Rockefeller Center, New York City. RCA Building, general view from the old Union Club
Ilargi: People say the darnedest things (which is funny really only in kids), and sometimes it's good to look more closely. We've noticed the Anglo media's tendency to talk down other countries' economies many times before, and that just won't stop. In their view, Germans are incredibly stupid, and so are the Chinese. They should do what America and Albion do: why won't they recognize the shining examples these two provide? Likewise, economists, politicians and investors can't seem to be able to quit touting the advantages of innovations in the markets, no matter that they are tearing entire economies, including their own, to shreds.
I guess the light supposedly shining through the trees on the green shoots in the gutter actually makes them believe what they say, even as I find it hard to believe it could. But why wouldn't they feel good, now that we see the US administration back down off its salaries and bonuses limits for the financial industry? Look at the bright side: whoever gets a piece of the upcoming GM bankruptcy action, first Chapter 11 and later Chapter 7, stands to make billions. (Which reminds me, 7/11 gets a whole new meaning).
Long time economics writer Anatole Kaletsky states in Europe waits for Germany to come to the rescue:
That continental Europe — and Germany, in particular — has suffered far worse from the credit crunch than the US or Britain should come as no surprise.[..]Mr. Kaletsky, I know a lot of people will read this and believe what you say without any questions. As for me, I'd like to know what your conclusion is based on. And for me, it does come as a surprise. So much so that I don't believe a word you say.
The German economy has now been falling at a rapid and accelerating rate for four consecutive quarters, resulting in a year-on-year decline of 6.9 per cent. The comparable figures for the US and Britain are 2.6 per cent and 4.2 per cent.First, according to the Bureau of Economic Analysis at the US Department of Commerce the US falls far faster today:
"Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 6.1 percent in the first quarter of 2009, (that is, from the fourth quarter to the first quarter), according to advance estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP decreased 6.3 percent."What I find more interesting, though, is the well-established inbred temptation within the US to underreport all negative numbers. I haven't seen such things in Germany. What I have seen are lots of apples and oranges comparisons in the UK and US, applied with the express purpose to make their own respective economies look better. Let's try this on for size: no German carmaker has yet gone bust. In the US, one has, and the second will follow any day now. No German state is on the verge of collapse; in the US, the economically largest state is. At best, we're talking numbers that are disputable. To contend that "Germany, in particular — has suffered far worse from the credit crunch than the US or Britain.." merely serves to make its author look either disingenuous or lacking in active neurons.
In Asia will author its own destruction if it triggers a crisis over US bonds Ambrose Evans-Pritchard scales new lows by stating that :
"Asia cannot yet stand on its own two feet"Excuse me, but what sort of statement is that? Ambrose uses China's (and Japan's) economic problems to argue that they have no choice but to keep buying US debt. With what, AEP? With the same money you yourself claim is badly needed to build domestic demand for their industry? While Chinese exports are down 23%? It's tempting to see the Chinese as really dumb people, isn't it? And you know what I think? I think they like it that way, because while you're blabbering to the hand, they can do what they want. China cannot stand on its own feet, after doing so for thousands of years?
And while we're at it, let's put out Niall Ferguson by the curb with the trash as well. The man's an economics professor at Harvard, believe it or not. The following paragraph from Diminished Returns in the New York Times is the blindest piece of trash:
"We need to remember that much financial innovation over the past 30 years was economically beneficial, and not just to the fat cats of Wall Street. New vehicles like hedge funds gave investors like pension funds and endowments vastly more to choose from than the time-honored choice among cash, bonds and stocks. Likewise, innovations like securitization lowered borrowing costs for most consumers. And the globalization of finance played a crucial role in raising growth rates in emerging markets, particularly in Asia, propelling hundreds of millions of people out of poverty."
Economically beneficial? The pure illusion of riches is economically beneficial?
"New vehicles like hedge funds gave investors like pension funds and endowments vastly more to choose from..."
Gave them vastly more to choose from. And then blew them to smithereens. Beneficial? Hundreds of millions of people "propelled" out of poverty? Does it matter that billions now fall (backward or forward) into new-found poverty? Economists like Ferguson are delusional dangers to their environment. This sort or "reasoning" is akin to saying that shooting up heroin must be beneficial, because, after all, it makes you feel good.
The only reality that lasts is that these creative and innovative instruments are murdering all but a handful of pension funds and endowments, along with countless cities, counties, states and a multitude of other entities including soon entire nations, that consumers who "profited" from borrowing costs lowered by securitization are losing their homes by the millions, and that emerging markets should no longer be called emerging; disappearing markets is a much more accurate term.
Financial innovation has burdened our economies, and our individual selves, with a debt-load that until as recently as 10 years ago would have been considered completely unimaginable. For a professor of economics at Harvard, however, reality is something entirely different: it's a world where the only thing that has real value is the high that occurs in the first few instants after you pull the needle out of your arm.
Smaller US banks need additional $24 billion
Small and medium-sized US banks must raise some $24bn to meet the capital standards set by the government in its stress tests of large institutions, research for the Financial Times shows. News of the potential capital shortfall could increase pressure on many of the 7,900 US banks that form the backbone of the US financial system. As many as 500 more banks could close, according to investment bank Sandler O’Neill, which carried out the research. Since this month’s release of the tests for the 19 largest banks, regulators and investors have increased their focus on the next tier of lenders, amid concerns some of them might struggle to survive if the economy worsens. The government’s stress-case would result in capital shortfalls for 38 per cent of the 200 banks below the 19 largest financial institutions, leading to a deficit of around $16.2bn in common equity, according to Sandler O’Neill. Applying similar criteria to the remaining 7,700 banks in the US would result in a further $7.8bn capital deficit.
The banks have to repay a combined $27bn in aid from the Troubled Asset Relief Programme (Tarp) but they could do that from internal resources rather than raising more funds. The US Treasury has said that it does not intend to extend the stress tests beyond the 19 top institutions it examined. But analysts say that the public release of the government’s test methodology and capital adequacy philosophy means that the tests’ standards will become a model for the rest of the US banking system. "This will ultimately migrate down the banking industry no matter what Treasury says," said Robert Albertson, chief strategist at Sandler O’Neill. "It’s like telling bank examiners to close their eyes and not to think of a chicken." The government found 10 of the largest 19 US financial institutions in need of additional capital earlier this month, identifying a $74.6bn combined shortfall. The application of the large bank stress tests could make some smaller banks vulnerable, say analysts. Some smaller banks may either struggle to raise capital or have less flexibility to do so. That, in turn, could lead to a flurry of takeovers. "At some point there’s going to be massive consolidation," said one industry banker. "But for now, a lot of banks are going to raise as much capital as they can."
At Geithner's Treasury, Key Decisions on Hold
Seven weeks after the Treasury Department announced that it was ousting General Motors chief G. Richard Wagoner Jr. in the federal bailout of the company, he is still technically on GM's payroll.
Wagoner's removal has been held up because senior Treasury officials have yet to decide whether he should get the $20 million severance package that the company had promised him. The delay is one of many hitches that have slowed a host of important policy actions in the four months since Timothy F. Geithner became Treasury secretary. While Geithner has taken dramatic steps to address flashpoints in the economy, the work of carrying out those policies has bogged down because critical decisions about how to do so aren't being made, interviews with a broad range of federal officials show.
Government officials, inside the Treasury and out, say the unresolved issues are piling up in part because of vacancies in the department's top ranks. But some of the officials also cite the Treasury's ad-hoc management, which is dominated by a small band of Geithner's counselors who coordinate rescue initiatives but lack formal authority to make decisions. Heavy involvement by the White House in Treasury affairs has further muddied the picture of who is responsible for key issues, the officials add. One of the department's signature initiatives, considered vital for getting at the root of the financial crisis, aims at relieving banks of their toxic assets. But to those familiar with the program, it remains unclear who will decide some of the practical details, such as whether foreign firms will be allowed to participate in the funds that buy the assets. This uncertainty is slowing the rollout of the program, which in any case has proven daunting to design. Announced in early February, it may not launch until July, officials say.
