The Chain Bridge over the Potomac near Washington.
Ilargi: Blogs and sites like The Automatic Earth and others that deal with the dark side of finance and the economy typically find that their attendance numbers drop significantly when the overall sentiment in the media and the markets is that things seem to be looking up. Barry Ritholtz noted as much last week for his blog, the Big Picture, perhaps the best read among its peers. Remarkably, for The Automatic Earth -well, so far at least, knock knock- this hasn't happened; the loss is negligible, no more than a few percentage points at most.
I think that is very encouraging, not just for us, but much more because I think these rosy days are exactly when people should read The Automatic Earth. Those rosier times don't just happen out of nowhere.
Here is a bit of genuinely good news: The NAR’s Pending Home Sale Index rose 1.1% from March 2008. The less significant monthly gains were also positive, rising 3.2% from February to march 2009.
By making statements like that, Ritholtz, whom I have the utmost respect for, puts himself, in my eyes, far too close to NAR head cheerleader Lawrence Yun, someone he makes fun of. What exactly is so good about the news? Is every sale of every home a good thing? I think not, in my view hardly any sale these days that involves a mortgage is a good thing. And that view is corroborated by today's Wall Street Journal article on the Federal Housing Administration and its role in home loans and sales. The article’s title "The Next Housing Bust" is an awfully poor choice, since there have been a thousand pieces of that same name lately. The content, however, provides an interesting angle that is hardly ever addressed.
Last year banks issued $180 billion of new mortgages insured by the FHA, which means they carry a 100% taxpayer guarantee. Many of these have the same characteristics as subprime loans: low downpayment requirements, high-risk borrowers, and in many cases shady mortgage originators. FHA now insures nearly one of every three new mortgages, up from 2% in 2006.
In other words, the FHA, with taxpayer money, acts in cahoots with Fannie Mae and Freddie Mac (and don't forget the Federal Home Loan Banks), who also use taxpayer money to interfere in the US housing market, which in their case means buying 90% of mortgages from lenders. Now that you know that, does the rise in pending home sales still look so good? Or do you, like me, get the idea that homes only sell if your money guarantees any losses on the sales and loans? Is that rosy color real or is it fake? Sure, loans have never been cheaper, the last time prices were lower there was no Twitter, and any and all industry and media pundits say the bottom is here. But is it? When the entire market leans on your tax shoulders? Where is the good news in that supposed to be? As far as I can see, nothing fundamental changed, the downfall was just pushed forward a few months at a phenomenal (re: $4 trillion and counting) cost.
So yes, sure, Obama's mortgage cram-down plan was defeated in the Senate, but is that so bad? Even if a judge can reset a mortgage principal lower, what will it be set to? Home prices are down close to 30% so far, but what happens when they lose the next 30%? Will the cram-down judges incorporate that in their assessments? Make that a no. People bought homes at three times their accurate value, and yes, that's going to hurt.
What is needed in today's market, no matter how painful it may be, is for the government to get out of the market and let things be. If that doesn't happen, people will keep on buying overvalued properties, a process whose only beneficiaries are the banks. Sound familiar? And about those banks, Bloomberg today says:
Banks are hoarding a record $1.1 trillion of cash even after the Treasury and central bank made emergency capital injections and set up special lending programs to ensure lenders extended credit to households and businesses.
You’re still being played guys. You can make a few bucks on the upside, but do you want to take the risk? There is no credit left in the market, other than what piggybacks on the taxpayers’ payola, and that is all going to blow up in your faces. The system is dead, even if it seems to show some signs of life from time to time.
The Next Housing Bust
Everyone knows how loose mortgage underwriting led to the go-go days of multitrillion-dollar subprime lending. What isn't well known is that a parallel subprime market has emerged over the past year -- all made possible by the Federal Housing Administration. This also won't end happily for taxpayers or the housing market. Last year banks issued $180 billion of new mortgages insured by the FHA, which means they carry a 100% taxpayer guarantee. Many of these have the same characteristics as subprime loans: low downpayment requirements, high-risk borrowers, and in many cases shady mortgage originators. FHA now insures nearly one of every three new mortgages, up from 2% in 2006.
The financial results so far are not as dire as those created by the subprime frenzy of 2004-2007, but taxpayer losses are mounting on its $562 billion portfolio. According to Mortgage Bankers Association data, more than one in eight FHA loans is now delinquent -- nearly triple the rate on conventional, nonsubprime loan portfolios. Another 7.5% of recent FHA loans are in "serious delinquency," which means at least three months overdue. The FHA is almost certainly going to need a taxpayer bailout in the months ahead. The only debate is how much it will cost. By law FHA must carry a 2% reserve (or a 50 to 1 leverage rate), and it is now 3% and falling. Some experts see bailout costs from $50 billion to $100 billion or more, depending on how long the recession lasts.
How did this happen? The FHA was created during the Depression to help moderate-income and first time homebuyers obtain a mortgage. However, as subprime lending took off, banks fled from the FHA and its business fell by almost 80%. Under the Bush Administration, the FHA then began a bizarre initiative to "regain its market share." And beginning in 2007, the Bush FHA, Congress, the homebuilders and Realtors teamed up to expand the agency's role. The bill that passed last summer more than doubled the maximum loan amount that FHA can insure -- to $719,000 from $362,500 in high-priced markets. Congress evidently believes that a moderate-income buyer can afford a $700,000 house. This increase in the loan amount was supposed to boost the housing market as subprime crashed and demand for homes plummeted. But FHA's expansion has hardly arrested the housing market decline. The higher FHA loan ceiling was also supposed to be temporary, but this year Congress made it permanent.
Even more foolish has been the campaign to lower FHA downpayment requirements. When FHA opened in the 1930s, the downpayment minimum was 20%; it fell to 10% in the 1960s, and then 3% in 1978. Last year the Senate wisely insisted on raising the downpayment to 3.5%, but that is still far too low to reduce delinquencies in a falling market. Because FHA also allows borrowers to finance closing costs and other fees as part of the mortgage, the purchaser's equity can be very close to zero. With even a small drop in prices, many homeowners soon have mortgages larger than their home's value -- which is one reason FHA's defaults are rising. Every study shows that by far the best way to reduce defaults and foreclosures is to increase downpayments. Banks know this and have returned to a 10% minimum downpayment on their non-FHA loans.
In a rational world, Congress and the White House would tighten FHA underwriting standards, in particular by eliminating the 100% guarantee. That guarantee means banks and mortgage lenders have no skin in the game; lenders collect the 2% to 3% origination fees on as many FHA loans as they can push out the door regardless of whether the borrower has a likelihood of repaying the mortgage. The Washington Post reported in March a near-tripling in the past year in the number of loans in which a borrower failed to make more than a single payment. One Florida bank, Great Country Mortgage of Coral Gables, had a 64% default rate on its FHA properties. The Veterans Affairs housing program has a default rate about half that of FHA loans, mainly because the VA provides only a 50% maximum guarantee. If banks won't take half the risk of nonpayment, this is a market test that the loan shouldn't be made.
These reforms have long been blocked by the powerful housing lobby -- Realtors, homebuilders and mortgage bankers, backed by their friends in Congress. They claim FHA makes money for taxpayers through the premiums it collects from homebuyers. But keep in mind these are the same folks who said taxpayers weren't at risk with Fannie Mae and Freddie Mac. A major lesson of Fan and Fred and the subprime fiasco is that no one benefits when we push families into homes they can't afford. Yet that's what Congress is doing once again as it relentlessly expands FHA lending with minimal oversight or taxpayer safeguards.
As Foreclosures Surge ...
The Obama administration sat by last week as 12 Senate Democrats joined 39 Senate Republicans to block a vote on an amendment that would have allowed bankruptcy judges to modify troubled mortgages. Senator Obama campaigned on the provision. And President Obama made its passage part of his antiforeclosure plan. It would have been a very useful prod to get lenders to rework bad loans rather than leaving the modification to a judge. But when the time came to stand up to the banking lobbies and cajole yes votes from reluctant senators — the White House didn’t. When the measure failed, there wasn’t even a statement of regret.
Mr. Obama’s plan to keep struggling Americans in their homes now relies on lenders to voluntarily rework bad loans. The plan provides ample incentives, including payments to servicers who successfully modify loans and, in some cases, payments to mortgage investors who agree to modifications. Whether that will be enough remains to be seen. The administration estimates that its plan will prevent three million to four million foreclosures, but it will take several months before there is enough data to evaluate. In the past, however, voluntary modifications have failed to curb the rise in foreclosures. The number of foreclosure filings in March was very high, with estimates between 290,000 and 341,000. Even if lenders do agree to modify loans, many Americans will still be in trouble. That’s because nearly 14 million homeowners are "under water" — they owe more on their mortgages than their homes are worth.
In a bankruptcy, such homeowners would likely have their loan principal reduced, lowering their payments and helping them to rebuild equity. In a typical voluntary loan modification, however, the monthly payment is reduced, but not the principal. That puts under-water borrowers at high risk of redefault, because there is no equity to fall back on if a financial setback leaves them unable to make mortgage payments. The negative feedback loop — foreclosures beget falling home prices, which beget foreclosures, further weakening the banks — is well under way. We hope the president’s plan can break the loop, but without bankruptcy reform it is going to be a lot harder.
US Construction Spending, Pending Home Sales Increase
Total U.S. construction spending rose for the first time in six months in March, beating analyst expectations as public sector outlays increased. Separately, a forecasting gauge of home sales rose more than expected in March, buoyed by first-time home buyers taking advantage of lower prices. U.S. construction spending rose 0.3% to a seasonally adjusted annual rate of $969.7 billion during the month, the Commerce Department reported Monday. Analysts expected construction spending would fall by 1.3% in March. U.S. construction spending has been falling since September, taking with it thousands of construction jobs. It has fallen more than 11% on a year-over-year basis. In revising February's construction spending estimates, the the Commerce Department on Monday said spending fell 1.0%, slightly more than its original estimate of a 0.9% drop.
In March, the Commerce Department data shows residential construction spending fell, dropping by 4.1% to $265.85 billion. Residential spending fell a revised 5.6% in February, up from the Commerce Department's original estimate of a 4.1% drop. Residential spending in March was down 33.3% from March 2008. Spending in the non-residential sector, rose 2.0% in March as spending for educational and power facilities rose while spending on office construction remained fairly steady. February's non-residential spending marked a bright spot in that month's report, climbing 0.5% amid declines in outlays for certain other types of construction. Total nonresidential construction is up 1.7% for the year. Private sector construction spending fell 0.1% in March to $661.0 billion. Private sector spending had fallen a revised 2.1% in February. Public-sector construction spending by state and federal governments rose 1.1% in March to $308.7 billion. Public sector spending was up a revised 1.3% in February.
