Customers entering Tri-County Farmers Co-op Market in Du Bois, Pennsylvania
Ilargi: Yes, transparency is what's needed, and at the same what's lacking more than anything (well, that and money, and honesty, and ....). The BankUnited seizure by the FDIC yesterday looks positively weird to me.
Mind you, it's not possible to see all the details of what's going on here, but then, that is the problem, isn't it?. Deals like this should be 100% transparent. What we do know is that the taxpayer, through FDIC funds, forks over $4.9 billion, and will never see any of that back. The investors, BlackRock and Carlyle, bloody handed pirates, pay $900 million, or less than 20% of what the taxpayer pays, and take control of the bank's assets, minus that $4.9 billion in toxicity. Nice gift if you can get it, but what's up with that?.
Perhaps even more unsettling is that BankUnited was seized and sold on the same day, or in other words it had been sold before it was seized. There had allegedly even been a bidding war, and if that is true, were taxpayers' interests fully negotiated to the best of the FDIC''s abilities? Is it a good thing for BankUnited's clients to now be in the hands of secretive private capital that is accountable only to very rich investors? What if the depositors' interests are in conflict with those of the investors? Why would you keep your money there? Are you nuts?
More non-transparent nuttiness, though likely with better intentions: Ron Paul's revived Fed Transparency Act. I suggested a few days ago, before the petition signing etc. came alive (see Yves' nakedcapitalism.com), when addressing the Fed trying to hijack SEC powers, that before any such thing could happen, we''d need an independent (from industry AND government) panel to audit the Fed's books going back at least 50 years. My conclusion was that it ain't ever going to happen. And that applies to Ron Paul's initiative as well, no supported by Yves and many others. To me it looks so obvious that it will not be that I suspect Ron Paul of less than honest motives. He's a very smart man, but this he doesn't see? I find that hard to swallow.
Paul wants the Government Accountability Office (GAO) to do the grinding bit. But I remember that David Walker, one of the few US government officials I hold in any esteem, who headed the GAO from 1998 to 2008 as US Comptroller General, left frustrated. It doesn't get any easier when you realize that in 2008 Walker was recruited by Peter G. Peterson, co-founder of the Blackstone Group, and former Secretary of Commerce under Richard Nixon, to lead his new foundation. Then again, the Foundation distributed the documentary film, I.O.U.S.A., which follows Walker and Robert Bixby, director of the Concord Coalition, around the nation, as they engage Americans in town-hall style meetings.
Yeah, it's real lovely when the power brokers organize the very protest against themselves, isn't it? Hey, if that sort of thing surprises you, it's time to open your eyes. However it all murkily operates, though, calling for a Fed audit by the GAO is a recipe for never ever getting what you want. Which would be transparency.
And no, I'm not saying I hold the ready made solution in my hands. From where I'm sitting, the whole system is so throughly rotten that the only thing to do is dig a very deep hole, throw in the entire shebang, fill it up with toxic waste (plenty of that to go around) and if you have any funds left, shoot the whole thing into faraway outer space.
The only way to get rid of the Fed is to repeal the law that founded it in 1913. And that won't happen with the present occupants of the White House, Senate and Congress in place. Not a chance. You're going to have to take it from their cold dead hands. These guys have the best deals on the planet, and they have the power and the money to protect them. Audit? Get them audited by a team of 20 year-old brilliant Chinese, Korean and Indian minds. Nah, don't bother, not even close to a challenge.
For the moment, you have yourselves a class of untouchables. And you probably deserve it, after all, isn't that something that gave Americans great pride in the 1930's?
Have a great holiday weekend. And ask yourself this question whenever you pass by a mirror:
Who's your daddy?
U.S. 10-Year Note Falls Most Since June on Supply, Credit
Treasuries fell, pushing 10-year notes to their biggest weekly loss since June 2008, as investors prepared for the U.S. government to resume debt sales after a two-week hiatus. Ten-year yields rose above 3.4 percent for the first time since November amid concern the record supply of Treasuries to pay for a mounting budget deficit may jeopardize the U.S.’s AAA credit rating. Longer-maturity notes and bonds led the declines, sending yields on 10-year securities to 2.56 percentage points above those on two-year notes, the most since November. "We are testing key levels on the long end of the market," said Hicham Hajhamou, a trader in New York at BNP Paribas, one of the 16 primary dealers that trade with the Federal Reserve. "There’s a lack of confidence in dollar assets and the bond market is repricing itself."
The yield on the 10-year note rose nine basis points, or 0.09 percentage point, to 3.45 percent at 2:15 p.m. in New York, according to BGCantor Market Data. The price of the 3.125 percent security due in May 2019 fell 3/4, or $7.50 per $1,000 face amount, to 97 1/4. The yield has surged 32 basis points this week, the most since gaining 35 basis points to 4.26 percent in the period ended June 13 on concern about inflation. Yields on 10-year notes touched the highest level since Nov. 19 after Standard & Poor’s cut its outlook on the U.K.’s AAA credit rating yesterday and Pacific Investment Management Co.’s co-chief investment officer, Bill Gross, said the U.S. will "eventually" lose its top rating.
President Barack Obama has pushed the nation’s marketable debt to an unprecedented $6.36 trillion. His administration raised on May 11 its estimate for the deficit this year to a record $1.84 trillion, up 5 percent from the February estimate, and equal to about 13 percent of the nation’s GDP. "It’s not an issue of whether the rating changes now," Mohamed El-Erian, Pimco’s chief executive officer, said in a CNBC interview today. "It’s whether the markets start pricing in some change." White House Press Secretary Robert Gibbs said Obama isn’t concerned about "a change in our credit rating." Asked if he expects a change, Gibbs said, "I don’t believe they will be cut." Gibbs was responding to questions at his regular briefing. The U.S. will issue a record $3.25 trillion of debt in fiscal year ending Sept. 30, according to Goldman Sachs Group Inc., another primary dealer.
The Treasury announced this week it will auction $40 billion in two-year notes on May 26, $35 billion in five-year notes on May 27 and $26 billion in seven-year notes on May 28. The Treasury also sell $61 billion in three-month and six-month bills weekly auction on May 26. "We are at a point where the supply considerations are overwhelming to the dealer community," said David Ader, head of U.S. government bond strategy at Greenwich, Connecticut based RBS Greenwich Capital, in an interview on Bloomberg Radio. "The world is having a hard time digesting all this supply." After gaining 14 percent in 2008 as investors sought a refuge from mounting losses on securities tied to subprime mortgages, Treasuries have lost 3.86 percent since December, according to Merrill Lynch & Co.’s U.S. Treasury Master index. German bunds have lost 0.8 percent, according to Merrill data.
Weakness in the U.S. dollar has made U.S. assets less attractive to foreign investors. The Dollar Index, used by the ICE to track the U.S. currency versus the euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona, has fallen 11 percent from its high this year of 89.624 on March 4. "The urgency for money managers with large U.S. dollar holdings to diversify could well intensify," analysts led by Callum Henderson, global head of currency strategy in Singapore at Standard Chartered Bank, wrote in a research note today. Central bank data indicates continued foreign demand for U.S. assets. The Fed’s custodial holdings of Treasuries for foreign accounts including central banks rose to a record $1.89 trillion, according to the Fed. Foreign holders added $26.7 billion of Treasuries for the week ended May 20, the largest increase since December.
The cost to hedge against losses on U.S. government bonds for five years climbed to a three-week high, indicating perceptions the nation’s credit quality is deteriorating. Credit-default swaps on U.S. debt rose 3.5 basis points to 41, the highest since April 29, according to prices from CMA Datavision in New York. An investor would have to pay $41,000 a year to protect $10 million of debt from default. Credit-default swaps, contracts to protect against or speculate on default, pay the buyer face value if a borrower fails to adhere to its debt agreements. Treasury yields rose even as the Fed bought $18.277 billion of U.S. debt in three purchase operations this week and minutes of the central bank’s April 28-29 policy meeting showed some officials judged the policy makers may need to boost asset purchases to secure a stronger economic recovery, while all agreed to hold off on such a move.
Ten-year yields have increased 92 basis points since March 18, when the Fed announced it would buy up to $300 billion in U.S. debt over six months in an effort to lower consumer borrowing costs. "The Fed may have to announce a change in quantitative easing to help support the market," said Thomas Tucci, head of U.S. government bond trading in New York at RBC Capital Markets, the investment-banking arm of Canada’s biggest lender. "The Fed will have to have an alternative or expansion to the current quantitative easing policy to help support the market." The central bank has bought $122.984 billion in government securities through the program. The Fed’s next purchase is scheduled for May 26, when it will buy Treasury Inflation Protected Securities maturing between January 2010 and April 2032, followed by a purchase of debt maturing between May 2012 and August 2013 on May 27.
Geithner Vows to Cut U.S. Deficit on Rating Concern
Treasury Secretary Timothy Geithner committed to cutting the budget deficit as concern about deteriorating U.S. creditworthiness deepened, and ascribed a sell-off in Treasuries to prospects for an economic recovery. "It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term," Geithner said in an interview with Bloomberg Television yesterday. He added that the target is reducing the gap to about 3 percent of gross domestic product, from a projected 12.9 percent this year. The dollar extended declines today after Treasuries and American stocks slumped on concern the U.S. government’s debt rating may at some point be lowered. Bill Gross, the co-chief investment officer of Pacific Investment Management Co., said the U.S. "eventually" will lose its AAA grade.
Geithner, 47, also said that the rise in yields on Treasury securities this year "is a sign that things are improving" and that "there is a little less acute concern about the depth of the recession." The benchmark 10-year Treasury yield jumped 17 basis points to 3.36 percent yesterday and was unchanged as of 12:18 p.m. in London. The Standard & Poor’s 500 Stock Index fell 1.7 percent to 888.33 yesterday. The dollar tumbled 0.5 percent today to $1.3957 per euro after a 0.8 percent drop yesterday. Gross said in an interview yesterday on Bloomberg Television that while a U.S. sovereign rating cut is "certainly nothing that’s going to happen overnight," markets are "beginning to anticipate the possibility." Nobel Prize-winning economist Paul Krugman, speaking in Hong Kong today, nevertheless argues it’s "hard to believe" the U.S. would ever default.
Britain’s AAA rating was endangered when Standard & Poor’s yesterday lowered its outlook on the nation’s grade to "negative" from "stable," citing a debt level approaching 100 percent of U.K. GDP. It’s "critically important" to bring down the American deficit, Geithner said. In its latest budget request, the administration said it expects the deficit to drop to 8.5 percent of GDP next year, then to 6 percent in 2011. Ultimately, it forecasts deficits that fluctuate between 2.7 percent and 3.4 percent between 2012 and 2019. Ten-year Treasury yields have climbed about 1 percentage point so far this year, in part after U.S. economic figures indicated that the worst of the deepest recession in half a century has passed. The yield on 30-year bonds has jumped to 4.31 percent, from 2.68 percent at the beginning of the year.
The Treasury chief said it’s still "possible" that the unemployment rate may reach 10 percent or higher, cautioning that the economic recovery is still in the "early stages." "The important thing to recognize is that growth will stabilize and start to increase first before unemployment peaks and starts to come down," he said. While "these early signs of stability are very important" this is "still a very challenging period for businesses and families across the United States," he said. Initial claims for unemployment insurance fell by 12,000 in the week ended May 16 to 631,000, according to Labor Department statistics released yesterday. Still, the number of workers collecting unemployment checks rose to a record of more than 6.6 million in the week ended May 9. As of April, the unemployment rate was 8.9 percent, the highest level since 1983. The economy has lost 5.7 million jobs since the recession started in December 2007.
Also yesterday, Geithner said the U.S.’s $700 billion financial rescue package can’t be used to aid cities and states facing budget crises. The law "does not appear to us to provide a viable way of responding to that challenge," Geithner told a House Appropriations subcommittee in Washington. Among the hurdles: money from the Troubled Asset Relief Program was designed for financial companies, he said. Geithner said he will work with Congress to help states such as California that have been battered by the credit crunch and are struggling to arrange backing for municipal bonds and short-term debt. The municipal bond markets are "starting to find some new balance and equilibrium," he said.
Ilargi: Sheila Bair got a JFK award for bravery this week, for speaking out before others on the demise of the markets. And listen to her now. Garbage man, you missedt a bag....
Two Illinois Banks Seized, Bringing U.S. Tally This Year to 36
Two Illinois banks with combined assets of almost $1 billion were closed by regulators, pushing the toll of failed U.S. lenders to 36 this year amid the longest recession since the 1930s. Strategic Capital Bank in Champaign and Citizens National Bank in Macomb were closed and the Federal Deposit Insurance Corp. was named receiver of both, the FDIC said. Strategic Capital’s deposits were assumed by Midland States Bank of Effingham, Illinois, and deposits at Citizens National were purchased by Morton Community Bank. "Deposits will continue to be insured by the FDIC, so there is no need for customers to change their banking relationship to retain their deposit insurance coverage,” the FDIC said.
Regulators are closing banks at the fastest pace in 15 years, including BankUnited Financial Corp. in Florida yesterday, and pumped $200 billion into the biggest banks in a Treasury rescue program. Costs from closing banks in the second quarter climbed to more than $8 billion, including $4.9 billion for BankUnited, from $2.28 billion in the first, FDIC data show. Midland States will buy $536 million of Strategic Capital’s $537 million in assets, with the FDIC sharing losses on about $420 million of them, the regulator said. Midland States will assume all of the failed bank’s $471 million in deposits. Strategic Capital’s lone office will open on May 26 as a branch of Midland States. Morton Community will buy $240 million of Citizens National’s $437 million in assets and signed a loss-sharing agreement with the FDIC on $200 million. Half of Citizens National’s $400 million in deposits will go to Morton Community, with the other $200 million in brokered deposits being paid directly to the brokers, the FDIC said.
Citizens National has offices in four Illinois cities, according to its Web site. The FDIC said they will open tomorrow as branches of Morton Community. The failures are the fourth and fifth in Illinois this year. The FDIC estimates the seizures will cost the federal government’s deposit insurance fund a combined $279 million. U.S. regulators are signaling that economic conditions are improving. FDIC Chairman Sheila Bair said May 12 that banks have "moved beyond the liquidity crisis” of last year. "We are now in the cleanup phase,” Bair said in a speech in Washington. "But to be honest, there’s still more pain to go.” The Commerce Department on April 30 said personal incomes fell in March for the fifth time in the past six months. The S&P/Case-Shiller Index of home prices in 20 major U.S. cities dropped in February, extending a decline that began in January 2007. The Labor Department May 8 reported employers shed 539,000 jobs in April, extending the decline to 5.7 million jobs since December 2007.
The FDIC insurance fund is down 64 percent from its peak at the start of the second quarter last year, reflecting the shutdown of 22 lenders from April through December. The agency voted 4-1 today to impose a fee of 5 cents per $100 of assets, excluding Tier 1 capital, backing away from a proposal of 20 cents per $100 of insured deposits. The FDIC estimates the fee will raise $5.6 billion, lifting the fund from its lowest level since 1994. U.S. regulators conducted unprecedented stress tests on 19 of the biggest banks, concluding on May 7 that losses could reach $599.2 billion in the next two years under economic conditions that are worse than economists forecast. The FDIC will report first-quarter bank earnings May 27. FDIC-insured banks lost $32.1 billion from October through December, the first aggregate quarterly loss since 1990. The agency insures deposits at 8,305 institutions with $13.9 trillion in assets.
Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone
The odds on the dollar, Treasury bonds and the U.S. government’s AAA grade all heading for the dumpster are shortening. While currency forecasting is a mug’s game and bond yields can’t quite decide whether to dive toward deflation or surge in anticipation of inflation, every time I think about that credit rating, I hear what Agent Smith in the "Matrix" movies called "the sound of inevitability." Several policy missteps suggest that investors should stop trusting -- and lending to -- the U.S. government. These include the state’s pressure on Bank of America Corp. to buy Merrill Lynch & Co.; the priority given to Chrysler LLC’s unions over the automaker’s secured creditors; and the freedom that some banks will regain to supersize executive bonuses by giving back part of the government money bolstering their balance sheets.
Currency markets have been in a weird state of what looks almost like equilibrium for the past couple of months. What’s really going on is something akin to an evenly matched tug of war that fails to move the ribbon tied around the center of the rope, giving the impression of harmony while powerful forces do silent battle until someone slips. "All currencies are being debased dramatically by their central banks at extraordinary speeds and so in relative terms it appears there is no currency problem," Lee Quaintance and Paul Brodsky of QB Asset Management said in a research note earlier this month. "In reality, however, paper money is highly vulnerable to a public catalyst that serves to acknowledge it is all merely vapor money."
Why pick on the dollar, though? Well, not necessarily because the U.S. economy is in worse shape than those of the euro area, the U.K. or Japan. The biggest problem is that external investors -- particularly China -- have more skin in the dollar game than in euros, yen or pounds, which makes the U.S. currency the most likely candidate to meet the cleaver in a crisis of confidence about post-crunch government finances. China owns about $744 billion of U.S. Treasury bonds in its $2 trillion of foreign-exchange reserves. Chinese exports, though, are dropping as the global economy weakens, with overseas shipments declining 23 percent in April from a year earlier, leaving a nation that has already expressed concern about its U.S. investments with less to spend in future.
Those kinds of concerns are starting to surface in a steepening of the U.S. yield curve, driven by an increase in 10- and 30-year U.S. Treasury yields. The 10-year note currently yields 3.23 percent, about 235 basis points more than the two- year security, which marks a near doubling of the spread since the end of last year. "When the government parks its tanks on capitalism’s lawns, that spells trouble for those who invest, add value and create jobs," says Tim Price, director of investments at PFP Wealth Management in London. "Trillion-dollar bailouts do not only leave massive public-sector deficits in their wake, they also leave the presence of the heavy hand of government all over industry and markets, so the outlook for government bonds is less promising than the economic textbooks on deflation would have us believe."
Earlier this month, the U.S. reported the first budget deficit for April in 26 years, with spending exceeding revenue by $20.9 billion, even though that’s the month when taxpayers have to stump up to the Internal Revenue Service and the government’s coffers should be overflowing. So far this fiscal year, the U.S. shortfall is $802.3 billion, more than five times the $153.5 billion gap in the year-earlier period. For the fiscal year ending Sept. 30, the Congressional Budget Office forecasts a record deficit of $1.75 trillion, almost four times the previous year’s $454.8 billion shortfall and about 13 percent of gross domestic product. Bear in mind that the target demanded of European nations wanting to join the euro was a deficit no greater than 3 percent of GDP.
