amounts April 6.
President Barack Obama is asking Congress to approve a $3.55 trillion budget for 2010. The nonpartisan Congressional Budget Office estimated the deficit at $1.38 trillion, higher than the White House’s $1.17 trillion projection. “The market is going to constantly test the Fed’s resolve to keep interest rates low,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “The ongoing wave of new Treasury debt is going to possibly alarm the Fed, and I think the Fed may have to step up its activity in the market to keep rates down.” Economic data was mixed this week. The unemployment rate increased to 8.5 percent, as forecast in a Bloomberg News survey, from 8.1 percent in February, a Labor Department report showed. Employers cut 663,000 jobs, bringing total losses since the recession began to about 5.1 million, the biggest slump since World War II.
The Institute for Supply Management’s factory index climbed to 36.3 in March, a third consecutive gain that brought it closer to the breakeven point of 50. The number of contracts to buy existing homes in February rose 2.1 percent, the National Association of Realtors said. “People think things are looking better, so they are not buying bonds,” said Mark MacQueen, who helps oversee $7.5 billion as co-founder of Sage Advisory Services Ltd. in Austin, Texas. “Any hint of a real turnaround in the economy, employment or the financial sector is going to be very negative for Treasuries.” The difference, or spread, between yields on 10-year notes and Treasury Inflation Protected Securities, which reflects traders’ outlook for consumer prices, narrowed to 1.40 percentage points from 1.43 percentage points a week ago. The gap touched a 2009 low of 91 basis points on Feb. 10. It has averaged 2.26 percentage points for the past five years. After subtracting for consumer prices, the so-called real yield for 10-year notes is about 2.7 percent, more than double the five-year average.
Estimate of TARP's Cost to Taxpayers Increases
The Congressional Budget Office has quietly altered its estimate of the ultimate cost to taxpayers of the $700 billion Troubled Asset Relief Program, now figuring the initiative will be much more expensive in the long run than it previously figured. Some TARP outlays eventually will be returned to the government as banks return capital the Treasury has invested in them or as the government sells loans or securities it acquires as part of the financial rescue. In January, the CBO pegged the ultimate cost to taxpayers of the $700 billion TARP at $189 billion. When the agency issued revised numbers in late March, it revised that to $356 billion, a change that drew little attention.
The larger estimate reflects, among other things, the Treasury's move to use the TARP to help avoid foreclosures, as well as the changing details of its aid to American International Group Inc., and the deterioration of financial conditions and of banks in which the Treasury has invested TARP money. The CBO estimates the program's ultimate cost using techniques similar to those generally applied to federal loans and loan guarantees, and adjusts for market risk. More precisely, it puts the net cost to taxpayers at the difference between what Treasury pays for investments or lends to firms and "the present value, adjusted for market risk of any future earnings from holding purchased assets and the proceeds from their eventual sale."
The White House budget office doesn't use the present-value technique in booking the cost of the TARP. Instead, it records the outflows of cash now, and says it will record inflows of cash in the future. But in his 2010 budget, President Barack Obama estimated that if Congress approved another $750 billion for the banks, the government eventually would get about $500 billion of that back for a net cost of $250 billion. The CBO's new figures suggest its estimate of the ultimate cost to taxpayers of coming up with $750 billion for financial institutions would be closer to $375 billion than the administration's $250 billion projection.
Biggest Challenges Still Await Congress
The new Congress has enacted an array of laws in its first three months, but the biggest challenges lie ahead when lawmakers return from a two-week break to tackle health care and climate change. When Democrats took office in January with sizeable majorities in both the House and the Senate, they pledged to change the country's direction. It is too early to say whether they will succeed, but they have at least set the stage for coming battles over President Barack Obama's ambitious agenda to expand health coverage to more Americans, address climate change and improve the education system. After pushing through a $787 billion stimulus package and a $410 billion spending bill for 2009, both chambers on Thursday passed Mr. Obama's $3.6 trillion budget for 2010. The plan aims to shift the government's priorities from the Bush era by increasing spending on health care, energy and education.
Congress has also enacted a series of less-noticed laws in its first 88 days that expand health-insurance coverage to an additional four million children; facilitate efforts by women to sue for equal pay; create 175,000 new public-service positions; and set aside two million acres of wilderness as protected areas. "This Congress has probably done as much as any Congress in which I have served," House Majority Leader Steny Hoyer (D., Md.) said in an interview. "No one can be absolutely positive that what we are doing will work. You can't guarantee success. But you can guarantee failure if you fail to act." Some legislative success was to be expected, given the size of the Democrats' majorities, of 254 to 178 Republicans in the House and 58 to 41 in the Senate, and a Democratic White House. "They're getting their stuff through," said Stephen Hess, a scholar at the Brookings Institution, a Washington-based think tank. "It may not be pretty. But when you start with a stimulus bill like that one, it's a big achievement."
