Row houses, Baltimore
Ilargi: Yaayyyyy!!! What a great day! Sterling is up, the Euro is up, the loonie is doing great, and on the strength of commodity prices, no less.., gold is up, so is oil, we're all saved and soaring, no more gloom and doom, it's all boom and zoom now. Well, that is, if you’re willing to ignore the fact that the US dollar is tanking. 'Cause that spoils all the fun: nothing really goes up, there's just one element that goes down. Oil is a bit of an exception, that's true. I’m thinking the folks who invest in oil today must know something I don't, like upcoming warfare, the sort of knowledge that makes people wonder why Chinese fishing boats are getting the heebee out of Korean waters. Because other than a Middle East armed conflict, I can't seem to see what would drive up oil prices any further. Well, other than more smartasses betting on shootouts. Demand is scraping the gutter, production is so far out of hand that OPEC isn't even trying to slap on quotas, every Saudi container larger than a bathtub has been filled with the stuff, and there's people expecting a price surge? Bonds are shaky but holding up, of course they are, this is just the first batch at risk, wait till all the rest comes on the market, and then get some stocks in companies that produce valium and ADHD medication.
More mañana, got a long drive ahead and got to go.
Troubled Bank Loans Hit a Record High
Overall loan quality at American banks is the worst in at least a quarter century, and the quality of loans is deteriorating at the fastest pace ever, according to statistics released this week by the Federal Deposit Insurance Corporation. The report highlighted that even as the government and major banks have scrambled to deal with the impaired securities the banks own, the institutions have been plagued by an unprecedented volume of old-fashioned loans going bad.
Of the entire book of loans and leases at all banks — totaling $7.7 trillion at the end of March — 7.75 percent were showing some sign of distress, the F.D.I.C. reported. That was up from 6.9 percent at the end of 2008 and from 4.1 percent a year earlier. It also exceeded the previous high of 7.26 percent set in 1990 and 1991, during the last crisis in American banking. The F.D.I.C. has been collecting the figures since 1984. Virtually the only encouraging news in the report was that the banks’ loan portfolio might be worsening more slowly than it was. While the increase of 3.65 percentage points in a year is the highest ever, the quarterly rise was smaller than in the fourth quarter of last year.
The figures, as shown in the accompanying charts, include loans that are more than 30 days behind in payments, a category that will include some loans that catch up and become current. But the percentage that are at least 90 days overdue, or on which the bank has stopped accruing interest or written off, is also higher than at any time since 1984. As recently as mid-2006, the proportion of troubled loans was at a historic low, and bank regulators were confident that the institutions were well capitalized and could survive any likely economic downturn. They were wrong, it turned out. The problems stretch across nearly every category of loan, and every size of bank, although the loan problems appear to be somewhat less severe at smaller banks.
Over all, 8.77 percent of real estate loans are troubled, but some types of such loans are in far worse shape than others. Construction and development loans are in the worst shape, with 17.68 percent of loans troubled, and loans secured by farmland are in the best shape, with only 2.98 percent of such loans reported as having problems. One area that could get much worse is loans on commercial buildings, including stores and offices. Just 4.01 percent of such loans are troubled, less than half the peak of the early 1990s. A large number of those loans will need to be refinanced in the next few years, however, which could be impossible where real estate values have fallen sharply.
Loans to businesses — called commercial and industrial loans — also appear to be doing better than they did in the early 1990s. That could reflect the fact that many such loans are no longer on bank balance sheets, having been sold into the securitization market. Some analysts also fear a wave of defaults on these loans. The rising stress for some consumers is shown by the fact that banks are taking charge-offs for bad debt at an annual rate of 7.79 percent, and that about one in seven of such loans is classified as troubled. The F.D.I.C. reports that two-thirds of the banks that paid dividends in 2008 either reduced or eliminated their dividends in the first quarter of this year, a sign of the stress being felt even by banks that have raised new capital. Until the tide of bad loans begins to ebb, banks may be hesitant to take on much additional risk by making new loans to risky borrowers.
A failing state
When Arnold Schwarzenegger appeared on The Tonight Show on Tuesday, he joked with Jay Leno about advice he had given in a recent address to students at the University of Southern California. "I told them to work like hell and marry a Kennedy," he said, to laughter and applause. The studio audience loved Mr Schwarzenegger, who is married to Maria Shriver, John F.Kennedy’s niece. Making his 25th appearance on the show, he was in his element sparring with Mr Leno, who poked fun at the California governor’s Austrian accent. But he has had little to laugh about away from the television studio. In the past two weeks the former movie star has had to deal with the biggest crisis of his short political career after voters in a "special election" spurned revenue raising measures he hoped would avert financial disaster.
Hailed as the state’s saviour when he replaced Gray Davis, who was ousted in 2003, Mr Schwarzenegger’s poll ratings have reached their lowest ever. Amid a 29 per cent fall in tax revenues since last September, the state faces a budget deficit this year of $24bn (£15bn, €17bn) and the Republican governor is threatening to take a Conan the Barbarian-style sword to spending on health, education and other vital public services. "The people have spoken," he says in a Financial Times interview. "We have to live within our means." With its beaches and laid-back lifestyle, California epitomises the delights and rewards of the American dream. Yet that dream appears to have soured. The state would be the eighth largest economy in the world if it were a separate country, but for the more than 36m people who live there, fiscal meltdown is threatening its very fabric.
No area of public expenditure is being spared in the effort to cut the deficit. At least 200,000 public workers are being asked to take a 5 per cent pay cut and thousands of firefighters, nurses and teachers are expected to lose their jobs. CalWorks, the programme that provides help to the poor and out of work, is to be dismantled. Grants to poor and low-income students are likely to be axed and thousands of jobs will go in the prison system. The early release of some prisoners has been mooted to save money. Most worryingly, large cuts in Medi-Cal, the state-funded health programme, are being proposed, which would leave an estimated 2m people without adequate health insurance. Money to treat people with Aids and other serious diseases is also at risk.
"Quite frankly, people are going to die," says Bonnie Castillo of the California Nurses Association. "The vulnerable, the sick, children, the elderly, are all going to have the rug pulled out from under them." This picture of the poor and dying being denied help is far from the usual one of the Golden State, where a waitress can become a film star and a technology entrepreneur can create a company worth billions of dollars from a garage or basement. One cause of the problem is the state’s dysfunctional political system. California is one of only three in the US that requires a two-thirds majority in its legislature to approve a budget. With the state’s upper and lower houses evenly split between Republicans and Democrats, securing a two-thirds majority on all but mundane matters is practically impossible. A two-thirds majority is also required to raise taxes, which limits the ability of the governor to balance the books.
California’s system of direct democracy, while laudable in aim, is another headache. "Ballot initiatives" were introduced in 1911 by Hiram Johnson, then governor, who wanted to curtail the influence of the mighty Southern Pacific Railroad and return power to the people. Since then, any issue can be put to a state-wide vote, provided half a million or so signatures are gathered to support a change in the law. Ballot initiatives were intended to give a voice to voters. "It was supposed to be about mom and pop talking about something around the dinner table and then getting all their friends to sign a petition," says Dan Mitchell, professor emeritus at the UCLA Anderson School of Management and the School of Public Affairs. "But most initiatives on the ballot don’t start that way." Instead wealthy individuals and special interest groups "pay a couple of million dollars to employ people to collect signatures outside of supermarkets".
Ballot initiatives have resulted in controversial laws being passed, such as the amendment to California’s constitution that outlawed gay marriage in California last November. The state’s constitution is bursting with such amendments, which can often impose huge constraints on financial planning, such as the 1998 proposition that committed the state to spending 40 per cent of its annual budget on education. Mr Schwarzenegger admits the two-thirds majority rules and the ballot proposition process have been a hindrance. "It’s governing with your hands tied behind your back," he says. The final link in California’s fiscal chain is its tax system. "It’s flawed," he adds. "It has failed us over and over again when we have a downturn.
We in California rely very heavily on rich people paying taxes – income taxes and capital gains." This imbalance is partly because of legislation passed in 1978 – via a ballot initiative, naturally – that set strict limits on property taxes. Though California is home to some of the richest people in America, the economic slump has decimated its tax base. To offset against the impact of future downturns, Mr Schwarzenegger tried in the recent vote to increase the size of the state’s rainy-day fund. "You go through these economic cycles," he says. "There is a downturn and then [during periods of growth] you have a surge in revenues. But we don’t prepare for the downturn." Voters rejected that idea, however, and Mr Schwarzenegger is now looking at options to raise money to reduce the deficit. Near the top of the list is the sale of publicly owned buildings, such as the San Quentin prison and the Los Angeles Coliseum, which hosted the 1984 Olympics.
Cuts to health and social programmes, though, have sparked the biggest public response, which leads Prof Mitchell to conclude that the governor may have an ulterior goal. "California is trying to do what North Korea is trying to do," he says. "And that is to get Barack Obama’s attention. California doesn’t have a missile to shoot off like North Korea but if we have to put sick and dying children on the street?...ultimately, the Obama administration is not going to be able to run away from that." The state has already received federal stimulus money. It is seeking more help, although it has not made a direct request for cash. "We don’t want any more money [from the government] to bail us out," says Mr Schwarzenegger. "You can get one-time money from the federal government and the next year you have the same problems. We have to make cuts so that next year we don’t have [these problems]."
Instead, the state is asking the government to guarantee its bond sales – to become, as Bill Lockyer, state treasurer, puts it, "a municipal market backstop". It needs $15bn to meet short-term spending obligations, such as teachers’ and doctors’ salaries. But its fiscal troubles have left it with the country’s worst credit rating. With its deficit set to balloon past $24bn to more than $40bn within 12 months, the cost of issuing bonds will rise sharply. "If [the US Treasury] backs us, we will get a lower interest rate," says Mr Schwarzenegger. "That’s what we’re looking at." Treasury assistance would cut the cost of borrowing but also set a precedent the White House might prefer to avoid as other states and municipalities struggle with the recession.
