Drinking fountain on the county courthouse lawn. Halifax, North Carolina
Ilargi: There's no better way to prove that, and why, we will not climb out of our present crisis hole on the sunny side than to read and hear reporters and the people they quote. Everybody tells us that everything they do and say is shaped by their firm look towards the future. And the problem, of course, is that nobody is actually looking at the future. Everyone looks at the past, to pick what they like best, maybe tweak, twitch and embellish it a little bit, and project in unto and into the future. But that particular kind of future is no longer available. Too many among us have too much debt, and would need to make absolute fortunes in order to ever pay it off.
Instead, we're on our way back to making what we need. Literally. Those of us who are lucky. It's like Chris Whalen explained over the weekend, and again today, about AIG. There was never any chance of AIG paying its debt, since there was never any way the company could generate enough income to cover its CDS contracts. Or, as Tim Freestone put it years ago, addressing AIG's actual value: “To justify the share price [..], it would have to grow about 63% faster than [its] peers for the next 25 years. If investors believe that AIG can sustain this type of performance for that period of time, then AIG is properly valued“.
It's probably clear to many of you that AIG has no future, and that the only reason your money is dumped in it is the risk (or certainty) that its demise will bring down some, if not most, of the most powerful financial institutions on the planet.
What is apparently much less evident is that AIG is the perfect, tailor-made metaphor for our entire economic system and indeed our entire societies. We would all have to grow that 63% for those 25 years in order to save our skins as the nations and communities we are today. It is equally impossible.
The fact that AIG is still around makes it much harder to learn the lesson that lies in that metaphor, understand what has happened and why it has, and then move on. By refusing to owe up to our losses, we rob ourselves of the chance to prepare as societies for what lies ahead. And if we don't do that, individual preparations, while not necessarily redundant, become an all-out crapshoot.
I see very few people who, when they talk about their own ways to try and get ready for what will admittedly always be an uncertain endeavor, fully take into account how they fit into their societies in all their multiple layers. Just about everyone relies on concepts of the world which surrounds them staying more or less the same to a large extent. And it won't, not a chance.
We need to stop what we're doing, we need to stop the people who are doing what they do for us and to us. We need to get off this road we're on, and we need to do it fast. We get deeper into debt every single day, and we have nothing to show for it. We can't get back to the future, even though that's very literally what we're trying to do. We can either organize our societies in ways that allow for survival as societies, as best we can, or there will no longer be societies, and everything will shatter to the ground in a disaster whose magnitude we cannot begin to imagine.
So far, however, we are busy spending all the wealth we have left, and then some, to keep dead corporations alive, and craving, hoping and praying for greenshoots, light between trees and other maddingly meaningless spinmeister drivel. We are, both as individuals and as societies, addicted to the sweetest of dreams such as can only be provided by the deadliest of potions.
In all honesty, I have grave doubts that we have it in us to get out of this in one piece. I can make rational arguments, and have done so incessantly, but I see a world merely longing for the next fix, for the dreams and hollow visions to linger one more hour, one more day, one more year. We may be a species blessed with reason, but how much of a blessing it is is a huge question, and moreover, it's not the only quality we possess. Our present predicament should be more than sufficient evidence for that.
But that's not what we see in it.
Why Barack Obama Cannot Prevent America's Next Great Depression
Barack Obama, America's 44th President, is one of the most brilliant, hard working and innovative politicians to occupy the White House. If the current economic crisis were a typical post-war cyclical recession, there is no doubt that President Obama would be up to the challenge, and lead the United States to renewed growth and prosperity. Alas, we are in different times, with a uniquely devastating and dangerous economic disaster of worldwide scope. Not even as gifted a leader as Barack Obama, I fear, will prove sufficient in arresting the rampaging Global Economic Crisis.
No one can accuse Obama of not recognizing that the U.S. faces a severe economic recession. Most of his administration's initial activity has centered around crafting policy responses to the recession, primarily involving the unprecedented expenditure of borrowed money in an attempt to revive growth. However, the very character and essence of his administration's economic policymaking reveals the lack of comprehension of how dire and unique the Global Economic Crisis is on the part of President Obama. At his core, Obama believes that the American economic system is basically sound, but slid into a severe recession because of irresponsible behavior on the part of some actors within the financial oligarchy.
Hence, by restoring growth through deficit spending and enacting a new regulatory regime to restrict the destructive greed of some Wall Street tycoons and bankers, we can return to the happy economic days of yore. In effect, Obama is acting like a nostalgia buff, hoping that the correct policies will recapture the solid economic model of pre-George W. Bush America. Unfortunately, this view of America's political economy is mythological. The U.S. economy was unhinged under the presidency of Bill Clinton as much as it has been under Bush, yet Obama has chosen Clintonites to serve in the most important economic policymaking positions in his administration. Cheerleaders for a failed model will not lead America to a new economic Jerusalem.
A major part of the problem Obama is facing is philosophical. He is following a conventional view of counter-cyclical economics; when a recession occurs, the sovereign can go into debt and use borrowed money to artificially increase demand and thus arrest the decline in growth. Once the recession is arrested, government fiscal policy can return to a more prudent policy of balanced budgets, as restored economic growth eliminates the need for the government to maintain demand. Sounds simple, as this has been enshrined as the recession-fighting bible created by economist Maynard Keynes. The only difference, the Obama administration would argue, is that this recession is much bigger than previous economic downturns, and therefore requires much more significant deficit spending. Otherwise, the Keynesian model remains unaltered.
This perspective by the Obama administration, in my view, is myopic. Like many contemporary politicians and economists, President Obama and his senior economic advisors have misread Maynard Keynes. Contrary to public perception, Keynes was no economic radical, but a centrist in dealing with the challenge of managing economic cycles within a capitalist system. Though Keynes did believe deficit spending was justified as a means to stimulate economies in deep recession, he also advocated budget surpluses during times of relative prosperity. In effect, Keynes believed in "rainy day" economics; in times of plenty you put away a little fiscal cushion that can then be spent during a recessionary period to enable the sovereign to maintain economic demand during a time of private sector contraction and declining tax revenues. This is actually a conservative philosophy that many farmers are familiar with.
In the United States, even during times of sustained economic growth, massive government deficits have been de rigeur during the past nine years, in the process doubling the national debt. There is no rainy day fund to speak of, so the staggering deficits that are now being enacted by the Obama administration are, in my judgement, fiscally unsustainable. Already, the projection for the current fiscal year's deficit has risen by $200 billion to a stratospheric $1.8 trillion; my own estimate is that it will top $2 trillion. Looking into the future, the current Obama fiscal agenda foresees annual deficits of $1 trillion or more for several years into the future, gambling that the recession will be short-lived, with growth returning as early as the last quarter of 2009, leading to increased tax revenue and declining deficits.
But are we in a recession? The current downturn is already the most protracted and destructive since World War II. However, there is another ingredient that has been added into this toxic economic stew: globalization. We are in a Global Economic Crisis in which synchronized contractions across the world create multiple negative feedback loops that reinforce the underlying negative causation. The subprime collapse in the United States crippled banks in the U.K. and devastated Japan's export machine; the Eurozone economic contraction is now impacting America's export driven manufacturers. When China's exports to America decline, commodity exporters and peripheral economies that supply value-added components to China's export goods get whipsawed. This phenomenon is occurring at an accelerating pace, despite attempts by the Obama administration to portray minor statistical anomalies to the prevailing trend as "rays of hope" and "green shoots." Reading tealeaves is no substitute for critical analysis.
The ongoing Global Economic Crisis has proven to be so severe, sustained and virulent that if it is not yet a global depression, it has embarked on that dangerous trajectory. However, another flaw in the Obama administration's approach is its failure to recognize that a substantial part of the financial system is rotten to the core, and not merely a fundamentally sound system with a few bad apples populating it, who can be restrained by improved regulation. More importantly, the Obama economic team seems to have convinced themselves that "mind over matter" is the best palliative for the nation's stricken banking system. When a sovereign's private banks are essentially insolvent and not engaged in normal loan activities, this is another manifestation of an economic depression.
Rather than admit the truth, the Obama administration cobbled together a make-believe series of bank stress tests, which supposedly show that America's banking system, with a few minor problems, is essentially sound and fiscally healthy. This conclusion is an utter fraud, designed to artificially create a climate of economic confidence. It won't work, and by delaying an honest approach towards the nation's crippling level of bank insolvency, the policymakers are insuring that the final cost of the inevitable day of reckoning will be far more costly to the taxpayers.
The economist Hernando de Soto has captured the essence of the Global Economic Crisis as few others have. In his view, the Western world, and principally the United States, who have for so long railed against Third World inefficiency and corruption, have created the largest, most toxic shadow economy in the history of human civilization. More than one quadrillion dollars in unregulated financial derivatives paper, according to de Soto, has destroyed inter-bank and financial counter party trust to such an extent, credit flows have largely frozen despite unprecedented levels of taxpayer-funded borrowing to bailout the global financial system. Nothing short of an honest accounting of the true value of the toxic assets underlying these colossal derivatives products, which equal twenty times the entire world's GDP, can put the global economy on the road to recovery. Until these unregulated "unknown unknowns" become fully transparent, all other government interventions, including Obama's massive borrowing binge, are doomed to failure.
Sadly, as the bogus bank stress tests reveal, President Barack Obama and his Clinton-era economic advisors have financial transparency as the least important objective on their agenda. It seems that President Obama, despite his obvious leadership gifts and towering intellect, has chosen to place his faith in a team of advisors who are tied to the Wall Street oligarchy by an umbilical chord than cannot be severed. In a sense, Obama is following the path of the last Soviet leader, Mikhail Gorbachev, who also sincerely wished to resolve his country's economic problems, but believed that the system was fundamentally sound and only required a modicum of reform to correct its distortions. Only after the collapse of the USSR did Gorbachev conclude that the system itself was unsustainable. Now it appears to this observer that President Obama may be fated to travel the same path as Gorbachev, and like him, end up as a valiant failure.
Japan Economy Shrinks by Record 15.2%
Japan's economy shrank at its fastest pace on record in the January-March quarter, battered by a record drop in exports amid a global slowdown and weak domestic demand, government data showed Wednesday.
Gross domestic product fell price-adjusted 4.0% from the previous three months, Cabinet Office data showed. The decrease translates into an annualized 15.2 drop, and comes as business and consumer spending fell sharply along with exports. The decline was sharper than the U.S. or Europe's biggest economies, highlighting how Japan's heavy reliance on exports has magnified its pain from the global economic malaise. Economists polled by Dow Jones Newswires had expected a fall of 4.4% on quarter and 16.5% in annualized terms.
The Cabinet Office also revised down figures for the October-December period. GDP in that quarter fell 3.8% from the previous three months, or an annualized 14.4%, rather than sliding 3.2% on quarter, or an annualized 12.1%, the data showed. As well as being the sharpest fall since Japan's government adopted the current data format in 1955, the latest figure also marks the first-ever four-quarter run of declines, demonstrating the severity of Japan's worst recession since World War II. Exports of goods and services fell a record 26.0% on quarter, the data showed. That marked the second straight quarter of decline and the biggest drop on record. Imports were down 15.0% after rising for two quarters in a row.
Wednesday's GDP readings stood out among the Group of Seven leading industrial powers. The U.S. economy, for example, fell by an annualized 6.1% during the first quarter, while Italy's sank by 9.4%. Germany's trade-reliant economy shrank a record 14.4%, the sharpest since 1970 but better than Japan. Still, Japan's outlook is slightly improving. Many analysts say its economy probably bottomed in the January-March period and may rise mildly in the following quarter, though they still see the economy shrinking for the whole of Japan's financial year started in April.
Let battle commence
Last Wednesday night, David Clark, a London-based banker, received a nasty shock. Reports from Washington suggested the US government would soon impose restrictive new regulation on the derivatives world – a move Mr Clark believes could severely damage financial business in London and New York. He duly prepared a furious statement on behalf of the Wholesale Market Brokers’ Association, a lobbying group he leads. But when, a few hours later, he saw the proposals from Tim Geithner, US Treasury secretary, Mr Clark had second thoughts. “What Geithner has written may not be so bad,” he says, adding there is now “uncertainty” about what will happen next.
No wonder. Until recently, the technical detail of derivatives excited only financial geeks. Now it is turning into a political hot potato with potentially big implications for bank profits. After the first wave of policy reforms unleashed by the administration of Barack Obama in response to the financial crisis, focused on short-term crisis measures, such as the “stress tests” of the health of banks, the next frontier is a fight about how the financial industry is structured – and run. And what makes the once arcane issue so emotive is that they are not just central to the banks’ modern business model but also raise questions about the degree to which financial players should be free to innovate, without state control.
A public debate about derivatives is long overdue. For while politicians – and consumers – largely ignored this sector during the first seven years of the decade, an extraordinary revolution has quietly unfolded in recent years. When the trading of “derivatives” – instruments whose value “derives” from something else – took off on a large scale three decades ago, it was a marginal corner of finance. By the start of this decade, the Basel-based Bank for International Settlements estimated there were about $100,000bn of outstanding deals. By late 2008 there were nearly $600,000bn, 16 times global equity market capitalisation (and 10 times global gross domestic product). Bankers insist that these astonishing numbers are misleading, since many outstanding contracts offset each other in economic terms. Indeed, the BIS estimates that, after such netting, the “real” net market value of derivatives deals was “only” $34,000bn last year.