The National Association of Realtors' index for pending sales of previously owned homes rose 3.2% to 84.6 from a revised 82.0 in February, the industry group said Monday. Private analysts projected pending sales would grow just 1.0% during March. The gauge rose to a revised 82.0 in February from 80.4 in January. Still, Lawrence Yun, NAR chief economist, said it's too early to declare a housing market recovery. "This increase could be the leading edge of first-time buyers responding to very favorable affordability conditions and an $8,000 tax credit, which increases buying power even more in areas where special programs allow buyers to use it as a down payment," Mr. Yun said in a statement. "We need several months of sustained growth to demonstrate a recovery in housing, which is necessary for the overall economy to turn around." In its monthly forecast on the industry, the NAR projected existing-home sales at 5.28 million in 2010 and 4.97 million in 2009. That compares with 4.91 million in 2008.
The median price for an existing home is seen at $196,800 in 2010 and $188,500 in 2009. It was $198,100 in 2008. A month ago, the NAR forecast 2009 sales at 4.96 million and 2010 sales at 5.25 million. The 2009 median price was projected at $188,500 and the 2010 price at $196,200. The NAR pending sales index, based on signed contracts for previously owned homes, was 1.1% above the level of 83.7 in March 2008. The NAR's pending home sales index was designed to try to measure which way the housing market will go in the future. It is based on pending sales of existing homes, including single-family homes and condominiums. A home sale is pending when the contract has been signed but the transaction hasn't closed. Pending sales typically close within one or two months of signing. By region, pending sales in the Northeast grew 34.9% in March from February; they were down 20.0% since March 2008. Midwest activity grew 20.2% in March from February; it's up 12.4% since March 2008. Activity in the South grew 34.2% in March from February; it has grown 8.9% since March 2008. In the West pending sales rose 23.9% in March from February; they're up 4.3% since March 2008.
Fed Says U.S. Banks Expect Loan Losses to Deepen This Year
Most U.S. banks expect loan delinquencies and losses to increase this year, a Federal Reserve report showed today ahead of this week’s release of stress tests of the nation’s 19 largest lenders. More than 70 percent of respondents on net said bad loans will rise should the economy progress "in line with consensus forecasts," the Fed said in a quarterly survey of banks’ senior loan officers. More firms made it tougher for consumers to get home and credit-card loans in the past three months, while fewer tightened terms for businesses than in the previous survey. The report indicates that signs of stabilization in the U.S. economy aren’t resulting in an easing in lending terms.
Banks are hoarding a record $1.1 trillion of cash even after the Treasury and central bank made emergency capital injections and set up special lending programs to ensure lenders extended credit to households and businesses. "The vast majority of domestic and foreign respondents indicated that they expect deterioration in credit quality for all types of business and household loans," today’s Fed report said. The Fed is scheduled to release results of stress tests on the 19 largest banks on May 7. Chairman Ben S. Bernanke is taking unprecedented steps to expand credit and break the back of a financial crisis, and the Obama administration has said it’s prepared to make further taxpayer funds available to ensure no major American bank fails. Fed policy makers said in their policy statement last week that "tight credit" is still restricting consumer spending.
The central bank’s Open Market Committee, meeting April 28-29, left the door open to boosting programs to aid lending even with "some easing of financial market conditions." The senior loan officers’ survey was conducted from March 31 to April 14. A larger share of banks reported tightening terms on residential mortgages compared with the previous survey, the central bank said. At the same time, about 35 percent of domestic respondents saw increased demand for prime mortgages, a reversal from a net 10 percent reporting weaker demand in January. That was the first increase in such demand in at least two years, the Fed said.
About 65 percent of banks, up from 45 percent in January, lowered credit-card lines for new or existing customers, while the share of banks raising minimum required credit scores also increased, the Fed said. Last week, the U.S. House of Representatives passed a so- called credit-card bill of rights after adding a provision requiring banks to apply consumers’ payments to balances with the highest interest rates first. Lawmakers said they’re under increasing pressure from constituents to respond to rising interest rates and abrupt changes to consumers’ accounts. In the previous survey, released Feb. 2, the Fed said a majority of U.S. banks had made it tougher for consumers and businesses to get credit in the prior three months.
Euro zone budget gap to more than triple by 2010-EU
The euro zone budget deficit will more than triple to 6.5 percent of gross domestic product next year as a result of the worst recession since World War Two, the European Commission forecast on Monday. It predicted the aggregated budget gap of the 16 countries sharing the euro would rise to 5.3 percent of gross domestic product this year from 1.9 percent in 2008, well above the European Union's limit of 3 percent. In the whole 27-nation EU, the budget deficit is to more than double to 6 percent this year and rise further to 7.3 percent in 2010, reflecting both the slowdown and the public spending measures taken to support the economy. European Central Bank Vice President Lucas Papademos said the forecasts indicated a "serious fiscal deterioration", which given the depth of the crisis was clearly warranted because reviving the economy was fiscal policy's first priority now.
But he warned governments to strike the right balance between stimulus and keeping public trust in EU budget rules. "Fiscal policy needs to have a credible exit strategy from the current extraordinary circumstances," he said. "Governments need to be credibly committed to achieving sound fiscal positions as soon as possible," he said. Of the 16 euro zone members, only three will manage to keep their budget gaps below the EU's 3 percent ceiling this year and next -- Cyprus, Luxembourg and Finland. Ireland will have the biggest budget gap in Europe of 12 percent of GDP this year and 15.6 percent in 2010. The Commission forecast in January that Ireland would have a budget gap of 11 percent this year and 13 percent in 2010, but Almunia said the end-2013 deadline set for Dublin to bring its deficit back below 3 percent was appropriate.
Ireland is likely to win praise from euro zone finance ministers, or the Eurogroup, meeting on Monday in Brussels for tough austerity measures decided last month to curb the gaping hole in the budget, despite a severe recession. "I do think that the Irish government with great courage and a deep sense of responsibility are on the way to take the right step in a very difficult situation," the chairman of the ministers' talks, Jean-Cluade Juncker, said before the meeting. "We will discuss with the Irish, but I do think that the Irish are behaving in the right sense," said Juncker, who is also Luxembourg's prime minister and finance minister.
Spain will come second with an 8.6 percent deficit this year and a 9.8 percent shortfall next year, while France will come third with a gap of 6.6 percent this year and 7 percent in 2010. The Commission also revised sharply upwards its deficit forecast for Greece to 5.1 percent this year and 5.7 percent in 2010 from the previously seen 3.7 and 4.2 percent. Nevertheless, Almunia said Athens should still reduce the shortfall to below 3 percent by the end of next year, as recommended earlier by EU finance ministers. "We are determined to succeed in our fiscal efforts to reduce fiscal deficit and debt and to continue those efforts after the crisis," Greek Finance Minister Ioannis Papathanasiou told a seminar before the Eurogroup meeting.
Outside the single currency area, Britain's budget gap will double to 11.5 percent this year and rise further to 13.8 percent in 2010, with Latvia close at its heels with an 11.1 percent shortfall this year and 13.6 percent next year. Almunia said the Commission would proceed with disciplinary budget steps for exceeding the 3 percent deficit limit, as envisaged by EU budget rules, against Malta, Poland, Romania, Lithuania and Latvia. It has already launched such steps against France, Ireland, Spain, Greece, Britain and Hungary. "There is a broad consensus to support the (European) Commission on starting deficit proceedings," German Finance Minister Peer Steinbrueck said on entering the Eurogroup meeting. "If necessary next year, possibly against Germany too."
Euro-Area GDP to Shrink 4% This Year, Jobless Rate to Soar, EU Forecasts
The European Union cut its forecast for the euro-area economy to show a contraction twice as deep as it projected just three months ago, and said the region’s budget deficit will swell to more than double the EU limit. The economy of the 16 countries sharing the euro will shrink 4 percent in 2009 and 0.1 percent in 2010, the European Commission, the EU executive in Brussels, said today, revising a January estimate for a contraction of 1.9 percent this year. The region’s average budget deficit will swell to 6.5 percent of output next year, when unemployment will rise to 11.5 percent, the commission said.
Companies across the continent are cutting production and firing workers to survive the worst recession since World War II, while governments’ efforts to support their banks and economies have pushed public deficits beyond the limit of 3 percent of output set out in European rules. The European Central Bank may this week announce new measures to combat the recession after cutting its benchmark rate to a record low. "We are no longer in free fall, but even if some positive signals appear, we don’t have the critical mass of data to say we are out of the woods," EU Monetary Affairs Commissioner Joaquin Almunia told a news conference in Brussels. "I hope this will be the last downward revision of our forecasts." The euro traded at $1.3269 against the dollar at 12:40 p.m. in Brussels, compared with $1.3288 before the report.
The commission’s new forecasts are in line with numbers from the International Monetary Fund and the Organization for Economic Cooperation and Development. The IMF said on April 22 that the euro-area economy may shrink 4.2 percent this year and 0.4 percent in 2010, while the OECD forecast a contraction of 4.1 percent this year and 0.3 percent in 2010. Infineon Technologies AG, Europe’s second-largest maker of semiconductors, and BASF SE, the world’s largest chemical company, are among companies cutting jobs. Infineon has reduced its workforce by 9 percent since September and BASF last week said it would cut 2,000 jobs. As the global slump curbs orders and rising unemployment undermines consumer spending, companies are being forced to hold the line on prices. Paris-based Carrefour SA, Europe’s largest retailer, is launching a budget range covering 400 product lines to help reverse declining sales in its home market.
Euro-area inflation will slow to 0.4 percent this year before accelerating to 1.2 percent in 2010, the commission projected. That follows a report from the commission last week showing consumers expect prices to decline over the next 12 months, the first time the price-outlook gauge has been negative since at least 1990. The commission doesn’t see a "serious risk for deflation in the EU or in the euro area," Almunia said. The EU sees the euro region’s unemployment rate increasing to 9.9 percent this year and 11.5 percent in 2010, with the highest rates expected in Spain and Ireland. The budget deficit will probably swell to 5.3 percent this year and 6.5 percent in 2010 from 1.9 percent in 2008, it said. The overall shortfall will break the EU limit of 3 percent of gross domestic product for the first time since 2003 and next year 13 euro members will breach the threshold.
This year, Ireland will contract 9 percent, Germany 5.4 percent and economic output in Italy will drop 4.4 percent. The economy of the 27 countries in the EU will also shrink 4 percent this year, according to the commission forecasts. Europe’s economy may be moving past the worst of the recession, data last week and today suggested. Confidence in the euro area increased for the first time in 11 months in April, the European Commission said, and an index of European manufacturing rose to a six-month high. European investor confidence also rose for a second month in May. Beyond Europe, U.S. consumer confidence jumped the most in more than two years and data showed today that China’s manufacturing expanded for the first time in nine months in April.
Still, German retail sales fell unexpectedly in March, the Federal Statistics Office said, as unemployment increased. The economic slump has prompted the ECB to embark on the most aggressive series of interest-rate cuts in its 10-year history. The Frankfurt-based central bank has lowered its benchmark rate 3 percentage points to a record low of 1.25 percent and signaled another cut is likely at its next meeting on May 7. President Jean-Claude Trichet has said policy makers will decide on any additional measures at that meeting.