David Walker, a former U.S. comptroller general, wrote in the Financial Times on May 12 that the U.S.’s top credit rating looks incompatible with "an accumulated negative net worth" of more than $11 trillion and "additional off-balance-sheet obligations" of $45 trillion. "One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate," he wrote. It is undeniable that the U.S. government’s ability to finance its borrowing commitments has deteriorated as its deficit has ballooned. Dropping the U.S. from the top rating grade, though, wouldn’t mean the nation is about to default on its debt obligations; there’s a subtle distinction between ability to pay and propensity to fail to pay.
There’s also a compelling argument that no government should be enjoying the benefits of a top credit grade in the current financial climate. Using the definitions outlined by Standard & Poor’s, a one- step cut into the AA rated category would nudge the U.S.’s creditworthiness into a "very strong" capacity to fulfill its commitments, just weaker than the "extremely strong" capabilities demanded of AAA rated borrowers. That seems an appropriately nuanced sanction -- albeit one that the rating companies might turn out to be too cowardly to impose.
Ilargi: I thought a small reminder, a perspective, of where we truly stand might be in order. From Doug Short:
The US triple-A: Nothing to worry about
Bill Gross seems to have caused a bit of an uproar with his off-the-cuff comment to Reuters: "Asked what is driving the market declines, Gross told Reuters via email that investors fear the U.S. is "going the way of the U.K. — losing AAA rating which affects all financial assets and the dollar." On the one hand, as ex post explanations for market declines go, this one’s quite good: if true, it helps explains why both stocks and bonds are going down on the same day. What’s more, it tidily fits in to a news story — that S&P has downgraded the UK’s triple-A outlook — and journalists love any explanation for a market move which makes it seem that it’s some predictable result of an event in the news.
But let’s get some perspective here. The Dow and the S&P 500 closed down 1.5% and 1.9% respectively, which by recent standards is a perfectly normal move, well within the range of what you’d expect on any given day. What’s more, S&P putting the UK on watch for a possible downgrade is a decision prompted by economic fundamentals. Any such move with the US, by contrast, would be entirely political, and in any event would say much more about S&P than it did about Treasuries. The most important thing to remember here, however, is that ratings agencies don’t matter any more. They lost their credibility when structured finance blew up, and the number of people buying Treasuries because S&P says that they’re triple-A rated is exactly zero.
There are lots of triple-A rated securities; people buy Treasuries because they’re liquid. The US triple-A may or may not disappear at some point, but if and when that happens it’ll be a lagging indicator, and there will already be a select group of alternative securities which are trading at lower yields in dollars. So long as Treasuries have the lowest yields in the dollar-denominated world, they will retain their triple-A, and there are much more important things to worry about.
Financial de-globalisation, savings drain, and the US dollar
In a new financial landscape in which leverage is limited by worldwide regulation and the gradual digestion of toxic assets will weigh on bank’s balance sheets, the US will face tougher terms to finance its external imbalance. Perfectly at odds with the global imbalance premonitions of the early 2000s, the dollar’s weakness will likely be the best gauge of the turnaround of the global crisis.
For several years before the current crisis, economic doomsayers predicted an apocalyptic scenario where investors would turn their back on US assets, leading to a downward spiral of dollar weakening and US rate steepening. While this apocalyptic scenario did materialise, it occurred in a very different way than most had expected. A few weeks into the crisis, it was clear that the global flight to safety was benefiting US Treasuries (Reinhart and Reinhart 2008), and that the financial deleveraging was favouring the US dollar, along with other so-called “funding” currencies (Figure 1).
Figure 1. Response of US dollar and Treasury rates to the crisis
We believe this behaviour can be largely explained by three factors of varying degrees of persistence:
- A drastic decline in risk appetite that benefited low-risk US assets.
- A collapse of financial cross-border flows – i.e., “financial de-globalisation” – associated with an increase in the home bias of domestic portfolios, which brought home an important stock of dollar -funded portfolio investment abroad.
- A sharp increase in US household savings due to the combined wealth effect of the burst of the housing bubble and stock market correction that, together with lower oil prices, contributed to balance the current account.
We believe this unexpected response of the US dollar will be reversed and that quantitative easing will only temporarily be able to keep US long-term rates at their current low levels. Three reasons lie behind this (See Broda, Ghezzi and Levy-Yeyati, 2009):
- An increase of global risk aversion that is eminently a transitory phenomenon that benefits US assets.
- The “savings drain” that has replaced the pre-crisis savings glut, as fiscal stimulus and narrower trade surpluses take hold in major external savers (Japan, China and oil-exporting countries).
- The lower degree of financial globalisation in a world with more financial regulation, which will toughen the terms at which current-account deficit countries can finance themselves
Coming home: The dollar bias of “home bias”The widely publicised “flight-to-safety” dimension that favoured US Treasuries as a safe haven for investors all over the world has masked a potentially more important aspect – cross-border capital flows have collapsed. Figure 2 succinctly illustrates the undoing of financial globalisation. After reaching a peak in mid-2007, gross flows started to fall dramatically, particularly since mid-2008, reflecting an increase in the so-called “home bias”, as investors’ relocated their battered savings to domestic assets.
Figure 2. The undoing of financial globalisation
Note: Figure 2 shows the sum of assets abroad and foreign-owned assets of the largest 30 countries globally by portfolio volume.
Source: IMF, Barclays Capital
This pattern has been particularly dramatic among private investors. Private inflows to the US have reversed as foreign investors have reduced their holdings of American assets in the past two quarters by $115 billion (whereas in a typical quarter between 2003 and 2007 private capital inflows were close to $300 billion). A similar pattern is evident in the behaviour of American investors, who have repatriated their foreign capital aggressively in recent quarters. In a typical quarter Americans tend to buy around $250 billion of foreign assets, in 3Q08, Americans sold $240 billion of foreign assets. Concurrent with the decline in overall cross-border flows, the shift in the composition of foreign investors’ portfolios toward US Treasuries has also been notable. Although total inflows by foreign investors declining sharply, the demand for Treasuries increased at the expense of both agencies and corporate bonds. The flight to safety in recent quarters is an unmistakable pattern in the data.
Dollar warning: The “savings drain” of global lendersThe bursting of the oil bubble and China’s shift toward domestic sources of growth, coupled with Japan’s falling savings and a generalised collapse in international trade, are bound to lower external savings in current account surplus countries (global lenders). This reduced availability of funds is expected to worsen the terms under which countries with current account deficits (global borrowers) are likely to be able to fund themselves (see Figures 3 and 4).
Figure 3. Global lenders and borrowers in 2007
Note: Current account = Savings – Investment. Asia lenders ex China Japan include Singapore, Taiwan, Malaysia, Hong Kong, Thailand, Indonesia, Philippines, Laos, Nepal, Myanmar.
Source: IMF, Haver, Barclays Capital.
Figure 4. Expected fall in global lenders’ external savings, 2008 vs 2009
Note: Asia lenders excluding China and Japan include Singapore, Taiwan, Malaysia, Hong Kong, Thailand, Indonesia, Philippines, Laos, Nepal, and Myanmar.
The Chinese side of the global imbalance has been the subject of lively debate in recent years, fuelled by concerns about a growth path increasingly dependent on exports and investment. However, as Figures 4 suggests, the fixation with China should not mask the general nature of the decline of current account surplus countries. Indeed, the expected fall in China’s external surplus is not even the largest among global lenders in 2009. The collapse in oil prices immediately implies lower savings for oil-exporting countries. Likewise, Japan has been running trade deficits since August 2008. Part of that may be directly related to the crisis, but there is an underlying structural decrease in the Japanese savings rate that suggests more deficits to come.
Is the US getting hit or getting away with it?The ongoing return of risk appetite will cease to favour low-risk, low-yield US assets. Moreover, the collapse of financial cross-border flows – the more persistent aspect of “financial de-globalisation” – will require that global investors allocate a larger share of their cross-border portfolio to assets of current account deficit countries such as the US (see Box 1). The new financial landscape – with greater financial regulation and lower leverage – is likely to make this shortage of international capital more persistent. In turn, the retrenchment of private savers – especially in oil-exporting countries and Japan – and expansionary fiscal policies almost everywhere are likely to lead us towards a “savings drain” by global lenders – the opposite of the “savings glut” in pre-crisis years.
In a new financial landscape in which leverage is limited by worldwide regulation, and where the gradual digestion of toxic assets will weigh on bank’s balance sheets for some time, limiting the availability of credit, the US will face tougher terms to finance its external imbalance. In our view, these tougher terms, together with the sharp increase in US household savings, could have gone a long way towards unwinding the global imbalances in a non-traumatic way. However, that would have entailed passive fiscal and monetary policies and a politically unpalatable economic contraction. Instead, a massive fiscal stimulus partially financed directly by the Fed through the purchase of Treasuries should ultimately lead to a reversal of the dollar bonanza. Perfectly at odds with the global imbalance premonitions of the early 2000s, the dollar’s weakness will likely be the best gauge of the turnaround of the global crisis.
Box 1: Financial de-globalisation is bad news for the US
A notable feature of the period of financial globalisation that started in 2002 is that, despite the heavy borrowing in recent years, the US has financed its large current account deficits without experiencing an unusual build-up in foreign investors’ holdings of US assets. A simple exercise helps clarify this point (Figure 5). Consider a two-country world with one surplus country (country A) and one deficit country (country B). To focus on the effect of gross – as opposed to net – flows, assume that current account balances remain unchanged before and after the crisis, but the level of A’s investable income halves from a pre-crisis level of 1,000 (20% of which goes to finance country 1’s current account) down to 500. It follows that, to finance the same current account deficit in the post-crisis, country B needs to induce country A’s investors to double their foreign portfolio share by raising expected returns, which could be achieved either through higher rates or appreciation expectations.
The example illustrates the effect of today’s sharp decline in capital flows. In the past five years, the cumulative US borrowing has been $3.4trn, which amounted to almost 60% of net external surpluses. However, courtesy of the surge in financial globalisation, US borrowing was only 23% of the assets that foreign investors were investing abroad, less than its estimated share in the global asset portfolio (Figure 5). Even debt securities, blessed by the flight to quality, captured 41% of 2007 cross-border debt flows, roughly in line with their 37% share at the beginning of the year. In other words, international flows to the US were barely keeping track with the foreign portfolio shares of international investors. Not anymore. We believe this pattern of drier international capital markets is likely to persist for many quarters, in which case, the same US funding needs would need to stretch the share captured by US assets – at a cost in terms of higher rates and/or a weaker dollar.
BankUnited Sale May Signal Shift by FDIC in Bank Buyout Rules
WL Ross & Co., Blackstone Group LP and Carlyle Group’s purchase of BankUnited Financial Corp., the largest U.S. bank to collapse this year, came with a signal from regulators that they may be willing to let more buyout firms snap up banks as failures soar to a 15-year high. The Federal Deposit Insurance Corp., citing the interest of private-equity firms in buying banks in receivership, said yesterday that it will soon provide "policy guidance" for potential investors. Spokesman David Barr declined to elaborate on the statement. "The FDIC’s guidance will address the issue of safety and soundness in private equity deals," said Patricia McCoy, who teaches banking and securities regulation at the University of Connecticut School of Law in Hartford. Regulators "will probably ask for greater assurance that the private equity fund will stand ready as a capital backup if the depository institution becomes undercapitalized."
Carlyle and Blackstone, the world’s two biggest leveraged buyout firms, are among those considering buying banks on the cheap after global losses from the credit crisis topped $1.4 trillion. The FDIC in January agreed to sell IndyMac Bank to private-equity investors after failing for five months to find a buyer among the lender’s stronger rivals. BankUnited’s winning bidders are injecting $900 million into the Florida lender. "It is a lot like the IndyMac sale, except the FDIC found a buyer right away," said Bert Ely, a banking consultant in Alexandria, Virginia. The BankUnited purchase will cost the FDIC $4.9 billion. IndyMac cost the agency an estimated $10.7 billion, according to a March statement from the FDIC. The Office of Thrift Supervision in January cleared MatlinPatterson Global Adviser LLC’s purchase of Flagstar Bancorp Inc., based in Troy, Michigan. The Federal Reserve has told private-equity companies it won’t permit a firm that isn’t regulated as a bank to own a majority stake in a lender, even if it walls off its investment in a so-called silo deal, according to a Fed lawyer who declined to be identified.
In the case of BankUnited, none of the members of the buyer’s group will hold more than 24.9 percent control, according to John Kanas, the former North Fork Bancorp chief executive officer who will serve in the same role at the Florida lender. His group beat out at least one other bid from Goldman Sachs Group Inc. and Toronto-Dominion Bank. Kanas said on a conference call yesterday that he contacted the FDIC to express an interest in buying BankUnited four months ago. Unlike IndyMac, which was seized in July and not sold for five months, BankUnited’s seizure and sale took place on the same day. Pasadena, California-based IndyMac was sold to investors led by Steven Mnuchin, a former Goldman Sachs executive, and including buyout firm J.C. Flowers & Co.
BankUnited’s acquisition marked "the first time, to my knowledge, that private capital has come in on such short notice and at such size and begun to run a bank literally the next day," he said on the call. Other potential suitors would have instituted "drastic consolidation," closing branches and eliminating "a great number of jobs," Kanas said. He said his group would mostly avoid that and allow management to stay "largely intact." BankUnited, based in Coral Gables, had $8.6 billion of deposits as of March 31 and lost money for three straight quarters amid surging defaults on option adjustable-rate mortgages. The FDIC deposit fund is down 64 percent from its peak at the start of the second quarter last year, reflecting the shutdown of 22 lenders from April through December. Total losses to the regulator’s deposit fund now top $10 billion, according to data compiled by Bloomberg.
The FDIC has proposed an emergency fee of 20 cents per $100 in insured deposits to replenish the fund, a decision the agency will make today. FDIC Chairman Sheila Bair has said raising the agency’s line of credit with Treasury to $100 billion from $30 billion could help reduce the size of the levy. BankUnited joined 33 banks that have been seized since January. The lender had assets of $12.8 billion as of May 2, according to the FDIC, and its 86 offices will be open today during normal business hours. BankUnited’s fiscal second-quarter loss probably rose to $443.1 million, or $12.55 a share, from a loss of $65.8 million, or $1.88, a year earlier, the company said in a May 12 regulatory filing. Loans no longer collecting interest rose to 18 percent of total loans from 14 percent in December. Bank of America Corp. and Skadden Arps Slate Meagher & Flom LLP advised Kanas and the investor group. Simpson Thacher & Bartlett LLP counseled Blackstone, Carlyle, and Centerbridge, and Wachtell Lipton Rosen & Katz counseled Ross.
A market solution to secure banks’ future
by William Poole, former president and CEO of the Federal Reserve Bank of St Louis
How long will the US economy live with a banking system in which some institutions are too big to fail ? Not long, we should all hope, because large banks today, under federal protection, can raise short-term funds more cheaply than their smaller competitors, which are allowed to fail. "Too big to fail" is an unstable system. Politically inspired constraints on large banks leave them not knowing what will come next out of Washington, while there is no way of knowing whether any given bank is just small enough to be let go or will be bailed out if it gets into trouble. But here we are, more than a year after the rescue of Bear Stearns, without a plan for the future except for vague – and, as far as I can tell, totally empty – statements coming out of Washington about tighter regulation. What exactly does Washington have in mind?
Here is a proposal, not at all original but deserving of serious public discussion. As a condition of enjoying the benefits of a bank charter, every bank must issue 10-year subordinated notes equal to 10 per cent of its total liabilities. The specification can be adjusted, but this one serves to illustrate the proposal. The subordinated debt would be unsecured; holders would stand last in line among all creditors in the event that a bank had to be shut down. The sub debt requirement would be in addition to existing requirements for equity capital. Genuine reform requires that four minimal requirements be met, and the sub debt proposal qualifies. First, banks need more capital to protect the federal deposit insurance fund. Second, there must be more market discipline: each bank would be forced to roll over maturing sub debt equal to 1 per cent of its liabilities each year. Third, financial stability requires that a bank not be subject to runs. Sub debt cannot run, because of the 10-year maturity.
Fourth, and critically important, some creditors and not just equity owners must be at risk, which is clearly the case with sub debt. Sub debt provides much more market discipline than equity, because a bank in trouble with a weak share price is not forced to do anything. Maturing sub debt, however, does discipline the bank and if the bank cannot roll over the debt, it must shrink by 10 per cent to live within its remaining outstanding sub debt. This system is stable because any bank can contract by 10 per cent within a year by letting loans run off and/or by selling other assets. It is highly desirable that contraction be managed by the bank itself and not by regulators. We cannot depend on regulatory agencies to prevent a recurrence of financial crisis. Ahead of the crisis, regulators, myself included, did not understand the risk of subprime mortgage paper in bank portfolios. Nor did the senior management and directors of the most sophisticated financial firms in the world.
This is not the first time regulators and firms have failed to assess risk adequately. Large international banks accumulated Latin American loans in the 1970s; when Mexico defaulted in 1982 and other defaults followed, a financial crisis was narrowly averted. Long-maturity bonds create much more market discipline than do short-term obligations. Holders of three-month certificates of deposit, for example, assume that they can always exit quickly by letting the CDs mature. It is for this reason that bond spreads over Treasuries of comparable maturity are systematically higher for longer maturities than for shorter maturities.
Banks hate the idea of a substantial sub debt requirement, because sub debt will be expensive. But bankers should think carefully about their opposition. Would they rather face market discipline from sub debt or much heavier Washington regulation, including opaque and changing rules? Given the scale of our financial crisis and taxpayer losses, intrusive regulation will be the norm for years to come. Do bankers really want to face unpredictable constraints such as they have seen on executive compensation? I challenge leaders of our large banks to support a market-based reform such as the one I have outlined. A return to the status quo ante, with banks enjoying the benefits of "too big to fail", does not seem likely. Regulators will not dare risk a repeat performance. Bankers who think that their political influence will control the regulatory process are in for a rude surprise.
Russia Dumps the U.S. Dollar for Euro as Reserve Currency
The US dollar is not Russia’s basic reserve currency anymore. The euro-based share of reserve assets of Russia’s Central Bank increased to the level of 47.5 percent as of January 1, 2009 and exceeded the investments in dollar assets, which made up 41.5 percent, The Vedomosti newspaper wrote. The dollar has thus lost the status of the basic reserve currency for the Russian Central Bank, the annual report, which the bank provided to the State Duma, said. In accordance with the report, about 47.5 percent of the currency assets of the Russian Central Bank were based on the euro, whereas the dollar-based assets made up 41.5 percent as of the beginning of the current year. The situation was totally different at the beginning of the previous year: 47 percent of investments were made in US dollars, while the euro investments were evaluated at 42 percent.