Nevertheless, the presence of those $600,000bn overlapping deals is important, since banks typically collect a fee on every (gross) contract written. Moreover, these deals have trapped banks and other financial players in a complex web of counterparty risk. In the equity market, most trading occurs on a regulated exchange where deals can be publicly monitored by every?one. Trades are then “cleared” on a central platform, which completes a deal even if one counterparty collapses. Some derivatives deals – such as government bond futures – are traded on similar exchanges in Chicago and London. However, BIS data suggests four-fifths of outstanding derivatives trades have been cut in the so-called “over-the-counter” world, via private deals.
That means in many cases there is no centralised system to monitor prices or deals nor any third party to ensure a trade is completed if a counterparty fails. And while the industry has tried to mitigate this “counterparty risk” by encouraging traders to post collateral when they cut deals, these arrangements are not always seen as robust. When Lehman Brothers collapsed last autumn, for example, markets froze because investors were unsure whether their deals would be completed. Worse, because trades were private, neither regulators nor investors knew where the risks lay. As a result, the US government was convinced the insurance group AIG – which had credit derivatives deals with dozens of other banks – could not be allowed to collapse. As Mary Schapiro, chair of the Securities and Exchange Commission, says: “OTC derivatives, particularly credit derivatives ... contributed to the financial mess we are cleaning up today.”
The proposals Mr Geithner, Ms Schapiro and others have unveiled try to tackle these problems in four ways. First, they demand all “standardised” derivatives are centrally cleared to remove counterparty risk, even if they are not traded on an exchange. Second, they “encourage” the industry to use regulated exchanges in addition to clearing platforms (because it is only on exchanges that investors get equal access to trading and price data, rather than being forced to rely on a small club of dominant banks). Third, the Obama administration wants all institutions to record every derivatives trade to enable supervisors to prevent market abuse. Fourth, it wants to tighten rules on capital and collateral provision to ensure all derivatives players have buffers to absorb any losses. That is a radical step because, while banks already face such rules, hedge funds, companies and insurance groups such as AIG do not.
More striking still, the administration wants to impose a sliding scale of capital charges to “steer” behaviour. Derivatives deals conducted on regulated exchanges will attract lower charges than OTC deals. To some, the measures look timid. Christopher Whalen, a US financial analyst says the way to remove systemic risk is to force all trades on to transparent exchanges. Banks, he says, will fight this as OTC activity is a dominant source of profits for some. Deals cut on exchanges typically produce a few basis points of commission but OTC trades can produce revenue of several percentage points. “Despite the appearance of reform, the Treasury proposal ... still leaves the OTC market firmly in the hands of the large derivatives-dealer banks,” says Mr Whalen. “Without the excessive rents earned by JPMorgan Chase and the remaining legacy OTC dealers, the largest banks cannot survive.”
Frank Partnoy, a former derivatives trader, now an academic, thinks the proposals fall short because they cover only “standardised” deals – not the complex contracts that wreaked havoc at AIG and elsewhere. “By bifurcating the market into some derivatives that are standardised and disclosed, and some that are not, there is a [loop] hole that can only get bigger,” he says. Although the administration has not defined “standardised”, a narrow definition may capture less than half of all recent deals. In credit derivatives most index trades and deals on single company bonds can be considered standardised by some measures. Bundles of derivatives, such as collateralised debt obligations, cannot. The banking industry, by contrast, complains the reforms go too far. Most senior financiers are willing to move some activity on to a clearing platform. Indeed, this shift was under way before last week’s announcement – ventures offering clearing functions for credit derivatives started operating this year. Some large brokers, such as Icap, also accept the idea of limited exchange trading – not least because Icap runs an electronic exchange.
However, bankers oppose the idea that all activity should be channelled to an exchange, claiming it would crush innovation and reduce liquidity, because banks would no longer have a profit incentive to cut deals. “Forcing OTC products on to exchanges ... would result in increased risks and costs for end users,” says Mr Clark of the WMBA, which says British pension funds have saved themselves £40bn recently by hedging with derivatives. Or as Anthony Belchambers, head of the Futures and Options Association, says: “This kind of regulatory pressure will distort free-market competition and restrict product diversity.” In reality, it is unclear how far the administration plans to drive ac?tivity on to exchanges. Washington is still trying to steer a careful line between populist politicians who can sense public anger and the powerful financial lobby. Senior US officials hope a sliding scale of charges will be less controversial than a ban. After all, they point out, market-based “incentives” sit more easily with US free-market ideals than government diktat.
But nobody in Washington expects the debate to be won fast. And what makes Mr Geithner’s plan doubly controversial is that its implications go way beyond Washington itself. When he met reporters last week Mr Geithner paid lip service to the “very important process” of global co-ordination. However, Washington appears to have engaged in scant consultation with Europe before last week’s announcement. The European Commission is now preparing measures to impose centralised clearing on credit derivatives, which it may extend to OTC derivatives. US finance officials assume European measures will ape US moves but this is not guaranteed. In the meantime, bankers in London are preparing to exploit any transatlantic regulatory gaps. “Only 25 per cent of all OTC trading actually happens in America,” one senior London-based banker says. “So we don’t think what Geithner says is going to change anything for us ... and even if [Brussels] does the same, activity will just go to Singapore or Switzerland instead.”
Sentiments like that explain why US politicians distrust the derivatives world. They also illustrate the nightmarish difficulty reformers face. After all, several times in the past three decades, US politicians have tried to clamp down on derivatives – and each time the Wall Street lobby has fought back. Some observers, such as Willa Bruckner, a partner at Alston & Bird law firm and veteran of earlier battles, hope this time will be different. In the past the industry convinced regulators it was able to regulate itself. “But because of the magnitude and the breadth of this crisis, these arguments are not so convincing now,” she says. Not everybody agrees Mr Geithner truly has the stomach for change. The one thing that is crystal clear is that “the [banking] industry is girding for battle, [hiring] armies of lobbyists and lawyers,” as Mr Whalen says. Stand by for a long – and potentially bitter – derivatives war.
Fear and Looting in America: Geither Caves to Wall Street
"I don't think our government should set caps on compensation," Timothy Geither, treasury secretary, told a private Newsweek luncheon on May 19. That makes it official. The Obama administration does not want to put the screws to Wall Street's lavish compensation packages. Why? Here are some possible arguments and why they don't make sense:
1. In America, the free-market of supply and demand should determine compensation packages. While that may be true for most of the economy, we know that supply and demand broke down entirely in the financial sector. Wall Street crashed and nearly sent us into a Great Depression. It has taken trillions in bail out funds, loans, and asset guarantees from the public trough. Without that money most of the major banks would have gone under and financial salaries would have tanked. We saved their butts... and hopefully ours as well.
2. If we cap salaries we will lose talent to firms overseas and to hedge funds. So what? Let them go. These are precisely the dudes who crashed the system -- the seven figure derivative traders and the executives who gave them the green light.
3. If we cap salaries we will be left only with mediocre talent as young bright graduates enter other fields. That sounds like a great idea. It would be good to have more engineers, doctors and teachers rather than financial wizards earning outrageous salaries. We saw what the best and brightest did at the helm of our financial system. Let's try mediocre bankers.
4. There's no need to cap salaries because the Wall Street crash and more stock holder involvement will reduce compensation packages and tie them to real performance. Fat chance. As long as these institutions are too big to fail, there is no measure of real financial performance. Profits due to government largess don't signify much. Every bank will become profitable soon because they are borrowing money for free from the Fed and then lending it out at higher rates.
5. It's a bad precedent for American capitalism: Let's see: The financial community gets trillions from us to keep from going under. And then we put salary caps on the folks led us into the crash and who made hundreds of millions along the way from what turned out to be fantasy finance and phony profits. Sounds right to me.
6. It will shock our fragile financial sector and spook the stock market: Let's be straight. If this logic holds, it means that we live entirely at the mercy of Wall Street. If they don't like something, we can't do it. I refuse to accept that logic. Geitner has to face up the fact that the wage gap between the elite and the rest of us has gotten totally out of hand. Let me repeat some outrageous numbers we churned up for my upcoming book: In 1970, the gap between the top 100 CEOs' average pay and the pay of average workers was 45 to 1 ($296,170 to $6,542), reflecting the restraints of lingering New Deal financial controls and mores. As those controls weakened, the gap increased to 127 to 1 by 1980. As deregulation, tax cuts, and the union bashing of the Reagan era took hold, the gap jumped to 321 to 1 by 1990.
In 2000, as "financial innovation" pumped up fantasy finance, the ratio of CEO pay to the average workers' pay hit an obscene level of 1,510 to 1. And then by 2006, at the height of the fantasy finance boom, it climbed to a whopping 1,723 to 1 ($50,877,450 to $29,529). While Geither fears a direct assault on this problem, the American public is more than ready. So what's my alternative? The President's Wage Cap: No employee of an institution receiving government bailout funds shall earn more than the president of the United States ($400,000). Bankers can't live on that? Get a life.
Kabuki on the Potomac: Reforming Credit Default Swaps and OTC Derivatives
by Chris Whalen
Despite bringing the world economy to its knees and costing taxpayers hundreds of billions of dollars in bailouts for events such as Bear Stearns, Lehman Brothers and American International Group, the Masters of the Universe who run the largest Wall Street firms of have learned not a thing when it comes to credit default swaps ("CDS") and other types of high-risk financial engineering. Indeed, not only are the largest derivative dealers fighting efforts to reform the CDS and other derivative instruments that caused the AIG fiasco, but regulators like the Federal Reserve Board and US Treasury are working with the banks to ensure that a small group of dealers increase their monopoly over the business of over-the-counter ("OTC") derivatives.
Why such a desperate battle for the OTC derivatives markets? For the world's largest banks, the OTC derivatives markets are the last remaining source of supra-normal profits - and also perhaps the single largest source of systemic risk in the global financial markets. Without OTC derivatives, Bear Stearns, Lehman Brothers and AIG would never have failed, but without the excessive rents earned by JPMorgan Chase and the remaining legacy OTC dealers, the largest banks cannot survive. No matter how good an operator JPM CEO Jamie Dimon may be, his bank is DOA without its near-monopoly in OTC derivatives -- yet that same business may eventually destroy JPM.
The key thing for the public and the Congress to understand is that the "profits" earned from these unregulated derivatives markets are illusory and do not cover the true risk of OTC derivatives. Put another way, on a systemic basis, risk-adjusted profits from OTC derivatives are not positive over time. As with the current crisis, the net loss from the periodic collapse of what is best described as gaming activity gets off-loaded onto the taxpayer, thus OTC derivatives must be seen as any other speculative activity, namely a net loss to the economy and society. But unlike taking a punt on a pony at the racetrack, bank dealings in OTC derivatives vastly increase systemic risk, make all banks unstable and threatens the viability of the real economy.
As we told Tim Rayment of The Times of London in his article, "Joseph Cassano: the man with the trillion-dollar price on his head," in our view AIG never had the possibility of generating sufficient income to cover its CDS contracts, thus honoring these gaming debts of AIG at face value as Tim Geithner, Ben Bernanke, et al., have done using public funds is ridiculous, even criminal. As we've said before, AIG should be in bankruptcy so that all creditors may be treated fairly - but "fairly" means a steep discount to par value without the subsidy from the Fed.
Unfortunately, the Treasury and the Fed are so captured by the large banks that they will never admit the truth of what you have just read - at least so long as Geithner and Bernanke, respectively, are still in charge of the Treasury and Fed. These two fine public servants stuffed the Fed of New York with the $30 billion cost of JPM's acquisition of Bear Stearns, then used the Fed's balance sheet to float trillions of dollars more in toxic waste and bailed out AIG and its dealer counterparts for good measure. But the good deeds of Geithner and Bernanke are not yet finished. Next comes the "reform" of the OTC derivatives markets.
By no coincidence, the Geithner Treasury just announced an initiative to improve the regulation of OTC derivatives. SIFMA and the large OTC dealers are making cautious noises of disapproval, but be not fooled by this Kabuki on the Potomac. As with past legislative efforts to "reform" the banking industry or protect taxpayers from large bank bailouts, the Washington game is already rigged. In that regard, read Tim Carney's comment on Treasury Secretary Tim Geithner, "Loophole Secretary," in the May 2009 issue of The American Spectator.
One part of the proposal finally would improve the availability of CDS prices to the public, but in reality this "innovation" of public price transparency has been fought by the dealers for years and is small concession now. Buyers of CDS still cannot seen the best price in the markets. You have to canvas your counterparts. And of course the bid ask spread on a given contract is different with every dealer.
Despite the appearance of reform, the Treasury proposal announced last week still leaves the OTC market firmly in the hands of the large derivatives dealer banks. The industry is girding for battle to make sure that the dealers keep the ball in terms of overall control of the OTC markets. Armies of lobbyists and lawyers have been marshaled by JPM, the near-monopoly player in trading and non-dealer clearing in the OTC derivatives market with nearly 50% market share and the organization with the most to lose from true regulation. It is a monument to the kindness of JPM CEO Jamie Dimon and the bank's board that they have employed a number of lobbyists formerly in the service of Fannie Mae, Freddie Mac, etc.
