Drugstore in Newark, Ohio
Ilargi: At the top of the pyramid spectrum, we find Goldman Sachs, which manages to rake in dozens of billions of dollars in public funds without running the risk of pesky government oversight or those darn socialist leaning bonus cuts. The IMF's fresh estimate of $4 trillion in global toxic assets? Goldman poses as the Teflon financial. The next round of bank bail-outs? Goldman turns into the Velcro bank. Has the firm avoided all the risk that has sunk others? Has it been more truthful in writing down assets? No and no.
And why would it? If your own people run the government, any and all new legislation, and any and all rescue and bail-out plans, can and will be tailor-made for you to benefit to the maximum of your abilities. While you may see -and have- varying opinions on whether Goldman is indispensable to the US financial system, the only thing that matters is without it there'd be no functioning US treasury. So why wonder how exactly it functions? Just pour in more grease, and hope the wheels will keep churning. What else are you going to do?
At the bottom of the pyramid, we find the resurgence of debtors prisons (don't worry, they won't be called that). The billions will have to come from somewhere, after all. US states, with Florida leading the way, see their tax revenues slide so hard and fast (no surprise there) that they start to lean on their citizens like so many loan sharks. And yes, that's a system based on threats and fear. In Ireland, where we see the first full-blown emergency budget in the west as well (a writing on the wall if ever there was one), they never bothered to erase debtors prisons from their laws. Good luck to the Irish.
Governments at all levels will find it hard to resist the temptation to raise taxes, and then raise them some more. The results are undeniably obvious before the circus even starts. Prisons will be filled with people who have no access to the money and the jobs needed to pay what they ostensibly owe. Play that game long enough, and you'll have tax revolts, in whatever form they take on. The US already incarcerates far more people than any other repressive society in the world. Where do we think this wil lead? I think we all have an idea where.
The top of the pyramid is convinced that saving their part of the edifice is what counts, and that the scraps falling off their tables will suffice to satisfy the bottom dwellers. But they fail to see that less and less scraps do fall down, and that the top cannot hold without the bottom. The whole thing will just fall to pieces, and the top has the longest way to fall.
How Not to Price Toxic Bonds
WHAT IS THE MAXIMUM PRICE OF A BOND? You can ask this question to newly minted MBAs to distinguish the merely smart from the truly clever. The "smart" answer, approved in all the best business schools, is "the sum of the future cash flows." Occasionally someone will provide something more interesting. My all-time favorite answer came from a fellow who became a very successful trader. The maximum price of a bond? "Whatever the stupidest investor is willing to pay for it." This definition came to mind while reading the term sheets for the latest manifestation of Treasury's plans to buy toxic debt from the banks. The American taxpayer is once again being cast in the role of "stupidest investor."
Treasury Secretary Tim Geithner's plan has three immodest objectives: price discovery, fairness to taxpayers and getting the banks lending again. His plan is likely to fail on all three counts.
START WITH PRICE DISCOVERY. Geithner and the interventionist crowd repeatedly claim that we are in the midst of genuine market failure with respect to toxic securities. Nothing is trading because nobody knows what anything is worth. According to many commentators, the securities are not tradable because their value is unknowable. One of the principal aims of Geithner's plan is to provide a market where none exists, so that these securities can be valued and traded. But it is not true that nothing is trading because nobody knows what things are worth. Nothing is trading because too many people know what things are really worth.
It is true that the banks that gorged themselves on toxic debt are unwilling to sell at the price that potential buyers are bidding, but that is not a "market failure." Whenever the explanation for a problem is "market failure," it makes sense to look for a simpler explanation. Here the simpler explanation is obvious: Banks don't want to sell to astute investors, who are bidding conservatively for something that may continue to fall in value. Banks want to sell to investors who will overpay for noneconomic reasons. Geithner proposes to give them that chance.
GEITHNER'S PLAN, the Public-Private Investment Program, or PPIP, presumes that the involvement of private asset managers in valuing the toxic debt will ensure that the debt is fairly priced and that the public gets a good deal. Ironically, the plan is a collateralized debt obligation, the very structure that supposedly caused all the trouble. The sine qua non of CDOs is "non-recourse leverage," meaning that if the assets decline in value, the owners don't have to pay back the debt. A second attribute of CDOs at the core of the recent unpleasantness was that the bulk of the purchased assets were financed at very low interest rates. Issuance of collateralized debt obligations ground to a halt at the end of 2007, when it became impossible to find senior investors willing to provide leverage on such uneconomic terms.
Enter the U.S. taxpayer. Under the PPIP, there are two classes of investors, a junior and a senior. The senior investor, hereinafter known as Uncle Sugar, provides 84% of the total. The junior investors are the government again and private asset managers, each contributing 8%. Assume that the assets are purchased at 50% of face value and that, in five years, they either fall to zero or return to 100% of face value. Under the downside scenario, both the private investors and the taxpayers lose all their money. But under the recovery scenario, the private investors will reap a 625% return -- nearly 50% a year. Uncle Sugar's annual return in the upside scenario is unlikely to climb much above 10% -- it depends on how low the senior financing rate is set.
Some of the largest fixed-income asset managers were quick to get behind the plan. They wouldn't really price the asset; they would price an option on the asset, with enormous upside and limited downside. Such an asymmetric bet, with somebody else putting up most of the money, would tend to lead to an artificial inflation of prices. Geithner's plan is not an attempt to discover prices, but to inflate them. We can sum up much of the current financial problem as stemming from a surfeit of cheap financing that induced investors to overpay for financial assets. Geithner's solution is to create a surfeit of cheap financing to induce investors to overpay for financial assets. As Will Rogers asked, "If stupidity got us into this mess, why can't it get us out?"
THE PPIP WILL NOT PROVIDE meaningful price information, and it will not give taxpayers a fair deal. What is worse, it is unlikely to achieve its paramount goal of getting credit flowing again. The proposition we hear over and over again is that these toxic bonds are clogging the arteries of the credit system and that, when they are removed, credit will flow freely again. It is a picturesque metaphor, but it does not really explain what is broken. Geithner seems to have swallowed whole the arguments of the bankers, who desperately want the government to overpay for the toxic bonds. To lure the taxpayers into their scheme, they hold out the carrot of lending again. But what is broken is not the large banks' willingness to extend credit.
What is broken is the shadow banking system in which the big banks played a significant but supporting role. The shadow banking system has been the driver of credit creation for the past two decades. It is not clogged; it no longer exists. And it cannot be recreated by overpaying for Citibank's bad loans. The shadow banking system is that complex interplay of banks, hedge funds, structured investment vehicles, mono-line insurers, derivative products companies and the likes of AIG-Financial Products. Consider that AIG-FP alone had insured over $400 billion of mortgage securities. Most of these securities were "owned" by banks, but it is a mistake to classify the banks as lenders. The banks didn't think they were lending; they thought they were providing funding only to the extent someone like AIG was there to take the risk.
Schemes designed to get banks lending again overlook the financial developments of the past 20 years. If we want to return to 1988, when for instance Citibank held its credit-card assets on its own books, we will quickly discover that the capital of the banks, even if unimpaired by bad debt, will finance only a much smaller amount of credit. The real problem is much more difficult than coaxing banks to lend. The shadow banking system evolved over 20 years and imploded in just six months. AIG-FP and the other institutions that made super-cheap credit available cannot easily be recreated. Geithner's plan seems to miss this point. The next act of this financial tragedy should not be to discover that spending still more money pushing ahead with PPIP has not done any good.
U.S. deficit nearly $1 trillion in first half of fiscal year 2009
The U.S. budget deficit almost hit $1 trillion during the first six months of this fiscal year which began on October 1, according to estimates released on Monday by the Congressional Budget Office. The government likely recorded $953 billion in red ink from October through March including $290 billion for the Troubled Asset Relief Program, or TARP, which was to provide much-needed cash to struggling financial institutions, the CBO said. Receipts during the six-month period dropped about $160 billion, or 14 percent, over the same period in fiscal 2008. Nearly half of the drop, $73 billion, came from a fall in corporate income tax receipts.
The CBO, the nonpartisan budget analyst for Congress, said the drop in corporate receipts was the largest in more than three decades. In comparison, the federal deficit for the first six months of fiscal 2008 was $313 billion, roughly a third of the estimated current total. More red ink is expected to pile up this fiscal year, with CBO projecting the deficit could total more than $1.8 trillion -- by far a record. CBO has forecast the deficit would drop a bit in fiscal 2010, to nearly $1.4 trillion. In addition to dropping revenue and the bailout money for Wall Street, the government has poured more money out the door to try to jump-start the ailing economy, which has been in recession since December 2007.
Congress approved a $787 billion stimulus package in February and most of the funds are expected to hit the street this year and 2010 through tax breaks as well as spending on infrastructure and other projects. President Barack Obama proposed a $3.55 trillion budget for fiscal 2010, but his fellow Democrats in Congress are trying to trim it to avoid increasing the deficit more. Republicans have complained the budget had too much spending and tax increases. Washington could recoup some of its investments in financial firms and the CBO calculated the potential cost of the program in a couple of ways. Using an alternate approach, the CBO estimated government outlays under TARP at $140 billion through March, leading to an estimated U.S. budget deficit of $803 billion through January.
The CBO also said $46 billion in federal aid was given in March to Fannie Mae and Freddie Mac, the U.S. mortgage financing companies that were taken over by the government. A total of $60 billion has been paid to the two firms during the six-month period. An arm of the U.S. Treasury Department also loaned $10 billion to credit unions to help them address recent liquidity pressures, the CBO said. Net interest on the public debt for the first half of fiscal 2009 did drop compared to the same period a year ago, falling some 35 percent to $84 billion through March compared to $129 billion in the first half of fiscal 2008.
Treasurys fall ahead of rising debt issuance
Treasury prices declined Monday, with longer-term debt reversing earlier strength, as investors remained wary of buying before the Treasury Department auctions $59 billion in new debt this week. Earlier support dissipated after the Federal Reserve purchased $2.53 billion in Treasurys maturing between 2019 and 2026, less than some had expected. Ten-year note yields rose 4 basis points, or 0.04%, to 2.93%. Yields move in the opposite direction of prices. Shorter-term notes were little changed, as declines in U.S. equities hinted at skepticism among investors that may keep them in the relative safety of government debt and away from riskier assets. Yields on 2-year notes fell 2 basis points to 0.94%. The Dow Jones Industrial Average declined 1.1% in recent trading.
The Fed was expected to buy between $7 billion and $10 billion in the operation, in line with amounts in its most recent buybacks, said analysts at Morgan Stanley. Last week, the market was very disappointed it only bought $2.5 billion of longer-dated debt, they said. Dealers submitted $11.6 billion to be bought. The bulk of the debt purchases matured in 2019 and 2020. The Fed's next purchases will take place on Wednesday when it will buy shorter-term securities maturing in 2010 and 2011. The Treasury also announced it will auction $35 billion in 3-year on Wednesday and $18 billion in 10-year notes on Thursday. It previously said it would sell $6 billion in inflation-linked securities on Tuesday. The amounts are roughly in line with estimates from Wrightson ICAP, a research firm specializing in government finance. Analysts also noted that trading volume was low ahead of upcoming holidays. Passover starts Wednesday and markets are closed for Good Friday.