In March, Treasury officials clashed over a $15 billion initiative to use money from the federal bailout package to free up credit for small businesses. Geithner's counselors pressed to announce the program quickly, despite protests from the career staff members who said it would not work. Unable to raise the issue with Geithner himself, the staff members appealed directly to the White House but were rebuffed, according to sources familiar with the episode. President Obama announced the program two months ago, and it is still struggling to get off the ground. Officials are looking to overhaul the proposal. And in the wake of the public firestorm over bonuses paid by American International Group, senior Treasury officials have been meeting several times a week all spring to review, one by one, the payments to the company's executives. But the time-consuming discussions have never resolved whether any of the executives should get paid.
Geithner said in interviews that some of the department's internal difficulties result from the intense pressure on officials to develop a raft of rescue initiatives in a very short time. "We were just putting enormous pressure on these people to put in place and execute this comprehensive set of programs," Geithner said. "In a crisis, the most important thing is to show the capacity for credible initiative that is actually going to fix the problem. That's why we are trying to do so much so early." He added, "It could get tough at times . . . but I think they are doing a great job in that context, and they are working 24 hours a day to put out A-plus policy."
Still, some lawmakers and government officials said Geithner needs to be a stronger manager. "No one knows how to get decisions made," said a senior government official familiar with the Treasury's inner workings. "Major decisions can happen very fast at the top, and then after that there are tons of detail and nuances that have to get worked out without clear chains of command. Either the seats are unfilled . . . or you have to answer to a half a dozen counselors running around." So far, nearly four months after the Obama administration took power, the Treasury Department is still without a deputy secretary. Two undersecretary positions -- including the vital post overseeing domestic finance -- have not been filled and many other division heads have not been named. The White House vetting of potential candidates has proven arduous, and nearly all of those individuals nominated have yet to win Senate confirmation and fill out Geithner's team.
"I've seen the effect of this, and I wish he would move quicker to put in his own people," said Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee. Help could soon be on the way. Confirmation hearings for Neal Wolin, the administration's pick for deputy Treasury secretary, began a week ago. Treasury staff members have been impressed by the management skills of former Fannie Mae chief executive Herbert M. Allison Jr., who awaits confirmation as Geithner's pick to lead the bailout operations. The White House is also seeking to bolster the Treasury's ranks by adding former Clinton press secretary Jake Siewert as counselor to Geithner.
Aside from getting officials into place, Geithner still needs to define the roles of his senior counselors and delegate some decisions to lower-ranking officials, several government officials said. "Tim's nature is to be very inclusive," said an official who frequently interacts with the Treasury. "But there are too many decisions to make with 20 guys around his table." While federal departments often experience a degree of upheaval when administrations change, the difference between the Treasury of former secretary Henry M. Paulson Jr. and Geithner's has been stark. Under Paulson, the department nearly always made its own decisions. The Bush White House, nearing the end of its tenure, hardly intervened. But now, even minor matters, such as Web site design or news releases, are reviewed by the White House.
Staff members detailed from the National Economic Council, reporting directly to Obama senior economist Lawrence H. Summers, roam the Treasury building. Treasury staff members working on restructuring the nation's automakers took much of their direction from the NEC, sources said. Geithner said he welcomes the input from senior White House officials because they provide intelligent feedback and because he has been short-staffed. After studying the last dozen Treasury secretaries, Geithner said he became convinced that the Treasury needed to closely collaborate with the White House. But the time spent meeting with White House colleagues on high-priority issues -- from the federal budget and tax policy to health-care reform and a proposed overhaul of financial regulation -- has left him little chance to manage his staff.
"People think he's very, very smart, but he has not exerted a management presence yet," added a source familiar with the Treasury's inner workings. "He's being stretched in a thousand directions . . . but I don't know if that absolves him of responsibility for management." Geithner insists he has been tending to his staff, reaching out across the department in a way his predecessor never did. He said he encourages anyone with problems to come to him directly and regularly speaks with the rank-and-file. "I know everyone would like a little more clarity about who's going to be working for whom, which we are trying to give them," he said. "But in the interim we are just trying to get stuff done the best we can."
America's New Savings Habit Kills Global Trade
Americans have rediscovered the joys of saving, but that revelation has hardly been joyful for exporters overseas. Today's chart compares the savings rate to container volume at the Port of Los Angeles, where many imports from China arrive. Though volatile, there's a nice symmetry. As the savings rate declined throughout the late 90s and early part of this decade, port volumes soared. Both of those trends have reversed violently in just the last few quarters.
Voters to Face 6 Measures on Finances in California
When California voters go to the polls on Tuesday to decide the fate of six budget-related ballot measures, one could argue that they have only themselves to blame. After all, most of the measures — Propositions 1A through 1F — alter laws or rules they previously passed by initiative. Proposition 1E, for example, temporarily redirects money guaranteed for mental health services by Proposition 63, which voters approved in 2004. Proposition 1D does the same for money due to early childhood programs and guaranteed by Proposition 10, passed in 1998. And Proposition 1C seeks to modernize the lottery, which was created by voters in 1984, and allow the state to borrow from future profits. "No one piece is incredibly complicated," said Mac Taylor, the head of the Legislative Analyst’s Office in Sacramento. "But with some I don’t know how a voter on their own would make sense of them."
All six measures were put on the ballot after a much-delayed budget deal passed in February, closing a $42 billion gap. But pollsters say the complexity of the issues and a profound sense of voter discontent may have a deadening effect on turnout, something that proponents of the measures fear. "I do hope that voters understand how serious this is," the California Assembly speaker, Karen Bass, a Los Angeles Democrat, said in an interview last week. "I do think if we fail and if we have to impose more cuts, the outrage will far surpass the anger people feel in having to participate in fixing the budget." The voting will take place at a time when Californians are deeply unhappy with the performance of their elected leaders. Polls have shown five of the six propositions trailing. Tellingly, the only measure leading — Proposition 1F — is one that seeks to place curbs on legislators’ salaries.
Perhaps the biggest issue in front of voters, policy experts say, is Proposition 1A, which would increase the amount of money funneled into the state’s rainy-day fund, restrict spending from it and extend several temporary taxes. Proposition 1B, which is related, would require $9.3 billion to be paid to education to make up for shortfalls in spending levels set, as it happens, by Proposition 98, which voters approved in 1988. Gov. Arnold Schwarzenegger, a Republican, has been campaigning for the measures, saying they would "stop that madness" of budget booms and busts. But opponents say the first measure is just a reheated version of the spending cap that Mr. Schwarzenegger unsuccessfully tried to have passed in a 2005 special election. "This is just his next attempt to put a fiscal straitjacket on the investments we need to build a better California," said Mike Roth, a spokesman for the union-backed No on 1A coalition.
The measure is also opposed by antitax groups already upset at the passage of an additional 1 percent sales tax, which would be extended by two years under Proposition 1A, and at increased vehicle and income taxes. All were approved in the February budget deal. Supporters of measures have cast passage as an important step in solving the state’s budget troubles. But the ballot questions are not being sold as silver bullets. Last week, in fact, Mr. Schwarzenegger announced that the state, battered by recession, would face a budget gap of $15.4 billion for the coming year even if the measures passed. The damage, though, would be even worse if they failed. Such arguments do not seem to be resonating with voters. Mark Baldassare, the president and chief executive of the Public Policy Institute of California, said Californians had lost confidence in state leaders on fiscal issues. "Now the governor and Legislature are coming to say, ‘This is the best we can to do,’ " Mr. Baldassare said. "And thus far, that has not been a message that has swayed voters."
Dealer Math Is More Sales from Fewer Stores as GM, Chrysler Mimic Toyota
General Motors Corp. and Chrysler LLC, borrowing from the playbook of Toyota Motor Corp., are betting they can sell more cars with fewer dealerships. Plans announced last week to shed almost 2,000 retail outlets are designed to bolster the survivors, GM and Chrysler said. Reducing competition from stores with the same brands is supposed to allow the remainder to boost prices and profit, and to reinvest in their businesses to keep adding customers. That echoes the strategy of Toyota, the world’s largest automaker, in growing to second behind GM in U.S. market share. U.S. stores for Toyota and Honda Motor Co. each averaged more than 1,100 sales in 2008, almost three times as many as GM’s and Chrysler’s, consulting firm Grant Thornton found.