Europe must learn from Japan's experience
by Wolfgang Münchau
Our Great Recession has been compared with several crises of the past, but Japan's lost decade is perhaps most relevant. This is not because of the way the two crises developed -we do not yet know what will happen to us- but because of our failure to learn from Japan's mistakes. Otto von Bismarck said only fools would learn from their own mistakes, while he preferred to learn from the mistakes of others. We are mostly fools. I am particularly struck by the similarity of the policy responses in Japan then and Europe today. Adam Posen, deputy director of the Peterson Institute in Washington, made the following observation in a book he published in 2000 about the parallels between Japan's lost decade and US policy during the savings and loan crisis. He wrote: "Bank regulators issued a litany of announcements meant to be reassuring about the extent of the bad loan problem and the adequacy of Japanese banks' capital, each of which was correctly disbelieved by other financial firms, foreign banks, and by Japanese savers as understating the problem."
This is exactly what is happening in Europe today. Governments are not coming clean on the scale of the crisis. Süddeutsche Zeitung, the German newspaper, recently revealed an internal memo from Bafin, the country's banking regulator, showing the estimated scale of write-offs would be more than 800bn ($1,061bn, 712bn), about a third of Germany's annual gross domestic product. By comparison, the entire capital and reserves of its monetary and financial institutions were only 441.5bn in February. If the leaked number is true, it would mean the German financial system is broke. Bafin was outraged by the leak, and launched legal action. Senior officials tried to play down the significance of the number. This is what Dr Posen described in his critique of Japan. Robert Glauber, now at Harvard University, wrote in the same book that "the government's timidity in informing taxpayers of the full cost to resolve the crisis produced a large, unnecessary delay. The delay in both cases turned a relatively small cost into a staggering large one". Again, this is happening today. Both the Geithner plan in the US, and the recently announced, but not yet detailed German financial rescue plan, pretend that the rescue can be largely cost-free to the taxpayer.
Japanese governments also made several attempts to resolve the crisis during the 1990s, but these plans were too timid. Japan's lost decade ended only in 2002 after Heizo Takenaka, minister for financial services under Junichiro Koizumi, the former prime minister, forced the banks to write down bad debt, and to accept new capital from the government. Just like the Japanese, the US and European governments will do the right thing eventually. But just like the Japanese, they are determined to do all the wrong things first. What could we learn from Japan's fiscal policy? The purpose of increased government expenditure during a severe financial crisis is to break down the toxic feedback loops between the real economy and the financial sector. In that respect, the European stimulus programmes are much less satisfactory than US policy, not so much in terms of the gross headline numbers, but in terms of their net effect on economic growth. Just like Japan in the 1990s, the eurozone cannot deliver effective fiscal stimulus, in our case due an inflexible rule-based system of economic governance, heavy bureaucracy and an astonishing lack of co-ordination. I would not be surprised if the total economic effect of the US stimulus ended up twice as large as the total of the various European programmes.
The only European institution that seems to have grasped the need to learn from Japan's experience is the European Central Bank. European money market rates are close to zero, and while one can always argue about the finer details of monetary policy, central banks on both sides of the Atlantic are close to having exhausted their freedom of manoeuvre. The ECB will this week cut official interest rates again, probably by another quarter point, but even further rate cuts will not make much difference to real world interest rates. I consider myself agnostic about the benefits of quantitative easing, both in terms of its effectiveness in shifting long-term interest rates, and in terms of the difficulties central banks might encounter in the future. From the evidence I have seen from Japan, it was the resolution of the banking crisis more than the adoption of quantitative easing by the Bank of Japan that finally did the trick. All this leaves Europe with a policy mix only slightly better than Japan's in the 1990s. Yet, Europe faces an additional problem. While Japan had its crisis when the rest of the world was booming, Europe has no such luck. I see nothing in our situation or our policy response to persuade me that it will take less than a decade to get out of this.
Spain Largely Avoids Unrest Even as Economy Slumps
Spain's unemployment rate has topped 17%, and economists expect it to hit 20% next year. But Depression-era scenes don't dot its landscape. Spaniards aren't, en masse, sleeping under bridges. Tent cities haven't sprung up outside Spanish towns. Labor has yet to call a single major strike. Europeans are notoriously quick to take to the streets to defend their economic interests. Yet, as the Continent endures its worst economic crisis since the end of World War II, things seem unusually calm. Even Friday's May Day marches were more muted than expected. Though hundreds of thousands of people across Europe took part in the annual demonstrations, calling on governments to support jobs and workers, overall participation was less than unions had hoped for, considering the severity of the downturn.
Exact reasons for the subdued mood vary from country to country, but a common theme emerges: The very factors that make some European economies sluggish and inflexible during times of plenty also help cushion the impact of the downturn. Spain exemplifies this. During the good times, its economy is held back by low productivity, an extensive underground economy and scant labor mobility. Studies show that Spaniards are unusually reluctant to move away from their home region -- a trait that acts as a drag on the economy. Today, however, being close to one's extended family is a lifeline. Members of Spanish families help one another pay the mortgage, so there are fewer foreclosures. Even when they lose their homes, Spaniards rarely end up on the street. For the most part, they move in together. "The family represents kind of a social-welfare network that allows the country to withstand a much higher rate of unemployment," says Rafael Doménech, chief economist for Spain and Europe at BBVA bank.
Then there is the question of who would lead any unrest. The huge job losses in Spain have been borne almost entirely by temporary workers -- women, immigrants and the young -- who aren't represented by anyone. The types of workers who tend to belong to labor unions -- middle-aged men on full-time contracts -- have scarcely been touched by layoffs. In fact, the latest jobs report showed they had slightly increased their number in the first quarter of the year -- even as 800,000 temporary and self-employed workers lost their jobs. Another issue Spain shares with other southern European countries is its extensive black economy. During the good times, economists have encouraged countries like Spain and Italy to bring the black market under control. In the bad times, however, that market can give many Spaniards secret, undeclared sources of income that can keep them afloat.Analysts say it could represent as much as one-fifth of the Spanish economy, providing work for people who are formally unemployed.
Most mainland European nations are also simply more accustomed to living with high unemployment. Even at the height of Spain's credit-fueled boom, with an overheated economy running at full tilt, the country's unemployment rate fell only to 8%. Given the rigidities of its labor market, the country's "natural" rate of unemployment is far higher than that of other countries. Economists at Spain's BBVA bank put the country's so-called Nairu -- the sustainable rate of unemployment that can be reached without the economy overheating -- as high as 14%. Spanish police had braced for violence during Friday's May Day marches. But just 6,000 people turned out for the parade in Madrid, according to Spanish police, in a largely good-natured event that featured samba dancing, not Molotov cocktails. Other Spanish cities also drew relatively small crowds.
In Germany and France, demonstrations attracted more people than last year. But Germany has seen little other sign of widespread protest or labor unrest. In France -- synonymous in many people's minds with revolution -- Friday's marches drew fewer people than a general strike two months ago. The country's biggest unions said over the weekend that they weren't planning to organize another strike right away lest they plunge the country into chaos. Overall, other than a few boss-nappings and some local protests, things have been reasonably tranquil. A notable exception since the global economic crisis began is Greece, where one-fifth of people live below the poverty line. There, hundreds of youths clashed with police over four days of rioting in December, underscoring frustration over the high youth-unemployment rate.
Spain last suffered an unemployment rate of 17% only a decade ago, following the recession of the early 1990s. In the early 1990s, it regained growth by devaluing its currency. Now that it uses the euro, it no longer has that option. The only way it can make its wrenching economic adjustment is by shedding jobs. Spain has no obvious industry to pick up the slack now that the country's bloated construction sector has collapsed. Because of its onerous labor laws, employers will wait a long time to hire, even when a recovery begins. And the Socialist government has made it clear it has no intention of overhauling labor laws. The idiosyncrasies of European economies have so far permitted governments to take a more laid-back approach to fighting the downturn than, say, the U.S. But if the recession drags on, their people's patience will be tested. Then, Greece's riots could become the rule, rather than the exception.
Spanish banks lead the way in risk management
Every Wednesday morning at 9.30am, five BBVA board members gather at the Spanish bank’s head office in Madrid. For the following three hours, they review new loans and discuss broader risks that might affect the bank’s operations. When necessary, they reconvene the next day. In 2007, they met a total of 74 times. These meetings are similar to those that are held regularly in banks around the world. But in the case of the make-up of BBVA’s risk committee there is one important difference: just one of its members, José Maldonado Ramos, is a full-time bank executive. The other four are non-executive directors. Other Spanish banks take a similar approach. Santander, BBVA’s main domestic rival, has a five-member risk committee, including three non-executive directors, which met 102 times last year.
Managers believe that this intense board-level focus on risk is one reason why Spain’s large banks have so far weathered the credit crunch in better shape than many of their European rivals. This approach is now winning admirers elsewhere. Lord Turner, chairman of Britain’s Financial Services Authority, recently argued that banks might benefit from non-executive board members who devoted most of their time to one institution. Sir David Walker, the respected investment banker, is expected to consider this question in his review of banks’ corporate governance. The notion of full-time non-executive directors is one of the main suggestions to emerge from a new report on European bank governance by Nestor Advisers. "Banks will need people to come to their boards in a very dedicated fashion, and though they are non-executives, become more hands-on in terms of the way risk is run," says Stilpon Nestor, the corporate governance consultancy’s founder. For some directors, many of whom have full-time jobs elsewhere, the notion of a weekly meeting is unthinkable.
Some bankers fear that a move in this direction would scare off potential board members who are already concerned by the workload and public scrutiny associated with being the director of a large financial institution. Institutional investors fret that full-time directors would have less independence than their part-time counterparts. "We do not believe in a system of full-time independent directors: this could lead to a loss of independence and would rule out our being able to attract serving executives from other companies and sectors to become non-executive directors on our board," Marcus Agius, chairman of Barclays, told shareholders of the British bank last month. Given the current scrutiny of bankers’ bonuses, there is also the thorny question of compensation: members of Santander’s risk committee are paid more than twice as much as normal non-executive directors of the bank.
It would also be simplistic to suggest that introducing a full-time risk committee, or appointing more bank executives to the board, could have prevented the problems some banks have experienced. The board of UBS, for example, delegated many of its risk-management decisions to a small committee of former executives who failed to spot that the bank was piling highly rated but risky loans onto its balance sheet. Mr Nestor points out that all eight of the European banks that have outperformed in the crisis have an experienced banker as chairman. But so did half the banks that have underperformed. The performance of Spanish banks is also due to the tight controls imposed by the country’s central bank, which banned off-balance sheet vehicles and forced banks to build up extra reserves during the boom.
