Grocery and Coca-Cola shack in Alabama
Ilargi: Derivatives expert Satyajit Das, in another excellent article, says the current economic order was built to fail. Nor deliberately set up to do so, but set up in a way that made the downfall inevitable from the start. Das writes: ”The ability to sustain high rates of economic growth, decreed by governments and central bankers, is questionable” , which seems a very kind way of phrasing the issue. Almost all of us can understand that perpetual growth of any kind, and in any system, is impossible. How to apply this principle, or even law, to financial matters is less obvious to many. Which is probably a logical consequence of the fact that our fiat money doesn’t represent anything of real value, and we are confused about what it does represent.
There's also our perception of time, and how it relates to perpetual growth: we may know that nothing can grow forever, but we can still think that growth can continue into next week, or next year, or during our lifetimes. This is certainly a paradox at heart, but it's one that's been fed by the simple reality that most among us have perceived the world we have grown up in as one in which growth has been an integral part of our lives. That fact that we perceive it that way almost entirely obliterates another fact, namely that it's not true, that overall economic growth in the western world peaked sometime in the early 1970's. There are all sorts of means to measure this, and Das provides a nice one: the amount of dollars in debt required to achieve $1 in growth.
The way in which we have been fooling ourselves into thinking there has indeed been growth in the past 35 years, despite evidence to the contrary, tells us a lot about the reasons why we do not understand today that our economic order has failed. The same forces who've had an interest in keeping the growth illusion alive until now are now trying to make us believe that a little tweaking of the system here and there is all that's needed to restart the growth machine, that the engine hasn't failed, it's merely temporarily sputtering. Nothing a mechanic with a good manual can't fix.
But there is no good manual, something that has repeatedly been admitted, willingly or not, by various parties to the decision making process. The fact that the only people who have correctly predicted the situation we now find ourselves in were, and still are, standing on the periphery, literally on the outside looking in, while those in the center have consistently been embarrassingly wrong, yet remained where they were is ample proof that there is no manual. Many decision makers have also, at times when doing so seemed convenient, talked about the unchartered waters they saw ahead. That leads us seamlessly into the next problem: there are no good mechanics, al least not where it counts.
So why are the bad mechanics and their friends still in charge of the journey, who are trying to fix a motor, and to keep a patient alive, that has long since ceased moving? First of all, because their interest, which is to stay put in the place where the money and power goodies are, coincides with the interests of the other power groups. Control of our societies lies with politicians, business leaders (especially financiers) and media. Together, they form a mighty triangle. Controlling what people see and hear, how they see it and in what words the messages are delivered, that's nine tenths of what it takes to make them believe.
Still, it's far too easy to point fingers elsewhere, and moreover, by blaming others for what's ailing you, you also surrender your power to educate and perhaps heal yourself. The main and basic issue here remains, simple because it has to, that we ourselves wish so desperately hard to believe that growth will continue. No matter that we rationally understand it cannot, no matter that we see the signs everywhere that say growth is over, we will collectively jump on the bandwagon of the next story-teller who promises to restore the growth we desire against all odds and all logic. It's who we are, we are an addictive species. It's funny, though, somehow, somewhere, that we wish for things to change (growth changes things) because we wish for them to stay the same. We see growth as something that allows us to stay in our comfort zones, even though growth necessarily brings about change. We've never known anything else but growth, which equals change.
I’ll get back to this theme soon, and probably more than once, there's enough there to write a book about, and there is nothing more important when it comes to understanding what is happening to us, with us, and because of us . Who among you, for one thing, understand that, and why, growth is over, and with it our economic order? Who among you believe that the present US administration, or some other government, will be able to "turn things around", even as you realize that down the line growth can achieve only negative consequences in your lives? I've avoided trying to come up here with proof in numbers, even though it's obvious that increasing job losses, fast rising personal and national debt obligations, plunging home prices and surging foreclosures, as well as page after page of other figures, inexorably paint the picture of a profoundly deep dark black hole, which even if we were able to climb out of it, would leave its disfiguring scars on all our lives for decades.
I’ll leave you with just one question: how many are left among you who sincerely believe that their children, our children, will, individually or as a group, enjoy better and richer lives than you have? I think perhaps that is a way of looking at things that will cause people to pay - a bit more- attention.
When I first read Satyajit Das state that the current economic order is "built to fail", two questions immediately came to me:
- how many people acknowledge that it has indeed failed, and
- what are we going to do now?
Unfortunately, the answer to the first is that there are so few of us who acknowledge the failure that we don't even get around to contemplating the answer to the second. And that simple little fact will turn out to be even far more damaging to us then all the causes of the downfall put together. That is our tragedy, and we can't help ourselves. We want to believe. Against all we know, if that's what it takes. We desperately need to look beyond what we have, but we don't know where to look, and so we don't. We don't know where we're going, so we deny we're going there. Easy.
Lessons Of The Global Financial Crisis: 3. Built To Fail
by Satyajit Das
The key lesson of the global financial crisis (GFC) may be that the current economic order is "built to fail".
The ability to sustain high rates of economic growth, decreed by governments and central bankers, is questionable. The aggressive increase in debt globally resulted in a sharp increase in sustainable growth rates. $4 to $5 of debt was required to create $1 of growth. Approximately half the recorded growth in the US over recent years was driven by borrowing against the rising value of houses (mortgage equity withdrawals). As the level of debt in the global economy decreases, attainable growth levels also decline.
The world used debt to accelerate its consumption. Spending that would have taken place normally over a period of many years was squeezed into a relatively short period because of the availability of cheap borrowings. Business over invested misreading demand and assuming that the exaggerated growth would continue indefinitely creating significant over-capacity in many sectors.
The nouveau Jeffersonian trinity - "whoever dies with the most toys wins"; "shop till you drop"; and "if it feels good, do it" – has proved to be unsustainable. Growth in global trade and capital flows was also "built to fail". It was built on a financing model where sellers of goods and services indirectly financed the purchase. When the buyer is unwilling or unable to pay, the seller suffers doubly - sales fall and also the money advanced to the buyer falls in value.
The GFC has already reduced global trade and cross border capital flows. In late 2008, the World Bank forecasts a fall in global trade volumes for the first time in over 25 years. The Baltic Dry Freight Index, a measure of supply and demand for basic shipping, has fallen 90 % since mid 2008 although it recovered slightly in early 2009. Exports from Japan, Korea, Taiwan and China fell between 10% and 40% in late 2008 also signaling reduced demand for commodities.
The Institute for International Finance forecasts net private sector capital flows to emerging markets in 2009 will be less than US$165 billion - 36% of the US$466 billion inflow in 2008 and only one fifth the record amount in 2007. The projected decline in capital flows is around 6 % of the combined gross domestic product of the emerging countries. This compares to a decline of approximately 3.5 % of combined GDP in the Asian financial crisis and 1.5% in the Latin American crisis.
Investors in US government bonds have expressed deepening concern about the safety and security of their investments. Yu Yongding, a Chinese economist and former advisor to China’s central bank, warned in 2008 that: "If the US government allows Fannie and Freddie [government sponsored enterprises] to fail and international investors are not compensated adequately, the consequences will be catastrophic. If it’s not the end of the world, it is the end of the current international financial system."
Kwag Dae Hwan, head of global investment, of South Korea’s US$220 billion National Pension Fund noted: "The image of US Treasuries as a safe haven has been tainted by the ongoing financial debacle … A big question mark hangs over whether the US can deal with an unprecedented amount of debt. That is unnerving all the investors, including me."
As the risk of trade and financial protectionism emerges, globalisation of trade and capital flows is reversing - the "flat world" is rapidly going "pear shaped".
Slowing exports, lower growth and loss of jobs are encouraging trade protectionism. Several countries have implemented trade barriers (import tariffs and export subsidies). The fiscal packages in many countries are "economic nationalist" encouraging spending on domestically produced goods and supporting national champions and local industries. The US, France, Germany, Spain have announced bailouts for domestic companies. Asian countries are seeking to weaken the currencies to support exports to maintain global competitiveness. The US Treasury Secretary recently accused China of manipulating its currency drawing angry responses from Beijing.
Financial protectionism has also emerged. Governments are supporting domestic banks and increasingly "directing" lending to domestic firms and households. Concerns about immigration are emerging. There have been protests in UK against hiring foreign workers. This has serious implications of countries like Mexico, Eastern Europe, India and the Philippines that depend on worker remittances that are already slowing.
In an essay titled "The Great Slump of 1930," published in December of that year, Keynes observed: "We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand."
Failure to Summit
The current crisis calls into question the ability of government and policy makers to maintain control of the economy – Lenin’s "commanding heights". Governments may not be able to address the deep-rooted problems in the current economic models. Government spending, if it can be financed, may not be able to adequately compensate for the contraction of consumption and lack of investment made worse by over capacity in many industries.
Government spending has little multiplier effect or velocity. The badly damaged financial system means that the circulation of money in the economy is at a standstill. While government spending may provide short-term demand boost and capital injections may partially rehabilitate banks, it is far from clear what will happen when all these measures are reversed.
Governments and central banks have limited available tools. Keynes famously described monetary policy as the equivalent of "pushing on a string". Given that interest rates are now at or approaching zero in many developed countries, there is no string at all. Fiscal policy could be described as "pulling on the same string". The experience of Japan is salutary. Zero interest rates and repeated doses of fiscal medicine have not restored the health of the Japanese economy that remains mired in a form of suspended animation. The rest of world’s current struggle is to avoid turning "Japanese".
In the run-up to the 1929 election, Keynes discovered a seminal political truth about deficit spending. Lloyd George, an economically challenged politician, was delighted when Keynes provided the rationale for spending taxpayers’ money on social programs to bribe voters.
Keynes absorbed this lesson well and maintained a constructive ambiguity throughout his life allowing him to appeal to politicians who favoured government spending and those who favoured middle-class tax cuts. Writing in the Financial Times (5 February 2009) Benn Steil, Director of International Economics at the Council on Foreign Relations, succinctly set out current economic thinking: "when the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes."
Correcting global imbalances provides greater challenges. The world has relied heavily on debt fuelled American consumption to drive global growth. With 5% of the world’s population, the US is 25% of global GDP, 20% of global consumption and 50% of global current account deficit. The US needs to decrease consumption, increase savings, reduce debt, export more and import less. The countries with large savings and trade surpluses need to do exactly the opposite, specifically encourage domestic consumption. Currently both surplus and deficit countries are doing the opposite of what is required.