Critics say Mr Schwarzenegger’s plan to impose swingeing cuts runs counter to the aims of Mr Obama’s stimulus package. "The cuts are an anti-stimulus package by every measure," says Art Pulaski, executive secretary of the California Labor Federation, which represents close to 2m workers in the state. "Every dollar that comes into California from Obama will be dismantled dollar for dollar by the Schwarzenegger cuts. The state should instead be looking at the billions of dollars in corporate tax giveaways that were in the budget." Mr Schwarzenegger, though, suggests California needs a reality check. "The state and its people have to make major sacrifices," he says. "There are no two ways about it."
With 18 months left before the end of his final term as governor, he is running out of time to turn California around. He continues to be popular outside the state, mainly thanks to his role as a leading advocate of action to curb greenhouse gas emissions. But at home his approval ratings are likely to fall even further as California absorbs the impact of his budget cuts. Mr Schwarzenegger says he is unconcerned. "You don’t go into this business to win a popularity contest. I have been sent to Sacramento to lead this state in good times and in bad. I’m just the person trying to lead and bring people together so we are all marching in the right direction." When campaigning for his first term, Mr Schwarzenegger said he would shake up the state – invoking the Terminator, the ruthless cyborg that is his best-known character. The worry now is that California may face its own version of Judgment Day.
Rising U.S. bond yields may spark Credit Crisis II
The global financial crisis may morph into a second, equally virulent phase where borrowing costs rise again, hobbling an embryonic economic recovery, debilitating cash-strapped banks, and punishing investors all over again. Early warnings signs of this scenario include surging government bond yields, a slumping U.S. dollar, and the fading of the bear market rally in U.S. stocks. Optimists hope that a fragile two-month rally in world stock markets, a rise in U.S. Treasury yields from record lows during the depths of the crisis in late 2008, and some less scary economic data all signal that a recovery is around the corner.
But gloomy analysts insist that thinking is delusional. Once Credit Crisis Version 2.0 ramps up, foreign investors may punish the U.S. government for borrowing trillions of dollars too much by refusing to buy its debt until bond prices plunge to much cheaper levels. The telling harbinger is benchmark Treasury note yields' surge to six-month highs around 3.75 percent this week, as investors began to balk at the record U.S. government borrowing requirement this year. The U.S. Treasury plans to sell about $2 trillion in new debt this year to fund a $1.8 trillion fiscal deficit.
Heavy selling of U.S. dollar-denominated assets could trigger a full-blown currency crisis and usher in surging inflation, forcing mortgage rates and corporate bond yields up, undermining any rebound in economic activity. "The financial crisis is a downward spiral with two twists," said George Feiger, chief executive of Contango Capital Advisors in Berkeley, California. First came the banking crisis and a huge contraction of credit, starting in mid-2007 which resulted in the stock market panic of 2008 which triggered the deepest U.S. recession in at least two decades. "Once you have got a recession you have good old-fashioned credit losses," Feiger said. "The second leg is now the consequences of the massive recession and it is just now working its way out," he said.
Investors, many of them foreigners who own a large chunk of the U.S. Treasury market, are steadily demanding higher yields. The price of the historic rescues of banks, insurers, manufacturers, and securities markets, to prevent a complete collapse during the worst financial crisis since the Great Depression, has meant a record U.S. government borrowing requirement. But by issuing so much debt, the United States risks repulsing a critical buyer: foreign central banks, who own more than a quarter of marketable U.S. Treasuries. China recently overtook Japan as the biggest such buyer.
"We are getting into that stage which I call 'the markets revenge'", said Martin Weiss, president of Weiss Research Inc. in Jupiter, Florida.
Weiss, known for his especially pessimistic views on the banking system and economy, recently published a book entitled: "The Ultimate Depression Survival Guide". "The market attacked anyone who had the toxic assets," he said. Now, foreign investors' primary target is the U.S. government because it has bought many of the tarnished securities from banks and some of the failing institutions itself, but the selloff will soon spread to all U.S. dollar-denominated assets, Weiss expects. Selling could push up the 10-year Treasury note's yield to about 6.0 percent Weiss warns. For now, he urges investors to stash much of their savings in short term Treasury bills, which carry minimal interest rate risk.
Foreign investors are running out of patience with the U.S. government's debt issuance, he argued. "What happened at the end of this month is the beginning of the end of that goodwill period," Weiss said. "There could be a major near-term selloff in the dollar." This month, the euro has gained nearly 7.0 percent against the U.S. dollar. Meanwhile, the benchmark ten-year U.S. Treasury note's yield has surged to six-month highs around 3.75 percent, nearly doubling from its lowest level in 50 years of 2.04 percent seen last December. Ultimately, corporate bond yields, although still at very wide yield spreads of more than four percentage points above Treasuries according to Merrill Lynch data, will also spike again, Weiss warned.
The S&P 500 stock index may fall to 500 points in this next phase of the crisis he added, down from 911 points early on Friday, he said. On the other hand, many economists reckon the U.S. government and Federal Reserve have averted a rerun of the Great Depression by swiftly orchestrating financial rescues and monetary and fiscal stimulus to offset sagging consumer spending. Yet even as the U.S. economy and banking system struggle to recover from two years of turmoil, Europe's banks are even more debilitated, raising the threat of a second global systemic crisis spreading back across the Atlantic to the United States, some analysts fear. "I think the most likely origins for a major crisis would be beyond our borders," said David Levy, chairman of the Jerome Levy Forecasting Center in Mount Kisco, New York.
Bond markets defy Fed as Treasury yields spike
The US Federal Reserve may soon be forced to launch a fresh blitz of quantitative easing whatever the consequences for the US dollar, or risk seeing economic recovery snuffed out by the latest surge in long-term borrowing costs. Yields on 10-year Treasury bonds have risen relentlessly since March when the Fed first announced its plan to buy $300bn (£188bn) of US government debt directly, a move that briefly forced rates down to nearly 2.5pc, a level thought to be the Fed's implicit target. Yields have jumped to 3.69pc – after spiking as high as 3.74pc on Wednesday – pushing up the standard 30-year mortgage loan to 5.08pc and lifting the borrowing cost for corporations. "The Fed is going to have to consider doubling its purchases of Treasuries," said Ashraf Laidi, from CMC Capital Markets.
"We could be nearing the end-game for the US dollar but the Fed has little choice at this point. We're in a vicious circle where any policy aimed at supporting the US economy must be at the expense of the dollar." The US Mortgage Bankers Association yesterday highlighted the fragility of the US housing market, reporting that 12pc of homeowners are either behind on their payments or facing foreclosure, the highest level since records began. Almost 6pc of "prime" borrowers are in arrears, showing how far the crisis has moved beyond the sub-prime. Most arrears are caused by job losses. The US unemployment rate has reached 8.1pc, and is even higher under older definitions, running at 15.8pc under Clinton-era metrics.
It is unclear why US bond yields have spiked so violently, with spill-over effects on gilts and bunds. One camp of investors is worried that inflation is rearing its ugly head again: others fear a sovereign debt crisis as over-extended states loses their AAA ratings. What is clear is that the market choked on $100bn of US Treasury debt issued in three auctions this week, and on the knowledge that Washington must raise a further $900bn by September. Governments around the world must fund $6 trillion of deficits this year, exhausting the capital markets. The US is at the front of the firing line. Beijing is clearly losing its patience with the Fed's policy of printing paper, seen as a form of stealth default. There is some risk that further moves to step up quantitative easing could cause China to boycott US Treasury auctions. China and Japan together hold 23pc of all US federal debt. Dallas Fed chief Richard Fisher said his recent trip to Asia was an eye opener. "Chinese government senior officials grilled me about whether or not we are going to monetise the actions of our legislature."
Bond Vigilantes Confront Obama Credibility as Bernanke Housing Aid Falters
They’re back. For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.
The 1.5-percentage-point rise in 10-year Treasury yields this year pushed interest rates on 30-year fixed mortgages to above 5 percent for the first time since before Bernanke announced on March 18 that the central bank would start printing money to buy financial assets. Treasuries have lost 5.1 percent in their worst annual start since Merrill Lynch & Co. began its Treasury Master Index in 1977. "The bond-market vigilantes are up in arms over the outlook for the federal deficit," said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York. "Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever."
What bond investors dread is accelerating inflation after the government and Fed agreed to lend, spend or commit $12.8 trillion to thaw frozen credit markets and snap the longest U.S. economic slump since the 1930s. The central bank also pledged to buy as much as $300 billion of Treasuries and $1.25 trillion of bonds backed by home loans. For the moment, at least, inflation isn’t a cause for concern. During the past 12 months, consumer prices fell 0.7 percent, the biggest decline since 1955. Excluding food and energy, prices climbed 1.9 percent from April 2008, according to the Labor Department.
Bill Gross, the co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co. and manager of the world’s largest bond fund, said all the cash flooding into the economy means inflation may accelerate to 3 percent to 4 percent in three years. The Fed’s preferred range is 1.7 percent to 2 percent. "There’s becoming an embedded inflationary premium in the bond market that wasn’t there six months ago," Gross said yesterday in an interview at a conference in Chicago.
Bonds usually rally when the economy is in recession and inflation is subdued. Gross domestic product dropped at a 5.7 percent annual pace in the first quarter, after contracting at a 6.3 percent rate in the last three months of 2008, according to the Commerce Department. This time it’s different because the Congressional Budget Office projects Obama’s spending plan will expand the deficit this year to about four times the previous record, and cause a $1.38 trillion shortfall in fiscal 2010. The U.S. will need to raise $3.25 trillion this year to finance its objectives, up from less than $1 trillion in 2008, according to Goldman Sachs Group Inc., one of 16 primary dealers of U.S. government securities that are obligated to bid at Treasury auctions.
"The deficit and funding the deficit has become front and center," said Jim Bianco, president of Bianco Research LLC in Chicago. "The Fed is going to have to walk a fine line here and has to continue with a policy of printing money to buy Treasuries while at the same time convince the market that this isn’t going to end in tears with fits of inflation." Ten-year note yields, which help determine rates on everything from mortgages to corporate bonds, rose as much as 1.71 percentage points from a record low of 2.035 percent on Dec. 18. That was two days after the Fed said it was "evaluating the potential benefits of purchasing longer-term Treasury securities" as a way to keep consumer borrowing costs from rising.