Even so, as policymakers and politicians attempt to improve corporate governance and risk management at banks in an attempt to prevent a repeat of the crisis, the Spanish approach is worth debating. Emilio Botín, Santander’s chairman, recalls a visit from a former chairman of the US Federal Reserve who expressed surprise at the amount of time the bank devotes to risk management. "It’s true, it consumes a lot of our directors’ time," Mr Botín said in a speech last year. "But we find it essential. And it is never too much."
Learning Labor Market Lessons from Germany
By reforming benefits and other programs, unemployment in Germany has increased only slightly. The U.S. could learn a thing or two. Germany's economy is among the most troubled in the European Union, yet unemployment has so far risen only modestly. Why the sturdy labor market? In recent years, Berlin has rejiggered benefits and other programs to help ensure jobs don't go unfilled just because there's no one around with the right skills. The progress may offer lessons for the U.S. Germany's experience suggests that generous unemployment benefits can make it too comfortable for an out-of-work welder to spend the day watching Desperate Housewives reruns rather than learning a new trade, so it helps to establish limits. But without incentives, companies are less likely to offer retraining—and workers may not see the benefit of trying something new. Germany long had the highest ratio of unfilled jobs to unemployed people in Europe.
Then, in 2003, Berlin launched the so-called Hartz reforms, ending generous unemployment benefits that went on indefinitely. Now payouts for most recipients drop sharply after a year, spurring people to look for work. From 12.7% in 2005, unemployment fell to 7.1% last November. Even now, after a year of recession, Germany's jobless rate has risen to just 8.6%. At the same time, lawmakers introduced various programs intended to make it easier for people to learn new skills. One initiative instructed the Federal Labor Agency, which had traditionally pushed the long-term unemployed into government-funded make-work positions, to cooperate more closely with private employers to create jobs. That program last year paid Dutch staffing agency Randstad to teach 15,000 Germans information technology, business English, and other skills.
And at a Daimler (DAI) truck factory in Wörth, 55 miles west of Stuttgart, several dozen short-term employees at risk of being laid off got government help to continue working for the company as mechanic trainees. Under a second initiative, Berlin pays part of the wages of workers hired from the ranks of the jobless. Such payments make employers more willing to take on the costs of training new workers. That extra training, in turn, helps those workers keep their jobs after the aid expires, a study by the government-funded Institute for Employment Research found. Café Nenninger in the city of Kassel, for instance, used the program to train an unemployed single mother. Co-owner Verena Nenninger says she was willing to take a chance on her in part because the government picked up about a third of her salary the first year. "It was very helpful, because you never know what's going to happen," Nenninger says.
Another successful program lets people who start a small business continue receiving full jobless benefits for an extra six months. Two-thirds of the subsidy recipients were still self-employed 41/2 years later. One beneficiary is Manfred Prusensky, who worked at a Kawasaki motorcycle dealership that shut down. Instead of collecting unemployment, which Prusensky regards as "hell," he receives $1,300 a month, which he's using to fund a motorcycle repair shop he launched. "It's going good," Prusensky says. "We've got lots to do." The bad news is that unemployment could begin to rise sharply should the economy continue to struggle. If that happens, politicians may cater to nostalgia for the days when jobless benefits were almost as lucrative as working, and no one had to take a position they didn't want. With national elections coming in September, the center-left Social Democrats are calling for increased benefits for long-term unemployed people with children, while the more radical Left Party has made repeal of the Hartz reforms a centerpiece of its platform.
"Politicians have an incentive to implement measures that are popular but could damage the labor market," says Hermann Gartner, an economist at the Institute for Employment Research. And despite the progress, it's clear that Germany hasn't eliminated the mismatch problem. German universities still aren't turning out enough engineers and IT specialists, according to the Adecco Institute, a think tank funded by Swiss temp giant Adecco. Even amid the recession, an Adecco study says, 29% of large German companies have trouble filling technical jobs. The upside to such problems, though, is that companies cling to their best workers as long as they can. "I want to keep everybody," says Henning Fehrmann, president of Fehrmann Metal Processing, a family-owned outfit in Hamburg that employs about 70 people making heavy-duty windows for ships. "If I let them go and I need them one year later, it will be a huge investment to retrain them."
How Big Banks Want to Game the Mortgage Mess
Given the current housing crisis, there is wide support for measures to make it easier for homeowners to modify their mortgages. That is understandable. Nobody likes seeing the wave of foreclosures. Plus, mortgage modifications may help stabilize home values. But in the rush to do something, Congress is showing a regrettable willingness to adopt constitutionally suspect legislation that runs roughshod over the Fifth Amendment of the Constitution, which prohibits the taking of private property without just compensation. Ever since this current foreclosure crisis began, Congress has complained that the companies administering mortgages -- "servicers" -- have not done enough to modify home loans in ways that might prevent foreclosures. Why? Because, it is said, the servicers fear being sued by those who have invested in mortgage-backed securities.
To put a halt to such lawsuits, Rep. John Conyers (D., Mich.) is pushing legislation -- the Helping Families Save Their Homes in Bankruptcy Act -- that Congress is likely to pass in some form this year. The bill would grant servicers immunity from lawsuits so long as they can claim that investors will be better off -- even by a penny -- under a modified mortgage. The problem is that servicers also get a free pass to game the system. Distressed homeowners often have both a first mortgage and a second mortgage (like a home-equity loan), which by the legal standard in any bankruptcy is junior to the first loan. The four biggest banks in the country -- Bank of America, Citigroup, Wells Fargo, and J.P. Morgan Chase -- hold a combined $441 billion worth of second-mortgage loans. By contrast, these banks are not big investors in first mortgages. They therefore would prefer to see first mortgages modified in a way that makes it more likely that second mortgages are paid.
And they are in perfect position to make sure that happens. These four banks -- the "Top of the TARP" -- service more than half of all first mortgages. The result is a huge incentive for self-dealing by servicers to rewrite the investor-owned first mortgages in ways that increase the value of their affiliated bank-owned second mortgages. Favoring second mortgages in this way turns upside-down the basic legal standards governing lenders, both inside and outside of bankruptcy. The only thing protecting against this blatant conflict of interest is the contractual right of investors in first mortgages to sue servicers. But Mr. Conyers's bill would put the kibosh on that safeguard. Even a recently announced Treasury plan targeting second mortgages does not help. It pays servicers to modify first and second mortgages proportionally.
But the servicers' contracts require them to treat first mortgages as senior -- not equal -- to second mortgages. By rewriting contracts so that servicers can overturn well-established rules regarding priority among creditors, the proposed safe harbor runs headlong into the Takings Clause of the Fifth Amendment. That provision is intended to prevent the government from forcing an unlucky few to bear public burdens that should be borne by the population at large. The investors in securities backed by first mortgages manage these investments on behalf of employee pension funds, charitable organizations, college endowments, 401(k) plans and many others. The Constitution protects against irrational legislation that takes valuable contractual rights from investors to line the pockets of big banks.
Mr. Conyers's legislation isn't necessary to address the housing crisis. The director of the Federal Housing Finance Agency, James B. Lockhart, recently noted that servicers "can work within the present system" -- without lawsuit protection -- "and get a lot of loan modifications done." The government has tried ripping up financial contracts in the past only to get burned in the process. Two decades ago, in the Savings and Loan Crisis, regulators entered into contracts with financial institutions that took over failing thrifts. Congress then substantially eliminated the benefits contained in those contracts. What followed was years of costly litigation that eventually compelled the government to pay damages. The value of those damages may run into the billions of dollars. Congress should not make the same mistake this time.
Citigroup Said to Pursue Capital-Raising Maneuvers That Avert U.S. Control
Citigroup Inc., girding for results of the Federal Reserve’s bank stress test, may try to wring capital from private investors instead of U.S. bailout funds as a way of bolstering equity without ceding control to the government, people briefed on the matter said. Regulators have indicated to the New York-based bank, which got a $52 billion rescue last year, that another taxpayer-funded cash infusion won’t be required, according to one of the people, who asked not to be identified because the talks aren’t public. Discussions now center on how much of the government’s preferred shares in the firm must be converted into common stock, the person said. Under a plan set in February, the government would convert as much as $25 billion of its stake, for a 36 percent voting interest.
Getting money from private backers may help Citigroup dissuade the Treasury Department from converting all or part of its remaining $27 billion investment -- a step that may increase the government’s ownership to more than 50 percent and nationalize what was once the biggest U.S. bank. One likely solution for the company would be to convert $10 billion of privately held securities that could easily be added to the pending exchange, said Kevin Starke, who analyzes bank capital structures for hedge-fund clients of CRT Capital Group LLC. "That would bring in another $10 billion of common equity, which could be enough to bring Citi over the threshold" required by regulators, said Starke, whose Stamford, Connecticut-based firm specializes in evaluating multiple classes of a company’s securities. He has no rating on Citigroup’s stock.
Jon Diat, a Citigroup spokesman in New York, said he couldn’t comment on the stress tests. Michelle Smith, a spokeswoman for the Federal Reserve, which is overseeing the administration of the stress tests, declined to comment. None of the largest U.S. banks has succumbed to government control, as insurer American International Group Inc. and mortgage-finance companies Fannie Mae and Freddie Mac did last year. The Treasury Department designed the Troubled Asset Relief Program, or TARP, so the government got non-voting preferred shares in exchange for bank-bailout funds. The KBW Bank Index, which tracks the 24 biggest banking stocks, has plunged 63 percent in the past year, partly on concern that banks don’t have enough common equity, one of the most conservative measures of capital, to absorb mounting losses during a prolonged recession.
Treasury Secretary Timothy Geithner, who on Feb. 10 announced a plan to test how bank balance sheets would fare under a "stress" scenario where unemployment climbs above 10 percent, says the government will ensure the 19 biggest U.S. banks get enough capital to withstand the crisis. The government says it will inject additional capital where needed and consider converting TARP preferreds into common stock. Last year, the Treasury amassed $45 billion of preferred shares in Citigroup in exchange for bailout funds and another $7 billion of preferreds for a guarantee on $301 billion of the bank’s troubled loans and bonds. Bank of America Corp., which like Citigroup got $45 billion of bailout funds, also may wind up partially owned by the government if its TARP preferreds are converted into common. Bank of America hasn’t received a "final number" from the Fed on how much capital it may need to raise, spokesman Scott Silvestri said today in an interview.
Citigroup, beset by mortgage-bond writedowns and surging losses on credit-card loans, has recorded a $36 billion net deficit over the past six quarters, reducing its tangible common equity to $29.7 billion as of March 31. Some investors say tangible common equity is the most reliable portion of a bank’s capital because it excludes goodwill, the intangible asset booked when a company makes acquisitions. Goodwill may have to be written off in a market where the value of acquired businesses becomes suspect. Chief Executive Officer Vikram Pandit, 52, has announced a plan to sell "non-core" businesses to free up capital. Last week the bank said it would get a $2.5 billion boost to tangible common equity from the sale of its Japanese brokerage, Nikko Cordial Securities. The bank also is selling majority control of its Smith Barney brokerage to Morgan Stanley, a transaction that will add another $6.5 billion to Citigroup’s tangible common equity. That deal is scheduled to close in the third quarter.