The challenge is evident in two telling statistics. Consumption is around 40% of the economy in China against over 70% in the US. Average earnings in China are only 10% of that in the US. The size of the adjustment is substantial.
David Rosenberg, an economist from Merrill Lynch, described the process of adjustment: "This is an epic event; we’re talking about the end of a 20-year secular credit expansion that went absolutely parabolic from 2001-2007. Before the US economy can truly begin to expand again, the savings rate must rise to pre-bubble levels of 8%, the US housing stock must fall to below eight-months’ supply, and the household interest coverage ratio must fall from 14% to 10.5%. It’s important to note what sort of surgery that is going to require. We will probably have to eliminate $2 trillion of household debt to get there, this will happen either through debt being written off, as major financial institutions continue to do, or for consumers themselves to shrink their own balance sheets."
Corrective action will only deepen the recession and disrupt global funding flows. Wen Jiabao, the Chinese Prime Minister, recently indicated that China’s "greatest contribution to the world" would be to keep it’s own economy running smoothly. This may signal a shift whereby China uses its savings to invest in the domestic economy rather than to finance US needs.
Redirection of capital held in central banks and sovereign wealth funds to domestic economies affects the global capital flows needed to finance banking system recapitalisation and spending packages in the debtor countries. Maintenance of the cross border capital flows to finance the debtor countries budget and trade deficits slows down growth in emerging countries and also perpetuates the imbalances.
There is now acknowledgement that the economic model itself is the source of the problem. Zhou Xiaochuan, governor of the Chinese central bank, commented: "Over-consumption and a high reliance on credit is the cause of the US financial crisis. As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits." More ominously Chinese President Hu Jintao recently noted: "From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies."
In the GFC, politicians, bureaucrats and central bankers have been exposed to have no more powers than the Wizard of Oz – old desperate men (they are mainly men) behind the curtain running from one lever to another in a desperate attempt to maintain illusions. In the words of the 19th century American humorist Josh Billings: "It is better to know nothing, than to know what ain’t so."
Limits to Growth
The GFC’s seriousness and gravity is unquestioned. Initially, the world viewed the destruction of financial institutions as an entertaining blood sport. There was a sense of schadenfreude as the Masters of the Universe received their comeuppance. The "financial" crisis has now spread to the "real" economy – jobs, consumption, and investment. It is now everybody’s problem.
In the US alone, more than 3.6 million jobs have been lost. In Spain, unemployment has reached the middle teens. Exports and production have fallen in countries as varied as Spain, Japan, South Korea and Taiwan by amounts that beggar belief. An astonishing US$30 trillion of wealth has been obliterated in America alone. Entire countries – Iceland and Ireland – have been savaged.
The GFC coincides with another crisis: the GEC or Global Environmental Crisis. "Toxic debt" and "toxic emissions" increasingly clamor simultaneously for politician’s attention. Irreversible climate change, scarcity of vital resources (food and water) and falling biodiversity are not unconnected with the existing economic system. Economists and politicians implicitly assume that high levels of growth drive increased living standards, rescuing people from poverty and social development. No limit to economic growth is recognised.
At the launch of the "Redefining Prosperity" project, Tony Jackson, Professor of Sustainable Development at the University of Surrey, writing in the New Scientist noted that a UK treasury official accused the authors of wanting to "go back and live in caves". The project sought to raise concerns about environmental and social limits on economic growth. Ironically, the GFC has illustrated the limits and illusions of economic growth starkly.
A lower growth future has political and social implications. For example, China and India are deeply concerned about failing to provide jobs for the millions coming into the workforce each year. One in fifteen migrant workers in China are expected to be out-of-work in 2009. Chinese security leaders have warned about rising social unrest.
Demagogic debates about the ideological differences between neo-liberalism, compassionate capitalism and social democracy are unhelpful. In truth, all competing economic philosophies are underpinned by the same reliance on growth and built to fail economic models. The world needs to adjust to a new economic order and a world of reduced expectations. In the short run, the primary focus surely should be to dealing pragmatically with the GFC and its potentially devastating human and social costs. There will be time enough for recriminations and blame.
At the fall of the Berlin Wall, when asked - "who won", political scientists cited the triumph of capitalism over socialism. The economist’s response was simply: "Chicago". The reference is to the Chicago Graduate School of Business and its unshakable belief in free markets exemplified in the title of Milton Friedman’s most accessible work – Free To Choose (1990).
The GFC marks the end of unquestioned advocacy of free markets. Wang Qishan, Vice Premier of China, tartly observed: "The teachers now have some problems".
There is no time for "triumphalism" or "mission accomplished" speeches. The GFC brings into question much of established orthodoxy of economic models and approaches. It calls into question social and political models based on high levels of economic growth and financial rather than real economy driven growth. It also questions the ability of mandarins to control the economic engines.
Recently in Canary Wharf, the financial district in London’s docklands, I noticed a small street stand erected by the English Teachers Union to recruit teachers. The two affable recruiters explained that they had heard that there was "a bit of financial crisis". Well-educated and highly motivated bankers who were losing their jobs by the thousands might like to consider a new career teaching.
I questioned the adjustment in salaries – a reduction of 60% to 95% - that the change in careers would necessitate. One recruiter’s response stays with me: "If you haven’t got a job then it’s not relevant is it? It was never real money and it wasn’t going to ever last was it?"
Different strategies exist for dealing with the GFC. Politicians and theoreticians are enjoying their "I told you so" moments. Crisis denial, advocated by Lars Nonbye, general manager of the Nonbye sign-making company in Denmark, places a ban on any talk about the crisis from work premises. The most productive strategy may be to use the GFC to redirect talent and resources into the real economy and adjust living standards and expectations of economic growth.
As Keynes wrote in 1933: "We have reached a critical point. We can ... see clearly the gulf to which our present path is leading….[If governments did not take action] we must expect the progressive breakdown of the existing structure of contract and instruments of indebtedness, accompanied by the utter discredit of orthodox leadership in finance and government, with what ultimate outcome we cannot predict."
Enjoy the rally while it lasts - but expect to take a sucker punch
Our delicious spring rally is nearing the limits. The 40% rise on global bourses since March assumes that central banks have conjured away the debt overhang by slashing rates to zero and printing money. Nothing of the sort has occurred. Two thirds of the world economy will be in deflation by July.
Bear market rallies can be explosive. Japan had four violent spikes during its Lost Decade (33%, 55%, 44%, and 79%). Wall Street had seven during the Great Depression, lasting 40 days on average. The spring of 1931 was a corker. James Montier at Société Générale said that even hard-bitten bears are starting to throw in the towel, suspecting that we really are on the cusp of new boom. That is a tell-tale sign. "Prolonged suckers' rallies tend to be especially vicious as they force everyone back into the market before cruelly dashing them on the rocks of despair yet again," he said. Genuine bottoms tend to be "quiet affairs", carved slowly in a fog of investor gloom.
Another sign of fakery – apart from the implausible 'V' shape – is the "dash for trash" in this rally. The mostly heavily shorted stocks are up 70%: the least shorted are up 21%. Stocks with bad fundamentals in SocGen's model (Anheuser-Busch, Cairn Energy, Ericsson) are up 60%: the best are up 30%. Teun Draaisma, Morgan Stanley's stock guru, expects another shake-out. "We think the bear market rally will end sooner rather than later. None of our signposts of the next bull market has flashed green yet. We're not convinced the banking system has been fully fixed," he said Mr Draaisma said US housing busts typically last nearly about 42 months. We are just 26 months into this one. The overhang of unsold properties on the US market is still near a record 11 months. He expects the new bull market to kick off later this year – perhaps in October – anticipating real recovery in 2010.
Keep an eye on the upward creep in yields on the 10-year US Treasury, the benchmark price of world credit. This alone threatens to short-circuit the rally. The yield reached 3.3% last week, up over 1% since January and above the level in March when the US Federal Reserve first launched its buying blitz to pull rates down. Bond vigilantes are taunting the Bank of England in much the same way, driving the 10-year gilt yield to 3.73%. The happy view is that this tightening of the bond markets is proof of recovery fever, but there is a dark side. Governments need to raise $6 trillion (£4 trillion) this year to fund bail-outs and deficits, led by this abject isle with needs of 13.8% of GDP (EU figures). China fired a warning shot last week, saying the West risks setting off "inflation for the whole world" by printing money. It hinted at a bond crisis.
Yes, the glass is half full. China's PMI optimism gauge has jumped back above the recession line. The global PMI has been rising for seven months. But this usually happens after a crash as companies rebuild battered inventories for a quarter or two. Note that container volumes in Shanghai fell 17% in January, 22% in February, and 9% in March. Rail freight volumes in the US were down 32% in April on a year earlier. The Economic Cycle Research Institute (ECRI) says the US recession will be over by summer, insisting that its leading indicators have never been wrong – except once, in the Great Depression. Quite.
SocGen's other bear, Albert Edwards, says the new element in this slump is that GDP is contracting in "nominal" terms, not just real terms. Money incomes are flat. It is a crucial difference. "This is like drinking hemlock. The US is gradually slipping further towards outright deflation, just as Japan did," he said. As companies retrench en masse they risk tipping the whole economy into Irving Fisher's "debt deflation trap". If we are spared – still a big if – we can thank a handful of central bank governors and policy-makers who tore up the rule book, defied tabloid opinion, and took revolutionary action in the nick of time.
We owe much to the Fed's Ben Bernanke (leaving aside past sins as Greenspan's cheerleader), to Britain's Mervyn King, and the Canadian, Japanese and Swiss governors. Hats off, too, to the Greek speakers at the European Central Bank who have just carried out a monetary putsch, outflanking German tank-traps on the Rhine. The hero is Athanasios Orphanides, the Cypriot governor who drafted the Fed's anti-deflation strategy during his 17-year stint in Washington. The ECB's belated embrace of QE is a watershed moment, even if only a token purchase of €60bn of covered bonds. What poisoned the early 1930s was beggar-thy-neighbour monetary policies. Any country that tried to reflate alone was punished by currency flight (gold loss), yet the mediocrities in charge lacked the imagination to reflate together.