The dollar share had increased to 49 percent and remained so as of October 1. The euro share made up 40 percent. The rest of investments were based on the British pound, the Japanese yen and the Swiss frank. The report also said that the reserve currency assets of the Russian Central Bank were cut by $56.6 billion. The losses mostly occurred at the end of the year, when the Central Bank was forced to conduct massive interventions to curb the run of traders who rushed to buy up foreign currencies. The currency assets of the Central Bank had grown to $537.6 billion by October 2008. Therefore, the index dropped by almost $133 billion within the recent three months. The majority of Russian companies, banks and most of the Russian population started to purchase enormous amounts of foreign currencies at the end of 2008. The dollar gained 16 percent and the euro 13.5 percent over the fourth quarter.
The demand on the US dollar was extremely high, and the Central Bank was forced to spend a big part of its dollar assets, experts say. The change of the structure of the currency portfolio of the Bank of Russia has not affected the official peg of the dual currency basket, which includes $0.55 and 0.45 EUR. The investments of the Bank of Russia in state securities of foreign issuers have been considerably increased, the report said. About a third of Russia’s international reserves are based on US Treasury bonds. Russia became one of the largest creditors of the US administration last year, the US Department of the Treasury said. Russia increased its investments in the debt securities of the US Treasury from $32.7 billion as of December 2007 to $116.4 billion as of December 2008.
Dollar hits five-month low
The dollar dropped to a five-month low against a basket of currencies on Friday as fears over the US debt position grew in the wake of a downgrade to the outlook for the UK. Standard & Poor’s lowered its outlook on the triple A rating on UK debt to "negative" from "stable" on Thursday. The ratings agency based its warning on a forecast that net UK government debt risked approaching 100 per cent of national income. While the pound fell sharply immediately after the announcement, it quickly reclaimed its losses as investors mulled the possibility that the US debt could be the next in line to face scrutiny from the ratings agencies.
"The dollar has continued to slide as investors conclude the US might be the next major economy to put on negative credit watch by rating agencies," said Hans Redeker at BNP Paribas. "S&P criteria for putting the UK under negative watch, namely its projection that public debt will reach 100 per cent of GDP in 2013, may also apply for the US." The dollar’s soft tone continued on Friday. The dollar index, which tracks its value against a basket of six major currencies, dropped 0.2 per cent to a fresh low for the year of 80.349. The dollar also fell 0.4 per cent to a five-month low of $1.3941 against the euro, eased 0.1 per cent to a six-month trough of $1.5839 against the pound and lost 0.2 per cent to Y94.17 against the yen.
Credit Card Debt Swallows American Households
Americans built up a lot of spending power over the last three decades, but it wasn't because they started earning more money. As today's chart starkly illustrates, credit card debt has exploded, making up for more modest gains in median household income. As you can see, for the very first time in history, credit card debt is creeping down, though it has a long way to go. And of course, this doesn't even include home all the home equity loans Americans used in place of the ATM. (Both lines are based on non-adjusted numbers)
Bondholders Stand Firm Against G.M. Debt Swap
General Motors, the struggling automaker, inched closer to a bankruptcy filing on Friday when the company’s largest bondholders reiterated they would reject an offer to convert their debt into G.M. stock. The decision by the bondholders threatens to derail G.M.’s efforts to eliminate $27 billion in debt before a June 1 deadline set by the Obama administration. G.M. has offered its bondholders 225 shares for each $1,000 worth of debt, which over all would give them a 10 percent stake in the company. The company has said it needs 90 percent approval from its bondholders by next Tuesday if it is to avoid bankruptcy.
But the committee of G.M.’s biggest bondholders, which represent 20 percent of the overall debt, said there was no support for the current offer. "It’s been a universal ‘no’ from the get-go," a spokesman for the committee, Nevin Reilly, said. "Bondholders are being seen as speculative bad guys, but bondholders are investors, many of whom put their retirement money into G.M." Other, smaller investors have also protested the offer as unfair, increasing the likelihood that G.M. will fall well short of the 90 percent threshold. There was no additional comment from G.M. The company’s chief executive, Fritz Henderson, has said it is unlikely that G.M. will increase the offer.
G.M., which is subsisting on $15.4 billion in government loans, has until June 1 to meet President Obama’s mandate for a broad restructuring that includes reducing its unsecured debt. But bondholders have balked at the terms offered by G.M., saying that competing creditors, like the United Automobile Workers union, have received better treatment. The U.A.W. said on Thursday that it had reached a tentative agreement with G.M. on how to finance obligations estimated at $20 billion for retiree health care. The union’s president, Ron Gettelfinger, declined to divulge terms of the deal until its 61,000 G.M. members vote on it next week. But people close to the deal said the union agreed to take a 39 percent stake in G.M. to finance half of a union-run trust set up to administer retiree health care.
Bondholders have criticized the terms as far more generous than what they have been offered thus far. On Friday, the president of the Canadian Auto Workers said the union and General Motors Canada had agreed on a cost-cutting deal. Under G.M.’s latest restructuring plan, the Treasury Department would get at least a 50 percent stake in the company in exchange for forgiving $10 billion of its outstanding loans. G.M. has also pledged to cut another 21,000 jobs and four of its brands as part of its last-ditch effort to avoid bankruptcy. But Mr. Henderson has said recently that bankruptcy is "probable" because of the difficulty of getting 90 percent of its bondholders to approve a debt-for-equity swap.
Why a GM Bankruptcy Would Be a Disaster
Obama isn't just ruling on the fate of a single company. A GM bankruptcy could devastate the very economy he is attempting to stabilize. President Obama is nearing the most important decision a President has made in modern times regarding the American economy. On or about June 1, he will push General Motors (GM), the nation's largest industrial company, into bankruptcy. The key trigger may be on May 26, when GM's offer to bondholders to accept 10¢ on the dollar fails to win acceptance from 90% of them, a criterion that Obama has set for continued loans to GM. But there's a strong probability the decision to push GM into bankruptcy will be disastrous. The mere threat of bankruptcy caused GM's U.S. sales to fall by 50% in the first quarter from already depressed levels. If GM were to declare Chapter 11 bankruptcy, sales would decline even further.
The reality—which the investment bankers and bankruptcy lawyers guiding Obama don't seem to understand—is that the auto industry is unique in the way it is built on long-term confidence. Buying a vehicle is second only to home buying as the most important financial decision people make, and Americans want to know that the company making their vehicle will exist for at least five more years, that their dealer will continue in business, that their auto loan won't be summarily revoked, and that parts and servicing will be available. That is a fundamentally different psychology from when a consumer buys a ticket from a bankrupt airline or purchases electronics or clothing from a bankrupt retailer. In those instances, there is an expectation of onetime or short-term use.
Then there are the thousands of suppliers, organized in multiple tiers, that support GM. This system depends on a vast, delicately balanced series of contracts and long-term relationships. Many of these suppliers are already hanging by their fingernails. The longer the uncertainty of bankruptcy lasts, the more likely they are to delay making crucial parts and the more likely it is that some will simply go out of business. In cases where alternate suppliers are not available, GM's assembly lines could start experiencing difficulty or even be forced to shut down. The risk of liquidation would then loom large because the financial losses would mount. The dislocation would cascade through the economy, not just the Midwest. GM, with its suppliers, represents a full 1% of the economy.
It is the largest private-sector purchaser of information technology, so Silicon Valley will feel it; and Madison Avenue will feel the collapse of its advertising spend. Any hopes that the U.S. economy has stabilized would take a beating—there would be another sickening lurch downward. Obama isn't just ruling on the fate of a single company; he is about to pull the trigger on a wide swath of the same economy he is attempting to stabilize. The Obama camp seems to believe that the Chrysler bankruptcy is a template for what it wants to achieve at GM, but that's a critical mistake. Chrysler was a shell of a company, having been stripped of engineering and design talent by Daimler (DAI) and then mismanaged by private equity owner Cerberus Capital Management. The arrangement is to give the United Auto Workers 55% of Chrysler's shares and to give management control to Italy's Fiat group.
This may work in political terms, but it's not a real-world business arrangement. The supposedly rescued Chrysler is, in fact, a house of cards that almost certainly will come tumbling down. GM, in contrast, has invested heavily in product development and new technologies, such as the lithium ion battery for the Chevrolet Volt. It was in the late stages of a transformation effort when the U.S. economy collapsed last fall. Obama should not force such a company into bankruptcy because it cannot be "surgical" or "controlled," as some in the Administration are stating. Bankruptcy lawyers are arguing that GM can emerge within 60 days, but that is highly suspect. Even a Section 363 bankruptcy, in which GM would be allowed to park bad assets like dealer franchise agreements and bonds in a "bad" GM that stays in bankruptcy, then reemerge as a "good" unencumbered GM is highly complex.
The reasons are the sheer size of the company, its extensive global operations that account for more than half its sales, and the range of interest groups that will fight tenaciously for their piece of the pie. The real precedent in this situation is Delphi, GM's largest parts supplier, which went into bankruptcy in 2005 and now faces probable liquidation. The bankruptcy lobby does not want to acknowledge this failure—they are too busy anticipating the huge fees from the mother of all bankruptcies at GM. Obama has arguably achieved a large measure of what any government would want in this situation—it has ousted Chief Executive Rick Wagoner and pressured successor Fritz Henderson into implementing the tough restructuring plan that the company's critics have long advocated. The United Auto Workers apparently has just accepted management's latest very tough restructuring plans.
Obama should now bring the full weight of his Presidency on all the remaining stakeholders and create the best possible solution outside of bankruptcy court. Then the government should get out of the way and let management execute on its plan, with continued loans for a period of months, not years. Obama should proclaim that, in view of the dramatic progress that management and the union have achieved, the threat of bankruptcy has been lifted and that it's time for Americans to at least consider buying GM cars in view of their dramatic improvements in quality, cost, and design. He should be helping to create confidence in the future of GM, not destroying it. If he sincerely wants GM to be in position to help him achieve the fuel-emission goals he has established, he must not allow GM to get bogged down in a protracted bankruptcy. But if the decision to push GM into bankruptcy is inevitable, as it appears to be, Obama should take a deep breath and recognize that once he makes the decision, it will be too late to reverse course. History will regard his decision as an unambiguous indicator of whether Obama knew what he was doing or actually compounded the economic crisis he inherited.
U.S. to Steer GM Toward Bankruptcy
The Obama administration is preparing to send General Motors into bankruptcy as early as the end of next week under a plan that would give the automaker tens of billions of dollars more in public financing as the company seeks to shrink and reemerge as a global competitor, sources familiar with the discussions said. The move comes as the administration prepares to lift the nation's other faltering car company, Chrysler, from bankruptcy protection as soon as next week, industry sources said. The shifts into and out of bankruptcy are landmarks in the Obama administration's attempt to broker a historic restructuring of the American auto industry in the space of months.
The legal tactic is viewed by some as the best means of reviving the companies. But the speed of the government-led transformation has triggered complaints that the rights of investors and dealers are being trampled. Meanwhile, fears that a bankruptcy could lead to cascading business failures are spreading throughout GM's vast chain of suppliers. Under the GM draft bankruptcy plan, the company would receive just short of $30 billion in additional federal loans, a source said. The figure is a starting point in negotiations between the government and the company, the source said, and could change. A cash injection that large would boost the U.S. investment in GM to nearly $45 billion. The timing of the filing is also fluid, and could happen the first week of June.
The government previously indicated that it planned to take at least 50 percent of the restructured company, and likely would take the right to name members to its board of directors, as it has at Chrysler, where the government will control four of nine seats. The United Auto Workers retiree health fund is set to own as much as 39 percent of the restructured GM, in exchange for giving up its claim to at least $10 billion that the company owes it. Yesterday, the union announced that it reached an agreement with GM that will reduce the company's labor costs.
Still unknown is what part the Canadian government might play in the ongoing GM restructuring. GM operates several plants north of the border. The Canadians agreed to invest about $3.5 billion in the Chrysler restructuring and control one of the nine board seats. In the GM negotiations, the Canadians are poised to make a similar investment, but they are seeking assurances that the share of GM production in their country will remain the same. "China isn't putting up the money, and Mexico isn't putting up the money," said Tony Clement, Canada's Minister of Industry. "But if we're putting up the money, just as the Americans are, then we have the right to protect our production capacity."
Clement added that the Canadian Auto Workers union would have to make more concessions before the government agrees to get involved in the GM rescue. "We've basically been joined at the hip with U.S. Treasury on our approach with both Chrysler and GM," he said. "We have officials down here in Washington all the time. We basically review the information together. We devise strategy together and execute strategy together."
Both Chrysler and GM have been saddled with too much in debt and labor costs to compete against rivals from Japan and Korea, industry analysts say. To alleviate the financial burdens, the Obama administration has engaged for months in negotiations with the union, dealers and creditors in hopes of reducing automaker costs without having to resort to bankruptcy court. But last month, the administration concluded that the only way to free Chrysler of its debt was to file for Chapter 11, and it is now nearing a similar decision with GM. The chief obstacle to an out-of-court settlement for GM remains: There has been no agreement between the company and the investors who hold $27 billion worth of GM bonds.
Under orders from the Obama administration, GM has offered to give the bondholders a 10 percent equity stake in the restructured company in exchange for giving up their bonds. So far, however, the investors have resisted that proposal and if no accord is reached by June 1, GM will follow Chrysler into bankruptcy. The speed with which the Chrysler bankruptcy has proceeded has given the administration more confidence that the best path for GM may be a similar trip, where the claims of disgruntled creditors and dealers can be more easily resolved. In the Chrysler proceedings, the court has yet to stand in the way of plans to create a new company led by Italian carmaker Fiat. Chrysler's existing assets would be sold to the new company and the new entity could be up and running as soon as next week.
That's because Chrysler is asking U.S. Bankruptcy Judge Arthur Gonzalez to waive the customary 10-day waiting period before the order approving the sale becomes effective. The hearing on the sale is scheduled for next Wednesday at 10 a.m. Gonzalez has already granted a similar request to expedite proceedings. Time and again in court, Chrysler executives and attorneys have argued -- and the court has agreed -- that Chrysler's core assets are "wasting" and that an immediate sale must take place to preserve value. "Subject to the closing conditions, a new Chrysler could emerge as soon as the ink is dry on the judge's order," said Scott Van Meter, managing director of LECG, a consulting firm. The administration is taking steps to prepare. It is drafting the paperwork for a $4.7 billion loan to sustain Chrysler after it emerges from bankruptcy. On Wednesday, the automaker announced that C. Robert Kidder, former chairman of Borden Chemical and of Duracell International will become the company's new chairman. He will succeed Robert L. Nardelli.
Chrysler still could encounter some delays. The company faces a new legal challenge from pension funds representing Indiana teachers and police officers as well as a state construction fund. The investors, who contend that the automaker's sale violates their rights as senior secured lenders to Chrysler, are seeking to move the bankruptcy proceedings to federal district court, which has authority over the bankruptcy court. A hearing on the matter is scheduled in district court Tuesday. There are also challenges outside court. Chrysler has moved to close 789 dealerships on June 9. But Sen. Kay Bailey Hutchison (R-Tex.) has introduced legislation that would withhold federal funding if the automaker does not give dealers an extra 60 days to close down operations and sell remaining inventory. Her amendment has won the backing of a number of other senators.
Judiciary Committee chairman Rep. John Conyers Jr. (D-Mich.) said he hopes to meet with White House officials today to discuss changing Chrysler's bankruptcy plan and GM's future. Conyers did not outline what he wanted, but a nine-person panel he assembled for a hearing yesterday offered a hint. Liberal consumer advocate Ralph Nader, a conservative Heritage Foundation analyst and minority auto dealers all criticized the automakers' restructuring. Conyers and other committee members attacked the administration for abusing bankruptcy laws, unfairly eliminating dealerships and jeopardizing consumer safety. "GM now stands for Government Motors," said Rep. Lamar Smith (R-Tex.). "While the UAW is cashing in, it's the dealers, creditors and American taxpayers who are being forced to cash out."
GM prepares for bankruptcy
General Motors Corp won a cost-cutting deal from its Canadian labor union on Friday, part of a package of concessions the automaker is expected to take into a federal bankruptcy court by the end of this month in a showdown with its bondholders. GM's tentative agreement with the Canadian Auto Workers union comes a day after the embattled automaker won parallel concessions from its major union, the United Auto Workers. The deals to cut operating costs at GM's North American factories help clear the way for the automaker to be steered into bankruptcy with the backing of the Obama administration if a longshot attempt to win over bondholders fails.
GM has been kept in operation since the start of the year with more than $15 billion in emergency federal loans and has said it will need billions of dollars in additional financing if it moves into bankruptcy. "All of our discussions that we had, it's very likely that they will go into Chapter 11," said CAW President Ken Lewenza at a Toronto news conference to announce the union's tentative contract agreement with GM. GM bondholders, who hold about $27 billion of the company's debt, have balked at the terms they have been offered which would give them a 10 percent stake in a restructured company. A spokesman for a committee representing GM bondholders said institutional investors remained solidly opposed to that offer as unfair.
"It's been a universal no from the get-go," said Nevin Reilly, a spokesman for the committee. "Bondholders are being seen as speculative bad guys, but bondholders are investors, many of whom put their retirement money into GM." GM faces a June 1 deadline to restructure its debt and operations and has said it could file for bankruptcy if it fails to get bondholders to agree to forgive some $24 billion of the amount they are owed. Creditors and auto dealers have complained their rights have been ignored in the restructuring of both GM and its smaller rival Chrysler, which has been operating in bankruptcy since April 30.
Critics argue that the Obama administration has favored the position of unionized auto workers and has run roughshod over claims from other creditors in the process. But the U.S. government's strong direction of the Chrysler bankruptcy has moved the carmaker much faster toward a sale of its main business to Italy's Fiat than skeptics had suggested. That transaction now appears on track for completion by the end of the month, a stunning achievement given the complexity of the Chrysler bankruptcy. "There is a clear path to the sale going through. And the court is really trying to help that along," said Carren Shulman, a partner in the bankruptcy practice at Sheppard Mullin.
Under its deal with GM, the UAW agreed to change the payment terms on some $20 billion it is owed for a trust that will pay for retiree healthcare. In exchange, GM offered the union a 39 percent stake in a reorganized company. Four Republican lawmakers complained to Treasury Secretary Timothy Geithner that the restructuring of GM subverts the rights of bondholders, according to a letter from the lawmakers obtained by Reuters on Friday. The restructuring favors the claims of the United Auto Workers "over the rights and claims of the company's diverse group of bondholders, who collectively hold $7 billion more in General Motors debt than the UAW's health trust and are equal members of the creditor class," the lawmakers said. "Bondholders must have a seat at the table during negotiations in how the company would be restructured," said the letter to Geithner from Representatives Jeb Hensarling, Eric Cantor, Mike Pence and Pete Sessions.