The yield on the 10-year note climbed 14 basis points, or 0.14 percentage point, to 3.60 percent this week, according to BGCantor Market Data. The price of the 3.125 percent security maturing in May 2019 tumbled 1 5/32, or $11.56 per $1,000 face amount, to 96 2/32. The yield touched 3.748 percent yesterday, the highest since November. The dollar has also begun to weaken against the majority of the world’s most actively traded currencies on concern about the value of U.S. assets. The dollar touched $1.4135 per euro today, the weakest level this year.
Ten-year yields climbed from 5.2 percent in October 1993, about a year after Clinton was elected, to just over 8 percent in November 1994. Clinton then adopted policies to reduce the deficit, resulting in sustained economic growth that generated surpluses from his last four budgets and helped push the 10-year yield down to about 4 percent by November 1998. Clinton political adviser James Carville said at the time that "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody." The surpluses of the Clinton administration turned into record deficits as George W. Bush ramped up spending, including financing of the wars in Iraq and Afghanistan.
The bond vigilantes are being led by international investors, who own about 51 percent of the $6.36 trillion in marketable Treasuries outstanding, up from 35 percent in 2000, according to data compiled by the Treasury.
New Group "The vigilante group is different this time around," said Mark MacQueen, a partner and money manager at Austin, Texas- based Sage Advisory Services Ltd., which oversees $7.5 billion. "It’s major foreign creditors. This whole idea that we need to spend our way out of our problems is being questioned." MacQueen, who started in the bond business in 1981 at Merrill Lynch, has been selling Treasuries and moving into corporate and inflation-protected debt for the last few months.
Chinese Premier Wen Jiabao said in March that China was "worried" about its $767.9 billion investment and was looking for government assurances that the value of its holdings would be protected. The nation bought $5.6 billion in bills and sold $964 million in U.S. notes and bonds in February, according to Treasury data released April 15. It was the first time since November that China purchased more securities due in a year or less than longer-maturity debt. Treasury Secretary Timothy Geithner, who will travel to Beijing next week, will encourage China to boost domestic demand and maintain flexible markets, a Treasury spokesman said yesterday. Obama spokesman Robert Gibbs said the president is confident that his budget and economic plans will cut the deficit and bring down the nation’s debt.
"The president feels very comfortable with the steps that the administration is taking to get our fiscal house in order and understands how important it is for our long-term growth," Gibbs said. Investors are also selling Treasuries as the economy shows signs of bottoming and credit and stock markets rebound, lessening the need for the relative safety of government debt. And while yields are rising, they are still below the average of 6.49 percent over the past 25 years. The world’s largest economy will begin to expand next quarter, according to 74 percent of economists in a National Association for Business Economics survey released this week. The Standard & Poor’s 500 has risen 34 percent since bottoming on March 9, while the London interbank offered rate, or Libor, that banks say they charge each other for three-month loans, fell to 0.66 percent today from 4.819 percent in October, according to the British Bankers’ Association.
Three-month Treasury bill rates have climbed to 0.13 percent after falling to minus 0.04 percent Dec. 4. That flight to safety helped U.S. debt rally 14 percent in 2008, the best year since gaining 18.5 percent in 1995, Merrill indexes show. "Yes there’s been a big move, and you can argue the big move is driven by the renewed appreciation of the risks associated with holding long-term Treasury bonds," said Brad Setser, a fellow for geoeconomics at the Council on Foreign Relations in New York. Fed officials see several possible explanations for the rise in yields beyond investor concern about inflation. Among them: The supply of Treasuries for sale exceeds the Fed’s $300 billion purchase program, the economic outlook is improving and investors are selling government debt used as a hedge against mortgage securities.
Central bankers want to avoid appearing to react solely to market swings. Bernanke hasn’t formally asked policy makers to consider whether to increase Treasury purchases and may not do so before the Federal Open Market Committee’s next scheduled meeting June 23-24. Officials are confident they can mop up liquidity without gaining additional tools from Congress, such as the ability for the Fed to issue its own debt. The Fed declined to comment for the story. Bernanke has an opportunity to discuss his views when he testifies June 3 before the House Budget Committee in Washington. "We have daily reminders from bond vigilantes like Bill Gross about the prospect of losing our AAA rating," Federal Reserve Bank of Dallas President Richard Fisher said in Washington yesterday. "This cannot be allowed to happen."
The government and Fed are trying to repair the damage from the collapse of the subprime mortgage market in 2007, which caused credit markets to freeze, led to the collapse of Lehman Brothers Holdings Inc. in September and was responsible for $1.47 trillion of writedowns and losses at the world’s largest financial institutions, according to data compiled by Bloomberg. The initial progress Bernanke made toward reducing the relative cost of credit is in jeopardy of being unwound by the work of the bond vigilantes. The average rate on a typical 30-year fixed mortgage rose to 5.08 percent this week from 4.85 percent in April, according to North Palm Beach, Florida-based Bankrate.com. Credit card rates average 10.5 percentage points more than 1-month Libor, up from 7.19 percentage points in October.
"Longer term the danger is that the rise in yields disrupts the recovery or the rise in inflation expectations dislodges the Fed’s current complacency on inflation," Credit Suisse Group AG interest-rate strategists Dominic Konstam, Carl Lantz and Michael Chang wrote in a May 22 report. Inflation expectations may best be reflected in the yield curve, or the difference between short- and long-term Treasury rates. The gap widened this week to 2.76 percentage points, surpassing the previous record of 2.74 percentage points set on Aug. 13, 2003. Investors typically demand higher yields on longer-maturity debt when inflation, which erodes the value of fixed-income payments, accelerates.
"The yield spreads opening up imply that inflation premiums are rising," said former Fed Chairman Alan Greenspan in a telephone interview from Washington on May 22. "If we try to do too much, too soon, we will end up with higher real long- term interest rates which will thwart the economic recovery." Other economists are more pointed. After falling from 16 percent in the early 1980s, 10-year yields have nowhere to go but up, according to Richard Hoey, the New York-based chief economist at Bank of New York Mellon Corp. "The secular bull market in Treasury bonds is over," Hoey said in a Bloomberg Television interview. "It ran a good 28 years. They’re never going lower. That’s it. It’s over."
Government bonds enter the danger zone
With risk appetites returning, investors are no longer herding to the safety of government paper - at just the moment when a torrent of new issuance is hitting the market to fund ballooning deficits. The appearance of "green shoots" in investors' minds has already helped drive up government bond yields. In the US, the 10-year yield has risen from a low of 2.1pc in December to 3.7pc. There was a particularly sharp rise on Wednesday. Meanwhile, governments across the world have seen their budget deficits explode as they seek to cushion their economies from the crisis. In the US and the UK, the fiscal deterioration is especially severe - with deficits this year around 12pc of GDP each and no credible medium term plans for balancing their budgets.
Some market participants want central banks to counter the rise in bond yields by stepping up their purchases of government paper. The notion is that more aggressive "quantitative easing" would help mop up the flood of Treasuries, gilts and the like. This is a bad idea that could well backfire. Investors might then conclude that the authorities were engaged in undisciplined money-printing that would debase their currencies and eventually spawn inflation. The outcome then would be a further hike in bond yields as investors slapped on an inflation premium. The least bad way forward is for governments to take the hit of higher funding costs on the chin and hope buyers don't go on strike. At present, such an Armageddon scenario is unlikely. But there are some worries.
First, there is the possibility of governments' credit ratings being downgraded. Last week Standard & Poor's warned that the UK might lose its AAA rating, although this week Moody's reaffirmed the US rating. Second, the Chinese government is getting itchy about holding so much of its wealth in Treasuries. For the time being, Beijing is still buying US paper but it has switched to shorter-dated instruments. That means the US will have to roll over its debts at a faster rate. Finally, there are banks. Across the world, they have been big buyers of government bonds during the crisis. In many ways, it was the simplest way rebuild tattered balance sheets. They have been able to buy bonds, which pay a coupon of say 3pc, and fund themselves at less than 1pc by borrowing short-term money from their central banks.
That seemed like a nice risk-free "carry" trade. The snag is that the recent capital losses from holding bonds could have wiped out the small benefit from this carry trade. If banks now turn from being buyers of government bonds into sellers, this would push yields up further as well as increase the funding strain on the authorities. The bond danger zone doesn't have to be a disaster for governments. If the green shoots turn into a real recovery, tax receipts will rise and budget deficits shrink. But until the money starts rolling in again, there is a risk things could go wrong. All the more reason for governments to reassure investors that they have credible medium-term plans to balance their budgets.
U.S. Economy Contracted at 5.7% Rate in First Quarter
The U.S. economy shrank at a 5.7 percent annual pace in the first quarter, capping its worst six- month performance in five decades and reflecting declines in housing, inventories and business investment. The contraction in gross domestic product was smaller than the government estimated last month, revised figures from the Commerce Department showed today in Washington. The drop was larger than economists had forecast, and followed a 6.3 percent tumble in the last three months of 2008. The slowdown is forecast to ease this quarter, reflecting smaller declines in stockpiles of unsold goods and in construction, which may set the stage for a return to growth later this year. Still, companies are likely to continue cutting jobs as profits remain under pressure, causing consumers to limit spending and slowing any expansion.
"The decline in GDP will be much smaller in the second quarter and will move to positive in the third quarter," said David Resler, chief economist at Nomura Securities International Inc. in New York, citing company inventories. "What we’ll see thereafter is not going to be particularly exciting." Stock-index futures, which had risen earlier in the day, remained higher after the report, while Treasuries were little changed. Contracts on the Standard & Poor’s 500 Stock Index were up 0.6 percent at 910.20 as of 8:45 a.m. in New York and yields on benchmark 10-year notes were at 3.6 percent.
The median forecast of 75 economists surveyed by Bloomberg News projected GDP, the sum of all goods and services produced, would shrink at a 5.5 percent pace. Estimates ranged from declines of 4.9 percent to 6.3 percent.