But many measures passed over fierce Republican opposition, and Mr. Obama's hopes for a broad bipartisan coalition haven't yet materialized. That could spell trouble for his grandest plans: overhauling the health system and enacting a plan to fight global warming. "Democrats in Congress have a big job, but thus far they've dropped the ball," said House Minority Leader John Boehner (R., Ohio). "Instead of working with Republicans to deal with the problems we face, the House Democratic leaders seem to have just one answer -- spend more taxpayer money." Lawmakers, heading into a two-week spring recess now, plan upon their return to plunge into areas where it could be substantially harder to win support, especially from Republicans. Time may be short. Democratic leaders want to enact most of their agenda this year, when they have political momentum and Mr. Obama's popularity remains high.
As the November 2010 elections approach, the atmosphere will likely turn more political, making it more difficult to achieve compromises. Among the first orders of business will be writing new regulations for the financial-services industry. Lawmakers from both parties expect some bipartisan cooperation over this effort. Consensus may be harder to achieve when it comes to overhauling the health-care system. Three House committees are working together to come up with a plan. In the Senate, Sen. Max Baucus (D., Mont.) is struggling to forge a bipartisan bill. Wide differences remain, especially over Democrats' insistence that any new system should include a publicly run health plan, to give consumers more coverage options.
Sen. Ben Nelson of Nebraska, a Democrat who often works with Republicans, predicted that a health bill of some sort will pass this year, but said it may not be as sweeping as some would like. Climate change may be the toughest issue of all. Some Democrats as well as Republicans oppose Mr. Obama's proposal for a "cap-and-trade" system, which would set up a market where companies would pay to emit set amounts of greenhouse gases. Many Republicans say such a system would affect all consumers and the broader economy. "It's also a tax on all economic activity, from factory floors to front offices," Senate Minority Leader Mitch McConnell (R., Ky.) said on the Senate floor recently. "This tax won't just hit American households, it will cost us jobs."
Big Banks Resist Call To Aid Chrysler
Chrysler LLC's lenders are resisting efforts to convert most of the automaker's debt to equity, a conversion key to Chrysler's plan to restructure without filing for bankruptcy protection, according to a published report. Banks including JPMorgan Chase & Co., Goldman Sachs, Citigroup Inc. and Morgan Stanley loaned Chrysler $6.8 billion in 2007 when Cerberus Capital Management LP acquired an 80.1 percent stake in the automaker. Now, Chrysler needs to swap $5 billion of that debt for equity in the automaker, as part of the plan for the company to become viable, The Wall Street Journal reported Friday, citing unnamed people familiar with the talks. The banks' reluctance is slowing Chrysler's efforts to reach a definitive deal on an alliance with Fiat Group SpA, and also stalling the company's attempt to reach a health care agreement with the United Auto Workers union, the Journal reported.
Chrysler released a statement saying it "is committed to working closely with all constituents, the administration, U.S. Treasury and the (government's auto) task force over the next 30 days to reach a successful conclusion." Because the banks hold debt secured by collateral, they have the right to take Chrysler plants and assets if the company files for bankruptcy protection. That means they may be better off with what's left of Chrysler in liquidation than what they'd get if they agree to restructure the debt. The government has little leverage to force the banks to make concessions if they believe they'll be better off in bankruptcy court. But the banks that are pushing back against Chrysler and the government are also the direct recipients of government aid through the banks' own bailouts.
One person familiar with the matter said the four banks have had senior people involved in talks with the Treasury Department during the last two days. Chrysler also owes money to Cerberus and Daimler AG, but they already have agreed to exchange all that debt for Chrysler equity. Other lenders also appear willing to make concessions, but JPMorgan is leading the negotiations with Treasury, the Journal reported. Chrysler and General Motors Corp. have received a combined $17.4 billion from the government to keep them alive amid the worst auto sales market in 27 years. On Monday, President Barack Obama announced that the companies' plans to become viable and repay the loans were insufficient. The government gave Chrysler 30 days to show it is deserving of more government help by securing a definitive deal with Fiat and getting further concessions from debtholders and the UAW. GM has 60 days to satisfy the government or face bankruptcy.
Hooray, We've Adopted Japan's Banking Solution
In the 1990s, when I was a technology analyst on Wall Street, I often heard economists explain why Japan's economy and stock market were mired in a lost decade. Japan, the economists said, refused to acknowledge that its banks were insolvent. Japan was allowing the banks to continue to pretend that they were healthy--by not writing down bad loans and by making new loans so companies could pay interest on bad loans and the bankers could say that the bad loans were good loans. Until Japan forced its banks to write off bad loans and stop making new loans to pay interest on bad loans, the economists said, Japan's economy would suffer.
The economists always said this as though it was the most obvious thing in the world. The Japanese were just wimpy socialists who lacked the balls to face up to reality. And now so are we! A few years ago, the U.S. put an accounting rule in place that was designed to help us avoid becoming Japan: mark-to-market. Since the market is the best judge of the value of any security (better than the average individual, always), mark-to-market makes it harder for banks to lie to themselves and the rest of us about what their loans are worth. Banks loved mark-to-market when markets were going up, because they no longer had to defend the high prices they placed on their assets. They could just mark them to the market price, watch billions of dollars of profits flow through to the bottom line, and cash in at the end of the year.