Austan Goolsbee, a member of the White House Council of Economic Advisers and the Obama administration's autos task force, said GM bondholders needed to recognize that they would have to sacrifice. "You know the bondholders are going to have to take some haircut. What we've seen over past months is the bondholders in some cases holding out, thinking that the government will step in and bail out the car companies and we'll get paid off," Goolsbee told Reuters Television in an interview. Goolsbee said he expected GM's restructuring efforts to run right up to the June 1 deadline but not beyond. "Usually these things, and as you saw with Chrysler, go right up to the deadline," Goolsbee said.
The CAW's Lewenza said the Canadian union had been told that it needed to reach a new contract deal with GM urgently so that President Barack Obama could review the terms of the automaker's business plan. Lewenza said he was told that Obama would need to see the GM business plan, which will include details of how many jobs it will cut, by the weekend. "We wanted to be on President Obama's desk as part of the business plan moving forward," he said. GM shares, which the automaker has warned could be worthless in bankruptcy, were down 34 cents or 17.7 percent at $1.58 on Friday afternoon on the New York Stock Exchange.
This year's auto sales forecast falls to 10 million
Automakers will sell just 10 million new cars and trucks in the U.S. this year, the worst in at least three decades, respected forecaster J.D. Power and Associates said Thursday as it cut its 2009 prediction by 400,000 vehicles. For the staggering auto industry, "Recovery will not be a quick proposition," said Gary Dilts, senior vice president of Power's automotive operations. Chrysler's already in Chapter 11 bankruptcy reorganization. General Motors faces a June 1 government deadline to finish overhauling its operations or head for Chapter 11, too. Even normally healthy automakers such as Toyota and Nissan are losing money. The industry and its analysts had been hoping for signs of a rebound, but now don't foresee any this month.
Power forecast an annualized sales rate for May of just 9.3 million. JPMorgan auto analyst Himanshu Patel predicted earlier in the week the May selling pace would be just 9.1 million. Worst rate this year: February's 9.12 million. Before the auto collapse last year, car companies routinely sold more than 16 million new cars and trucks annually in the U.S. But there were potential bright spots:
- The U.S. Treasury said Thursday it will invest $7.5 billion of taxpayer money in lender GMAC. That should give it more cash to lend buyers of both GM and Chrysler vehicles. Automakers say they're losing about 25% of their sales because would-be buyers can't get loans. The government will have a 35.4% stake in GMAC. GM will end up with 10% or less and private equity firm Cerberus Capital Management with 15% or less. Other investors own the rest. Treasury gets two directors on the nine-member board.
- GM reached a tentative agreement with the United Auto Workers, a key requirement to satisfy the government and stay out of Chapter 11. Apparently resolved is whether GM can import small cars from China, rather than build them in the U.S., though details weren't available late Thursday. GM stock bounced up 32%, to $1.92 Thursday, on a day the major stock indexes were down.
- A so-called cash-for-clunkers bill was introduced in the Senate on Thursday, similar to one in the House. Intended to spur sales, reduce pollution and cut fuel consumption, the legislation would give discounts of up to $4,500 to people who trade in older cars or trucks rated 18 miles per gallon or less for more efficient new ones.
U.S. could take 17 years to exit GMAC after an IPO
GMAC LLC, which is giving the U.S. Treasury Department a 35.4 percent equity stake, said on Friday it might take 17 years for the government to shed its investment if the auto and mortgage lender were to go public.
The timetable suggests that federal involvement in GMAC's affairs could persist long after troubles plaguing the economy and the auto industry end. GMAC has gotten $12.5 billion of government infusions since December, including $7.5 billion on Thursday. The Treasury Department separately said on Thursday it expects to swap a previous $884 million loan it made to General Motors Corp for the 35.4 percent stake in GMAC. It also won the right to appoint two directors to GMAC's board.
In a U.S. Securities and Exchange Commission filing, Detroit-based GMAC said that if it were to go public, the Treasury Department would begin to liquidate its stake no later than seven years after an initial public offering. It said the government would thereafter have a "goal of liquidating between 10 percent and 20 percent of the Treasury's interest in GMAC's equity securities in each succeeding year." Thursday's $7.5 billion infusion includes $4 billion for GMAC to make loans to Chrysler LLC dealers and vehicle buyers, and $3.5 billion to bolster GMAC's capital position. These sums are on top of $5 billion that GMAC got in December from the government's Troubled Asset Relief Program.
GMAC is the preferred lender to buyers of GM and Chrysler customers. GM and private equity firm Cerberus Capital Management LP CBS.UL have stakes in GMAC. Regulators this month ordered GMAC after the conclusion of a stress test to raise $11.5 billion of capital to withstand a potentially deep economic downturn. GMAC has until June 8 to present a plan to raise the needed capital. The two Treasury Department nominees who will join GMAC's board are Robert Blakely, a former Fannie Mae chief financial officer; and Kim Fennebresque, a former Cowen Group Inc chief executive. GMAC said in Friday's filing that the Treasury Department would be entitled to name a majority of directors if its ownership stake were to exceed 70.8 percent.
Beijing Auto signals Opel interest
China’s Beijing Automotive Industry Corp (BAIC) has expressed an interest in buying a stake in Opel together with the rest of General Motors’ European operations, for which three other companies have already entered entered bids this week. The Chinese automaker sent a letter expressing interest in Opel to Commerzbank’s Dresdner Kleinwort unit, which is advising GM on the stake sale, on Thursday - a day after a bidding deadline passed, according to two people close to the deal. BAIC could not be reached for comment, and a GM spokesman at its European headquarters in Zurich declined to comment. BAIC’s offer was described as an expression of interest rather than a formal bid, and is unlikely to move forward, one of the people said. Italy’s Fiat, Canada’s Magna, and Brussels-listed RHJ International all entered bids for the strategic stake on Wednesday, for which GM is seeking about €650m ($900m).
BAIC is one of China’s leading commercial vehicle manufacturers, and manufactures Hyundai passenger cars in a joint venture with the Korean carmaker. It sold 250,000 vehicles in the first quarter of this year, making it the fifth largest Chinese automaker, according to official figures. GM’s sale of a stake of Opel/Vauxhall has aroused significant interest despite its financial problems, which could see the company file for "surgical" bankruptcy protection in the US as soon as June 1. GM’s European operations are to be spun off as a new German-headquartered company, for which the Detroit carmaker is seeking €3.3bn of German and other European government loan guarantees, and in which it will retain a significant stake. Fiat wants to merge Opel with its own autos division and recently-acquired Chrysler, and Magna’s bid – if successful – would also see Russian automaker Gaz join it in making cars. One of the people briefed on BAIC’s bid said the carmaker was primarily interested in importing Opel cars or technology to China, where it would compete with GM, one of the country’s largest carmakers.
"They would be discouraged from going forward," this person said, requesting anonymity because of nondisclosure requirements around the sale. Industry analysts in China were also sceptical about whether BAIC could be a serious bidder, given the costs involved. "No Chinese car company can afford to pay that much money," said Li Chunbo of Citic Securities in Beijing. The Chinese government has also discouraged Chinese car companies from making hasty overseas acquisitions of distressed overseas brands that they lack the expertise to manage. BAIC missed Wednesday’s deadline, and talks on the stake are now "moving quickly," the second person said, as GM vets the three formal bids before signing a memorandum of understanding with one or more groups. Magna’s offer has gained key political and union support for its bid. Unlike Fiat, which is offering its assets as payment for the deal, Magna and RHJ are also said to be offering cash, which GM prefers as it faces a liquidity crunch.
Why public private plan has bankers squirming
by Gillian Tett
Cometh the hour, cometh the acronym. Thus might run the unspoken motto of American financial policy these days. As the banking saga has unfolded in the past two years, a string of US initiatives have tumbled out, with titles so lengthy I will not attempt to list them in full. Remember the M-LEC programme that was launched to reorganise the shadow banks (but quickly died)? Then came Talf, TSLF and Tarp, which aim to provide liquidity, restart the securitisation machine and recapitalise the banks. Now a new focus is emerging. This week Tim Geithner, US Treasury secretary, said that a PPIP – or public-private investment plan – would start in early July to use $75bn-$100bn of state funds to encourage the sale of up to $1,000bn of toxic assets by banks. Part of the programme will cover loan sales and be run by the Federal Deposit Insurance Corporation; the other half, relating to securities, will be organised by the Treasury. In both schemes, asset managers will be given state finance to encourage bids.
So will this latest acronym-filled endeavour work? (Or, at least, avoid the fate of the ill-starred M-LEC?) If you listen to some senior US bankers, it is easy to feel pretty doubtful that the PPIP can really fly. The key sticking point is price. The PPIP plan will work if banks take part to sell assets. But right now, no banker wants to participate in an auction that produces asset prices lower than those on bank books. After all, if that were to happen, banks would face pressure to make more writedowns – which they can ill afford. The Treasury and FDIC hope to avoid this scenario by encouraging asset managers to place high bids for the bank assets, by offering non-recourse leverage of up to five times (or far higher than non-recourse leverage available in the market). Some politicians hate that, since the details of the deals mooted so far appear to leave taxpayers with little embedded upside. That political scrutiny, in turn, makes asset managers nervous. As a result, it is still unclear whether enough asset managers will produce bids that are high enough to make the banks happy with an auction price.
So some large banks are – unsurprisingly – adopting a policy of quiet footdragging. A senior official at one large bank observed this week that his group would participate in a pilot scheme, as a gesture of goodwill. But after that token gesture, this bank will probably stop. And while the government wants to set a minimum lot size of $1bn, this bank is lobbying for a figure nearer $250m to limit the auction to a few choice (token) assets. Unsurprisingly, this banker – like others – concludes that he is "not optimistic" about PPIP, not least because the urgent pressure to sell assets is receding as banks raise capital. That view may not be entirely representative: another bank tells me it is preparing to get properly involved (not least because it has the financial strength to have written many assets down). Government officials running the PPIP scheme insist there is strong overall interest from potential buyers and sellers. They also point out that it need not matter if the scheme ends up being limited in size.
After all, what PPIP is trying to do (like Talf and much else) is reignite market activity, not replace it. Think of it as a chunk of firelighter on a pile of wet wood. Thus, the sheer act of talking about PPIP – and then staging a few sales – may be enough to kickstart a private sector trading toxic assets again. Or so the hope in Washington goes. "Success is what happens to the market overall," says one. They have a point, given that there is some evidence that schemes such as Talf are contributing to a market thaw. But, almost irrespective of whether PPIP "succeeds" in delivering many deals (and personally I have doubts that it will), there may be another reason to welcome it. Most notably, irrespective of the complexities of arranging deals, the PPIP has already served one extremely valuable function by highlighting the sheer insanity that has bedevilled the financial world in relation to asset prices. Most notably, if large American banks had previously marked their assets at a realistic market-based price, they would not be so scared of engaging in auctions with PPIP now.
Better still, they might have spotted earlier the degree to which their assets were deteriorating – and taken action to address it. But precisely because the supposedly "free market" western financial system has become stuffed with complex assets that were rarely traded – even during the credit boom – banks have been able to use fantasy prices for their assets for years. Hence their continued horror at the idea of open trading. That is the real scandal that bedevils the PPIP idea. That in turn points to a wider lesson for the future: namely that to avoid a similar credit disaster, it is crucial that financiers are forced to place as much financial activity as possible on transparent trading arenas. Better still, they need to do that well before a bubble bursts – or there is any need to start fighting over whether a PPIP can truly fly.
TARP Warrants Shows Banks May Reap 'Ruthless Bargain'
Banks negotiating to reclaim stock warrants they granted in return for Troubled Asset Relief Program money may shortchange taxpayers by almost $10 billion if Treasury Secretary Timothy Geithner’s first sale sets the pace, data compiled by Bloomberg show. While 17 financial institutions have repaid TARP funds, two have come to terms with the U.S. on the value of the rights to buy stock that taxpayers received for the risk of recapitalizing the industry. The first was Old National Bancorp in Evansville, Indiana, which gave the Treasury Department $1.2 million last week for warrants that may have been worth $5.81 million, according to the data.
If Geithner makes the same deal for all companies in the rescue program, lenders may walk away with 80 percent of the profits taxpayers might have claimed.
"For once we’d like to get a fair value when we come into contact with the banking system," said Representative Brad Miller, a North Carolina Democrat and chairman of the Investigations and Oversight Subcommittee of the House Science and Technology Committee. "We don’t want a ruthless bargain." Under the Old National warrants formula, Bank of America Corp. would save $2.03 billion, followed by Wells Fargo & Co. at $1.48 billion and JPMorgan Chase & Co. at $1.46 billion. Morgan Stanley’s benefit would be $983 million, Citigroup Inc.’s would come in at $965 million and Goldman Sachs Group Inc. would have $693 million, according to the data compiled by Bloomberg. For the 20 largest TARP recipients, the total savings would be $9.985 billion, the data show.
Geithner wants to move swiftly to sell the TARP warrants, he said on May 20. Their worth depends on assumptions about the chances the underlying stock will go higher than the rights. Depending on the input, different valuation models reach a range of conclusions. Lenders shouldn’t be trusted to make suppositions that would be to the advantage of taxpayers, said Linus Wilson, an assistant professor of finance at the University of Louisiana at Lafayette. "Bank managers have stronger incentives than Treasury personnel to get a better deal for their constituents," said Wilson, who has written about appraising warrants. Because Old National was the first to repay TARP money and buy its rights back, the transaction "sets the price point for the whole program," said Simon Johnson, a fellow at the Peterson Institute for International Economics in Washington.
"The point of the warrants is that taxpayers participate in the upside," said Johnson, who testified on the securities before Miller’s subcommittee on May 19. "It defeats the whole purpose if you’re going to sell them way below market price." Treasury Department spokesman Andrew Williams declined to comment on Old National. "We’re doing our best to protect the taxpayers’ interest and make sure we get fair market value," he said. The department has a "robust process" of evaluation, using two modeling systems, consulting with an asset manager and collecting bids from market participants, Williams said. The U.S. received rights to buy 1.4 billion common shares in exchange for $287 billion in TARP capital, according to data compiled by Bloomberg. A company that accepted aid had to grant warrants equal to 15 percent of the TARP investment at a strike price equal to the 20-day trailing average of the shares. A strike price is that at which an option can be exercised.
Now that Goldman Sachs, JPMorgan and Morgan Stanley have applied to return the $45 billion they received, they may also reclaim their warrants. Those may be worth about $4 billion, data compiled by Bloomberg show. If the U.S. followed the Old National formula for the three New York-based banks, taxpayers would receive less than $1 billion. JPMorgan spokesman Joseph Evangelisti declined to comment. Mark Lake, a spokesman for Morgan Stanley, said the bank "would support any program that is focused on benefiting the U.S. taxpayer." Goldman Sachs spokesman Michael DuVally said company officials have "always said the taxpayers should benefit from the value associated with these warrants." In the case of Old National, each of the 813,000 warrants had a strike price of $18.45.
On May 11, the day the U.S. announced the sale, the stock’s option-implied volatility, derived from market prices of stock options that are traded daily, was 61 percent, according to data compiled by Bloomberg. The risk-free rate of return, or the yield of government debt, was 3.47 percent that day. Based on that volatility and that rate, the Black-Scholes options valuation tool appraised one Old National warrant at $7.18. The bank paid the U.S. $1.48 for each. "We were able to reach a deal that was good for our shareholders and Treasury felt was good for taxpayers," said Old National Chief Executive Officer Bob Jones. The bank, with more than $8 billion in loans and branches in Kentucky and Illinois, hired an appraiser to evaluate the warrants, Jones said. The government rejected his first offer of $600,000, he said. The second TARP recipient to reclaim stock-purchase rights was Iberiabank Corp., a Lafayette, Louisiana-based lender with $5.6 billion in assets that took $90 million in TARP assistance.
Iberiabank paid $1.2 million to buy 138,490 warrants at $8.66 a share, according to a May 20 filing. They may have been worth $19.78 each, or a total of $2.74 million, according to data compiled by Bloomberg and modeled by Black-Scholes. The lender was able to slash the number of warrants from 277,000 by selling common stock in December, a reduction allowed under TARP rules. A risk management device, Black-Scholes was developed in 1973 by Fischer Black and Myron Scholes to estimate the fair market value of stock-option contracts. Williams, the Treasury spokesman, declined to say whether Black-Scholes is one of the two models the department employs. At the University of Louisiana, Wilson used Black-Scholes and two other systems to evaluate Old National’s warrants, plugging in three volatility assumptions: 37.1 percent, 59.72 percent and 72.89 percent. The lowest, calculated from the bank’s stock price movements over the past seven years, yielded the smallest warrant value, ranging from $2.50 to $6.72 per warrant. The highest, based on changes since Jan. 1, 2008, returned a range from $8.88 to $11.05. The middle estimate -- the options-implied volatility -- said a right was worth from $5.93 to $9.69.
Wilson said the government would serve taxpayers better by auctioning off the securities to investors. The law that established the TARP allows for an auction. Miller, the North Carolina congressman, said the Treasury should have insisted on terms for taxpayers similar to those Warren Buffett secured for Berkshire Hathaway Inc. shareholders when he invested $5 billion in Goldman Sachs in September. Buffett received 43.5 million warrants valued by Black- Scholes at $3.6 billion, or $82.18 each, on the date of the transaction, data compiled by Bloomberg shows. Taxpayers injected twice as much into Goldman Sachs and got 12.2 million warrants worth $882 million, or $72.33 each. The American Bankers Association said in an April 16 letter to Geithner that a company that wants to get out of TARP now faces an "onerous exit fee" because it has held the investment for so little time.
"There is no reason for Treasury to impose such a punitive obstacle to exiting," said Diane Casey-Landry, the association’s chief operating officer in Washington. After Shore Bancshares Inc. returned $25 million in TARP money, plus $208,333 in interest, it offered to buy its 173,000 warrants, according to CEO Moorhead Vermilye. He declined to disclose the bid, which he said the U.S. rejected. The Easton, Maryland-based bank’s warrants were valued yesterday at $12.33, or $2.1 million, according to data compiled by Bloomberg and modeled by Black-Scholes. Paying that to reclaim them would amount to an annual interest rate of more than 30 percent a year. "It’s a tough penalty for the short time we had the money -- three months," Vermilye said.
Britain looks to the land of the rising sun with envy
Loss of "AAA" status is not in itself a death sentence. A string of rich countries have been ejected from the club over the past decade without calamitous results, and most have clawed their way back in after a few years of penance. It is less clear whether Britain can hope to muddle through so easily if Standard & Poor's pulls the trigger, given its reliance on foreigners to fund its debt and deficits. Norway lost its AAA in 1987, Finland in 1990, Sweden in 1991, Canada in 1994 and this year Spain and Ireland, both acutely vulnerable since, as eurozone states, they cannot devalue their way out of trouble or print money. The risk does not go away in a currency union: it shifts from debasement to default. Perhaps most surprising is that Japan fell in 1998, though it was by then the world's top creditor with more than $1.5 trillion of net foreign assets (now $3 trillion). Lender abroad, it is a mega-debtor at home, the result of Keynesian pump-priming to fight perma-slump. The stimulus vanished into those famously empty bridges in Hokkaido.