The improvement from the 6.1 percent pace of contraction estimated last month reflected a narrower trade deficit and a smaller reduction in stockpiles than previously estimated. Today’s preliminary GDP report is the second of three estimates on first-quarter growth. Consumer spending rose at a 1.5 percent annual rate last quarter, less than previously estimated, after plunging at a 4.3 percent annual rate in the last three months of 2008, when it fell the most since 1980.
Spending may falter again this quarter as job losses mount. Economists surveyed by Bloomberg forecast unemployment, currently at a 25-year high of 8.9 percent, may reach almost 10 percent by the end of the year. Firings in the auto industry, with Chrysler LLC already in bankruptcy and General Motors Corp. likely to follow next week, will probably depress the labor market in coming months. Commerce today revised down their estimate for wages and salaries in the fourth quarter as the job market deteriorated. Pay decreased by $21 billion in the last three months of 2008, $8.6 billion more than previously estimated. The update reflects more comprehensive figures from employer payrolls.
Companies trimmed stockpiles at a $91.4 billion annual rate last quarter, the biggest drop since records began in 1947. Still, the decline was smaller than the $$103.7 billion estimated last month. Excluding the reduction, the economy would have contracted at a 3.4 percent pace. Reduced stockpiles raise the odds the economy will once again grow in the second half of the year as government stimulus measures and Federal Reserve efforts to reduce borrowing costs and unclog lending start to pay off. "We still have more to go, but lean inventory positions can be a strong source of leverage for the economy once demand stabilizes and starts to grow again," Russell Price, a senior economist at Ameriprise Advisor Services in Detroit, said before the report.
Corporate profits, including estimates for the value of inventories and adjustments for capital investments, climbed 3.4 percent from the previous three months, the first gain in almost two years. United Technologies Corp., the maker of Otis elevators and Carrier air conditioners, is among companies seeing signs that government stimulus programs, particularly in China, may be starting to take hold. "China could be the first market to recover as we see government stimulus starting to take effect," Chief Executive Officer Louis Chenevert said yesterday during a presentation at conference in New York. "Both Otis and Carrier have seen increased dialogue with builders and developers in China, only in the last few weeks. It’s still early to conclude" recovery is under way.
Orders at Otis, the world’s biggest elevator maker, had been declining at a rate of 30 percent to 40 percent from a year earlier. The drops are now "smaller than this," Chenevert said. Increasing demand from overseas means the trade gap may keep shrinking and help foster a recovery. The deficit shrank to $302.6 billion last quarter, adding 2.2 percentage points to GDP. Companies cut total spending, including equipment, software and construction projects, at a record 37 percent annual pace. Residential construction fell at a 39 percent pace last quarter, the most since 1980. Government spending fell at a 3.5 percent pace, the most since 1995. The drop reflected cutbacks in defense spending and the biggest decrease in state and local government outlays since 1981.
NY State Pension Fund Loses 26.3% In Fiscal Year Ended March 31
A steep decline in the value of New York state's government employee pension plan will require higher payroll contributions beginning in 2011, State Comptroller Thomas P. DiNapoli said Friday. State and local government employers in New York in two years will likely see their pension contribution requirements jump to an estimated 11% of payroll from the current level of 7.5%, DiNapoli told reporters at a press conference. DiNapoli announced that legislation is being proposed to help ease the budgetary strain the increase will create, but the proposal will also require participating employers to pay into special accounts during years when contribution rates decline, in an effort to reduce future rate volatility.
Assets of New York state's Common Retirement Fund dropped about 26.3% to about $109.9 billion in the fiscal year ended March 31, according to preliminary estimates. DiNapoli attributed the decline to the global economic crisis, which he said drove major U.S. stock indices 33% to 40% lower. "It's the worst year in anybody's memory" for performance at the pension fund, which provides retirements for a range of state as well as local municipal employees, DiNapoli told reporters. Although the exact percentage of payroll required in 2011 hasn't been finalized, the 11% rate is a "reasonable" estimate, he said. The final decision for 2011 will be announced in September. Last September, DiNapoli announced that employer contribution rates for 2010 would be reduced for a fifth consecutive year. At the time, he said rates were likely to increase in 2011.
The legislation being proposed to ease the rate increase's impact would allow state and local government employers to amortize a portion of the added costs over time, providing tens of millions of dollars of temporary budget relief, DiNapoli said. Similar legislation was passed in 2003 to help participants manage a rate increase at that time. In addition to the amortization option, the legislation would set up special accounts that state and local governments would pay into during years when rates decline. The accounts would be used to reduce the volatility of payments in future years. DiNapoli said the fund allocated about 42% of its assets to publicly traded stocks. Still, he said the fund performed well relative to its peers, finishing in the top third of 74 peer funds tracked internally and in the upper half of the 125 funds tracked by Wilshire's Trust Universe Comparison Service.
Business Activity in U.S. Contracts at a Faster Pace, Chicago Index Shows
U.S. business activity contracted at a faster pace than forecast this month as orders and employment dropped. The Institute for Supply Management-Chicago Inc. said today its business barometer decreased to 34.9 from 40.1 in April. Readings below 50 signal a contraction. The report ran counter to others this month that indicated manufacturing was starting to improve this quarter, perhaps signaling that Chicago’s proximity to the auto slump in neighboring Detroit may be affecting the entire Midwest. Still, private economists have scaled back forecasts for economic growth in the second half of the year.
The figures are "undoubtedly affected significantly by shutdowns in the ailing automotive industry," Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., said in a note to clients. "The rate of decline in manufacturing output will moderate in coming months." Another report showed confidence among consumers rose this month to the highest level since September, reinforcing signs that the worst recession in half a century is abating. The Reuters/University of Michigan final consumer sentiment index increased to 68.7, more than forecast, from 65.1 in April.
Stocks were little changed after the reports and Treasury securities rose. The Standard & Poor’s 500 Stock Index climbed 0.4 percent to 910.14 at 10:23 a.m. in New York. Economists forecast the Chicago gauge would rise to 42, according to the median of 55 projections in a Bloomberg News survey. Estimates ranged from 34.2 to 45. A separate report today showed the economy shrank at a 5.7 percent pace in the first quarter, less than the government estimated last month. Following a 6.3 percent slump in the last three months of 2008, the decline capped the worst six-month performance in five decades.
Economists watch the Chicago index for an early reading on the outlook for overall U.S. manufacturing, which makes up about 12 percent of the economy. Prior to the Chicago report, economists forecast the Institute for Supply Management’s national manufacturing index, due June 1, probably climbed in May for a fourth consecutive month, signaling a slower pace of decline, according to the Bloomberg survey median. Other regional figures earlier this month were more upbeat. The Federal Reserve Bank of New York factory index rose to minus 4.6, the highest level since August, and the Philadelphia Fed gauge climbed to an eight-month high. The Chicago purchasers’ orders index fell to 37.3 from 42.1, the employment gauge fell to 25, the lowest level since January 2002, from 31.8.
The production index was unchanged at 38.1 this month. The government is scheduled to release its May employment report on June 5. The U.S. has lost 5.7 million jobs since the downturn began in December 2007. A measure of prices paid for raw materials increased to 29.8, from 28.4 the prior month, the lowest level since 1949. A gauge of delivery times fell to 43 from 45.4. Fed policy makers, in a statement following their April meeting, cited improved financial conditions, stronger business and household sentiment, and expectations of an increase in industrial production to replace inventories, as reasons why the pace of economic contraction will probably ease.
Deere & Co., the world’s largest maker of farm equipment, had a second-quarter profit that topped analysts’ estimates, helped by "strong" sales of agricultural machines. Even so "I think it’s early for anybody in this economy to declare victory, relative to the global recession," Chief Financial Officer Mike Mack said May 20 on a call with analysts. Automakers continue to struggle. Chrysler LLC this month idled its 22 U.S. plants after filing for bankruptcy. General Motors Corp. also has cut output as a bankruptcy deadline looms. Visteon Corp., the former parts-making unit of Ford Motor Co., filed for bankruptcy protection May 28 after revenue fell. In the U.S., automakers’ sales plunged 37 percent through April from the same time last year, with sales at Ford dropping 40 percent.
U.S. Banks Have $168 Billion Reason to Avoid PPIP
U.S. banks have a $168 billion reason to shun a government program designed to strip toxic loans from their books. That’s how much lenders could lose if the banks sell loans into the Public-Private Investment Partnership at market prices instead of their balance-sheet valuation, based on estimates in regulatory filings. It would erase the $75 billion that banks were told to raise by the Federal Reserve to withstand a deeper recession. The imbalance helps explain why the Legacy Loans program, the Federal Deposit Insurance Corp.’s side of PPIP, is "stuck in the rut on the side of the road," said Walter "Bucky" Hellwig, who helps oversee $30 billion at Morgan Asset Management in Birmingham, Alabama.
FDIC Chairman Sheila Bair herself signaled this week that participation in PPIP may be low, saying lenders may be reluctant to sign up because of "discomfort" that lawmakers could change the rules. She cited legislation that imposes conflict-of-interest restrictions on buyers and sellers. Banks say they have enough capital after the Fed’s stress tests on 19 lenders this month and will profit by holding their loans until they are repaid at full value. They have little incentive to sell loans at a discount to BlackRock Inc. and other investors that plan to participate in the $500 billion PPIP. "Banks that have gone out and raised all this money are not going to be inclined to take that hit," said Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York. "You really only want to sell a distressed security if you have to."
Bank of America Corp., the largest U.S. bank, has a $44.5 billion gap between the carrying value of its loans and their fair value, based on data included in a regulatory filing. It’s the widest variation of the top 19 banks, according to data compiled by Bloomberg. JPMorgan Chase & Co. followed, with a $21.7 billion difference, and Citigroup Inc. was third, at $18.2 billion. All told, the gap at the banks was $168 billion. Some banks included other commitments and receivables with loan valuations. Bair on May 15 signaled regulators may pressure some banks to sell their assets under programs to cleanse balance sheets. "The troubled assets are still there and the need is still there to clean that up," Bair said on Bloomberg Television.