Now that markets are going down, however, banks are screaming bloody murder about mark-to-market, because it is making them insolvent. Banks don't like being insolvent (who would?), so they have been kicking and screaming about how mark-to-market should be eliminated. (Of course, the banks aren't stupid, so they don't say that mark-to-market should be eliminated because it is putting them out of business. They say it should be eliminated because, this time, the market is wrong: It's not that so many loans are going to go bad. It's that we are having a little liquidity crisis. The moment we fix the liquidity crisis, prices will go back up.) Banks employ lots of people (voters) and give lots of money to politicians.
So, naturally, when banks screamed about the horrific unfairness of mark-to-market, politicians listened. And began screaming, too. And so did investors, who kept losing their shirts. And with the politicians and bankers and investors all screaming and losing their shirts, the folks who work at FASB (the people who establish accounting rules) suddenly began to feel a little less popular at cocktail parties. No longer were they the folks who had figured out how to help our banks and investors and politicians get rich in the boom years. Now, they were the folks who were putting our banks out of business, costing investors their shirts and employees and politicians their jobs. All in the name of some silly little accounting rule that no one understands.
So FASB caved. And changed mark-to-market. So now banks can go back to saying their assets are worth whatever they want them to be worth again. And we can pretend that bad loans are good loans and make more bad loans to help keep other good loans from going bad (would you like a new loan to pay the interest on that old loan?) and investors won't get wiped out and employees and politicians won't get fired and everything can be hunky dory. Just like in Japan.
US Aid to Borrowers Not Preventing Rising Delinquency
Mortgage lenders have boosted their foreclosure-prevention efforts, but homeowners nonetheless are increasingly falling into delinquency even after receiving help on their loans, according to a government report issued yesterday. The report, by the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which regulate mortgage lenders, illustrates the challenges facing industry and government efforts to tackle the foreclosure crisis. Foreclosure rates are expected to continue to increase as the economy falters and the labor market weakens. It could take months for the Obama administration's prescription for the foreclosure crisis to begin to have an impact.
The financial services industry has been increasingly focused on finding affordable mortgage levels for troubled homeowners, said Faith Schwartz, executive director of the Hope Now Alliance, a group of mortgage lenders. "Our members are reporting to us that they have been increasingly using loan modifications during 2009," she said in a statement. According to the report, a growing number of homeowners are falling behind on their payments and borrowers with prime mortgages, which traditionally are considered less risky, are a growing part of the problem. The number of prime loans that were seriously delinquent -- the borrower having missed two or more payments -- exceeded seriously delinquent subprime loans for the first time in the fourth quarter, the report said.
The report also found that many borrowers are quickly falling behind on their payments after receiving a modified loan, which can include lowering their interest rate or extending the length of the loan. Of the borrowers who had loans modified early last year, for example, about 35 percent had missed at least three payments within nine months and about 57 percent had missed at least one payment. "These lenders blame the homeowner for being late in the first place, and now they are blaming them for defaulting on the modification, when in both cases the payments were unaffordable," said Bruce Marks, chief executive of the Neighborhood Assistance Corp. of America, which has been critical of industry foreclosure-prevention efforts.
The more a borrower's payment is lowered, the more likely he or she is to stay current on the loan, the report found. But during the fourth quarter, most borrowers with modifications, about 58 percent, did not end up with lower monthly payments. "I am like everybody else -- I want to be a optimistic. But studies like this don't promote optimism," said John Taylor, president of the National Community Reinvestment Coalition. "The re-default rates of these modifications show they are not effective enough." Also, an increasing proportion of homeowners, about 1.44 percent during the fourth quarter of 2008, are falling behind before making a single payment on their mortgages, according to the report.
The increase could be a sign of fraud, that the loans weren't reviewed properly at the outset, or of the worsening economy, said John C. Dugan, comptroller of the currency. "Circumstances have changed more quickly for some borrowers, and they have not been able to make payments they thought they could," Dugan said. A recent Washington Post investigation of loans backed by the Federal Housing Administration found that in the past year, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages nearly tripled. Some of the loans in yesterday's report are FHA-backed.
OPEC Loses Influence Over Oil Prices
OPEC may have found the limit to its influence over oil prices, as doubts emerge about the group's ability to cut production enough to match weak demand. The Organization of Petroleum Exporting Countries agreed last year to cut production by 4.2 million barrels a day. Oil prices plunged from highs above $145 a barrel in July to below $34 a barrel in December, close to a five-year low. OPEC's high compliance with its announced cuts halted that slide. The cuts helped set the stage for a nearly 60% rise in oil prices over the last six weeks. Since then, crude-oil futures have traded around $50. Friday, light, sweet crude oil for May delivery settled 13 cents lower, or 0.3%, at $52.51 a barrel on the New York Mercantile Exchange. "I don't expect prices to go below $40 for a long period of time, [OPEC has] succeeded on that level," said Greg Priddy, an analyst with Eurasia Group, a consultancy.
In other commodity markets:
COFFEE: Prices rose, supported by speculative buying and continued strength in physical coffee prices. Colombian coffee physical prices rose to 12-year highs Friday. Because of tight Colombian coffee supplies, Folgers, owned by J.M. Smucker Co., confirmed it would raise list prices 19% on new orders containing 100% Colombian coffee. The ICE Futures U.S. May contract gained 1.60 cents to $1.1840 a pound.