We can now test the Friedman-Bernanke hypothesis that the Fed could have halted the Depression by letting rip with bond purchases. Japan was not a proper test. It eked out a recovery of sorts earlier this decade by embracing QE, but only in the context of a global boom and a yen crash. There is at least one more boil to lance before we put this debt debacle behind us. The IMF says eurozone banks have so far written down a fifth of likely losses ($750bn) compared to half for US banks. They must raise $375bn in fresh capital. Good luck. Germany's BaFin regulator goes further, warning of $1.1 trillion of toxic assets on German bank books. Landesbanken are a calamity. If the IMF and BaFin are right, Europe has not yet had its crisis. When it does, we will see a second stress pulse through Eastern Europe and Club Med. The echoes of 1931 are ominous. That year began with green shoots, until Austria's Credit-Anstalt buckled in the summer and took Central Europe with it. Continentals who still thought it was an American crisis learned otherwise. Plus ça change.
So, You Think This Is Another Great Bull Market...
Jubliation has replaced fear, and the consensus is now that the second-worst bear market in US history ended on March 9th and it's all champagne and roses from here. Let's hope. In the meantime, let's review what happened after the two other biggest bear market bottoms of the past century, 1932 and 1974 (see Prof Shiller's chart). In both cases, as now, the market had a sharp rally off the lows.
In real terms (after adjusting for inflation), the 1932 market almost doubled in a year. The 1974 market, meanwhile, jumped about 35% over two years. But it's what happened after that that matters now.
After doubling off the low, the 1930s bear market pushed another 50% higher over the next three years to 1937 (not bad!). But it then got cut in half again, and it remained below the 1937 peak for 15 years. In 1949, 17 years after the 1932 bear-market low, when the next secular bull market finally began again, the market was 50% below the 1937 rebound peak and about 70% below the 1929 bull-market peak.
In 1974, the market rebounded 35% in a couple of years. In 1982, however, eight years later, when the actual bull market began, it was back below the 1974 low. The 1973 peak, of course, was lower than the 1966 high, so the bear market that ended in 1982 was actually 16 years long.
That's why they call them "secular" bear markets.
So even if March 9th was the bottom of a Great Bear Market that took stocks down 60%+ in 9 years from the 2000 peak (in real terms), let us not celebrate too much about what is likely coming next. As Jeremy Grantham has said, the great bear markets don't hurry, and this one probably has a long way to run.
Here's Merrill strategist David Rosenberg on this topic. Rosenberg, by the way, thinks the bear-market rally has now run its course and we're going to quickly retest the March lows:
At this time, we believe it is necessary to provide clients with some historical perspective from the last colossal credit collapse in the 1930s, understanding that there were similarities as well as differences. It was extremely difficult for equity investors to make money in the decade following the June 1932 bottom. After the three-month rally (+75%) off the bottom in 1932, equity markets were extremely volatile and largely sideways for the next nine years. Keep in mind that the jury is still out as to whether the March 2009 lows were in fact the bottom, as was the case in 1932.
If March 9 was the low, what does it mean for the outlook?
It doesn’t say much, actually. The same goes for corporate spreads. The S&P 500 bottomed in mid-1932 and soared nearly 75% in the next three months. Anyone who bought at that point and hung on to their position saw no capital appreciation for nine years. Baa spreads also hit their widest levels at 724 basis points in mid-1932, a year later they were down to 380 basis points. While the initial the surge in the stock market and the tightening in corporate spreads from stratospheric levels presaged the bottom in GDP in the third quarter of 1932, the reality is that the Great Depression did not end until 1941 (and the next secular bull market did not commence until 1954). The prior peak in GDP was not reattained until the end of the 1930s, fully seven years after the introduction of the New Deal stimulus. By then the unemployment rate was still at 15%, consumer prices were deflating at a 2% annual rate and government bond yields were on their way to sub-2% levels.
Our preference is to stick with fixed-income securities
Be careful about jumping into the stock market with both feet after this monumental rally. Consider whether or not it would be more appropriate to take advantage of the run-up to reduce equity exposure. Our preference is to stick with fixed-income securities, which we believe will work much better from a total return standpoint, as they did for years after the economy hit bottom back in the early 1930s. When we are finally coming out of this epic credit collapse and asset deflation, we should expect that the trauma exerted on household balance sheets will have triggered a long wave of attitudinal shifts toward consumer discretionary spending, homeownership and credit. The markets have a long way to go in terms of discounting that prospect.
The Risks of Denying Reality
In "What If It Doesn't Work?" I highlighted a blog post by Information Arbitrage, "What Keeps Me Awake At Night: Economy Edition," that explored the issue of what could happen if the economy has not, in fact, turned the corner the government and others are saying it has.
In "Why the Government's Attempt to Instill False Confidence Will Backfire," George Washington's Blog further elaborates on the risks of denying reality and failing to apply the only real cure for what ails us.The government is doing its best to try to "restore confidence" in the economy. Indeed, Obama's top economics advisors believe they can fool people into believing that everything is fine, and then the economy will recover.As (further) evidence of the fact that the so-called "green shoots" of recovery appear to be more a case of wishful thinking and misguided policymaking than an assessment of what is really going on, I thought it was worth highlighting a recent Newsweek "Web Exclusive" by Kevin Kelly, CEO of Emerald Packaging, entitled "Recovery? What Recovery?":
And for that reason, defenders of the status quo think that it is important for everyone to keep quiet about how severe the crisis really is.
Are they right?
As economist Irving Fisher pointed out (as recounted by economist Steve Keen):
Hobbled by this naive belief in equilibrium, the economics profession was as unprepared for today’s crisis as it had been for the Great Depression. Now that the crisis is well and truly with us, all conventional “neoclassical” economists can offer is the hope that the crisis can be overcome by a good, strong dose of confidence.
From [Irving] Fisher’s point of view, such a belief is futile. In an economy with an excessive level of debt and low inflation, he argued that confidence was irrelevant–and in fact dangerously misleading, as he knew from painful personal experience.
In short, happy talk and fake confidence-building exercises don't work.Indeed, trying to instill false confidence will actually backfire on Geithner, Summers and the boys and make the crisis worse.Why?Because psychologists say that - until government and business leaders prove they can behave responsibly, and until the perpetrators of financial fraud are held accountable - real trust will not be restored and the economy will not recover.Trying to put a happy face on a grim situation, continuing to do things which are transparent attempts to instill false confidence, and leaving in power the people who caused the crisis reinforces the market's convictions that (1) government and business leaders are behaving irresponsibly instead of addressing the fundamental problems and (2) there is no accountability.So people's trust declines still further, thus substantially delaying any chance of a sustainable economic recovery. In other words, by trying too hard to instill confidence, the powers-that-be actually undermine it and exacerbate the financial crisis.Keeping quiet about how bad things are won't help. As the leading independent economists and financial experts all agree, the three things that will help are:
- Honestly addressing the causes of the crisis;
- Honestly addressing the necessary - if bitter - medicine needed to get out of the crisis; and
- Holding responsible those who caused the crisis.
Don't tell me that the economy is getting better, or has even hit rock bottom. My faith in an imminent recovery deserted me on May 5, when one of our customers, Salyer American Foods, based in Monterey, Calif., suddenly fell into receivership. There had been little to no indication that the company was so close to financial ruin. As it turns out, the company's lenders say Salyer owes them over $34 million, a debt equal to almost half its sales. A company attorney told local media that tight credit markets and the economic recession had pushed Salyer over the edge. If the receiver doesn't find some way to revive the company's fortunes, our bag manufacturing company stands to lose nearly $1.5 million in revenue, about 2 percent of our $60 million in sales.
On the same day my customer fell into receivership, Fed chairman Ben Bernanke told a congressional committee that he believed the economy was in the process of bottoming out and "would turn up later this year." He's not alone in his optimism. Over the past two weeks or so, it has become a cottage industry among economists and the media to spot the first "green shoots" of a recovery. Certainly shoots there may be. The stock market has rebounded smartly over the past two months, as has consumer confidence. Pending home sales have ticked up, while unemployment claims are easing. And many economists insist a manufacturing revival is in the wings because inventories have fallen so low that restocking must begin soon.
But I haven't found many small-business owners ready to jump on the recovery bandwagon, and for good reason. We're still experiencing the "bottoming out" phase and worry that another bottom remains below this one. Call us pessimists, but we're not sure the green shoots aren't just weeds.
Who can blame us? Take the experience of a friend of mine, who runs a $6 million company that provides promotional material to businesses. His sales are down 20 percent compared with last year. Over dinner last week, he said he certainly wasn't shedding customers at the same pace he had been in the fall, but customers were still defecting. "I can't see any reason why they'd come back soon," he said. So he's getting ready for a second round of layoffs and plans to end spending on marketing until things look more promising.
He's not alone among my friends and colleagues in his sense that bad times may be here to stay. One friend just decided to abandon her two-year-old Web-based gift boutique thanks to declining sales. She has another friend whose promising e-business startup had its venture funding yanked when it failed to meet sales goals. "Two years ago they'd have been given time to work things out," she says. Instead they recently closed. Another friend of mine works for a commercial real-estate company that's instituting 10 percent wage cuts beginning in mid-May. "It's better than people losing their jobs," he said to me, "but I don't expect to be getting the money back any time soon." Given the growing worries about commercial real estate, he's probably right.
Even some companies that are supposed to be recession-resistant remain worried. I know the general manager of a small candy company, who says his sales haven't stopped sliding despite the belief that people supposedly eat more comfort food during bad economic times. He has cut back a shift and won't be rehiring soon. Representatives for a small local bank have told me that they haven't seen an uptick in business lending, and that they don't have businesses looking for money other than those they wouldn't lend to in the first place. And a long-time machine supplier of mine has had a completed bag-making machine on its floor since late 2008, when the customer decided not to go through with the purchase. Despite a steep discount, the company can't find a buyer.
Based on my company's experience, I don't necessarily see a positive side to low inventories. Over the past several months, we've seen lead times on orders fall at least 30 percent. Where our customers used to give us three to four weeks to fill an order, now they give us as little as two. Shorter lead times have followed the trend toward smaller orders. Where companies would once order 3 million bags and hold them on their floors for several weeks, now they're asking for only 1.5 million and reordering at the last possible moment. In most cases, it's not that their sales are falling, just that they're slashing order sizes and reducing lead times in order to avoid tying up capital in inventory. Since they're entering smaller orders more often, we're less likely to hold inventory as well. In my corner of the manufacturing sector, the revival that economists have been pointing to seems a long way off.