The Obama administration unveiled the two-part PPIP on March 23 as a centerpiece of its effort to shore up the financial system by removing illiquid assets. It would be funded by $75 billion to $100 billion from the Treasury’s Troubled Asset Relief Program. The Legacy Loans program aims to encourage private investors to buy loans, with funding assistance from the Treasury and guarantees from the FDIC. The Legacy Securities program, run by the Treasury and the Fed, would use federal money and funds raised by companies from private investors to buy distressed mortgage-backed securities. They’re considered distressed because they’re backed by assets such as troubled commercial and residential mortgages.
Government officials are still pitching the Legacy Securities program, said Philip Feder, chairman of global real estate at law firm Paul, Hastings, Janofsky & Walker LLP. "The Fed is urging private equity players to meet with them and to think about ways to participate on the buy side," said Feder. "Today alone, I heard about three clients that have meetings with either the Fed or the U.S. Treasury to talk about PPIP." Treasury Secretary Timothy Geithner originally said that the Treasury would announce the companies that had qualified to participate as funds managers for the program on May 1, and that the auctions could begin shortly afterward. It missed that deadline without comment, then said May 20 that both programs should start within six weeks.
Since PPIP was announced, U.S. banks raised $67.9 billion, Bloomberg data show. The 19 largest lenders sold stock and converted preferred shares to add capital. "Many banks do not feel the same amount of pressure to get involved because of their ability to raise capital right now," said James Reichbach, leader of Deloitte LLP’s U.S. banking and securities group. "The program has always been questioned by the market." The FDIC intends to target pools of real-estate loans. Mutual funds, pension plans, hedge funds and private investors will be encouraged to bid on the soured assets. Banks would be barred from purchasing their own assets.
"Banks have been able to raise a lot of new capital even before taking more aggressive steps to cleanse their balance sheets, so the incentives to sell may be less," Bair said on May 27. President Barack Obama signed a mortgage bill May 20 that included a measure heightening scrutiny for managers of the public-private investment funds and set rules for more disclosure of the debt sales. Bair said the law may pose a conflict of interest on managers of PPIP funds to ensure securities purchases are "arm’s-length" transactions. She said there "are a couple of factors that remain in play" as the FDIC and Treasury are coordinating how to get the program operational.
Ilargi: Dean Baker seemed to have some clever things to say at times. Turns out, he's a complete fool.
A third stimulus. Because the first two worked so great?! Oh wait, no, because they didn't work. "Well there's no point in mourning about the past." Says Mr. Baker. To me that sounds like: stop whining about your missing eyebrows and the peeling skin on your hands and forehead. Before the fire gets bigger, throw on that third helping of gasoline. Make your children proud!!
Economists, Win Back the Respect of Your Children, Support the Third Stimulus!
ntsWe know it's not easy being an economist these days. Everyone blames you for the fact that they are losing their jobs and their homes, and their life savings. They hold you responsible because you didn't warn the country about an $8 trillion housing bubble. Well there's no point in mourning about the past. The point is to get right next time. And this is next time. The recession continues to deepen and throw more people out of work by the day. While the stimulus passed by Congress in February will be helpful, it clearly is not enough given the severity of the downturn. So, it's time to step up to the plate and seize the opportunity. Add your name to the list of those calling for a third stimulus. It's what the economy needs and you can make kids proud by saying it clearly.
Bernanke's Bid to Revive U.S. Housing Scuttled by Climbing Rates, Defaults
Kyle McGee went to his mortgage broker’s office yesterday hoping to refinance and save about $200 a month. He walked away empty-handed. McGee was expecting a rate of 4.7 percent; the broker offered him 5.375 percent. The average 30-year fixed-mortgage rose to 5.27 percent as of yesterday, according to Bankrate.com. "We feel like we might have missed the boat," said McGee, 37, an adjunct professor of social work at Hunter College School of Social Work in Manhattan. Federal Reserve Chairman Ben S. Bernanke’s efforts to bring down borrowing costs to revive the housing market and help the economy are stalling. Mortgage rates are almost back to where they were in March before the 30-year rate fell to a record and sparked a refinancing boom.
Mortgage delinquencies rose to a record 9.12 percent of U.S. home loans and house prices dropped the most on record in the first quarter, industry reports show. "Housing is not going to be the engine to get us out of this recession," said Robert Eisenbeis, chief monetary economist for Vineland, New Jersey-based Cumberland Advisors Inc., and former research director at the Federal Reserve Bank in Atlanta. "They’ve squeezed a lemon and now they’re trying to squeeze some more, but you can only get so much juice out of a lemon." Rates are rising as President Barack Obama is trying to spur a housing recovery. Obama has pledged to spend $275 billion to help keep as many as 9 million Americans in their homes and stem the rise of foreclosures. His measures also include a tax break of as much as $8,000 for first-time homebuyers that wouldn’t require repayment.
On April 9, Obama cited interest rates at less than 5 percent and the foreclosure program as the two top reasons for people to buy or refinance a home. "We are at a time where people can really take advantage of this," he said.
Homeowners aren’t cooperating. Refinance applications this week fell 19 percent to the lowest since early March, before the U.S. announced a loosening of Fannie Mae and Freddie Mac rules to allow more borrowers with little or no home equity to arrange new loans. The Fed also announced increased purchases of mortgage-backed securities and a program of buying Treasuries. The 30-year fixed rate fell to a record 4.78 percent twice in April, according to Freddie Mac, the McLean, Virginia-based mortgage buyer. The average rate for a 30-year loan rose to 4.91 percent from 4.82 percent a week earlier, Freddie Mac said yesterday.
Rates at historic lows have convinced prospective buyers and homeowners that even 5 percent seems high, said Greg McBride, senior financial analyst at Bankrate in North Palm Beach, Florida. Yesterday’s rate of 5.27 percent is the highest since February. "People are looking for that magical four percent," said McGee’s broker, Norman Calvo, chief executive officer of Universal Mortgage Inc. in Brooklyn, New York. "When you get there you have that feeling of ‘Oh my God it’s the best thing, I’ve got to buy.’" Calvo said that after months of doing largely refinancing work, in April and May his company was doing 50 percent refinancing and 50 percent mortgages for purchase. Freddie Mac estimates 73 percent of the projected $2.7 trillion of mortgage originations in 2009 will be for refinancing.
In 2005, when the annual rate of home sales peaked, 48 percent of the $3.3 trillion in mortgages were refinancings, according to Freddie Mac. Refinancing originations may rise 145 percent to $1.87 trillion this year, according to a Mortgage Bankers Association estimate, the first increase in four years. The Fed plans to buy as much as $1.25 trillion of mortgage- backed securities and up to $300 billion in Treasuries as part of a plan to lower rates. Minutes of the central bank’s April 28-29 meeting show some officials said the Federal Open Market Committee may yet boost asset purchases to spur a more rapid economic recovery.
The central bank’s purchases of mortgage bonds guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae had brought down the yields of those securities, allowing lenders to reduce the rates on new home loans and still sell the mortgage securities at a profit. Fannie Mae and Freddie Mac are government-chartered mortgage companies that are being supported by $400 billion of back-up taxpayer capital. Federal agency Ginnie Mae packages low-down payment loans insured by the Federal Housing Administration into securities. Yields on Fannie Mae and Freddie Mac mortgage bonds rose earlier this week, driven higher in part by climbing Treasury rates. The yield on the 10-year Treasury note was at 3.64 percent yesterday, compared with 3 percent the day before the Fed’s March 18 announcement.
"The Fed has to step up the purchases just to keep rates from rising further," McBride said. "As much buying as the Fed is doing this year of Treasuries and mortgage-backed debt almost exactly equates to the amount of new Treasury debt being dumped onto the market." The decline in refinancing leaves consumers with less to spend to help the ailing U.S. economy. Mortgage delinquencies and foreclosures rose to records in the first quarter as rising unemployment led consumers to default. The U.S. delinquency rate jumped to a seasonally adjusted 9.12 percent from 7.88 percent, the biggest-ever increase, and the share of loans entering foreclosure rose to 1.37 percent, the Mortgage Bankers Association said yesterday. Both figures are the highest in records going back to 1972.
The group’s mortgage refinancing index is 48 percent lower than in January when it hit a six-year high. Treasury yields are rising as the U.S. government sells debt and investors anticipate more supply of government securities being sold to fund federal spending. That in turn is helping push mortgage rates higher. "There was an expectation on my part that the program wasn’t sustainable to end of year because of supply pressures," said Jay Brinkmann, the Mortgage Bankers Association chief economist. "This turnaround is a few months earlier than I would have expected but I knew these pressures were coming."
For McGee, who has a $1,600 a month mortgage payment, higher rates mean less money in his pocket. McGee may have been able to save about $200 a month with a 4.7 percent loan. There’s no way for him to get that savings with a new rate unless his two bedroom co-op in the Kensington area of Brooklyn is appraised at $10,000 more than the 2007 purchase price, he said. "People are still struggling with the amount that their homes are worth right now, so having the interest rates go up, even if it’s still relatively moderate, kind of tips the balance a bit more toward people holding off on making a change," McGee said.
US borrowers with good credit fuel foreclosures
The mortgage crisis is spreading and hitting new heights: Borrowers with good credit now make up the largest share of foreclosures as job losses and pay cuts exact their toll. A record 12 percent of homeowners with a mortgage were behind on their payments in the first quarter, the Mortgage Bankers Association said Thursday. And the trend is predicted to continue until the end of next year, about six months after unemployment is expected to peak. The genesis of the recession -- risky adjustable-rate loans made to borrowers with bad credit -- remains a significant factor in foreclosures.
Today, almost half of all subprime ARMs are past due or in foreclosure. In Florida, New Jersey and New York the number is above 55 percent. When those borrowers started defaulting in droves in late 2006, it forced dozens of lenders out of business and sparked a credit crisis in the summer of 2007. Businesses nationwide couldn't get short-term loans to finance new orders or even cover their payrolls. Economic production began shrinking at the end of 2007 in what has become the longest recession in the United States since World War II. The impact has now filtered out, consuming homeowners who until recently had a good track record of paying their bills on time.