"The Japanese didn't take the downgrade seriously," said Russell Jones, of RBC Capital, a Japan veteran from the 1990s. "They didn't think they would have any trouble funding their debt." They were right. Yields on 10-year bonds fell to 1pc by the end of the decade, and to 0.5pc in the deflation scare of 2003 – confounding those who expected Japan's emergency stimulus to stoke inflation and push up yields. Eisuke Sakakibara, then the finance minstry's "Mr Yen", was insouciant enough to swat aside the Moody's downgrade as an irrelevance. "Personally, I think if Moody's continues to behave like that, the market evaluation of Moody's will go down,'' he said. Japan had a crucial advantage: its captive bond market. Some 95pc of government debt was held by Japanese savers or the big pension funds. The foreign share of UK public debt has risen from 18pc to 34pc over the past six years. The central banks of Asia, Russia and emerging economies like gilts because they offered 1pc extra yield over bunds. This was the "proxy euro" trade.
"We're far more vulnerable than Japan ever was," said Albert Edwards, global strategist at Société Générale. "Japan had a huge current account surplus and a strong currency. The UK is a deficit country, at risk of a sterling collapse. Years of UK macro-mismanagement have dragged the UK economy to the edge of a precipice." S&P said yesterday that UK debt is likely to reach 100pc of GDP in the "medium term" even if the Government tightens its belt. Prof Charles Goodhart from the London School of Economics said the danger is a debt compound trap when interest rates rise. "If that happens we're in real trouble. We could be close by next year," he said. Britain is at the mercy of foreign powers. Marc Ostwald, of Monument Securities, said Russia's central bank held 9.7pc of its reserves in sterling at the end of last year. "They are going to lighten the load if Britain is downgraded. It will be slow attrition," he said. Hong Kong's monetary authority is obliged to hold 96pc of its reserves in AAA assets, and a number of small states have similar restrictions. "The question is which foreigners are holding your bonds," said Hans Redeker, currency chief at BNP Paribas. "Some countries have to reduce exposure because of Value-at-Risk rules if the UK loses its AAA.
Britain has a double problem because it has to raise £220bn in gilts this year at a time when foreign direct investment is going to fall off sharply because of the new tax regime. "The only way out of this is for Britain to tighten fiscal policy and keep monetary policy loose. That will weaken the currency, which is what you need. If they're not disciplined about spending, Britain is going to run into huge problems." Hopefully, we can at least count on the big powers to shield us from total disaster. "Japan is part of the G7 and the last thing they want to do is destabilise the market by selling gilts: they are good allies of the West," said Brad Setser, of the US Council for Foreign Relations. Besides, where can China, Korea, or Brazil, if they want, rotate out of dollars into other currencies? Simon Derrick, currency strategist at the Bank of New York Mellon, says global reserves are 59pc in dollars, 31pc in euros, 5.5pc in pounds, 2pc in yen, so not much fresh money will go into US Treasuries. "The advantages of sterling may sound far-fetched but it is really not so bad in a world where everybody has got problems," he said.
Why Britain has to curb finance
by Martin Wolf
The UK has a strategic nightmare: it has a strong comparative advantage in the world’s most irresponsible industry. So now, in the wake of the biggest financial crisis since the 1930s, the UK must ask itself a painful question: how should the country manage the cuckoo sitting in its nest? The question is inescapable. London is one of the world’s two most important centres of global finance. Its regulators have, as a result, an influence on the world economy out of proportion to the country’s size. In the years leading up to the crisis, that influence was surely malign: the "light touch" approach led the way in a regulatory race to the bottom. The fiscal costs of this crisis will be comparable to those of a big war. Thursday’s threatened downgrade by Standard & Poor’s is a reminder of those costs. Loss of jobs and incomes will also scar the lives of hundreds of millions of people around the world. All this occurred, in part, because institutions replete with highly qualified and highly rewarded people were unable or unwilling to manage risk responsibly. The UK, as a country, the City of London and the broader financial industry bear much responsibility for this calamity. This is a time for self-examination.
A recent report on the future of UK international financial services, produced by a group co-chaired by Sir Win Bischoff, former chairman of Citigroup, and Alistair Darling, chancellor of the exchequer, fails to provide such self-examination. This is partly because the committee consisted of the industry’s "great and good". It is far more because Mr Darling had already decided that "financial services are critical to the UK’s future". Thus, the report’s remit was "to examine the competitiveness of financial services globally and to develop a framework on which to base policy and initiatives to keep UK financial services competitive". If you ask the wrong question, you will get the wrong answer. The right question is, instead, this: what framework is needed to ensure that the operation of the financial sector is compatible with the long-run health of the UK and world economies? Quite simply, the sector imposes massive negative externalities (or costs) on bystanders. Thus, the recommendation "that the financial sector be allowed to recalibrate its activities according to the sentiments and demands of the market" is wrong. A market works well if, and only if, decision-makers confront the consequences of their decisions. This is not – and probably cannot be – the case in finance: certainly, people now sit on fortunes earned in activities that have led to unprecedented rescues and the worst recession since the 1930s. Given this, the industry has become too big. If implicit and explicit guarantees and externalities, including volatility, were fully charged, the sector would surely shrink.
So how should one manage a sector that produces such "bads"? The answer is: in the same way as any polluting activity. One taxes it. At this point, the authors of the report will surely ask: "How can you suggest taxing a sector so vital to the UK economy?" The answer is: easily. Financial services generate only 8 per cent of gross domestic product. They are more important for taxation and the balance of payments. But this tax revenue turns out to be perilously volatile. True, in 2007, the last year before the crisis, the UK ran a trade surplus of £37bn in financial services, partially offsetting an £89bn deficit in goods. But smaller net earnings from financial services would have generated a lower real exchange rate and more earnings elsewhere. Given the costs imposed by the financial sector, a more diversified economy would have been healthier. Such sacrilegious ideas are, of course, not to be found in the Bischoff report. How then should the UK approach policy towards the sector? I would suggest the following guiding ideas.
First, the UK needs to make global regulation work. It should discourage regulatory arbitrage even if it expects to gain in the short run. Second, it must, in particular, help ensure that owners and managers of financial institutions internalise most of the costs of their actions. Third, it must reject egregious special pleading from the industry. The sector argues that moving derivatives trading on to exchangesmight damage innovation. So what? Maximising innovation is a crazy objective. As in pharmaceuticals, a trade-off exists between innovation and safety. If institutions threaten to take trading activities offshore, banking licences should be revoked. Fourth, while trying to create a stable and favourable environment for business activities, the UK should try to diversify the economy away from finance, not reinforce its overly strong comparative advantage within it. Fifth, UK authorities need to ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state. They should not let the country be exposed to the risks created by inadequately supported and under-regulated foreign institutions. At the very least, they should not undermine other governments’ efforts to regulate their own institutions. The "old normal" was simply unsustainable. The "new normal" must be very different. It is far from clear that the industry and government recognise this grim truth.
A Bad Connection in the Markets
Michael J. Panzner
At first glance, news that Standard & Poor's has placed the AAA rating of the United Kingdom under review for a possible downgrade would seem to have no real connection to the fact that U.S. bond yields jumped to six-month highs. But that would be a mistake. In fact, these and other recent developments likely reflect an increasingly widespread fear among analysts, creditors, and fixed-income investors that a growing number of governments no longer view sound finances as a key policy goal. Since the turn of the year, five countries -- Japan, Ireland, Spain, Portugal, and Greece -- have had their formerly top-notch credit ratings cut by S&P, Moody's, or Fitch amid expectations that faltering economic growth, burgeoning public spending, and an increasing reliance on borrowed money has undermined these countries' financial prospects.
In general, deteriorating credit ratings translate into higher borrowing costs. That is not a welcome development when government budgets are already under pressure and public sector demand for credit is expanding rapidly around the globe. And while some might argue -- with good reason -- that rating agencies' opinions shouldn't matter all that much considering how badly they did when it came to evaluating the creditworthiness of institutions and an array of financial instruments during the recent credit boom, global credit markets are also telling an alarming story. Around the world, despite -- or, perhaps, because of -- the efforts of central bankers and legislators, long-term bond yields in many countries are at or near six-month highs and yield curves -- essentially, the gap between long and short-term rates -- have been widening, in some cases dramatically.
Taken together, this combination can be seen as a clear sign that investors are starting to worry about the prospect of sovereign delinquencies or defaults, or the threat of serious inflation -- or both. If history is any guide, it would not take much for such fears to begin feeding on themselves, eventually translating into a widespread vote of no confidence that will leave many governments -- and their citizens -- exposed to myriad risks, not least of which is an inability to fund essential spending on infrastructure and defense. Yet despite these warning signs, many mainstream economists and policymakers here and elsewhere continue to push for more and more spending, bailouts, rescues, and borrowing than the already substantial amount we've seen so far -- without a coherent plan, accountability for how the money is being spent, or a clear sense of what the endgame is.
In their view, the need to address near-term economic woes far outweighs the longer-run implications of what might be described as an imprudent course of action. Even among those who are alert to the risks posed by the orgy of government spending, there is a belief that the strategy can be easily reversed once the time is "right." Unfortunately, the track records of policymakers and politicians, in the United States and in other countries, have proven they are wholly inadequate when it comes to making such assessments, even if one only takes more recent events into account. Moreover, assuming that those in charge somehow figure out when they've "solved" whatever problem it is they are worrying about -- that is, if they actually know themselves -- the markets are likely to be anything but accommodating.
At that point, in fact, there's a very good chance that we will see the loss of confidence that is already gaining pace in a host of countries evolve into a full-fledged run on the banks -- or, in this case -- the currencies and the bond markets of those governments that decided deficits and debts don't matter in the short run. By then, everyone will understand why today's seemingly unrelated events are so deeply connected.
Treasury Budget Hikes Aimed at Tax Collection
Treasury Secretary Timothy Geithner says the majority of additional money he is seeking for his department will be devoted to improve tax collection efforts.
Ilargi: First to go: programs for those who have the least means to defend themselves and the least political power: the old, the young and the sick. You can't miss with that one. It's precisely what societies need more than anything to prevent, and it's also the first thing they fail at.
Schwarzenegger: No gimmicks to fix budget deficit
Abandoning plans to ease California's deficit with borrowed money, Gov. Arnold Schwarzenegger on Thursday called for greater cuts in such areas as children's health care, college loan assistance and state parks. The move was a direct reaction to Tuesday's special election, when voters rejected five budget-related measures that relied on borrowing, funding shifts and higher taxes. Schwarzenegger said voters were telling lawmakers to live within the state's means without resorting to borrowing and gimmicks that shift money from one fund to another. "There's one thing for sure, there will be no revenue increase," he told reporters during a news conference following his appearance at a capital prayer breakfast. "It means cuts, cuts, cuts and living within our means. That is the message of the people."
California faces a practical problem if lawmakers were to consider more borrowing to deal with the state's $21.3 billion deficit: Its credit rating is the worst of any state, adding to its borrowing costs. The state treasurer's office estimates that California would pay an extra $500 million to $1 billion in lender fees on a $15 billion short-term loan. California's controller and treasurer are expected to brief lawmakers Friday on the state's options. However the state handles its cash-flow needs in the coming months, the governor wasted no time making lawmakers aware of the severity of the cuts the state must make. Under the state Constitution, the Legislature has to pass a balanced budget by June 15.
Schwarzenegger's deputy finance director, Ana Matosantos, told lawmakers Thursday during a budget committee hearing that the administration is seeking to eliminate or heavily reduce programs not required by the federal government. The state's low-cost health insurance program for children known as Healthy Families, the CalWORKS welfare-to-work program, mental health services and children's welfare programs all face elimination, she said. The administration also will look to reduce financial aid for college students as well as funding for state parks. The Republican governor also has proposed selling state assets such as San Quentin State Prison, the Los Angeles Memorial Coliseum and CalExpo, the state fairgrounds in Sacramento.
This summer, California's cash-flow shortage is expected to be so severe that it may need to borrow as much as $23 billion just to pay for the government's basic operations. To get fees and interest rate down on those loans, Schwarzenegger and Democratic state lawmakers have floated the idea of having the federal government back California's borrowing. Schwarzenegger has received no assurance so far that the Obama administration or Congress would support such an arrangement. Voters this week resoundingly rejected a slate of measures that included higher taxes, funding shifts and borrowing against the assumed value of future state lottery revenues. Two-thirds of those who cast ballots rejected each of the five budget-related measures. Voters approved just one ballot measure in Tuesday's election, Proposition 1F, which will prohibit lawmakers from receiving pay raises during deficit years.
Overseer of Thrifts Is Faulted
High-level Office of Thrift Supervision officials played a direct role in allowing thrifts to inappropriately backdate capital contributions, federal inspectors said Thursday, even though such moves allowed firms to report misleading financial results. The U.S. Treasury Department's Office of Inspector General said a review of six cases where a thrift backdated a capital infusion to a previous quarter found that the OTS facilitated the move.
In two cases, including IndyMac Bank, which later failed, OTS management specifically directed or authorized the backdating. "We consider these matters very serious and find it alarming that such high-level OTS officials were not only aware of the backdating at two thrifts, but either directed or authorized the thrifts to backdate the capital contributions," the report said. In three further cases, the agency allowed a thrift's backdating to remain after discovering it.
In one case, the OTS objected to a thrift backdating its capital infusion but the thrift went ahead nonetheless and the OTS let it stand. In only one of the six cases did the OTS direct the thrift to reverse the transaction. The OTS has been under fire for what critics contend was an overly light approach to regulation that contributed to the collapse of several large financial institutions it oversaw. "This is old news," OTS spokesman William Ruberry said. "We began addressing these issues in December and we have taken the necessary actions to remedy the situation," he said. Additionally, OTS Acting Director John Bowman said in a letter to the Treasury inspector general that the capital contributions were "consistent with OTS's primary safety and soundness mission and longstanding practice of requiring holding companies to serve as sources of financial support" to their thrift subsidiaries.
Fannie HomeSaver Program Sees 70% Recidivism
A program aimed at helping delinquent borrowers become current once more on their mortgages will likely see decreased volumes at mortgage giant Fannie Mae after the Federal Housing Finance Agency (FHFA) noted a significant majority of participants soon redefaulted after receiving aid. Fannie first launched the HomeSaver Advance (HSA) program in February ‘08 as a solution for borrowers experiencing temporary hardship. It allows servicers to offer unsecured, personal loans so delinquent borrowers can keep up on payments until the temporary hardship — unemployment, sickness, etc. — passes and borrowers can resume regular payments. "This loan can offer these borrowers another alternative, and help prevent a temporary setback from becoming a foreclosure," a Fannie executive in the single-family credit risk management division said in a media statement announcing the program.
But as mortgage performance deteriorated through ‘08, Fannie’s conservator, FHFA, noticed an alarming trend among the mortgages participating in the advance program. "HSA is showing high redefault rates on the early offerings," FHFA director James Lockhart noted in a Congressional report this week. "Performance on the February through April offerings shows a redefault [or recidivism] rate of almost 70%, which calls into question the program’s assumptions that borrowers have the capacity to make payments going forward." In response to the sliding performance of these mortgages, Fannie took steps to focus on modification options like the Administration’s Making Home Affordable (MHA) program. The company revised its mortgage workout heirarchy to favor the Home Affordable modificaiton program.
"The HSA is not an appropriate foreclosure prevention alternative, and must not be used, for a borrower with a permanent or long-term financial hardship," Fannie officials said in the late-April report revising its heirarchy. Instead, the new heirarchy reccommends HSA as an appropriate alternative to the MHA modification program in cases where the borrower experiences only a temporary hardship and cannot qualify for MHA. "Given the depth and scope of MHA, we anticipate a decrease in HomeSaver Advance volumes," Fannie spokesperson Amy Bonitatibus tells HousingWire. "Although HomeSaver Advance loans continue to be a viable foreclosure prevention solution for borrowers facing a temporary hardship, other home retention strategies, particularly modifications, are becoming more prevalent based on assessments of the needs and condition of borrowers."
Former Head of US Federal Pension Agency Refuses to Testify
The former head of the federal agency that guarantees the pensions of 44 million Americans invoked his Fifth Amendment rights at a Senate hearing, refusing to discuss his contacts with Wall Street firms bidding for business. Charles E.F. Millard is being investigated by Congress over his relationships with JPMorgan Chase & Co., Goldman Sachs Group Inc. and other firms while he led the Pension Benefit Guaranty Corp. during the Bush administration. Millard cited the constitutional right against self- incrimination three times today during a session of the Senate Special Committee on Aging. The pension agency reported a $33.5 billion deficit earlier today. "Congress’s recent actions and statements have created a biased and hostile environment toward Mr. Millard," his attorney, Stanley Brand, said in a statement. "Certain members of the United States Congress appear to already have reached adverse conclusions."
Senator Herb Kohl, who heads the Senate panel that explored the future of the PBGC at today’s hearing, said the agency should reopen bidding on contracts issued last year to manage $2.5 billion in assets. Kohl, a Wisconsin Democrat and chairman of the Senate committee, said the bidding process was "improperly influenced." Labor Secretary Hilda Solis, who has jurisdiction over the PBGC, has said she may cancel the contracts, according to Kohl. A report by the PBGC’s inspector general alleges that Millard had inappropriate communications with eight of 16 Wall Street firms that bid last year to manage $2.5 billion of the agency’s $48 billion investment portfolio.
Six senators today sent the report to Attorney General Eric Holder asking for an independent review of the matter.
Millard, who ran the agency from December 2007 through January 2009, may have violated "blackout" rules that prohibited him from contacting bidders on three contracts for "strategic partnerships" that were to involve investments in stock, real-estate and private equity assets, the report said. Fees on the contracts were expected to exceed $100 million, according to the report, which was released last week by the House Education and Labor Committee. Goldman was awarded in October a contract to invest $700 million of PBGC assets in private equity, and JPMorgan and BlackRock Inc. were each given contracts to invest $600 million in real estate and $300 million in private equity, according to the report.
Brand has said his client acted in a "transparent and ethical manner." Millard, in a letter to the PBGC included in the report, said the conversations he had were personal and unrelated to the contracts. Millard said his conduct was "appropriate as a policy matter, based firmly on agency regulations." He is a former Lehman Brothers Holdings Inc. managing director and had worked for New York Mayor Rudolph Giuliani’s administration. The PBGC, a government-owned corporation set up to protect the employee pensions of bankrupt companies, must be put "back on track" or taxpayers may face the burden of having to absorb its obligations, Kohl said before excusing Millard from the hearing. Vince Snowbarger, the PBGC’s acting director, said the agency’s deficit tripled to $33.5 billion in the past six months as companies canceled retirement plans in the U.S. recession. About $11 billion is for "completed and probable terminations" of company plans and $7 billion is from a decrease in interest rates that boosted liabilities, Snowbarger told the committee.