Fed purchases last week did little to keep Treasury yields down, as equity gains and data revived some optimism among investors. A dismal monthly payrolls report on Friday was better than the even grimmer report some investors had braced for. Ten-year note yields increased 15 basis points last week, pushing back towards levels last seen before the Fed surprised markets after its last policy meeting by announcing it would purchase $300 billion in Treasurys in the following six months. "The Fed's problem is that the market realizes that $300 billion in Treasury buybacks is just a drop in the bucket compared to $2.5 trillion in estimated net Treasury issuance this fiscal year," said strategists at UBS Securities. The fiscal year ends in September.
Toxic debts could reach $4 trillion: IMF
Toxic debts racked up by banks and insurers could spiral to $4 trillion (£2.7 trillion), new forecasts from the International Monetary Fund (IMF) are set to suggest. The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia. Banks and insurers, which so far have owned up to $1.29 trillion in toxic assets, are facing increasing losses as the deepening recession takes a toll, adding to the debts racked up from sub-prime mortgages.
The IMF's new forecast, which could be revised again before the end of the month, will come as a blow to governments that have already pumped billions into the banking system. Paul Ashworth, senior US economist at Capital Economics, said: “The first losses were asset writedowns based on sub-prime mortgages and associated instruments. But now, banks are selling ‘plain vanilla' losses from mortgages, commercial loans and credit cards. For this reason, the housing market will play a crucial part in how big the bad debt toll is over the next year or two.” In its January report, the IMF said: “Degradation is also occurring in the loan books of banks, reflecting the weakening outlook for the economy. Going forward, banks will need even more capital as expected losses continue to mount.”
At the same time, there is a clear shift in congressional attitudes in the United States about simply pumping money into the system, Mr Ashworth said. The British Government is also under pressure to repair its tattered finances. Injecting more money into the banks could further undermine its fiscal position. The IMF's jump will come as little surprise to economists who have suggested that the bad debts will be much higher than anticipated. Nouriel Roubini, chairman of RGE Monitor, expects bad debts from US-originated assets to reach $3.6 trillion by the middle of next year. This figure is expected to rise when bad debts from assets elsewhere are calculated, he said.
Government Sachs is in control
Goldman Sachs' bailout bonanza
Lloyd Blankfein must be the luckiest guy on Wall Street. He leads one of the Street's biggest bailed-out firms, but unlike other companies propped up by taxpayers, Blankfein's Goldman Sachs Group Inc. is far more profitable. And it's poised to become a more influential force with greater market share. Different from American International Group Inc. or Citigroup Inc., Goldman hasn't had to forfeit an ownership stake in its firm, and its shareholders -- many of them management and employees -- have benefited. Goldman shares trade above $100. That's less than half of where Goldman shares traded at their peak, but far better than the $1 and $3 that AIG and Citigroup shares trade for, respectively.
Since the fall of Bear Stearns Cos. a little more than a year ago, Goldman has taken more than $20 billion in taxpayer cash through loans, payments and backstops. Goldman's latest bailout coup was a $12.5 billion paid out of AIG's $180 billion government cash infusion. Until it was fully extricated, Goldman always characterized its exposure to AIG as "immaterial," and that its $20 billion notional exposure to AIG was hedged. Turns out that it was -- through government bailouts that didn't exist when Goldman entered the contracts. Even former New York Luv Guv Eliot Spitzer told journalist Fareed Zakaria on Sunday that he thinks something smells. "The web between AIG and Goldman Sachs is something that should be pursued," Spitzer said. "Why did [those payments] happen, what questions were asked, why did we need to pay 100 cents on the dollar for those transactions if we had to pay anything, what would have happened to the financial system had it not been paid?"
But the AIG-Goldman affair is just the beginning, under the policy enacted by former U.S. Treasury Secretary Henry Paulson, Goldman's chief executive until 2006. Major competitors have failed or been diminished. Goldman already seems, if not just poised, to be dominating what's left of the investment banking landscape. We last visited Goldman in the early days of the Troubled Asset Relief Program, or TARP, in October. Then, it appeared Goldman would come out ahead by virtue of avoiding a major investment by a commercial bank. Merrill Lynch had just been sold to Bank of America Corp., and Morgan Stanley had just sold a 20% stake to Tokyo's Mitsubishi UFJ.
Five months later, Goldman's position in the marketplace looks even stronger -- its future even more brilliant. "Goldman Sachs has the most powerful investment banking franchise and the most successful trading operation on Wall Street," Brad Hintz of Bernstein Research wrote Friday, adding that he's been told "new leverage limits are not expected to impact Goldman's trading performance." Hintz said Goldman is touting how it plans to avoid tighter leverage limits. For one, its trading desk can take advantage of widening bid-offer spreads. Fewer players in the marketplace mean there's a bigger gap to exploit. Without Lehman and with a diminished Morgan Stanley, Goldman has more ability to corner a market.
Goldman's commodities oil-trading desk has been linked to the failure of Semgroup Holdings, an oil-trading company in Tulsa, Okla., that declared bankruptcy in July 2008. Semgroup investors say Goldman had access to the company's trading books and could have used that information against the company, according to Forbes. That's just the trading business. Goldman also will have less competition when it comes to underwriting stocks and bonds, advising corporate clients and providing prime brokerage services -- including trading leverage -- to hedge funds. Goldman ranked No. 1 among advisers with $316 million in revenue during the first quarter, according to Dealogic. Goldman won't rake in the exponentially growing profits that it did during the middle part of the decade -- it reported $9.54 billion and then $11.6 billion in 2006 and 2007, respectively -- but it will improve mightily on the $2.04 billion in returns it earned last year.
As glittering as Goldman's recent history has been and as bright as its future looks, there is a dark cloud on the horizon. Paulson's successor at Treasury, Timothy Geithner, is proposing a market-risk regulator that would put the regulatory squeeze on any institution deemed so big that its failure would take down the system with it. Geithner wants to encourage break-ups and the creation of smaller institutions, said John Garvey, a risk management and banking consultant with PriceWaterhouseCoopers. Goldman, which could easily divide itself into a hedge fund, trading business, private equity shop and advisory firm, would be in the crosshairs of such a plan.
Even separated, though, why would Goldman's roll stop? In the last year, Goldman has benefited from Paulson's selective bailouts, a fortuitously timed ban on short selling, a liberal interpretation of bank holding company rules and soon, an easily gamed auction of distressed securities run by the government. A conspiracy theorist might think this run of fortune has something to do with the former Goldman executives having influential roles in the Treasury Department. Market-risk regulator? Smaller companies? Goldman will find a way around it. It just seems to have that kind of luck.
Connecticut Attorney General questions bailout money for credit rating companies
Connecticut Attorney General Richard Blumenthal Monday said he has opened an investigation into why a Federal Reserve bailout program will steer up to $400 million to the three largest credit rating agencies, which have been widely criticized for their role in the current financial crisis. The firms, Standard & Poor's, Moody's and Fitch Ratings, are expected to benefit from fees generated from rating securities related to the government's $1 trillion Term Asset-Backed Securities Loan Facility, or TALF. The Fed's program was created in November to unclog frozen credit markets by purchasing new securities backed by loans such as student, auto and credit cards.
The securities have to be rated by two or more "nationally recognized rating agencies," according to Fed rules. However, all three top agencies have come under a lot of fire for assigning top ratings to complex financial instruments based on subprime mortgages, only to later downgrade them, which caused havoc in the credit markets last year. "It is outrageous that the very firms which facilitated the credit debacle are now being rewarded for their ineptitude," says Sean Egan, managing director of Egan-Jones, a small ratings agency. Blumenthal sent a letter to Federal Reserve chief Ben Bernanke, asking him to revise the program. Blumenthal said the process "contradicts and undermines Congress' intent to enhance competition," and "rewards the very incompetence … that helped cause our current financial crisis."
Federal Reserve spokesman David Skidmore said: "We have received the letter and are considering a reply." Blumenthal subpoenaed all three agencies for documents and information that relates to the rating agencies' "possible influence on TALF rules that steer them business." Fitch said in a statement it "disagrees … that the rating agencies exerted 'possible influence' on the Federal Reserve in its determination of TALF rules." Moody's declined comment. S&P said the investigation is "without merit." Spokesman Ed Sweeney said: "It should also be noted that S&P's fees for this work are subject to fee caps." However, the ratings agencies have lost a lot of credibility. In October, former Fed chairman Alan Greenspan testified before Congress and said "unrealistically positive rating designations by the credit agencies was, in my judgment, the core of the problem," referring to the current credit crisis.
Short Sellers Squeezed All Around
Securities regulators and some financial firms are making it more difficult for investors to pile on when stocks are falling and further drive down prices. The Securities and Exchange Commission, facing years of criticism, has begun to crimp the ability of traders who bet against stocks to depress prices by selling millions of shares they don't possess, known as naked short selling. And some financial firms have cut back on lending to traders who want to bet against stocks. The result: The number of stocks in which big chunks of shares haven't properly been delivered to investors has plummeted, to a daily average of 79 in the three months ending in March from 529 in the first nine months of 2008, according to an analysis of trading data from major stock exchanges. At issue are short sellers, traders who sell borrowed shares, betting they can replace them later with shares bought at a lower price.
Critics say short sellers, with the aid of brokerage firms, cause these delivery failures by shorting stocks without first borrowing shares, as required by securities law. Such activity drives down stocks by adding to the selling pressure. The moves come as the SEC meets Wednesday to discuss further potential restrictions on short sellers. These include reinstating the "uptick rule," which until 2007 had required short sellers to wait for a rise, or uptick, in a stock's price before placing their bet that it would go down. Critics say such trading by short sellers roiled stocks last year by swamping the market with sales that characterized the 2008 market volatility. Amid that turmoil, the SEC closed loopholes that had allowed sold shares to go undelivered.
The developments come at a critical time. Stock prices have surged roughly 20% within weeks, despite Monday's decline. Traditionally, short sellers have been an important cog in helping alert investors to warning signs at companies ranging from Enron Corp. to Lehman Brothers Holdings Inc. Some say short-sales restrictions have helped fuel the recent rally. Despite the reductions in delivery failures, critics say the SEC took too long to act forcefully and still hasn't gone far enough because failures still occur. "The majority of these failures-to-deliver are not the result of honest mistakes or bad processing," former SEC commissioner Roel Campos wrote in a letter posted on the SEC's Web site. "Rather, these companies are instead targets of illegal and manipulative trading, with intentional failures-to-deliver used by traders to extract profits as the share price plummets."
An SEC spokesman said in an email: "Reducing long-standing failures to deliver has been central to commission actions in this area." The SEC first attempted to address the problem in 2005, with the implementation of Regulation SHO, which mandated "threshold securities" lists, daily compilations by exchanges of stocks that had suffered at least five consecutive days of delivery failures totaling at least 10,000 shares and at least a half a percent of their outstanding shares each day. Once a stock hit the threshold lists, traders were required to close out failed deliveries by the 13th day after the trade. But there were loopholes in the regulation, and there was no requirement to close out delivery failures of securities that weren't on the lists. The threshold lists averaged about 300 securities a day in the first two years after Regulation SHO was instituted. In 2007, the daily average climbed to 414. In the first nine months of 2008, as the markets and banks crumbled, the lists averaged 529 securities.