Nearly 6 percent of these prime borrowers with fixed-rate mortgages were past due or in foreclosure, nearly doubling in the last year. "These (borrowers) are the best of the best out there," said real estate analyst Mike Larson with Weiss Research. "Clearly, borrowers far and wide are getting hit by this." The worst of the trouble continues to be focused in California, Nevada, Arizona and Florida, which accounted for 46 percent of new foreclosures in the country and reported the worst delinquency and foreclosure rates on prime fixed-rate loans. The four have suffered massive job cuts in the housing industry. There were no signs of improvement. But experts expect the pain to spread throughout the country as job losses mount.
MBA's chief economist Jay Brinkmann estimates the unemployment rate will top out in mid-2010 and foreclosures to abate about six months afterward. The number of newly laid off people requesting jobless benefits fell last week, the government said Thursday, but the number of people receiving unemployment benefits reached 6.78 million in mid-May, the highest on record. The continuing rise in unemployment, which economists say could reach double digits, means more trouble for the ailing financial system and the economy. Lower incomes and lost jobs are the No. 1 reason people lose their homes through foreclosure. Higher unemployment also means people have less money to spend on basic necessities, let alone luxuries.
And borrowers without jobs are harder for lenders to help with loan modifications. Nadine Harris in California is hoping to modify her 30-year fixed-rate mortgage under President Barack Obama's loan modification and refinancing program introduced earlier this year. The 55-year-old was laid off two years ago by Sears after working there 34 years. Harris found another job, but she makes $20,000 less a year. The $925 she takes home every two weeks doesn't cover her $1,522 mortgage and other living expenses. She's used all her savings to stay current on her payments, but next month the reserves will run dry. "I'll have to scrimp to make up the payment in June," she said. Jodi Woodsmith, a housing counselor at Self-Help Enterprises, said in the last eight weeks she's seen more and more homeowners with similar stories walk through her door.
"Those who had savings, they've exhausted their savings hoping they could ride it out," she said. Woodsmith said a recent change to the president's program allows borrowers to use unemployment benefits as a source of income for a loan modification. Income from spouses who are not on the mortgage also is taken into account. Though the plan might stem some foreclosures, it might not be enough to significantly alter the crisis. "It may be too much to say that the numbers will fall because of the plan," Brinkmann said. "It's more correct to say that the numbers won't be as high."
Freddie’s Mortgage Portfolio Contracts
Even as the Obama Administration’s Making Home Affordable initiatives began taking effect, one of the government-sponsored mortgage giants saw its April portfolio shrink from year-ago levels as its monthly purchases and issuance fell 32.5%. Government-sponsored enterprise (GSE) Freddie Mac saw its mortgage portfolio decrease at an annualized rate of 8.1% in April, according to the monthly volume summary released today. Freddie’s total mortgage-related purchases and issuance fell to $58.1bn in April from $86.1bn in March. It sold $20.2bn in April from its total mortgage portfolio.
The declines in mortgage activity at the GSE came even as it began purchasing refinance loans through the Administration’s new housing program. Freddie purchased $43.3bn of refinance loans in the month through the Making Home Affordable Program (MHA Program). Officials from the GSE said refinance activity will likely remain high in coming reports as Freddie continues to purchase refinance loans through the program. Despite the future outlook on refinance-related activity, Freddie’s April portfolio contracted, also bringing down the unpaid principal balance (UPB). The aggregate UPB of Freddie’s mortgage-related investments portfolio decreased to $830.3bn at month-end. The GSE entered into $956m of mortgage purchase and sales agreements for its mortgage-related investments portfolio, down from $15.8bn in March.
As Freddie’s portfolio contracts, the deteriorating performance of its mortgages only becomes clearer, as the delinquency rate continues to rise each month for the past 12 months. The total delinquency rate among Freddie’s single-family mortgages increased to 2.44% from 2.29% last month, according to Freddie’s report. The rate is up from 0.81% in April of ‘08. "Our temporary suspension of foreclosure transfers, which expired on March 6, contributed to the increase in our single-family delinquency rates," Freddie officials say in a media statement today. "We are currently assessing the impact on our delinquency rates of the suspension of foreclosure transfers that began on March 7 for loans eligible for modification under the MHA Program."
Refinance Applications Dive
On the heels of a record quarter of home price declines, total mortgage applications sit 28.5% above the same week last year, even as the weekly momentum of refinance applications slips, according to a weekly survey released Wednesday by the Mortgage Bankers Association (MBA). The volume of mortgage loan applications submitted in the week ending May 22 showed a week-over-week loss of 14.2%. Applications for refinance mortgages alone fell 18.9%, while applications for purchase loans inched up 1% from a week earlier. Refinance applications accounted for 69.3% of total applications this week, down from 73.6% in the previous week, the MBA found.
A separate survey that adjusts raw data to count multiple applications from a single household as one entry — effectively breaking down total mortgage application activity to the total volume of households applying for mortgages — saw the rate of decline in activity double since last week. This Mortgage Application Index — or MAX — fell 2.4% in the week ending May 22, indicating household activity in the application process declined in tandem with overall application activity as found by the MBA’s results.
The MAX publisher Paul Descloux, in his weekly commentary on the index, attributes this to a possible balancing out of demand. Efforts from the central bank to force mortgage rates down sparked a substantial interest in mortgage loans and especially refinance, but now that the shine has worn off, the market might begin to see more realistic levels of mortgage application interest, Descloux says. "Organic home sales are near their seasonal peak while refinancings have reached equilibrium with the current rate structure," he writes. "Given the resources already deployed and the reality of financing USA debt, mortgage rates are unlikely to move lower."
Richard Shelby: U.S. "On The Road To Socialism"
Sen. Richard Shelby said Friday the government should have allowed the marketplace to decide General Motors' fate and that the huge federal stake in the company puts Washington on "the road to socialism." Shelby, ranking Republican on the Banking Committee, argued that the financially beleaguered GM could have saved "lots of money" if it had chosen six months ago to file a Chapter 11 bankruptcy petition. "What I worry about" is Washington's large interest in the company, the senator said in a nationally broadcast network interview. "It's basically going to be a government-owned, government-run company ... a company that has been sadly run into the ground." Shelby represents Alabama, a state with a significant presence of non-U.S. automakers, including Honda, Mercedes and Hyundai.
Facing a restructuring deadline, GM is in the process of brokering a last-minute deal with bondholders and the United Auto Makers, and then is expected to file Monday what would be one of the largest bankruptcies ever. Said Shelby: "I'm sure they haven't cut enough and there are not enough concessions there." The Treasury has loaned GM $19.4 billion and would provide $30 billion in additional financing to keep the new GM operating under bankruptcy protection. The government would get 72.5 percent of the new company's stock under the plan. "I think this is a sad day," said Shelby. "This was a great company ... But they're where they are ... they were mismanaged for a long time. Look at the wealth they've lost, look at the prestige they've lost. It's just not a good day."
Asked on CBS's "The Early Show" whether he expected taxpayers would ever be reimbursed for the money Treasury has sunk in GM, Shelby replied, "That's a great question. I think it's a daunting task for the people running this company." "We should have let the market forces work it out," he said. "That's the way we've always done it ... What we've done ... it's the road toward socialism, government intervention in the market in a big way. What's the end game here and can the American people afford it. I think the answer is obviously not." A stronger picture of the nature of the company's restructuring emerged Thursday after a bloc of General Motors Corp.'s biggest bondholders agreed to a Treasury sweetened deal to wipe out $27 billion of the automaker's unsecured debt in exchange for company stock.
GM's union employees are due to finish voting Friday on whether to ratify a modified contract that would cut some of their benefits but slash the automaker's labor costs. And the company's board of directors will begin two days of meetings to decide what the automaker will do when its government restructuring deadline arrives Monday. A senior Obama administration official estimated that GM would be under bankruptcy protection for 60 to 90 days, longer than the expected reorganization of Chrysler LLC, because GM is bigger and more complex. The official spoke on condition of anonymity because of the sensitivity of the negotiations.
Bloated U.S. Consumer Unfit for Recovery Marathon
Here’s a cautionary word for investors and export nations like Germany, Japan and China: This week’s report of the biggest gain in consumer confidence since 2003 is no sign that America’s shoppers are in any shape to start gorging again. The harsh reality is that the once-mighty U.S. consumer is setting out on a long, debt-reduction marathon that will mute economic recovery in America and among its major trading partners. No wonder folks like Pacific Investment Management Co. Chief Executive Officer Mohamed El-Erian were talking in recent weeks of a "new normal" of 2 percent or less for U.S. economic growth. The issue with consumers: Their balance sheets are a bloated mess with household debt still unsustainably high at more than 130 percent of income.
Getting the ratio down to a more realistic sub-100 percent level -- never mind the 60 percent to 70 percent range seen in the 1960s and 1970s -- involves serious consumption cutbacks. With consumers accounting for about 70 percent of the U.S. economy, this one-time engine of growth may easily become a dead weight. That surely undermines hopes for a V-shaped economic recovery, as well as a belief that stocks have entered a broad new bull market since hitting bottom in early March. At the least, it calls into doubt moves like the almost-50 percent rise from March lows in some funds that track consumer discretionary stocks, the kind of companies that shine when people do more than just hoard canned goods and bottled water. "Essentially a world accustomed to relying on the strength of the U.S. consumer now must look to a new source for growth," Jeffrey Rosenberg, credit strategist at Bank of America-Merrill Lynch, wrote in a report earlier this month.
The problem with consumers’ balance sheets was a long time in the making, so it shouldn’t come as a surprise that a resolution won’t be quick or easy. U.S. household debt had been growing at a faster clip than incomes since 1960. The trend grew more worrisome in the 1990s, though things didn’t get completely out of hand until the start of this decade. Low interest rates, funky new mortgage products and an overall lowering of lending standards led to a borrowing binge that wrecked household balance sheets. Undoing that will be painful, at least based on past experience. That was the finding of a mid-May research note by Reuven Glick, group vice president, and Kevin Lansing, senior economist, at the Federal Reserve Bank of San Francisco.
