May 13 2009 2: The New Two-Doors

Jack Delano Gently into the night January 1941
Foggy night in New Bedford, Massachusetts

Ilargi: I don’t have much, I was just wondering what the plan is for GM. The company will go into Chaper 11 before the end of the month, so much seems clear enough, but with everybody including staff selling off shares it's getting doubtful whether it will make it that far and hold on for so long. A share price hovering around a buck and a market cap of $700 million are very wobbly foundations. That market cap is way less than 1% of the total -negative- equity. GM will shed 2000 dealers pre-bankruptcy if granted the time. If GM makes it to Chapter 11 in an orderly fashion, which becomes less likely by the hour, there is nothing anywhere close to a guarantee that it will ever come out. The procedures may take years to complete, and the last thing the company has on its side is time. Take a look at the speed at which the stimulus money is handled and handed out. The timeframes for these things simply can't be compressed at will.

I keep remembering quotes I wrote about a number of times last year, when almost nobody considered a GM default a serious risk. Those quotes said that if Detroit had to cut production by 50%, 2.5 million US jobs would be lost. Well, we’re there. Start sending those slips. And remember: what’s good for GM ......

GM in numbers:

• Market Capitalization: $700 million
  
• Operating income: - $21.284 billion
  
• Net income: - $6.0 billion
  
• Total assets: $ 91.047 billion
  
• Total equity: - $86.154 billion
  
• Employees: 252,000

sources: Wikipedia a.o., latest available

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The New Tudors

Strong-willed but bumbling, the King knows that right is right, especially when it suits his interests. He summons a factotum . . .

King: Sir Rahm, my trusted servant, God hath vouchsafed me a vision. Confusion and disarray in Detroit, he doth tell me, is from the sin of excess -- they build cars that are too big. I shall reclaim my ancient rights and remake Detroit. They will make smaller, more Godly cars. It will be my legacy. My reign and that of my descendants and surrogates shall be called the Tudor Dynasty.

Rahm: The 2-door dynasty?

King: Even better!

With each step forward, however, unforeseen problems arise. His subjects believe their rights and interests and traditions have been ignored. There is rebellion in the north. The King is frustrated and depressed.

King: What of my disloyal subjects in the province of La Grande Pomme? They stand in the way of my plan to hand Detroit over to my faithful retainer, Ron of Gettlefinger.

Rahm: Your subjects in New York are most recalcitrant, but the law is on their side.

King (passionately): The law knows not the fierce urgency of now!

Rahm: I know. I have recruited a specialist, the honorable Ronald Bloom, a commoner, to help them see a higher law.

Enters a new player, with a distinct northern accent.

King: So, Mr. Bloom, how will you deal with my high and mighty lords of New York?

Bloom: We have a story where I come from about a man who visits his dentist and grabs the dentist by the nether parts and says . . .

Rahm (interrupting): The King is not interested in your colorful local folkways.

Bloom (resuming): Majesty, the mightiest of your northern vassals, Lord Citibank, Lord Morgan and Lord Chase, need the King's favor. Even now they are subjected to stress tests. They will come to heel with a few more turns of the winch.

King: Excellent.

Bloom: As for the lesser vassals and hedge funds . . . for them, the dentist treatment!

At first, the news from the north is good. A compliant functionary at the court of bankruptcy has secured the King's ends with respect to Chrysler. Mr. Bloom returns to receive the King's thanks.

King: I hear you have delivered to Ron of Gettelfinger and his United Auto Workers a 55% stake in Chrysler. Well done.

Bloom: It is a propitious number -- 55% is the stake I secured in 1995 for the pilots of United Airlines.

King (alarmed): Didn't the pilots promptly fly the airline into the ground with their extravagant wage and benefit demands?

Bloom: Yes. But my firm earned a large fee.

The King's foreboding is amply repaid in the months that follow. Ron of Gettelfinger has retired to a monastery. His men are demanding reinstatement of their health-care benefits and other bennies. His successor, who must be elected by the men, can't very well plead helplessness when he effectively selects Chrysler's management. He meets their demands. Chrysler's costs skyrocket. The people turn away from its products. And Don Sergio of Turin, a fickle Italian city-state, whom Mr. Bloom recruited to build the King's godly small cars at Chrysler, is nowhere to be found.

King: Why hath Don Sergio forsaken me?

Rahm: He says making small cars in the U.S. is unprofitable for his company Fiat when gas is $2. He complains the King's treasury has not provided the funds to subsidize the 2-door revolution.

King: We must invade Italy!

Rahm: Alas, it is impossible. The treasury is bankrupt due to your highness's generosity in providing health care, green energy and the right of every child not only to attend graduate school but to graduate with honors. My Lord, even your courtiers have begun to flee. Because this is a family newspaper and not Showtime, they complain life at court has become less, er, invigorating with the absence of certain distractions available on an R-rated cable channel. Tune in next week, when the King discovers Bo has chewed up his favorite pair of Nike Kobe Zoom IVs.

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GM, Chrysler to cut up to 3,000 dealers

General Motors Corp and Chrysler aim to drop as many as 3,000 U.S. dealers and are expected to begin sending notifications as early as Thursday, three people briefed on the still developing plans said. GM, facing a U.S. government-imposed deadline of June 1 to restructure or file for bankruptcy, is expected to send termination notices to up to 2,000 dealers -- a third of its roughly 6,000 U.S. dealers, the sources told Reuters. Chrysler, which filed for bankruptcy on April 30, will also tell up to 1,000 of its 3,189 U.S. dealers it is terminating their franchise agreements, according to the sources who asked not to be identified because the controversial closure plans have not been yet announced. The moves to shut down auto dealerships underscores how the economic pain caused by the downward spiral of both automakers -- now operating under U.S. government oversight -- is spreading beyond their home base in Detroit.

The development comes as dealer representatives have stepped up lobbying in Washington to try to slow down closures they estimate would cost 200,000 dealership jobs. The involuntary terminations are also widely expected to prompt a legal challenge from dealers who are independent retail networks protected by state franchise laws. Chrysler spokeswoman Kathy Graham said the automaker had not announced its dealership closure plans. "We have not announced anything at this point," she said. "We are not done with our process at this point." A GM spokesman was not immediately available for comment. More than 100 members from the National Automobile Dealers Association, a group representing the country's 20,000 new car dealers, met members of the House of Representatives and Senate in Washington on Wednesday, asking them to intervene with the Obama administration's autos task force on planned reductions.