The financial condition of the PBGC may worsen amid the likelihood of more pension-plan failures, he said. In the first half of the fiscal year that began in October, the PBGC took on almost four times the number of participants as it did in all of 2008. The potential for General Motors Corp. and Chrysler LLC to end their plans leaves the PBGC facing the prospect of adding 900,000 current and future beneficiaries. The PBGC estimates that $77 billion of the automotive industry’s pensions are underfunded, with about $42 billion of that guaranteed by the agency for retirees. Auburn Hills, Michigan-based Chrysler filed for bankruptcy protection on April 30. Detroit-based GM is facing a U.S.- imposed June 1 deadline to reduce its costs and debt obligations or face bankruptcy.
The PBGC, created by Congress in 1974, also faces the risk of increased responsibilities from companies in other sectors of the economy, including retail, financial services and health care, Snowbarger said. Barbara Bovbjerg, associate director of the Government Accountability Office, told the committee that the PBGC’s board is failing to provide adequate oversight and direction. The three-member board includes Treasury Secretary Timothy Geithner, Commerce Secretary Gary Locke and Labor Secretary Hilda Solis. The three have yet to meet since joining the board this year. "These board members have numerous other responsibilities, and are unable to dedicate consistent and comprehensive attention to the PBGC," Bovbjerg said.
Representatives of the board members did meet as recently as November and there have been telephone calls and other contacts with PBGC senior management, said Jeffrey Speicher, an agency spokesman. The previous board last met in February 2008, according to Bovbjerg. That’s when the board approved a new investment strategy pushed by Millard to shift more money from safer Treasury securities to stocks, real-estate and private-equity considered to have the potential for greater returns. Millard never fully implemented the less conservative investment strategy before he left the agency in January, the PBGC has said. About 30 percent of the agency’s $48 billion investment portfolio is in equities, 69 percent in fixed-income, and less than 2 percent in alternative assets.
San Francisco Home Prices Fall 41% in Past Year on Foreclosures
San Francisco Bay Area home prices fell 41 percent in April from a year earlier as foreclosures accounted for almost half of all sales, MDA DataQuick said. The median price dropped to $304,000 from $518,000 a year earlier. That’s 54 percent below the peak reached two years ago, the San Diego-based research company said today in a statement. A total of 7,139 new and existing houses and condominiums sold in the nine-county area, a 13 percent increase from April 2008. "Job losses and historically high foreclosure levels continue to pose serious threats to housing stability," John Walsh, president of MDA, said in the statement. "In much of the Bay Area, there’s the added problem of ‘jumbo’ loan financing still being relatively expensive and, for many, hard to get."
Low mortgage rates, the availability of home loans backed by the Federal Housing Administration and discounted foreclosure properties are driving sales across the U.S. Fixed rates for 30- year loans fell to 4.82 percent, mortgage buyer Freddie Mac said today, as the Federal Reserve purchases as much as $1.25 trillion in mortgage-backed securities to push down rates. In the Bay Area, foreclosed homes totaled 47 percent of all transactions, the lowest since November, as first-time buyers in lower-cost counties finance purchases with FHA mortgages and push sales to near-record highs, MDA DataQuick said. Mortgages above $417,000, known as jumbo loans, were used to finance 22 percent of home sales, down from more than 60 percent before the credit crunch hit in August 2007. That’s kept sales in expensive coastal areas near record-lows, said MDA DataQuick, a unit of Vancouver-based MacDonald Dettwiler and Associates.
Sales rose 67 percent in Solano, 34 percent in Contra Costa, 22 percent in Sonoma and 17.5 percent in Alameda and 11.5 percent in Santa Clara, MDA DataQuick said. Sales declined 1 percent in Napa, 19 percent in Marin, 22.5 percent in San Mateo and 34 percent in San Francisco. Prices tumbled in all nine counties and declined the most in Solano, dropping 44 percent to a median $180,000. Prices fell 43 percent to $225,000 in Contra Costa; 39 percent to $289,197 in Alameda; 37 percent to $315,000 in Napa; 34 percent to $405,000 in Santa Clara; 30 percent to $290,000 in Sonoma; 27 percent to $585,000 in Marin; 23 percent to $520,000 in San Mateo; and 16 percent to $628,500 in San Francisco, MDA DataQuick said. The Bay Area median price fell 4.8 percent from March. The last time the median rose from the previous month was in October 2007, when it increased 1 percent, MDA DataQuick said. The peak price of $665,000 was reached in June and July 2007.
How Beijing is Battling the Global Crisis
The West is pinning its hopes on China to revive the global economy. Beijing is orchestrating its efforts to combat the crisis as meticulously as it once planned the country's spectacular economic ascent. Everything is colored a bright red, from the tent roofs protecting throngs of shoppers from the elements to the banners encouraging them to buy. Wang Shiqin, a 62-year-old farmer, hurried to the market in the early morning hours. Like most shoppers here, he already owns a television set, but now he wants to buy his first refrigerator -- subsidized by the Chinese government. The mood is a mixture of carnival and rally at the market in Feidong, a city in rural Anhui Province about a three-hour train ride northwest of Shanghai. The vendors are loudly pitching household appliances, especially domestic brands, which benefit from this government campaign to fight the global financial crisis. The Chinese are among the world's most diligent savers, hording almost five times as much of their disposable income in their bank accounts as the Germans do. But now the Communist Party wants to promote collective consumption. The country's 800 million farmers, in particular, are needed as new customers for China's global factory. The same view is held in the West, where even the tiniest grain of optimism suggesting that the crisis could soon come to an end is eagerly snapped up.
Last week, European Central Bank President Jean-Claude Trichet said cautiously that the global economy is "near a turning point." In a cover story, the German business daily Handelsblatt wrote that the "nosedive of the German economy appears to have been stopped." Germany's export business could be digging itself out of the red, thanks in part to Asia. But even members of the government in Berlin are unwilling to hazard a prediction as to whether this is truly a trend reversal or merely a flash in the pan. China appears to be primarily responsible for this bit of optimism. The West, for its part, is hoping for an increase in China's interest in its machinery, goods and know-how. The West hopes that millions of Chinese consumers like farmer Wang will, at least in part, replace consumers in Europe and the United States, who have been buying fewer and fewer goods that are "made in China" since the crisis began. Chinese exports plunged by about 22 percent in April alone. It doesn't take much to convince the Chinese masses to spend their money, as they embark on an enthusiastic shopping spree, in Anhui and other provinces, particularly in the country's relatively backward western regions, into which Beijing is currently funneling large amounts of government funds. "Jiadian Xiaxiang," or "Electric Household Appliances for the Villages," is the title of the campaign currently underway in China. The economic stimulus program is straightforward: Buyers must identify themselves as farmers. After purchasing their new television sets, refrigerators, washing machines or mobile phones, the customers receive a 13-percent rebate on the purchase price from their local tax offices.
Beijing is using similar government stimulus programs to boost car buying. A tax imposed on the purchase of certain small cars was cut in half, bringing it to 5 percent. The government is spending about €560 million ($755 million) in the hope of stimulating sales of vehicles in rural areas. And it seems to be working. In March alone, the Chinese bought more than 770,000 new cars, a 27-percent rise over the previous month and a new record monthly sales figure. The stimulus programs recently helped China overtake the United States as the world's largest automobile market. The government stimulus programs, financed with the help of its massive currency reserves, could also benefit the West. Hardly any other country is pumping money as enthusiastically into the tired economic cycle, and almost nowhere else is the government intervening as rigorously and deeply in the market as in the People's Republic. China was one of the first countries to announce an economic stimulus program. In November 2008 the government in Beijing launched a two-year plan to inject 4 trillion yuan (about €450 billion, or $608 billion) into the economy. This is about seven times as much as the German government plans to invest in its economy. Since the crisis began, Beijing has launched new infrastructure projects practically at the press of a button. Some projects had been planned for a long time, while others were completely new. They include the paving or repair of 300,000 kilometers (186,000 miles) of roads, as well as an investment of €68 billion ($92 billion) in new railroad lines, or about twice as much as in the previous year.
Last year, Beijing put many projects on hold, partly to reduce pollution during the Olympic Games and partly to cool what was then an overheated economy. As part of this strategy, China's central bank increased interest rates six times before the crisis, but then it frantically reversed course and reduced rates five times in a row. Now Beijing's economic planners are stepping on the gas once again, in all sectors of the economy. In light of the crisis, the government and the Communist Party are quickly scaling down considerations of environmental protection and sustainability, which had been raised increasingly in recent years both abroad and in China. In only two days, the country's Environment Ministry hastily approved 90 projects worth a total of about 240 billion yuan (€27 billion, or $36 billion), including power plants, aluminum smelters, cement factories and steel mills. This accelerated approval process is dubbed, with absolutely no irony, "Green Passage." China's communists are suddenly in their element once again. They are well used to government-run campaigns, going back to when then-Chairman Mao Zedong invoked ill-fated "Great Leap Forward" in the 1950s and later launched the Cultural Revolution. Nowadays, the party's Public Enemy No. 1 is the global crisis, which is mainly spilling over from the United States, Beijing's important export market. Beijing is also worried about its financial investments in the US. With about one third of its $1.9 trillion (€1.4 trillion) in foreign currency reserves invested in US treasury bonds, China is the Western superpower's biggest creditor. In other words, the Chinese and the Americans are essentially sitting in the same leaky boat.
To protect their borrowers from collapse, the Chinese have hardly any choice but to continue buying up American treasury bonds. Nevertheless, Beijing is also taking advantage of the crisis to portray itself as an alternative to the United States and a future superpower. It is gratifying for the Chinese leadership to look on as the West reaches for solutions that smack of state capitalism. China's leaders stand a good chance of winning this global competition, at least in the short term. After all the planned market economy is their own turf. Furthermore, the Communist Party has no democratically elected parliament to worry about, one that could seek to influence its "market economy with Chinese characteristics." And they can practically order their state-owned banks to issue loans to companies, many of which are also state-owned. In March alone, Chinese banks increased the volume of loans to companies by the equivalent of €216 billion ($292 billion). As a result, investments in factories and real estate in urban areas rose by more than 30 percent from January to April. The party has also been dispatching its officials to visit companies throughout the country. Part of the purpose of these visits is to determine which companies need government support. At the same time, the party officials have begun pressing local company managers not to let any workers go or close factories -- a trend that triggered an initial wave of angry protests around the end of last year. At first, the crisis took the party by surprise in Guangdong Province, China's export powerhouse in the Southeast, bordering Hong Kong. When thousands of privately owned factories that produced inexpensive products like shoes and toys were shut down, about 20 million migrant workers throughout China lost their jobs.
But local party officials made sure that the newly unemployed were paid back wages. In Shanghai, the Communist Party's crisis managers are virtually omnipotent. In this city of skyscrapers, communist city officials control the most important large companies, from supermarket chains to China's biggest carmaker. Recently, the city spent 1 billion yuan to quietly rescue SVA, a local flat-screen TV manufacturer, from bankruptcy. "The party is the key to overcoming the economic difficulties," says Yu Zhengsheng, the head of the Communist Party in Shanghai. The collective goal of China's economic planners is to achieve 8-percent growth, which the Beijing leadership sees as the minimum level necessary to preserve the constantly invoked social harmony in the enormous country. In fact, China will likely announce a growth figure at the end of the year that is completely in synch with the planned figure -- regardless of whether the actual growth figure ends up being exactly 8 percent or, for example, 7.8 percent. In the first quarter of 2009, the world's third-largest economy grew by 6.1 percent. This is a disappointing number when compared with the double-digit growth China experienced until 2007. Nevertheless, the People's Republic is still in good shape compared with the West, which is sliding more and more deeply into recession. Prime Minister Wen Jiabao has already indicated that he has still has "more gunpowder" available to protect his country against the downturn. But by building new roads, railroads and airports, Beijing is only driving up the unhealthily high proportion of such investments in the general economy, which had already exceeded 40 percent in 2007. Offering tax rebates for cars and TV sets is not going to solve China's real challenge, which is to free itself from dependency on exports in the long term and stimulate domestic consumption.
To achieve this goal, China would have to bridge the growing gap between rich and poor. In the 1980s, urban Chinese earned about twice as much on average as rural residents. By 2008, city dwellers were making 3.3 times as much as members of the rural population. The People's Republic urgently needs to develop a sustainable social welfare system, one that is far more extensive than current plans call for. Most of China's 1.3 billion people have neither adequate health insurance nor any significant retirement pensions. China, a late-comer to industrialization, urgently -- and far more so than the West -- needs private entrepreneurs willing to take the risks involved in developing its own high-tech brands. Instead, the country's economic planners continue to puff up stolid government behemoths with their loans. Even the central bank in Beijing, in its most recent quarterly report, expressed the concern that China must accelerate "innovation and reform." Instead, provincial party bosses vie to perpetuate the glory of the party by erecting ostentatious buildings of steel and concrete. Ni Jinjie, a prominent financial commentator, warns that if Beijing continues to hand out money indiscriminately, "the structure of our economy could quickly fall out of balance." The new China bubble is already beginning to quietly inflate on the markets. In Shenzhen, where the stock index has already shot up by more than 50 percent this year, market regulators felt the need to issue an official warning to Chinese investors: "Beware of the dangers of blindly speculating with stocks!"
Trichet needs help to deliver the bad news
The omnipresent Jean-Claude Trichet brings apparent simplicity to the European Central Bank, where he has been president since 2003, by dominating its external policy representation. In reality, though, the ECB’s constitutional life is Byzantine in its complexity: the 22 central bankers on its decision-making council oversee a unified currency and interest rate policy for 16 countries, each with its own government, parliament and finance ministry. It is time for the ECB to put its governance and public image on to a broader footing. The bank should form a muscular six-person "committee for euro stability" to carry its policy messages to a wider public inside and outside economic and monetary union. Over the next two years, Europe’s multi-speed recovery from financial crisis will bring exceptional pressures. Europe is suffering from a lack of political clout, nationally and at the European Commission. The ECB should make an effort to fill the leadership vacuum. The central bank’s handling of the financial and economic crisis has been reasonably deft so far. Although it erred in raising interest rates by ? percentage point when Europe was entering recession in July last year, the ECB has won general praise for handing out plentiful liquidity to European banks, including when the subprime mortgage crisis first broke in August 2007. It has cut interest rates seven times in eight months.
However, tough times lie ahead. Europe’s recovery will be patchy. It is likely to be led by Germany and other export-oriented northern countries. Debt-burdened southern and western nations – Greece, Italy, Ireland, Portugal and Spain, suffering from low competitiveness, large current account deficits and financial imbalances – will lag behind. Probable ECB interest rate increases later this year will see it accused of stifling an upturn in the euro area’s troubled periphery. Reflecting the political fragmentation that remains the euro’s main weakness, the ECB is reluctant to shed light on its decision-making processes. The ECB council fears unfavourable publicity from contradictions between the positions of its national representatives – who are supposed to consider overall euro area requirements – and the disparate needs of individual member states. For these reasons, the ECB’s decision-making processes are more opaque than those of the Federal Reserve or the Bank of England. But these factors also put Mr Trichet in pole position. A man who combines charm and steel in equal measure, Mr Trichet is by far the most experienced member of the ECB board. He plays a commanding role in internal deliberations and in external policy utterances.
The strains on the euro are now sufficiently grave that the ECB needs to move away from undue reliance on its president. Five council members should join Mr Trichet in an active policy unit arguing on a variety of platforms – including before national parliaments – for policies to secure the euro’s longer-term solidity. This euro stability committee could comprise some of the most articulate of the 22-member council, including Mario Draghi, governor of the Bank of Italy, Axel Weber, the Bundesbank president, and Athanasios Orphanides, governor of the Central Bank of Cyprus. Mr Draghi is tipped to take over from Mr Trichet when the latter’s eight-year term ends in 2011, and could use a spell in the European limelight as a dress rehearsal. Mr Weber, who consistently pleads for firmness in Germany, needs to test his hawkishness across the euro area.
Mr Orphanides, who served for 17 years at the Federal Reserve, can launch his skills on a wider plane. The committee needs to argue for public spending and debt cuts as soon as the first signs of recovery appear. It should admit that, by opting for a single currency among countries with varying inflation, Europe’s governments have inevitably caused dramatic distortions in eurozone competitiveness, which it will be arduous to reverse. And it should explain that "one size fits all" interest rates bring initial benefits, by spurring growth of higher-inflation members, but cause pain later. For the euro to prosper, this pain has to be spread. Sometimes central bankers should ration communications with the outside world. This is not one of those times. The ECB should embrace collective leadership and tell the euro area’s people some sobering truths about the challenges they face – before it is too late.
Brown Goes Full Circle as Debt Raises Rating Doubt
When Gordon Brown took over as Britain’s Labour finance minister in 1997 after 18 years of Conservative rule, he pledged "sustainable public finances" to cut a debt load that was near the highest in more than a decade. Brown, prime minister since 2007, is leaving the next government -- either his own or one led by the Conservatives -- a mess worse than the one he inherited. Standard & Poor’s yesterday highlighted the task facing the next finance chief, saying it may cut Britain’s AAA credit rating for the first time as debt heads to 100 percent of gross domestic product amid the worst recession since World War II. "We have gone full circle," said Danny Gabay, director of Fathom Financial Consulting in London and a former Bank of England economist. "Like then, there was a massive collapse in the fiscal position. Whoever is in government won’t have the luxury of waiting because the situation is pressing."
Debt costs will consume 6.9 percent of government spending by 2013, double the current rate, crowding out funds available for roads, schools and hospitals, according to the independent Institute for Fiscal Studies in London. The government expects to spend 60 percent more servicing debt next year. By 2014, it will be paying lenders almost as much as it spends on defense. Britain needs to sell a record 220 billion pounds ($344 billion) of bonds in the fiscal year through March 2010. Chancellor of the Exchequer Alistair Darling says the budget deficit will reach 175 billion pounds, or 12.4 percent of GDP, the highest among the Group of Eight nations. Since S&P lowered the U.K. credit outlook to "negative" from "stable" yesterday, the pound has fallen to $1.5809 after a five month rally against the dollar, the FTSE 100 Index slid 2.3 percent, and the cost of insuring U.K. debt against default rose by 7 basis points.