Now, I know businesspeople can be notoriously wrongheaded when it comes to spotting trends. Aren't the Big Three automakers at least partly responsible for their own demise because of their failure to anticipate the need for more fuel-efficient cars? I know I've almost blown the opportunity to capitalize on growth in the past by being too conservative about buying new equipment. In fact, I've angered customers by stretching out lead times rather than investing, because I've been worried that the sales growth isn't sustainable. Talk about a self-fulfilling prophecy. Even right now, when I can see that a judicious equipment purchase could propel our company forward, I worry about taking on more debt and hold back, even with one supplier offering terms that would give us a machine for a year without any payments.
Then I have a day like May 5. I read the Fed chairman's testimony and feel a bit upbeat, only to get surprised by the collapse of Salyer. Certainly, as my brother points out, it is unlikely we'll lose the entire sales volume even if our troubled customer disappears, because other customers will step in to fill the gap, and they'll buy product from us too. But is it insane to hold off on optimism when you're not sure whether another customer could bite the dust? Perhaps waiting to make any big investments makes sense until we're completely sure recovery is on its way. Of course, if I wait, and lots of other businesspeople like me wait, what will become of those green shoots that may be dotting the landscape?
Are Taxpayers Bailing Out Troubled Banks Twice?
The federal government is taking up the fight against credit card companies accused of taking advantage of consumers. In taking aim at what he called "abuse that goes unpunished," President Obama has asked Congress to send him a bill by Memorial Day that prevents credit card companies from suddenly raising rates on everyday customers. "Americans know they have a responsibility to live within their means and pay what they owe," Obama said. "But they also have a right to not get ripped off by sudden rate hikes, unfair penalties and hidden fees." Congress is moving swiftly to comply with the president's request.
A credit card holder's Bill of Rights has already passed the House. The bill would prohibit retroactive rate increases, prevent companies from issuing cards to anyone under 18 and eliminate what's called "double-cycle billing." Double-cycle billing is a little known calculation used by many companies. The company looks at your current monthly balance, as well as your previous months' spending, and averages them both, charging you a higher interest rate. Although the practice is considered deceptive, credit card holders often consent to it when they sign a contract. "Most of these credit card companies have a little clause left somewhere in the back on page 28 in language that says, 'we can charge you any amount we want, at any time we want, for no reason at all,'" said Elizabeth Warren, a law professor at Harvard.
Warren chairs the Congressional Oversight Panel, an independent agency that tracks the hundreds of billions in taxpayer dollars already being used to help the banks survive. On the heels of this week's stress tests, which showed 10 of the nation's 19 largest banks will need a further injection of cash to survive, she said it's no secret where the banks will get the money. "We've seen a sharp rise in interest rates in the last few months on good customers who are paying. It's coming from banks taking taxpayer dollars." Warren said. In essence, that means the banks will raise rates on taxpayers who helped them out in the first place.
One of those taxpayers, Mindy Busch, graduated from college today. She and her husband, Michael, are now expecting a baby. What they were not expecting were the rate hikes on the credit cards they pay faithfully. Bank of America raised their interest rate from 20 percent to 32 percent. "It's just not fair," Busch said. "We pay every month, and this is a bank that is benefitting already from our taxpayer dollars." Bank of America told ABC News they could not comment on an individual's account. As far as rates go, the bank said, "Any hikes reflect the current economic conditions. Our costs of providing credit have significantly increased."
Shift to Saving May Be Downturn’s Lasting Impact
The economic downturn is forcing a return to a culture of thrift that many economists say could last well beyond the inevitable recovery. This is not because Americans have suddenly become more financially virtuous or have learned the error of their free-spending ways. Instead, these experts say, Americans may have no choice but to continue pinching pennies. This shift back to thrift may seem to be a healthy change for a consumer class known for spending more than it earns, but there is a downside: American businesses have become so dependent on consumer spending that any pullback sends ripples through the economy.
Fearful of job losses and anxious over housing and stock declines, Americans are squirreling away more of their paychecks than they were before the recession. In the last year, the savings rate — the percentage of after-tax income that people do not spend — has risen to above 4 percent, from virtually zero. This happens in nearly every recession, and the effect is usually fleeting. Once the economy recovers, Americans revert to more spending and less saving. Over the last 30 years, the savings rate has fluctuated from over 14 percent in the 1970s to negative 2.7 percent in 2005, meaning Americans were spending more than they made.
This time is expected to be different, because the forces that enabled and even egged on consumers to save less and spend more — easy credit and skyrocketing asset values — could be permanently altered by the financial crisis that spun the economy into recession. “I expect that the savings rate will end up at the end of this recession higher than it was going into it,” said Jonathan A. Parker, a finance professor at the Kellogg School of Management at Northwestern University. “It’s hard to see how it wouldn’t.” Sustained increases in household saving would cause a difficult period of restructuring for the American economy, which has become increasingly driven by consumer spending. Such spending makes up about 70 percent of the nation’s gross domestic product.
Add the decline in consumer spending to the planned expiration of government stimulus spending, and a painful readjustment in demand for goods and services could occur, economists say. The effect would be felt here and abroad, as many developing economies also depend on America’s big-spending ways. “If Americans cut back, as they almost have to do, what will replace that source of demand?” asked William G. Gale, director of the economic studies program at the Brookings Institution, a liberal-centrist policy research group. “The easy answer is the Chinese consumer,” he said, but unlike their more prodigal American counterparts, the Chinese save about a quarter of what they earn. “We may cut back faster than they expand into that space, so there might be a lull.”
Why might the higher savings rate outlast the recession? Social critics like David Blankenhorn, president of the Institute for American Values, hope that introspection about America’s “culture of consumption” will awaken Americans to the virtues of thrift, just as the Great Depression reset American financial values for a generation. But many economists believe consumers will change their habits for more pragmatic reasons.
Consumers have lost a huge chunk of their net worth, in the housing bust and the stock market, and to resuscitate their retirement accounts or children’s college funds they will have to channel more of their paychecks toward saving — unless those asset markets soar again. Forms of easy credit that were once prevalent, like mortgages with no down payments, also may not return, either because the government regulates them out of existence or because banks dare not venture back into such risky lending. That means if Americans want to buy a house, they will have to save more and borrow less.
Whether for reasons moral or otherwise, consumers are already thinking a bit differently about their long-term budgets. A recent Pew Research Center survey found that many more Americans had begun regarding products like microwave ovens as luxuries rather than necessities. Such attitudes suggest that retailers will have to change their marketing strategies, said J. Walker Smith, executive vice chairman of the Futures Company, a marketing and research consultancy. “People are realizing they can’t accumulate everything they want anymore, and they’ll have to prioritize more,” he said. “That may be hard for a lot of brands — figuring out not only how to get considered by consumers, but put at the top of their list.”
Consumers planning big purchases are also anticipating that their borrowing options will remain limited. Last year, Aryn Kennedy and her husband, Brian Ewing, who live in Los Angeles, spent “every dollar” they earned on debt repayment and living expenses. When local housing prices began to fall, Mr. Ewing toyed with the idea of a low-down-payment mortgage. “By the time we really started looking at buying, I knew from reading blogs that most loans like that were not really available anymore, since lenders didn’t want to take risks,” said Ms. Kennedy, who said she was suspicious of such offers anyhow.
Since then, through “windfalls” like a salary increase for Mr. Ewing, and by cutting expenses for clothing, entertainment and other items, Ms. Kennedy says the couple has begun saving about 25 percent of their take-home pay in anticipation of making a traditional down payment of 20 percent on a house. Even after they buy, Ms. Kennedy said, the couple plans to keep saving 25 percent of their pay. A recent Gallup poll found that most Americans who have recently increased their savings believe their budget adjustments represent a “new, normal pattern for years ahead.” Despite the immediate jolt to the economy, more personal saving would be a positive step in the long run, analysts say. More saving leads to more investment, which promotes economic growth, which leads to better living standards.
At the family level, social critics, economists and even many consumers seem to agree that a forced financial conservatism may be for the better. Kenny Tran of Santa Ana, Calif., for example, said he had been nervous about saving enough to buy his first house — he and his fiancé have been setting aside about $800 a month for the last year and a half — but he has no regrets about not buying a home when credit was looser and saving was less of a priority. “A couple years ago it would have been easier for us to get a loan,” despite the fact that the couple’s combined income was lower, Mr. Tran said. “But if we would have gotten a loan, and a house, a couple years ago, we’d probably have ended up in foreclosure now.”
The Credit Card Squeeze
At a time when everyone is talking about troubled banks, Congress can provide relief to millions of their increasingly alarmed customers. Many credit card holders are complaining about unexpected increases in fees or interest rates that double or triple for no reason. The Center for Responsible Lending estimates that at least 10 million cardholders have seen their interest rates skyrocket in the last six months through no fault of their own. The center has also found that instead of changing their behavior in anticipation of tough new Federal Reserve rules that will take effect in July of next year, most big banks continue to engage in practices that provoked the public outcry and the Fed’s response in the first place.
Five of eight top credit card issuers in the country have added new fees on transactions like cash advances or for monthly maintenance. One major card company began charging a late fee of 3 percent on unpaid balances, which means that on a $5,000 balance, the cost of being just a day or so late jumped from $39 to $150. Fortunately, however, Congress is moving to turn much of the Fed’s reform package into law. The House has already passed its version by a wide margin, giving Carolyn Maloney, a New York Democrat, the support she has been seeking for years for the Credit Cardholders’ Bill of Rights. Christopher Dodd, a Democrat now facing a tough re-election fight in Connecticut, is trying to steer a somewhat tougher version of Ms. Maloney’s bill through the Senate.
Both bills require adequate advance notice of rate increases or changes in terms. Both make it far harder for students to get credit cards and for banks to increase rates on existing balances. Both end the practice of charging interest on balances already paid. The House bill would give banks a year to deal with these new rules; the Senate would give them nine months. That is already too long for many customers. Fed Chairman Ben Bernanke argues that banks need the extra year to adjust. Senator Charles Schumer, a Democrat from New York, says the Fed’s leisurely timetable is “unconscionable.” He should make this same point with his Senate colleagues in order to make the new law go into effect much sooner. From the looks of it, the banks are ratcheting up fees and interest before the Fed’s rules kick in and it is too late. This makes an earlier deadline imperative.