"A rapid cut of dealers is a bad idea," NADA Chairman John McEleney said in a statement. McEleney said his organization does not oppose dealer consolidation, but believes the administration and the companies are moving too fast. NADA leaders are scheduled to meet the U.S. auto task force on Thursday. The task force, headed by former investment banker Steve Rattner, is driving the restructuring of both companies, which are planning to close plants, cut jobs and restructure dealer lineups to establish viability. GM, which is operating with $15.4 billion of U.S. government loans, has to cut debt and operating costs and present a new restructuring plan to officials by June 1 to avoid a government-controlled bankruptcy.

Both GM and Chrysler have faced pressure to cut struggling dealerships to bring their large sales networks line with those run by more successful rivals led by Toyota Motor Corp. Toyota, No. 2 in U.S. sales behind GM, has about 1,200 dealerships in the country. Chrysler is using the bankruptcy process to move faster toward that goal, while GM plans to tell its dealerships they are being dropped for not meeting standards for capitalization and profitability. GM wants to cut its dealer network to 3,605 from over 6,246 at the end of 2008. But it has not specified how it would achieve that and how many dealerships would be involuntarily terminated and how many it expected to go bankrupt or shut down on their own. Chrysler's plan has remained under wraps.

GM Chief Executive Friz Henderson said on Monday the automaker was completing its plans for dealership consolidation this week. Chrysler Chief Executive Bob Nardelli said in a memo to staff on Tuesday, a copy of which was obtained by Reuters, that the automaker would determine how to organize its dealer networks during the rest of the week. Carroll Smith of Monument Chevrolet in Houston, one of the 100 new car dealers who lobbied lawmakers in Washington, warned that a rapid wind down of outlets could lead to a flood of new vehicles hitting the market simultaneously at much lower prices, further undercutting hard-hit dealers. "Dealers are not cost. What we are are retail and distribution," Smith added.

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GM May Fail Even After Bankruptcy Reorganization

General Motors Corp. will "absolutely" seek bankruptcy and its reorganization plan could fail if the automaker emerges too quickly from court protection, said Edward Altman, a professor of finance at the Stern School of Business at New York University. "Yes they can come out in 30 to 60 days but I think that would be a mistake," Altman said today in an interview on Bloomberg Radio. "They’re going to be coming out in the teeth of a severe recession. They probably will not have plugged all the holes necessary. And the very viability of the plan is, in my opinion, still up for grabs." Altman, creator of the Z-Score formula that calculates a company’s probability of bankruptcy, also said "they still come up very seriously in the Z score test into the bankrupt zone" after a 30- to 60-day reorganization.

"They’ve got to increase sales pretty quickly," Altman said. "They’ve got to cut costs a lot more than even they’re talking about, and frankly I’m not sure it’s possible." A filing will be more complex than the reorganization at its smaller rival, Chrysler LLC, which filed for bankruptcy protection on April 30, Altman said. "Chrysler is a dress rehearsal for GM," he said. "I don’t see any chance of them doing it outside of the court," Altman said of a GM filing for Chapter 11 bankruptcy reorganization. "They’ve got all these dealerships across the country. They’ve got to deal with a very complex capital structure."

In April, GM said it intends to cut its dealerships by 42 percent to 3,605 from 6,248 at the end of last year to reduce liabilities and keep $15.4 billion in government loans. In a separate interview today on Bloomberg Television, Altman the government is treating debt holders of Chrysler and General Motors unfairly. "They’re taking a hard line with respect to the creditors and they’re forcing them to take, in their eyes, a very poor deal," Altman said.

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Economic-Stimulus Cash Is Moving Slowly

Some government departments are facing a tougher time than others disbursing economic-stimulus money. Vice President Joe Biden, in his first quarterly report on the status of the $787 billion program, said "significant progress has been made toward implementation." The administration said it is on target for 70% of the money in the plan to be used by the end of 2010. A little more than $28 billion had been spent through April, according to federal department reports. An additional $60 billion has been sent out, but the recipients haven't spent it yet. With the exception of two agencies, none have reported more than 3% of the funds allocated to them as having been used by recipients. The slow speed reflects the often complex procedures set out by the program for both government agencies dispensing money and the governors, municipal authorities, nonprofits and private companies getting it.

The stimulus plan contains about $500 billion in spending and $287 billion in tax breaks. The Council of State Governments, a nonpartisan network, said that of the $500 billion, about $230 billion is going to the states; some $100 billion is being given out as grants for which nonprofits, universities and local and state governments can compete; and $170 billion is for federal departments to spend themselves. Two federal departments—Health and Human Services, and Labor—have already made more than two-thirds of their funds available, mostly by making large payments to plug holes in Medicaid budgets and unemployment funds. More than half of the money they sent out has been spent.

The Transportation Department has also gotten out a lot of the money under its jurisdiction, mostly because states already had lists of projects they wanted to get done. The stimulus program's distribution process only required such projects to be approved by the department. The department has approved 3,000 projects so far, including resurfacing a highway in Merrimack, N.H., and replacing a bridge over Big Sandy River in Carroll County, Tenn. It has made a total of $10 billion, about a quarter of its funds, available to the states, which reported that $34 million has been spent so far. "All of our money's going to go out the door this year," Transportation Secretary Ray LaHood said in an interview. Other agencies are facing a lengthier process in allocating money. The Energy Department is set to allocate $45 billion, almost as much as Transportation, but it has only disbursed about 8% of its money, mostly to increase the size of existing contracts for nuclear cleanup projects.

States seeking to get more funding for existing energy programs, such as home-weatherization projects, must submit new applications that address extra requirements of the economic-recovery act. Meanwhile, the Energy Department is moving to get new programs up and running, including some grants for renewable-energy research. And it has to finalize criteria for applicants of some $13 billion of research and development funds, which are expected to attract thousands of applications. Matt Rogers, the agency's newly appointed senior adviser on implementing the stimulus plan, said the Energy Department has been hiring new staff and reassigning existing employees, as well as recruiting volunteers, to prepare for an expected flood of paperwork from both states and private grant applicants for deadlines every week until Labor Day. "We now feel like we're in pretty good shape for it," he said.

The Energy Department has struggled in the past with running big programs, and some government agencies have taken up to a year to award money after a grant competition closes. "That's not happening on my watch," Mr. Rogers said. "There's more staff to handle it and frankly, it's really important." Chris Whatley, the Washington director of the Council of State Governments, said many states are focusing on how to use the money they have received from federal agencies. But some private companies are becoming anxious over what they see as the government's slow pace in opening up grants for competitive bidding. "Many of them are hoping the economy gets better so they can just go get venture capital and don't have to worry about any of this," said Isaac Seliger, owner of Seliger & Associates Grant Writing, a Seattle-based consulting firm that advises applicants for government grants, including in the energy sector.