The move couldn’t have happened at a worse time for Brown, who trails in opinion polls and is struggling to overcome a scandal regarding expense reimbursements provided to lawmakers - - a controversy that toppled the Speaker of the House of Commons for the first time since 1695. A BPIX Ltd. survey published May 17 showed Brown, who must call an election by June 2010, lagging behind the Conservatives by 22 points. "Does this government in its current state have the steel and the authority to put through a painful program of tax increases and spending reductions and nurture the economy in a consensual way through a period of difficult economic adjustment?" said George Magnus, senior economic adviser at UBS AG. "No. The politics just aren’t right." Regardless of whether Brown’s Labour Party or David Cameron’s Conservatives win the next election, Britain is headed for years of pain as the government raises taxes and slashes spending to restore credibility with investors, economists say.
"The huge deficit will still require significant and active tightening of fiscal policy," said Ben Broadbent, a U.K. economist at Goldman Sachs Inc. in London. A credit rating cut may drive government borrowing costs higher, eating further into what a Brown or Cameron government can spend on public services. Fathom’s Gabay said the average interest rate paid by the government following a downgrade may rise to about 7 percent. That rate was last seen in 1997, and, because of the size of the debt, servicing costs as a share of the economy may rise to their highest since 1946. The government estimates it will devote 5.9 percent of spending to paying interest by 2011, jumping from a low of 4.1 percent this year. That’s still less than the 9.1 percent when Brown became chancellor in 1997.
For now, the Treasury plans on paying an average interest rate on outstanding debt of 4.8 percent from April 2010. That compares with averages of 10 percent in the early 1980s and 7 percent in the 1990s. With the economy shrinking, tax revenue is crumbling and the deficit ballooning. The government says debt may total 1.4 trillion pounds by 2014 from about 600 million pounds last year. Darling has already announced a spending squeeze and higher taxes that will boost Treasury coffers by almost 27 billion pounds a year. The International Monetary Fund said earlier this week that those steps aren’t enough to restore the government’s finances and urged further action. "Britain’s economic reputation is on the line," said George Osborne, the lawmaker in charge of Treasury affairs for the Conservatives. "Unless Britain has a government with a credible plan to reduce debt, there will be a further downgrade, with all of the serious consequences for our prosperity that would entail."
Debt and ratings concerns are already starting to affect other countries. Yesterday, U.S. Treasury Secretary Timothy Geithner committed to cutting the budget deficit as concern about deteriorating creditworthiness deepened. Britain’s debt next year will be 66.9 percent of GDP, exceeding Canada’s 29.1 percent and Germany’s 58.1 percent, according to April 22 forecasts by the IMF. The U.S. will be at 70.4 percent, and the 16-nation euro area at 68 percent, according to the Washington-based lender. "We’ll get to 100 percent quite easily," said Colin Ellis, an economist at Daiwa Securities SMBC Europe Ltd. in London. "The public finances are really in trouble."
UK GDP: inventories fall at record pace
British companies ran down stocks at a record pace in the first quarter as the deepening recession led to a slump in investment and household spending. Inventories over the first three months of the year dropped by a record £6bn - the biggest quarterly fall since records began in 1948, the Office for National Statistics said on Friday in a second estimate of gross domestic product. Brian Hilliard of Societe Generale called the fall in inventories "staggering" and "savage". Destocking by companies cut 0.6 percentage points off first quarter GDP, which dropped an unrevised 1.9pc in the period. In the fourth quarter on 2008 inventories fell by 4.1bn, down from a rise of £1bn in the third quater. The fall in GDP, while the biggest quarterly decline since 1979, was in line with analysts' forecasts and underlined the broad weakness of the economy at the start of this year. Spending by households fell by 1.2pc, the biggest drop since 1980. the only sector of the economy making a positive contribution to growth was government spending. Other key points were:
- Manufacturing - biggest quarterly fall in output since records began in 1955
- Production - biggest quarterly fall in output since Q1 1974
- Compensation for employees - biggest quarterly fall since records began in 1955
"The breakdown of Q1 GDP gives a pretty grim picture of weakness right across the economy in the early months of this year," said Jonathan Loynes of Capital Economics. "We remain unconvinced that recent 'green shoots' will translate into a return to decent growth next year." He expected household spending and investment to fall "considerably further" due to weak housing and labour markets and the reluctance of banks to lend. Ross Walker of Royal Bank of Scotland said: "They are awful numbers, but there is not a lot of news here and I guess they are pretty neutral for markets ... I think we are on course for what on any yardstick would be substantial fall - a drop of 0.7pc quarter on quarter. So it is stil going to be a painful contraction." Economist expect the fall in inventories to slow over the coming months.
U.K. Treasury Refuses to Release Stress Tests on RBS, Lloyds
The U.K. refused to release the results of stress tests conducted on British banks, two weeks after the Federal Reserve said similar reviews showed 10 U.S. lenders needed to raise a total of $74.6 billion. Publishing the information may increase instability and force the government to take further action to shore up the U.K. financial system, the Treasury said in response to a Freedom of Information Act request by Bloomberg News that sought the test results and criteria used to evaluate banks. U.S regulators said publishing their findings would ease concerns about lenders. "Keeping the information under wraps will only serve to create more uncertainty in the long term," Vince Cable, the opposition Liberal Democrats’ spokesman on treasury issues, said in an e-mailed statement. "We need a system that is as open and as transparent as that in the United States."
The Financial Services Authority carried out stress tests on U.K. banks earlier this year to determine their ability to withstand losses amid the worst recession in 60 years. Barclays Plc is the only bank to have disclosed its results, saying it will continue to meet the regulator’s capital requirements under various credit risk, market risk and economic scenarios. Disclosure of the results "at this time may lead to uncertainty in financial markets, either in relation to specific institutions or more generally," the Treasury said in its response to Bloomberg. "Such instability could require further action by the authorities." The same request to the FSA was rejected on the grounds it would be too costly to retrieve the documents. Lesley Richardson, an FSA freedom of information officer, said the results wouldn’t be released in any case because the information was confidential.
The U.K. has committed as much as 1.4 trillion pounds ($2.2 trillion) to bolster the nation’s banking system through direct investments, asset insurance and underwriting loans. The government has nationalized Northern Rock Plc and Bradford & Bingley Plc, and taken controlling stakes Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc. The scenarios used to test Barclays’ assets included a 50 percent drop in U.K. house prices and a recession lasting two years, the Financial Times reported in March, without saying where it got the information. Alistair Smith, a Barclays spokesman, declined to comment. The Federal Reserve gave banks six months to fill any capital shortfalls identified by the U.S. tests or face expanded federal ownership. At the time, Chairman Ben S. Bernanke said releasing the findings should reassure investors about the soundness of the financial system.
"The transparency of companies over the last few months has significantly improved so it is ironic that the one body who isn’t joining in the transparency is the regulator itself," said Ian Gordon, an analyst at Exane BNP Paribas in London. Representatives of RBS, Lloyds, Northern Rock and HSBC Plc declined to comment on whether they passed the U.K.’s stress tests when contacted by Bloomberg News. Bank stress test results should be made public to improve risk management, Andrew Haldane, executive director for financial stability at the Bank of England, said in a speech in February. "There is a case for having these results set out regularly in firms’ public reports," he said. "Having a standardized, published set of such stress-testing results would help improve financial markets’ understanding and hence pricing of bank-specific risk."
Disgraced British MPs quit - and blame the voters
MPs caught up in the expenses scandal blamed the anger of their constituents and the public backlash for their decision to quit Parliament. Ben Chapman, Labour, and Anthony Steen, a Conservative, said that they would stand down at the next election while maintaining that they had done nothing wrong. Last night the Labour MP Ian Gibson also offered to stand down if the voters asked him to, amid claims that he sold a taxpayer-subsidised property to a member of his family. He insisted that he had acted within the rules. Such is the pressure on MPs that party whips have told The Times that they fear it could result in suicides.
In an astonishing outburst Mr Steen, who spent £90,000 on his second home, including big sums for lopping trees in its grounds, said that his critics were jealous because he lived in a large house. He blamed the Freedom of Information Act for his plight and asked what right the public had to interfere with his private life. "I’ve done nothing criminal, that’s the most awful thing, and do you know what it’s about? Jealousy," he told the BBC. "I’ve got a very, very large house. Some people say it looks like Balmoral. It’s a merchant’s house of the 19th century. It’s not particularly attractive, it just does me nicely." Mr Steen later apologised after being threatened by David Cameron with removal from the party.
Mr Chapman, who overclaimed £15,000 in mortgage interest, allegedly on erroneous advice from the Commons Fees Office, said he was standing down because of the effect of the hurtful publicity on his friends, family and supporters. "I maintain that I have done nothing wrong and have acted in good faith and with absolute transparency." Douglas Hogg is the only other MP to stand down voluntarily. The former Tory Cabinet minister said on Tuesday that he was retiring over claims he submitted for cleaning his moat. Sir Peter Viggers, a Tory MP, was ordered by Mr Cameron to retire at the next election over his claims for the cost of his duck pond.
The Labour MPs Elliot Morley and David Chaytor have been suspended over mortgage claims while Shahid Malik stood down from his role as a Justice minister over the location of his main home. All say the claims were within the rules but face expulsion from the party if they cannot prove their innocence. Up to 100 MPs are said to be considering standing down, with several admitting to The Times that they have lost confidence in their abilities to represent their constituencies. Nadine Dorries, the Tory MP, said that there was too much pressure on parliamentarians. "The atmosphere in Westminster is unbearable. People are constantly checking if others are OK. Everyone fears a suicide," she wrote on her blog.
Downgrades loom for Spanish banks
Bad debt problems at Spanish banks and cajas, the regional savings and loans institutions, have triggered at least one skipped interest payment on a mortgage-backed bond this week and prompted new warnings of imminent downgrades by credit rating agencies. Caja Madrid, Spain’s fourth biggest financial institution, on Wednesday confirmed that a deterioration of the underlying mortgages had caused the automatic cancellation of more than €1m ($1.4m) in interest owed to junior holders of mortgage-backed securities issued in 2006 and 2007 by special purpose vehicles. However, Caja Madrid, the originator of the mortgages packaged in the relevant securities, said no outside bondholders were affected since it had kept the junior tranches for itself and only the triple A paper had been sold. Senior holders will be affected only if more underlying mortgage holders default.
"It’s happened before in Spain. It’s happened before in other jurisdictions," said one Caja Madrid executive. Moody’s, the credit rating agency, meanwhile put half of Spain’s banks and unlisted cajas, the regional savings and loans institutions, on notice of possible credit downgrades because it expects asset quality to deteriorate further during the country’s deep recession. Moody’s said it had placed 36 banks and cajas on review for possible downgrades of their bank financial strength ratings – including all the listed banks. Of the banks reviewed, 34 were likely to face downgrades for their deposit and senior debt ratings and 22 for their subordinated or hybrid securities. The agency also warned it might downgrade the triple A ratings of seven Spanish programmes of mortgage covered bonds, four public sector covered bond programmes and 57 series of multi-issuer covered bonds.
So far, most Spanish banks have remained relatively robust during the global financial crisis, in part because of "generic" loan loss provisions they were obliged to make in previous years by the Bank of Spain. However, the proportion of non-performing loans has risen sharply in recent months to reach 4.27 per cent of the Spanish banking system’s assets in March. Even that figure has been flattered by corporate debt restructurings organised by the banks to keep some of their large real estate and construction clients afloat. Moody’s expressed concern that the bad loan problem was now spreading from property to other sectors of the economy. The agency expected most of the senior debt downgrades to be limited to one or possibly two notches, and none was likely to fall below Baa3, the agency’s lowest investment grade.
Slovenia Is 'Severely' Affected by Global Crisis, IMF Says
The International Monetary Fund, which has aided eastern European countries including Hungary and Serbia avoid economic collapse in the past six months, said Slovenia is "severely affected" by the global economic crisis. "After a long period of strong economic performance that allowed a rapid catch-up to EU levels, Slovenia is now severely affected," IMF executive directors wrote in the Article IV statement today. Slovenia will have to "press ahead with broad?ranging reforms" to raise the economy’s growth potential, bolster competitiveness, and ensure fiscal sustainability, the IMF said.
Slovenia’s export-driven economy, which expanded a record 6.8 percent in 2007, is struggling with its worst economic decline in more than 15 years as demands in recession-hit Europe slumps. First-quarter results due next month will be "bad," Finance Minister Franc Krizanic said on April 18. The government’s forecasting institute sees a contraction of as much as 6 percent if the recession in the 27-member European Union, which the Adriatic nation joined in 2004, persists. The IMF sees the economy shrinking 2.7 percent this year. The international credit crunch "has considerably increased the banks’ vulnerability on the liability side, given their high reliance on foreign financing," the IMF also said.
Freebasing in Caymans Would Be a Banker's Dream
The race to the bottom is on for the two boards that set most of the world’s accounting standards. This can mean just one thing. It’s time they got competition. Let us begin with a critical question. In this era of infinite possibilities, what might a truly industry-friendly setter of accounting principles look like? Allow me to present for your consideration the Financial Reporting Irregularities Board. That’s FRIB, or "Free-Bee," for short. Its motto would be simple: You report, you decide. Ever since last fall, the big news from the accounting mandarins in the U.S. and Europe has been one relaxation of their precious rules after another. One day, the International Accounting Standards Board in London is rushing to please bankers and politicians by softening its pronouncements on "mark-to-market" accounting, only to watch the U.S. Financial Accounting Standards Board loosen its own rules later.
Nothing they’ve done has been enough to satisfy the banking and insurance industries. They just keep playing the two boards against each other, begging for more breaks. After the FASB’s latest cave-in, for example, U.S. Representative Spencer Bachus, ranking Republican on the House Financial Services Committee, last month called for new congressional hearings, saying that "questions remain as to the ultimate effectiveness of the fair-value accounting revisions." Meanwhile, some European finance ministers complained the IASB hasn’t done enough to match the FASB’s changes. The U.S. Chamber of Commerce’s "Fair Value Coalition," composed mostly of banks and insurers, says managers still lack the discretion they need to "recognize true economic losses and allow for a realistic valuation of assets." In other words, they want to value their companies’ securities at the prices they wish they could get, rather than what others would pay.
So now it has come to this. The world must find a way to make sure neither of these boards can win this sordid contest. That leaves only one option: Let the banks start their own accounting board to win it instead. From its sunny headquarters at a mail-drop in the Cayman Islands, the Free-Bee would gather the best and brightest minds from the planet’s greatest financial catastrophes to create a new set of free-market standards. Lehman Brothers, Royal Bank of Scotland, American International Group, Fannie Mae, the nation of Iceland -- their former brain trusts all would reside here. Adherents, known as freebasers, would prepare their financial statements in accordance with Free-Bee rules, all of which would fit neatly in a 10-page brochure, double-spaced. Most importantly, not one of this new board’s members would be an accountant. The Free-Bee would be a for-profit venture, designed to maximize revenue. And there’s no surer way to screw up a perfectly good set of toothless accounting standards than to let some bean counter take a crack at writing them. How would this operation work? I’m glad you asked.
Let’s say your company would show earnings of two to three bucks a share under FASB or IASB rules, and $5 under Free-Bee rules. The Free-Bee would get a cut of the difference, negotiated quarterly on a client-by-client basis. Naturally, your company would be free to spend these extra "profits" however it sees fit -- perhaps, for instance, on larger executive bonuses. Before you dismiss this plan as a mere pipe dream, take a look at this quote by Charlie McCreevy, the European Union financial-services commissioner, from a speech he gave May 7 in Brussels. "Accounting is now far too important to be left solely to -- accountants!" he said. "Independence of standard- setters is important, but they must be fully accountable." To this, the Free-Bee’s trustees would cry out: Hear, hear! They would promise to be fully accountable to you, the humble chief executive, and you alone. Sure, you could try getting the FASB and IASB to keep outdoing each other, using the same tried-and-true pressure tactics. By this point, though, all those campaign checks to lawmakers would be a waste of good money you otherwise could be spending on yourself.
Imagine the possibilities. Just this week, the FASB said it will make banks bring zillions of dollars of assets back onto their balance sheets next year by eliminating an off-the-books trick known as qualified special purposes entities. While the Free-Bee’s staff might not understand what a QSPE thingy is, they would know this: If the FASB wants to ban them, then the Free-Bee adores them and would demand you get them back. Do you treasure the discretion to value worthless commercial real-estate loans any way you like? It’s yours. Remember, the better your values, the greater the Free-Bee’s profits. Have you had enough with all the red ink on junk-rated mortgage securities? The Free-Bee’s board members would be strong believers in the principle that all losses are temporary and all non-cash gains are golden, especially when the asset prices you’re using exist only in your imagination.
Or perhaps you run a publicly traded strip-club chain and want to make sure certain back-room activities don’t get reported as violations of the Foreign Corrupt Practices Act. Not only could this new board help you keep hookers off your balance sheet. The Free-Bee would deliver them back to your doorstep, showered and re-perfumed, with just 30 minutes notice. Let the mainstream accounting poobahs have their race to the bottom. The Free-Bee’s mission would be to win it hands down. And while this new board may face hurdles, such as formal recognition by the U.S. Securities and Exchange Commission or the European Commission, history has taught us there’s nothing we can’t overcome as long as we have the right connections. Any takers? I thought so.
Bear Stearns to Algebra I Means Lost Dollars in Trickle-Down
After former Bear Stearns Cos. trader Guy Irace lost his job on the bond desk a year ago, he moved back to Long Island to teach high school math and dropped 40 pounds. Jack Yang’s deli in Manhattan cut three employees. Cavonberry’s, Yang’s 46th Street shop near the headquarters of the New York firm taken over by JPMorgan Chase & Co., once bustled with finance workers jostling to buy a barbeque chicken chopped salad and bottled water for $12. "They used to be turning them away at the door," Irace said. Last week, slow enough that one cashier instead of the usual two operated the register at midday, Yang tallied up the ripple effect of the financial slump that cost Bear Stearns its independence: He negotiated a $4,000 monthly decrease in rent with Sierra Realty Corp., to $17,000, and is spending 35 percent less a week with Fischer Foods of New York Inc. for such things as artichokes and ham. "Since January, everything’s dead," said Yang, 52.
The biggest Wall Street crisis since the Great Depression isn’t just a setback for New York or bankers. The finance industry’s contraction may wipe out $185 billion in wages and profits, or $600 for every man, woman and child in the U.S., according to Thomas Philippon, a finance professor at New York University’s Stern School of Business. The trail of reduced income affects car mechanics, waiters, sports teams, hair stylists, jewelers, housecleaners and watch repair shops. "We’re seeing lots of lives derailed," said Simon Johnson, professor of entrepreneurship at the Massachusetts Institute of Technology. Irace, who worked at Bear Stearns for 19 years and is now a teacher in Uniondale, New York, is one of 255,441 people who’ve lost U.S. finance jobs since January 2008, according to data compiled by Bloomberg. Thousands more have seen cutbacks in pay.