COPPER: Futures rallied to a five-month high as speculators snapped up the metal amid optimism about an economic recovery. Thinly traded nearby April copper rose 11.15 cents, or 5.9%, to settle at $1.9995 a pound on the Comex division of the Nymex.
Gazprom May Cut Multibillion-Dollar Investment Program
Russia's OAO Gazprom said it might have to cut its multibillion-dollar investment program this year amid collapsing demand for natural gas as Russian prime minister Vladimir Putin offered the company state aid to get it through the global downturn. The economic slowdown has triggered a slump in natural gas consumption by industry and power generators in Europe, Gazprom's main export market. Gas use in Europe's largest economies fell as much as 16% this winter despite unusually cold conditions, according to IHS Global Insight.
Gazprom's revenue is expected to fall sharply this year amid a steep decline in the export price of gas, which normally lags behind oil's price by several months. The company has responded to the decline in demand by cutting output, last month producing almost a quarter less gas year on year, according to official statistics.
In another sign of how the financial crisis is squeezing Gazprom, the ratings agency Moody's downgraded the company Friday by one notch, bringing it in line with Russia's sovereign rating. Moody's said it no longer believed it appropriate to assign Gazprom a rating higher than Russia's because both were affected by the price of oil and gas and the health of the Russian economy.
The gas giant is Russia's biggest borrower, with $47.6 billion in debt as of mid-2008. About a quarter of that is short term and may need to be refinanced this year. But Moody's analyst Victoria Maisuradze said Gazprom's debt burden was not excessive. She said the company's debt-to-book value ratio had fallen to 23.6% at the end of the 2008 third quarter from 30.7% at the end of 2007, and it wasn't expected to rise materially this year. In an indication that the appetite for Gazprom debt hasn't waned, the company successfully placed Eurobonds valued at 400 million Swiss francs late Thursday, the first such placement by a Russian borrower since the onset of the global financial crisis last year.
Gazprom has experienced a sharp reversal in its fortunes since last summer, when Chief Executive Alexei Miller predicted the price of oil would rise to $250 a barrel and said that Gazprom would soon have a market capitalization of $1 trillion. Since then, the price of crude has plunged to around $50, taking Gazprom's share price with it. The company's market value is now a little less than $100 million. Gazprom's fall mirrors that of the Russian economy. The ruble has lost 30% of its value since November, and budget revenue has shrunk as the price of oil, Russia's main export, has tumbled. In December, Gazprom's board approved a 920.44 billion ruble ($27.6 billion) investment program for 2009. But company managers indicated in February that thefigure might be reduced later this year, depending on how deep the recession in Europe turned out to be and on the outlook for future gas demand.
European Finance Chiefs Say ECB Is Doing What It Can
European finance chiefs said the European Central Bank is doing what it can to fight the worst recession since World War II even after policy makers yesterday cut borrowing costs by less than economists expected. The Frankfurt-based ECB yesterday reduced its benchmark rate by a quarter point to 1.25 percent, compared with the half- point reduction forecast by 49 of 55 economists in a Bloomberg survey. The euro-region economy may shrink as much as 4.1 percent this year, faster than the ECB forecasts, according to the Organization for Economic Cooperation and Development. “I expected a 50 basis-point cut yesterday,” Cypriot Finance Minister Charilaos Stavrakis told reporters today in Prague where he met with finance chiefs from the European Union, adding that the central bank had “done a good job.” Finnish Finance Minister Jyrki Katainen said “there is more room for extra cuts.”
ECB President Jean-Claude Trichet at the Prague meeting today repeated that the central bank may lower the key rate further next month, when he said policy makers also will decide on any new “non-standard measures.” The U.S. Federal Reserve, the Bank of England and the Bank of Japan have cut their key rates to almost zero and are pumping money into their economies by buying government and company securities. The ECB is “making an effort” to “ease policy,” Portuguese Finance Minister Fernando Teixeira dos Santos said. Austrian counterpart Josef Proell said he “hoped” the rate reductions so far may be “enough.”
The euro declined against the dollar on speculation the central bank is moving too slowly in tackling the crisis. The single currency fell to $1.3437 as of 7:06 p.m. in Prague after rising to $1.3461 yesterday. The decision by policy makers to wait until next month to decide on other tools “is probably euro negative” on the longer term as it confirms that the ECB is behind the curve,” said Jeremy Stretch, a senior currency strategist in London at Rabobank International, the biggest Dutch mortgage lender. While the rate of contraction in European manufacturing and services industries is slowing, European leaders face increasing pressure at home as unemployment continues to increase. In the U.S., the unemployment rate jumped in March to the highest level since 1983 as the economy lost 663,000 jobs.