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States' Tax Collections Continue to Fall

State tax collections continued to fall in the first quarter as muted consumption, falling incomes and weak profits plunged states into a deeper financial hole, the Nelson A. Rockefeller Institute of Government at the State University of New York said in a report to be released Wednesday. The 47 states that have reported first-quarter revenues saw total tax collections fall 12.6% -- about $20 billion -- compared with the first three months of 2008, the institute said. The steepest drops were in income taxes: Corporate income taxes declined 16.2% in the latest quarter, reflecting weaker profits. Personal income taxes fell 15.8%. Sales taxes were down 7.6%. Forty-five of the 47 states saw revenues decline.

Robert Ward, deputy director of the institute, said he expects tax collections to fall further in the second quarter, with weak consumer spending, rising unemployment and stock-market turmoil almost certain to reduce income taxes from earners large and small. "We don't normally use the word plummet but that is the operative word right now," said Mr. Ward. Tax returns filed in April likely contain unwelcome news from high-income earners. "The expectation is that April income tax collections will be very weak," he said. The worst recession in a generation is forcing municipalities of all sizes to furlough employees and cut programs in areas such as public safety and education. To cope, state and municipalities are scrambling for federal stimulus money, and some are raising tax rates.

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Tax Increases Could Kill the Recovery
by Martin Feldstein

The barrage of tax increases proposed in President Barack Obama's budget could, if enacted by Congress, kill any chance of an early and sustained recovery. Historians and economists who've studied the 1930s conclude that the tax increases passed during that decade derailed the recovery and slowed the decline in unemployment. That was true of the 1935 tax on corporate earnings and of the 1937 introduction of the payroll tax. Japan did the same destructive thing by raising its value-added tax rate in 1997. The current outlook for an economic recovery remains precarious. Although the stimulus package will give a temporary boost to growth in the current quarter, it will not be enough to offset the combined effect of lower consumer spending, the decline in residential construction, the weakness of exports, the limited availability of bank credit and the downward spiral of house prices.

A sustained economic upturn is far from a sure thing. This is no time for tax increases that will reduce spending by households and businesses. Even if the proposed tax increases are not scheduled to take effect until 2011, households will recognize the permanent reduction in their future incomes and will reduce current spending accordingly. Higher future tax rates on capital gains and dividends will depress share prices immediately and the resulting fall in wealth will cut consumer spending further. Lower share prices will also raise the cost of equity capital, depressing business investment in plant and equipment.

The Obama budget calls for tax increases of more than $1.1 trillion over the next decade. Official budget calculations disguise the resulting fiscal drag by treating Mr. Obama's proposal to cancel the 2011 income tax increases for taxpayers with incomes below $250,000 as if they are real tax cuts. The plan to modify the Alternative Minimum Tax to avoid increases for some taxpayers is also treated as a tax cut. But those are false tax cuts in which no one's tax bill actually declines. In contrast, the proposed tax increases are very real. And despite the proposed tax increases, the government's new spending and transfer programs would cause the annual budget deficit in 2019 to exceed $1 trillion, or 5.7% of GDP.

Mr. Obama's biggest proposed tax increase is the cap-and-trade system of requiring businesses to buy carbon dioxide emission permits. The nonpartisan Congressional Budget Office (CBO) estimates that the proposed permit auctions would raise about $80 billion a year and that these extra taxes would be passed along in higher prices to consumers. Anyone who drives a car, uses public transportation, consumes electricity or buys any product that involves creating CO2 in its production would face higher prices. CBO Director Douglas Elmendorf testified before the Senate Finance Committee on May 7 that the cap-and-trade price increases resulting from a 15% cut in CO2 emissions would cost the average household roughly $1,600 a year, ranging from $700 in the lowest-income quintile to $2,200 in the highest-income quintile.

Since the amount of cap-and-trade tax rises with income, the cap-and-trade tax has the same kind of adverse work incentives as the income tax. And since the purpose of the cap-and-trade plan is to discourage the consumption of CO2-intensive products, energy or means of transportation by raising their cost to consumers, the consumer-price increases would be the same for a 15% reduction in C02 even if the government decides to give away some of the CO2 emissions permits. But while the cap-and-trade tax rises with income, the relative burden is greatest for low-income households. According to the CBO, households in the lowest-income quintile spend more than 20% of their income on energy intensive items (primarily fuels and electricity), while those in the highest-income quintile spend less than 5% on those products.

The CBO warns that the estimate of an $80 billion-a-year tax increase could be significantly higher or lower, depending on how the program is designed. The Waxman-Markey bill currently before Congress calls for reducing greenhouse gasses 20% by 2020 and by an incredible 83% by 2050. As the government reduces the amount of CO2 that is allowed, the price of the CO2 permits would rise and the pass-through to consumer prices would also increase. The next-largest tax increase -- with a projected rise in revenue of more than $300 billion between 2011 and 2019 -- comes from increasing the tax rates on the very small number of taxpayers with incomes over $250,000. Because this revenue estimate doesn't take into account the extent to which the higher marginal tax rates would cause those taxpayers to reduce their taxable incomes -- by changing the way they are compensated, increasing deductible expenditures, or simply earning less -- it overstates the resulting increase in revenue.

Since the projected revenue from this source is already designated to be used for Mr. Obama's health plan, some other tax increases will be needed. Moreover, Mr. Obama's budget characterizes the projected $634 billion outlay for health-care reform as just a down payment on the program. The budget notes that there would be "additional resources and new benefits to be determined with Congress." Those additional resources would no doubt be even higher taxes. The third major tax increase is the plan to raise $220 billion over the next nine years by changing the taxation of foreign-source income. While some extra revenue could no doubt come from ending the tax avoidance gimmicks that use dummy corporations in the Caribbean, most of the projected revenue comes from disallowing corporations to pay lower tax rates on their earnings in countries like Germany, Britain and Ireland. The purpose of the tax change is not just to raise revenue but also to shift overseas production by American firms back to the U.S. by reducing the tax advantage of earning profits abroad.

The administration is likely to be disappointed about its ability to achieve both goals. Bringing production back to be taxed at the higher U.S. tax rate would raise the cost of capital and make the products less competitive in global markets. American corporations would therefore have an incentive to sell their overseas subsidiaries to foreign firms. That would leave future profits overseas, denying the Treasury Department any claim on the resulting tax revenue. And new foreign owners would be more likely to use overseas suppliers than to rely on inputs from the U.S. The net result would be less revenue to the Treasury and fewer jobs in America. It's not too late for Mr. Obama to put these tax increases on hold. If he doesn't, Congress should protect the recovery and the longer-term health of the U.S. economy by voting down this enormous round of higher taxes.