The Stress Tests: Designed to Help Banks Raise Capital
Most critics of the Stress Test have missed the point of the tests and underestimate the Obama Administration’s cleverness in helping banks raise capital. The Stress Tests weren’t about regulatory supervision and certainly weren’t an excuse for the Obama Administration to nationalize the banks. The tests were designed to provide standardized benchmarks, assumptions and projections for private investors to evaluate banks and decide whether or not to participate in recapitalization transactions. Obama’s ploy to help investors help themselves invest in banks seems to be working. Since the Stress Test results were announced the unthinkable has happened. Two banks, Morgan Stanley and Wells Fargo, executed public offerings of stock that went well. And, the bank everyone loves to hate, Bank of America, was up more than 60% for the week making it possible for them to sell common equity to private shareholders.
For each bank that was “stressed,” investors have been provided a government sanctioned set of financial forecasts to debate, criticize and analyze. Without government prodding and help this information never would have made it into investor hands because of legal risks and securities law restrictions. And, even if the information was provided, banks lacked credibility so that investors wouldn’t have believed the results. The Stress Tests provide a government sanctioned and verified safe harbor for bank managers to give shareholders “what if” scenarios without being ridiculed or sued. Even better, the Stress Test results are quickly turning into the centerpieces of bank equity offerings which are necessary to recapitalize the industry.
A big problem that the Obama Administration had to deal with when they took office was a failure of investor confidence in banks, management teams and financial statements. After having been “WAMU’ed” to the tune of hundreds of billions of dollars, bank investors were understandably reluctant to put new capital to work in the banking system. In January, investors were convinced that buying bank stocks was the investment opportunity of a lifetime; that is the opportunity to lose a lifetime’s worth of savings in the blink of an eye. Back in January any bank executive that stood up and made a prediction that his bank was solvent was publicly ridiculed. If the public could have tarred and feathered bank CEOs, we would witnessed a bunch of middle aged guys looking like big fat chickens as they ran around in circles squawking about their lousy jobs and low pay.
When it took office, the Obama Administration quickly realized that if they couldn’t figure out a way to get private investors to recapitalize banks the nation faced the real prospect that most of industry would be nationalized. No business can survive the capital drought that the banks were experiencing. Obama’s economic advisors understood that they needed to immediately change the rules of the game. “Self regulation” and non-enforcement had created a mixture of mistrust and failure that had to go.
Bank management teams were rapidly running out of options. In January investors didn’t trust bank managers to tell the truth about easy stuff like the current condition of their institutions or about current period earnings. And, if investors didn’t trust managers to tell the truth about facts that could be quickly verified, they certainly weren’t going to listen to management’s opinions about tough things like future performance of their institutions based upon esoteric and complicated economic and financial assumptions. Managers knew that it they tried to offer multiple sets of projections with sensitivity analysis for different economic assumptions they would have been immediately mocked in the media and sued by shareholders.
I remember when I was a young professional, working first as a lawyer and then later as an investment banker, the equivalent of stress tests were a pretty important issue in bank recapitalizations. I started my career in the 1980s during what seemed to be a decade of one bank and thrift crisis after another. And, most of my clients were trying to recapitalize to cover for mortgage related losses. Investors were always asking me what the regulators were saying about how much capital my clients really needed and how they were calculating the deficiency. My professional responsibilities prevented me from answering the question but I still believe that many deals happened because behind closed doors management told leading institutional investors what the government thought was needed to fix their institution.
The Stress Test results are the Obama Administration’s answer to the disclosure problem that I faced 25 years ago. But now how much capital the government thinks is needed and how the deficiency was calculated is an open topic for discussion. By providing transparency into what the government is thinking Obama is restoring faith in the system. While almost no one agrees with the assumptions used in the Stress Tests (everyone has their own opinion and is convinced that their assumptions are the only correct ones), there is enough information out in public for every investor to rerun the calculations and come to his/her own conclusions.
Even better, Obama has manipulated the media into becoming his unpaid shill to promote the Stress Test results. Using marketing techniques that rival the best propaganda campaign of any government regime (current or past and good or evil), the Obama Administration orchestrated political theatre that transformed a boring and esoteric banking topic into front page news. TV and radio talk show hosts that last month couldn’t balance their checkbooks became overnight bank experts and started debating Stress Tests with the same conviction and knowledge that they regularly debate politics, abortion, torture and sports.
A few nights ago I knew that the Obama propaganda engine had really succeeded when an airport limousine driver recognized me as a guy who is on TV a lot and asked me which banks I thought were going to pass and which banks I thought were going to flunk the Stress Tests. But, before I could answer he told me which banks he thought were “keepers” and which stocks he was shorting. By the time I got dropped off at my hotel I not only knew what he thought but also knew which stocks most of his relatives were buying.
Obama has made it safe for investors to buy bank stocks and participate in the recapitalization of the banking industry. Bank executives have a way to explain their business plans and the risks in their institutions without being belittled. And, investment bankers are practically giddy about their new government sanctioned tool to help them sell bank stocks. Of course, the investment bankers are also grateful for the fees that will be generated from raising billions of new equity for the industry. Pundits that underestimate the Obama Administration do so at their own peril. Unlike TALF which hasn’t worked, execution of the Stress Tests was brilliant, intuitive and creative. But, then again, not everything that the Obama Administration tries is going to work. The Stress Tests are a big win for the new administration and the nation.
Has Geithner's Bank Confidence Game Worked?
From his earliest days as Treasury Secretary, Tim Geithner's biggest challenge has been restoring confidence in America's fragile banks without taking the politically costly step of asking Congress for more money. To judge by the results of the government-run stress tests released Thursday afternoon, Geithner has somehow pulled it off - at least for now. Not that three months of supervisory scrutiny of the country's top 19 banks hasn't produced some grim news. If the economy dropped to Depression-era levels of unemployment and credit shrinkage, according to the Treasury and the Federal Reserve, those firms could lose nearly $600 billion by the end of 2010, on top of the $350 billion they've already lost since mid-2007. Bank of America needs nearly $33.9 billion in new capital, Wells Fargo needs $13.7 billion and Citigroup needs $5.5 billion. Altogether, 10 of the top 19 need $74.6 billion in additional capital.
But in a remarkable bit of salesmanship, Geithner has managed to package those findings as positive. Most of the banks can meet or beat the newly imposed government capital requirements on their own, either by selling off parts of their business, converting loans into stock or participating in the fledgling government-led effort to get toxic assets off their balance sheets. And those that are short on cash won't need more in total than the $110 billion to $135 billion the Treasury still has from the original $700 billion in TARP funds that Congress gave the Bush Administration for bank rescues last fall. "There is a reassurance in clarity," Geithner said at a briefing on Thursday.
Those revelations were greeted on Capitol Hill with stunned silence by Republicans and barely suppressed joy by Democrats. "I believe that many of [the banks] will be able to meet their capital needs, without further government capital," Federal Reserve Chairman Ben Bernanke told the Joint Economic Committee on Wednesday. Further, he said, Administration officials "don't think there's a near-term need" for more money from Congress. "That would be terrific!" chirped the committee's Democratic chair, Carolyn Maloney, of New York.
The news, leaking out over the course of several days, likewise lifted the markets, sending bank stocks up dramatically for the week by close of business Thursday. And for all the grim numbers, the banks themselves were touting the results, too. "The regulators demonstrated that the industry is strong now and, should conditions worsen, will only need minimal capital to remain strong," says Scott Talbott, a top lobbyist for the banks. So three months after he rolled out his bank-rescue plan to disastrous reviews, Geithner, with help from Ben Bernanke and others, has bolstered the confidence of the banks, Congress, the stock market and much of the country. In an economy that runs on credit, that's half the battle.
But it's not all of it. Facts are important too, and some think Geithner and the government are fudging them. Nouriel Roubini, the hard-headed pessimist who foresaw the financial crisis, wrote Tuesday in the Wall Street Journal that the overall positive message of the stress tests "would be good news if it were credible," but it's not. He points to the recent IMF report that estimated $2.7 trillion in U.S. loan and security losses, and his own estimate of $3.6 trillion for the same potential losses. "The financial system is currently near insolvency," he concluded. Bernanke disputes the numbers, saying banks have "taken significant write-downs, they have reserves and there are substantial earning capacities." But Roubini is not alone in questioning whether the government used appropriately pessimistic assumptions in conducting the stress tests, especially as the financial sector faces a potential flood of commercial real estate losses that could mirror the residential market's recent woes.
Still, even if the numbers are based more on positive thinking than cold hard facts, it's tough not to be impressed by what Geithner and company have accomplished. In addition to the boost in public confidence, they've apparently figured out how to get the banks to support Geithner's other iffy program, the one designed to rid banks of toxic assets. Until now, banks have resisted selling the highly securitized, largely illiquid toxic assets, arguing they're worth more than the current fire-sale prices being offered on the open market. But taking them off the banks' books is key to restarting lending, and the stress tests' mandate to boost capital may be enough to get the process started.
The Treasury has given the troubled banks until June 8 to decide how to raise that capital, and until November to do so. Just by chance, early June is right around the time the Treasury expects big-time fund managers to have come up with the $500 million they need to leverage government subsidies to purchase the toxic assets on the cheap. All of which goes to show that whatever his faults, Tim Geithner knows how to game America's confidence in the banking system. But does that mean the stress tests themselves are one big confidence game? Perhaps. The playwright David Mamet said such scams get their name not from the confidence the victim places in the con man, but the trust the con man pretends to place in the victim to elicit trust in return. By that standard, Geithner may be the most effective con man around, for better and for worse.
Snipping Credit Lines for Small Businesses
For small business owners, a line of credit can be a lifesaver, giving them a buffer against cash-flow problems and enabling them to handle regular expenses such as payroll. But beginning in March, according to documents obtained by BusinessWeek, JPMorgan Chase suspended credit lines for a large number of business owners. According to someone familiar with the matter, the move affected thousands of businesses. They had been clients of Washington Mutual before Chase bought the ailing bank in September 2008. The documents show that Chase tasked a special group inside the bank with responding to inquiries from borrowers.