“There are encouraging signs, but they are not many,” said Luxembourg Finance Minister Jean-Claude Juncker. Trichet said 2009 “appears to be a difficult” year. Sagging demand has employers from French car manufacturer Renault SA to German Heidelberger Druckmaschinen AG, the world’s largest maker of printing presses, reduce production, postpone investment and fire workers. European Union Monetary Affairs Commissioner Joaquin Almunia today suggested that “materializing downside risks” will probably prompt the EU to cut its economic-growth forecasts. The updated projections will be released on May 4. At the same time, both Almunia and Trichet stressed the need to envisage the policies that will be needed when growth returns. “We have to be credible in the exit strategies for all we are doing today, fiscal policies, monetary policies,” Trichet told reporters.
Finance ministers also welcomed the Group of 20’s blueprint for stronger regulation of the finance industry, including stricter limits on hedge funds, executive pay, credit-rating firms and risk-taking by banks and a pledge for more than $1 trillion in emergency aid to cushion the economic fallout. “I am very satisfied” with the G-20 meeting, French Finance Minister Christine Lagarde told reporters, saying she saw “considerable progress.” German Finance Minister Peer Steinbrueck said the agreement by the G-20, which gathers the world’s largest industrialized nations and emerging economies, shouldn’t be “underestimated.” Hedge funds that are “systemically important” will be subjected to greater oversight as will all key financial instruments, markets and instruments, the G-20 said. While German Chancellor Angela Merkel and French President Nicolas Sarkozy wanted all of the investment funds to brought under the spotlight, Czech Finance Minister Miroslav Kalousek told reporters that the hedge-fund rules that the G-20 agreed on are “sufficient.” Trichet stressed the need to implement the measures “as rapidly as possible” in order to revive bank lending. Almunia said that “the treatment of impaired assets and the cleaning of balance sheets in the financial sector is of the essence.”
EU Ministers Say Accounting Convergence With U.S. Is 'Critical'
European Union ministers said it is “critical” that convergence on accounting standards is reached on the continent to ensure that the region’s banks are not placed at a disadvantage against U.S. competitors. The International Accounting Standards Board, which writes the rules used in Europe, must cooperate with the U.S. Financial Accounting Standards Board, the ministers said in a statement today following a meeting of European finance ministers and central bankers in Prague. A goal is to avoid “competitive distortions,” they said. European lenders may face a disadvantage without changes to mark-to-market rules similar to those decided by the U.S. on April 2. The U.S. move stands to help banks such as Citigroup Inc. report higher profits by easing requirements to recognize fluctuations in the value of investments.
Critics of the fair- value rule say it hurts banks by forcing them to book paper losses in the midst of the crisis. “If it was up to me to decide, I would just download the U.S. text with Google and adopt it with a European blessing,” Italy’s Finance Minister Giulio Tremonti told reporters after the meeting. German Finance Minister Peer Steinbrueck said he wants similar accounting principles in Europe as in the U.S. Investors’ Sentiment European countries are under more pressure to achieve concrete progress on regulation. Ministers noted today “the critical importance of converging accounting standards at a global level” as well as “ensuring adequate transparency of banks’ financial situation is key to restoring confidence in financial markets.”
“The U.S. has already taken the lead on accounting standards, with the recent FASB decisions on mark-to-market which lifted investors’ sentiment,” Marco Annunziata, chief economist of UniCredit Group said in an interview today. “If the EU wants to play a guiding role on the issues it claims are most important, it will need to accelerate its decision process.” “We need to arrive at a level playing field on this matter,” French Finance Minister Christine Lagarde told reporters in Prague today. “We need to stress to the IASB the urgency to examine accounting principles, in particular those concerning the valuation of illiquid assets.”
Britain should not fear asking for IMF cash
Economists have warned that the UK's public finances are in such a bad state there is a real possibility that Britain will seek help from the fund. The G20 agreed this week to establish a new scheme, controlled by the IMF, which countries of all backgrounds can go to if they are experiencing financial problems. That coincided with a concerted push by British ministers to argue that there would no longer be any stigma attached to asking for cash. The previous Labour Government's bail-out by the IMF in 1976 was seen as a national humiliation and helped sweep the party from power for 18 years.
A senior Cabinet minister said, however, that the new fund would not be like the 1970s version and should not be seen as such. He said there would be nothing wrong if America or Britain used the facility. He said: "Previously a country would only go if they were in a very bad state. It was a bit like going to accident and emergency to get urgent help. "This new facility will not be like that. It is a bit more like getting wellbeing care or even like going to a spa to recuperate." World leaders agreed in London to increase resources available to help economies in trouble to $750 billion. Gordon Brown said in his closing comments to the G20 summit that countries like Mexico, which is not in immediate danger of economic collapse, were considering using the IMF.
Stephen Timms, the Treasury minister, and Lord Mandelson, the Business Secretary, said this would remove some of the "stigma" of using the facility. Mr Timms was quoted as telling a meeting earlier at the G20 that Mexico's move showed "we have gone beyond the era of stigma." Mr Brown, when asked whether Britain would now be free to use the system, replied that he was "not proposing to do so". But yesterday Simon Johnson, the former IMF chief economist, said: "In the past, you got loans from the IMF when you were facing complete disaster. Now the IMF is going to come in before you get into real trouble. "Gordon Brown and his ministers, they need help. Your economy is in big trouble."