Since the legacy GSEs, including the Federal Home Loan Banks, are buried in mounting losses and seemingly are headed for liquidation, there is not much need for lobbyists. But the New GSEs such as JPM require representation. If you have not done so, read the March 17, 2008 interview with Robert Feinberg, "GSE Nation: Interview with Robert Feinberg", where our friend and long-time observer of Washington predicted much of the response to the financial crisis, namely the embrace of the GSE model by Washington as the explicit template of choice for America. And since the largest GSEs earn a disproportionate portion of profits from unregulated OTC derivatives, managing the reform process is obviously of paramount concern.
The immediate objective of JPM and the dealer community is to counter attempts to truly regulate and, most important, make standardized commodities of OTC derivatives, even as the dealers clothe the new regime proposed by Tim Geithner for clearing and trading OTC contracts in the language of reform, transparency and efficiency. Terms like innovation, productivity and competitiveness are again heard in the halls of Congress after a several months hiatus, this in connection with arguments that OTC derivatives help to manage, rather than create, risk.
But the fact is that for JPM, Citigroup (NYSE:C), Goldman Sachs (NYSE:GS) and other dealers, the OTC derivatives markets are the last remaining source of supra-normal profits - and also perhaps the single largest source of systemic risk in the global financial markets. Without OTC derivatives, Bear Stearns, Lehman Brothers and American International Group (NYS:AIG) would never have failed, but without the excessive rents earned by JPM and the remaining legacy OTC dealers, they cannot survive either.
Let's go back to the beginning of the story. Swaps started out in the early 1980s as a way for companies to manage financial risks. Originally swaps were private contracts, agreed to between two sophisticated parties like a bank and a large multi-national corporation. Although often described as complicated, swaps actually work on a simple principle: one party will trade the variable price of something, such as an interest rate or the price of oil, for a fixed price for that same product - that is, certainty.
For example an oil refiner might agree to pay a fixed price of $50 per barrel for oil, in exchange for a bank agreeing to pay the market price for a barrel of oil. A swap agreement will provide that every six months or so for the next several years the parties will exchange payments based on their respective obligations; the refiner paying $50 to the bank, and the bank paying the then-current price of oil.
The parties to a swap agreement like the one described above enter into such a contract because the customer (the oil refiner) has a real risk it is trying to manage (the price of oil). The bank facilitates the transaction to help its customer manage financial risk, which is what banks are supposed to do. But notice that at least one party to this illustrative transaction actually had an economic interest in the underlying commodity or the basis of the derivative contract.
As long as private swap contracts remained individual and unique, custom tailored agreements between banks and their customers, there were few problems. In fact the ability of a company to transfer its financial risks to a bank was widely seen as a good development: the company could focus on its core business without having to worry about events beyond its control. These benefits were so obvious that the market for swaps grew rapidly with the full blessing of regulators and politicians alike. By 1999 the market had grown to have a notional value of $88 trillion dollars.
But a potential problem loomed: the participants in these markets felt U.S. law was unclear as to whether the contracts were legal. This led the Clinton Administration and Congress to change U.S. law to provide special protection for swap agreements. Called the Commodity Futures Modernization Act of 2000, this law was designed to protect the ability of banks and sophisticated institutions to continue to enter into privately negotiated swap agreements. But as so often happens in Washington, the law also unleashed the growth of fully interchangeable, unregulated markets which by some measures have rendered many of the worlds largest financial institutions technically insolvent.
Originally banks created swaps to help their customers manage financial risks. The contracts were a customer service, designed to enhance a bank's existing relationship with its corporate clients. But early on the banks realized they could make huge profits from small differences in the prices they charged different customers entering into the agreements. Thus was born the deliberately opaque and secretive inter-dealer world of CDS, the market between and among the dealers themselves, which has become an engine for manufacturing the appearance of profits - even while increasing systemic risk.
As the demand for swaps increased, banks learned they could effectively take the fixed value they received from one customer and pass it onto another, keeping a small piece of the action. In effect the banks turned into riskless middlemen, profiting by matching buyers and sellers. This was, in part, the opportunity that would lure AIG, a huge seller of credit default swaps, to its destruction. (See our previous comment on AIG, "AIG: Before Credit Default Swaps, There Was Reinsurance", April 2, 2009. But to maximize their profits, the banks needed to make sure all their contracts matched. So they changed the private, customized nature of swaps into standardized contracts that could be easily traded throughout the financial system. There was nothing new about this type of business. In fact stock exchanges operate on exactly the same principle. But exchanges are fully regulated, with collateral and margin requirements enforced by the clearing members.
Moreover, to protect customers and the public, exchanges make sure everyone plays by the same set of rules and receives the same treatment. That means equal access to such important protections as the ability to see what the market price is for a security and the assurance that the market will honor your trade even if your counterparty can't. The swaps market, originally designed for a world where banks negotiated private agreements with their customers, has none of these basic market protections and arguably is deceptive by design, placing customers at the mercy of the large derivatives dealers.
In 2005, the New York Fed began to fear that the OTC derivatives market, at that time with a notional value of over $400 trillion dollars, was a sloppy mess - and it was. Encouraged by the Congress and regulators in Washington, the OTC market was a threat to the solvency of the entire global financial system - and supervisory personnel in the field and the Fed and other agencies had been raising the issue for years - all to no effect. This is part of the reason why we recommended to the Senate Banking Committee earlier this year that the Fed be completely relieved of responsibility for supervising banks and other financial institutions.
Parties were not properly documenting trades and collateral practices were ad hoc, for example. To address these problems, the Fed of New York began working with 11 of the largest dealer firms, including Bear Stearns, Merrill Lynch, Lehman, C, JPM, Credit Suisse and GS. Among the "solutions" arrived at by these talks was the creation of a clearinghouse to reduce counterparty credit risk and serve as the intermediary to every trade. The fact that such mechanism already existed in the regulated, public markets and exchanges did not prevent the Fed and OTC dealers from leading a multi-year effort to study the problem further - again, dragging their collective feet to maximize the earnings made from the existing OTC market before the inevitable regulatory clampdown.
For example, in the futures markets, a buyer and seller agreeing to a transaction will submit it to a clearing member, which forwards it to the clearinghouse. As the sell-side counterparty to the buyer and the buy-side counterparty to the seller, the clearinghouse assumes the risk that a party to the transaction might fail to pay on its obligations.. It can do this because it is fully regulated and by well capitalized. As the Chicago Mercantile Exchange is fond of saying, in 110 years no futures clearinghouse has ever defaulted. While the NY Fed believed that a central counterparty was necessary to reduce risks that a major OTC dealer firm might default, the banks firmly resisted the notion. After all, they make billions of dollars each year on the cash and securities which they required their hedge fund, pension fund and other swap counterparties to put up as collateral.
Re-pledging or loaning these customer securities to other clients is very lucrative for the dealers and losing control over the clients collateral would dramatically impact large bank profits. A clearinghouse would eliminate the need for counterparties to post collateral and a lucrative source of revenue for the dealer firms. So they bought the Clearing Corporation, an inactive company that had been the clearinghouse for the Chicago Board of Trade. If they had to clear their trades, the dealer firms reasoned, at least they would find a way to profit by controlling the new clearing firm. Such is the logic of the GSE mindset.
Meanwhile, other viable candidates for OTC derivatives clearing were eager to get into the business, such as the Chicago Mercantile Exchange and the New York Stock Exchange. Both had over 200 years experience in clearing trades and were well suited to serve as the impartial central counterparty to the banks and their customers. If the NYSE and CME were to trade derivatives, the big banks knew they would not be able to control their fees or capture the profits from clearing. Therefore, they sold The Clearing Corp. to the Intercontinental Exchange, or ICE, a recent start-up in the OTC derivatives business which had been funded with money originally provided by, you guessed it, the banks.
In the deal with ICE, the banks receive half the profit of all trades cleared through the company. And the large OTC dealer banks made sure, through their connections with officials at the Fed and Treasury, that ICE was the winner chosen over the NYSE and CME offerings. That's right, we hear that Tim Geithner personally intervened to make sure that ICE won over the NYSE and CME clearing units.
Note that the FRBNY forced the approval of ICE through as "bank," another obvious power grab (include it with the insurance companies, etc). Some internal Board staff argued that this closed, Sell-Side counterparty was not the optimal market solution, but instead allowed the preservation of the dealer oligopoly in CDS. For the dealers, it was the least bad solution that gave Geithner, FRBNY OTC market risk honcho Theo Lubke and the staff of the FRBNY something they could tout as progress. But what it has done is taken too-big-to-fail banks (which aren't) and bound them together in a too-big-to fail central counterparty for CDS!.
Why is ICE styled as a NY state bank again? The Fed waived bank capital requirements. In fact, this "special" bank doesn't even have to report the ratios to the Fed as do other banks, an amazing concession which allows everything to be kept secret. If ICE didn't want to be a bank, it shouldn't have asked for a bank charter, but the Fed's accommodation of ICE and the dealers that control it should forever put to rest the notion that the Fed board is able to act independently when it comes to safety and soundness regulation.
If this new central counterparty is so transparent, when are ICE and the dealers going to publish the margin methodology and the central guarantee fund methodology? We understand that each counterparty uses the same portfolio (parametric) VaR method to calculate required margin. The same VaR calculation at a somewhat higher confidence then gives the guarantee fund contribution requirements. Doesn't anyone remember that VaR is pro-cyclical and is reliant on historical volatilities and correlations? This "new" system is game-able from day one. Dealers facing margin calls could actually sell more protection in names that have been historically negatively correlated to reduce margins. That's right... sell more protection on an absolute basis to reduce the margin requirements.
But don't worry; the crack NYFRB team is looking at the models -- just like they were looking at C models and rated everything satisfactory. The good people the NYFRB had in charge of market risk supervision in recent years never built or ran a commercial VaR model in their lives. Maybe these are the same folks who kept asking us about the Economic Capital model in the IRA Bank Monitor, even after we showed them the page in the textbook.
We hear that the FRBNY supervision "SWAT team" has been a rotation of non-experts, apparently purposefully, who are very similar to the crowd around Secretary Geithner at Treasury in Washington. And neither the FRBNY nor the Treasury ever listen to people inside the Fed that have actual market experience. These are academic, monetary economists by and large, not technocrats. Power, control and information rule the day -- not competence nor concern about the effectiveness of policy.
After the VaR based guarantee fund there is a "commitment" by each ICE dealer to pony up more in case the guarantee fund is fully drawn. A commitment from banks under severe stress to save each other -- how much is that worth? A bank in that situation has to make the best business decision for its shareholders, and that could very well be to walk away from any commitment to dump billions into ICE because a competitor fails.
Has the Fed learned nothing? At least each of the sell-side counterparties in the group knows the parameters of the margining and how it could go awry. The outside world, the un-favored counterparties to the dealers, have no idea how good or bad the margins and commitments might ultimately be for them. It's in Fed they trust - because they have no choice. An open exchange with a set of transparent rules, margin requirements, and price discovery is the optimal solution. Why the Fed would push through something else is clear -- it is in bed with the dealers.
Confused yet? The Fed and the dealer banks sure hope so, because it makes it less likely you will fully grasp their stranglehold on the OTC markets. In order to ensure that the OTC business never left their grasp they made sure the ICE-TCC entity was formed as a bank, regulated by the NY Fed; the harder for their regulator to object.
Then to top it off, the banks told the regulators that they would report all their trades through a so called central trade repository, the Trade Information Warehouse. This entity is owned by an outfit called the Depository Trust Clearing Corporation; all you need to know about DTCC in the global clearing system is that it too is controlled by the banks. Indeed, the DTCC is a Fed member bank. While many of the initiatives taken by the DTCC over the past half decade to improve the OTC markets are laudable, they must all be seen in the context of the DTCC's place within the community of dealer banks.
Moreover, to protect their monopoly in derivatives, the banks are lobbying Congress and the Obama Administration to require that anyone that wants to engage in the OTC derivatives business must be, wait for it . . . a bank. The banks are selling this idea under the rubric of creating a "systemic risk regulator," a powerful federal agency with the power to see across markets and participants in order to identify and forestall systemic risk. Reaching new heights of disingenuousness, the OTC dealer banks propose that the Federal Reserve, their regulator and the agency that missed every sign leading up to the present financial collapse, the cheerleader for the banks, become the systemic risk regulator.
By proposing that anyone engaging in the OTC business must be a bank, the banks would ensure that their regulation wouldn't change in any way. But their potential competitors in this area, such as energy companies, hedge funds and commodity firms, would effectively be pushed out of the business. That is the little surprise that the Fed and Treasury have for Buy Side funds in the OTC reform legislation.
House Agriculture Committee Chairman Colin Peterson (D-MN) and Senate Banking ranking member Richard Shelby (R-AL), seem to see the Geithner reform plan for OTC derivatives for what it is, namely a proposal by and for the large banks. But others, such as House Financial Services Committee Chairman Barney Frank (D-MA), appear all too eager to do something, anything, to address this complex issue -- no matter how misguided or anti-competitive it might be. Frank's continuing infatuation with the Fed as the center of the regulatory universe is a subject of quiet wonderment by even some Democrats on the committee, but none are yet willing to challenge the temperamental and volatile Frank.