The bank can expect plenty of those, at least partly because in many cases the businesses whose lines were cut had not missed loan payments. Instead, their credit score or their financials had deteriorated, and credit-line agreements typically give banks the right to change the terms of the line if there is a change in the borrower's financial situation. In this case, the changes in the terms are dramatic. If business owners can't convince Chase of their creditworthiness, they have three options: 1) pay off the balance in full; 2) agree to a conversion of the line of credit into a term loan; or 3) go into default.
Business owners who accept the conversion to a term loan will likely see dramatically higher monthly payments. A business owner may be able to keep a line of credit open with interest-only payments, but term loans typically have to be paid off -- interest and principal -- within three to five years. Plus, they may carry higher interest rates. Thomas Kelly, a spokesman for Chase, says the bank continually reviews the lines of credit in its portfolio. "We contact customers if we determine there has been an adverse change in their financial condition or credit history. We may eliminate the unused portion of their credit line and set up a standard repayment plan."
Kelly says the bank encourages customers to contact Chase if they want the decision reevaluated or if they want to provide information such as their federal tax return. And he says the bank has assigned staff to work with customers who want such decisions reexamined. Donald Raftery, managing director at Greenwich Associates, a Stamford (Conn.)-based financial-services consulting firm, says the banks, overwhelmed with problem loans, are "trying to take a very active approach on a broad segment of companies. There's no individual type of approach. [Small companies] feel like they're being treated like a number."
Mark Fitchett, the owner of $300,000 music school operator L&M Music in Long Beach, Calif., would certainly agree. He had been a Washington Mutual customer before the bank was acquired by Chase. He had four overdraft lines of credit of $10,000 each, one for each of his schools and one for the parent company, and has been drawing on them at the beginning of each month to help pay the music instructors that contract with his company. In late April, Fitchett was checking his account online and noticed that two of the lines were not showing up. That day a letter arrived saying that, due to an adverse change in his "financial condition and/or credit history," Chase was blocking him from drawing on those two lines. Fitchett said he called Chase, but still doesn't understand what change prompted the move. He's trying to get the lines reinstated, but he's also shopping around for a new line. "I'm thinking now about how I'm going to cover the first week [of paychecks] next month," Fitchett says.
The phenomenon may extend well beyond Chase and its borrowers. "I'm hearing it more and more," says Stacey Sanchez, senior community loan officer with San Diego-based CDC Small Business Finance, a community development corporation, who says entrepreneurs often turn to her institution when their credit lines are pulled. Sanchez says the increased aggressiveness on the part of lenders may be due in part to banks now being in possession of 2008 tax returns for most of their clients, which show the full ugliness of the last quarter of 2008.
And suspending lines of credit is certainly an efficient way to reduce the risk on a bank's balance sheet. According to officials at the Office of the Comptroller of the Currency, bank reserves for bad loans are based on the total exposure to a customer. So if a bank has a $100,000 line of credit with a small firm and only $20,000 is drawn down, the total exposure is still $100,000, and the bank usually will reserve for loan losses based on that amount. But if they convert the $20,000 outstanding to a term loan and cancel the line of credit, or if they simply cut the line to $20,000, the reserves would be based on that $20,000 figure.
Regulatory pressure likely plays a part as well. Bert Ely, an Alexandria (Va.)-based financial-services consultant, says he hears repeatedly from banks around the country that while the White House and Treasury talk about the need for lending to small business, local bank examiners continue to pressure them to upgrade the quality of their loan portfolios. "You have a disconnect between what policymakers are saying and what the rank-and-file bank examiners and supervisors are saying," Ely says. That has painful repercussions for business owners around the country.
Experts say GM bankruptcy is almost inevitable
For General Motors Corp., the task at hand is so difficult that experts say a Chapter 11 bankruptcy filing is all but inevitable. To remake itself outside of court, GM must persuade bondholders to swap $27 billion in debt for 10 percent of its risky stock. On top of that, the automaker must work out deals with its union, announce factory closures, cut or sell brands and force hundreds of dealers out of business — all in three weeks. "I just don't see how it's possible, given all of the pieces," said Stephen J. Lubben, a professor at Seton Hall University School of Law who specializes in bankruptcy.
GM, which has received $15.4 billion in federal aid, faces a June 1 government deadline to complete its restructuring plan. If it can't finish in time, the company will follow Detroit competitor Chrysler LLC into bankruptcy protection. Although company executives said last week they would still prefer to restructure out of court, experts say all GM is doing now is lining up majorities of stakeholders to make its court-supervised reorganization move more quickly. "If we need to pursue bankruptcy, we will make sure that we do it in an expeditious fashion. The exact strategies I'm not getting into today, but we'll be ready to go if that's required," Chief Executive Fritz Henderson said last week.
The threat of bankruptcy, however, may be just a negotiating ploy to pull reluctant bondholders into the equity swap deal. In Chrysler's case, some secured debtholders resisted taking roughly 30 cents on the dollar for what they were owed, but most gave in after they were identified in court documents. Henderson, who took over in March when the government ousted Rick Wagoner, said last week there's still time to get everything done by the deadline, although he conceded it will be difficult to meet a government requirement that 90 percent of its thousands of bondholders agree to the stock swap. The biggest obstacle to GM restructuring out of court appears to be its bondholders, who have been reluctant to sign on to the stock swap when the government and United Auto Workers union would get far more stock in exchange for debts owed by GM.
GM has proposed issuing 62 billion new shares, 100 times more than the 611 million now offered publicly. Even though the U.S. government has agreed to back up GM and Chrysler new-car warranties, potential car buyers already view GM as if it's in bankruptcy, reflected by the company's steep revenue drop in the latest quarter, Lubben said. On Thursday, GM posted a $6 billion first-quarter loss and said its revenue dropped plunged by nearly half, largely because bankruptcy fears scared customers away from showrooms. "I don't think anyone is buying cars from a company who is wringing their hands about a potential bankruptcy for the past year or so," he said. Under Chapter 11, a company can stay in operation under court protection while sheds debts and unprofitable assets to emerge in a stronger financial position.
At this point, GM needs to resolve the uncertainty and get in and out of bankruptcy as quickly as possible, Lubben said. The company is talking with the UAW and Canadian auto workers unions about concessions, including getting the UAW to take roughly 39 percent of its stock in exchange for half of the $20 billion GM must pay into a union-run trust that will take over retiree health care payments next year. About 50 percent of the stock would go to the government for its loans. GM said last week it would need another $2.6 billion in May and $9 billion more for the rest of the year, bringing the total to $27 billion. One percent would go to current shareholders, with bondholders getting the other 10 percent.
Bondholders are reluctant to take the deal because the government and UAW are getting far bigger stakes in the company, said Kevin Tynan, an industry analyst for Argus Research in New York. "When you look across at what the union is getting and what the government is getting, to expect them to take 10 percent is just unrealistic," he said. Cutting dealers also remains a huge hurdle, with GM hoping to shed 2,600 of its 6,246 dealerships by 2010. But dealers are protected by state franchise laws, and trying to shed them outside of bankruptcy would result in either millions of dollars in payments or multiple lengthy lawsuits, Lubben said. "That means you've got to negotiate with each one of those dealers individually."
Also, GM on Friday told its major parts suppliers that it would move up payments due on June 2 to May 28. Company spokesman Dan Flores said it was being done to help the suppliers at a critical time, but he denied that the payments were pulled ahead of a potential June 1 bankruptcy filing. GM has begun to temporarily close 13 assembly plants for up to 11 weeks through mid-July in an effort to control inventory. With Chrysler plants also shut down during its bankruptcy proceedings, parts suppliers will soon have no income and could go under. It would help speed up GM's stay in bankruptcy court if it could pull together big blocks of stakeholders to agree on reducing debt or changing other stakes, said Robert Gordon, head of the corporate restructuring and bankruptcy group at the Clark Hill PLC law firm in Detroit.
During its quest for government aid, GM executives said bankruptcy would severely cut their sales, with research showing that people would shy away from GM vehicles for fear that warranties would not be backed and parts would not be available. Tynan said the executives now can't change their story, even though they likely know that bankruptcy is inevitable. "They're sort of morally obligated to say 'we're intent on doing this outside of bankruptcy,'" he said. "But at the end of the day, they just want the magnitude of the restructuring to get done."
Middle East Growth to Fall by 50% This Year, IMF Says
Growth in the Middle East will fall by 50 percent this year, the International Monetary Fund forecast, as it encouraged countries in the region to boost government spending to stimulate their economies. The economies of the world’s three biggest oil producers, Saudi Arabia, the United Arab Emirates and Kuwait, will contract as lower energy prices force production cuts and tighter credit availability squeezes the private sector, the Washington-based lender with 185 member nations said in its Regional Economic Outlook report today.
Middle Eastern countries were hurt by the first simultaneous recession for six decades in the U.S., Japan and Germany as oil prices plummeted around $90 a barrel from a record high in July of $147.47 a barrel and international banks stopped lending to local companies. The region’s oil importers have also been hit by falling foreign investment. “Our basic point has been that you save for a rainy day,” Masood Ahmed, Middle East director for the IMF, said at a conference in Dubai. “It’s certainly raining.” Saudi Arabia, the biggest Arab economy and world’s largest oil exporter, said it will have a 65 billion-riyal ($17 billion) deficit this year as the kingdom maintains fiscal spending to build infrastructure and create jobs. The Saudi government plans to spend $400 billion over the next five years to stimulate the economy.
For the region as a whole, gross domestic product is projected to grow 2.6 percent this year, down from 5.7 percent in 2008, the IMF said. Saudi Arabia will have a decline in economic growth of 0.9 percent, compared with a 4.6 percent increase last year. “The drop in oil prices has most directly affected the oil-exporting countries, whose oil revenues in 2009 will be less than half what they were in 2008,” the IMF said. “The tightening of international credit markets and lower investor appetite for risk is affecting capital inflows, depressing asset prices and reducing investments in these countries.” The economy of the United Arab Emirates, the Arab world’s second-largest economy, is forecast to contract 0.6 percent after growing 7.4 percent last year, while Kuwait’s economy is projected to contract 1.1 percent after 6.3 percent growth in 2008, the IMF said.