George Osborne, the shadow chancellor, seized on the comments. He and David Cameron have repeatedly warned that Britain may have to go cap in hand to the IMF.
Mr Osborne said: "This is a pretty extraordinary warning from the former chief economist of the IMF and shows just what a mess Britain's public finances are in." Mr Timms began the softening up process last month when he told MPs that the new IMF lending instruments would help "overcome the problem of stigma that has been attached to IMF programmes in the past, to the extent that some countries feel it is politically impossible to contemplate approaching the fund."
RBS needs five years to get over ABN fallout
Royal Bank of Scotland will take at least three to five years to recover after the disastrous acquisition of ABN Amro assets that were instrumental in damaging the bank's balance sheet, chief executive Stephen Hester has said. Speaking at the bank's annual meeting on Friday, Mr Hester said insufficient risk controls, a short-term profit focus and misguided strategy were among a series of problems that, combined with the ABN acquisition, saw the once-great Scottish bank fail. There were now "no sacred cows" among the group's business divisions as it embarked on a five-year overhaul to resuscitate its fortunes. "I wish it would be quicker but I am sorry to tell you it won't be," he said to shareholders, who rejected by a nine-to-one majority a resolution to pass the bank's remuneration report.
Sir Philip Hampton, RBS chairman, said the vote was "disappointing" and an obvious backlash against the £703,000 annual pension secured by former chief executive Sir Fred Goodwin. Sir Philip repeated he had spoken to Sir Fred in February, urging him to surrender part of his entitlement, but there is no sign of Sir Fred agreeing.
RBS has also overhauled its remuneration policies in response to concerns and the changing regulatory and economic environment, he told the packed Edinburgh International Conference Centre. "Fred's deal won't happen again," Sir Philip added. Fielding questions from shareholders angry at Sir Fred's huge payout, Sir Philip said "more lawyers than you could shake a stick at" were poring over the former chief executive officer's contract.
One private shareholder, Bert Allen, questioned the legacy of what he claimed was the "regime of fear" of Sir Fred's era. Sir Philip said: "I have heard those stories . . . it's clear that Fred Goodwin was a hard-driven and decisive character. There's no room in RBS now for victimisation and bullying," he said. He also called for an end to the "public flogging" of RBS – which reported a £24bn loss for 2008 – while foreshadowing more job losses. "We have suffered a major financial hit and continued collateral damage from public criticism will compound the problem, not resolve it," he said. He was unable to quantify the number of likely redundancies to follow the 2,700 jobs already cut. "We can only be honest and say that this will not be the end of the story and more are expected in the UK and internationally." Investors reacted positively to the news, with RBS closing up 2.4 at 30.6p
Spain’s savings banks could face €40bn hole in capital
Caja Castilla la Mancha is only a small bank. But the Bank of Spain's rescue of this caja, or savings bank, has raised alarm bells - for good reason. The cajas, which are mutual banks controlled by regional politicians, have a bigger problem with bad debts in Spain than shareholder-owned counterparts such as Santander and BBVA. The cajas were more aggressive during the good times - loans to developers increased by more than 50pc in 2006, and account for a fifth of their total loan books. This explains why the ratio of non-performing loans stands at 4.5pc for the cajas, against 3.2pc for commercial banks.
It looks like the Bank of Spain, which kept Spanish banks from buying toxic assets out of the US, wasn't prudent enough at home. True, banks were ordered to build a thick cushion of generic provisions during the good years. But for some cajas, these provisions will be eaten up by losses. In the last year, the sector's ratio of provisions to bad debts, or coverage ratio, has fallen from about 200pc to just 56pc. As property prices fall and new developments sit unsold, the cajas' losses mount. Credit Suisse estimates the cajas will need to raise €60bn just to keep the ratio of equity to non-performing loans at 160pc. That may be high. Suppose 10pc of whole loan book - and a quarter of the €172bn of loans to developers - go bad. And suppose only 40pc of their value of the loans is recovered. The total losses would be about €34bn - eliminating nearly half of the current equity in the sector.
Savings banks could cover part of the hole with operating profits and existing provisions. But they have only €23bn in provisions now. To get the buffer up to 75pc of non-performing loans, another €16bn needs to be found. Some of the missing capital - losses and reserves - will be generated by operating profits, running at €15.2bn annually. Add it all up, and there still seems to be a capital hole of nearly €40bn. The gap isn't spread evenly, and the richer cajas aren't likely to want to share much with their poorer brethren via mergers. The Boss of Spain's biggest savings bank, La Caixa, recently said mergers made more sense when financial margins were wider. So in practice, the shortfall is likely to be larger. Some cajas can sell industrial stakes. But they can't raise equity from private shareholders, as Santander recently did, because they are not listed. It looks like the government may have to foot most of the bill.
Ireland’s Economy to Shrink 12% By 2010, Central Bank Says
Ireland’s economy will shrink as much as 12 percent between 2008 and 2010, as a construction slump deepens and unemployment surges, the country’s central bank forecast. Gross domestic product will drop 6.9 percent this year and 3 percent in 2010, the Dublin-based bank said in its quarterly bulletin published today. The bank in January forecast a 4 percent contraction this year. Unemployment will soar to around 14.4 percent next year, the bank said. Ireland is mired in one of the worst recessions in its history as a slump that began with the ending of a decade-long property boom is amplified by the global credit crisis and cooling export demand.