Even worse, with the US taxpayer now owning substantial stakes in most of the large dealer banks, what incentive does the US Treasury have to eliminate the banks' last truly lucrative monopoly? In a very real sense, without the excess rents earned from the OTC markets, large dealers such as JPM, C and GS might not be viable in their present form. Remember, on a nominal basis, OTC derivatives appear to be the most profitable activity of many large banks. It is only when you assess the OTC derivatives dealing activity of large banks on a risk-adjusted basis does the value destruction become apparent.
One can only hope that reason will prevail, especially the version of reason that now prevails in the Senate, where there is little illusion about the true nature of the relationship between the large OTC dealer banks, the Fed and the Treasury. True reform of the OTC space would force most derivatives on exchange while leaving the banks free to offer customized risk management contracts to their customers, subject to stringent capital requirements.
But JPM and the other OTC dealer banks will fight to their last taxpayer dollar to stop that from happening. The only question now is whether the smaller banks, and the large Buy Side and other non-bank participants in the OTC markets, including some of the largest investment, industrial and energy firms in the world, can deliver the message to Washington that the current reform proposals for OTC derivatives are ill-advised and contrary to the public interest.
This crisis is a moment, but is it a defining one?
Is the current crisis a watershed, with market-led globalisation, financial capitalism and western domination on the one side and protectionism, regulation and Asian predominance on the other? Or will historians judge it, instead, as an event caused by fools, signifying little? My own guess is that it will end up in between. It is neither a Great Depression, because the policy response has been so determined, nor capitalism’s 1989. Let us examine what we know and do not know of its impact on the economy, finance, capitalism, the state, globalisation and geopolitics. On the economy, we already know five important things. First, when the US catches pneumonia, everybody falls seriously ill. Second, this is the most severe economic crisis since the 1930s. Third, the crisis is global, with a particularly severe impact on countries that specialised in exports of manufactured goods or that relied on net imports of capital.
Fourth, policymakers have thrown the most aggressive fiscal and monetary stimuli and financial rescues ever seen at this crisis. Finally, this effort has brought some success: confidence is returning and the inventory cycle should bring relief. As Jean-Claude Trichet, president of the European Central Bank, remarked, the global economy is “around the inflection point”, by which he meant that the economy is now declining at a declining rate. We can also guess that the US will lead the recovery. The US is again the advanced world’s most Keynesian country. We can guess, too, that China, with its massive stimulus package, will be the most successful economy in the world. Unfortunately, there are at least three big things we cannot know. How far will exceptional levels of indebtedness and falling net worth generate a sustained increase in the desired household savings of erstwhile high-spending consumers? How long can current fiscal deficits continue before markets demand higher compensation for risk? Can central banks engineer a non-inflationary exit from unconventional policies?
On finance, confidence is returning, with spreads between safe and risky assets declining to less abnormal levels and a (modest) recovery in markets. The US administration has given its banking system a certificate of reasonable health. But the balance sheets of the financial sector have exploded in recent decades and the solvency of debtors is impaired. We can guess that finance will make a recovery in the years ahead. We can guess, too, that its glory days are behind it for decades, at least in the west. What we do not know is how far the “deleveraging” and consequent balance-sheet deflation in the economy will go. We also do not know how successfully the financial sector will see off attempts to impose a more effective regulatory regime. Politicians should have learnt from the need to rescue financial systems stuffed with institutions deemed too big and interconnected to fail. I fear that concentrated interests will overwhelm the general one.
What about the future of capitalism, on which the Financial Times has run its fascinating series? It will survive. The commitment of both China and India to a market economy has not altered, despite this crisis, although both will be more nervous about unfettered finance. People on the free- market side would insist the failure should be laid more at the door of regulators than of markets. There is great truth in this: banks are, after all, the most regulated of financial institutions. But this argument will fail politically. The willingness to trust the free play of market forces in finance has been damaged. We can guess, therefore, that the age of a hegemonic model of the market economy is past. Countries will, as they have always done, adapt the market economy to their own traditions. But they will do so more confidently. As Mao Zedong might have said, “Let a thousand capitalist flowers bloom”. A world with many capitalisms will be tricky, but fun.
Less clear are the implications for globalisation. We know that the massive injection of government funds has partially “deglobalised” finance, at great cost to emerging countries. We know, too, that government intervention in industry has a strong nationalist tinge. We know, as well, that few political leaders are prepared to go out on a limb for free trade. Most emerging countries will conclude that accumulating massive foreign currency reserves and limiting current account deficits is a sound strategy. This is likely to generate another round of destabilising global “imbalances”. This seems an inevitable result of a defective international monetary order. We do not know how well globalisation will survive all such stresses. I am hopeful, but not that confident.
The state, meanwhile, is back, but it is also looking ever more bankrupt. Ratios of public sector debt to gross domestic product seem likely to double in many advanced countries: the fiscal impact of a big financial crisis can, we have been reminded, be as costly as a large war. This, then, is a disaster that governments of slow-growing advanced economies cannot afford to see repeated in a generation. The legacy of the crisis will also limit fiscal largesse. The effort to consolidate public finances will dominate politics for years, perhaps decades. The state is back, therefore, but it will be the state as intrusive busybody, not big spender. Last but not least, what does the crisis mean for the global political order? Here we know three important things. The first is that the belief that the west, however widely disliked by the rest, at least knew how to manage a sophisticated financial system has perished.
The crisis has damaged the prestige of the US, in particular, pretty badly, although the tone of the new president has certainly helped. The second is that emerging countries and, above all, China are now central players, as was shown in the decision to have two seminal meetings of the Group of 20 leading nations at head of government level. They are now vital elements in global policymaking. The third is that efforts are being made to refurbish global governance, notably in the increased resources being given to the International Monetary Fund and discussion of changing country weights within it. We can still only guess at how radical the changes in the global political order will turn out to be. The US is likely to emerge as the indispensable leader, shorn of the delusions of the “unipolar moment”.
The relationship between the US and China will become more central, with India waiting in the wings. The relative economic weight and power of the Asian giants seems sure to rise. Europe, meanwhile, is not having a good crisis. Its economy and financial system have proved far more vulnerable than many expected. Yet how far a set of refurbished and rebalanced institutions for international co-operation will reflect the new realities is, as yet, unknown. What then is the bottom line? My guess is that this crisis accelerated some trends and has proved others – particularly those in credit and debt – unsustainable. It has damaged the reputation of economics. It will leave a bitter legacy for the world. But it may still mark no historic watershed. To paraphrase what people said on the death of kings: “Capitalism is dead; long live capitalism.”
Commercial property slump worsens across the globe
The slump across global commercial property markets has accelerated since the turn of the year, with the emerging markets in particular struggling under the combination of capital value and rental falls. The pace of decline in capital values accelerated in the first quarter, while almost every country in the world is reporting a slide in rents, according to the global property survey from the Royal Institution of Chartered Surveyors, released on Tuesday. Countries across Europe suffered price falls, with particularly significant pessimism over capital values in France, the Netherlands and the Republic of Ireland.
Surveyors expect little easing in the pace of price declines in these markets. However, there was better sentiment in Spain and the UK, where the extent of the market slump means many hope to see a bottom soon. The UK, in particular, led the rest of the world when the market peaked in the summer of 2007 and is now showing signs of price stabilisation in certain types of defensive (well-let) property. The developed regions leading the property cycle generally saw investment and lettings demand fall at a slower pace. Purchasing activity is expected to rise across western Europe and Asia for the first time in over a year. But Germany remains the outperforming market, with expectations towards property values less pessimistic than elsewhere.
However, the Japanese and US markets continued to deteriorate, with virtually all surveyors reporting falling capital values. There was a marked downturn in sentiment in many parts of central and eastern Europe, the worst performing emerging market region. This belies hopes property in certain emerging market economies would be decoupled from the global downturn. All respondents in Ukraine, Russia, Poland and Croatia reported a fall rather than a rise in capital values. The decline in capital values is only part of the broader concerns for commercial property, given indications that rents are also falling across the world. Property owners rely on rents to provide income, often linked to their debt, which supports total returns even when prices are falling.
Rents are falling across more than 90 per cent of the 46 countries in the survey, with only Brazil, Saudi Arabia and parts of Africa yet to report declines. Weaker tenant demand has led to faster rises in reported available space, which has compounded the gloomy rental outlook. Rental expectations are weakest in Singapore, Hong Kong and Ireland, with sentiment in countries in emerging Europe also gloomy, particularly in Hungary, Romania and Ukraine. Available space has risen across every region, forcing agents to offer increasingly larger incentive packages in order to secure lettings. Oliver Gilmartin, senior Rics economist, said the rental downturn was gathering momentum. “The repricing in developed markets has increased pressure on some emerging locations where on a relative basis assets remain expensive.”
Bank of America, Citigroup Insiders Reap Over $25 Million Buying Stock
Bank of America Corp. and Citigroup Inc. executives and directors have profits of more than $25 million after purchasing shares earlier this year amid speculation that the lenders would be nationalized. Bank of America directors and managers including Chief Executive Officer Kenneth Lewis gained about $6.57 million from buying stock in January and February. Citigroup’s Roberto Hernandez Ramirez, a former director who is nonexecutive chairman of subsidiary Banco Nacional de Mexico, bought 6 million shares at $1.25 on March 2 and the stock has gained more than $15 million in value. Bank of America, the largest U.S. bank by assets, and Citigroup, the third-largest, have surged by 196 percent and 155 percent, respectively, since March 1 amid speculation that growth in the U.S. economy may resume later this year. The banks are benefiting from improved bond-trading revenue, helping push first-quarter profit above analysts’ expectations.
“I give these guys some credit, they bought it well- timed,” Ben Silverman, research director at InsiderScore.com, said about the Bank of America purchases. His company tracks purchases by officers and directors. Citigroup and Bank of America each accepted $45 billion in capital from the U.S. Treasury’s rescue fund, which carries curbs on executive compensation. Those rules don’t prevent executives and directors from using their own money to purchase shares on public stock exchanges. Investors track insider buying and selling to speculate on a company’s performance before the results are officially disclosed. Citigroup rose 18 cents, or 5 percent, to $3.82 as of 2:54 p.m. New York time, and has declined 43 percent this year. Bank of America was little changed at $11.69.
Lewis holds a $2.5 million profit after buying 400,000 shares for $4.81 to $6.03 each, according to data compiled by Bloomberg. That’s more than his $1.5 million salary in 2008, when Lewis got no bonus for running Bank of America, the biggest U.S. lender. Twelve other directors and officers bought about 640,000 shares for as little as $3.78, with some more than tripling their investment at today’s prices. Almost all the purchases were made in the three weeks after Charlotte, North Carolina-based Bank of America reported its first quarterly loss in 17 years on Jan. 16. The stock sank to a two-decade low of $2.53 in February as analysts predicted the bank would be seized, and shareholders stripped Lewis of the chairman’s title in April. Defaults on credit-card, housing and small-business loans and writedowns of mortgage-backed securities caused a $1.79 billion loss in the fourth quarter.
Bank of America rebounded to a $4.25 billion profit in the first quarter, aided by demand for home refinancings and improved credit-market trading. Lewis, 62, owned as many as 4,697,070 shares as of Feb. 9, according to the bank’s proxy statement, the bulk of them acquired in previous years. The stock sold for more than $55 in November 2006. The bank’s new chairman, retired college president Walter Massey, 71, bought 2,000 shares in February at $6.21 with gains now totaling $11,040, according to the data compiled by Bloomberg. Director Robert Tillman, 65, retired CEO at Lowe’s Cos., bought 200,000 shares on Jan. 20 and has a paper profit of $1.2 million. Tillman previously owned 20,000 shares. Temple Sloan, 70, the bank’s lead director before Massey’s election as chairman, bought 156,500 shares and has gains of about $1 million. Brian Moynihan, 49, president of the Global Banking and Wealth Management unit that oversees Merrill Lynch & Co., made about $330,000 purchasing 50,000 shares at $3.89 to $6.13 apiece through yesterday’s trading, according to the data.
The bank bought Merrill Lynch last July. “We are committed to improving shareholder value and operating the company in the most efficient manner possible,” Bank of America spokesman Jerry Dubrowski said. Citigroup earned $1.6 billion in the first quarter, aided by an increase in net interest margin, or the difference between what a bank pays to borrow and what it charges to lend. Government lending programs including a guarantee on debt sales are enabling banks to reduce their interest expense. Hernandez, 67, was among four Citigroup executives who bought shares in early March, when the bank’s stock swooned to an all-time low of $1.02. Other buyers that week included Latin America regional head Manuel Medina-Mora, Vice Chairman Lewis Kaden and Controller John Gerspach. At the time, bank spokesman Gerardo Chavez called the purchases “a sign of confidence and trust in Citi’s future.”
Blue collar U.S. males lose more ground
Rodney Ringler is an unemployed blue collar male without a college degree. He's hardly alone. Men like him have been the main victims of the current recession in the United States. "I haven't worked since December of 2007, around the time this recession started," Ringler, a 49-year-old computer technician, said as he walked his dog in a Dallas suburb. He sees little light at the end of the tunnel. "I've been looking to get into law enforcement because it's a growth area," he said, but had no immediate prospects.