Last summer and fall, the SEC issued emergency orders restricting the short sales of certain financial firms and tightening the requirements for deliveries. Most important, observers say, was a new rule requiring short sellers to close out any delivery failure by the open of trading on the fourth day after the trade. The number of securities on the threshold lists has since plummeted. Pension funds and other institutional investors have curtailed lending stock to short sellers, which also might have contributed to the decline in delivery failures. But stricter SEC delivery requirements may have instilled a new discipline in market participants. In the past, hedge-fund and bank executives said, brokers were quick to tell clients not to worry about finding borrowed shares to sell short, even if there was some risk that they wouldn't be able to find and deliver the stock.
Most delivery failures result from honest mistakes by brokers, not intentional misconduct by short sellers, says James Chanos, the short seller who runs Kynikos Associates LP, a New York hedge fund. Mr. Chanos says the view that the SEC is cracking down on short sellers may have boosted investor confidence and helped fuel the current rally. Peter Chepucavage, a former counsel at the SEC who helped draft Regulation SHO, said the initial weakness of the rule and the years it took the SEC to stiffen it can be traced to the lobbying efforts of hedge funds and Wall Street. Brokerage firms "have made huge amounts of money" facilitating short selling, said Mr. Chepucavage, general counsel for Plexus Consulting Group, a Washington firm that advises nonprofit firms and broker-dealers. "They want and have argued strenuously for flexibility."
How to Clean a Dirty Bank
Commercial banks in the United States are not subject to the bankruptcy statute — when they become insolvent they are simply acquired by the government. This is what banks sign on for in return for a charter, deposit insurance and direct access to the Federal Reserve lending window, which generally allow banks to prosper as long as they control risk. Now Treasury Secretary Timothy Geithner wants to apply this same swift acquisition process to large insolvent “shadow banks” that risk doing damage to the financial system — big hedge funds, investment banks, insurance holding companies and the like — because bankruptcy proceedings move too slowly to allow these institutions to be quickly refinanced or restructured.
Secretary Geithner says the lack of a good mechanism to restructure Lehman Brothers contributed to that firm’s failure last fall. And it is why the Bush administration’s ill-designed overnight infusion of capital into American International Group turned out to be such a mess. The company avoided bankruptcy, but could not be properly restructured. Mr. Geithner is right to want a rapid seizure system for shadow banks. What’s odd is that at the same time that he is proposing one, the government is failing to use powers it already has to restructure insolvent commercial banks. Instead, Mr. Geithner continues to suggest a variety of other actions that seem unlikely to solve the banks’ central problem — a lack of equity capital. Perhaps he fears what would happen if large bank holding companies were to default on their bonds, which are held by insurance companies and other institutional investors. But that is a problem that needs to be tackled head-on, not by propping up failing banks.
Consider what happens when the government acquires an insolvent bank. The shareholders and the debt holders of the bank’s holding company may be essentially wiped out — even as the bank itself is merged into another institution. That is what happened, for example, when JPMorgan Chase “acquired” Washington Mutual bank; its holding company promptly went bankrupt. This approach allows the market to properly discipline banks. The fear of loss gives investors the critical incentive to deny capital to those that take excessive risks. Also, when the price of a bank holding company’s stock and debt plummets, it is an early warning of trouble.
Treasury’s new plan, the Public-Private Investment Program, reduces that incentive by preserving shareholder and debt holder ownership of insolvent banks. It also injects capital into those banks in a roundabout, unproductive way. Under the program, the government will help private investors buy at auction the banks’ toxic assets (what Treasury now calls “legacy assets”). Private firms will use government funds, along with some money of their own, to buy the assets at prices above current market value. The government will bear almost all the exposure to losses from these transactions, but earn only a small fraction of any profits. Another problem is that if the buyers of these assets harvest significant gains, they will have to worry that Congress might seek to recapture the money in the future, as it has threatened to in the recent bonus turmoil at A.I.G. This fear will lower the bids and therefore the amount paid for the toxic assets.
Even if it is successful, the program will add very little new capital to the banks — roughly only the amount paid for toxic assets that is over and above their current value. There is a simpler, sounder and fairer way to recapitalize an insolvent bank. The government should seize it, as it is already authorized — indeed, compelled — to do. Then it could inject cash (in the form of Treasury notes) as equity in the bank and, at the same time, remove the toxic assets the bank holds. Bank regulators might perhaps swap Treasury securities for toxic assets “at par” — that is, in an amount equal to the original purchase price of the assets removed. This would be a fair transaction, and it would cost nothing, because the government would own both the bank and the bonds. The toxic assets could then be placed in the basement of the Treasury building while we wait to see what they turn out to be worth.
The government could then quickly — say within a month — auction off the bank. Speed would be critical: If Treasury were to hold a large bank for a long time, it would be difficult to retain the most talented employees, and it is the people, along with a clean balance sheet, that make a bank valuable. If markets work at all (and if they don’t, Treasury’s new plan is doomed to fail), such an auction would produce a new privately owned “clean” bank, with ample capital to lend. It would also generate proceeds from the sale that would be at least as great as the value of the securities injected into the bank as equity — and likely greater.
If the recapitalized bank could not be sold at a price that amounts to (at least) the new cash injected, then the bank would be worthless, but not because of the toxic asset problem. It would be because the bank has been mismanaged or has other bad loans unrelated to the mortgage crisis, and such a bank should be allowed to fail. If the sale succeeds, however, the government would have created a fully financed private bank at essentially no incremental cost to taxpayers, and Treasury would still hold the toxic assets on its books — to be sold whenever it becomes economical to do so. This is a simple and fair plan. And unlike the Public-Private Investment Program, it would not reward bank investors for their folly or inject too little capital when more is needed.
ECB attacks G20 plan to boost IMF drawing rights to pump cash into global economy
The European Central Bank has issued a blistering attack on G20 plans to use the International Monetary Fund to pump liquidity into the word economy, calling it "pure cash creation" outside the normal mechanisms of control. "This is helicopter money for the globe," said Jürgen Stark, the ECB's chief economist and Germany's member on the bank's executive board. "There hasn't been a study to see whether the world needs additional liquidity. In the old days one would take a long time to to explore such a thing," he told the German business newspaper Handelsblatt. The paper cited an "unidentified" central banker protesting that the G20 had rammed through radical changes that could do "irreperable damage" to the global financial system
" What is happening with the IMF is scandalous. They are going to lay waste to everything in this crisis as a result of political horse-trading," he said. Markets have been in confusion over the implications of the G20 deal last week instructing the IMF to issue $250bn (£170bn) in Special Drawing Rights, a hybrid instrument that lets governments around the world take out an overdraft but also contains the seeds of a global currency in is own right. The summit communique stated clearly that the purpose of the activating the Fund's SDR powers was to "inject $250bn into the world economy and increase global liquidity". This is separate from the move to tripple the IMF'fire-fighting fund to $750bn. If used to create liquidity, the plan turns the Fund into a proto-central bank for the world, running an expansionary monetary policy over the heads of existing central banks. It appears that G20 delegations from Germany and other EU states may have signed the agreement in the rush last Thursday without studying the exact details.
The use of SDRs on this scale poses a immediate threat to the ECB, which is worried about a resurgence of inflation once recovery begins. It has pursued a more restrictive "steady-as-you-go" policy than the Anglo-Saxons, Swiss, and Japanese. Dennis Snower, head of the IWF Institute in Kiel, said the scheme not only risks inflation down the road but also incubates future crises as badly-run countries are able to put off their day of reckoning. "If the international community does not take steps against this, the future bill for this stimulus could prove expensive," he said. The dispute between the ECB's hawks and policy-makers in the rest of the world stems from a deep disagreement about the nature of this crisis. The IMF fears that the globe is in the grip of self-feeding spiral akin to the events of the early 1930s. It has warned of widespread civil unrest and even wars if this process is allowed to unfold.
RBS sees global monoline-related markdowns of $80 billion
Royal Bank of Scotland said the deterioration in monoline credit quality stepped up in the first quarter and added that it expects global monoline-related markdowns of about $80 billion (54.6 billion pounds), including over $50 billion from European banks. It seems not all banks have marked down conservatively enough, notably Barclays and Deutsche Bank, which, taken with their tight capital positions, remain key "sells," the brokerage said. Barclays with $11.8 billion in monoline assets and Deutsche Bank with $9.2 billion remain most exposed, followed by Societe Generale with $4.8 billion, UBS with $3.9 billion and Credit Agricole with $3.6 billion, the brokerage said.
"The timing of recognition is difficult to predict, but as more monolines get downgraded to 'junk' -- as was the case with MBIA and Radian Group Inc -- we believe it will be more difficult to get away with low provisioning rates," the brokerage said. It added that Credit Suisse, which has no monoline exposure, remained its top pick in the sector. The principal driver behind Barclays, Deutsche Bank and UBS markdowns remains monoline credit quality deterioration, implying that changes in mark-to-market rules should be much less of a support, the brokerage said. On the other hand, French banks' markdown estimates are driven much more by potential asset price declines, leaving more room for manoeuvre, assuming a change in accounting rules, it added.
George Soros warns 'zombie' banks could suck lifeblood out of economy
Billionaire investor George Soros has warned that bailing out banks could turn them into "zombies" that suck the lifeblood of the American economy, which he predicted is in for a "lasting slowdown". He also cautioned that the recent rise in global stockmarkets is a "bear market rally because we have not yet turned the economy around". His gloomy verdict weighed on Asian stockmarkets today, alongside a report that the International Monetary Fund now estimates that the toxic debts racked up by banks and insurers could spiral to $4tn (£2.7tn). Tokyo's Nikkei index edged down 0.3% to 8832.85 while Hong Kong's Hang Seng fell 1.1% and Singapore's Straits Times index was down 2.1%. However, the FTSE 100 index in London rose 33 points to 4027.15 in early trading.
Soros said he does not expect the US economy to recover until next year at the earliest. "The recovery will look like an inverted square root sign," he said. "You hit bottom and you automatically rebound some, but then you don't come out of it in a V-shaped recovery or anything like that. You settle down, step down." His comments last night came after Morgan Stanley warned the bear market was not over. Its much followed strategy team led by Teun Draaisma moved its recommendation on equities from neutral to underweight. The team said in a note yesterday: "We have to decide whether this is towards the end of another bear market rally that we should sell into now that hope has grown, or the start of a much larger advance, maybe even a new bull market. Our decision is to sell into strength now."
Soros stressed that restoring health to the "basically insolvent" banking system and the housing market is key to any recovery. The public-private investment funds introduced to rid US banks of bad debts will work but won't be enough to recapitalise the banks so they can start lending again, he said. "What we have created now is a situation where the banks will be able to earn their way out of a hole but by doing that, they are going to weigh on the economy," Soros said. "Instead of stimulating the economy, they will draw the lifeblood, so to speak, of profits away from the real economy in order to keep themselves alive." Analysts agreed that the financial system remains a problem and thought recent optimism that the worst may be over was overdone. "The market's stance on banks had been too optimistic recently," said Nagayuki Yamagishi, a strategist at Mitsubishi Securities in Tokyo. "Some large US banks have already passed stress tests, but others haven't, and given that results are coming up soon, this simply reignited investor uncertainty."