In New York City alone, bonuses fell to $18.4 billion last year from $32.9 billion in 2007, the largest absolute drop ever, according to the state comptroller’s office. The consumer discretionary and industrial sectors -- dependent on people who buy refrigerators, restaurant meals or cars -- are the only areas that have shrunk more than finance, with 383,340 and 270,278 job losses, according to the data. For each finance post eliminated, 3.3 in other industries will vanish, the comptroller’s office estimated. "The higher your income, the more in services you consume," said Ariell Reshef, an economics professor at the University of Virginia in Charlottesville. "You don’t iron your own shirt." On the convertible bond desk at Bear Stearns, traders made from $175,000 to $1 million annually, depending on bonuses, Irace said. He dined with co-workers at Del Frisco’s Double Eagle Steak House, home of the $55.95 porterhouse. Now he earns $75 to $175 a day at Kellenberg Memorial High School and often brings a packed lunch from home. "You buy a pound of ham and you’ve got sandwiches for the whole week," said Irace, 44.
Other banking refugees are navigating new lifestyles. Peter Stavropoulos, a one-time hedge fund strategist, said he handles drunk-driving cases as a lawyer in upstate New York. Amy DePaulo, a facilities manager at a New York bond firm for 14 years, may retrain as a paralegal after losing a job paying $100,000 annually. Michael Gabriel, a former money market fund manager for Victory Capital Management in Cleveland, said he’s applied for 100 jobs since his position was eliminated in 2007. All are cutting back, with consequences for those who depended on banks’ outsized pay. The average securities industry salary reached a record high of almost $400,000 in 2007, or 6.8 times the average for nonfinancial jobs in the city, according to the comptroller’s office.
Gabriel started cutting his own lawn, costing his gardener $450 a year, he said. DePaulo used to splurge on gifts for her nephew, spending $1,000 at Christmas. This past year the 22- year-old got lots of underwear, she said.
Stavropoulos, whose father, George, was a clothing designer who made dresses for opera singer Maria Callas, got a dual degree in law and business and worked for almost a decade as a credit analyst at firms including Standard & Poor’s. He joined the Stamford, Connecticut, hedge fund Sailfish Capital Partners LLC in 2006. He left in 2008, as the firm wound down funds. Now his office looks out over a supermarket’s rooftop in Millerton, a town of 925 people about 100 miles (160 kilometers) north of Manhattan.
Earning less, the attorney stopped buying a daily venti black iced tea, unsweetened, from Starbucks Corp., which said Jan. 28 it will cut 6,700 jobs this year. He goes less often to Procter & Gamble Co.’s Frederic Fekkai salon in Greenwich, Connecticut, where haircuts start at $125. His wife’s cousin in Queens trims it. "I used to take $300 for the week -- that was walking- around money," he said. "Now I take $100 for the week. Forget about ordering sushi for lunch." Stavropoulos remembers accompanying 16 people in mid-2007 to Morimoto, the West Village sushi restaurant of Masaharu Morimoto, from the "Iron Chef" television program. The group spent more than $3,200, he said, then headed to the Buddha Bar, where patrons rubbed shoulders in a high-ceilinged space resembling an Asian temple. Many nights, financial types crowded tables where "bottle service" starts at $250 for a Veuve Clicquot Brut Rose 2000 champagne, said Jessica Rosa, a waitress at the time.
It wasn’t uncommon to see someone with a black American Express Co. card ringing up a $30,000 tab, said Tim Gaglio, who helped start the restaurant and bar in 2006. The black "Centurion" card, billed as "the world’s rarest," is available by invitation only, according to the company’s Web site. At the peak, Rosa, 30, said she made $85,000 a year working three days a week. "You wouldn’t see an empty chair here," she said, surveying the half-filled lounge last week. As tips fell, Rosa stopped taking frequent trips to Miami, where she ate at the Prime 112 steakhouse on Ocean Drive, and to Puerto Rico, where she stayed at the Palmas del Mar resort. Buddha Bar’s Gaglio said he’s planning for sales of $12 million this year after they reached $20 million in 2007, when the restaurant was one of the country’s highest-grossing. He’s added cheaper wines, like a J. Lohr Chardonnay for $11 by the glass, and is squeezing fish vendor F. Rozzo & Sons and beef seller John Jobbagy for pennies per pound. He asked employees to work harder, and said he terminated three last week.
"For such a long time, it was such enormous volume that people got very complacent and spoiled," he said. The pullback may prove worthwhile in the long run, by directing the economy to more productive areas, said the University of Virginia’s Reshef. Wall Street compensation may have been as much as 50 percent too high from 1995 to 2006, according to his December 2008 survey with NYU’s Philippon of the U.S. finance industry over the past century. The other period of excess pay was around 1930, the year after the stock market crashed. "What happened here is a misallocation of capital on a gigantic scale," Reshef said. Eventually, people will replace lost income as they retrain, gain new skills, move and find jobs -- which may take as long as 10 years, said Johnson, the Cambridge, Massachusetts- based economist.
"An economy like the United States has the ability to create new jobs and it has a bounce-back ability that we shouldn’t discount," he said. Irace, who enjoyed coaching Little League baseball as a teenager on Long Island, said he considered a career as a coach or an athletic director when he graduated in finance from Fairfield University, in Fairfield, Connecticut. Instead he found a job at Salomon Brothers with the help of a roommate’s father, a managing director. Two years later, he moved to Bear. After Irace got his termination papers in June from JPMorgan Chase, he called "Brother K." Brother Kenneth Hoagland, the principal at Kellenberg, a private Catholic institution, taught Irace at Chaminade High School in Mineola, New York. Hoagland called Irace in for an interview in August, when he needed a replacement for a math instructor on leave. A month later, the former trader was teaching quadratic equations and factoring to freshmen in five 40-minute periods of algebra a day. He enrolled in refresher math classes at Nassau Community College, sometimes learning subjects a day or two ahead of the kids.
This semester, he’s teaching sixth-graders measurements and percentages. Seated at wooden desks, 21 to 39 in each class, they get excited when he flashes the animated math adventures of a robot named Moby onto a classroom projector. After school, Irace, now 198 pounds (90 kilograms), puts a whistle on a yellow cord around his neck and runs girls through conditioning drills as an assistant coach for the lacrosse team. The extra coaching stipend runs $1,000 to $2,000 for the season. Irace used to spend about as much in Manhattan every month, when he had an apartment in Gramercy Park and co-workers joked that he attended more New York Knicks games than Jeff Van Gundy, the National Basketball Association team’s former coach. This week, he stayed home and graded papers.
Single -- with his three-bedroom, Colonial-style house in Oyster Bay, Long Island, paid off -- Irace got what he called a "very generous" severance from JPMorgan that runs out in September. His teaching job ends June 16, and with no guarantee of a job in the fall, he plans to look into unemployment benefits. Irace tells Wall Street friends he won’t be back. "Things don’t always work out this way," he said, recalling what one teacher told him when he got the Kellenberg job: "This is probably your true calling."
The New Politics of Inflation: Asian and Monetary
When future chroniclers describe the late 20th century and early 21st century global inflation now about to renew, the rise of Asia will be an even bigger causation than the massive money expansion set in motion over a quarter of a century by the U.S. Federal Reserve. And this will be true even though Chairman Ben Bernanke has been pouring trillions of dollars into the bail-out of a reckless and metastasized U.S. financial system. In a nutshell, the rise of Asia - approaching 60% of the earth's population and on the cusp of a plurality of world wealth- is realigning global economics and political power. The history of such great realignments is inflationary. If it were not, prices would not have risen twenty or thirtyfold since the European Renaissance and the original Price Revolution five hundred years ago. As of 2009, from Turkey and the Persian Gulf east to Indonesia, China and Siberia, it's Asia's turn to make the waves, rock the global financial boat and set a new international course . Think of this upheaval as the Second Price Revolution. The United States will be a major participant, but more importantly a principal loser.
When I published my first book, The Emerging Republican Majority way back in 1969, I discovered that Washington politicians and pundits had trouble grappling with unanticipated watersheds in the political status quo. Now the same seems true again for the seeming incapacity of the New York and London financial power structure to deal with the economic upheaval now occurring. So here's a relevant bit of economic history - and an admission. The Second Price Revolution notion has been one of my theses since the inclusion of a chapter about it in my 1982 book on the radicalization of Reagan era economics (entitled Post-Conservative America) During the original price revolution 500 years ago, when Europe gained global supremacy with the Renaissance, the rise of capitalism, and a new maritime supremacy in Arabian, Indian and East Asian coastal waters, coupled with the influx of huge quantities of precious metals from the Spanish-controlled new world, the increase in European price levels over roughly a century reached some 400-600 percent.
Pleasure and pain were unequally distributed. Those with capital and skills enjoyed unprecedented opportunity. Peasants who did not understand what was happening usually lost purchasing power. The last three or four decades have been somewhat similar. So powerful was the Renaissance-era version that the the New Cambridge Modern History went so far as to split the title of its 16th century volume, calling it The Counter-Reformation and the Price Revolution, 1559-1610. For many years, common wisdom attributed the first price revolution to the arrival in Spain and subsequent distribution across Europe of the gold and silver carried by treasure galleons from the Americas. But as the editor of the New Cambridge Modern History explained some years back, "we no longer regard the 'price revolution' as solely the sudden product of an influx of silver from America after the opening of the Potosi mine in 1543 any more than we think of the Renaissance as caused by the sudden influx of Greek scholars after the fall of Constantinople in 1453.
Nevertheless, the flood tide of American silver, pouring in on top of other deeper and longer-term movements of population, of trade and of finance, did quicken and steepen the price rise and make this a more difficult time for governments and for all whose incomes were comparatively inflexible." So much for the long-ago. Let us turn to the contours of recent, present and future inflation in what contemporary Americans may shorthand as the Alan Greenspan-Ben Bernanke era from 1987 to 2010. If Greenspan is now caricatured as Easy Al, Bernanke may be nick-named Printing-press Ben. Okay, skeptics will say, but what does that have to do with Asia?
Actually, all too much. Let us begin with the major inflationary pressures of 1966-1981 - a drawn-out, expensive U.S. war in Southeast Asia and then a two-stage oil price increase put through by OPEC, an Asia-dominated cartel. During the late 1980s, U.S. economic policies were sufficiently coordinated with Tokyo that Chicago economist David Hale joked that the Washington-responsive Bank of Japan ought to register as a Republican political action committee. The Asian currency crisis, in turn, was a major financial event of 1997, the Russian mess drew headlines in 1998, and the three U.S. wars between 1991 and 2003 involved Kuwait and Iraq, Afghanistan, and Iraq again. Southwest-Asian religious extremists orchestrated the 9/11 attack on New York's World Trade Center and the Pentagon. These Asian-linked circumstances helped pressure Washington towards permissive fiscal and monetary policy.
This decade's ongoing overseas military imbroglios and corollary budget vulnerabilities involve Iraq, Afghanistan and Pakistan. Oil price pressures center in Asia, as do this decade's wealth realignments and huge overseas holdings of U.S. dollars -- $2 trillion in China alone - that menace the embattled greenback like a sword of Damocles. Both Easy Al and Printing-press Ben, as well as administrations of both parties, have depended on Asian willingness to tolerate and underwrite Washington-New York public and private debt expansion and bubble-blowing. Something else New York and Washington have enjoyed is finagled U.S. inflation data, which during this decade understated price-hike reality by about one half. Bill Gross of PIMCO, the world's biggest bond manager and a critic of Pollyanna statistics, pointed out in 2008 that over the decade, global inflation had averaged nearly 7 percent even while Washington proclaimed an official U.S. average of 2.6 percent. "Does it make any sense," said Gross, "that we have a 3 percent to 4 percent lower inflation rate than the rest of the world?"
Yes and no. No, it doesn't have much statistical logic, but yes it does make tactical sense if you are a Fed chairman running a low-inflation pretense for Wall Street leverage gamesters, G-7 central bankers and Washington budget pseudo-balancers. None of these power centers can afford the various inhibitions attendant on recognizing a Second Price Revolution. Moreover, despite the Greenspan-Bernanke pretensions that the decade's inflation was in the 2.6 percent range, in mid-2008 the International Monetary Fund let the cat out of the bag by candidly acknowledging the "broadest and most buoyant commodity price boom since the early 1970s."
The IMF's published data on country-by-country average consumer prices for the 1980-2008 period - charts are available on their website - underscores the Asian depth and sweep. In a nutshell, the data presents the 2000 price level in each nation as 100 and shows the earlier and later inflation rates as percentages of that amount. Here are the progressions for Asia seven biggest economies: China - 25 (1980), 100 (2000) and 158 (2008); India - 18 (1980), 100 (2000) and 144 (2008); Indonesia - 13 (1980), 100 (200) and 201 (2008); Japan - 75 (1980), 100 (2000) and 100 (2008); Korea - 33 (1980), 100 (2000) and 128 (2008); Pakistan - 21 (1980), 100 (2000) and 159 (2008); and Russia - 21 (1995), 100 (2000) and 266 (2008). Note that the 2008 figures were based on IMF estimates. The average 400-600 percent rise is roughly comparable to the changes in Europe during that continent's Price Revolution.
A similar parallel exists in the convergence of 1980-2008 economic, demographic and geopolitical trends changing the relationships between continents and escalating Asia's new global centrality. With latterday petroleum movements playing some of the role of 16th and 17th century gold and silver flows, the U.S. National Intelligence Council in late 2008 summed up the emerging re-alignment: "In terms of size, speed and directional flow, the transfer of global wealth and economic power now underway - roughly from West to East - is without precedent in modern history." And NIC analysts also assumed that Asia, especially China and India, would account for the vast majority of new demand for food ad energy and the related price pressures.
This, in turn, ties in with Spring's' renewal of predictions of predictions that China and India are on track for substantial economic growth even while the U.S., Europe and Old Asia (especially Japan and Singapore) go through their worst economic downturn in 50-70 years. Jim O'Neill, the Goldman Sachs chief economist who pioneered two related concepts - a realignment in favor of the "BRIC" nations (Brazil, Russia, India and China) and a "decoupling" between economic behavior in the U.S. and Asia - renewed his thesis in an April 23 commentary in the Financial Times. China could overtake the U.S. by 2027.
In the meantime, the United States, with an economy already in hock to Asian creditors and desperately requiring further funding and tolerance from China, Japan and the Persian Gulf, is suffering through the pre-inflationary agony of having to spend (and print) trillions of non-existing dollars to bail out the quasi-collapse of leading U.S. financial firms. These culprits, of course, are centerpieces of an overgrown, metastasized U.S. financial structure that crippled itself in an orgy of borrowing, speculation and issuance of unsound. By 2030, history books will remember these mistakes, for decades aided and abetted by the Federal Reserve, as a milestone in Asia's 21st century emergence. The new debt and liquidity-related inflation being unleashed in the United States, in turn, comes on top of the early 2000s global commodity inflation identified by the IMF but cockily ignored by the Bush administration up through 2008. Both the White House and the Fed, waving very suspect government statistics, dismissed inflation as no problem. Then, as the financial system started to sink in 2007-2008, Washington reached back into Chairman Bernanke's academic bag of 1930s analogies for deflationary scare-talk remedies.
Unfortunately, that 1930s analogy had more holes than a torn sieve, not least the fact that the 1929-33 U.S. financial and economic implosion took place in a deflationary global context of collapsing commodity prices. Let me paraphrase one economic historian: between 1925 and 1929, the average price of the combined leading agricultural commodities fell about 30 percent and kept on tumbling during the Crash. In the U.S., the wholesale price index dropped from 93 in 1925 to 78 in 1930 and 59 in 1933, and so too around the world. In 2007-2009, by contrast, the underlying commodity pattern was strongly inflationary until the recession took hold in 2008, and as of May we can already see signs of commodity price inflation re-emerging. This was also the pattern in the stagflation of the 1970s - commodity prices would slump in the recession periods but go higher during recoveries.
The fallacy guiding Washington policymakers circa 2009 can be summed up. The global, but Asia-linked Second Price Revolution is the truth that U.S. officialdom seemingly cannot face. The current inflationary politics of trillion-dollar budget deficits and Federal Reserve printing presses are pouring gasoline on still smoldering red embers only barely covered by 8-12 months of gray deflationary ashes. Both Americans and foreigners concerned about the incendiary potential of inflation and the devaluation of the dollar have good historical reason for concern.
Ilargi: China finishes -part of- its strategic reserves, fills them up, and everybody and their pet hamsters are tied up in a wet panties tizzy. I can't fathom why. Those reserves are the only place left on the globe by now where oil can still be stored. Extra storage space is non-existent, and actual demand keeps plunging. World electricity use is even down, a first in 65 years or more. And what I’ve said before still is true: because of shrinking revenues, most producers are putting oil on the market at fever rates, which makes OPEC cuts a laughing matter, and, for that matter, OPEC itself as well. Oil has only one direction to go, barring large scale Middle East warfare.
Power use faces first postwar fall
Global electricity consumption will fall this year for the first time since 1945, according to a dramatic portrait of the effects of the slowdown in developed and emerging economies from the International Energy Agency. The watchdog for developed energy consuming countries will tell energy ministers from the group of eight leading economies on Sunday that electricity demand will fall by 3.5 per cent in 2009. In China, where power use is seen as a more reliable barometer of economic activity than official economic measures, consumption will be more than 2 per cent lower than 2008. Russia will see a fall of almost 10 per cent, while countries in the Organisation for Economic Co-operation and Development will see a fall of almost 5 per cent.
Three-quarters of the global decline in consumption is accounted for by industrial rather than household demand, reflecting the fall in demand from China's manufacturing-heavy economy. Consumption in India, by contrast, is expected to increase by 1 per cent. "This shows how deep a recession we are in," said Fatih Birol, IEA chief economist. "Oil demand has declined in the past due to oil price shocks, financial crises - but electricity consumption has never decreased." In a report published last year, before the extent of the financial crisis was clear, it had forecast electricity consumption would rise 32.5 per cent between 2006 and 2015. World electricity demand grew by almost a quarter between 2000 and 2006. In 2007 it rose 4.7 per cent and in 2008, the year the crisis set in, it grew 2.5 per cent. "It's a good barometer of economic activity," said David Rosenberg, chief economist at Gluskin Sheff. "It's very cyclical."
Global oil demand, which is more sensitive to consumer sentiment than electricity, has fallen several times since the second world war. The IEA this month forecast oil consumption would be 3 per cent lower in 2009 than 2008, the ninth consecutive lowering of its forecast for this year. The agency will also tell ministers that its calculation of the stimulus spending required from G20 nations on renewable energy was inadequate, and should rise by a factor of six if greenhouse gas emissions targets set by the United Nations were to be met. The IEA will also warn that the fall in investment in oil production could lead to a supply squeeze in 2012. The agency said about 2m barrels per day in capacity were cancelled, and another 4.2m bpd were delayed by at least 18 months.