One statistic that stands out in America's recession-stung economy is the unemployment rate for adult men: in April for the second month in a row it surged ahead of the national average to 9.4 percent versus 8.9 percent for all workers. The jobless rate for adult women was 7.1 percent. The reasons are clear: male-heavy sectors such as construction and manufacturing have been hard hit. But the implications may be dire for the broader economy and hamper the recovery as families that once had male breadwinners struggle. "In the 2001 recession, 51 percent of all job losses were for men. It was evenly split. But in this recession 80 percent of the jobs that have been lost have been men's," said Andrew Sum, a labor economics professor at Northeastern University who has studied this issue in detail.
Men also incurred about 80 percent of the job losses in the 1990-91 recession, but Sum said by his calculations the numbers this time were dramatically different. In the 1990-91 recession, men lost 1.037 million jobs. They have lost 4.5 million to date in this one. "This time around it is amazingly different in terms of the magnitude," Sum said. It's difficult to compare to earlier recessions because women entered the workforce in big numbers from the 1970s, and industries that continue to grow such as health services favor women. The male jobless rate is pumped up by white collar banking jobs lost during the global financial crisis. A few of these may have been sent overseas but job growth in this sector should come back in time, analysts said.
The fact that American males without a college degree are especially vulnerable in this cycle point to more hard times ahead for the U.S. working class, which has endured stagnant and declining wages for the last three decades. The skilled and semi-skilled jobs they traditionally held have been moving overseas to places like China and Vietnam. The jobs that remain pay less, amid declining union membership. One study by Julia Isaacs of the Brookings Institution think-tank found median U.S. family income rose to $53,280 by the middle of this decade in 2004 dollars from $37,384 in 1964. But for males aged 30 to 39, average annual personal income fell from the mid-1970s by around $5,000 to $35,000.
The growth in family incomes is mostly from women entering the workforce. But during this recession that will hardly compensate given the scale of male job losses.
For those without a college degree or better, it has been a bloodbath. "College-educated men have lost 1.4 percent of their employment levels since right before the beginning of the recession in November 2007, but for men as a whole it has been nearly six percent," said Sum. Sum said in the last recession the effects were felt more evenly across gender and occupational lines and that construction jobs grew from mid-2002 onward at a strong rate through 2007. But production and manufacturing jobs fell steadily through 2005 before making a modest recovery, and then falling swiftly.
This is grim news for struggling blue collar families. While women's role in the workforce has expanded, by some estimates the male remains the main breadwinner in about 75 percent of two-income U.S. households. "When males lose their jobs ... women become more important to family income, and those that have not been working will re-enter the labor market to sustain family income," said Peter Doeringer, a Professor of Economics at Boston University.
Patti Sutton, 58, a coffee shop worker in the Phoenix Valley, falls into this category. Her husband Scott was laid off in October last year. He had worked for 18 years for a company as a heavy equipment operator excavating the foundations for luxury homes, earning about $800-900 a week without overtime, and was among the last five workers to be laid off from a staff of 155. "I am now the family breadwinner," said Sutton. She went out to work to get health insurance coverage for her husband in the year before he was laid off after he lost coverage for a heart condition from his employer. He needs a heart transplant, and was facing insurance costs of $1,800 a month.
"It's not like I'm exactly earning enough to be the breadwinner," she said. "Basically this job is for insurance, what I bring home barely covers food and maybe a utility." Her situation may be permanent, she said, though construction jobs are seen coming back eventually, spurred in part by President Barack Obama's $787 billion fiscal stimulus plan that includes funds for road and bridge construction. But many manufacturing jobs are gone for good, as huge sectors like the auto industry suffer profound cuts. Doeringer said the recession will leave the economy "sharply restructured". "The construction jobs will return, but we are seeing an unusually sharp drop in what is left of manufacturing and much of that drop will not be recovered when the recession ends, and much of what does remain will have be at lower wages with reduced fringe benefits," he said.
Fed to Add Older CMBS to TALF Lending Program in July
The Federal Reserve will include legacy assets for the first time in a $1 trillion program to revive credit markets, expanding the effort to commercial real estate securities issued before the start of this year. The central bank also expanded the number of credit-ratings companies permitted to rate assets for the Term Asset-Backed Securities Loan Facility to five after Connecticut Attorney General Richard Blumenthal told the Fed that the three initial eligible companies helped fuel the global credit crisis. Today’s announcement is part of the U.S. government’s broader plans to revive credit for consumers and businesses and end the recession. Fed officials set terms for accepting older commercial mortgage-backed securities after some investors were disappointed that a May 1 announcement included TALF terms only for new CMBS.
The first deadline for investors to submit applications for loans to buy the older CMBS, or securities issued before Jan. 1, is in late July. Adding older CMBS to the TALF is aimed at improving liquidity for the securities, which in turn “should facilitate the issuance of newly issued CMBS, thereby helping borrowers finance new purchases of commercial properties or refinance existing commercial mortgages on better terms,” the Fed said in a statement. Fed policy makers have repeatedly expressed concern about a downturn in the commercial property market this year, and a housing report today suggested the market is finding it tough to get financing. Builders broke ground on 46 percent fewer condominiums, townhouses and other multifamily dwellings in April at an annual rate than the previous month, the Commerce Department said.
The CMBS market has financed about 20 percent of outstanding commercial mortgages and “came to a standstill in mid-2008,” the Fed said. Sales of CMBS plummeted to $12.2 billion last year from a record $237 billion in 2007, according to estimates by JPMorgan Chase & Co. The ratings expansion applies only to CMBS and not to the assets backed by auto and credit-card loans already accepted in the program, which began in March. The Fed said newly issued and older CMBS must have at least two AAA ratings from DBRS, Fitch Ratings, Moody’s Investors Service, Realpoint LLC or Standard & Poor’s and can’t have a rating below AAA from any of them. The Fed said it’s “more broadly” determining which ratings companies to use to determine eligible collateral for the central bank’s credit programs.
Blumenthal wrote to Bernanke last month “strongly” urging the Fed to “reassess and revamp its current policy,” which favors large firms “whose mistakes helped precipitate the current crisis, over smaller ones seeking to break into the market.” Bernanke responded that the Fed was “conducting a broad review of our approach to using rating agencies.” In March, the Fed and Treasury announced that the TALF may be expanded to finance older, or “legacy,” securities. The central bank set June 16 as the first due date for requests for loans to buy new CMBS. It didn’t give a specific July date for applications for older CMBS loans. The next date for loan requests on other asset-backed securities is June 2.
TALF loans to investors to buy asset-backed securities totaled $15.9 billion as of May 13. Bernanke said last week that “early indications” show that investor demand for the central bank’s loans to buy ABS will rise next month from May’s total of about $11 billion. DBRS, based in Toronto, in 2003 became the fourth ratings company to be recognized by the U.S. government. Horsham, Pennsylvania-based Realpoint won that designation last June and specializes in analysis of CMBS. Fitch is a unit of Paris-based Fimalac SA. S&P is a unit of McGraw-Hill Cos. Moody’s is a unit of Moody’s Corp. All three ratings firms are based in New York.
The so-called haircut, which is how much cash an investor will have to put up to buy the bonds, will be calculated by dividing a base haircut by the current market price. Buyers will have to put up more equity to purchase debt that’s trading at lower prices. The Fed used a 17 percent base haircut as an example. If that bond is trading at 50 cents on the dollar, investors will have to put up 34 percent of the purchase price. If the bond is trading at 75 cents on the dollar, an investor would put up 23 percent of the purchase price.
New York AG sues Texas, Arizona debt settlement firms
New York Attorney General Andrew Cuomo sued two debt settlement companies for fraud, deceptive practices and false advertising on Tuesday as part of a probe of their treatment of consumers in the financial crisis. CSA-Credit Solutions of America, Inc of Richardson, Texas, which describes itself as the largest debt settlement company in the United States, and Nationwide Asset Services Inc of Phoenix, Arizona, were sued on behalf of about 20,000 New York customers, Cuomo's office said in a statement.
"These companies are taking advantage of people in New York and throughout the entire country who are facing tremendous economic hardship," Cuomo said in the statement. "Today's lawsuits send a clear message that we are prepared to rein in this unregulated industry and protect New Yorkers who are proactively trying to work their way out of debt." The lawsuit charged that CSA promised a 60 percent reduction in customers' outstanding debt, but only an average of 1 percent of consumers received that savings. It said CSA collected approximately $17 million in fees from New York consumers.
CSA said in a statement that it "disputes liability over the complaints and supposed practices" which largely occurred in 2007 during a 12-month period when the company was under different ownership. Chief Executive Doug Van Arsdale said the company was disappointed with the action because it had "worked hard to bring integrity and regulation to the industry. We are part of the solution." The lawsuit against Nationwide in Buffalo, New York, said the company promised a 25 percent to 40 percent reduction in consumers' outstanding debt, but only one-third of 1 percent of consumers received that savings.
"Customers suffered continued harassment and lawsuits by creditors and had their credit ratings destroyed," the attorney general's office said. Nationwide said in a statement that its attorney had not yet seen the lawsuit, and the company declined comment. It said it had cooperated with Cuomo's investigation and supplied all documents requested by his office. On May 7, investigators subpoenaed 14 debt settlement firms nationwide seeking information about their fee structures and what kind of relief they are providing to consumers
Short work of it
Economic data coming out of Germany may all spell doom and gloom. But viewed from her sun-drenched Stuttgart terrace, things do not look that bad for Regina Walz. “This talk of crisis is wildly exaggerated,” she says. “We’ve been saving all our lives and we have a big family. Even if things go as wrong as they say, we’ll always manage.” She should know. The 42-year-old mother of five is no ordinary hausfrau: Ms Walz is a Swabian housewife. To Germans, it is they who personify thrift and solid common sense – values that Angela Merkel, for one, thinks the world could have done with a bit more of in recent years. After the collapse of Lehman Brothers in New York last September, Germany’s first woman chancellor proclaimed that anyone wanting to know how the west had got itself into such a mess should ask the Swabian housewife: “In her simple and true wisdom, she would have told you that nobody can live above their means forever.”
Economic oracle or no, Ms Walz is certainly not unusual in her sanguine outlook. Indeed, one of the remarkable aspects of the current crisis is the discrepancy between how badly it has affected Germany and how unconcerned its consumers and voters remain. Ordinary Germans, it appears, are unwilling to lose their cool. “Sentiment is a flat line right now,” says Rolf Bürkl of GfK, a market research group whose surveys show consumers in a sober yet stable mood. “It is not getting worse, nor is it improving. People do tell us there is an economic crisis, but it is as though no one felt it was affecting them.” That flies in the face of a 3.8 per cent contraction in gross domestic product for the first quarter, according to data released last week. The government’s latest forecast shows the economy contracting by 6 per cent this year, in the most abrupt downturn since the Great Depression, which brought Hitler to power and plunged the world into war. According to the International Monetary Fund, Germany is on course to be the worst performing industrial economy this year after Japan. Recent order figures and business sentiment may suggest a bottom has been reached, yet most economists expect unemployment to rocket from 3.6m to just shy of its record 5m by the end of next year.
Not only is export-reliant Germany suffering more from the global downturn than more balanced economies but its banking system has also been hit harder by the financial storm than almost anywhere apart from the US. Yet a GfK poll last week showed 57 per cent of respondents feared losing their jobs, a high figure but up by only 3 percentage points from a year earlier and, as Mr Bürkl points out, well below the levels of concern reached in previous downturns. Nor has political sentiment undergone any sudden swing. Ms Merkel remains as popular in the downturn as she has been through the four years of her term, which ends with national elections in September. No other chancellor has enjoyed ratings as high for such a long time. Her Christian Democratic party is not as popular as she is but, with an average rating of 35 per cent, it remains ahead of any other party by a wide margin. The Social Democratic party, junior partner in Ms Merkel’s “grand coalition”, has barely risen from its historical lows. Among the opposition, the radical Left party has seen a fall in support while the main winner in recent months has been the pro-business Free Democratic party. With support at 13-16 per cent, it has established itself as the strongest opposition force.
So what is the key to the riddle of German calm? Manfred Güllner of Forsa, another pollster, has part of the answer: “People think economic times are hard today – but so did they a year ago.” In other words, it is not so much that consumers are being flippant in the downturn but that they have always behaved as if they were in a crisis – even when the economy was booming. One reason is that Germany’s economic rebound, which began in 2005 and ended last year, was built largely on the improved competitiveness of its export industries. The price to pay was about 10 years of stagnation in real disposable income, a trend that helped keep labour costs low. While exports rocketed, consumption remained flat and the savings rate stayed at 11-13 per cent. “The German’s default reaction in time of uncertainty is to save even more,” says Karl Heinz Däke of the German Taxpayers’ Association. One good reason to save was fear of unemployment, which reached its record in 2005 under Gerhard Schröder, Ms Merkel’s SPD predecessor. When joblessness began to fall, helped by the export boom, those concerns were replaced by a fear of inflation. With energy and food prices now falling – and employees enjoying some of the most generous wage rises in a decade – GfK’s latest sentiment survey shows that inflation fears are receding again as job worries creep back.