Regulators completing the stress tests are working with banks to forecast profits and losses over the next two years. The goal is to see how much their capital would dwindle in a severe recession, and force them to address any potential shortfall. The results are scheduled to be released May 7. Under Citigroup’s plan to convert $25 billion of the government’s investment into common stock, holders of about $27 billion of privately held preferred shares also will convert their stakes. Citigroup induced the private holders to participate by suspending dividends on the preferreds -- eliminating an advantage the securities had over common stock. The bank also agreed to convert the preferreds at a premium to their market value. Citigroup may make a similar offer to holders of about $10 billion of enhanced trust preferred securities, known as E- Trups, which rank above regular preferreds in repayment order, according to CreditSights Inc. analyst David Hendler. The E- Trups are a bond-like security whose coupon can be deferred for 10 years without triggering a default.
Markets aren’t likely to warm to a secondary stock offering, and the bank may have trouble attracting investors who aren’t already entangled, he said. "It’s hard to get third parties involved if the investors who are already there haven’t had their pound of flesh extracted," Hendler said. "And the next class of investors to be in that donation mode are these E-Trups holders." Since the E-Trups are trading at 40 to 60 cents on the dollar, holders probably would come out ahead if Citigroup expands its exchange offer to include them, according to CRT’s Starke. "They just need to open the window wider," Starke said. Such a deal would come at the expense of common shareholders, who already have watched the stock price tumble 95 percent since the end of 2006. Citigroup gained 17 cents, or 5.7 percent, to $3.14 at 9:49 a.m. in composite trading on the New York Stock Exchange. Under the existing conversion plan, common shareholders would be diluted by 74 percent, and the dilution would increase if additional preferred holders were invited into the exchange. Citigroup’s E-Trups issued in December 2007 with an 8.3 percent coupon surged 12 percent last week to 61.5 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Is The White House Lying About Perella Weinberg Threat Story?
Allegations that the Obama administration behaved thuggishly in putting together its Chrysler rescue package aren't going away. Right now we're at a kind of impasse, with conflicting accounts that need to be resolved before we will know exactly what happened.
- White & Case partner fingers Rattner. Tom Lauria, the head of White & Case's bankruptcy practice, says that Obama's Car Czar Steve Rattner threatened to turn the White House press corps loose against Perella Weinberg if the firm continued to oppose the administration's plan. White & Case represented PW until the firm caved to White House demands. Now he continues to represent the remaining hold-out firms.
- Perella Weinberg doesn't deny the threats. The firm at the center of this controversy switched from opposing the administration's plans to supporting them. It hasn't said it wasn't threatened by Rattner. Instead, it says that some kind of new appreciation of the economics of the deal are what made it change its position. It's remained silent about the alleged threats, which may be a way of signalling that the threats really were made.
- The White House has issued a blanket denial. The stakes got far higher yesterday when the spokesman for the White House issued a complete denial, calling Lauria's story "completely untrue." This puts the credibility of the president on the line in a dramatic way. If any part of Lauria's story holds up, Obama's reputation for honesty will be tarnished.
We wouldn't be surprised if intense pressure is now being brought to bear on Lauria to recant his original story. If anything, it's surprising that Lauria has gone this far. For now, the Obama administration stands accused by a prominent lawyer of behaving thuggishly and lying about it. Perella Weinberg's silence on the threats seems to support this accusation. The ball is now in Obama's court.
Sales Have Treasury Chasing Its Tail
With more Treasurys to sell, the government has found itself paying up at its debt auctions, and this week could see more of the same. That means not just higher interest costs for the public purse. It also works against the government's goal of keeping longer-term Treasury yields low, as these are the benchmarks for corporate and consumer lending rates, including home loans. In the past months, Treasury auctions have, on average, resulted in higher yields than had been expected by the market. This outcome is known as a tail. Tails are good news for buyers, because they get a higher return and pay a lower price for the securities. But the overall Treasurys market tends to weaken after tailed auctions, leading to higher yields. Bond prices fall when yields rise.
Auctions have tailed as the government has sold massive amounts of securities to fund its many rescue plans; in the first quarter alone, it sold nearly half a trillion dollars of debt. In the current three-month period, it expects to raise $361 billion, and an additional $515 billion in the three months to September. The largest refunding round on record, $71 billion, will occur this week. Tails, while frequent, have been relatively small this year -- between 0.01 and 0.02 percentage point on average. Still, said David Ader, head of government bond strategy at RBS Securities, the possibility of tails could keep investors sidelined leading up to an auction, as they expect to be able to buy the securities for a cheaper price later. Dealers are starting to adjust to the larger and more frequent debt auctions, driving prices lower and yields higher heading into the sale. On Friday, the 10-year yield pushed as high as 3.21%, with 3.25% eyed as the next key level.
Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co., said a yield of 3.25% or more could affect private credit markets, and raise eyebrows at the Federal Reserve, which is buying up Treasurys to keep yields low. Still, only if tails are large and persistent even after the market has cheapened ahead of an auction would there be cause for concern. "It would show the Street is having to mark down prices continually to attract buyers at a time when a lot of buyers are needed," Mr. Crescenzi said. That's when auctions couldn't just come with tails, they could also fail, which happens when fewer bids come in than the amount on offer.
Short Selling of Banks Accelerates as New Financial Stress Test
Short sellers, the bane of Wall Street executives last year, are back. The number of Citigroup Inc. shares borrowed and sold short increased sixfold since Feb. 27, the day the U.S. Treasury announced it would convert some of its preferred shares in the New York-based bank into common stock. Short interest in Bank of America Corp., MetLife Inc. and American Express Co. climbed more than 40 percent in the same period, according to data compiled by Bloomberg. In total, short sales of the 18 publicly traded financial companies undergoing government stress tests were twice as high on April 15 as they were at their peak last year in July, two months before Lehman Brothers Holdings Inc. collapsed. "People are either positioning themselves for the potential of a preferred-to-common conversion, or they have an increased perception of risk in these companies," said Andrew Baker, an equity strategist at Jefferies & Co. in New York.
The Federal Reserve plans to release results of the tests on May 7. At least six of the 19 firms under review will require additional capital to absorb losses if the recession worsens, people briefed on the preliminary results said last week. Short sellers borrow shares and sell them hoping to make a profit by replacing the stock after prices fall. Douglas Cliggott, manager of the Dover Long/Short Sector Fund in Greenwich, Connecticut, said he is shorting some bank stocks on expectations they will lose value as earnings deteriorate. New York-based hedge fund manager Daniel Loeb is betting that financial firms needing more capital will exchange preferred shares for common to bolster their balance sheets. He’s seeking to profit from the price difference between the two securities by buying preferreds and shorting the common.
Citigroup is in the process of converting as much as $52.5 billion of preferred, including $25 billion held by the government. Charlotte, North Carolina-based Bank of America, the largest U.S. lender by assets, will change $25 billion to $45 billion of preferred shares into common to raise capital, said Richard Staite, an analyst at Atlantic Equities LLP in London, in a report to clients last week. Wells Fargo & Co., based in San Francisco, and three smaller rivals -- BB&T Corp., SunTrust Banks Inc. and Regions Financial Corp. -- also may have to turn their preferred shares into common as a result of the stress tests, according to analysts at New York-based Creditsights Inc. To entice investors to accept common shares, companies may offer preferred holders a premium to the current price, said Phillip Jacoby, a managing director of Stamford, Connecticut- based Spectrum Asset Management Inc., which oversees $6 billion. Citigroup is offering holders of the $2.04 billion 8.5 percent Series F preferred $21.70 worth of common shares, 24 percent more than their price of $17.48 as of May 1.
By exchanging preferred for common, banks would be able to increase their tangible common equity, or TCE, a measure of how much capital a firm has to withstand losses. The financial yardstick strips out intangible assets, goodwill -- the premium above net assets paid for acquisitions -- and preferred stock, including shares issued to the U.S. Treasury. Regulators want TCE to equal about 4 percent of assets, up from an earlier target of 3 percent, people with knowledge of the situation said last week. Seven of the banks under review have ratios of less than 4 percent, company reports show. "Banks are going to need more capital," Jacoby said. "Treasury doesn’t care about dilution. All they care about is financial mass and loss-absorption ability to offset what could be more nonperforming loans and writedowns in the future."
The increase in short selling occurred as the S&P 500 Financials Index posted its best two months since 1989, when Standard & Poor’s started keeping records. The 80-member index has surged 41 percent since Feb. 27. Stephen Wood, who helps manage $151 billion as senior strategist at Russell Investments in New York, said the stress tests will narrow the breadth of the rally. "It will end up resulting in a differentiation of the shares," Wood said. "It will be a vicious cycle for the companies that are not doing well. The share price will go down in anticipation of dilution with the issuance of new shares." Short sellers were accused last year by Wall Street chief executive officers, including Lehman’s Richard S. Fuld and Morgan Stanley’s John J. Mack, of using abusive tactics to attack firms. Fuld, 63, told congressional investigators on Oct. 6, less than a month after Lehman filed the biggest bankruptcy in history, that short sellers played a role in a "storm of fear" that led to the demise of the 158-year-old firm. Mack, 64, helped persuade government officials in the days following Lehman’s collapse to suspend short selling, which he said was sending his New York-based firm’s shares into a free fall.
The U.S. Securities and Exchange Commission imposed an emergency ban on bearish bets on more than 900 finance-related companies for a three-week period that ended Oct. 8. The agency also tightened requirements on delivering borrowed securities and imposed rules that require hedge funds to privately report short sales to the agency. The SEC will convene a meeting May 5 to discuss proposals for restricting short sales, including an outright ban when a stock’s price declines. "The ban last year crushed a lot of hedge funds and their investment strategies," Perrie Weiner, a partner at the law firm DLA Piper in Los Angeles, said in a telephone interview. "There are much cooler heads now. They are looking at ways by which they can say, ‘We’ve got a better regulated market, and we are on the road to recovery.’"
Short interest rose after Feb. 27 for 14 of the 18 publicly traded companies under review by the Fed, according to Bloomberg data. Citigroup’s increase was the biggest at 509 percent, followed by New York-based insurer MetLife at 66 percent, American Express at 44 percent and Bank of America at 42 percent. The average increase for the 18 companies was 47 percent. It was 201 percent excluding Citigroup. Representatives for Citigroup, Bank of America, MetLife, and American Express declined to comment. Detroit-based GMAC LLC, the auto and mortgage lender that received a $6 billion government bailout and is one of the 19 companies undergoing stress tests, wasn’t included in the Bloomberg data because it isn’t publicly traded. The total short interest for the 18 firms as of April 15, the last date for which New York Stock Exchange data are available, was 2.1 billion shares, or 7.1 percent of those available for trading. That compares with 1.05 billion shares on July 15, or 4 percent of those available for trading.