Soros Says Gain in U.S. Stocks Is ‘Bear-Market Rally’
George Soros, the billionaire hedge- fund manager who made money last year while most peers suffered losses, said the four-week rally in U.S. stocks isn’t the start of a bull market because the economy is still shrinking. "It’s a bear-market rally because we have not yet turned the economy around," Soros, 78, said in an interview yesterday with Bloomberg Television, referring to the recent rebound in stock prices. "This isn’t a financial crisis like all the other financial crises that we have experienced in our lifetime." The Standard & Poor’s 500 Index of largest U.S. companies has climbed 24 percent since March 9 on optimism the worst of the 16-month U.S. recession is over. The economy continues to contract, and there’s a risk the U.S. falls into a depression, Soros said.
"As long as we deal with this in a multilateral and more or less coordinated way, I think we’ll get through," said Soros, whose Quantum Endowment Fund rose 8 percent last year, compared with the average 19 percent decline of hedge funds tracked by Chicago-based Hedge Fund Research Inc. Marc Faber, managing director of Hong Kong-based Marc Faber Ltd. and publisher of the Gloom, Boom and Doom Report, said in a separate Bloomberg TV interview today that the S&P 500 may drop as much as 10 percent before resuming gains.
Soros gave a mostly positive review of the President Barack Obama’s administration. "He’s done very well in every area, except in dealing with the recapitalization of the banks and the restructuring of the mortgage market," said Soros, who has published an updated paperback version of his book "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means" (Scribe Publications, 2009). "Unfortunately, there’s just a little bit too much continuity with the previous administration." Soros said the U.S. housing market hasn’t bottomed, even as transactions in states such as California have increased. "There are some signs of hitting bottom, but we are not there yet," he said. "A lot has been done to forestall foreclosures."
U.S. stocks declined for the first time in five days yesterday on concern that government measures to shore up banks may not help as much as estimated by analysts and loan losses will exceed levels from the Great Depression. The S&P 500 fell 0.8 percent to 835.48. Soros said the banking system is "seriously under water" with banks on "life support." "They are weighed down by a lot of bad assets, which are still declining in value," he said in the interview in his New York office. "The amount is difficult to estimate, but I think it’s in the region of maybe a trillion-and-a-half dollars." Soros said the change to fair-value accounting rules will keep troubled banks in business, stalling a U.S. recovery.
"This is part of the muddling-through scenario where we are going to keep zombie banks alive," Soros said. "It’s going to sap the energies of the economy." The Financial Accounting Standards Board relaxed so-called mark-to-market rules last week, allowing banks to use "significant" judgment in gauging prices of some investments on their books. While analysts said the measure may reduce writedowns and boost net income, investor advocates and accounting-industry groups said it will help financial institutions hide their true health. The "bugaboo of nationalizing banks," which the Obama administration wants to avoid, means "we are nationalizing only one side of the balance sheet," Soros said. "We gradually take over the deficits on the balance sheet. But we aren’t actually going to benefit from the banks recovering."
Money being injected into banks under government rescue programs should be used to finance new lending, according to Soros. He said he participated in HSBC Holdings Plc’s rights offer, which raised about $19.1 billion. Soros’s firm oversees $21 billion. Its Quantum Endowment Fund rose 5.2 percent this year through February, data compiled by Bloomberg show. Soros ranked last year as the industry’s fourth-highest paid hedge fund manager, earning about $1.1 billion, according to Institutional Investor’s Alpha magazine. Hedge funds should be regulated like other financial firms, Soros said. It would be appropriate for authorities to monitor positions to see whether managers have "excessive exposure," he said.
The Group of 20 leaders said last week they would extend oversight to all financial institutions deemed vital to global financial stability, including "systemically important" hedge funds. U.S. Treasury Secretary Timothy Geithner said last month he wants to bring hedge funds, private-equity firms and derivatives markets under federal supervision for the first time. "The hedge funds that have used excessive leverage have actually failed or are on the way out, so I don’t think this is going to do any damage or hurt the hedge funds except for the fact that they have to fill out more forms," Soros said. "Recognizing that markets are inherently unstable does require a different kind of regulation than we had in the past," he said.
Soros Fund Management LLC was fined 489 million forint ($2.2 million) last month for attempting to manipulate the share price of OTP Bank Nyrt., Hungary’s largest bank, the country’s financial regulator said. The Soros fund attempted on Oct. 9 to "send out false or misleading signals about a security’s supply and demand or its share price" and short sold OTP shares, the regulator, known as PSZAF, said in a statement late yesterday. The short selling caused the shares to drop 14 percent in the final 30 minutes of trade, the regulator said. Soros apologized for the trade and said the fund had started an internal investigation. Hungarian-born Soros gained fame in the 1990s when he broke the Bank of England’s defense of the pound and drove the currency from Europe’s system of linked exchange rates. He also successfully bet that Germany’s mark would appreciate after the collapse of the Berlin Wall in 1989 and Japanese stocks would start to fall in the same year.
Soros said China’s economic growth will accelerate before the end of the year. "They have a pretty big stimulus package," he said. "They are going to use more, because not being a democracy, the leadership knows that their very survival, the avoidance of social unrest, requires them to generate growth." China’s economy grew 6.8 percent in the fourth quarter from the same period a year earlier, lagging the 9 percent expansion in all of 2008 and 13 percent in 2007. Industrial output growth slowed, forcing thousands of factories to close and leaving about 20 million migrant workers jobless. Brazil’s economy will resume growth "relatively soon," helped by Chinese demand for iron ore and soybeans, Soros said. "I think Brazil actually, together with China, will be among the recovering countries," he said. "The outlook for Brazil is better than for most other countries."
Stalled Economy Wil Take Years To Regain Speed
As the recession grinds on, more and more of the nation’s means of production — its workers, its factories, its retail outlets, its freight lines, its bank lending, even its new inventions — are being mothballed. This idled capacity, like baseball players after a winter off, takes time to bring back into robust use. So even if the recession miraculously ended tomorrow, economists estimate that at least three years would pass before full employment returned and output rose enough for the economy to operate at full throttle. While stock market investors have embraced tentative signs of improvement in the mortgage market and elsewhere, even a sharp pickup in demand for products and services will take considerable time to play out.
The mathematics are daunting. The shortfall is running at more than $1 trillion in annual sales and other transactions. Only once since the Great Depression has there been such a severe loss of output — in the 1981-82 recession — and after that downturn, it was seven years before the economy regained the lost production. Recovery from the current recession could be similarly sluggish. New occupants have to be found for empty stores. Factory owners who are hesitant to ramp up production will wait until they are sure of demand. Hiring the right people for an operation will take time. And imports, entering the country in ever greater quantities, will slow any expansion by siphoning sales from domestic producers.
Then there is the growth rate itself. In the six years of recovery from the 2001 recession to the current one, the economy grew at an average annual rate of only 2.5 percent, adjusted for inflation. If that growth rate were to resume, just $350 billion a year would be added back, requiring three years to restore the $1 trillion in lost capacity. But getting the economy to grow at all after so much output has been lost, and so many jobs, is no easy task. "Excess capacity, once entrenched, perpetuates itself, and that is what is happening now," said James Crotty, an economist at the University of Massachusetts, Amherst. "Companies cannot hire workers to make more goods and provide more services until their sales go up. But people can’t buy goods and services until they are hired — so the excess capacity just sits there."
It shows up everywhere. Lawyers are booking fewer hours. Retail space goes begging. Tourism is down. So is cellphone use, airline bookings, freight traffic and household borrowing, which is less than half what it was on the eve of the recession, the Federal Reserve reports. With orders dwindling, manufacturers are using less than 68 percent of the nation’s factory capacity, the lowest level since records were first kept in 1948. And while entrepreneurs are as inventive as ever, they may not be able to get venture capitalists to bankroll their creations. "We and others are funding start-ups as slowly as possible, or not at all," said Howard Anderson, a founding partner of Battery Ventures in Waltham, Mass., and a senior lecturer at the Massachusetts Institute of Technology.
He cites as an example a hand-held device, similar in shape to an iPod, that restaurant diners would use to order food and drink electronically. Waiters would bring the orders, but not take them. "The prototype just sits there," Mr. Anderson said, "and maybe the inventors will get funding to produce and market their device — and maybe their company never gets born." If there is an upside, it is the absence of inflationary pressure. With so much excess capacity rattling around, shortages do not develop that would push up prices. Indeed, interest rates are kept low to encourage more borrowing and spending. Neither is happening. Instead, demand continues to shrink and idle capacity to build up.
The Obama administration, like the Roosevelt administration 75 years ago, is trying to break this logjam through government spending, using it in effect as a substitute for consumers who are jobless or short of credit. The spending is also a substitute for companies that hesitate to extend themselves or see no profit in doing so. But the president’s solution, the recently enacted stimulus package, spreads $787 billion over two years. So even if every dollar of spending restored a dollar of output, President Obama would be nearing the end of his first term before output approached the level achieved just before the start of the recession in December 2007.
Or so says Robert J. Gordon, an economist at Northwestern University who specializes in tracking the gap between actual output and potential output, a k a full capacity. The Roosevelt economy also languished well below full capacity, Mr. Gordon said, until the summer of 1940, when France fell to Hitler’s armies. From then until the attack on Pearl Harbor, 18 months later, a galvanized administration more than doubled federal outlays — soon accounting for $1 of every $4 spent in the country — and the United States entered the war with its economy operating almost at full capacity. (Government currently accounts for $1 of every $5 spent, barely more than in 2007, and most of that spending is at the state and local levels, the opposite of 1940-41, when federal outlays shot up.)
"What you had was a revolution in the labor force," Mr. Gordon said. "Women poured into jobs in droves, often replacing men, and every factory went to three shifts." By V-J Day in 1945, the economy, propelled by war spending, was operating beyond what the experts thought of as full capacity, demonstrating the "squishiness" of the concept, as Mr. Gordon put it. Just the swing from one to three shifts alters capacity, he said, and so does the more intensive use of floor space. Capacity stretched again in the 1950s and ’60s, to feed demand created by the wars in Korea and Vietnam, and then again in the late 1990s, propelled by the dot-com boom. And there were downdrafts as recessions sapped demand, but none as punishing as the current one.
Sixteen months into this recession, the economy is operating at 7 percent below its potential capacity, the Congressional Budget Office reported last month. If that were to continue, today’s $14 trillion economy would be a $13 trillion economy by this time next year. Labor is contributing hugely to the shortfall. More than 24 million men and women, or 15.6 percent of the labor force, are either hunting for work or working fewer hours than they would like to work, or are too discouraged to seek work, although they would take jobs if offered them, the Bureau of Labor Statistics reports. The ranks of this "underutilized" group — the bureau’s label — are up by 10 million since early last year. Generating work for so many people would take several years, even if the nation’s employers stopped shedding more than 600,000 jobs a month, as they have done since December, and began hiring robustly. "We have rarely been in this deep a hole," said Nigel Gault, chief domestic economist for IHS Global Insight.
His concern is that nearly every nation — not just the United States — is suffering from idle capacity as the recession that started in America grips Europe and Asia. Struggling for sales in a marketplace swamped with goods and services, companies are cutting prices and shutting down operations, trying to keep supply in line with dwindling demand. The cutback is particularly severe in the auto industry, which had the capacity, going into the recession, to make nearly twice as many cars in the United States as are now being sold here. Indeed, some of the factories being closed are unlikely to ever reopen. "Eventually, once this recession is over, we will fill up capacity," Mr. Gault said. "Not only that, capacity itself will inevitably expand as the labor force grows and innovation kicks in. But the new capacity won’t be as great as it would have been if we had not gone through this terrible experience."