“The short to medium-term outlook for the U.A.E. and the Abu Dhabi economy remains fairly robust,” Ahmad Abu Ghaida, acting director of economic planning at the Abu Dhabi Department of Economic Development, told the International Monetary Fund conference in Dubai today. “We expect to see positive growth in the second half of 2009 and 2010.” After the global credit crunch started, Gulf central banks moved to protect their banking systems and add liquidity by providing guarantees for deposits at commercial banks. Regional sovereign wealth funds were also asked to support domestic asset prices, the IMF said. “There is a little bit of a concern because of the contraction of financing in emerging markets,” Ahmed said. “You will see in the coming 12 months an increase in the number of corporate defaults.”
The U.A.E. central bank in October set up a 50-billion dirham ($13.6-billion) credit facility for lenders and the federal government said it would deposit 70 billion dirham with banks to provide liquidity and lower interest rates after global credit markets froze. “We think 2009 will be a reality check for the region,” Howard Handy, chief economist at Riyadh-based Samba Financial Group, said at the conference. “This will prompt a healthy re- prioritization of the huge project pipeline, a correction in overheated real estate markets and a wakeup call for banks.” Among non-oil producers, Lebanon, with more than 400,000 expatriates in Gulf countries, is set to experience a slowdown because of higher debt-servicing costs and the decline in remittances from workers in the Gulf. The Lebanese economy is forecast to expand by 3 percent, after 8.5 percent growth in 2008.
China overtakes the US as Brazil's largest trading partner
China has become Brazil's most-important trading partner, disrupting a relationship between the United States and the Latin country that stretches back to the 1930s. Welber Barral, the Brazilian trade minister, said total trade between Brazil and China had amounted to $3.2bn (£2.14bn) in April, representing a near twelve-fold increase since 2001. The sum was greater than the $2.8 billion of imports and exports to the US and represented the second consecutive month that China had topped the trade table. "It is a historic moment," he said, adding that he expected China to remain in pole position for the rest of the year because its economy is still growing healthily. "China is now a platinum account [for Brazil]," said Douglas Smith, a Latin American economist for Standard Chartered bank.
The US has been Brazil's principal trading partner for nearly 80 years, but a sudden surge in Chinese demand for Brazilian iron ore in the first quarter of this year dislodged the Americans. The news is the latest sign of China's increasing challenge to US hegemony in Latin America. China has been steadily increasing its sphere of influence and has become particularly close to the four "Red" South American countries: Venezuela, Bolivia, Ecuador and Peru. China is already Chile's primary trading partner. In February, China's vice president, Xi Jinping, and its vice prime minister, Hui Liangyu, both travelled through South America to cement ties. They visited nine countries, including Brazil and Mexico, Venezuela, Ecuador and even Colombia, a staunch US ally. The month before, China contributed $350m to the Inter-American Development Bank.
However, despite much fanfare, China has not signed a bilateral trade agreement with Mercosur, the Latin American free trade bloc. Critics also point out that much of China's foreign investment in Latin America is funnelled directly into offshore tax havens in the Cayman Islands and Bermuda. Brazil said it now aimed to diversify its range of products to China. Currently the bulk of Brazilian exports is made up of soya beans, for Chinese tofu, iron ore, cellulose and fuel. President Lula is expected to ink further oil and gas deals when he arrives in Beijing for talks on May 18. "This is a very pressing issue to watch," said Mr Smith. "Brazil is seeking investment from many sources, including China, to help fund exploration from the Santos Basin, which will be very expensive to extract".
UK unemployment could peak at 4 million in 2012
Unemployment in Britain will continue to rise for at least another three years, according to a leading economic consultancy, as official figures out next week are expected to show another large jump in the number of jobless. At its latest economic forum, attended by several former members of the Bank of England's monetary policy committee, Fathom predicted that unemployment on the International Labour Organisation (ILO) measure, which includes those seeking work but not claiming benefits, would peak at 4 million in 2012.
However, some economists fear the picture could be even worse. Official figures out on Wednesday are expected to show that unemployment on this measure rose to 2.17 million. The number of people out of work and claiming benefits is forecast to have climbed by 80,000 last month to 1.54 million.
TUC general secretary Brendan Barber said: "Next week's unemployment figures will be grim reading. Unemployment is rising at a faster rate and is set to hit 2.5 million as early as June." He called for urgent action from the government to boost employment. "The government can play a pivotal role in tackling unemployment. But focusing on public spending cuts simply means further mass job losses. The government must re-focus on sustaining and creating new jobs in order to get our economy moving again." Howard Archer, chief European and UK economist at IHS Global Insight, said: "Despite some recent signs that the rate of economic decline is moderating, unemployment is a lagging indicator and the extended deep economic contraction seen since mid-2008 is continuing to hit the jobs market hard."
Thousands more jobs were put in jeopardy last week. Corus, the steel group owned by Indian firm Tata, said on Friday that it will halt work at one of its largest steel plants in the UK, putting 2,000 jobs at risk. Monteray, which maintains BT offices and buildings, warned that two thirds of its workforce of 1,600 face possible redundancy because of spending cuts. Microsoft also announced last week that it is to cut 5% of its UK workforce, about 150 jobs. Job centre staff are under increasing pressure as the number of people walking through their doors rises every day. Alex Flynn at the Public and Commercial Services Union (PCS), which represents job centre workers, said: "We've been calling for the government to open more job centres. They have been putting more resources into job centres but staff figures are only at 2005 levels when the economic situation was in a different place."
Like a fish, Europe is rotting from the head
Helmut Schmidt, the former German chancellor, last month made an astute observation: “The European Central Bank is the only institution in Europe that works well.” It is a remarkable statement in several ways. It implies of course that the other European institutions are not working well. I am afraid this is true. I have on previous occasions criticised the unco-ordinated policy response of Europe’s political leaders. Their anti-crisis strategy is to hope the US and China deliver sufficient growth to pull Europe out of recession. That will probably not happen this time. But there is another, less frequently discussed dimension to Europe’s mistaken policy response. The European Commission, the executive arm of the European Union whose job is to implement the region’s law and to drive its policy agenda, has failed abysmally in this crisis. The Commission was largely absent during the worst months of last year, and its subsequent responses fell consistently below what one would expect.
Of course, the Commission is not a government. It has only a small budget, no powers to raise taxes or issue bonds, and it operates under strict guidelines. But as various dimensions of economic policy are now integrated across Europe, one would expect the Commission to play a leading role as a co-ordinator and as a source of new ideas to fight the crisis. The problem with the Commission is not its civil servants. In the absence of political leadership, they apply the rules as they are, for example when they recommend brutal and politically suicidal wage cuts in Latvia, when they apply accession criteria to the eurozone with no flexibility, or when they produce ineffective financial regulation. These are not causes of the problem but mere symptoms of a lack of political direction.
There is a saying that the fish rots from the head, and this is exactly what has been happening here. There is nothing in European politics that stinks more than the apparent inevitability of another five-year term for José Manuel Barroso, the Portuguese president of the Commission. He spent most of the last few years on his bid for re-election rather than doing his job. If the centre-right wins the elections to the European parliament, as everybody seems to expect, nothing can stop Mr Barroso’s bandwagon. This state of affairs sends out a disastrous message – that job performance is irrelevant and that Europe has already reverted to business as usual. Mr Barroso is a conservative from a small country, who followed a socialist from a large country. Europe’s top jobs are not awarded on the basis of electoral success, but on whether you fit into an opaque political matrix.
In the case of a Commission president who has already served for five years, one would expect that he should at the very least be able to answer the questions: What exactly did you achieve during your first term? And what is your big idea for the second? In my view, Mr Barroso is among the weakest Commission presidents ever, a vain man who lacks political courage. He and his supporters will tell us that his big achievement is his dogged pursuit of the Lisbon agenda, a programme to boost Europe’s international competitiveness. Another supporter of Mr Barroso told me that his biggest legacy was the decision to set up the De Larosière committee, named after a former central banker whose group produced a moderately ambitious report to reform Europe’s system of banking supervision. Okay, let us give him some credit for that.
I suspect his big idea for the next five years is to relaunch the Lisbon agenda, and waste another five or 10 years on voodoo economics, and diverting attention from real and urgent policy issues, such as a more coherent system of economic crisis management. Everybody in Brussels is saying that Mr Barroso’s reappointment is almost a done deal. I suspect they are right. Ms Merkel apparently finds him a congenial and pliable Commission president, and the Socialists are too incompetent to field their own candidate. Gordon Brown, the British prime minister, is also supportive. Nicolas Sarkozy is not a fan, but then the French president is not a supporter of a strong and self-confident European Commission either, so Mr Barroso might suit him well for that reason. Silvio Berlusconi, the Italian prime minister, has other problems at the moment.
There are still a few potential obstacles to Mr Barroso’s re-election. The European elections might not go as well for the Christian Democrats as they hoped, and the centre-right might end up too fragmented. It is possible that the outcome of the second Irish referendum on the Lisbon treaty will have a bearing on the decision, which is why Mr Barroso wants EU heads of government to decide on his reappointment at their meeting next month, rather than in October, as Mr Sarkozy recently proposed. So it is not quite game, set and match yet, but it is as close as it could get at this stage. This is all very depressing. Mr Schmidt is right about the ECB. Indeed the central bank made a number of good decisions last week, when it delivered a robust policy response to the crisis. But I never thought that we would ever celebrate a central bank as the only political institution that really works in Europe. How did we get there?
The Depression that Hayek Built
To read the British press is to realize how fundamental the failure the theory of libertarian economic thinking has been. In this theory, the wealthy possess a special insight into the allocation of capital, and governments should abandon their role in allocating effort to a small extremely wealthy elite. It was a theory adopted by Iceland, which was lauded for its open laws and "flat tax." It was adopted by Lithuania, and to a lesser extent, by Spain. One country that embraced this idea more than any other, was Ireland, which took neo-liberal policies as virtually a doctrine. It attracted 40% of all American direct foreign investment in Europe, which liked it's educated English speaking population, proximity to the UK, and low prices. For its part, the government of Ireland threw the doors open. As the Guardian reports by piecing together individual stories the plunge has been swift and dramatic. A new Irish diaspora has begun, as the weight of debt and the utter absence of an internally driven capital system, leaves behind the husk of an economy.