Excluding Citigroup, which accounted for about half of the increase, the total stood at 866.1 million shares on April 15, higher than all but one period last year and 2.9 percent shy of the July peak. The number of shares sold short in Morgan Stanley totaled 52 million on April 15. While that’s down 12 percent since Feb. 27, it’s higher than the 45.3 million shares on Sept. 15, when Mack was lobbying lawmakers and regulators for a ban. The large short positions will fuel volatility in stock prices when regulators announce the results of the stress tests, said Matthew McCormick, a fund manager at Cincinnati-based Bahl & Gaynor Investment Counsel Inc., which oversees $2.1 billion. "With that massive amount of short interest, what those traders are saying is that they feel this process is not going to be managed well," said McCormick, whose firm doesn’t own any bank stocks. "There are going to be definitive winners and losers, which is exactly the opposite of what the government wanted to do."
Loeb’s Third Point LLC, which oversaw $1.8 billion as of April 1, was among investors shorting Citigroup stock and buying the preferreds. While the bank’s delay in completing the exchange has eroded his returns, Loeb told investors last week that he expects to reap gains when other banks swap preferred for common stock. "We expect to see more opportunities in this area as restructurings create more movement in markets," Loeb told his investors in an April 28 note. He confirmed the authenticity of the letter and declined to comment further when contacted by Bloomberg News. Cliggott, whose fund beat 97 percent of its peers last year, according to Bloomberg data, said he’s short New York- based American Express and Goldman Sachs Group Inc. because of his outlook for diminished earnings for the two firms. He unwound his short positions in New York-based JPMorgan Chase & Co. and Wells Fargo, saying the outcome of the stress tests for those banks is "too big of a wildcard." "There are a fair number of people in the marketplace who believe many financial stocks are extremely expensive given the rapid contraction of earnings," Cliggott said, citing the decrease in leverage in the industry as well as deterioration in consumer credit. "The government has added tremendous uncertainty about the future of the U.S. financial sector."
BofA and Citi in last push on stress tests
Citigroup and Bank of America are working on plans to raise more than $10bn each in fresh capital, even as they launch last-ditch attempts to convince the US government they do not need to bolster their balance sheets. People close to the situation said Citi, BofA and at least two other lenders would today try to convince the Treasury and the Federal Reserve that the findings of "stress tests" into their financial health were too pessimistic. But, with time running out - the government will present the final test results to 19 banks tomorrow with an announcement slated for Thursday - both Citi and BofA are looking at how they could raise extra capital. Preliminary findings have revealed that Citi, already been bailed out three times, could need an extra $10bn or more if the economy worsens. BofA, which has had $45bn in government aid, was found to need well in excess of $10bn, people familiar with the matter said.
Regional lenders Wells Fargo and PNC Financial are also among the banks that would need to raise more capital unless they could persuade the authorities their findings were wrong, said people close to the situation. Citi is believed to be considering a plan to convert more than $15bn in trust preferred shares - a hybrid of debt and equity - into common stock. Since trust preferred shares are held by non-government investors, this conversion could enable the authorities to inject further funds into the bank without raising its stake beyond the 36 per cent it has already agreed to buy. People close to Citi said it would have to force holders of trust preferred shares to convert them into common stock, which ranks below those securities and does not pay a yearly interest rate, by threatening to stop paying interest if they rejected the offer.
Troubled banks must be allowed a way to fail
by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City
When the financial crisis began to unfold in 2007, US policymakers reacted quickly out of fear that rapidly evolving events would lead to a global economic collapse. In my view, the policy response to this point has been ad hoc, resulting in inequitable outcomes among firms, creditors, and investors. Despite taking a number of actions to stabilise markets and institutions, uncertainty continues and markets remain stressed. I believe there is an alternative method for addressing this crisis that deals more effectively with the issues we currently face while also considering the long-run consequences of those actions: the implementation of a systematic plan to resolve large, problem financial institutions.
In recent weeks, I have outlined such a resolution framework for dealing with these large, systemically important institutions. Boiled down to its simplest elements, the plan would require those firms seeking government assistance to make the taxpayer senior to all shareholders, with the government determining the circumstances for managers and directors. These firms would be operated by outside individuals with no conflicts involving either the firm or its competitors. Non-viable institutions would be allowed to fail and be placed into a negotiated conservatorship or a bridge institution, with the bad assets liquidated while the remainder of the firm is operated under new management and re-privatised as soon as is feasible.
This plan is similar to what was done in Sweden in the 1990s and in the US with the failure of Continental Illinois in the 1980s. This plan has many advantages, including that management and shareholders bear the costs for their actions before taxpayer funds are committed. This process also is equitable across all firms; is similar to what is currently done with smaller banks; and provides a definitive process that should reduce market uncertainty. These are important reasons to implement this kind of resolution process. In contrast to this suggested approach, the current policy raises a host of issues:
- Certain companies have not been allowed to fail and, as a result, the moral hazard problem has substantially worsened. Capitalism is a process of failure and renewal, and a "too big to fail" policy undermines this renewal and makes the financial system and our economy less efficient.
- So-called "too big to fail" firms have been given a competitive advantage and, rather than being held accountable for their actions, they have actually been subsidised in becoming more economically and politically powerful.
- The US government has poured billions of dollars into these firms without a defined resolution process, adding to our national debt. While there will be some repayment, there also will be losses. The longer resolution is postponed, the greater the losses and the larger the debt burden.
- As these institutions are under repair, the Federal Reserve is making loans directly to specific sectors of the economy, causing the Fed to allocate credit and take on a fiscal as well as a monetary policy role. This is reflected in the fact that its balance sheet continues to swell, which may compromise the independence of the Federal Reserve and make it more difficult to contain inflation in the years to come.
- Failing effectively to resolve these non-viable firms has long-term consequences. We have entrenched these even larger, systemically important, "too big to fail" institutions into the economic system, assuring that past mistakes will be repeated.
Certainly, the approach I suggest for resolving these large firms also is not without substantial cost, but it looks to both the short and long run. A systematic approach would reduce the uncertainty that has paralysed financial markets; the cost is more measurable and therefre manageable; and there will be fewer adverse consequences compared to the path we are on now. Because we still have far to go in this crisis, there remains time to define a clear process for resolving large institutional failure. Without one, the consequences will involve a series of short-term events and far more uncertainty for the global economy in the long run. While I agree that central banks must sometimes take actions affecting the short run, they must keep the long run in focus or risk failing their mission.
Tug-of-war over stress tests shows banks have become too powerful
Informed debate is a crucial part of public policy development. But the behind the scenes tug-of-war between banks and the US government over the results of their recent stress tests strains the exercise’s already tenuous credibility. It also shows that banks have become too powerful. How so? First, banks and their overseers run stress tests all the time, on individual products, divisions and the institutions as a whole. Without them, it would be very difficult to manage risk or allocate capital among business lines. The current crisis proved these tests were inadequate – or in some cases, ignored. But that’s largely because of management incentives to take outsized risks, and the fact that the scenarios used in the tests were not sufficiently grim.
So it’s curious that regulators have put so much stock in the tests they unveiled in February. The release of their results has been delayed until next week, while banks ask for clemency. Since the results will determine which institutions will be forced to raise private capital or take further government infusions, the stakes are high. But like the banks’ earlier and insufficient stress tests, the government’s worst-case scenarios aren’t all that far-fetched. They also use banks’ own estimates – meaning unscrupulous managers could tweak them to get a better grade. And bankers say they’ll produce very little information that regulators don’t already have.
Because of this, bank risk managers (admittedly, not the most credible group these days) tend to view these tests as a public relations stunt that regulators will use to force their institutions to toe Uncle Sam’s line. That, in itself, is worrying. Regulators shouldn’t have to invent justifications for regulating properly. The right response by a bank when its overseer says jump is "how high?" That regulators are wrangling with banks over the results of these tests shows that they are not confident in their ability to understand the institutions. That gives banks too much power. It would be better for watchdogs to demand that they reduce their complexity to comprehensible levels. Otherwise they’ll retain the upper hand – and no amount of testing will be sufficient to diagnose their problems.
New York Fed Chairman's Ties to Goldman Raise Questions
The Federal Reserve Bank of New York shaped Washington's response to the financial crisis late last year, which buoyed Goldman Sachs Group Inc. and other Wall Street firms. Goldman received speedy approval to become a bank holding company in September and a $10 billion capital injection soon after. During that time, the New York Fed's chairman, Stephen Friedman, sat on Goldman's board and had a large holding in Goldman stock, which because of Goldman's new status as a bank holding company was a violation of Federal Reserve policy. The New York Fed asked for a waiver, which, after about 2,5 months, the Fed granted. While it was weighing the request, Mr. Friedman bought 37,300 more Goldman shares in December. They've since risen $1.7 million in value. Mr. Friedman also was overseeing the search for a new president of the New York Fed, an officer who has a critical role in setting monetary policy at the Federal Reserve. The choice was a former Goldman executive.
The case illustrates what a tangle of overlapping interests can arise at a hybrid institution like the New York Federal Reserve Bank, especially as the U.S. government, in addressing the financial and economic turmoil, grows ever more deeply enmeshed in American business and banking. Mr. Friedman, who once ran Goldman, says none of these events involved any conflicts. He says his job as chairman of the New York Fed isn't a policy-making one, that he didn't consider his purchases of more Goldman shares to conflict with Fed policy, and bought shares because they were very cheap. Last week, following questions from The Wall Street Journal, Mr. Friedman, 71 years old, disclosed he would step down from the New York Fed at year end. In an interview, he said he made the decision because the waiver letting him own Goldman stock and be a Goldman director expires at the end of the year. He added: "I see no conflict whatsoever in owning shares."
Jerry Jordan, a former president of the Fed bank in Cleveland, says Mr. Friedman should have stepped down once Goldman became a bank holding company in September and thus fell under the Fed policy barring stock ownership by certain directors of Fed banks. "Any kind of financial transaction at all by any of the directors is always a problem," Mr. Jordan said. "He should have resigned." New York Fed officials disagree. Last fall, then-New York Fed President Timothy Geithner was President-elect Barack Obama's choice to head the Treasury, and New York Fed officials say that to have forced Mr. Friedman off the board while it sought a Geithner successor would have deprived it of two leaders at a crucial time. "Steve Friedman is a very capable chairman," said Tom Baxter, the New York Fed's general counsel, "and was the kind of person who we needed to head the search" for someone to succeed Mr. Geithner.
In Washington, the Fed's general counsel, Scott Alvarez, also says Mr. Friedman was needed during the New York Fed's transition. He adds that Mr. Friedman was in compliance with the Fed's rules when he first joined the New York Fed board and was put in violation of the rules by events "outside of his control." Because he was wasn't allowed to own the stock he had, the Fed doesn't consider his additional December purchase to be at odds with its rules at the time. The Fed had no policy requiring directors to inform it of new stock purchases, and Mr. Friedman didn't. The Federal Reserve Board is now in the process of rewriting its rules for handling situations like Mr. Friedman's. The 12 regional Fed banks, contrary to a common impression, aren't government agencies. Nor are they private banks: They're a hybrid. Each is owned by member commercial banks, which collect a 6% dividend and control six of nine board seats.