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Default Rate Surges to Highest Since Depression, Moody’s Says
Thirty-five companies defaulted in March, the highest number in a single month since the Great Depression, according to Moody’s Investors Service. The rate at which speculative-grade corporate borrowers worldwide failed to meet their obligations rose to 7 percent from 4.1 percent at the end of last year, Moody’s said in a report today. So far this year, 79 companies rated by Moody’s have defaulted, the New York-based ratings firm said. Almost $1.3 trillion of losses and writedowns at financial institutions worldwide, combined with the deepest economic slowdown since World War II, have weakened companies’ finances, reducing their ability to pay debt.
The global default rate will peak at 14.6 percent in the final quarter of the year, Moody’s predicted, lower than last month’s 15.3 percent forecast. Defaults "will remain at an elevated rate," the report said. The forecast for the peak rate has been reduced "in the last couple of months as high-yield bond spreads have declined moderately." In the U.S., the default rate at the end of the first quarter was 7.4 percent, up from 4.5 percent at the end of 2008, and in Europe it jumped to 4.8 percent from 2 percent at the end of the final quarter of last year. European default forecasts remain the highest and are expected to peak at 21 percent in the fourth quarter, down from the 22.5 percent the ratings firm’s model calculated last month.
GM Said to Speed Bankruptcy Plans as Board Crafts Savings Goals
General Motors Corp. is speeding up preparations for a possible bankruptcy filing even as directors seek deeper savings this week to avoid that outcome, people familiar with the plans said. The bankruptcy readiness focuses on forming a new company from GM’s best assets if necessary, said the people, who asked not to be named because the matter is private. The cost-cut discussions center on how to go beyond GM’s proposal to slash debt by 46 percent and shed 47,000 jobs in 2009, and will include talks with Treasury officials, the people said. The moves are a response to President Barack Obama’s March 30 rejection of GM’s bid to keep $13.4 billion in federal loans. With bondholders and the United Auto Workers balking at concessions, a push for more savings makes bankruptcy more "probable," Chief Executive Officer Fritz Henderson has said.
GM’s board met today and yesterday, and more discussions are planned inside GM and with the Obama administration, the people said. Obama gave the biggest U.S. automaker 60 days to restructure, without specifying what steps were needed to stem $82 billion in losses since 2004. Planning for a court filing was ratcheted up in February as a precaution against a defeat for GM’s bid to keep its U.S. loans, the people said. Detroit-based GM said it prefers to restructure outside bankruptcy court. GM’s preparations include looking at a so-called 363 sale, a reference to a section of the Chapter 11 bankruptcy code that would help create a new automaker from the assets and brands of GM, boosting the company’s survival chances, the people said.
GM has $62 billion in debt, and its Feb. 17 presentation to Treasury envisioned shrinking that sum to $33.5 billion by trimming obligations to a union-retiree health fund and getting bondholders to accept less in an equity swap. Until new savings requirements are hashed out, substantive talks with the UAW and bondholders may be delayed, the people said. The board meetings and feedback from the Treasury’s auto task force may create a framework for new discussions this week, they said. A GM spokesman, Greg Martin, declined to comment today on any specific meetings this week. "As we have from the very start, we’re going to continue to work closely with the task force on our restructuring plans," Martin said in an interview.
Chief Financial Officer Ray Young was among executives who met with U.S. Treasury officials on April 3 before the board meeting. Additional meetings with Treasury officials are set for this week to review the new restructuring proposals, one person said, without giving a schedule. "We need to go further," Henderson said yesterday on CNN’s "State of the Union" program. "If the conclusion is you’ve got to go deeper and you’ve got to go faster, you can’t really afford to take anything off the table." Henderson, 50, said he still favors restructuring the company outside of bankruptcy. In a separate interview on NBC’s "Meet the Press" program, he said bankruptcy isn’t inevitable. He said last week that Treasury had not yet given new cost- cutting guidelines.
"It would only be prudent" to be prepared for all contingencies, Henderson added on NBC, so "we can move fast." Henderson was named to replace Rick Wagoner after he stepped down as CEO at the request of the Obama administration and director Kent Kresa took on Wagoner’s chairman role. Kresa, who described this weekend’s meeting as "extensive," is working to replace a majority of GM’s board before an August annual meeting as part of the changes the U.S. government wants.
Florida's Resurrection of Debtors' Prison
As the Christian world readies itself for extra masses, spiritual observance and ultimately glorious celebration during Easter Week, the concepts of charity and forgiveness seem to be missing in Florida. State judges have been throwing poor people into jail for not paying even minor debts owed to Florida courts. This is a frightening development, particularly when one considers that twenty-five other states are watching and eager to learn how to fundraise in this same horrifying manner. For those of us who prefer to learn from history rather than repeat it, this is a terrifying trend. One would hope shining a flashlight on the practice could help to eradicate it and discourage other states from emulating such poor behavior. The example given in a New York Times’ article cites a woman who was convicted and sentenced to a crime in 1996. The article outlines how she paid her fine, performed community service as required and thought she had left the justice system behind.
Recently a Florida state judge threatened her with jail. Why? Because she had failed to pay the final $240 in court courts that remained owing in her case. Obviously I do not know all the facts, but on the surface this seems completely and utterly absurd. Not to disparage the value of our civil servants who work hard like everyone else, when I file one piece of paper with my local county recorder it costs $42. Ten years ago it was $5. I understand the costs of these services are expected to be borne by those who use them, but $42 to stamp, record and scan a one-page document? It seems a bit steep, even for county government. I can only imagine how much the Florida courts think a judge, a court stenographer, a videographer, a bailiff and needed security, utilities and the public building are worth. However, how can a convicted felon - often unemployable and unable to even volunteer in most communities - expect to earn enough to survive and pay for these services?
For those of you who love math as much as I do, surely you would agree that the charges government often levies against defendants do not pass a good business analysis. Police all over the country grumble about our ineffective drug laws and how non-violent offenders continue to clog up our courts and overcrowd our prisons. In this regard, we are still number one. According to Wikipedia.com, as of the end of 2007, 7.2 million people were behind bars, on probation or being supervised through parole. The United States incarcerates more people than any other country in the world, more than one in every 100 adults. (China in 2007 came in second with 1.5 million people imprisoned but this rate is 18% of ours even with their massive population.) Government cannot always operate like a business, as funds must be raised and services provided for the common good. We could eliminate some taxes if we were willing to nationalize industries like energy, health insurance and medical services, but in the interim we must pay for such things as social security, medicare, medicaid, judicial matters, civil defense, societal infrastructure, schools and, of course, prisons.
Being jailed locally is not an exact equivalent of prison incarceration, but I did find some numbers published by the Florida Department of Corrections in September 2008. To house and feed an inmate in a typical adult male prison facility costs $43.11 per day. If that inmate is in a reception center, in which he will be evaluated, medically treated, given vocational training, etc., then the average cost is $94.87 per day. http://www.dc.state.fl.us/pub/statsbrief/cost.html It was not clear if the female cited in the NY Times’ article was a felon or had committed a misdemeanor but we could assume it was a non-violent offense or she would not have been given a sentence of fines and community service. This woman, incidentally, has not gotten into any further criminal trouble. She does owe $240 in remaining court costs and claims she cannot afford to pay the bill.
I would imagine that most judges could easily write a personal check for that amount. Some of us could as well, as it is rather piddly, but details of this woman's income and assets were not outlined. That said, I cannot fathom how jailing this woman, at a probable cost of at least $40 a day would be a practical solution. If the judge throws her in jail for even a week, the expense of imprisoning her far outweighs the balance she owes. It is obviously the threat that is the big stick for this debt-collection policy. I might even understand the judge's motivation if it was a punk juvenile whose parents bailed the kid out of every scrape he got in over the years, but as outlined in the Times article, this policy makes me feel sick. There are plenty of torturers from the Bush Administration, white collar criminals on Wall Street or running banks and insurance companies who should go in jail, but this poor woman? It is starting to feel like the justice system is focusing on the old lady who drives below the speed limit rather than the dangerous criminals who speed past her.
Wouldn't it make much more sense to have her do some sort of work for society that provides a benefit? Let her be a librarian's serf, empty trash baskets at the courthouse, scrub the sinks in public bathrooms, peel potatoes at a hospital or pick up trash in the local park. There should be some mechanism for working off court debts, particularly when the debtor is unemployed or impoverished and barely surviving anyway. I would imagine that even if the judge throws this woman into the local jail, her debt will remain outstanding. Once she gets out, if she still doesn't have access to that $240 and some new fines he will probably stick her with, I have to ask the question. What does the system gain? Do these judges have such fattened egos and cushy lives that they think they are truly better than the rest of us or can they simply not relate to such hopeless poverty in which so many abide?
But for the grace of the universe, my friends, go the rest of us. To me this kind of arrogance goes too far. Help the woman find a way to make that money and we'll all be happy. Isn't there some stimulus money available out of all those trillions we will spend to give her a part-time job for a few weekends so she can earn that money? One could surmise that forcing the judges and their clerks to become collection agents results in the same mindset of the worst in that profession. Obviously poverty, if you happen to be an imperfect person living in Florida in 2009, has become the sin for which you will be heartlessly punished. For you history buffs this is not new information, of course, but the Poor Law of 1601 in England assigned management of the poor to local parishes. These local officials housed all able-bodied people without resources in work houses and were expected to turn a profit on their labor. It was a harsh system, as most people in England did not own their own homes. Landlords could send one to these work homes with little more than a flick of the wrist. Persons were not allowed to live even in their own homes if they were unable to pay their taxes.
Of course, the lack of relief further complicated any sort of permanent recovery from debt. If a parent was in a work house, their children and families were required to go with them. Everyone in these debtors’ prisons worked, regardless of age, sex, medical condition or infirmity. It was an unimaginable hell for all. Obviously this was a poor system and the residents of these squalid places eventually included debtors, felons, orphans, the convicted or merely accused, the poor, the sane and insane. None of the wealthy and ownership classes, however, were then troubled with the homeless. They were hidden away, much like we handle them today as families live in their cars, under bridges and in other dark places. The English law was amended in 1834, but it did little to correct the horrid conditions of filth or the non-segregated communal housing of men, women, children, the old, the young, the violent and the disabled.
We are so accustomed to prisons, that it is odd for 21st century people to learn that incarceration did not arise as a punishment until the 18th century. Prior to that time the options were terribly grisly including only death or exile, the latter culminating in transport to some undeveloped outpost like England's Australian territory. Many innocent poor people were convicted or merely lost in the system. Once in the work houses without a family member or benefactor they were doomed merely because they could not afford legal counsel. When the US Congress embraced Phil Gramm’s version of deregulation - empowered through a Republican-dominated, taxes-on-the-rich-are-evil policy - we found ourselves with a burgeoning poverty class. Few cared, really, as long as their own 401(k)s doubled every few years and their employers continued to pay for medical and dental insurance. Unfortunately this failed policy, coupled with the greed, deceit and the fraud perpetrated on the American public resulted in George W. Bush’s on-going Great Recession.