Companies including Dell Inc, Royal Bank of Scotland Group Plc and C&C Group Plc are shedding jobs, pushing up unemployment and leaving the government with a widening budget deficit. “It is critical that firm and decisive action is taken to reverse the major deterioration in the general government deficit,” the bank said in the report. “Fiscal sustainability is necessary for the restoration of confidence in the economy.” The government, which had its top credit rating downgraded by Standard & Poor’s this week, will present an emergency budget on April 7, to start plugging the hole in state finances. The budget deficit soared tenfold to 3.72 billion euros ($5 billion) in the first quarter, the Finance Ministry said yesterday.
Beijing's 'Legless' Stimulus
China touted the effects of its $588 billion economic stimulus package at the Group of 20 meeting this week in London. Chinese policy makers, including President Hu Jintao, argued that the stimulus package proves Beijing is playing its part in jumpstarting the global economy. Some investors have been swept up in a wave of optimism about the package's positive impact. There is considerable evidence, however, that even if the stimulus manages to produce some positive headline numbers, it is likely to fall short on its ultimate aim of creating employment and jump-starting private consumption. This result is not accidental; it is the outcome of a political system dominated by state planners, large state corporations and local officials.
More than three-quarters of the stimulus package will be spent on construction, including transportation infrastructure, earthquake reconstruction, welfare housing and rural infrastructure. Much of the money spent on earthquake reconstruction may prove productive, assuming local officials don't allocate the money to pet projects. After more than a decade of intensive infrastructure building elsewhere in China, however, it is dubious that additional construction on such a massive scale can generate economic returns beyond boosting short-term employment for a few months.
Furthermore, the central budget finances only around one-quarter of the stimulus package. At least half of the remainder will be financed by banks in China. Rather than lending to the domestic private sector or consumers, banks are eager to finance these government-sponsored projects because they come with implicit government guarantees and thus pose less risk than private borrowers do. In addition to $588 billion in central projects, local governments have also proposed more than $3 trillion in additional investment projects. Not all of these projects can be financed, but local plans could potentially double the size of the central stimulus. Banks may end up financing as much as three-quarters of these local projects because local governments are typically cash-strapped, thus further crowding out private consumption and investment.
Local and central governments are in some cases at an impasse over how much land should be allocated to central projects. Land sales to developers and land mortgaging have been major sources of local discretionary spending in recent years, but the stimulus projects will demand large tracts of land from the local land banks at little compensation. Thus, local governments do not want to "waste" this land on public projects, especially when the central government has set a strict limit on the amount of farmland that can be developed. The Chinese press reports that sometimes local governments are simply stalling on central projects, especially when it comes to welfare housing. In other cases, local governments are forcefully resettling residents with little compensation to reduce the cost of obtaining land. The Ministry of Land and Resources apparently deems these problems serious enough that it has organized an internal work group to monitor them.
Of the remainder of the money, the government announced at the March National People's Congress a $54 billion fund for enterprise "innovation and restructuring." Most of this money will go to state-owned corporations. A significant portion of the $31 billion allocated to pollution reduction will also end up in state firms. These firms may not use the cash effectively. Large state firms witnessed a 25% decline in profitability at the end of 2008 from the end of 2007. Some state-owned corporations, such as China Eastern Airlines, stay afloat only due to central subsidies after botching deals on commodities futures. In addition, subsidies embedded in the stimulus and bank loans will be used by state firms in the steel, automobile, electricity, and coal industries to buy state-owned and even private competitors, which contradicts at least the spirit if not the letter of the antimonopoly law by creating oligopolies.
The revitalization plan for the automobile industry, for example, specifically demands consolidation of car producers from the current 14 to 10 in three years. From the perspective of building behemoth national champions, rescuing ailing state firms and subsidizing sector consolidation may be a fine strategy. However, from the perspective of generating employment and private consumption, it may not be particularly effective. To be sure, state-owned corporations have been ordered to not fire anyone, but with overcapacity looming over them, they are certainly not doing much hiring. In addition, it is unclear whether the no-firing rule applies to newly acquired subsidiaries of these state behemoths. The stimulus is thus legless: It looks impressive at the top, full of grandiose plans and ample financing from state banks, but lacks a solid foundation. The epic scale of central expenditure and state bank lending will generate some positive investment and GDP figures.
Its impact at the grassroots level, however, is dubious. Beyond the short-term boost in employment and relatively small sums spent on social welfare and health, ordinary Chinese will see few benefits, limiting their capacity to spend in the midst of the global demand slump. Already, the People's Bank of China's fourth-quarter monetary report indicates that household propensity to consume declined yet again in the fourth quarter of 2008. Given horrendous export figures in the first quarter of 2009, household propensity to consume is likely to decline again. The central leadership in Beijing has voiced its intention to boost domestic consumption. If they seek to maximize society's welfare over the long term, these leaders may be relied upon to carry out the right policies to boost consumption.