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Taylor Says Fed May Not Have Much Time Before Rate Rise Needed

The Federal Reserve may soon need to raise interest rates, said John Taylor, the former Treasury official who devised the "Taylor Rule," a formula for rate- setting based on the outlook for inflation and growth. "My calculation implies we may not have as much time before the Fed has to remove excess reserves and raise the rate," Taylor, a Treasury undersecretary under President George W. Bush from 2001 to 2005, said yesterday at an Atlanta Fed conference in Jekyll Island, Georgia. Fed Chairman Ben S. Bernanke said earlier this week at the conference the Fed was prepared to withdraw monetary stimulus "in a timely way" to prevent inflation from becoming a threat when the economy recovers. Former Federal Reserve Chairman Alan Greenspan said yesterday that the decline in the U.S. housing market may be bottoming and it’s "very easy to see" financial markets continuing to improve.

Taylor, a Stanford University professor, disagreed with economists who say his rule suggests the need for stimulus and justifies cuts in the federal funds rate to negative territory. Laurence Meyer, vice chairman of Macroeconomic Advisers, said in March the rule might suggest the need to reduce the funds rate to minus 7.5 percent by the end of 2009. He said his rule, based on inflation and economic growth compared with the long-term potential for growth, suggests a fed funds rate of 0.5 percent. The central bank has cut rates to between zero percent and 0.25 percent. The Fed helped to trigger the current financial crisis by keeping rates too low for too long, Taylor said. "Low interest rates led to the acceleration of the housing boom," he said. "The boom then resulted in the bust, with delinquencies, foreclosures and toxic assets on the balance sheet of financial institutions in the United States and other countries."

Taylor said that though policy makers were well intended, they were mistaken in trying to "fine-tune" the economy after about a quarter of a century during which long and deep recessions had been avoided. "Sticking to the basics, what worked, would have been much better" than to lower interest rates to 1 percent in 2003 to try to revive growth, he said. Taylor said the Fed’s growing balance sheet is a "systemic risk" because it may be difficult to unwind quickly enough without igniting inflation. The Fed’s balance sheet has more than doubled since last September to about $2 trillion as it purchased government and corporate debt to help unfreeze credit markets and support banks’ demand for cash.

Taylor also said proposals for a systemic risk regulator may be misguided. Such a regulator wouldn’t have prevented the financial crisis, he said. "If it were given its own regulatory powers, they would be very difficult to limit," he said. "The experience during the panic last fall is not reassuring that such an agency could resolve private institutions without causing more systemic risks than it was trying to reduce." A systemic regulator isn’t a "magic bullet" and its existence could affect the performance of other regulators, he said. "I worry about that a lot, the way government works and the way passing the buck tends to happen," Taylor said.

The Fed and other regulators need to avoid frequent bailouts of companies, he said, adding that policy makers need clear alternatives to avoid multiple rescues. "Too big to fail occurs way too often," he said. "We have a bailout mentality. It has gone too far. It has become a presumption" that large financial firms will be rescued. Bernanke and U.S. Treasury Secretary Timothy Geithner in March called for new powers to take over and wind down failing financial companies following the government’s rescue of American International Group Inc. They also called for stronger regulation to limit risks taken by firms that could endanger the financial system.

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Euro zone output plunges more than 20%

Euro zone industrial production plummeted by more than a fifth year-on-year in March, data showed, setting a record and indicating first-quarter economic output could have contracted more than expected. Industrial production in the 16 countries using the euro fell 2.0 percent month-on-month and 20.2 percent year-on-year, the European Union's statistics office, Eurostat, said on Wednesday. Economists polled by Reuters had expected a 1.0 percent monthly decline and an 18.0 percent year-on-year drop. "This sure is a horrible number," said Kenneth Broux, economist at Lloyds TSB Corporate Markets.

The data offered no cause for optimism about "green shoots" of economic recovery, seen in some forward-looking business surveys, economists said. "There are no green shoots here, everything is either a quarter or a fifth down on the year," said Stuart Bennett, European economist at Calyon. "Perhaps Q2 GDP will prove better than Q1 but the outlook remains very weak." Economists polled by Reuters expect first-quarter GDP to have shrunk by 2 percent, and see a contraction of 0.6 percent in the second quarter. A Eurostat estimate of first-quarter GDP is due on Friday at 10 a.m. British time. Industrial production accounts for roughly 17 percent of euro zone gross domestic product and the grim March output data could mean the economy shrank more than economists expect.

"Following today's release this indicator is pointing to a -2.2-2.3 percent quarter-on-quarter reading in Q1. This suggests downside risks to our 2 percent forecast," said Saleem Bahaj, economist at Goldman Sachs. Eurostat also revised down production data for February to a monthly fall of 2.5 percent from the initially reported decline of 2.3 percent and, in year-on-year terms, to a plunge of 19.1 percent from 18.4 percent. "Together with downward revisions to the previous monthly outcomes, this left output down by an astonishing 7.9 percent in the first quarter, compared to a 6.5 percent fall in the fourth quarter," said Nick Kounis, economist at Fortis. "The outcome is consistent with GDP contracting by just above 2 percent quarter on quarter in Q1, following the 1.6 percent fall seen in the previous quarter," he said.

The production drop resulted from a 27 percent annual fall in the output of intermediate goods and drops of more than 23 percent in the output of capital and durable consumer goods. "Fortunately, more recent evidence indicates that the second quarter will be considerably less negative and we continue to expect the economy to stabilise in the second half of the year," Kounis said. Economists in the Reuters GDP poll see a 0.2 percent contraction in the third quarter and 0.1 percent growth in the final three months of this year. In Germany, the euro zone's biggest economy, production in March eased only 0.4 percent month-on-month, Eurostat said, apparently bottoming out after monthly drops of 6.2 percent in January and 3.7 percent in February.

But France and Italy, the second and third biggest respectively, offered no relief with steeper-than-expected monthly output falls of 1.4 percent and 4.6 percent in March against -1.0 and -4.6 percent in February. Economists also said that, sooner or later, manufacturers were bound to benefit from a move to replenish inventories, which must have fallen in recent months as production shrank. But the timing for that was unclear. The latest European Commission survey for April showed companies still saw their stocks as too high. "With firms likely to continue to run down their stocks, the industrial sector looks set to act as a drag on the economy for some time yet," said Ben May, economist at Capital Economics.