"There’s the school of thought that if they want to emulate the success of brands like Toyota and Honda they should emulate their dealer structure," said Jack Nerad, an analyst for car-pricing company Kelley Blue Book in Irvine, California. "That certainly seems to be the view of the automotive task force." Nerad was referring to President Barack Obama’s car task force, which steered Chrysler into bankruptcy on April 30 and set a June 1 deadline for GM to finish restructuring outside of court. The panel said it wasn’t involved in the dealer cuts. GM, based in Detroit, is paring domestic dealers to a range of 3,600 to 4,000 from 5,969 by the end of 2010. On May 15, it notified about 1,130 retailers their franchise accords won’t be renewed, meaning they would stop selling cars in a year and won’t be able to order new inventory. A day earlier, Chrysler told 789 outlets they would stop selling cars by June 9.
Dumping dealers isn’t part of the cuts in costs and debt at GM and Chrysler. Instead, "underperforming" stores, as GM put it, were targeted to ensure the automakers’ future retail networks will be stronger for when the companies reorganize. GM’s U.S. dealers sold 2.9 million vehicles in 2008, while the total for Auburn Hills, Michigan-based Chrysler’s 3,188 stores was 1.5 million. Toyota City, Japan-based Toyota had 2.2 million sales at 1,459 U.S. dealers. "The strategy at Toyota is pretty simple: keep the dealer count rational, don’t locate them too close to each other and maximize their units per outlet," said Mike Michels, a company spokesman in Torrance, California. "A profitable dealer can invest in their dealership and personnel." Average new-auto revenue was $14.3 million for GM dealers and $12.8 million for Chrysler last year, compared with $40.9 million for Toyota, based on data from auto-research company Edmunds.com. Dealers also make money on used vehicles, parts and service.
Each GM store averaged 444 new-auto sales, while Chrysler had 405, according to consulting firm Grant Thornton. Ford Motor Co. was similar, at 483. Japan’s three biggest automakers dwarfed those totals, with 1,200 for Toyota, 1,150 for Honda and 764 for Nissan Motor Co., Grant Thornton found. Shrinking GM’s dealer ranks to about 3,600 would push the automaker’s retailers to an annual average of 750 sales, said Paul Melville, a Grant Thornton auto-retailing analyst in Southfield, Michigan. "It’s heading in the right direction, but it’s still only 65 percent of where Toyota is," Melville said. "They’ll still have a lot of low-volume stores." Mark LaNeve, GM’s North American sales chief, said the dealer cuts are needed to match the shrinkage in the company and in the U.S. auto market. GM plans to dispose of Hummer, Saturn and Saab and will end the Pontiac brand to focus on Chevrolet, Cadillac, Buick and GMC vehicles.
"Too many dealers, in actuality, is not the problem," LaNeve said on a May 15 conference call. "We’ve got too little industry and too little sales we have to contend with." Chrysler President Jim Press said on a May 14 call that "a powerful new dealer body" would be a pivotal part of the automaker’s restructuring, which includes an alliance with Italy’s Fiat SpA. GM and Chrysler may never match per-store sales with Toyota or Honda because the U.S. automakers have more dealers in rural areas, where profitable pickups are top sellers. Toyota’s dealer network is concentrated in urban and suburban areas. That means the focus must be on cutting overlapping stores in urban areas, where dealers tend to compete with each other by cutting prices rather than winning business from other automakers, said Melville, the Grant Thornton analyst.
Among those stung by the practice is Gordon Stewart, who owns a Toyota store in Alabama and Chevrolet outlets in Georgia, Florida and Michigan. His Garden City, Michigan, Chevrolet store competes with 45 others for the brand in metropolitan Detroit. Price wars drain much of GM dealers’ profits, leaving little money left to market autos to new buyers, said Stewart, who wasn’t on GM’s cuts list last week and backs the efforts to thin the dealers’ ranks. "Imagine how much money we could spend advertising if we had the whole market area to ourselves," Stewart said. "Right now, you’ve got so many weak dealers in the market area that nobody can afford to promote."
Banker Pay May Escape Obama Caps as Wall Street Eyes Guidelines
Wall Street expects the U.S. to loosen compensation caps for banks that received taxpayer aid, three months after Merrill Lynch & Co.’s $3.6 billion in bonuses drove Congress to impose them, according to executives at four of the country’s biggest financial firms. Lenders such as Citigroup Inc. and Bank of America Corp. that obtained money from the Troubled Asset Relief Program have been waiting since February for Treasury Department guidance on capping bonuses for their 25 highest-paid employees. Speaking on condition of anonymity, the four executives said they expect the Obama administration may seek to substitute guidelines or otherwise ease the mandatory limits.
As some companies prepare to repay TARP funds and free themselves of limits on compensation, those that can’t argue they shouldn’t have to comply with limits on pay that will leave them unable to hire and retain their best employees. "It is clear that the government’s going to have to come out with some guidelines on what will compensation be at the big institutions that have TARP," Gary Parr, who advises financial companies in his role as deputy chairman of Lazard Ltd. in New York, said at a May 4 panel discussion on the future of Wall Street sponsored by Bloomberg News. "There’s going to need to be something done so that there isn’t a picking off of certain institutions where they’re at a severe disadvantage to others." Lazard, an investment bank based in Bermuda, hasn’t taken any bailout money.
The bank executives differ on how far they predict the administration and lawmakers are willing to go in reducing the limits on bonuses. All four said the administration may apply the caps only to managers, freeing top traders or investment bankers from any restrictions. One said he didn’t think the mandatory limits would survive the year. JPMorgan Chase & Co. and Goldman Sachs Group Inc. are among banks that regulators determined have enough capital to withstand an economic deterioration. Both said they are hoping to repay their combined $35 billion in TARP purchases of preferred shares. Bank of America was found to need $33.9 billion as a cushion against further losses. Chief Executive Officer Kenneth Lewis told shareholders last month that the pay restrictions are causing his bank to lose "strong revenue generators."
Overall, movement between jobs in financial services is down from a peak in 2006, according to Richard Jacovitz at Liberum Research in New York. The annualized rate of employee changes and losses in 2009 is 34 percent lower than it was in 2008 and 49 percent less than three years before, the firm’s data show. Given such figures, Congress may not buy the argument that lawmakers have to loosen bonus caps for banks that can’t repay TARP quickly, said Steve Adamske, a spokesman for Barney Frank, the Massachusetts Democrat who serves as chairman of the House Financial Services Committee. "There would have to be more than a compelling case," Adamske said. "To speculate on any loosening of restrictions while the taxpayers are on the hook is I don’t think very wise." Eighty-one percent of U.S. voters supported government limits on how much companies receiving TARP money can pay their executives, according to an April 1 poll by Quinnipiac University in Hamden, Connecticut.
The worst financial crisis since the Great Depression has so far led to more than $1.45 trillion in writedowns and credit losses and 312,500 job cuts across the worldwide financial industry. Senior management at Citigroup, Goldman Sachs and Morgan Stanley lost their bonuses last year. Lloyd Blankfein, Goldman Sachs’s chairman and chief executive officer, was awarded a $67.9 million bonus in 2007, setting a pay record for a Wall Street CEO. He earned a $600,000 salary last year, unchanged from the prior year, according to regulatory filings. Wall Street executives and their lawyers and consultants said they’re more comfortable with principles guiding executive pay than dollar limits dictated to them. And some are already starting to manage their businesses accordingly. Blankfein on May 8 read aloud to Goldman Sachs’s annual shareholder meeting a set of principles that he said had been adopted by the firm and that included avoiding multiyear bonus guarantees and emphasizing stock awards over cash payments. The principles aim to align the long-term interests of employees and shareholders.
The standards wouldn’t necessarily reduce pay. In the first quarter of this year, Goldman Sachs’s compensation expense climbed 18 percent from a year ago even though the number of employees dropped 12 percent, according to the company. "When you don’t have the rule of law and you have voluntary guidelines it allows people to talk a lot about what they’re doing, but when it comes down to it probably the compensation is not going to change radically," said John Harrington, president of the investment advisory firm Harrington Investments Inc. in Napa, California, which invests in socially responsible companies. Merrill Lynch, which was the third-biggest U.S. securities firm, reported six consecutive quarters of losses, had to be rescued in an emergency sale to Bank of America in September and received $10 billion in government aid. The firm’s decision to pay $3.6 billion in bonuses to employees, including a combined $121 million to the four highest- paid people, sparked outrage at what voters saw to be a Wall Street culture of excess and entitlement.