The Fed banks also have quasi-governmental roles. They conduct bank examinations, under the direction of the Federal Reserve Board. Their presidents participate in discussions of Fed monetary policy and vote on it, on a rotating basis. The New York Fed has a strong regulatory role. Its president has a permanent vote on Fed interest-rate policy and is vice chairman of the Fed's policy-making committee. The New York Fed has historically been deeply involved in addressing financial crises, from hedge fund Long Term Capital Management in 1998 to today's upheaval. There've long been tensions at the New York Fed between the interests of member banks and those of the rest of the economy. The aggressive federal intervention in the economy is heightening worries about conflicts. The regional banks' presidents aren't subject to congressional confirmation, a feature of the 1913 Federal Reserve Act intended to give the Fed some independence from politicians.
"The Federal Reserve system was designed to be a bunch of special interests that would duel to a draw," says Anil Kashyap, a former Fed economist who is a University of Chicago business professor and member of an advisory board to the New York Fed. Mr. Friedman ran Goldman in the early 1990s, leaving in 1994. He joined the Bush White House in 2002 to oversee economic policy. The move required him to sell his Goldman shares and many other investments. Doing so "was very costly and a difficult thing to manage," he recalls. He left the White House in 2004 and later reinvested in Goldman shares, joining its board. He got involved in private-equity firm Stone Point Capital in Greenwich, Conn., where he is now chairman. In January 2008, he became a member of the New York Fed board and its chairman. In that role, he worked closely with Mr. Geithner.
The economists and directors of Fed regional banks share their views with the banks' presidents, helping shape the ideas the presidents express in meetings with the Federal Reserve. It's one way the Fed in Washington gets input from around the country to help it set policy. Mr. Friedman says the board has a strictly advisory role: "We don't get involved in decisions related to supervisory issues or issues related to particular companies." Charles Wait, another director, says Mr. Geithner "informed us in many instances, and we informed him in others, in quite important ways." Mr. Wait describes Mr. Friedman as a consensus-seeking chairman who encourages give-and-take and "is a listener. He solicits opinions more than gives them." Mr. Wait is chief executive of Adirondack Trust Co. in Saratoga, N.Y.
Mr. Geithner declined to discuss his interaction with the New York Fed board or Mr. Friedman. Amid the crisis, Goldman has been a lightning rod for criticism because a number of its executives hold or have held powerful government positions, including ex-Treasury secretary Henry Paulson, who like Mr. Friedman once led Goldman.
Goldman was one of nine big banks the Treasury aided with capital injections in early October. The prior month, the government decided, partly at the urging of New York Fed officials, to bail out insurer American International Group Inc. The initial $85 billion provided to AIG enabled it to pay a portion of $8.1 billion it owed to Goldman, stemming from past trading agreements. By the end of the year, Goldman had gotten all of the $8.1 billion as AIG received more government aid. Mr. Friedman says that although directors were briefed occasionally on the actions the New York Fed took regarding AIG, that was just a courtesy. "The New York Fed board was not involved in the decisions to take any actions related to AIG," he said. As Goldman's stock slid last fall and some wondered if the remaining big investment banks would survive, the Fed, in close consultation with Mr. Geithner, hurriedly approved applications from Goldman and Morgan Stanley to be commercial banks instead of investment banks. The goal was to show investors the institutions were under the closer watch of a national regulator, had access to emergency loans and could broaden their funding by taking deposits. Goldman and Morgan Stanley converted to bank holding companies.
Mr. Friedman says Goldman's regulatory-status change was "certainly not something that was brought to the [New York Fed] board for consideration." The change created a problem. The Federal Reserve Act bars directors representing the public interest from owning bank stocks or being bank directors or officers. Because Goldman had always been an investment bank, Mr. Friedman's board membership there and his ownership of about 46,000 Goldman shares, at that time, hadn't run afoul of this rule. Now it did. The regional Fed banks have three classes of directors: Class A, elected by member banks and representing them; Class B, elected by banks but representing the public; and Class C, representing the public but picked by the Fed. Under law, directors in Class C, including Mr. Friedman, and Class B can't be officers or directors of banks, and Class C directors like Mr. Friedman also can't own shares of banks. This means not of bank holding companies, either, by the Fed's interpretation of the 1913 law.
Mr. Baxter, the New York Fed general counsel, realized that the bank's chairman was now in violation of the Fed rules. But the institution had just lost another director, Richard Fuld Jr., a few days before the September collapse of the firm he led, Lehman Brothers Holdings Inc. So on Oct. 6, at the urging of New York Fed lawyers, Mr. Geithner asked the Federal Reserve Board for a waiver enabling Mr. Friedman to continue owning Goldman stock and serving on Goldman's board. While Fed officials in Washington weighed the request, Mr. Baxter stayed in touch with a senior lawyer there, pushing for a decision, says a New York Fed official. This official says that in conversations with Mr. Friedman, who began voicing concern about the delays in December, Mr. Baxter suggested that the Fed policy should be considered to be in abeyance until the waiver came through.
Mr. Friedman's role grew more prominent in November after Mr. Geithner became the pick for Treasury secretary. Mr. Friedman got the board started seeking a successor. There were two leading candidates: Federal Reserve Board member Kevin Warsh, who had worked with Mr. Friedman at the White House, and William Dudley, a former Goldman economist who ran the New York Fed's markets desk. Mr. Friedman saw that Goldman's battered stock was trading below book value, or assets minus liabilities. On Dec. 17, he bought 37,300 Goldman shares at an average price of $80.78, a $3 million purchase, according to regulatory filings. He says he checked with a Goldman lawyer to make sure there was no timing issue with such a purchase. He says he didn't check with the Fed. New York Fed lawyers say they didn't learn about his share purchases until the Journal raised questions about them in April. By mid-January, the New York Fed board had settled the Geithner-succession question, picking Mr. Dudley. On Jan. 21, Fed Vice Chairman Donald Kohn granted a waiver, until the end of 2009, of the rule barring Mr. Friedman from being a Goldman stockholder or director. The next day, Mr. Friedman purchased 15,300 more Goldman shares in two slugs, at average prices of $66.19 and $67.12, according to regulatory filings.
That million-dollar purchase brought his holdings to 98,600 shares, according to filings. Class C directors from a handful of other regional Fed banks have also sought waivers of Fed policy on stock ownership in recent months. As the Fed reviews its policy on the matter, one revision under consideration would bar directors from adding to or reducing their positions when they get temporary waivers. Meanwhile, Goldman's stock has rallied strongly. Investors liked the bank's announcement in early February that it hoped to repay its $10 billion federal capital injection, freeing it from pay and other restrictions. Then, after a surprisingly strong first-quarter earnings report in mid-April, Goldman raised about $5 billion in a public offering. Mr. Friedman has benefited from those events. On Friday, Goldman stock closed late in New York Stock Exchange trading at $127.08 a share. Mr. Friedman's December and January stock purchases now are showing accrued gains of $2.7 million.
Volcker's Great Recession Redefines Full Employment as Jobs Vanish Forever
Post-recession America may be saddled with high unemployment even after good times finally return. Hundreds of thousands of jobs have vanished forever in industries such as auto manufacturing and financial services. Millions of people who were fired or laid off will find it harder to get hired again and for years may have to accept lower earnings than they enjoyed before the slump. This restructuring -- in what former Federal Reserve Chairman Paul Volcker calls "the Great Recession" -- is causing some economists to reconsider what might be the "natural" rate of unemployment: a level that neither accelerates nor decelerates inflation. This state of equilibrium is often described as "full" employment. Fallout from the recession implies a "markedly higher" natural rate of unemployment, says Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel Prize in economics. "It was 5.5 percent; maybe it will be 6.5 percent, maybe 7 percent."
That has implications for policy makers as well as workers. The Obama administration and the Federal Reserve are counting on the jobless rate to fall to a medium-term equilibrium of about 5 percent as the economy recovers. A natural rate significantly above that would drive up the annual budget deficit -- which will top $1 trillion for the first time this year -- by reducing tax revenue and pushing up spending on unemployment benefits. A higher rate would also require the Fed to make a choice: Accept an economy with more Americans permanently out of work, or try to boost employment at the risk of heating up inflation. The government may report May 8 that the jobless rate jumped to 8.9 percent in April, the highest since 1983, from 8.5 percent in March, according to economists surveyed by Bloomberg.
Laurence Ball, an economics professor at Johns Hopkins University in Baltimore, says unemployment may peak at 10 percent, and "it will be a long time before we see 5 percent" again. The more time workers spend without a job, the less attractive they become to potential employers, Ball says. That in itself helps keep the unemployment rate elevated. "If you’re unemployed" for an extended period, "you’re not keeping up with new technology," he says. "You become discouraged and you change your lifestyle." A burst of productivity growth starting in the mid 1990s helped lower the natural rate of unemployment to around 5 percent from 6 percent, as profit-flush companies took on more workers. Now the fear is that will be reversed as industries downsize.
Already, almost a quarter of the unemployed have been out of work for 27 weeks or longer, the highest proportion since 1983. Permanent layoffs -- for workers who don’t expect to ever regain the same job -- hit a record 51.5 percent in March. Mass layoffs, those that affect 50 or more people, rose to a record 2,933, comprising almost 300,000 lost positions. "We’re shedding jobs in industries in a significant way, and we’re not going to see those same industries be the source of job creation," Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, said in an April 21 interview. "We’re going to be living in a world in which we’re going to be feeling that the normal on the unemployment rate is above 6 percent." About 27 percent of automotive-manufacturing jobs --roughly 257,000 -- have been cut during the recession as carmakers trimmed operations.
General Motors Corp., the largest U.S. automaker, has set a target of reducing 47,000 positions worldwide this year. The company also aims to eliminate about 2,600 of its 6,200 U.S. dealerships by 2010, a move the National Automobile Dealers Association estimates will cost as many as 137,000 jobs. GM wants to sell or eliminate its Pontiac, Saturn, Hummer and Saab brands. Chrysler LLC filed for bankruptcy protection on April 30 to streamline its operations in a reorganization that includes Italy’s Fiat SpA as a partner. Since being spun off from Germany’s Daimler AG in August 2007, Chrysler has fired about 32,000 workers. Half of the auto-industry jobs being cut "are gone for good," says Sean McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Michigan. He predicts that older displaced workers will retire, while younger ones will migrate to industries such as health care where wages are lower. "Autoworkers don’t readjust well," McAlinden says.
Employment in the financial sector -- which has seen the demise of investment banks Bear Stearns Cos. and Lehman Brothers Holdings Inc. -- has contracted by 4.5 percent, or 376,000, with more losses to come.