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SEC Staff to Recommend Civil Charges for Mozilo

Staff at the Securities and Exchange Commission have decided to recommend filing civil fraud charges against Angelo Mozilo, the co-founder of Countrywide Financial Corp., according to people familiar with the investigation. The SEC sent a so-called Wells notice to Mr. Mozilo several weeks ago alerting him of the planned charges, the people said. The potential charges include alleged violations of insider-trading laws as well as failing to disclose material information to shareholders, according to one person familiar with the matter. A Wells notice is a precursor to a civil lawsuit in an SEC investigation.

It outlines to an individual or company under investigation what charges might be filed against them and gives a target a chance to respond to the allegations. Mr. Mozilo's attorneys could still persuade the SEC's commissioners not to bring a case. Countrywide was once the nation's biggest home-mortgage lender. Amid the housing downturn, it was acquired last year by Bank of America Corp. Mr. Mozilo has previously maintained that he hasn't done anything wrong. If the SEC's commissioners approve the filing of a civil suit against Mr. Mozilo, it could be announced within the next few weeks, say people familiar with the matter. David Siegel, an attorney for Mr. Mozilo couldn't immediately be reached for comment. SEC officials also didn't respond to calls for comment.

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Obama Administration Plans New Regulations for Derivatives

The Obama administration will detail this afternoon its plan to regulate the exotic financial contracts that helped fuel the global crisis and crippled some of the biggest names on Wall Street, such as American International Group, sources familiar with the matter said. The proposal, which will require congressional action, imposes a number of restrictions on the so-called dark markets that trade a broad range of these instruments, known as derivatives, without government oversight. An announcement is scheduled for 4 p.m. The heads of the Treasury Department, Securities and Exchange Commission and Commodity Futures Trading Commission are likely to jointly unveil the proposal.

The administration is seeking to amend securities law so that most derivatives would have to be traded through central clearinghouses regulated by the SEC and the CFTC. In turn, the clearinghouses would require traders to maintain enough money in reserve so they could cover losses in any investments gone bad. These so-called margin requirements have been a hotly debated issue between the government and private traders because it curbs their profits. The two government agencies would also impose record-keeping and reporting requirements for the traders, ensuring a paper trail for their activities.

In addition, the government is seeking to increase the powers of the market regulators to clamp down on fraud. The government would also have greater authority to prevent anyone from cornering a market, especially in commodity trading where a few investors can have an outsized effect on the price of a critical good such as natural gas or cotton. Some derivative contracts would still be traded outside of the clearinghouses under the administration's plan. But such trades much be reported to the clearinghouses so that all investors could get a full view of the market activity.

Lack of information about derivatives raised grave concerns last fall as the crisis threatened to topple the financial system. Because regulators did not know precisely how many firms and investors were trading derivatives, officials struggled to understand how the crisis was spreading. In the late 1990s, some government officials proposed regulating this market. But top economic officials inside the Clinton Administration were concerned about undermining financial innovations and rejected the suggestion. The market for derivatives has since ballooned in the tens of trillions of dollars, outpacing the growth of the traditional stock and bond markets. Suspicious have grown about whether traders have been able to use derivatives to manipulate the market. While the SEC has oversight over most kinds of securities and the CFTC has oversight over most kinds of commodities, many derivatives have escaped regulatory scrutiny.

Several companies have already received approval from regulators to set up clearinghouses. The derivatives industry, aware of looming regulation, has been pushing derivatives firms to move their contracts onto clearinghouse platforms. Some analysts recently have been warn of loopholes in the administration's plan, which officials have hinted at in recent months. The proposal would allow a limited number of highly specialized derivatives to trade without going through a clearinghouse. Some analysts warn that this exception might lead derivatives traders to create increasingly complex derivatives to avoid regulation.

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Documents imply banks were given no choice on U.S. bailout

Newly released documents highlight the urgency last fall at the Treasury Department for the CEOs of nine major banks to accept billions of taxpayer dollars as the government worked to rescue the nation's banking system. The documents, which were obtained by the conservative legal watchdog group Judicial Watch through the Freedom of Information Act (FOIA), were released Wednesday. They seem to indicate the banks were given no choice but to take the money. According to a document marked "CEO Talking Points" prepared for then-Treasury Secretary Henry Paulson, "if a capital infusion is not appealing, you should be aware your regulator will require it in any circumstance ..." and warned, "We don't believe it's tenable to opt out because doing so would leave you vulnerable and exposed."

The talking points also showed how the department would announce the move, and how it would characterize the banks' participation. "We plan to announce the program tomorrow and that your nine firms will be the initial participants. We will state clearly that you are healthy institutions, participating in order to support the U.S. economy," the documents said. The Treasury Department had no comment. The crisis talks between the bank CEOs and the Treasury Department were widely reported last fall, but these documents reveal the minute-by-minute drama behind the scenes as the government pressured the banks to take the bailout money.

The Treasury Department gave the CEOs a one-page form containing four bullet points. Written in by hand on each form was the name of the bank and amount of money the bank would take from taxpayers. In exchange, the banks agreed in writing to "expand the flow of credit to U.S. consumers and businesses." E-mail communications among Bush administration officials reveal the concern at Treasury when they spotted the cameras staking out the entrance of the department as the CEOs arrived, and their attempts to keep the CEOs moving quickly into the building and away from the cameras. Other e-mails reveal that Paulson reached out to the presidential campaigns of both Barack Obama and John McCain to brief them on the program. 

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Congress to AIG: We don't trust you

The CEO of bailed-out insurer American International Group told Congress on Wednesday that the company has made "substantial" progress in its restructuring efforts, but lawmakers said they wanted more to show for it. "We are hearing, 'Trust us,' but we are not willing to let $180 billion go just on trust," said Rep. Edolphus Towns, D-N.Y., chairman of the House Oversight Committee. "We will question; we will inquire; we will verify." Chief Executive Edward Liddy, who said AIG is diligently working toward repaying its billion-dollar government bailout, described the company's plan.

"We continue to weigh every decision regarding the restructuring with several criteria in mind," Liddy said. "Will this action facilitate a reduction in systemic risk? Is this action the best use of the federal assistance we are receiving? Will this action enhance our ability to pay back the government?" "The restructuring efforts ... are a reflection of this thought process," he added. Liddy was asked by Towns to submit a roadmap of the company's repayment and restructuring plan, known as "Project Destiny," prior to the hearing. But AIG did not meet his request. "The questions we are raising today should be easy enough to answer, but unfortunately, AIG has failed to fully respond to straightforward requests for information," said Towns. "This cannot continue." Liddy said AIG will provide the committee with "broadbrush strokes" about the plan, but that details would provide sensitive information to the company's competitors.