You may think you are currently safe, but the combo has critically wounded what used to be our middle class. When March 2009’s job losses crested at 663,000, the highest unemployment rate in 25 years, it became certain that many more American families will fall into the poverty crevasse. My apologies for using so many chilly metaphors, but job losses are only the tip of the iceberg. As millions of small businesses have gone belly up in the last 15 months, the economic outlook is even bleaker. How bleak? During 2008, 43,546 bankruptcies were filed by businesses. Experts estimate that this would indicate an additional 87,000 to 130,000 businesses failed during that same time period. For every company that files for bankruptcy protection, another two to three simply shutter their doors. As small businesses are the engine under which most jobs are created in the United States, this does not bode well for workers or anyone else. Your house, your car and your possessions are not worth much if no one can afford to buy them from you.
One could assume from these statistics that the majority of people who are not totally discouraged by now are actively looking for work. A recent Time Magazine article illuminated the difficulties that two-parent/one-job families are having when the working parent loses his or her job. Time reported that stay-at-home moms are desperately trying to re-enter the job market, best illustrated by one dedicated web site for this group. Their site crashed when 34,000 women applied for the 54 open positions they listed. When a self-employed person looks for outside work, however, they do not show up in the unemployment statistics. Their employees, of course, can apply for unemployment benefits, but the owners and entrepreneurs are silent casualties. These people have been forced out in droves over the last few years as business credit declined. It seems that everybody in the middle and bottom of our socio-economic classes is hurting financially in some way.
This is taking its toll on families too. More divorces are evidenced as self-prepared papers are filed with the courts and domestic violence ramps up. One cannot turn on the news without discovering some newly unemployed person who has taken hostages, killed his wife and children or blown complete strangers up in some deranged, calculated plan. This sort of extraordinary mental stress also results in declines in the general population's physical health and mental health, further stressing our general infrastructure. All of these thoughts lead me to the conclusion that a modern version of a debtor's prison is not the answer. Wake-up, Florida. Your citizens need a compassionate attitude, not a punitive one. A judge, of all people, should be able to see that the new and old poor are already being punished enough.
Pinched Courts Push to Collect Fees and Fines
Valerie Gainous paid her debt to society, but almost went to jail because of a debt to Florida’s courts. In 1996, she was convicted of writing bad checks; she paid restitution, performed community service and thought she was finished with the criminal justice system. This year, however, she received a letter from Collections Court telling her that she was once again facing jail time — this time for failing to pay $240 in leftover court fees and fines, which she says she cannot afford. Ms. Gainous has been caught up in the state’s exceptionally aggressive system to collect the court fines and fees that keep its judiciary system working. Judges themselves dun residents who have fallen behind in their payments, but unlike other creditors, they can throw debtors in jail — and they do, by the thousands.
As Florida’s budget has tightened with the economic crisis, efforts to step up the collections process have intensified, and court clerks say the pressure is on them to bring in every dollar. "I would say there is an even more dramatic focus on those funds now," said Beth Allman, the spokeswoman for the Florida Association of Court Clerks. Other states are intrigued by Florida’s success, and several, including Georgia and Michigan, have also cracked down on people who owe fines. John Dew, the executive director of the Florida Clerks of Court Operations Corporation, said that when he attended national conferences about fees collection, states were "really looking to what we’re doing in Florida."
With 44 states facing budget deficits totaling $90 billion this year, 25 state court systems already have budget shortfalls, said Dan Hall, the vice president of the National Center for State Courts. Chief Justice Margaret H. Marshall of the Massachusetts Supreme Judicial Court told the American Bar Association in a recent speech that the state courts were in crisis because of budgetary and other issues. States facing lower revenue from income and property taxes are taking action that includes court cutbacks and fee increases. Oregon will try to save $3.1 million by closing its courthouses every Friday for four months and cutting the pay of 1,800 court workers by 20 percent. New Hampshire began suspending civil and criminal jury trials in eight counties for a month, starting last December, and postponed filling seven of the state’s 59 vacant judgeships.
Massachusetts is looking to cut its court system budget by 7.5 percent, which will almost certainly mean staff cuts. Maine is no longer staffing the metal detector checkpoints at its local courthouses. Utah is looking at imposing an $8 "conviction fee" to pay for security and metal detectors; civil filing fees in the state will be raised as well. Florida has cut its court payroll by 10 percent, with more cuts expected. Mr. Hall, of the courts organization, said that when states cut their judicial budgets, they "really cut deep into the fabric of our society" by causing delays of weeks or even months in resolving cases.
In Iowa, for example, where the courts are trying to make up for a $3.8 million budget cut, courthouses in every county will close for eight days between now and June 30, and travel budgets have been cut for judges who go from county to county to hear cases. This means delays for rural residents who have matters that have to be heard by a district judge, including divorce. Access to efficient courts is essential to helping people resolve life’s crises, like foreclosures, debt collection, divorce and child support, said Rebecca Love Kourlis, the executive director of the Institute for the Advancement of the American Legal System at the University of Denver. "You can’t put them on the back burner and say, ‘We’ll get back to you when we have more money and more staffing.’ "
Advocates for the poor have urged other states not to follow Florida’s example of squeezing defendants harder to make up for budget cuts. Rebekah Diller, deputy director of the justice program at the Brennan Center for Justice at the New York University School of Law, said the state’s system wasted resources "to get blood from a stone." Judges, she said, should not become "debt collectors in robes," which she called both demeaning to the judges and humiliating for the people who must stand before them. Rhode Island seems to agree. Faced with statistics showing that arrests for nonpayment cost far more than they bring in, the state passed a law in August granting judges latitude to waive court debts for poor defendants.
Florida, however, has continued to tighten its grip. Since 2004, the Legislature has required courts to support their operating expenses substantially, through fees collected by county clerks. Some of the clerks use collection agents, while about a third use the Collections Courts, state officials said. Here in Leon County alone, 839 people were arrested and jailed in the year ended last September over court debts or failure to appear at Collections Court, according to a study by the Brennan Center. Other Florida counties have less stringent policies. Around Leon County, there are some 5,400 outstanding "blue writs" — the civil equivalent of an arrest warrant for failing to appear and pay fees. Some people come in and pay when they receive their summons; others spend a night or more in jail, often having been arrested when the writ pops up during incidents like routine traffic stops.
It can be expensive to be arrested. Nancy Daniels, a Florida public defender who works in Tallahassee, said fines and fees for a first offense on third-degree felonies like credit card fraud or possession of cocaine are around $500 — $340 in court costs, a $100 prosecution fee and $50 for the public defender application fee. If the defendant cannot pay up front, starting a payment plan costs $25. The Brennan study said the program took in only $18,365 for the 12 months studied, after costs, from those arrested. The county court system said a more realistic amount was the $768,000 collected last year, because many people who were not arrested paid their fines to avoid even the threat of being called into court.
Constitutional law forbids jailing people solely over fees and fines they cannot pay, but Florida officials argue that, technically, they are jailing people because they violated court orders. Charles A. Francis, the chief judge of the state’s Second Judicial Circuit, said most judges found Collections Court "the most unpleasant part of the job." The judges try not to jail people over fees, he said, but added, "Do you allow the orders of your court to go ignored?" Few people are truly unable to afford monthly payments, he argued. Shannon Russell, the supervisor of the Leon County collections department, said: "People come in and say, ‘I can’t pay this.’ My answer is, ‘You shouldn’t have gotten arrested.’ "
When Ms. Gainous appeared in Collections Court recently, Judge Nina Ashenafi Richardson spoke compassionately but nonetheless pressed each of the dozens of people in the courtroom to pay what they could or face arrest. Ms. Gainous, 39, a single mother of four, said she had been sick and could not even make a $40 down payment on her $240 in fees. Suddenly, there was a startling moment of grace: another woman waiting in the courtroom, Latasha Penny, volunteered to pay the $40 for her. Ms. Gainous hugged her and sobbed. When Ms. Penny’s case came up, Judge Richardson reduced her monthly payment on $345 in fines to $30 from $45. "You did a very nice thing earlier," Judge Richardson said with a smile. Days later, Ms. Gainous was still incredulous and said she would pay the $10 a month. "It’s still hard," she said. "But I’m going to try to get that in, to keep from going to jail for being poor."
Irish credit union debtors more likely to go to jail than bank debtors
A person who does not pay back a loan is more likely to go to prison if the debt was with a credit union rather than with a large bank, legal aid organisation Free Legal Advice Centres (Flac) has said. Ahead of a conference on human rights yesterday, director general of Flac Noeline Blackwell said the bigger banks tended to see imprisonment as useless because it did not force the person to pay the debt. "Very often it is credit unions that pursue people to the point where they end up in jail," she said. In the last five years, 1,000 people were jailed for non-payment of debts. They spent on average 21 days in prison and when they were released, they still owed the debt.
The United Nations Human Rights Committee has recommended Ireland change its laws so that no one is imprisoned "for the inability to fulfil a contractual obligation". Although there were no statistics, Ms Blackwell said the cases Flac heard about tended to be merchants who did not get bills paid and credit unions, rather than the big banks. "They deal with it in a less strictly commercial way and in a more personal way," she said. "They see it nearly as a slight on the community when someone doesn’t pay their debt and very often they put people in prison so other people will continue to pay their debt."
Ms Blackwell said no civil society should seek to put one person in jail in order to ensure another person paid a debt. She called on the Government to immediately end imprisonment for non-payment of debt. A spokesman for the Irish League of Credit Unions said credit unions utilised every available avenue to avoid court, including the renegotiation or rescheduling of problem loans. "It is the act of disobeying an order of the court that may result in imprisonment," he said. "In that sense, the matter is out of the hands of a credit union whose involvement was merely in securing an instalment order for the repayment of a loan."
Irish Emergency Budget Aims to Avert 'Grave Crisis'
Ireland’s government, reeling from the loss of its top credit rating by Standard & Poor’s, may increase taxes and cut spending in an emergency budget today aimed at stemming the biggest deficit among euro-area nations. Finance Minister Brian Lenihan, who is making his second budget speech in six months, says the country faces a "very grave national crisis" as the deficit heads for 13 percent of gross domestic product, four times the European Union limit. He may also announce plans to remove toxic property loans from the nation’s biggest banks. Ireland’s fiscal woes are another symptom of the global economic crisis that brought the nation’s 14-year boom to a halt, leaving the government with a 23 billion-euro ($31 billion) hole in the public finances.
The economy, set to shrink the most of any euro area country this year, last month became the fourth member of the region to be downgraded this year. "The S&P downgrade was a kick up the backside," said Jim Power, chief economist at Friends First in Dublin. "There is a short-term firefighting issue in the budget and a longer-term sustainability issue." Lenihan may double the payroll levies he introduced in his previous budget in October and increase taxes on cigarettes and alcohol, the Sunday Business Post reported on April 5. The bank plan may involve setting up an asset-management company to remove some loans to real-estate developers. The minister is scheduled to deliver the statement to the parliament in Dublin at 3:45 p.m.
Budget deficits across the European Union have ballooned as governments pour billions of euros into stimulus measures to fight the worst recession since World War II. At the same time, tax receipts are falling and unemployment payments are rising. Ireland wants to keep the shortfall at 9.5 percent of GDP this year and forecasts it would widen to 12.8 percent without action. The EU sets a limit of 3 percent of GDP. After expanding an average 7 percent a year between 1994 and 2007, when it earned the title "Celtic Tiger," Ireland’s economy shrank 2.8 percent in 2008. Now the slump is deepening, with the government forecasting a 6.75 percent contraction this year. Tax receipts fell 23 percent in the first quarter.