Hubertus Pellengar of the HDE retailers’ federation says it is “business as usual” for consumers in the economic downturn – consumption is neither rising nor falling but remains as anaemic as ever. Car purchases have risen following the government’s introduction of incentives to scrap older vehicles but consumers have been saving elsewhere, as registered in a sharp fall in retail sales for April. “The government has just displaced consumption. The [scrapping] bonus was a gift to exporters to the detriment of retail and, as such, it is very much in line with the economic policy of the past years,” he says. Yet there is more to the quiet resilience of German consumers and, again, part of the answer can be found in Ms Walz’s native Stuttgart, the capital of Baden-Württemberg. The southern state, one of the most successful regions of Germany when it comes to growth and unemployment rates, is home to the densest network of small and midsized industrial companies in the country, the so-called Mittelstand that makes up the backbone of the German export machine. Entrepreneurship and engineering are as much part of Swabian culture as thrift.
Because of its success, however, Baden-Württemberg has suffered more than almost any other region in the downturn. Home to Porsche and Daimler, it has been hit hard by the automotive crisis. Thomas Klopf, chief executive of Natter, a maker of hydraulic and automotive parts nestled in the shadow of the futuristic Porsche Museum in Stuttgart, is candid about the downturn. “Within three to four months starting last November,” he says, “we lost 50 per cent of our turnover ... But there is this shocking discrepancy between how badly business is hurting right now and how little everybody is recognising it.” Like thousands of companies in the same situation, Mr Klopf tackled the problem by resorting to Kurzarbeit – short-time working where the government picks up part of the wage bill so employers can retain skills that will be needed in an upturn. The scheme, recently twice improved, can be credited for the relatively low increase in unemployment so far. The mood may sour once unemployment begins to rise in earnest – and many companies warn they cannot hoard labour for much longer without clear signs of a recovery. “Things could become messy when a lot of people fall from their solidly middle-class situation into relative poverty,” says Jürgen Falter of Mainz university, a prominent commentator. “But even if this happens, it will not be before the middle or the end of next year, by which time we will probably have overcome the crisis.”
Not only do developments in the labour market usually lag 12 months behind the rest of the economic cycle; those who lose their job this summer are also entitled to unemployment benefits worth up to two-thirds of their latest pay cheque for a year. When challenged about whether her government is doing enough to combat the crisis, Ms Merkel often points to the “automatic stabilisers” of the welfare state that provide a counter-cyclical boost by ensuring people still have money to spend. Indeed, Berlin has recently raised or guaranteed pension and long-term unemployment benefits, with one eye on the economy and another on the election. Prof Falter’s theory is that the taxpayers’ money being redistributed via Germany’s social security machine translates into political support for the status quo.
In other words, social benefits act as a form of anti-extremism insurance for moderate government parties. “The CDU claims it will fare well in the downturn because people will trust parties that have a reputation for economic competence. The Social Democrats say they will benefit because economic uncertainty will make people yearn for more social protection,” he says. “They are both right, which means September’s election will not see the victory of the hard left but another electoral tie and therefore another grand coalition.” So if he is correct and the Swabian housewife is as wise as Ms Merkel thinks she is, there is little the chancellor should be concerned about. For Ms Walz, the prospect of a middle-of-the-road Ms Merkel returning as head of another government of national unity is neither implausible nor unpalatable. “I actually quite like the way she has been handling things so far,” she says.
Regina Walz, 42, mother of five, trained carpenter turned housewife, now studying to become a nurse
“We never spent more than we earned, and whenever we needed extra money, as when we built our house, we asked the family for support. I think much of this crisis talk is exaggerated. I don’t think we’re back to the 1930s. I’m not particularly worried. Perhaps it’s because I can’t see the impact yet. I don’t know anyone who’s lost their job recently. Many of our neighbours are entrepreneurs or shop owners and everybody seems fine. Even my two older sons [trainees at carmaker Daimler and car-part group Bosch] have not been talking much about the crisis. Perhaps it’s because we’ve always run a pretty lean household anyway. If anything, we are a bit better off these days since my sons are working. The only thing the crisis has done so far is to reduce my confidence in our business and economic elite even more. It’s hard to trust them, with so many having been so wrong. I’ve always thought one had to be as financially independent as possible. You don’t want your fate to be in anybody’s hands. I’m more and more convinced of that.”
Michael Becher, 43, quality controller
“I’ve worked since I was briefly out of a job after fleeing the German Democratic Republic in 1988 so being on short shifts is a change. I think it’s fair, though, if I consider all I’ve paid into the unemployment insurance. Sure, I get €100 or €200 less a month but I have more time for my family and my Jack Russell. I don’t have big savings but I don’t have debt, either, so I’m not worried about unemployment. If I lost my job, I’d go back to school for a while. I look at a lot of companies and many are inefficient. Sometimes I feel we needed this crash to restructure our industry. Even where I work, a few people do more harm than good. I’m really angry at bankers – some of them should be locked up. But would I break windows and burn cars over it? It’s not the German way. We are too comfortable and cowardly for that kind of protest.”
Björn Alber, 37, managing director of Karl Alber tooling and machining
“This year was going to be the best in a long time. Since 2004, margins had been falling. Everybody was preparing for price rises and a lot of people had invested because of that. I did too. The crisis hit us last autumn – orders and prices started falling in November. I used to run at 150 per cent of capacity [outsourcing surplus orders]; today, we’re running pretty much at capacity. We still run two shifts, seven days a week, but prices are falling again. That’s where the crisis is hurting. [The sector] never had to chase business, so that’s a big change. I expect more orders after the summer but I fear there will be too many desperate companies around, meaning even lower margins. Another problem is that the carmakers could be forced to outsource even more to Asia or Latin America to cut costs at the expense of quality. As toolmakers, we are mainly involved with the automotive sector at the development stage, which means we should be the first to feel the recovery when it comes. Many companies in our sector are real pearls with unique competence but their finances are poor. They would be great opportunities for outside investors. One thing I’ve learnt in this crisis is that you cannot trust economists. They did not see the crisis coming and I don’t believe the projections they are making now. The problem is that the banks rely on their forecasts.
THE SALES REPRESENTATIVE
Alena Bura, 28, works at an engineering company
“I’ve been on a short-shift scheme for two months. I work two days a week, though we have to be flexible. I feel the difference in pay but the extra time is nice. I’ve always travelled to work by bus and never had time to get a driving licence, so I’m now taking lessons. I’ve always tried to save. Every time I have an extra cent I put it aside. Today is no different. We streamline the budget all the time. I would never buy food anywhere but a discounter. I never go to the supermarket unless I need something special, like lasagne.”
GM bankruptcy seen as all but inevitable
After 100 years in business and 10 months of frenzied but failed restructuring, General Motors Corp is weeks from the bankruptcy filing experts say will be required to complete the Obama administration's bid to reshape a fallen icon of American industry. Facing a government-imposed June 1 deadline to restructure, GM is scrambling to slash some $27 billion of bond debt, win sweeping cost concessions from the United Auto Workers union and eliminate almost 1,600 U.S. dealers. But with the clock ticking, experts see it as all but certain GM will follow its smaller rival Chrysler into federal bankruptcy court. "I almost think it is inevitable," independent auto industry analyst Erich Merkle said. "I don't know how they are going to escape it."
The battery of problems to have hit GM range from plunging sales and declining share to a line-up that has seen more misses than hits over the past decade and that trails engineering leaders like Toyota Motor Corp and Honda Motor Co in hybrid technology. But GM's debt-laden balance sheet is the source of its immediate crisis and the reason restructuring experts, analysts and auto executives do not see a way forward that avoids what could be a complicated and contentious bankruptcy. "The only way it is not inevitable is if the government accepts whatever percentage of bondholders have tried to exchange, whether it is 40 percent or 50 percent or 60 percent," said Peter Kaufman, president and head of restructuring and distressed mergers and acquisitions at the Gordian Group LLC in New York.
GM has said that it must have 90 percent of the $27 billion of bonds participate in the exchange or it will be forced to file for bankruptcy. GM's offer to its bondholders would give them only a 10 percent equity stake in a reorganized company. Representatives of a committee representing major bondholders have called that offer unfair given the payout being offered to the UAW. In a sign of how far apart the sides remain, bondholders have sought a majority stake in the new GM, the controlling position in a new and smaller auto company GM has offered to the U.S. Treasury. After extending $15.4 billion to keep GM afloat since the start of the year, the U.S. Treasury would own at least 50 percent of the automaker under GM's proposed terms.
A UAW healthcare trust would hold nearly 40 percent of GM in return for allowing GM to pay $10 billion -- half of its remaining funding obligation -- in stock, instead of cash. "Trying to get the bondholders, labor and the dealers and other constituents all onboard with an out-of-court plan is a very difficult goal," said Bob Gordon, a restructuring expert at Clark Hill PLC. Chrysler's case, the sixth-largest U.S. corporate bankruptcy, has been watched from the start by some analysts and administration officials as a dry run for a GM case. Chrysler, which filed for bankruptcy on April 30, has won court approval to proceed with a rapid sale of most of its assets to a new company led by Italy's Fiat SpA, paving the way for its emergence in as little as 60 days.
GM said last week that it would probably follow suit by looking for an equally quick sale of its best assets, but experts caution that its process could be harder. "GM is a case that is much larger in scale and by virtue of its size it's more complicated on many different levels," said Scott Stuart, a partner with Donlin Recano, a claims administrator for bankruptcy cases. "It will be a more traditional reorganization." Underscoring the divisions between GM and stakeholders, the UAW on Monday repeated its opposition to a GM restructuring plan that includes closing 16 U.S. plants. GM's announcement last week that it planned to drop more than a quarter of its nearly 6,000 U.S. dealers has also triggered an outcry from some of those independent businesses.
Chief Executive Fritz Henderson, who took GM's top job when his predecessor was fired by the Obama administration's autos task force, has said it could be possible for GM to complete the bankruptcy process within 60 days. But Chrysler was helped by having Fiat as a buyer waiting on the other side of its reorganization. It is unclear what entity would buy GM's assets if U.S. officials run its reorganization by the Chrysler play book, analysts said. "General Motors getting out of bankruptcy in 60 days? That's impossible," said Van Conway, a turnaround expert at Conway MacKenzie. "GM doesn't have a third-party suitor so they have to fix themselves in Chapter 11," Conway said. "That makes it a lot more time-consuming."
Chrysler's major secured lenders agreed to cut their claims on $6.9 billion in debt to 29 cents on the dollar. A similar consensus among GM's major bondholders is seen as unlikely. "GM has more moving parts and it's not clear whether they will have as broad of a consensus when it enters bankruptcy," Clark Hill's Gordon said. GM has warned that its shares could be worth nothing in a bankruptcy filing or less than two cents on the dollar if it presses ahead with an out of court restructuring that would include the issuance of 60 billion new shares. Shares have dropped 94 percent over the past year but were up more than 8 percent on Monday to $1.18. GM's 8.25-percent notes due in 2023 last traded weaker at about 4 cents on the dollar on Friday, when it yielded more than 185 percent. Those notes traded as high as 10.75 cents in late April, according to MarketAxess data.
GM Bankruptcy Would Include Quick Sale to Feds
If General Motors files for bankruptcy, as is widely expected, plans include a quick sale of the automaker's healthy assets to a new company owned by the U.S. government, a source familiar with the situation said Tuesday. The source, who was not cleared to speak with the media and would not be identified, said the plan also called for the government to forgive the bulk of $15.4 billion worth of emergency loans that the U.S. has already provided to GM.The source did not specify a purchase price and added that the new company is expected to honor the claims of secured lenders, possibly in full. The remaining assets of GM would stay in bankruptcy protection to satisfy other outstanding claims.
GM has about $6 billion of secured debt, including a secured revolving credit and bank debt. The government's plans include giving stakes in the new company to GM's union and bondholders, although the ownership structure of the company is still being negotiated, said the source who is familiar with the company's plans. In addition, the government would extend a credit line to the new company, the source said. The government has given GM until June 1 to restructure its operations to lower its debt burden and employee costs. If those talks failed, the company has said it would follow rival Chrysler into bankruptcy.
Setting up a new company to buy the healthy assets is aimed at reassuring consumers who might not be willing to make a major purchase from a bankrupt company, fearing it would not honor warranties or provide service. The board of the new company would be established with the tacit approval of the government. Fritz Henderson, who took the helm of GM earlier this year after the government pushed out Rick Wagoner, would likely head the new company, the source said. GM could not be immediately reached for comment. GM shares were up more than 9 percent Tuesday.
As Detroit crumbles, China emerges as world's auto epicenter
America's auto titans are dismantling their global empires. But across the Pacific, it's as if the global economic forces that have pummeled Detroit never struck. Chinese auto sales are up, and this year China is projected to displace Japan as the world's largest car producer. Now, the auto world is buzzing that China's auto industry may try to pick up the pieces of Detroit -- at a bargain. Chinese companies have tried to dampen speculation, issuing regulatory filings that deny bids to buy Ford's Volvo or General Motor's Saab. But there's little doubt among analysts that Chinese automakers are interested in the United States and that Detroit's automakers are interested in them.