He said he submitted the roadmap to the Federal Reserve under a confidentiality agreement. After prodding by several committee members, Liddy tentatively agreed to share the plan with Congress under a similar understanding. "If all of the operating details were to be made public, it would put us at a severe disadvantage to repay the American public," Liddy said. In a broad description of the company's plan, Liddy said AIG will sell stakes in its foreign life insurance units to the government, and a 20% stake of its property and casualty business (AIU) in an initial public offering.

Oversight: For the first time since their January appointment, the three trustees overseeing AIG's restructuring also testified. Jill Considine, a former Depository Trust official; Chester Feldberg, a former New York Fed official; and Douglass Foshee, chairman of El Paso Corp. were appointed on Jan. 16 by the Federal Reserve to represent the taxpayers' 77.9% ownership stake in AIG. The trustees said they didn't actually start doing any work until March 4, because it took that long for the insurer to transfer its stake in the company to the government. Little is known about trust's operation, and Congress grilled the trustees about their responsibilities. The trustees said they were tasked to act as independent shareholders, though they are required to report to the New York Fed on a monthly basis. They said they meet at least once a week and submit their meeting minutes to the New York Fed. "We are in uncharted waters," said Considine. "We're a unique instrument, but the trust is perfectly tailored to the situation."

Several committee members asked for more transparency, including copies of those minutes, but the trustees said they believed the minutes were the property of the Fed. The three trustees also said they are mandated to stay out of AIG's day-to-day operations and are not allowed to sit on the insurer's board of directors. But in an effort to meet their responsibility for voting on behalf of shareholders, they said they are actively seeking new board members for AIG. They also had mostly favorable comments about Project Destiny, which they have reviewed. "Based on what we've seen, the plan makes sense," said Foshee. "But one of the challenges AIG faces is you don't want to sell the crown jewel assets in a market where you won't get full value for them."

Bailout progress: AIG's recovery was expected to be a relatively quick process, but the government's bailout of AIG more than doubled to $182 billion in eight months, of which AIG has drawn more than $130 billion. AIG has been trying to sell off many of its businesses to repay the loan, but in the current credit environment, few companies have been receptive to AIG's asking prices. Also hampering its repayment efforts, AIG posted its sixth straight quarterly loss last week, even as it made significant strides to wind down its financial products division, which was at the root of the company's collapse. Liddy estimated that the bailout could be repaid in three to five years, "if global market conditions stay the same or improve." "How long the plan will ultimately take will very much depend on how quickly and how strongly the global economy recovers," Liddy said.

Bonuses: Liddy continued to face scrutiny about the millions of dollars of bonuses it paid to its executives last year. Liddy was grilled about the discrepancy between the $165 million in retention bonuses it sent to executives at its crippled financial products division announced in early March, and the $454 million in bonuses it paid to all of its executives, which the company later announced. "I apologize for confusion," Liddy said. "The first question we were asked was about corporate bonuses, how many bonuses were paid corporate wide, anywhere in the country. A different question led to a larger number." "We try to be cooperative, but sometimes we are drowning in requests," he added.

Rep. Patrick McHenry, R-N.C., also questioned Liddy about when Treasury Secretary Tim Geithner first learned about the bonuses. A controversy brewed in March, after Geithner initially said he learned about the bonuses in the second week of the month, but Liddy testified that Geithner knew of the bonuses in the first week. Geithner later clarified his comments, saying he only learned of the "full scope" of the bonuses in the second week of March. McHenry wanted to know if Geithner, when meeting with AIG as president of the New York Fed in late 2008, discussed the bonuses with Liddy. "You met with Geithner in September, October, November, but did not mention the word 'bonus?'" asked McHenry. "No," replied Liddy.

Ohio pensions: Liddy also faced scrutiny from Rep. Dennis Kucinich, D-Ohio, about a fraud case involving Ohio state employees and AIG. The case involved a so-called finite reinsurance transaction with competitor General Re that then-New York state Attorney General Eliot Spitzer said allowed AIG to improperly boost its loss reserves by $500 million in 2000 and 2001, inflating financial results. The investigation led to the ousting of then-AIG CEO Hank Greenberg in 2005, and the insurer's stock fell substantially. Three Ohio state pension funds then sued AIG for substantial losses resulting from the investigation. AIG paid $1.6 billion to New York state regulators, but the case in Ohio is ongoing. Kucinich took issue with the controversial decision for AIG to pay back its counterparties in full on losses suffered from derivatives that the AIG insured. "AIG repaid counterparties one to one, dollar for dollar, but when it comes to teachers and firefighters in Ohio, [they got] zero," Kucinich said. "This is not acceptable, Mr. Liddy. I'm not going to let you get away with it." 

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Québec hearings on Caisse’s $40 billion ABCP losses

The Caisse de dépôt et placement du Québec (Caisse), through its representatives, provided clarification on its 2008 financial results at the public hearing held today in Québec City by the National Assembly’s Committee on Public Finance:

Fernand Perreault, Strategic Adviser to the President, Claude Bergeron, Senior Vice-President, Legal Affairs, and Assistant Secretary, and Richard Guay, Strategic Adviser to the President, each made a brief statement before answering the Committee members’ questions. The texts of their statements are available on the Caisse website.

Statement of Fernand Perreault (PDF)
Statement of Claude Bergeron (PDF)
Statement of Richard Guay (PDF)

The statements are in French, but there was some media coverage in English. What the committee heard was that the Caisse ignored warning signs:

Days before the market for non-bank commercial paper collapsed, in August 2007, the Caisse de depot et placement du Quebec was still buying the paper, which turned out to be tainted investments.

Claude Bergeron, senior vice-president of legal affairs at the Caisse told a Quebec legislature committee Tuesday that despite the warning signals, which he described as "a certain panic" a month earlier, the Caisse did not foresee the collapse.

"No one could predict that a few days later we would live through such an event," Mr. Bergeron said Tuesday.

He told the committee, which is looking into how the Caisse lost $40-billion in the value of its portfolio last year, that Caisse managers considered the commercial paper to be safe, an opinion reinforced by the DBRS bond-rating service, which blessed it with its top AAA rating.

Warning signals came, Mr. Bergeron said, when Coventree, a Toronto company the Caisse held shares in, and an issuer of commercial paper, warned its products contained 4% subprime mortgages.