Taxpayers have put about $200 billion into banks through capital injections since October. The banks that have received the largest amounts are Bank of America and Citigroup, the largest- and third-largest U.S. banks by assets, followed by JPMorgan, Goldman Sachs and Morgan Stanley. In mid-February Christopher Dodd, a Connecticut Democrat who is chairman of the Senate Banking Committee, added a provision to the government’s economic stimulus bill that prohibits the 25 highest-paid employees at banks that received $500 million or more in bailout money from receiving cash bonuses. The employees can receive bonuses in long-term restricted stock, as long as the value is no more than one-third of total compensation. The Dodd amendment, which also prohibits so-called golden parachute payments to departing executives and permits firms to recoup bonuses if they’re later found to be related to "materially inaccurate" earnings or revenue, went further than previous government moves to limit bank compensation.
Dodd’s legislation also provided an exception for any bonus required by an employment contract written before Feb. 11, a clause that was later criticized for allowing American International Group Inc. to reward them to employees. Treasury Secretary Timothy Geithner has "an awful lot of leeway" in interpreting how the restrictions would be implemented, Dodd said on Feb. 20. Banks are still waiting for those interpretations, including answers to questions such as which employees get counted in the top 25. In a May 15 statement, Dodd urged Treasury "to act soon" to clarify the rules. Because the Dodd provision limits only bonuses, some banks have considered whether to raise salaries for key employees to help mitigate the impact, according to compensation consultants. UBS AG, the European bank with the biggest losses from the financial crisis, plans to boost salaries for senior bankers by an average of 50 percent to stem defections, three people with knowledge of the matter said last week. Zurich-based UBS was responding to Swiss government pressure to slash variable pay and doesn’t have any money from the U.S. government.
Geithner and President Barack Obama have shown less appetite for bonus caps than in industrywide compensation guidelines that would ensure employees aren’t rewarded for taking short-term risks that later backfire. "Regulators must issue standards for executive compensation practices across all financial firms," Geithner said in March 26 testimony to Congress. On April 21, he said his department was completing a draft rule to implement the Dodd amendment. Sheila Bair, chairman of the Federal Deposit Insurance Corp., said in a Bloomberg TV interview on May 15 that she favors principles that would discourage rewarding risky behavior with short-term profits. "If we’re not talking about the situations where the government has put a lot of money into an institution, but just banks generally," she said, "I don’t think prescriptive rules or dollar limits are appropriate."
Ilargi: A friend sent me this chart last week, saying it was from a pay site, hence off limits. But now it's all over the net, so here's your look at how great we're doing:
Asia will author its own destruction if it triggers a crisis over US bonds
Japan beware, crashes have a habit of bringing regime change. Et tu Tokyo? If Washington is counting on Japan to act as last-resort buyer of US dollar bonds, it may have to think again. Masaharu Nakagawa, finance chief of the Democratic Party of Japan (DPJ), told the BBC that his country should not purchase any more US debt unless issued in yen as "Samurai" bonds, akin to "Carter bonds" in 1978. This is the sort of petulance that tends to emerge in the late phase of slumps (1840s, early 1930s) when mass lay-offs provoke a populist backlash and hotheads run away with the agenda. Mr Nakagawa later played down the comments, calling them private thoughts, but the genie is out of the bottle.
We have come to assume that Japan under the Liberal Democratic Party (LDP) will always cleave to America, if only to safeguard US protection against Chinese naval expansion. Backed by Washington after the war as a rural counterweight to the urban left, the LDP has held an almost unbroken grip on power since 1955. But crashes have a habit of bringing regime change. Brian Reading, a Japan veteran at Lombard Street Research, predicts a "seismic shock" over the next four months as voters rebel. "With unemployment heading for 5 million by end-year, something must happen," he said.
The tremors from Japan follow near-weekly fulminations from Beijing, which suspects that Washington is engineering a stealth default on America's debt by the trickery of quantitative easing. This was put bluntly in February by Luo Ping, head of China's banking commission: "We hate you guys. Once you start issuing $1 trillion-$2 trillion, we know the dollar is going to depreciate." Premier Wen Jiabao picked up the theme more politely, asking whether the "massive amount of capital" lent to the US was still safe. Since then the People's Bank has floated ideas for a world currency. China and Japan together hold 23pc of America's $6,369bn federal debt. This has caused alarm on the US talk radio circuit, but fears of imminent "dollardämmerung" and a collapse of American economic power may prove far off the mark.
Who ultimately holds a gun to the head of whom? If Asia's leaders give free rein to frustrations and crater the US bond market, they will ensure their own political destruction. Japan already risks descent into demographic death, deflation, and debt atrophy (its public debt is nearing 200pc of GDP). China's regime depends on perma-boom for post-Maoist legitimacy. Could it survive the wrath of jobless graduates and rural migrants if it provokes America into erecting trade barriers, killing the globalisation goose that lays the golden egg? American can if necessary retreat into its vast home market and rebuild its industrial base, well-armed with 12 aircraft carrier battle groups.
The last 12 months should be lesson enough that Asia cannot yet stand on its own two feet. Its mercantilist export model remains a "high-beta" play on the West, to use trader parlance. Japan's industrial output has fallen 34pc. China's exports are down 23pc. Ray Maurer, from Qatar's QNB Capital, said China may be too busy closing factories it should never have built to challenge US primacy over coming years. "China is not going to be a juggernaut until it creates a viable economy based on home consumption. It's just a tiger, living a myth," he said. Lombard's Charles Dumas says the "super-savers" (China, Japan, Germany) have warped their own economies by relying on exports and, therefore, on perpetual debt build-up by the West. "Their currencies are due to decline against the dollar as weak US recovery throws a few scraps from its table, over which the world's exporters will have to scrabble, cutting their prices and currencies in the process. The US is not, and is not about to become, Argentina or Zimbabwe," he said.
Let us not forget how we got here. Japan amassed a quarter trillion dollars of US bonds from January 2003 to March 2004 in a frantic effort to drive down the yen and stave off deflation. It has not yet won that battle. Producer prices fell to minus 3.8pc in April, a 22-year low. China's holdings of US bonds are a consequence of its own policy of holding down the yuan to boost exports. Beijing may rage about America's "helicopter" stimulus, but what would have happened to the factories of Guangdong if the Fed had not taken emergency action or if the US Treasury had allowed the banks to collapse? China wants it both ways. The world economy has long been running on fumes. The debt appetite of the Anglo-sphere and Club Med kept demand afloat, concealing excess capacity. The deformed interplay of Asia's Confucian model and Western consumption ran unchecked, until the imbalances blew up. Yet it is easier to blame Uncle Sam, subprime, and friendless bankers. A folk tale has captured political discourse everywhere, from Beijing, to Tokyo, Moscow, and Berlin. If they are foolish enough to act on this self-serving illusion, they will pay the higher price.
If financial crises were distributed along a bell curve — like traffic accidents or people’s heights — really big ones wouldn’t happen very often. When the hedge fund Long-Term Capital Management lost 44 percent of its value in August 1998, its managers were flabbergasted. According to their value-at-risk models, a loss of this magnitude in a single month was so unlikely that it ought never to have happened in the entire life of the universe. Just over a decade later, many more of us now know what it’s like to lose 44 percent of our money. Even after the recent stock-market rally, that’s about how much the Standard & Poor’s 500 index is down compared with October 2007.
Financial crises will happen. In the 1340s, a sovereign-debt crisis wiped out the leading Florentine banks of Bardi, Peruzzi and Acciaiuoli. Between December 1719 and December 1720, the price of shares in John Law’s Mississippi Company fell 90 percent. Such crashes can also happen to real estate: in Japan, property prices fell by more than 60 percent during the ’90s. For reasons to do with human psychology and the failure of most educational institutions to teach financial history, we are always more amazed when such things happen than we should be. As a result, 9 times out of 10 we overreact. The usual response is to introduce a raft of new laws and regulations designed to prevent the crisis from repeating itself. In the months ahead, the world will reverberate to the sound of stable doors being shut long after the horses have bolted, and history suggests that many of the new measures will do more harm than good.