As he tries to correct the deficit, Lenihan has to be careful that he doesn’t "kill off the consumer with ill-judged tax increases," said Power. In Britain, Chancellor of the Exchequer Alistair Darling put off tax increases and spending curbs until April 2010 to help the economy weather the worst recession since 1980. Even after lowering Ireland’s rating one step to AA+ last month, S&P left the nation’s debt on a "negative" outlook. Moody’s Investors Service and Fitch Ratings have also placed Ireland’s rating up for review. The budget "will probably not be enough to avert the loss of the composite AAA rating, but it should be enough to comfort current and future holders of Irish bonds," Padhraic Garvey, head of investment-grade debt strategy in Amsterdam at ING, said in a report today.
Credit-default swaps on Irish government debt rose to 211 basis points today from 206 yesterday, according to CMA Datavision. They reached a record 396 basis points on Feb. 17. The difference in yield, or spread, between Irish and German 10-year government bonds was little changed at 202 basis points. The spread was 39 basis points a year ago. In addition to waning domestic and external demand, S&P cited the "scale of the deterioration of asset quality in the banking sector." Ireland last year became the first European nation to guarantee the liabilities of its largest banks. It also nationalized Anglo Irish Bank Corp. and pumped 7 billion euros into Bank of Ireland Plc and Allied Irish Banks Plc.
The government’s next step may see it set up an asset management company to take over banks’ loans to real estate developers. Ireland’s financial regulator estimates that the banks have about 39 billion euros in speculative loans to developers and Lenihan said on Feb. 26 that he was looking to "sequester" some of these to free up lending. Bank of Ireland rose as much as 15 percent in Dublin trading and was 11 percent higher at 98 cents at 9:47 a.m. Allied Irish advanced 8.6 percent to 1.27 euros. "If that helped clear up the balance sheets and helped the restoration of some sort of normality, it makes sense," said Ray Kinsella, a professor of banking and insurance studies at the Smurfit Graduate School of Business in Dublin.
British tax rises on cards to pay for Treasury's £39bn 'black hole'
The Government may have to find an additional £39bn a year in tax rises and spending cuts to plug the black hole in the public finances, which are being ravaged by recession, an influential think tank has warned. The Institute for Fiscal Studies estimated that the sum would have to be found by 2015-2016, if spiralling Government borrowing is to be brought under control again after lower tax revenues and higher spending on recession-related benefits. It predicts that borrowing in the financial year 2008-2009 is likely to reach £95bn, and £150bn this year, respectively almost £17bn and £32bn more than the Chancellor forecast at the pre-Budget report in November.
To fund the £39bn shortfall, the Government would have to increase taxes by an extra £1,250 per family, per year, or cut spending for five years with even the much favoured areas of health and education hit hard. In the absence of fiscal tightening, net debt would stand at about 90pc of national income by the early 2050's, according to the IFS. The gloomy review highlights the unenviable task Alistair Darling faces with the Budget on April 22. He has already admitted that the Government underestimated the severity of the recession, signalling significant downgrades to the Treasury's economic growth forecasts. The IFS also projected that the national debt would hit 73.5pc of national income in 2015-2016, or 82.4pc if the Government's intervention in the banks was taken into account, based on the International Monetary Fund's estimate that it would cost the taxpayer £130bn, or 9.1pc of national income.
If investors "take fright" as the public finances deteriorate further, there is a risk that borrowing costs could rise for the Government, the IFS warned. Simon Hayes, economist at Barclays Capital, said: "I don't think you can argue with the harm that the macro economy is doing to the public finances, relative to the pre-Budget report forecasts. There's no doubt that you're looking at significant increases in taxation and curbing on spending which will take some political will, but the idea that we'll be plunged into some sort of post-war austerity is absurd." The British Chambers of Commerce on Monday called on the Government to announce further targeted measures in the Budget to help businesses not only survive the recession but pull the country out of it. David Frost, director general of the BCC, said: "It will be business that drives the UK out of recession and for this reason it is vital that they have the freedom to create jobs and wealth."
A report published by the BCC on Tuesday shows that although there are signs the UK services sector may have hit the bottom and started to improve, there is "more pain to come" for manufacturing, which hit record lows in the first quarter economic survey. For example, the domestic sales balance for manufacturing - calculated by subtracting the number of companies reporting decreases from those reporting increases - dropped 17 points to -55pc, from -38pc in the previous quarter, the lowest in 20 years. The equivalent balance for services rose by eight points to -23pc, from -31pc.
U.K. Manufacturing Drops Most Since at Least 1968
U.K. manufacturing dropped the most in at least four decades as the global economic slump throttled demand for goods from cars to ceramics. Production fell 6.5 percent in the three months through February, the most since records began in 1968, the Office for National Statistics said today in London. Output declined 0.9 percent from January. Economists predicted a 1.5 percent drop, the median of 30 forecasts in a Bloomberg News survey showed. Policy makers are struggling to haul the economy out of its worst recession in almost three decades. While the Bank of England is buying assets and an index of services rose to a six- month high in March, car sales dropped by almost a third and Ernst & Young LLP says British companies had the most profit warning since 2001 in the first quarter.
"It’s going to take a long time before we see any expansion in the economy again," said Alan Clarke, an economist at BNP Paribas SA in London. "The pace of contraction may moderate, but ultimately the bank may have to do a lot more." The slump in factory production was led by transport equipment, basic metals and non-metallic mineral products such as ceramics, the statistics office said. While the monthly drop was the smallest in six months, the annual decline of 13.8 percent was the largest since 1981. Out of 13 categories of manufacturing, eight fell and five rose on the month, the statistics office said. Factory production has now dropped for 12 months, the longest stretch since 1980.
U.K. auto sales fell 31 percent in March, the Society of Motor Manufacturers & Traders said yesterday. PSA Peugeot Citroen’s Peugeot brand logged the biggest drop among the top five best-selling makes in the U.K. Sales of Aston Martin Lagonda Ltd.’s luxury cars dropped 40 percent. Bank of England Governor Mervyn King said last month that the first three months of the year will probably see a similar drop in gross domestic product to the fourth quarter’s 1.6 percent, which was the biggest in almost three decades. King’s central bank has already taken the unprecedented step of cutting rates close to zero and buying government bonds with newly-created money to rescue the economy. The central bank makes its next monetary policy decision on April 9 and all but one of the 62 economists in a Bloomberg survey expect policy makers to keep the rate unchanged at 0.5 percent.
A gauge of factory sales slumped to minus 55 in the first quarter, the lowest since records began two decades ago, the British Chambers of Commerce said today. The BCC conducted its survey of 6,500 companies from Feb. 23 to March 16. Smiths Group Plc, the world’s biggest maker of mechanical seals for the energy and marine industries, said March 25 that first-half profit dropped at four of its five divisions. Today’s report showed overall industrial production, which includes output of mining, utilities, oil and gas, fell 1 percent in February. From a year earlier, it dropped a record 12.5 percent. Production has dropped for a 12th month, the most since records began. "It’s pretty grim out there," said Peter Dixon, an economist at Commerzbank AG in London. "The authorities have thrown the kitchen sink at this problem. Now it’s time to wait for it to have an impact."
Spanish Recession Hits Hard
The economic downturn is exposing deeper structural problems that likely must be fixed before the country can get back on a growth track. Madrid's financial district has lost its shine. Near the iconic Puerta de Europa Towers in the northern part of the city, For Sale signs adorn newly completed office blocks while cranes sit motionless next to half-finished construction projects. In a local restaurant that tailors to the once-bustling lunch crowd, 31-year-old waiter Manuel Gutiérrez can't remember business ever being so slow: "No one expected the (economic) crisis to last this long," he says. The recession may have taken some Spaniards by surprise, but its consequences will be felt for many years. After posting average annual gross domestic product growth of 3 percent over the past decade, Spain's economy is now expected to contract by around 3 percent this year. Unemployment already stands at 16 percent -- the worst in the European Union-and many economists reckon the level could hit 20 percent by 2010, the highest since the early 1990s. "The crisis is getting worse and worse," says Fernando Ballabriga, director of the economics department at ESADE business school in Barcelona. "If things don't pick up in three or four months, companies will run out of money. People are now in a panic".
The severity of the crisis is forcing policymakers to take a hard look at the country's growth model. When credit was cheap and abundant, Spain's real estate and construction industries, which constituted a combined 20 percent of the country's annual GDP in 2007, boomed as firms such as Sacyr Vallehermoso and Metrovacesa invested billions of dollars in commercial and residential property. Although financial regulators steered Spanish banks away from US subprime assets-sparing them that toxic exposure-many, including partly government-owned savings and loans such as La Caixa and Caja Madrid, became highly leveraged on domestic real estate. Now the downturn has wiped billions off property prices, thrown thousands of workers out of jobs, and left banks reeling with bad debt. Equally important, the recession has exposed costly inefficiencies in the Spanish economy such as low worker productivity and high administrative costs that were papered over during boom times. All of a sudden, Spain has turned from a highflier to the sick man of Europe.
The drastic change of fortune has prompted calls from the country's business leaders, politicians, and citizens for wholesale reform in how the domestic economy is run. Topping many economists' lists of desired structural reforms are changes to Spain's rigid labor laws and internal market. That includes everything from reducing labor costs to cutting bureaucratic hurdles for businesses and startups in an effort to jump-start the lagging economy. "We need to change our growth model," says Rafael Domenech, head economist for Spain and Europe at Spanish bank BBVA. "Luckily, it's easier to change things in the bad times, when reforms are more acceptable to the entire society." Still, policymakers may face an uphill battle to persuade Spaniards to give up some of their social benefits. Take the country's labor market: As in many European nations, Spain offers generous employment protections that make it difficult to fire workers-and thus make companies less willing to hire them in the first place. For instance, laid-off workers get up to 45 days of severance pay for every year they've been employed-so sacking a 15-year employee could cost nearly two years' salary. Such rules, says Hilario Albarracín, head of advisory services in Spain for consultancy KPMG, have led to an inflexible, costly workforce that finds it difficult to adapt to the current economic climate.
To boost Spain's competitiveness, analysts say, hard choices must be made. That includes cutting employee benefits, delinking worker salaries from inflation, and outlining inevitable job losses. Already, automakers such as Ford, BMW, and Citroën have reduced the number of shifts at their Spanish plants, with layoffs expected by the end of the year. KPMG's Albarracín figures many domestic companies will cut wages between 10 percent and 20 percent this year, as well as reduce employees' working hours. "People in Spain are prepared to accept lower salaries than had been expected in the past," he says. That was true for Claudia Hervoso, a 29-year-old graphic designer from Madrid, who took an 8 percent pay cut in January. Faced with falling customer demand at the midsize marketing firm where she works, Hervoso says she was willing to accept a reduced salary if it meant she kept her job. "I have a mortgage to pay and can't afford to be unemployed," she says. "If I have to take a pay cut, so be it."