That was July 24, 2007.

Then-Caisse president Henri-Paul Rousseau was informed of the problem on Aug. 9, 2007, Mr. Bergeron said.

Mr. Rousseau has accepted responsibility for the Caisse investment in the non-bank commercial paper, which accounted for $4-billion of the $40-billion lost last year.

Mr. Bergeron explained that the Caisse had been buying the commercial paper since 1998, because it carried a bit more interest than treasury bills, the conventional way the Caisse held its liquidities.

"We adopted the behaviour of the market," he said.

In addition to the AAA rating, because the assets backing the notes were from several sources, this plurality of assets reduced the risk, Mr. Bergeron said.

The market for commercial paper collapsed when investors realized they were backed by subprime mortgages and other dubious assets.

A bit more risk than T-bills? Hah! Try a hell of a lot more risk than T-bills. What exactly was the spread over T-bills? If it was a nominal spread (20 basis points), appearing to be safe, then why didn't this spread accurately reflect the liquidity risk and embedded leverage risk of the trusts? Moreover, why did the benchmark governing the cash portfolio not reflect credit risk, liquidity risk and embedded leverage of non-bank ABCP? How much money did the money market portfolio managers and senior management make over the last five years as they easily beat this bogus benchmark?

Everybody in the world knows what Treasury bills are, including my 90 year old aunt. But when you start buying crap that some ratings agency slapped a "AAA" rating (DBRS rated ABCP R1, the highest rating for commercial paper) on without conducting your own proper due diligence on the underlying investments, you are either completely incompetent or willfully trying to game your benchmark by buying assets with a liquidity mismatch and credit risk so you can then turn around to collect a big bonus at the end of the year. It's the scam of the century and Quebecers should be outraged.

Fernand Perreault, the former interim head of the Caisse and Richard Guay, the man he replaced, also spoke at the hearing:

Fernand Perreault, the former head of the Caisse, also testified and attributed the disastrous result in 2008 to the "error" of acquiring so much asset-backed commercial paper and to the collapse of the market.

Perreault, who was interim CEO after the departure of Richard Guay, said the Caisse would have done well had it not been for the ABCP and the exceptional circumstances.

Perreault also defended the Caisse's risk management policy, which has been cited as one of the reasons for the pension-fund manager's poor performance in 2008.

He said the Caisse's policies were similar to those of other financial institutions.

Perreault later admitted the practices constituted "too high a risk" by the end of 2008, when the markets were in freefall.

"Our practices in terms of diversification, leverage, risk management, variable pay, were neither new, nor unique, nor unusual nor excessively risky in the context that existed before the fall of 2008," Perreault said.

Guay also testified Tuesday at the commission, saying he was exhausted and overwhelmed by the effects of the financial crisis while in the top job. He said he preferred to quit his post rather than make mistakes at the helm of the financial institution.

"I did not know that the financial crisis would reach such a scale," he said.

Guay said he was beset by anxiety and fatigue shortly after taking the job and took the "difficult and agonizing" decision to return to the sidelines.

"I was split between my duty to the organization, to support the management and my colleagues to find a solution to the financial crisis which had hit the Caisse's holdings and my fears of making mistakes due to fatigue," he said.

Here is what irks me. The Caisse invests in the best hedge funds in the world. You'd think some of these "geniuses" would have told them that they saw trouble brewing after those Bear Stearns hedge funds folded back in June 2007. That was the first sign that counterparty risk was set to explode.

Importantly, it's just too easy to say "we didn't see this coming" when in reality it was their job to protect the fund's total assets from such a disaster scenario. What exactly was the game plan?

And defending the Caisse's risk management policies? What risk management policies? Give me a break. How many senior portfolio managers lost hundreds of millions at the Caisse in 2008? How can Mr. Perreault defend risk management policies with a straight face knowing the internal blow-ups that took place at the Caisse in 2008?

Keep in mind Mr. Perreault is the Head of Real Estate at the Caisse, and in my experience, most real estate managers don't have a clue about proper risk management in public markets.

All in all, the media coverage of these hearings is flimsy. I hope we get better coverage next week when the big guy - Henri-Paul Rousseau - shows up to testify. That should be interesting.

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Megacities Threaten to Choke India

Voting is drawing to a close Wednesday in India's largest election ever, and a slowing economy, terrorism and the rural poor have been front and center in the campaign. But of growing concern are the country's teeming new megacities, which are swelling rapidly even as jobs dry up and funding for infrastructure disappears. This capital of the northern state of Uttar Pradesh was once an orderly place known for its baroque monuments and lush gardens. Today, Lucknow has more than 780 slums, overflowing sewage pipes and streets choked by gridlock. Its population of 2.7 million, nearly triple the number in the 1980s, is adding as many as 150,000 new residents a year.

Shami Shafi, a 35-year-old laborer in Lucknow, has seen his daily income drop by half in recent months to 50 rupees, or about $1, for carrying bags of potatoes and other goods in a local market. But "I'm not going back to my village," he says. If work gets harder to find, "I'll just go to another city." Across India, poor migrants keep streaming into cities like Lucknow, many of which are woefully mismanaged and ill-equipped to handle the influx. India has at least 41 cities with more than one million people, up from 23 two decades ago. A half dozen others will soon join the megacity list. Urban experts say the risk is now rising that some of these cities could face the same fate as Mumbai and Calcutta, which became synonymous with poverty and decay in the 1970s and 1980s. Indian politics has long been dominated by rural constituencies -- 70% of the population still lives in the countryside. But urban voters are seen by candidates as increasingly crucial. Both of the main political parties have tried to capitalize on rising urban discontent by promising to deliver more spending on power, roads and other infrastructure.

There is "no doubt that India's future is in the cities," says M. Ramachandran, secretary at India's Ministry of Urban Development. What's happening in India is part of a world-wide challenge. Megacities are sprouting around the globe. But in billion-person India, the trend is on steroids. The country already has 25 of the world's 100-fastest growing urban areas, according to City Mayors, an international urban-affairs think tank. That compares with eight in China. Pune, near Mumbai, has more than four million people, about the same as the Houston area. Kanpur, in north central India, has more than three million, as does Surat, in western India. India is expected to add 10 million people a year between 2000 and 2030 to its 5,161 cities, according to the United Nations. If India fails to get a handle on its new urban areas, it could be saddled with more bottlenecks and inefficiencies that could doom the country to years of subpar growth, says Dharmakirti Joshi, an economist at Mumbai ratings agency Crisil. India's gross domestic product has been growing faster than that of most other developing countries, averaging 8.8% a year in the past five years, according to the International Monetary Fund. But economists say inadequate roads, electricity and other infrastructure shave one to two percentage points off growth each year.