The classic example is the legislation passed during the British South-Sea Bubble to restrict the formation of joint-stock companies. The so-called Bubble Act of 1720 remained a needless handicap on the British economy for more than a century. Human beings are as good at devising ex post facto explanations for big disasters as they are bad at anticipating those disasters. It is indeed impressive how rapidly the economists who failed to predict this crisis — or predicted the wrong crisis (a dollar crash) — have been able to produce such a satisfying story about its origins. Yes, it was all the fault of deregulation.
There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans — who supposedly have much better-regulated financial sectors than the United States — have even worse problems in their banking sector than we do. The German government likes to wag its finger disapprovingly at the "Anglo Saxon" financial model, but last year average bank leverage was four times higher in Germany than in the United States. Schadenfreude will be in order when the German banking crisis strikes.
We need to remember that much financial innovation over the past 30 years was economically beneficial, and not just to the fat cats of Wall Street. New vehicles like hedge funds gave investors like pension funds and endowments vastly more to choose from than the time-honored choice among cash, bonds and stocks. Likewise, innovations like securitization lowered borrowing costs for most consumers. And the globalization of finance played a crucial role in raising growth rates in emerging markets, particularly in Asia, propelling hundreds of millions of people out of poverty.
The reality is that crises are more often caused by bad regulation than by deregulation. For one thing, both the international rules governing bank-capital adequacy so elaborately codified in the Basel I and Basel II accords and the national rules administered by the Securities and Exchange Commission failed miserably. It was the Basel system of weighting assets by their supposed riskiness that essentially allowed the Enronization of banks’ balance sheets, so that (for example) the ratio of Citigroup’s tangible on- and off-balance-sheet assets to its common equity reached a staggering 56 to 1 last year. The good health of Canada’s banks is due to better regulation. Simply by capping leverage at 20 to 1, the Office of the Superintendent of Financial Institutions spared Canada the need for bank bailouts.
The biggest blunder of all had nothing to do with deregulation. For some reason, the Federal Reserve convinced itself that it could focus exclusively on the prices of consumer goods instead of taking asset prices into account when setting monetary policy. In July 2004, the federal funds rate was just 1.25 percent, at a time when urban property prices were rising at an annual rate of 17 percent. Negative real interest rates at this time were arguably the single most important cause of the property bubble.
All of these were sins of commission, not omission, by Washington, and some at least were not unrelated to the very considerable political contributions and lobbying expenditures of the financial sector. Taxpayers, therefore, should beware. It is more than a little convenient for America’s political class to blame deregulation for this financial crisis and the resulting excesses of the free market. Not only does that neatly pass the buck, but it also creates a justification for . . . more regulation. The old Latin question is highly apposite here: Quis custodiet ipsos custodes? — Who regulates the regulators? Until that question is answered, calls for more regulation are symptoms of the very disease they purport to cure.
Ilargi: CKMichaelson has this astute comment on the following article: "With graduates flooding out of the colleges and universities with dim prospects for employment you might think that unemployment would increase. It won't. If you've never had a job, your are not counted as being unemployed. To U-3 and U-6 we [need to add] a new category: U-Lose."
Diploma in Hand, Job Out of Reach
Seas of caps and gowns. Eagerly turned tassels. Crowds of proud families. And an economic recession that has many graduates from the area's universities still searching for a job, feeling anxious and vulnerable about the future. Student strategies have ranged from tirelessly sending out dozens of résumés to waiting out the storm in graduate schools. Some say they are lucky to find an extended internship. Emily Petro, 22, of Allentown, Pa., said she applied to more than 40 companies. The public communication major interned at Global Events Partners during the fall and spring of her senior year at American University. She said she used job search sites including Monster.com, Career Builder, Craigslist and Career America, but nothing came of it.
"A lot of us ended up in training and internship programs," said Petro, who hopes to work in event planning but accepted an offer to enter a five- to six-month training program with the Washington Nationals in premium client services. "I'm lucky that I have what I have." Typically, 10 to 15 percent of members of a graduating class haven't nailed down a job or plans for graduate school, said Paul Villella, chief executive of HireStrategy, a recruiting and staffing company based in Reston. But after contacting between eight and 10 area schools this year, he said, "about 35 to 40 percent are graduating without jobs or a predetermined plan in place." The National Association of Colleges and Employers said in its spring "Job Outlook" that employers plan to hire 22 percent fewer new graduates from the class of 2009 than they hired from the class of 2008.
Sable Sweeper of Passaic, N.J., a sociology major who is graduating from Georgetown University this weekend, is delaying a serious job search while she applies to a paralegal studies program. "I came here thinking when I come out of Georgetown, people will look at my level of education and see my skills," she said. "But what we're going into -- there are no jobs. "And even the people who do have jobs, they are so nervous because companies are making cuts," she added. "The situation is so bad that now even the people with jobs know that if they make one little mistake, they can be gone." Mike Schaub, executive director of Georgetown's Career Education Center, said he encourages students to be flexible about their career options. "We tell them to be open to new fields and to be realistic," to look at smaller companies and consider different job locations, he said.
"This year's class seemed more anxious," Schaub said. "I've been seeing helplessness and hopelessness. Some [students] took the lack of internships and jobs personally." Some students had the added stress of worrying about their parents' finances. "I saw several students whose parents had lost jobs," said Alisa Schwartz, a Georgetown staff psychologist who sees students at the university's Counseling and Psychiatric Service. "It was painful for students with concrete concerns in terms of what their parents could afford this summer," she said. "It was also very emotional." Added Hallie Lightdale, also a staff psychologist there: "Some are fearful about the changes in their parents and about the responsibilities they must now assume. Some students are going to lose family health coverage and for the first time have had to consider purchasing their own."
Ayana Watkins-Northern, chief psychologist and director of Howard University's Counseling Service, said: "This graduating class has faced challenges unlike those before them. The days of college students having normal stressors about adjustment have gone by the wayside." Students, both those with and without jobs, said they are nervous and confused about what the next few years will bring. Many, like Brittany Lewis, 21, of Dover, Del., hope President Obama's message of change will translate into a better job market and a stable future. Lewis, who graduated from Howard last week and hasn't found a job, has interned at five news organizations, including WTTG (Channel 5), VH1, Vital Marketing and the American Federation of Government Employees. "I'm just hoping Obama comes to save us," she said with a half-smile.
Kevin Shaks, 24, of Richmond, Calif., put off graduating from Howard with a degree in audio production until December in the hopes of waiting out the recession. "A lot of people are very confused," he said. "They really don't know what they're going to do. But it adds to the excitement because Barack Obama is president. With him in office, there may be more jobs and opportunities." Most graduates say that the recession has not taken away all of the excitement that comes with walking across the stage. They talk of resilience and a sense of community in the class of 2009. "I think the recession is a bad thing, but I feel that we should learn from the experience," Sweeper said. "We bounced back from the Great Depression, and now we're in this situation. We just need to be more mindful of our money and our spending habits so that this doesn't happen again." Sweeper, like so many other students, hopes that the recession will be a learning lesson for a generation of students who know what it is like to bear the brunt of decisions made by their predecessors.
Pound a 'Screaming Buy' as U.K. Attracts Investment
The pound’s 20 percent drop in the past year made Britain the first choice when Schroders Plc started buying real estate in Europe last month. "Weaker sterling makes U.K. property more attractive," said Neil Turner, the Wiesbaden, Germany-based executive in charge of the money manager’s new 300 million-euro ($403 million) property fund. "The U.K. property market is a screaming buy compared to rivals in continental Europe." While the Bank of England said it expects a "protracted" economic recovery in the U.K., where unemployment is the highest since Prime Minister Gordon Brown’s Labour Party came to power in 1997, investors from Millennium Asset Management to Mellon Capital Management Corp. are betting the pound’s decline is coming to an end.
Strategists at New York-based Citigroup Inc. said in a report last week the pound is "among the most undervalued major currencies," trading almost 15 percent below "fair value" versus the dollar. Barclays Plc predicts it will rise as much as 18 percent against the dollar and 11 percent versus the euro in the coming year. Goldman Sachs Group Inc. sees a 23 percent gain versus the dollar and 15 percent advance against the euro. Money is already pouring into Britain. Currency flows into the pound from pension funds, insurers and other institutional investors in the 60 days to May 13 were more than 99 percent higher than any comparable period since 1997, according to Boston-based State Street Global Markets LLC, the world’s second-largest custodian of financial assets, with $11.3 trillion.