The two researchers looked at the experience of non- financial companies in Japan, following the bursting of that country’s stock-market bubble in 1989 and real-estate bubble in 1991. It took those companies 10 years to reduce their debt-to- gross domestic product ratio from 125 percent to 95 percent. During that time, the companies had to change from being borrowers to savers. For U.S. households to cut their burden similarly, the debt-to-income level would need to drop to 100 percent by 2018, Glick and Lansing wrote. And for that to happen, household savings rates "would need to rise from around 4 percent currently to 10 percent by the end of 2018." The upshot of that would be a reduction in the consumption growth rate -- meaning consumers would buy a lot less stuff. This would "result in a substantial and prolonged slowdown in consumer spending relative to pre-recession growth rates," Glick and Lansing wrote.
There are some equally unpalatable alternatives. Rather than save their way out of debt, consumers could default their way out of it. That would cleanse personal balance sheets, yet transfer losses on homes, credit cars and cars to banks. In that case, the economy again would face headwinds as banks husband capital to deal with losses, reducing their capacity to lend. Another possibility would be for households to rely on rising incomes to bring debt down to the more sustainable level of about 100 percent of income. It’s tough to see that happening anytime soon, especially with the U.S. unemployment rate at 8.9 percent. In fact, many people now expect their incomes to fall, not rise.
"People are used to going to their bosses and asking for a raise and that’s not happening anymore," said Jonathan Basile, an economist at Credit Suisse Group. Falling incomes lead to "the collective creditworthiness getting worse," he added. Couple that with crimped lending by banks, and consumers face a "sea change" in terms of their use of debt, Basile said. So too do the businesses, and countries, who came to depend on the U.S. consumer regularly splurging on everything from flat-screen TVs to granite countertops. That doesn’t leave much room for confidence.
Still Working, but Making Do With Less
The Ferrells have cut back on dance lessons for their twin daughters. Vaccinations for the family’s two cats and two dogs are out. Haircuts have become a luxury. And before heading out recently to the discount grocery store that has become the family’s new lifeline, Sharon Ferrell checked her bank account balance one more time, dialing the toll-free number from memory. "Your available balance for withdrawal is, $490.40," the disembodied electronic voice informed her. At the store, with that number firmly in mind, she punched the price of each item into a calculator as she dropped it into her cart, making sure she stayed under her limit. It was all part of a new regimen of fiscal restraint for the Ferrells, begun in January, when state workers, including Mrs. Ferrell’s husband, Jeff, were forced to accept two-day-a-month furloughs.
For millions of families, this is the recession: not a layoff, or a drastic reduction in income, but a pay cut that has forced them to thrash through daily calculations similar to the Ferrells’. Even if workers have managed to avoid being laid off, many employers have cut back in other ways, reducing employees’ hours, imposing furloughs and even sometimes trimming salaries. About 6.7 million people were working fewer than 35 hours a week in April because of "slack work or business conditions," nearly double the number a year earlier, according to the Bureau of Labor Statistics. A recent survey of 518 large companies by Hewitt Associates, a human resources consulting firm, found 16 percent had cut pay and 20 percent had cut hours or imposed furloughs, far more than the firm has seen in previous recessions. (The actual percentage of workers affected is likely to be significantly lower.)
Some have managed to absorb the shrinking of their paychecks with minimal pain, especially households where a second income has helped cushion the blow. Melissa Saavedra, a customer service technician for the City of Redlands, Calif., who normally earned about $38,000 a year, took a 10 percent pay cut along with other city workers in January. In part because Ms. Saavedra’s husband was still employed at an electronics company, the family of five had so far made only modest adjustments. She and her husband take their lunch to work now; she tries to buy meat on sale at the grocery and clips coupons. "We probably had extra money left over every month," she said. "Now there’s less of that money, but we’re still O.K."
For families like the Ferrells, however, who were already just a car repair or an appliance breakdown away from falling behind, even a modest step down can bring hard choices. The furloughs meant a roughly 9 percent reduction to Mr. Ferrell’s $72,000-a-year salary as an industrial hygienist, in which he evaluates health hazards in the workplace. The couple and their two sets of twins — the older twins are 7 and the younger are 20 months — have had to make do with about $450 less per month. Should they cut the $315 a month they were spending on ballet lessons for the older twins? What about the $55 a month for the satellite television service they had because they could not get regular cable in their semi-rural home here about 40 miles outside of Sacramento?
Rising living expenses over the last few years had mostly exhausted the family’s savings and led to several thousand dollars in credit card debt. The Ferrells had only recently begun to relax a bit after Mr. Ferrell, 55, received a 5 percent raise in December. But the furloughs, which are slated to extend at least to mid-2010, took away the raise and then some, dropping Mr. Ferrell’s take-home pay to $4,856 a month from $5,308. In January, the couple sat down at their computer in their cluttered living room and waded through their major bills, including the mortgage, utilities and car insurance. The Ferrells concluded they had just $1,200 a month left over to cover everything else, from groceries to diapers.
Many of their remaining expenses seemed impossible to reduce by much, like the roughly $360 a month for gas. It quickly became apparent how little the family had left over for necessities like food. "People just say: ‘Oh, it’s just a 10 percent pay cut. Cut the fat out of your budget,’ " Mrs. Ferrell said. "But we’ve cut the fat. We’ve cut the fat all along, and so this is really pushing us close to the bone now." Mrs. Ferrell began mapping out family dinners a month in advance on a refrigerator whiteboard. Instead of grocery shopping at regular supermarkets, she began loading up her minivan once a month at WinCo, a giant, no-frills discount grocery chain. "That way I can control exactly what I buy," she said. "I make menus so that I don’t over-shop, or don’t impulse-purchase at the store."
Mrs. Ferrell estimated the approach saves the family as much as $200 a month. When the Ferrells told the children’s dance teacher they might have to take a break, she let them attend free for a month. Eventually, the couple decided to continue to pay for lessons, on a reduced schedule, which saved $65 a month. "They’re little girls, and they shouldn’t have to worry about it," Mr. Ferrell said. "They should be able to enjoy their childhood. They only get the one." The couple decided to keep the satellite television because of the children’s programming. But Mrs. Ferrell has not had a haircut in six months; Mr. Farrell longer than that. They have also cut back on trims for the older twins.
"We put a lot of conditioner in," Mrs. Ferrell said. When the family ran short on sliced bread, Mrs. Ferrell hauled out the breadmaker. She takes few pictures of their toddlers now, because of the cost of film and developing. The Dollar Store has become a regular stop. The air-conditioning in Mrs. Ferrell’s minivan broke recently. Instead of fixing it, she tries to drive only when it is cool out, or go to places where she knows she can park in the shade.
In the end, a stash of savings bonds that Mrs. Ferrell’s grandparents gave her as a child, which the couple had hoped to save for a home renovation, has become the family’s salvation. In late March, Mrs. Ferrell redeemed one for $2,300. She calculates that at their current rate they have enough bonds to last another year. Gov. Arnold Schwarzenegger, however, is proposing an additional 5 percent salary cut. Mrs. Ferrell hopes her family can simply hang on.
Eurozone inflation falls to zero
Eurozone inflation has fallen to zero, the lowest since comparable records began in 1991, and could fall even lower as a result of the region’s severe recession as well as cheaper oil prices. The annual inflation rate in the 16-country region fell from 0.6 per cent in April to 0.0 per cent this month, according to Eurostat, the European Union’s statistical office. Economists said inflation would turn negative in June, complicating further the task of the European Central Bank as it seeks to combat the worst economic downturn for half a century in continental Europe.
Among the eurozone’s biggest countries, Germany and Spain have already reported negative national inflation rates. The worry for the ECB will be that below-zero inflation rates will stoke fears of full-blown deflation – generalised and persistent falls in prices that wreak significant economic damage. Jean-Claude Trichet, ECB president, warned earlier this month that eurozone inflation was likely to be negative "for some months". He argued recent falls reflected the statistical effects of last year’s oil price rises and forecast a pick up in inflation later this year. The ECB also argues that long-run inflation expectations – which it watches closely – remain in line with its goal of an annual inflation rate "below but close" to 2 per cent.
However, the latest inflation data were weaker than expected and economists believe the recession will reduce inflationary forces further in coming months. "The severe contraction in activity has created a huge margin of space capacity in the economy, which will exert strong downward pressure on core prices," said Martin van Viet at ING bank. "There remains a real risk that the eurozone will see more than a whiff of deflation." Forward-looking confidence indicators have suggested the eurozone is contracting at a much slower pace than at the start of the year. But latest ECB credit data underscored the continuing weakness of eurozone economic activity. They showed annual growth in eurozone mortgage lending and consumer credit turned negative in April for the first time since the launch of the euro in 1999.
The ECB has cut its main interest rate by 325 basis points since last October to 1 per cent, the lowest ever, and is not expected to announce any change after its meeting next week. But it has followed the US Federal Reserve and Bank of England in announcing an emergency asset purchase programme to help revive financial markets. The ECB will next week announce details of its plans to buy €60bn in "covered bonds, which are issued by banks and backed by public sector loans and mortgages. One likely solution is that the package will be split according to eurozone countries’ capital shares in the ECB, which would result in Germany accounting for about 25 per cent of the €60bn programme.
Pimco’s Gross Says Harvard, Yale May Need to Alter Investments
Yale University and Harvard University may have to cut investments in hedge funds and private equity because the risks of holding the hard-to-sell assets outweigh the returns, said Bill Gross, co-chief investment officer of Pacific Investment Management Co. "The Yale and Harvard portfolios, which have succeeded enormously over the past 10 or 20 years in terms of the emphasis on illiquidity and private investments and risk-taking -- you have to question that model," Gross said yesterday at an industry conference in Chicago.
The two Ivy League schools had more than half of their endowments in hedge funds, private equity, real estate and hard assets such as commodities at June 30. Gross, who manages the $150 billion Pimco Total Return Fund, the world’s biggest bond mutual fund, recommended in March buying securities that provide stable income this year rather than more speculative and illiquid investments, as slowing economic growth and higher unemployment depress returns. "Everything in this ‘new normal’ world should be questioned in terms of the returns going forward," Gross, 65, told the audience at Morningstar Inc.’s annual fund-industry conference.