But these are heroic assumptions. In an autocratic regime, generating employment is not the only means of holding on to power. At the same time, powerful rent-seeking lobbies, including the state corporations and local officials, demand their large slices of the stimulus package. Even if the current leadership is sincere about its desire to reorient the economy, they are under pressure to address the concerns of powerful rent-seeking interests, who directly influence the leadership's ability to stay in power. Ordinary citizens and small firms, in contrast, are largely absent from the political process, and thus exert no direct influence on the implementation of the package. This is not to say the American stimulus will perform any better, but the Chinese political system certainly diminishes the effectiveness of the stimulus. When China claims that it has done enough to jump-start domestic demand, G-20 leaders should take that message with a large grain of salt.
City Tries to Hang On Amid Auto Collapse
This factory town has held its own through decades of auto-industry retrenchment and downsizing, staving off the blight that has spread to so many nearby cities. When an auto-supply plant here closed two years ago, city leaders found a defense company to fill the property. And the city's finances remained strong enough that Sterling Heights hasn't had to cut into core services such as the police and fire departments. Now, local officials are wondering whether the auto industry's fight for survival is pushing this Detroit suburb toward a breaking point.
Last week, one of four main auto plants in Sterling Heights -- Chrysler LLC's assembly plant -- was idled for a month for the second time this year, causing 1,100 employees to turn to unemployment assistance. That caused one of the plants' suppliers, also based here, to suspend work for 217 people. Property values are falling, leading to a drop in the real-estate taxes that are the city's main revenue source. "Everything is costing more, and there is less coming in," said Mayor Richard Notte, adding that economic conditions are the worst he has seen in his 16 years as mayor. "There isn't any light at the end of the tunnel right now." Conditions in Sterling Heights, home to 128,000 people 20 miles north of Detroit in Macomb County, may foreshadow what is looming for dozens of other communities tied to Chrysler and General Motors Corp., which the government is pushing into wrenching restructurings -- and possibly bankruptcy filings -- in return for federal bailout money.
Cities and towns from Tennessee to Ohio to Michigan that rely heavily on the auto industry are suffering in the wake of the companies' plummeting vehicle sales. Auto makers have closed factories, cut wages, offered buyouts and laid off workers, all of which hurts the local businesses whose revenue is indirectly dependent on car sales. Even places that have managed to stay afloat fear they may not escape the current tempest. The largest employer in Sterling Heights is the auto industry, with a Chrysler car plant and a Chrysler stamping plant, two Ford Motor Co. parts plants and their auxiliary suppliers strewn along four-lane roads spotted with big-box stores, gas stations and modest restaurants. That industrial base has helped keep the city's employment and population levels steady the past few years, even as Michigan lost more than 700,000 auto-industry jobs.
Its declining fortunes mirror what is playing out through Michigan's economy. The state's unemployment rate is 12%, foreclosures are among the highest in the nation and one in 10 residents is on food assistance. "It's not as though we've been blindsided by this," said Sterling Heights city manager Mark Vanderpool. "We are having to navigate through the storm." The city has joined forces with other municipalities across the country to lobby Washington for assistance. The group met with President Barack Obama's auto task force this past week. To minimize vacant properties -- Mr. Vanderpool warns that blight "spreads like a cancer" -- city leaders spent two years trying to find buyers to take over an industrial site vacated by an auto supplier. And last year, using a package of tax incentives, the city landed defense contractor BAE Systems, which promised to invest $60 million and create 500 jobs. The earlier addition of 4,000 other jobs in the defense sector had helped to hold the local labor force steady until this year's sharp drop.
But even as city officials scramble to adjust, the community is struggling. Dean Zelenak is a supervisor at the Chrysler assembly plant that was just idled. Reassigned to another plant, Mr. Zelenak said he is stretched thin because layoffs have left remaining workers to juggle multiple responsibilities. "We're basically fighting for our jobs on a daily basis," said the 41-year-old father of two, whose wife also works for Chrysler in logistics. "We're all nervous. No one sees any light." Mr. Zelenak said that a year ago, two shifts of workers were building 1,100 Dodge Avengers and Chrysler Sebrings a day. "Now, we're not even building 1,100 cars a month," he said. This past week, the auto task force gave Chrysler 30 days to put together a viability plan or face liquidation. The company is scrambling to finalize a partnership with Italian automotive company Fiat SpA and strike deals with its bondholders and union workers to meet the deadline.
Across the street from the plant, Guiseppe D'Anna just took over a restaurant that he sold some years ago to his manager, who recently had to give it up because he could no longer afford the lease. To make it work, Mr. D'Anna has cut prices, trimmed portions and offered coupons. "I put the price of chicken parmesan at $7.99 and still they don't come. They cannot buy a hamburger for that price," he said. Noreen Pannebecker, who works at a nearby florist shop, said she and her husband have stopped eating out unless they have a coupon. She has had 11 hours cut from her 40-hour work week. Even funeral orders are drying up, Ms. Pannebecker said. "A lot of people have strayed away from buying flowers. They may give the family a little bit of money or help out by giving food."