"There was an extreme undershoot of sterling versus the euro during the financial crisis," said David Powell, a currency strategist in London at Bank of America-Merrill Lynch. "The risk of implosion for the financial system has largely passed, sparing the U.K. economy and sterling." The pound strengthened 0.7 percent to 88.25 pence per euro as of 12:06 p.m. in New York, taking its advance this month to 1.4 percent. Against the dollar it rose 0.8 percent to $1.5297, a 3.5 percent gain for May. The currency appreciated 3.3 percent in April against the dollar, the biggest gain since soaring 5.1 percent in the same month of 2006. Investors are turning bullish on sterling as the slowdown in the U.K. economy shows signs of abating. Gross domestic product contracted at a 4.1 percent rate in the first quarter, the most since Margaret Thatcher was prime minister in 1980.
British house prices rose in March following a 16-month decline, according to Nationwide Building Society. Manufacturing fell at the slowest pace in more than a year in March, the Office for National Statistics said. Retail sales increased 6.3 percent in April from a year earlier, British Retail Consortium data show. U.K. home sellers raised asking prices by 2.4 percent in May from April, the most in more than a year, as buyers’ access to mortgages improved and the number of properties for sale dwindled, Rightmove Plc said today. A Citigroup index measuring economic surprises in the U.K. climbed to 64 on May 15, from a 2 1/2-year low of minus 68 in January. The index gives a positive reading when data surpass economists’ expectations. The average reading for the Group of 10 developed nations was 29. "The U.K. will actually exit the downturn on the earlier side," said Robert Blake, head of strategy for North America in Boston at State Street. "The pound is undervalued."
Sterling tumbled as much as 36 percent since reaching a 27- year high of $2.12 in November 2007, three months after losses on bonds linked to subprime mortgages started to freeze credit markets and plunged the global financial system into the worst crisis since the Great Depression. U.K. companies have been among the hardest hit. BT Group Plc, the country’s largest phone company, lowered its dividend on May 14 to 6.5 pence from 15.8 pence after posting a fourth- quarter loss of 977 million pounds and said a further 15,000 jobs will be cut this year. Any recovery may be stunted by Britain’s dependence on the financial industry. Banks and insurers, which account for about 10 percent of the economy, are eliminating about 29,000 jobs in London this year, the Centre for Economics & Business said. The budget deficit will swell to 12.4 percent of GDP this year, according to government estimates, and U.K. banks had $8 trillion of foreign-currency loans outstanding as of March 2008, the most in the world, Citigroup said May 7. The figure quadrupled since 2000.
"The high amount of leverage will take several years to clear out," said Hans-Guenter Redeker, global head of foreign- exchange strategy in London at BNP Paribas SA, France’s largest bank. "Sterling is going to come under pressure once again and current levels in euro-sterling are a buying opportunity." The pound will weaken to 96 pence per euro, according to Redeker, who said he will abandon the forecast if it strengthens to 88.6 pence. Schroders chose the U.K. for its property fund after the currency made British commercial real estate cheaper relative to the rest of Europe, helping boost yields, after accounting for foreign-exchange conversions, Turner said. Yields in the U.K. "have adjusted upwards by 250 to 300 basis points across many parts of the market," he said. "While we’ve seen some adjustment in Europe, you haven’t seen it to the same extent."
The average price of London office real estate declined to 8,020 euros per square meter last quarter, from more than 22,500 euros in mid-2007, according to CB Richard Ellis Group Inc., the biggest commercial property broker. By contrast, Paris rates fell to 12,480 euros from about 24,000 euros. That difference would be less than 2,000 euros per square meter if not for the pound’s decline, CB Richard Ellis says. London office prices would be 10,930 euros per square meter if the currency had remained at its January 2007 level of 67.57 pence, it estimates. "The fall in the exchange rate has made assets of all kinds in the U.K. more attractive to people overseas," Bank of England Governor Mervyn King said on May 13. "We are seeing that in the property market, and I suspect we will also see it in terms of people thinking which businesses to purchase. That’s one of the stimulatory consequences of a lower exchange rate."
The pound may recover even as Gordon’s Brown’s popularity declines amid voter discontent about his management of the economy and a scandal over parliamentary expenses. Brown’s Labour Party is 22 points behind the opposition Conservatives, according to a poll called out by BPIX that ended May 16. Labour had 20 percent support, compared with 42 percent for David Cameron’s Conservatives. Goldman Sachs is bullish on the pound against both the euro and the dollar because "relative financial conditions and valuation" are "big drivers," in currency markets, Dominic Wilson, the firm’s senior global economist in New York, wrote in a research note on May 10. The U.K.’s economy is likely to contract 0.4 percent in 2010, while Germany’s, Europe’s largest, will shrink 1 percent, the International Monetary Fund said on April 22.
Goldman Sachs recommends its clients buy the pound versus the dollar as one of its top trades this year, targeting $1.65. Barclays said the currency will rise to $1.73 and 82 pence per euro by year-end. Credit Suisse raised its three-month forecast on May 12 to 84 pence per euro from 93 pence and told investors to sell the euro versus sterling as a "tactical trade." Trading patterns suggest the pound may strengthen to 87.48 pence per euro before it meets a so-called resistance level, according to technical analysis using Fibonacci numbers. That level is a 50 percent retracement of a decline that started on Oct. 20 at 76.94 pence and ended on Dec. 30 at 98.03 pence. If sterling breaks through that level, the next area of resistance is the 200-day moving average, currently 86.45 pence.
"The huge monetary easing and the 30 percent depreciation of the pound make the U.K. better off on the road to recovery, compared to many other countries, particularly Europe," said Richard Benson, who oversees $14 billion of currency funds at Millennium Asset Management in London. Hedge funds and other large speculators reduced wagers on a drop in the pound to the lowest level since August 2008, according to the Washington-based Commodity Futures Trading Commission. The difference in the number of bets on a decline and those on a gain fell to 22,437 on May 5, from 49,359 in September, the most since the CFTC started compiling the data in 1992. "The pound is cheap," said Jonathan Xiong, who has been betting on sterling’s recovery in the $18 billion he oversees as vice president and senior portfolio manager at Mellon Capital in San Francisco. "The euro-zone is lagging as far as the recovery goes. They are behind."
Europe waits for Germany to come to the rescue
Last Friday the European Commission published what were arguably the most catastrophic economic statistics produced by any official institution in the capitalist world since 1945. These figures showed that Germany has suffered the steepest economic collapse ever recorded in a major industrialised country; and that several of the countries in Central Europe and on the periphery of the eurozone are now in a state of economic and financial meltdown comparable with Argentina, Indonesia and Russia in the 1990s or with Iceland last year. The 3.8 per cent decline in Germany's first-quarter GDP reported on Friday translates into an annualised rate of 16 per cent. That was almost three times the rate of decline in the United States and Britain and steeper than most estimates of the economic collapse during the worst years of the Great Depression. And this was not just some temporary fluke or statistical exaggeration.
The German economy has now been falling at a rapid and accelerating rate for four consecutive quarters, resulting in a year-on-year decline of 6.9 per cent. The comparable figures for the US and Britain are 2.6 per cent and 4.2 per cent. More important than comparisons with other countries is the contrast between the present disaster and the recessions that Germany has suffered in the past. Before the present 6.9 per cent slump, the worst year-on-year decline that Germany had recorded was 2.7 per cent in 1975. What these statistics confirmed is that the credit crunch has been a far greater disaster for Germany and most of continental Europe than for the US and Britain. In fact, it is Europe that faces a genuinely unprecedented economic crisis, whereas the recessions in America and Britain are broadly similar in scale to the ones of the past three decades (see charts).
That continental Europe — and Germany, in particular — has suffered far worse from the credit crunch than the US or Britain should come as no surprise. I have described repeatedly the three interacting elements now hitting Europe in a "perfect storm". The first element is Germany's dependence on exports, especially of capital goods, cars and other consumer durables. The vaunted strength of Germany's export industries has turned out to be its Achilles' heel, at a time of contracting global demand. To make matters worse, the mercantilist assumption in Germany that exports are somehow more virtuous than housebuilding or domestic consumption has left it entirely dependent on cycles of consumption and housing in other countries, while making German politicians unwilling to stimulate their own domestic demand.