Buying up iconic brands such as Hummer or Saturn could supply Chinese automakers with the technological expertise to help them leapfrog past long-established competitors, said Kelly Sims Gallagher, a lecturer at Harvard University's Kennedy School of Government, who wrote a book on Chinese automakers. "That's where Chinese firms are weakest," she said. "They have world-class business and manufacturing capabilities now. What they still lack is technological know-how, systems integration, being able to design new vehicles from scratch and get them to a manufacturing line." China still suffers from its reputation of being a copycat manufacturer. An acquisition could lend clout to some of the nation's 100 car companies that are largely unknown outside their home country.
Such a deal would be "off-the-shelf legitimacy that you can purchase," said Aaron Bragman, an auto analyst with IHS Global Insight. The global auto industry is restructuring. Italy's Fiat is on the verge of taking control of Chrysler. Last year India's Tata Motors, already famous for its $2,000 Nano, acquired Jaguar and Land Rover. And China's auto sector has emerged as a threat to the long-standing pecking order. Earlier this year, Geely Automobile, one of China's largest private carmakers, purchased an Australian drivetrain transmission supplier, a leading gearbox manufacturer. Weichai Power, one of China's top diesel engine manufacturers, acquired a French diesel engine producer. Another Chinese company, BYD, which counts Warren E. Buffett as an investor, launched a mass-market plug-in electric car, ahead of GM's anticipated Chevrolet Volt.
Detroit's annual auto show in January was somber, but Shanghai's show dazzled attendees with throngs of models, rock bands and light shows. This year, Nissan skipped Detroit and attended the Chinese event in April. Mercedes-Benz, BMW and Porsche all unveiled new-vehicle models in Shanghai. "The center of gravity is moving eastward," Dieter Zetsche, chairman of Daimler, told reporters at the show. "When we look back 20 years from now, the year 2009 is likely to be viewed as the year in which the baton of leadership in the global auto industry passed from the United States to China," Jack Perkowski, a Western transplant and former chairman of a Beijing auto parts company, wrote in his blog "Managing the Dragon."
Some of China's bigger manufacturers, such as Chery Automobile, have trumpeted their intent to export Chinese-made vehicles to the United States in the next few years. To get there, they'll need to revamp their products to meet stringent U.S. emissions and safety standards. That's no simple problem. Previous plans to ship Chinese cars to U.S. soil have crumbled. A company called Brilliance missed its goal of launching U.S. sales in 2009. BYD said it would introduce its cars to Americans in 2010, but has pushed their arrival to 2011. Other potential contenders have gone out of business or are struggling to stay afloat.
In 1994, Beijing released a plan to triple auto production by 2000 and reduce imports. The government lured foreign producers to bring their technology overseas and invest in Chinese auto parts firms. It aimed to modernize domestic manufacturing by creating joint ventures with foreign automakers such as GM. As a result, China's auto sales took off in 2000. In 2002, they crossed the 1 million mark. More recently, the numbers have taken a hit in the economic crisis, forcing companies to curb exports to countries such as Russia and Vietnam. But after the industry pressed Beijing for a bailout late last year, the central government responded with subsidies and slashed the sales tax on small, fuel-efficient cars, spurring demand. And analysts say the expansion of the country's web of roads and highways -- part of an economic stimulus package -- coupled with a growing middle class could fuel more sales for years to come.
In April, China's vehicle sales jumped 25 percent, compared with a year earlier, to a record monthly high of 1.15 million units. It was the third consecutive month that China has surpassed the United States in sales. GM, which has two joint ventures in the country, also hit a monthly record in April with its sales jumping 50 percent from a year earlier. The automaker plans to import cars from China starting in 2011, according to a GM plan circulating in Congress. But in the United States, auto sales fell 34 percent last month. And GM, which has received $15.4 billion in U.S. government loans, says it is likely to file for bankruptcy protection.
Chrysler’s Pensions Are Underfunded by $10 Billion
Bankrupt Chrysler LLC’s pension plans may be underfunded by more than $10 billion, the federal Pension Benefit Guaranty Corp. has estimated. If the pensions are terminated, the agency’s claim for the shortfall in the automaker’s bankruptcy case “would exceed $9 billion,” according to a filing today in U.S. Bankruptcy Court in New York. Chrysler is seeking approval of a settlement among the company, the PBGC, Cerberus Capital Management LP and Daimler AG to partly fund the plans. Chrysler’s proposed sale would extinguish Daimler’s $1 billion guaranty securing the pensions and the PBGC to address the underfunding, Chrysler lawyers wrote in the filing.
Under the proposed settlement, Daimler will make $600 million in planned cash contributions to the pensions and replace the $1 billion guaranty with a $200 million guaranty even after the sale is completed. Also, Daimler will also forgive a $1.5 billion loan to Chrysler while Cerberus will forgive a $500 million loan, according to court papers. A hearing on the settlement is scheduled for May 27. Daimler said before the April bankruptcy that it would cede its remaining 19.9 percent stake in Chrysler to majority owner Cerberus and write off the $1.5 billion loan to help the company avoid bankruptcy. Chrysler won approval to auction most of its assets with a consortium of Italy’s Fiat SpA, a United Auto Workers union benefit trust and the U.S. and Canadian governments as the lead bidder. Having those contributions from Daimler, “will eliminate the threat of the PBGC terminating the Chrysler pension plans prior to the consummation of the sale,” according to Chrysler.
The Darwin Depression: Where Are We Now?
Back in December, I wrote a post here called "The Darwin Depression" -- my basic premise being that the US economy, and in fact, the global economy was in the midst of the bursting of the largest asset bubble in world history, and as we returned to a level of financial sanity, it was going to be a long slow descent to a more normal standard of living. This descent to normality means that we never will see assets, any assets, priced at the levels that we saw in 2005 and 2006 when the housing bubble and in turn the asset bubble it enhanced pushed the valuations of virtually everything we buy or touch to unsustainable levels. The concept of "recovery" is one, therefore, that we must understand clearly as we move forward.
Will recovery mean that people will, once again, be able to rent summer houses in the Hamptons for $60,000 a month? No, of course not. As there has been lots of coverage of this small economic issue, let's look at this more closely. Let's say a homeowner was used to getting $100,000 for a summer rental, and now is looking at only getting $50,000. Is that really a reduction of 50% or a return to a more normal level of sanity? I say the latter. But the economic impact of that drop is significant. I have been told that some of the private schools in the Hamptons are seeing significant withdrawals for next year, why? Because the families that were sending the kids to the schools were paying the bills with the summer rental income, and now, no income.
Now, what happens to a private school that loses 35% of its 5th graders because of withdrawals? Well, that's a significant loss of income to the school, devastating perhaps in conjunction with the expected drop in fundraising and the value of the endowment. Just as in the multiplier effect of money gains in an up cycle is enormous, so too is the depression multiplier in a down cycle. It's not that the homeowner is not getting the $50,000. It's the school is not getting paid, the landscape project is put off, a new car isn't bought, a vacation goes untaken. And so on. Now, remember, $50,000 is a huge amount of money for a summer rental. Huge. It's just that it feels like a depression to those experiencing, but it's not.
We're seeing the same issue with all the stories of frugality spreading around. One of my favorites was from the Boston Globe talking about how, horrors, parents of graduating students from local universities were staying in the apartments of their children when attending graduation to save money. Every set of parents doing that was probably taking $500 - $1,000 out of the local hotel economy, but, again, our parents and grandparents would not think anything of doing this and we shouldn't either. Will it have an impact? Of course, but again I don't think it's a depression. It's just a return to how things should have always been.
From major league baseball, when older players demanding $5,000,000 a year to play are not being signed to starting salaries out of school for recent graduates that are falling fast, we are seeing a fundamental restructuring of the valuation of everything in our world. How long will it take to get to the bottom? Well, again here's an interesting conundrum - what do we mean by the bottom? A bottom of the market is considered a buying opportunity because the market will go up from there. The 'bottom' that people are so desperately searching for, in retail sales, in the housing market, is not really the bottom. It's the new reality, so as housing prices still have to fall 30% more, as boat sales slow to a normal level, as vacation patterns return to normal, as it all returns to normal, it will take years of Americans adjusting to the 'bottom.'
Growth off of that floor will be slow, and steady. But there will be growth. Does this make me a pessimist? No. I don't think so. It's just the reality of a world gone deeply awry for the better part of a generation. It will take a long long time. In the end, I am an optimist because I think the Darwin Depression will return America to some form of emotional and fiscal sanity. Who among us hasn't expressed frustration at the material culture we live in and are trying to raise our children in? Who hasn't been shocked at the prices of houses? Or watching young kids walk around with $200 cell phones? It's not normal and it was fueled by debt, enormous sums of debt, that were unsustainable.
Bank of England makes £1 billion profit thanks to crisis measures
Despite the worst financial crisis in modern history, one City bank has managed to turn the biggest profits in its 300-year history. The Bank of England yesterday revealed it has made its biggest profits since its foundation in the late 17th century. The £995m pre-tax profits in 2008 were largely a result of the extraordinary measures carried out during the past year. The Bank makes most of its money from the spread on its money market operations and its repo operations, in which it lends money in exchange for collateral. Because the crisis has involved the Bank lending far more cash than usual, profits increased more than five-fold from last year.
After tax is paid, half the proceeds are to be returned as dividends to the Treasury, while the other half bolsters the Bank's own reserves. The Bank also made an income after tax of £573m on the special liquidity scheme. A spokesman insisted that the Bank had not been incentivised to increase its profits, and was instead acting in the best interests of the financial system. "The Bank's profit is a consequence of policy decisions to tackle the financial crisis," he said. "It is entirely right that it charges fees to set the right incentives for financial institutions to use its facilities, and protect itself and taxpayers from potential credit risk."
However, the profits are likely to infuriate some in the City who have bemoaned what they see as harsh terms on the Bank's rescue schemes. Governor Mervyn King also used the Bank's Annual Report to call on the Government to give the Bank more power in the future to oversee City institutions, saying: "The Bank's new statutory responsibility for financial stability is welcome. But... I regret that [it] has not been accompanied by any new powers to deal with banks before they fail." Mr King’s pension pot is now worth £5.4m. Both his deputy governors, Paul Tucker and Charlie Bean, have elected to receive smaller salaries and bigger pensions, following an external review of Threadneedle Street’s remuneration policies.
"Don't Buy Any Food You've Ever Seen Advertised"
"The real food is not being advertised. And that's really all you need to know."
Amy Goodman: Energy, healthcare, agriculture, climate change, global outbreaks like swine flu—what do all these topics have in common? Food. That’s right, none of these issues can really be tackled without addressing some of the fundamental problems of the food system and the American diet.
Well, my next guest is one of the leading writers and thinkers in this country on food. Michael Pollan is a professor of science and environmental journalism at University of California, Berkeley, author of several books about food, including The Botany of Desire, The Omnivore’s Dilemma and his latest, In Defense of Food: An Eater’s Manifesto, which just came out in paperback. ... Let’s start with the latest news over the last month, swine flu. How is that connected to industrialized agriculture?
Michael Pollan: Well, we don’t know for sure yet. We’re still kind of investigating. But the best knowledge we have is that this outbreak came from a very large industrial pork operation, pork confinement operation, where, you know, tens of thousands of pigs live in filth and close contact. And this was in Mexico.
And, you know, it’s very interesting. Last year, eighteen months ago, the Pew Commission on animal agriculture released a report calling attention to the public health risks of the way we’re raising pork and other meat in this country. And they actually predicted in that report—they said the way you’re raising pigs in America today creates a perfect environment for the generation of new flu pandemics, basically because once you get that mutation, which sooner or later is about to happen, it very quickly—you have ... so much genetic material coming together, so concentrated, and then so many pigs can catch it, and ... we’ve created these Petri dishes for new diseases. And here we go.
Goodman: And what has been the industry response?
Pollan: Oh, the industry response and the media response, by and large, is not to pay attention to that part of the story. We haven’t gotten a lot of investigation of, well, exactly how do these things evolve and how did these conditions contribute to it.
The other angle, too, is that, you know, as we bring any pressure to bear on American animal agriculture, the tendency is going to be for it to move to Mexico. And indeed, that appears to be the case here, that these are American corporations who have to escape any kind of environmental regulation, have moved their confinement, animal operations, south of the border.
Goodman: Explain how these animal operations work.
Pollan: Well, a pig confinement operation is a pretty hellish place. They are, you know, tens of thousands of animals, kept jammed together. The animals are so close together that they have to snip their tails off, because the animals are so neurotic—I mean, pigs are very intelligent; they’re smarter than dogs—that they will nip at each other’s tails. They’ve been weaned so early that they have this sucking desire, and so they take it out on the tails of the animal right in front of them. So they snip the tails off, not to stop the procedure, but to make it so painful that animals will avoid having their tails bitten, just to make them raw and painful.
They administer antibiotics to these animals on a regular basis, because they could not survive without them. And the waste goes down directly below the animals into this giant cesspool that’s flushed, two or three times a day, out. I mean, ... they’re incubators for disease.