Officials have taken some steps to improve things. The Jawaharlal Nehru National Urban Renewal Mission was launched in 2005 by the national government to help more than 60 major cities by spending $10 billion to upgrade sewers, water supply, roads and other necessities. But that falls far short of the $52 billion the government estimates it will take to fix India's urban infrastructure. Lucknow offers a case study of the challenges India's newer metropolises face. The city is famous as a center of high culture dating to the 1700s and 1800s, when it was ruled by a group of extravagant Persian noblemen known as nawabs. They built giant pleasure gardens and baroque monuments, some of which remain, and they left a legacy of courtly manners, poetry and fine cuisine. The city has changed dramatically in recent years. As the capital of Uttar Pradesh, India's most-populous state, Lucknow has attracted hundreds of thousands of migrants from rural areas, swelling the city's population. Yet the city hasn't completed any major new sewage infrastructure since before the country won independence in 1947. As much as 70% of residents don't have sewage service, leaving much of the waste to flow directly into the main river, the Gomti, which has become a stinking cesspool.

Traffic has overwhelmed downtown streets, and trash collection is inadequate. Much of Lucknow's rubbish is left to rot in piles or strewn about in residential neighborhoods. "I just see the city crumbling every year," says Mr. Joshi, the Mumbai economist. "It used to be a beautiful city." The number of slums in Lucknow has quintupled since the early 1970s, according to the Vigyan Foundation, a social-advocacy group in Lucknow. As many as one million people are living without proper sanitation, water supplies or other services, according to social activists. Many of the slums are located along railway beds or in flood plains, exposing residents to floods and other dangers. In one of the slums, a community called Azad Nagar, nearly 1,000 residents live in handmade thatch huts with packed mud floors and roofs held in place by trash and rag piles. Monsoon floods washed away much of the slum last year, but it was quickly rebuilt. Residents say cholera killed one child and snakes got another.

"At least it's better than in the village," says Shanti Kashyap, a 32-year-old mother of four who moved there from a rural town about 70 miles away. "In the village, you work all day long in the field and don't even get two meals." Now her husband works as a wall painter, earning about 100 rupees, or $2, a day. Of course, slums have always existed in Indian cities, including in Lucknow. But many advocates hoped India's modernization would reverse slums' growth. Instead, the opposite appears to be happening. Part of the problem: Lucknow, like many Indian cities, is managed by a bewildering array of government bodies that don't always coordinate activities. In theory, Lucknow is led by an elected mayor and 110-member Municipal Corporation, similar to a U.S. city council. Together, they share oversight of basic services such as water, housing and roads. But in practice, the elected officials' authority is sharply limited by the half-dozen or more other government bodies that wield power in town. Chief among them is the Lucknow Development Authority, a group of unelected bureaucrats who have the authority to develop new housing projects and roads within them. But after a few years, when the developments are completed, the LDA hands over management of the projects to the Municipal Corporation, which doesn't always have enough money to maintain basic services such as water, sewage and street lights.

The result is dysfunctional government, says U.B. Singh, an urban-studies professor at the University of Lucknow. The mayor has the power to authorize the building of new roads, but not new bridges -- a big problem in a city that flanks a river and is crisscrossed by canals. Despite rapidly falling water tables, there is no single authority empowered to determine when and where residents can drill wells. Private citizens regularly take matters into their own hands and drill for water themselves, further depleting the resources. "There is no concept of city planning, and what does exist only exists on paper," Mr. Singh says. "Planning has totally failed here." The mayor and a senior official at the Lucknow Development Authority say they're doing the best they can to follow sound planning guidelines and address residents' concerns. But they say the city is growing so fast that it's hard to keep up. Mukesh Kumar Meshram, vice chairman of the LDA, says the authority is adding thousands of housing units each year.

But, he says, "obviously the gap is always there. That's why the slums are being created -- whenever people find open space, they go." Lucknow does have a master plan, drafted by a team of 30 government staffers and finished in 2005. But its primary architect, a state planner named Satyavir Singh Dalal, says that master plans are routinely ignored by developers and politicians who start new projects wherever they please. "We have to make a lot of compromises," Mr. Dalal says. In some cases, he says, leaders follow planners' recommendations but take years or decades to get the work done. An earlier master plan in 1992 called for a new ring road to ease the city's traffic woes; it is only now nearing completion 17 years later. Another big problem is lack of money. Mayor Dinesh Sharma, a university professor, says his annual budget is $139 million. Some similar-size cities in the U.S. have budgets in the billions. He says his administration is focusing on projects it can control, such as an $800,000 program that involves rounding up stray dogs, monkeys and other animals and depositing them at a ranch called "Krishna's Garden."

The national Urban Renewal Mission project has helped by allocating roughly $150 million to Lucknow for sewage, wastewater treatment and other improvements. City and state officials say the sewage projects, which could be finished later this year, should cover most if not all of Lucknow's wastewater treatment needs. Mr. Dalal, the state planner, says that's unlikely. By his reckoning, about 30% of the city still won't have service after the improvements. Either way, the money is far short of the more than $960 million Lucknow needs to spend on roads, water and other projects, according to Feedback Ventures, a New Delhi-based infrastructure consulting firm that helped prepare a development plan for the city in 2006. Some advocates for the poor argue that money is available; it's just not being spent well. Urvashi Sharma, a local activist, says the Uttar Pradesh state government has allocated huge sums on projects of limited social value, including a $90 million monument being built to honor political leaders near the Gomti River.

It involves a massive domed monolith and public meeting area stretching over several city blocks, with a statue of Uttar Pradesh chief minister Kumari Mayawati across the street and a gallery of giant stone elephants, her political party's symbol. Navneet Sehgal, the state's secretary of urban development, says the project is an economic stimulus and has created jobs. Meanwhile, people continue coming. They include Ramesh Kumar, a man in his 40s who one recent morning was resting in the shade of 100-year-old Hindu temple where day laborers gather each day to wait for jobs. Mr. Kumar had come to Lucknow from a small village eight days before, leaving his wife and four children behind. He hadn't found work yet. He tried lowering his daily price from 100 rupees to 80 and then 60, without luck. Like many of the workers around him, he was sleeping on the ground by the temple. Living in the city may not be working out well so far. But then again, says Mr. Kumar, "we don't have anywhere else to go."

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