The second element of the perfect storm has been the reckless lending to Central Europe and the Baltic States, especially by banks based in Austria, Sweden, Greece and Italy, which in turn have been large borrowers from German investors and banks. Countries such as Latvia, Estonia, Hungary and Romania have been borrowing between 10 and 20per cent of their national incomes each year — largely in euros and Swiss francs, rather than their local currencies. As a result, their businesses and homeowners will suffer a tsunami of bankruptcies if their currencies ever fall. Eastern European governments are, therefore, desperate to avoid devaluations. But the actions they take to "protect" their currencies — for example, cutting public sector wages — only deepen their recessions and magnify the mortgage defaults.
The third component of the economic hurricane is the euro itself. In its first decade of existence, the euro contributed to continental Europe's growth by allowing Spain, Greece, Portugal, Ireland and Denmark to run enormous current account deficits and enjoy housing and mortgage booms far more extreme than anything seen in Britain or the US. These booms provided markets for Germany's production of cars and other consumer goods. In the past few months, however, the single currency has changed from a stabilising factor into a new source of vulnerability for members of the eurozone. The reason is that eurozone governments are no longer risk-free "sovereign credits", like the governments of the US or Britain, or smaller countries, such as Switzerland, Australia or New Zealand.
A government that borrows in its own currency will never default because, in extremis, it can always instruct its central bank to print money to pay its debts. But governments in the eurozone cannot do this. They are in the same position as US state governments or as Argentina, Indonesia and Russia when they borrowed in dollars. The default risks are particularly serious for governments that are deeply embroiled in the banking crisis. In Ireland, Greece and Spain, governments have been forced to guarantee banks whose liabilities are greater than the entire state budget. In Austria, Greece and Italy, financial risks have been magnified by bank exposure to Central Europe, which in the case of Austria is equivalent to 70 per cent of GDP. Now consider how the three elements of this perfect storm have begun to converge. The plunge in the German economy has devastated the manufacturing industries and wage remittances in Central Europe, with output in several countries falling at annualised rates of up to 40per cent, never before witnessed in any capitalist economy.
The economic collapse in Central Europe almost surely implies a tidal wave of loan defaults. These, in turn, will wreak havoc in the European banking system and could raise the possibility of sovereign defaults in Greece, Austria, Ireland and other eurozone countries. Finally, efforts by governments to maintain their credit ratings and to control deficits by slashing wages and imposing other deflationary measures will push down house prices and the ability of local borrowers to service their debts, a process that is already alarmingly visible in Ireland. The ultimate result is that the European economy will be caught in a 1930s-style deflationary spiral of deteriorating credit, deflationary government policies, falling wages and even further declines in credit.
The most plausible way for Europe to escape from this vicious circle will be for Germany to abandon its age-old philosophy of fiscal rigour, to embark on a large-scale fiscal stimulus and to guarantee the debts of all its partners in the eurozone. The present assumption in the financial markets is that, if conditions in Europe continue to deteriorate, the German Government will do exactly this. To offer unlimited pan-European bailouts and guarantees, regardless of potential costs to German taxpayers, might, indeed, be a rational policy for Germany to pursue in its own interests, given the scale of the economic and financial threat. But then the rational policy of the US Government last September was to prevent the collapse of Lehman, regardless of the potential cost to taxpayers. But then governments do not always act rationally — especially in a financial crisis that has to be resolved over a weekend. That, surely, is a lesson we should all have learnt from the past 12 months.
Germany needs more than an accounting trick
After the US, the country with the biggest banking problem is probably Germany. Last week the German cabinet adopted a bank rescue plan worth looking at in detail. If you want to know how long the European crisis will last, this might give you the answer. The Geithner/Summers plan in the US has two fundamental planks – a strategy to ring-fence structured finance products for which there is no market, and a strategy to recapitalise the banking system. Both seem to be based on unrealistically optimistic assumptions about the economic recovery. And both have been criticised sharply, mainly for that reason. The German scheme is constructed very differently. It is a ring-fencing plan only and it is voluntary.
Under the draft legislation put forward by the German government last week, a bank can apply to set up its own bad bank. A bad bank is not really a bank at all. It is a special purpose vehicle, similar to those off-balance sheet vehicles that triggered this crisis in the first place. The proposed SPV will have a shelf life of up to 20 years. It buys the structured securities from the bank at 90 per cent of book value – the price at which the securities are currently valued on the balance sheet. In return, the SPV issues new debt securities to the bank, guaranteed by the government. So if a bank shifts structured securities with a notional value of €10bn ($13.5bn, £8.9bn) to the SPV, it gets €9bn in good securities back. The state is the guarantor. The idea is to give the banks an incentive to lend again.
Will it work? The answer is: not in the way that has been proposed. First of all, the plan is a giant accounting trick. Under fair-value accounting, it could not possibly work because the bank would have to make a provision for future losses of the SPV. This would, of course, defeat the very purpose of the plan. It is constructed in the same spirit as some of the more eccentric debt securities. The fundamental problem is that the strategy might actually deter recapitalisation, which surely should be a priority. Under the plan the bank, not the government, is fully responsible for the SPV’s losses. So if the SPV sells the securities at a loss, the bank will have to pay for the loss out of earnings. So the bank will have to divert an uncertain proportion of its future earnings to pay off the SPV’s losses, and all this for up to 20 years. Which private investor in their right mind would provide new equity capital to a bank under such conditions? A spokesman for the federation of Germany’s private banks made a good analogy when he compared the scheme to a deep freezer. The banks are trying to buy time. When the crisis is over, they hope that the structured securities can be sold at reasonable prices. Until that happens nothing is resolved.
Why did the government opt for such an obviously daft plan? The answer is because it costs next to nothing. There is only a cost to the government if the SPV goes bankrupt, which is not going to happen soon, if at all. The SPV even pays a fee to the government to cover the expense of issuing the guarantee. So the scheme tries to be the equivalent of a free lunch. But it is only cost-free in a narrow accounting sense. The economic costs are huge. Last week the German government was told that the tax shortfall would be €300bn over three years – two-thirds of that due to the crisis. If you split the loss evenly over the three years, the pure tax effect of the crisis makes up some 3 per cent of gross domestic product for three years running. Not bailing out the banks will almost certainly end up being more costly than bailing out the banks. But a bail-out would be unpopular, and the government does not want to touch this issue until the federal elections in September. Until then, we have an insufficient ring-fencing plan only. What about after the elections? Will there be a better plan then?
I am not sure. Peer Steinbrück, Germany’s finance minister, last week gave a characteristically belligerent comment about the US stress tests – effectively accusing the US authorities of fixing the results. His position is that recapitalisation is primarily a problem for the banks, not the government. If the state were to recapitalise the banks, his scheme might just work, but without it, it cannot. No sane private investors are going to pour money into a structure whose obvious purpose is to deceive them. The German political classes have yet to comprehend that recapitalisation is necessary, and that it will end up costing the taxpayer a lot of money. The plan as it stands now offers no resolution, only procrastination. While US banks have already written off a fair proportion of the bad debts, the Europeans are adopting schemes that allow the banks to postpone resolution. The more I think about it, the more I am reminded of Japan. But this might be unfair to the Japanese. They solved the problem eventually. If we freeze our toxic securities for 20 years, a Japanese-style lost decade will soon come to be regarded as the optimistic scenario.
Ilargi: Some numbers for you to toy with from the Bureau of Economic Analysis at the US Department of Commerce
US Gross Domestic Product: First Quarter 2009 (Advance)
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 6.1 percent in the first quarter of 2009, (that is, from the fourth quarter to the first quarter), according to advance estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP decreased 6.3 percent.
The Bureau emphasized that the first-quarter "advance" estimates are based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4). The first- quarter "preliminary" estimates, based on more comprehensive data, will be released on May 29, 2009.
The decrease in real GDP in the first quarter primarily reflected negative contributions from exports, private inventory investment, equipment and software, nonresidential structures, and residential fixed investment that were partly offset by a positive contribution from personal consumption expenditures (PCE). Imports, which are a subtraction in the calculation of GDP, decreased.
The slightly smaller decrease in real GDP in the first quarter than in the fourth reflected an upturn in PCE for durable and nondurable goods and a larger decrease in imports that were mostly offset by larger decreases in private inventory investment and in nonresidential structures and a downturn in federal government spending.