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What created this collapse was the pure corruption at the top. A corruption seen in the expenses scandal now unfolding in Great Britain is destined to topple the ruling New Labor party -- as was seen in the borrowing binge of the very wealthy in Ireland. These two pieces are not unconnected: the culture of flowing money lubricated politicians, who naturally saw that its continuation was essential for their own secure life style. This is not an issue of left or right in the context of the age. There was no left, merely a right that wanted slightly more of the money to flow to socially useful causes. The aftermath? Spanish unemployment hits 17.4%, that is not a mistake. It is a number that is associated with the Great Depression, or the devastation of the post-war era. An economic bomb has hit what was a go go periphery. Ireland's economy is projected to contract by a total of 9% this year, with the decline extending into next year.
These however, are the branches. The trunk was the United States and a banking system that packaged revenue flows into securities, and these were then used as a loose paper money which London turned into investment vehicles. The grunt work was outsourced to Ireland, the holding of the small amounts of reserves to Iceland, and Spain became the vacation spot. The roots, however, are in the vast control of wealth which is not in the hands, by and large, of Americans. While banks enabled these flows, they were not the source of them. Instead there were a large pool of investors seeking government returns. That is absolutely secure. Now if you stop to think about it, that means something. If people want government returns, then there is demand for the kinds of investments that governments, and only governments, can provide. That is to say: public goods. If the investment demand had wanted really to invest in capital, it would have taken on more nominal risk.
What this means is that the fight, in economic ideology, was over how much of the investment in the future should be handled by a very wealthy elite, and what fraction should be handled by the public through government. The ideology of the time was that the wealthy elite, beyond defense and macro-economic stabilization – loosely speaking, making sure the good times kept rolling with low inflation and high money supply growth – was always right, and the public was always wrong. This theory has been proven false. The economic destruction of the New Depression, and Depression is the correct word, will extend for years, and has wiped out the fictional gains of the last 30 years. We are now exactly where we would have been without this experiment in a dictatorship of the propertariat, and we have nothing to show for it but a surplus of posh apartments and private jets.
The debt is not in money. The numbers being thrown around represent real work by real people and real sacrifices, to pay back that pool of money. It, and only it, has been declared to be off-limits. The theory of the day is that the rich own the world, and governments only rent it from them. Economic statistics on the percentage of Americans upside down in their homes, unemployment numbers, GDP numbers, do not reflect the reality of what these numbers mean. It is possible to dissect the recent Bureau of Labor Statistics release and see that private sector employment continues to collapse. 611,000 private payroll positions disappeared in April, and the number for the private sector was revised upwards for March. The slowing is taken as indicating an end to the freefall, because usually it has. However the damage is continuing at this pace, and will continue for some months.
The nominal bottom of the downturn is not far away, but the upturn is not for a long time after that. Estimates vary, but many put the return of substantial growth for the US only at the end of this year. The scale of this fall underlines what Bush and his regime thought was going on: 9/11 represented the chance for a "conservative World War II." A carte blanche to remake the US economy by shifting effort, permanently, to conservative projects and conservative priorities with conservative social structures. We have not seen such a large down shift in the economy, in terms of people employed, since World War II; with the next months data, we are going to fall through the recession of the late 1950's.
However, to have public investment, the public must demand that investment. In his poetic post on words Glenn Smith pointed out that ideas are stories, and the conservative story, of a world economy based on small luxuries, greed, and a blunt trauma to anyone who would not accept that world order, was fundamentally unworkable as a narrative. It leads today, as it led in the age of Pericles, to hubris and collapse. Masaccio was far more brute, pointing out that if there is no one to carry ideas, then they will die. The beginnings of this project are happening, but far from the light. Darcy Burner, for example, has been given pennies to start working for progressive ideas in a foundation. She has less in seed money than the private jet budget of some Republican congressional campaigns. And this is only one example.
The theory of the last 30 years was that a rich elite would always know better how to allocate capital than would others. Every neo-liberal economics text on "welfare economics" spends time pondering about situations where more money would be created, but most would go to the wealthy; and then deciding that this is a good policy, because we could then tax the wealthy. This turns out not to be the case, because the money created was never real, in the sense of allocating resources, but a fiction. And while it existed, the wealthy could easily bribe a few members of parliament, a few government officials, not to tax it for welfare purposes.
This collapse leaves a void in the minds of elites, and a directionless moment in thought and government. The public wants action, but even those well intended, do not know what to do. Indeed the likelihood is that the political developed world will follow Canada, France, and Germany in ousting parties of the neo-liberal left, and installing neo-liberal right parties out of disgust. This means that the project of change is not won in an election, or by faith in particular individuals. And the economic crisis, like depressions before it, leads into a long and uncertain darkness, with a continuing need for action today, tomorrow, and many tomorrows after it. Ideas, the right likes to say, have consequences. Look around you and see the consequences of theirs.
The Freighter Graveyards of South Asia
When times were good, shipping companies ordered huge numbers of new steel behemoths to ply the oceans. Now though, many of those same container lines are eager to get rid of their ships. The scrapping business in South Asia is booming. The sandy beaches north of Chittagong in Bangladesh look like giant steel graveyards. Ships line the banks ready for dismantling. Others are so far disassembled that their hulls are all that is left protuding morosely from the water, according to shipping industry journal Lloyd's List. All kinds of vessels get broken down here: bulk carriers, container ships, vehicle transporters and oil tankers. The wrecks are remnants of a disappearing world. Once they sailed the oceans as flagships of globalization. Now they're symbols of an order that threatens to sink with them.
The global economic and trade crisis is so severe that a growing number of ships, some larger than the Titanic, are being pulled from their routes and sent to scrap yards to be sold for parts. Freight and charter rates have fallen and regularly scheduled passenger lines are being cancelled. Those container ships that are still sailing can barely cover their costs. Over-capacity created in recent boom times has accelerated the trend toward scrapping ships. Yet one boom replaces another. With shipping down, shipbreaking is the business of the hour. The shift began late last year and initially targeted ships with a combined load-carrying capacity of 10 million tons. Now the heavy rigs are being lined up too as they sit idly anchored in harbors around the world. Much of the scrapping happens in South Asia and with little regulation in place.
As the economy worsens the shipbreaking business improves. The best place to beach large ships is near Alang, in the southern part of the Indian state of Gujarat. Tides are high here, allowing the ships to run ashore under their own power. Once the tide is low and the hulls are out of the water, work begins of gutting and cutting up the ships. It's a "non-stop boom," the Hindustan Times writes. Blowtorches hiss, steel windlasses screech, and sledgehammers pound along the 11 kilometer beach. Cranes remove the superstructures from the deck. A bulk freighter that until recently might have carried bauxite or grain disappears within 40 days.
A few years ago, when globalization was in full swing, few ships came near Alang. Many of the slots -- as the dismantling sites are now known -- were closed due to a lack of demand. Now millions of dollars are being earned from the scrap metal. Nobody knows this better than Indian-born Anil Sharma, a cash-buyer who promotes the bizarre boom all the way from Maryland in the US. In the jargon of the industry, a cash-buyer acquires ships from the shipping companies who want to get rid of their burdensome vessels. He then sells them to the scrappers. The scrap metal lands in small mills in places such as Chittagong or Karatchi to be turned into steel for the construction industry. Some parts may reemerge as hinges for shipping containers whose own demand is falling in the global downturn.
Anil Sharma's company, Global Marketing Systems, has grown into the world's largest buyer of scrap ships. He manages about a third of all ships doomed for scrapping. And new candidates show up almost daily. "I believe there will be more than 1,000 additional ships that will be scrapped," Sharma predicted at a convention in London last February. "The next two years will bring the liveliest business there's been so far," the Onassis of scrap told Lloyd's List.
Sharma's travels of the world's scrapping centers have taken him to the coast west of Karachi in Pakistan, where ships loiter in gigantic, watery parking lots. In some places the ships are stacked three vessels high on top of one another, he says. It sounds improbable but it fits the image of Alang, where more than 125 ships have landed between last December and March -- almost as many as in 2007 and 2008 combined. The shipping companies must dump their old freighters to tackle a dilemma. During the global economic boom they ordered new vessels non-stop, creating over capacity in much the same way as that troubling the car sector. In cases where orders can't be cancelled, new ships are coming off the conveyer belts just as demand declines. It makes the need for selling old ships as scrap all the more pressing.
Nearly 90 percent of the world's shipbreaking happens in India, Pakistan and Bangladesh. Workers drag at steel plates on long ropes; electric cables, pipes, boilers, hatchways, and generators litter the coast. As does asbestos and poisonous sealing compounds. Those parts that can't be smelted into steel get hawked along the road to Alang on a new kind of bazaar, Reuters reports. On sale here are doors, tables and sofas, carpeting, dishes, refrigerators, air conditioners and even a captain's bathtub. Ships have been landing at the Bay of Bengal and in the Arabian Sea for cheap recycling for the past three decades. Shipyards in Korea, Taiwan, Japan and Europe prefer to build or repair ships in their dry docks, leaving the un-glamorous scrapping to others.
A worker at Pakistan's Gadani beach earns 280 rupees -- less than three euros -- a day. Still, the scrapping regions do benefit from the industry. A country with few natural resources such as Bangladesh can make good use of scrap metal, particularly since producing its own steel from iron ore would be costly and time-consuming. And ship scrapping in South Asia is about to become more strictly regulated thanks to new guidelines penned by the UN's International Maritime Organization in London. The deal foresees a register of dangerous substances contained in ships and demands that scrappers lay out a recycling plan. It also stipulates that ships be inspected by experts before their final voyage to scrapyards.
The new rules are expected to be approved during a meeting next Monday in Hong Kong. But even if approved, it will take years for the nations involved to ratify and implement the rules, experts warn. One exception could be Bangladesh, where a court recently ruled that shipbreaking must become more environmentally friendly. Until such changes arrive, Chittagong scrap yard worker Omar Faruq will likely continue cutting up steel plates from the ships as he does every day. He ripped open his shin on a sharp edge of scrap last August and the wound required stitches, he told a reporter from the AFP. Others have been much more seriously injured at the shipbreaking yards -- or even killed. "I live in fear of accidents like that," Faruq said at the time. "But I'm even more afraid of not having any money if I can't get to work."