The sows remain in crates their whole lives, so they can be conveniently inseminated, and they have their babies right there in their crates. You know, to go to one of these places is to stop eating industrial pork, basically. If we could see into this industrial meat production, it would change the way most of us eat.
Goodman: It’s amazing, because the whole coverage, it seems, of swine flu is to be afraid of human beings coming over the border, that they are the main problem.
Pollan: Yeah, that they’re carrying it, yeah, yeah. No, it’s not—we don’t—it is not contracted by eating the pork. That doesn’t, you know, seem to be a problem. And some countries have taken that tact, used this to keep out American pork. But that link hasn’t been made.
Goodman: Can you talk about corporations in other ways, like Monsanto, talking about the sustainability of genetically modified foods?
Pollan: Yeah, Monsanto is very much on the attack right now, pushing its products, particularly in Africa, and making the case that the most sustainable agriculture will be intensive production on the land base we have. The argument is that there’s only so much arable land in the world, we have ten billion people on the way, and that the only way to feed them is to get more productivity over the land we have, to further intensify agriculture, using their genetically modified seeds.
And the word “sustainable” is never far from their lips. And they have this amazing ad campaign. Two things are notable about it. One is that the language of sustainability and the critique of industrial food is being picked up by some of the major players within industrial food, either as an effort to co-opt the rhetoric or simply confuse the consumer and the citizen.
The other thing is that it’s very interesting that Monsanto should be arguing that it has the key to improving productivity. If indeed what we need to do is improve productivity, don’t look at genetically modified crops. They have never succeeded in raising productivity. That’s not what they do. If you look at the—the Union of Concerned Scientists just issued a report looking at the twenty-year history of these crops, and what they have found is that basically the real gains in yield for American crops, for world crops, has been through conventional breeding. Genetic modification has—with one tiny exception, Bt corn used in years of very high infestation of European corn borers—has not increased productivity at all. That’s not what they’re good at. What they’re good at is creating products that allow farmers to expand their monocultures, because it takes less management. So, if indeed we need to go where Monsanto says, there are better technologies than theirs.
Goodman: What about companies boasting that they use real sugar, like that’s a health claim.
Pollan: Well, you know, it’s very interesting. Since this book came out, where I argue don’t buy high-fructose corn syrup and don’t buy products with more than five ingredients, suddenly the industry is—you know, they’re so clever. I have to hand it to them. But now they’re arguing that their products are simpler, and there’s new Haagen-Dazs 5, which is a five-ingredient Haagen-Dazs product. You know, it’s still ice cream. Ice cream is wonderful, but we shouldn’t treat it as health food because it now has only five ingredients. ... Frito-Lay potato chips now is arguing that they’re local. Now, you have to remember, any product is local somewhere. Right? This food doesn’t come from Mars. But to think that Frito-Lay as a local potato chip is really a stretch.
So—and on the high-fructose corn syrup thing, now that you’ve got Snapple and soon-to-be Coca-Cola making a virtue of the fact that they contain real sugar, no high-fructose corn syrup, what that is is an implicit health claim for sugar. And that is an incredible achievement on the part of industry, to convince us that getting off of high-fructose corn syrup has made their products healthier. It has done no such thing. Biologically, there’s no difference between high-fructose corn syrup and sugar.
Goodman: Well, explain why you were going after high-fructose corn syrup.
Pollan: Well, my argument about high-fructose corn syrup and why you should avoid it is it is a marker of a highly processed food. I’m just trying to help people, when they’re going through the supermarket—the main thing you want to avoid is processing, you know, extreme processing. And high-fructose corn syrup—I mean, think about it. Do you know anyone who cooks with high-fructose corn syrup? It’s not a home—it’s not an ingredient you’ll find in a home pantry. It’s a tool of food science.
My problem with it is its ubiquity through the food system. You have high-fructose corn syrup showing up where sugar has never been—in bread, in pickles, in mayonnaise, in relish, in all these products—that they basically have found that if you sweeten anything, we will buy more of it. High-fructose corn syrup is a very convenient, cheap ingredient, because we subsidize the corn from which it’s made.
But to boast about your product not having high-fructose corn syrup as being some kind of virtue is really stretching it. And I think what we see here is another example of the food industry’s ingenuity in taking any critique of industrial food and turning it into the next marketing strategy. It’s a lot like the low-fat campaign, you know, which began as a government critique of food, you know, beginning with George McGovern in the ’70s saying we should eat less red meat because of heart disease. Whatever you think of the science of that, which turns out not to have been that good, it was a well-meaning campaign to improve the American diet. Industry came back and re-engineered the whole food system to have less fat in it and no fat in it. And that campaign sold a lot more food. And, in fact, since that campaign, we’ve been eating about 300 more calories a day, and we’re a lot fatter. So, you can’t—you just can’t underestimate their ability turn any critique into a way to sell food.
So, I’ve had to update my rules. And with all this new marketing based on these ideas, my new suggestion is, if you want to avoid all this, simply don’t buy any food you’ve ever seen advertised. Ninety-four percent of ad budgets for food go to processed food. I mean, the broccoli growers don’t have money for ad budgets. So the real food is not being advertised. And that’s really all you need to know.
Goodman: Michael Pollan, the Food and Drug Administration is slapping General Mills with a warning over its claim that Cheerios is clinically proven to help lower cholesterol. They say it makes it a drug under federal law.
Pollan: Yeah. Well, good for them. I mean, you know, the FDA has been so lax, and the reason you see this proliferation of bogus health claims all through the supermarket has basically been the FDA has been hands-off for a decade. And to see them tighten a little bit and make these companies prove these health claims—
You know, another piece of advice from In Defense of Food is, don’t eat any food that comes with a health claim. It sounds counterintuitive, but if you’re worried about your health, that is not the healthy food. The healthy food is in the produce section. It’s sitting there very quietly, without budgets to do this research, without budgets for marketing, without packages to print health claims on. So just kind of tune that out.
Goodman: What do you make of the new Agricultural Secretary, Tom Vilsack?
Pollan: Well, it’s interesting. When Vilsack was appointed, I was disappointed initially. And I said something like, this was agribusiness as usual. He has surprised me in various ways, and I have some reason, cautious, for hope. I think he has a mandate from President Obama to begin reforming things.
He has appointed as his number two—the woman running the Department of Agriculture, Kathleen Merrigan, is a proven reformer. She developed the organic program in the department and as a staffer to Senator Leahy back in the ’90s. And she is really committed to sustainable agriculture. This woman will be running the Department of Agriculture. I think that’s wonderful. We’ll see what she can do. She’s up against an incredible amount of opposition.
He made an initial move to go after subsidies that was not very well handled and was rebuffed very easily by the agriculture committees in the House and Senate. He, I think, will do a lot to support local agriculture. He’s very committed to farmers’ markets and developing these local food chains, and I think that’s very encouraging.
But he has a mission to make “nutrition” the watchword of the nutrition programs in the Department of Agriculture: School Lunch, Food Stamps, WIC. Now, that sounds kind of “duh,” but, in fact, those programs have nothing to do with nutrition right now. They’re essentially ways to dispose of agricultural surpluses. So if they actually raise the nutrition standards and make that the focus—
Goodman: What do you mean, they’re the way to—
Pollan: Well, the reason we have a School Lunch Program, you know, it began as an effort really to get rid of this incredible overproduction of American agriculture. I mean, we’re using our children as a disposal for excess, you know, cheap ground beef and cheese and all these corn products, and that the—you know, under the School Lunch Program, we feed our kids chicken nuggets and tater tots in school. We’re using the School Lunch Program to teach them how to become fast-food consumers. So, it’s not about health, and it needs to be about health. So, if he can move that program in that direction, I think that will be wonderful.
Goodman: Michelle Obama’s organic garden, that the pesticide industry had in a memo that they shuddered when they heard her use the word?
Pollan: Yes. You know, I think her garden is actually a significant development. I mean, you can dismiss it as symbolic politics, but in fact symbols are important. And the word “organic” are fighting words in this—is a fighting word in this world. And she did not have to say it was an organic garden; she could have simply said it’s a garden. And that she did was noticed.
And the Crop Life Association, the trade group of the pesticide makers, wrote her a letter, being as cordial as you must be to a First Lady, saying, you know, “You’re really casting aspersions on industrial agriculture, and we really hope you will use our crop protection products.” In other words, “Buy our poisons, whether you need them or not.”
Goodman: We’re talking to Michael Pollan. His latest book, now out in paperback, In Defense of Food: An Eater’s Manifesto. Your words of wisdom? Your food for thought? Eat food, not too much, mostly plants?
Pollan: Yeah, it’s very simple. It really is. I mean, you know, as a journalist, you know this, that usually when you drill down into a subject, you find things are more complicated than you thought, and the blacks and whites don’t quite work anymore. When it came to nutrition science, the deeper I went, the simpler it got. And by the time I had spent two years studying what we know about nutrition and health, I realized that, you know, all the—that you could dismiss so much of this sketchy science, and as long as you ate real food, and not too much of it, and emphasized plants more than meat in your diet, you would be fine, and that the over-complication of food by industry, by government, is something really to be avoided.
And so, the challenge is, though, how do you identify food? Because now the market is full of these edible food-like substances, the ones that carry the health claims, the—
Goodman: What do you mean, “edible food-like substances”?
Pollan: Well, these are products of food science. These are the stuff in the middle of the supermarket, the stuff that doesn’t go bad for a year, deathless food, immortal food. You have to think, well, what does it mean to say a food has got a shelf life of six months or a year? It means it has been engineered to resist bacteria, pests of all kinds, fungi, mold. And what does that mean? Well, it has no nutritional value for those things. The insects, the bacteria, they’re not interested in the Twinkie, because there’s nothing of nutritional value in it.
Goodman: Can you talk about how the food system affects healthcare and the whole issue of healthcare reform?
Pollan: Well, I think that we are soon to recognize that we are not going to be able to reform healthcare, which depends on getting the cost of healthcare down, without addressing the American diet, the catastrophe of the American diet.
The CDC, Centers for Disease Control, estimates that of the $2 trillion we’re spending on healthcare in this country, $1.5 trillion is for the treatment of preventable chronic disease. Now, that’s not all food, because you have smoking in there, too, and alcoholism. But the bulk of it is food. Food is implicated in heart disease, which we spend, you know, billions and billions on. It’s implicated in type 2 diabetes. It’s implicated in about 40 percent of cancers. It’s implicated in stroke, all sorts of cardiovascular problems.
And, you know, in a sense, the healthcare crisis is a euphemism for the food crisis, I mean, that they are identical. And I do think that President Obama recognizes this. And I think that you will see programs to address this, because that is how you could—you know, a better School Lunch Program would be a down payment on the healthcare reform, because you would reduce long-term the costs of the system. Treating a case of type 2 diabetes costs the City of New York, every new case, $500,000. It is bankrupting the system. And it’s preventable.
Goodman: How is it treated?
Pollan: Well, type 2 diabetes is, once you contract it, it’s $13,000 a year in additional medical costs. It takes something like ten years off of your life span. It means an 80 percent chance of heart disease in your life, a possibility of amputation and blindness, you know, being tethered to machines and drugs your whole life. It’s a very serious sentence, and it’s entirely preventable with a change in lifestyle.
The interesting thing is, why don’t we have really powerful public interest ad campaigns to inform people about this? I mean, the way the government could save the most money the most easily would be having a public advertising campaign about the dangers of soda. There are a great many children that, simply by getting off soda, avert this whole course.
Goodman: What do you think of taxing soft drinks, that they’re talking about now?
Pollan: You know, I’m not sure, frankly. I haven’t really thought that through. It’s probably not a bad idea. I think that the cheapness of high-fructose corn syrup and sugars in our economy is part of the problem and that when we started subsidizing—I guess I would attack it on the other side. We should not be making these corn-based products so cheap with our tax dollars. I think we have to change the subsidies. The reason that soda is so cheap is that we subsidize corn in huge amounts, and I think we have to change the incentives down on the farm. I think that’s really where I would put my emphasis.
Goodman: What about large corporations buying up the farmland of poorer countries?
Pollan: Well, this is going on. There is a growing recognition that the great unrenewable resource is arable soil in this world and that countries like China realize that they will not be able to feed their population on their soil base, because of their numbers, but also because they poison so much of their soil. Their soil is polluted, and they have a serious problem with that. So they are buying up huge swaths of land in Africa.
This is a political disaster, you know, waiting to happen. I mean, Africans are going to stand by while their best farmland is being used to feed Chinese? I mean, I don’t see this as a sustainable solution for anybody. But this is what’s happening.
And we should take note and realize that our farmland is so precious, and we should be very careful about developing it, and we should certainly be careful about letting it run off into the Mississippi River because we’re failing to put in cover crops and things like that.
Goodman: [Y]ou wrote a long letter to President Obama, to the “Farmer-in-Chief,” as you put it. What’s the most salient point in it?
Pollan: The most salient point is simply, you are not going to be able to tackle either the healthcare crisis or climate change unless you look at our food system. In the case of climate change, food is responsible for about a third of greenhouse gases, the way we’re growing food, the way we’re processing it and the way we’re eating. And the healthcare crisis, as I’ve talked about. So we need to address it. It’s really the shadow issue over these other two issues.