Motor vehicle output subtracted 1.36 percentage points from the first-quarter change in real GDP after subtracting 2.01 percentage points from the fourth-quarter change. Final sales of computers added 0.05 percentage point to the first-quarter change in real GDP after subtracting 0.02 percentage point from the fourth-quarter change.
FOOTNOTE.--Quarterly estimates are expressed at seasonally adjusted annual rates, unless otherwise specified. Quarter-to-quarter dollar changes are differences between these published estimates. Percent changes are calculated from unrounded data and are annualized. "Real" estimates are in chained (2000) dollars. Price indexes are chain-type measures.
The price index for gross domestic purchases, which measures prices paid by U.S. residents, decreased 1.0 percent in the first quarter, compared with a decrease of 3.9 percent in the fourth. Excluding food and energy prices, the price index for gross domestic purchases increased 1.4 percent in the first quarter, compared with an increase of 1.2 percent in the fourth. The federal pay raise for civilian and military personnel added 0.3 percentage point to the change in the first quarter gross domestic purchases price index.
Real personal consumption expenditures increased 2.2 percent in the first quarter, in contrast to a decrease of 4.3 percent in the fourth. Durable goods increased 9.4 percent, in contrast to a decrease of 22.1 percent. Nondurable goods increased 1.3 percent, in contrast to a decrease of 9.4 percent. Services increased 1.5 percent, the same increase as in the fourth.
Real nonresidential fixed investment decreased 37.9 percent in the first quarter, compared with a decrease of 21.7 percent in the fourth. Nonresidential structures decreased 44.2 percent, compared with a decrease of 9.4 percent. Equipment and software decreased 33.8 percent, compared with a decrease of 28.1 percent. Real residential fixed investment decreased 38.0 percent, compared with a decrease of 22.8 percent.
Real exports of goods and services decreased 30.0 percent in the first quarter, compared with a decrease of 23.6 percent in the fourth. Real imports of goods and services decreased 34.1 percent, compared with a decrease of 17.5 percent.
Real federal government consumption expenditures and gross investment decreased 4.0 percent in the first quarter, in contrast to an increase of 7.0 percent in the fourth. National defense decreased 6.4 percent, in contrast to an increase of 3.4 percent. Nondefense increased 1.3 percent, compared with an increase of 15.3 percent. Real state and local government consumption expenditures and gross investment decreased 3.9 percent, compared with a decrease of 2.0 percent.
The real change in private inventories subtracted 2.79 percentage points from the first-quarter change in real GDP after subtracting 0.11 percentage point from the fourth-quarter change. Private businesses decreased inventories $103.7 billion in the first quarter, following decreases of $25.8 billion in the fourth quarter and $29.6 billion in the third.
Real final sales of domestic product -- GDP less change in private inventories -- decreased 3.4 percent in the first quarter, compared with a decrease of 6.2 percent in the fourth.
Gross domestic purchases
Real gross domestic purchases -- purchases by U.S. residents of goods and services wherever produced -- decreased 7.8 percent in the first quarter, compared with a decrease of 5.9 percent in the fourth.
Disposition of personal income
Current-dollar personal income decreased $59.9 billion (2.0 percent) in the first quarter, compared with a decrease of $42.9 billion (1.4 percent) in the fourth.
Personal current taxes decreased $193.5 billion in the first quarter, in contrast to an increase of $19.7 billion in the fourth.
Disposable personal income increased $133.6 billion (5.1 percent) in the first quarter, in contrast to a decrease of $62.6 billion (2.3 percent) in the fourth. Real disposable personal income increased 6.2 percent, compared with an increase of 2.7 percent.
Personal outlays increased $18.1 billion (0.7 percent) in the first quarter, in contrast to a decrease of $260.2 billion (9.5 percent) in the fourth. Personal saving -- disposable personal income less personal outlays -- was $453.0 billion in the first quarter, compared with $337.4 billion in the fourth. The personal saving rate -- saving as a percentage of disposable personal income -- was 4.2 percent in the first quarter, compared with 3.2 percent in the fourth. For a comparison of personal saving in BEA's national income and product accounts with personal saving in the Federal Reserve Board's flow of funds accounts and data on changes in net worth, go to http://www.bea.gov/bea/dn/nipaweb/Nipa-Frb.asp.
Current-dollar GDP -- the market value of the nation's output of goods and services -- decreased 3.5 percent, or $124.8 billion, in the first quarter to a level of $14,075.5 billion. In the fourth quarter, current-dollar GDP decreased 5.8 percent, or $212.5 billion.
U.S. Reliance on Oil an 'Urgent Threat'
Retired U.S. generals and admirals say the real cost of fossil fuel, including transport and security, is as much as hundreds of dollars a gallon. A group of retired senior U.S. military officers has concluded that the country's reliance on fossil fuels undermines its capacity to defend itself. Citing a "serious and urgent threat to national security," the group has urged the Pentagon to take the lead in shifting to a new age in energy. The dependence on oil-based fuels left the U.S. military seriously over-extended in Iraq and Afghanistan, according to the officers' report, issued on May 18 by CNA, a military think tank based in Alexandria, Va. The 62-page report asserts that the true cost of fuel, including logistics and the military protection of sea lanes, can run to hundreds of dollars a gallon. "Our energy posture is not sustainable. It can be exploited by those who want to do us harm," retired Air Force Lieutenant General Larry Farrell, a co-author of the report, said in an interview. Finding a suitable alternative fuel and scaling it up to the size of the U.S. economy "is a 30-year project," Farrell said. "We've got to get started now."
The report, called "Powering America's Defense: Energy and the Risks to National Security," was written by CNA's military advisory board, comprised of 12 retired generals and admirals. It's a follow-up to a 2007 report by the advisory board called "National Security and the Threat of Climate Change." Retired Admiral John Nathman, another of the co-authors, said in an interview that the board deliberately tried not to inject itself into the debate over climate change, instead accepting the view that temperatures are rising. Yet the report coincides with a fierce debate in Congress over so-called cap-and-trade, a proposal to control greenhouse gases by parceling out the right to emit them. The report also coincides with an elevation of economics and specifically energy in debates over U.S. national security. Nathman said the Pentagon is in the midst of assigning a senior officer to study the energy challenge; the officer would serve under Ashton Carter, an undersecretary of defense for technology and acquisitions. Already, Nathman added, each of the military service arms has assigned a three-star general to study how they are using energy. Plus, Jim Jones, President Barack Obama's national security adviser and a former marine general, is expected to create a new senior slot on the National Security Council for global energy.
In addition, the report discusses the U.S. electricity grid, which it says is "unnecessarily vulnerable." It cites a 2003 cascading blackout that affected 50 million people in the U.S. Northeast and Midwest and Ontario as evidence of how a fragile power grid can leave huge areas without working gas stations, rail service, and cell-phone coverage. While a threat to the country overall, the frailty of the grid is specifically a peril to the military, the report says. "An extended outage could jeopardize ongoing missions in far-flung battle spaces," it concludes. Reliance on oil, however, is the report's focus. It estimates that refueling military jets in flight raises the cost of each gallon of fuel to $42; on the ground the cost ranges from $15 a gallon to as much as hundreds of dollars a gallon depending on how much security and logistics are required to get the fuel to where it needs to be.
A full accounting of the cost of fuel would include the U.S. Navy's protection of sea lanes, the maintenance of military bases in countries such as Bahrain, and the stationing of massive numbers of troops abroad, according to the report and interviews with its authors. In Iraq, just 10% of fuel used for ground forces went to heavy vehicles such as tanks and amphibious vehicles delivering lethal force; the other 90% was consumed by Humvees and other vehicles delivering and protecting the fuel and forces. "This is the antithesis of efficiency," the report says. Another problem is batteries. In Afghanistan, each U.S. soldier is burdened by carrying 26 pounds of batteries, which "hinders their operational capability by limiting their maneuverability and causing muscular-skeletal injuries," the report says. The retired generals urge the Pentagon to take the lead in developing new technologies to take the place of fossil fuels and making these technologies economically reproduceable on a large scale. It notes the Pentagon's role in creating and incubating nuclear power as well as the Internet. It also points out that the military has served as an incubator for cultural change, such as integration, a fact that could prove crucial if the country needs to make a dramatic lifestyle shift because of a disruptive technological change surrounding how it powers itself. "People will see that if it works for the military, it will work for a lot of other things as well," Farrell said.