"New normal" in the global economy means heightened government regulation, slower growth and a shrinking role for the U.S., Mohamed El-Erian, who shares the position of investment chief with Gross at Newport Beach, California-based Pimco, said earlier this month. These conditions will force people to question traditional strategies, such as putting 60 percent of their money in riskier investments including stocks and hard-to-sell assets and 40 percent in bonds and cash, Gross said. The Yale endowment is run by Chief Investment Officer David Swensen. Harvard’s endowment, managed since July by Jane Mendillo, was overseen by El-Erian from February 2006 to December 2007.
El-Erian didn’t respond to a request for comment. John Longbrake, a spokesman for Harvard in Cambridge, Massachusetts, had no immediate comment. Tom Conroy, a spokesman for Yale in New Haven, Connecticut, declined to comment. Investment losses since September have forced colleges such as Harvard and Yale to freeze salaries, delay construction projects or borrow money to meet their budgets. Endowments have held onto illiquid holdings such as private-equity stakes as investor demand has waned and prices have plunged. Yale plans for its endowment to support 44 percent of the university’s budget this fiscal year. Harvard depended on the endowment for about 35 percent of its revenue during the fiscal year ended June 30.
Yale’s endowment was valued at $17 billion in December, a decline of 25 percent since June 30. It’s the second-largest U.S. college fund after Harvard’s, which stood at $28.8 billion in December after losing 22 percent since June. Swensen boosted Yale’s long-term returns by cutting the fund’s holdings of stocks and bonds and buying more real estate, private equity and hedge funds, a strategy that has been copied by endowment managers across the nation. His guiding principle is that the best stock and bond pickers don’t outperform bottom- rated managers by much.
Yale had 29 percent of its investments in hard assets such as oil, gas, timber and real estate as of June, according to the school’s annual report. Twenty-five percent was devoted to absolute-return strategies such as hedge funds, with 20 percent in private equity. Domestic stocks, bonds and cash made up 10 percent of its assets, while the remainder of the portfolio was held in stocks outside the U.S. Harvard had 11 percent of its portfolio allocated to private equity, 26 percent to commodities, timber and real estate and 18 percent in absolute-return strategies for the year ended June 30.
Harvard, projecting an endowment loss of as much as 30 percent this fiscal year, has frozen hiring and salaries and fired staff. Harvard raised cash by issuing $2.5 billion in bonds in December after failing to sell $1.5 billion in private- equity stakes. About 51 percent of endowment assets was allocated to alternative investments as of Dec. 31, an increase from 46 percent six months earlier, according to a March survey released by Commonfund Institute in Wilton, Connecticut.
Pimco Total Return gained 6 percent annually in the five years ended May 27, beating 99 percent of similarly managed funds, according to data compiled by Bloomberg. The fund has climbed 4.1 percent this year, leading 55 percent of its rivals. Gross said in a May 4 report that 2009 marks a "demarcation" in U.S. economic policy after the inauguration of President Barack Obama. He predicted that economic growth in the U.S. will slow to an annual rate of 1 percent to 2 percent, while unemployment will stay at 7 percent to 8 percent for "years to come." The U.S. is at "the beginning of government-policy counterpunching," Gross wrote in the commentary posted on Pimco’s Web site. "Asset values should be negatively affected."
In Finland, Nuclear Renaissance Runs Into Trouble
As the Obama administration tries to steer America toward cleaner sources of energy, it would do well to consider the cautionary tale of this new-generation nuclear reactor site. The massive power plant under construction on muddy terrain on this Finnish island was supposed to be the showpiece of a nuclear renaissance. The most powerful reactor ever built, its modular design was supposed to make it faster and cheaper to build. And it was supposed to be safer, too. But things have not gone as planned.
After four years of construction and thousands of defects and deficiencies, the reactor’s 3 billion euro price tag, about $4.2 billion, has climbed at least 50 percent. And while the reactor was originally meant to be completed this summer, Areva, the French company building it, and the utility that ordered it, are no longer willing to make certain predictions on when it will go online. While the American nuclear industry has predicted clear sailing after its first plants are built, the problems in Europe suggest these obstacles may be hard to avoid. A new fleet of reactors would be standardized down to "the carpeting and wallpaper," as Michael J. Wallace, the chairman of UniStar Nuclear Energy — a joint venture between EDF Group and Constellation Energy, the Maryland-based utility — has said repeatedly.
In the end, he says, that standardization will lead to significant savings. But early experience suggests these new reactors will be no easier or cheaper to build than the ones of a generation ago, when cost overruns — and then accidents at Three Mile Island and Chernobyl — ended the last nuclear construction boom. In Flamanville, France, a clone of the Finnish reactor now under construction is also behind schedule and overbudget. In the United States, Florida and Georgia have changed state laws to raise electricity rates so that consumers will foot some of the bill for new nuclear plants in advance, before construction even begins.
"A number of U.S. companies have looked with trepidation on the situation in Finland and at the magnitude of the investment there," said Paul L. Joskow, a professor of economics at the Massachusetts Institute of Technology, a co-author of an influential report on the future of nuclear power in 2003. "The rollout of new nuclear reactors will be a good deal slower than a lot of people were assuming." For nuclear power to have a high impact on reducing greenhouse gases, an average of 12 reactors would have to be built worldwide each year until 2030, according to the Nuclear Energy Agency at the Organization for Economic Cooperation and Development. Right now, there are not even enough reactors under construction to replace those that are reaching the end of their lives.
And of the 45 reactors being built around the world, 22 have encountered construction delays, according to an analysis prepared this year for the German government by Mycle Schneider, an energy analyst and a critic of the nuclear industry. He added that nine do not have official start-up dates. Most of the new construction is underway in countries like China and Russia, where strong central governments have made nuclear energy a national priority. India also has long seen nuclear as part of a national drive for self-sufficiency and now is seeking new nuclear technologies to reduce its reliance on imported uranium. By comparison, "the state has been all over the place in the United States and Europe on nuclear power," Mr. Joskow said.
The United States generates about one-fifth of its electricity from a fleet of 104 reactors, most built in the 1960s and 1970s. Coal still provides about half the country’s power. To streamline construction, the Nuclear Regulatory Commission in Washington has worked with the industry to approve a handful of designs. Even so, the schedule to certify the most advanced model from Westinghouse, a unit of Toshiba, has slipped during an ongoing review of its ability to withstand the impact of an airliner. The Nuclear Regulatory Commission has also not yet approved the so-called EPR design under construction in Finland for the American market.
This month, the United States Energy Department produced a short list of four reactor projects eligible for some loan guarantees. In the 2005 energy bill, Congress provided $18.5 billion, but the industry’s hope of winning an additional $50 billion worth of loan guarantees evaporated when that money was stripped from President Obama’s economic stimulus bill. The industry has had more success in getting states to help raise money. This year, authorities permitted Florida Power & Light to start charging millions of customers several dollars a month to finance four new reactors. Customers of Georgia Power, a subsidiary of the Southern Co., will pay on average $1.30 a month more in 2011, rising to $9.10 by 2017, to help pay for two reactors expected to go online in 2016 or later.
But resistance is mounting. In April, Missouri legislators balked at a preconstruction rate increase, prompting the state’s largest electric utility, Ameren UE, to suspend plans for a $6 billion copy of Areva’s Finnish reactor. Areva, a conglomerate largely owned by the French state, is heir to that nation’s experience in building nuclear plants. France gets about 80 percent of its power from 58 reactors. But even France has not completed a new reactor since 1999. After designing an updated plant originally called the European Pressurized Reactor with German participation during the 1990s, the French had trouble selling it at home because of a saturated energy market as well as opposition from Green Party members in the then-coalition government.
So Areva turned to Finland, where utilities and energy-hungry industries like pulp and paper had been lobbying for 15 years for more nuclear power. The project was initially budgeted at $4 billion and Teollisuuden Voima, the Finnish utility, pledged it would be ready in time to help the Finnish government meet its greenhouse gas targets under the Kyoto climate treaty, which runs through 2012. Areva promised electricity from the reactor could be generated more cheaply than from natural gas plants. Areva also said its model would deliver 1,600 megawatts, or about 10 percent of Finnish power needs. In 2001, the Finnish parliament narrowly approved construction of a reactor at Olkiluoto, an island on the Baltic Sea. Construction began four years later.
Serious problems first arose over the vast concrete base slab for the foundation of the reactor building, which the country’s Radiation and Nuclear Safety Authority found too porous and prone to corrosion. Since then, the authority has blamed Areva for allowing inexperienced subcontractors to drill holes in the wrong places on a vast steel container that seals the reactor. In December, the authority warned Anne Lauvergeon, the chief executive of Areva, that "the attitude or lack of professional knowledge of some persons" at Areva was holding up work on safety systems.
Today, the site still teems with 4,000 workmen on round-the-clock shifts. Banners from dozens of subcontractors around Europe flutter in the breeze above temporary offices and makeshift canteens. Some 10,000 people speaking at least eight different languages have worked at the site. About 30 percent of the workforce is Polish, and communication has posed significant challenges. Areva has acknowledged that the cost of a new reactor today would be as much as 6 billion euros, or $8 billion, double the price offered to the Finns. But Areva said it was not cutting any corners in Finland. The two sides have agreed to arbitration, where they are both claiming more than 1 billion euros in compensation. (Areva blames the Finnish authorities for impeding construction and increasing costs for work it agreed to complete at a fixed price.)
Areva announced a steep drop in earnings last year, which it blamed mostly on mounting losses from the project. In addition, nuclear safety inspectors in France have found cracks in the concrete base and steel reinforcements in the wrong places at the site in Flamanville. They also have warned Électricité de France, the utility building the reactor, that welders working on the steel container were not properly qualified.
On top of such problems come the recession, weaker energy demand, tight credit and uncertainty over future policies, said Caren Byrd, an executive director of the global utility and power group at Morgan Stanley in New York. "The warning lights now are flashing more brightly than just a year ago about the cost of new nuclear," she said. And Jouni Silvennoinen, the project manager at Olkiluoto, said, "We have had it easy here." Olkiluoto is at least a geologically stable site. Earthquake risks in places like China and the United States or even the threat of storm surges mean building these reactors will be even trickier elsewhere.