The other obstacle Spain must overcome, economists say, is the heavy bureaucratic burden placed on business. According to BBVA's Domenech, regulatory disparities among the country's 17 provinces make it expensive for companies to expand domestically. A Catalonia-based company looking to set up shop in Andalucía, for instance, would have to file paperwork in both Barcelona and Seville, adding extra layers of bureaucracy to the process of expanding a business. "The different rules produce competitive barriers within Spain's internal market," he says. To solve this problem, Domenech believes more coordination between the Spanish regions is needed to reduce companies' administrative costs. Yet while such reforms would certainly boost efficiency, skeptics question whether provinces such as the Basque Country and Catalonia, which jealously guard their independence, would be willing to give up certain powers to boost the nation's overall competitiveness. Market reforms may be unappetizing to some, but they will become more critical as Spain's unemployment rate continues to climb and the country's GDP goes from bad to worse. During the good times, Spaniards paid little attention to improving their global competitiveness. Now faced with the worst recession in generations, Europe's fifth-largest economy suddenly finds itself being forced to take action.
Greece Teeters on the Verge of Bankruptcy
Greece is on the brink of bankruptcy despite the fact that the global recession has yet to hit the country with full force. Strikes are paralyzing the country and the EU is putting on the pressure. But the government is still trying to put a positive spin on things. For 33 years now, Dionisis Sargentis, 58, has been selling medical and orthopedic supplies to hospitals, products like screws and clips for damaged vertebrae or broken joints, implants, and surgical instruments. He started out as a one-man business. Today he has 13 employees and annual sales of nearly €7 million ($9.3 million). One would think that his line of business would be recession-proof, given that there is always a need for medical supplies and his regular customers include major public hospitals in Athens. And yet Sargentis is currently on the verge of going out of business. "I love my work," he says, "but the business is no longer worth it." For four-and-a-half years now, the public hospitals haven't paid him for the supplies he has delivered. At the moment they owe him somewhere around €4.5 million -- more than half his company's annual sales.
Now he's fed up with waiting. Together with a number of other hospital suppliers he drove up in front of the General Hospital of Attica (KAT), which has the largest orthopedic department in Athens. But instead of delivering new supplies, he removed existing stocks from the clinic's storerooms. "We're only repossessing what belongs to us," he said. "They were just on loan." Sargentis and his fellow hospital suppliers are hoping that the Greek government will get the message and finally pay up. As of Dec. 31 last year, the Greek government owed the 75 member companies of the Greek association of medical equipment suppliers, which Sargentis is president of, almost exactly €800 million. An entire sector of the economy is on the brink of ruin. "Everyone is up to their necks in it," he said. There is a systemic reason for this. In Greece, hospital suppliers sell their goods to clinics on what is virtually a commission basis. The clinics pay only for what they use and in most cases only after a considerable time lag. Two to two-and-a-half years are considered normal waiting times. The suppliers take that into account in their planning. The orders made by the hospitals serve the companies as security for bank loans they take out to pay salaries and to place new orders with manufacturers. This is the way the business works -- or rather, this is the way it used to work.
But now the banks have stopped cooperating. They are refusing to provide new loans and this has caused the entire system to collapse. "It has cut off our oxygen supply," Sargentis says. "We are being suffocated by debt." But it is not the hospital suppliers' debts the banks are worried about -- it is the highly indebted Greek government they no longer see as being creditworthy. Companies like Sargentis's are the unwitting victims of the change in attitude. No wonder, then, that there is so much public displeasure being expressed against the Greek government. Over the past few weeks, workers and public employees have been calling strikes across the country. Last Thursday, tens of thousands of people took to the streets in Greece's major cities, paralyzing public life. Trains, buses, and ferries stopped running. Hospitals offered only emergency services. Public schools were closed. "The workers shouldn't be made to pay for the crisis," angry demonstrators shouted. They hold the government of Greek Prime Minister Costas Caramanlis responsible -- both for the bad old habits and the new financial crisis.
Crisis? The situation in Greece is not all that bad, insists Panos Livadas, the government's secretary general of information. The shops and cafés are full of customers, he points out. The Greek economy is "really indestructible. I don't understand these international situation assessments." Livadas's job is to make people see things through rose-colored glasses. He explains that in 2008 his country's economy expanded by 3.2 percent, "one of the highest growth rates in the euro zone." Over the past four years, he says, economic growth in Greece has been twice as high as the overall average in the currency union countries. He characterizes Greece's banking sector as being "basically sound" and "in considerably better condition" than those in other EU countries and in the United States. He notes that Greece was the first EU country to provide a government guarantee for personal savings up to a total of €100,000. Nothing seems to be able to shake the official's self-satisfied depictions of Greek reality. But is this what the situation really looks like?
One needs luck, especially in difficult times. At the crisis summits of EU member countries in Brussels, Prime Minister Caramanlis was lucky in the sense that the community was under such strong pressure to act in response to the crisis in Eastern Europe that not very much attention was given to the situation in Greece. But now the European Commission has instigated disciplinary proceedings, because Athens has exceeded the euro zone budget deficit limit of 3 percent for the third time in a row. The results of audits carried out by Brussels look very different from the information in Livadas's glossy brochures. In EU statistics, Greek government debt is listed as amounting to 94 percent of the country's gross domestic product. Italy is the only other euro zone country which has a higher level of government debt. Greece also has the lowest credit rating of all the euro zone countries. It has to finance its government debt under terms which are worse than for any other euro zone country, with the exception of Malta. Greece has yet to break its old habits. The level of competitiveness is low, much-needed reforms are overdue, government bureaucracy is bloated and corrupt, and the country continues to live beyond its means. Even though the national pension funds are chronically short of cash, female public employees with school-age children are allowed to retire at the age of 50.
Educated young people from the middle class have little prospect of finding employment, despite being well qualified, and are forced to take casual jobs to make ends meet. As a result, many young Greeks are forced to live with their parents until they are well past the age of 30. The anger of the "€700 generation" -- as the young people are known -- over their situation exploded last December in weeks of rioting throughout the country. The EU is now no longer willing to accept lethargy on the part of the Greek government. European Commissioner for Economic and Monetary Affairs Joaquín Almunia called for significantly harsher cost-cutting measures, a "prudent wage policy in the public sector," and greater efforts with regard to structural reforms. Georgios Provopoulos, the governor of the Bank of Greece, the nation's central bank, warned his countrymen against "self-satisfaction" and spoke of a looming danger of national bankruptcy. And Greece has still to feel the full effects of the global recession. "The negative factors you see here are all leftovers from the past," says one EU diplomat, adding that most of them are homegrown. Economic experts are anxiously waiting to see what's going to happen this summer. They fear there could be a decline in the tourism sector, one of the most important pillars of growth in the Greek economy, accounting for 17 percent of gross domestic product. The volume of tourist bookings from the United States is reported to have dropped by up to 50 percent. The number of British vacationers, some 3 million annually in the past, alongside 2.3 million Germans, is expected to shrink by up to 30 percent.
The situation of banks that invested in Eastern Europe and in the Balkans is uncertain. Greek financial institutions invested billions of euros in bank takeovers or in setting up their own branches in Romania, Bulgaria, and Serbia. Given that the value of the national currencies in some of those countries has fallen dramatically, what were originally seen as attractive investments in developing economies could well turn out to be huge losses. That's what the crisis looks like in Greece. "Nobody wants to see it, but everybody is afraid of it," says Kalliope Amyg, a young political scientist. "The country is dancing on a volcano." In Greek, there is no direct translation for the verb "save" in a monetary sense. And that is precisely the way the Greeks live. Greece continues to have a flourishing informal sector. "It helps to stabilize people's incomes and standard of living," observes one European businessman who works in Greece. "Families try to have as many separate sources of incomes as possible." For 24 years, Popi Kalogeropoulou, 48, has worked as a graphic artist for publishing companies, most recently for the women's magazine Young. At the end of last year she was laid off. The magazine was forced to cut costs, which meant job cuts.
Fortunately it didn't take her long to find a new job. Since mid-January, she has been doing the layout for a weekly newspaper. The pay she was offered isn't bad, more than €2,000 a month, which is a bit more than what she was getting in her last job. The only thing is, she wasn't given a contract -- she is being forced to work under the table. "I'm being made to do something I don't want to do," she says. She was paid for the first time eight weeks and one day after she started. But she only received €1,000 -- in cash, naturally. "Companies are simply taking advantage of the crisis," she says. Nobody believes that Greece will be able to cope with the crisis, if and when its hits the country with full force, using just its old inefficient habits. "We don't know what tomorrow will bring," says the entrepreneur Dionisis Sargentis. Sargentis only knows what will happen if the Greek government continues to be unable to pay its bills and the companies in his sector are unable to sell their goods. "This will spell the end of the health care system in our country." Among other things.
Arctic Ice Got Smaller, Thinner, Younger This Winter
Turns out there is such a thing as being too young and too thin. Arctic ice continued its decline this winter, with hardy, thicker old ice increasingly being replaced with quick-to-melt, thinner young ice, according to a new report by NASA and the National Snow and Ice Data Center. This winter's maximum Arctic sea ice extent was 5.85 million square miles (15,150,000 square kilometers)—about 278,000 square miles (720,000 square kilometers) less than the Arctic average between 1979 and 2000. "That's a loss about the size of the state of Texas," said Walter Meier of the National Snow and Ice Data Center (NSIDC) in Boulder, Colorado. "We used to have a winter ice maximum about twice the size of the lower 48 United States," Meier added.
This year's ice cover was not a record low, but it did continue a dubious streak. The past six years (2004-09) have seen the least Arctic ice at the time of maximum cover, in winter, since satellite records began in 1979. Ice a year or more old—thicker, hardier, and less prone to melting than younger ice—was at an all-time low at the end of this past winter, the new report says. Ice older than two years once accounted for some 30 to 40 percent of the Arctic's wintertime cover and made up 25 percent as recently as 2007. But last year it represented only 14 percent of the maximum. This year the figure fell to 10 percent. The team did report one ray of hope. In winter 2008-09, more new ice (in this case from winter 2007-08) had survived the summer than in years past. "From a record low last year of 5 percent or less [it was] back where it used to be, in the 10 to 15 percent range," Meier explained.
But he remains skeptical that enough of the younger ice could survive coming summers to make up for losses of older ice. "This is not something that can be done in a couple of cold winters. We're way below where we used to be, and it would take many years to get back to where we were in the 1980s." The Arctic's ice holds enough water to fill both Lake Michigan and Lake Superior. But since the ice floats atop ocean waters, its loss would not directly raise sea levels. Even so, vanishing sea ice poses severe hardships to Arctic plants and animals—including humans—that have evolved to coexist with the ice. The great Arctic melt may also worsen global warming.
In summertime Arctic ice reflects sunlight back into space. When the ice melts, newly exposed, dark ocean waters absorb that heat, with unpredictable consequences for wind and ocean circulatory systems worldwide. The new data are not surprising, said Sheldon Drobot of the National Center for Atmospheric Research in Boulder, Colorado. "It's almost like the new normal is a time frame where we're setting records or near-records every year," said Drobot, who was not involved in the research. Comprehensive Arctic satellite data stretches back some three decades, though some regions near Alaska and Siberia have been otherwise closely monitored since the 1950s.
Data from the rest of the 20th century, and previous centuries, are far less comprehensive. But scientists do have reports of ice cover from shipping records and other historic documents. "It's been a long time since we've seen so much open water," said Ron Lindsay of the University of Washington's Polar Science Center. "It really is unprecedented, what we've been seeing, for centuries and maybe thousands of years." The new study comes on the heels of a report released last week by the U.S. National Oceanic and Atmospheric Administration (NOAA) and the Joint Institute for the Study of Atmosphere and Ocean. That study used computer modeling and ice-level decline data to predict that most of the Arctic's summer ice could be gone in 30 years.