Zurich-based UBS AG, the biggest Swiss bank, last week confirmed plans to cut 2,000 positions in its U.S. wealth- management unit. "Some sectors of the economy seem to have clearly gotten well overbuilt," says Orley Ashenfelter, an economist at Princeton University in New Jersey and former Labor Department official. "Financial services is an extreme example." In the publishing industry, which is suffering from falling advertising and a migration of readers to the Internet, employment is down almost 8 percent since the recession began in December 2007, according to the Bureau of Labor Statistics.
Daily average circulation for 395 newspapers fell 7.1 percent to 34.4 million in the six-month period through March, the Audit Bureau of Circulations said last week. Five publishers -- including Tribune Co., parent company of the Los Angeles Times and Chicago Tribune -- sought bankruptcy protection, and printed versions of the Seattle Post-Intelligencer and Denver’s Rocky Mountain News were halted. New York Times Co. has threatened to close the Boston Globe, which was founded in 1872. "Most of the publishing job cuts we’ve seen are probably going to be permanent," says John Morton, a media-industry analyst and president of Morton Research Inc. in Silver Spring, Maryland. Workers displaced from large metropolitan dailies will wind up at community papers and other places "with considerably lower pay than they’re used to," he says.
Layoffs now taking place are similar to those in the 1981- 1982 recession, when unemployment peaked at 10.8 percent and 2.8 million jobs disappeared, leaving industries such durable-goods manufacturing permanently smaller. Some 14 percent of durable- goods positions vanished in that slump, and the sector never regained the employment level of June 1981. People who lost stable work in the early 1980s sustained large and long-lasting earnings reductions, according to research by economists Till von Wachter of Columbia University, Jae Song of the Social Security Administration and Joyce Manchester of the Congressional Budget Office. A typical 40- year-old man who became unemployed at the time went on to suffer a 20 percent loss in lifetime earnings, they found.
The income hit is all the greater when displaced workers have to start over in new careers because their old employers were in sectors that have shrunk. "People losing their jobs now in permanently downsizing industries have to be aware that they’re particularly at risk of pretty large losses" to lifetime wages, says von Wachter, who briefed staff at the Fed and the European Central Bank last month on the effects of mass layoffs. "People tend to think that when you come out of a recession you get the labor market you had when you entered it," says Lawrence Mishel, president of the Economic Policy Institute in Washington. "This time you may get something quite different."
Obama Wants to End Tax Rules That Save Companies $190 Billion
President Barack Obama will propose today to outlaw three offshore tax-avoidance techniques U.S. companies such as Caterpillar Inc. and Procter & Gamble Co. want to use to save $190 billion over the next decade and make it riskier for Americans to stash money in tax-haven banks. Obama and Treasury Secretary Timothy Geithner will target a strategy that allows U.S.-based multinational companies to effectively hide from the Internal Revenue Service the role their foreign subsidiaries play in shifting profits into low-tax jurisdictions such as the Cayman Islands, an administration official said. The proposal, affecting tax rules known as "check the box," would net $86.5 billion in revenue between 2011-2019 by overhauling regulations created in Democrat Bill Clinton’s administration and later written into law by a Republican- controlled Congress after Clinton tried to withdraw the rules.
The proposal, combined with a $60.1 billion plan to limit many expense deductions for American companies that take advantage of laws allowing them to defer tax on foreign profits and a $43 billion crackdown on abusive foreign tax credits, would be the biggest tax increase on U.S. corporations since 1986. Obama also would shift the burden of proof to individuals when the IRS alleges assets are being hidden in certain offshore bank accounts, the official said. "This is bad stuff," Kenneth Kies, a tax lobbyist at the Washington firm Federal Policy Group, said of Obama’s plans. "This is going to be the biggest fight for the corporate community in the next two years." Kies represents General Electric Co., Anheuser-Busch Cos. and Microsoft Corp., among others While the Obama administration expects companies to lobby against the proposals, the president believes his tax proposals strike at loopholes that give multinational companies an unfair advantage over companies that operate only within the U.S., an Obama official said last night on condition of anonymity.
In 2004, U.S.-based multinational corporations paid about $16 billion of U.S. tax while earning about $700 billion offshore, or an effective tax rate of about 2.3 percent, an administration official said. The top marginal tax rate for U.S. companies is 35 percent. Obama and Geithner will outline four tax proposals ahead of a more detailed budget they will unveil later this week. The biggest of the requests is the repeal of the so-called check-the-box rules, which took effect in 1997. The rules were designed to reduce paperwork for companies and the IRS by allowing companies to classify entities within their corporate structure in the most tax-efficient manner without inviting a tax challenge. The Clinton administration realized that the rules made it easy for U.S.-based multinationals to create entities whose only purpose was to shift profits into low-tax countries and out of reach of the tax authorities, according to a January Government Accountability Office report that found 83 of the 100 biggest companies had subsidiaries in tax havens.
Once the assets were in the haven, the U.S. parent company borrowed from the subsidiary. The interest payments were deductible in the U.S. and tax-free in the haven, the GAO said. The Clinton administration intended the rules to help U.S. companies minimize their foreign tax liability, not to avoid the IRS, said Andrew Lyon, a former Treasury Department tax official who is now a principal at PricewaterhouseCoopers LLP’s Washington office. As a package, Obama’s proposal "is just a massive change and targeting what really has been a growth area for the U.S. economy: the overseas activities of U.S. firms," Lyon said. When the Clinton administration tried to rescind the benefits of the tax rules in such cases, companies mounted a lobbying effort and got Congress to back the rule, an Obama official said. Obama believes the rules have no economic substance other than avoiding U.S. tax, the official said.
"Check-the-box was responsible for a lot of currently taxable passive income disappearing from the system," said Lee Sheppard, a tax lawyer and contributing editor at Tax Notes, a weekly industry journal.
Obama’s plan will be "surprising and cause a lot of pain" to U.S. companies, said Pamela Olson, a former top tax policy official in President George W. Bush’s Treasury Department. Many companies structured their international operations over the last decade based on rules such as check-the-box. "Everything they’ve done is going to get wiped out," Olson said. The Obama Treasury Department could have made most of the changes administratively, she said. By making it a legislative proposal, the new administration can count any revenue that results from the policy change in its budget.
Obama’s other corporate tax plans are patterned on those made in 2007 by House Ways and Means Committee Chairman Charles Rangel, a New York Democrat, an administration official said. The first would defer most expense deductions, including those for interest paid, for U.S.-based multinationals, until U.S. tax is paid on the foreign income. That would end a practice where companies deduct 35 cents of a dollar of interest paid to a foreign subsidiary that owes little or no tax in the country where it is located, the Obama administration official said. Such tax arbitrage, while now legal, reduces companies’ overall tax burdens often at the expense of the U.S. Treasury. The proposal stopped short of an outright repeal of U.S. tax-deferral rules, as feared by a coalition of companies spearheaded by the Business Roundtable, U.S. Chamber of Commerce, and National Foreign Trade Council, all Washington- based trade associations.
In letters to congressional officials including House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, the trade groups warned such a repeal would hurt U.S. companies’ competition with their foreign rivals by increasing operating costs. That would make U.S. companies vulnerable to takeover and cost American jobs, they said. Obama’s proposal would divert the revenue it collects to making permanent a research and experimentation tax credit that is popular with many of the same businesses protesting the end of the tax-deferral rules, the administration official said. That credit, which has expired 13 times, is due to expire again Dec. 31; while the research credit is renewed only temporarily, there has been only one year since 1986 when it and the tax deferral rules haven’t been on the books at the same time. Another Obama proposal would end abuses of foreign tax- credit rules. U.S. tax law gives companies a dollar-for-dollar credit for taxes paid for foreign governments, but companies are projected to use techniques over the next decade to artificially inflate or accelerate those credits by $43 billion, the administration official said. The Obama budget would recoup that revenue, the official said.
For individuals, Obama will propose shifting the burden of proof when the IRS believes money is being hidden offshore. In cases where individuals bank with financial institutions that haven’t agreed to report certain account information to the IRS, the individual will have to prove he or she doesn’t own the account, rather than requiring the IRS to prove ownership. The change is projected to generate about $9 billion in new revenue between 2011 and 2019, and Obama believes it will yield substantially more, the administration official said. Obama’s proposals could be superseded by recommendations by a panel led by Paul Volcker, whom the president named to make recommendations on tax overhaul by December, the administration official said. The panel won’t be constrained by the budget’s proposals, the official said.
Banks Get Tougher on Credit Line Provisions
Banks are shortening the terms on lines of credit that have long been used by companies to avoid cash crunches -- a sign that while lending is reviving, businesses are facing new hurdles to obtaining credit. These revolving lines of credit typically ran for three or five years and let companies borrow at low interest rates, in part because they were rarely drawn upon before the credit crunch. Companies could use the money if they were cut off from other sources of cash such as the commercial-paper market. Now, lenders are cutting the length of many commitments to less than a year. They are charging higher fees for the lines of credit, known as revolvers. And instead of promising an interest rate determined mainly by the company's credit rating, banks will now charge more if the cost of insuring the company's debt against default is higher.
The trend, unfolding for months, mirrors what's going on in the rest of the credit markets: Lending is occurring again following last year's freeze. But many borrowers are facing tougher terms. As the economy slows, companies are more likely to need extra cash to keep their businesses running. At the same time, rising loan defaults are making banks more cautious. Even the strongest companies must pay more for revolving credit lines, regardless of their plans to use them. Companies including Hewlett-Packard Co., Baker Hughes Inc. and Verizon Communications Inc. recently obtained new revolvers with such terms, according to Thomson Reuters Loan Pricing Corp. Verizon recently got a new $5.3 billion, 364-day revolver to replace a three-year, $6 billion facility that was to mature later this year. The telecommunications firm will have to pay between 0.75 and two percentage points above the benchmark London interbank offered rate, or Libor, if it borrows under the new facility. The rate on borrowed cash under its old revolver was just 0.2 percentage points over Libor, according to data from Loan Pricing Corp., or LPC. A Verizon spokesman declined to comment.
The changes mean that corporations will have to renegotiate their credit lines more frequently. And if their financial condition deteriorates, such funding could become a lot more expensive and more difficult to secure. Already, the higher revolver rates are leading some firms to forgo the credit lines or to issue more long-term bonds if they are able to. Weaker companies are pledging more assets to banks to get or renew revolvers. About 72% of the revolving credit facilities obtained by investment-grade companies in the first quarter of 2009 had 364-day maturities, or tenors, and no companies received five-year lines, according to LPC. In the same period a year ago, 30% of the facilities were for 364 days and 41% had five-year maturities. Most of them aren't backed, or secured, by assets. Roughly $600 billion worth of revolvers are set to mature between now and the end of 2010, according to LPC, leaving dozens of companies facing much tougher terms. The trend towards tighter terms began last year as the credit crunch left banks short of capital due to big losses on mortgages and other loans.
Banks also prefer the shorter terms because they can more easily judge credit risk over one year than five. Banks have to hold more capital against longer-term financing commitments than short-term ones, and they typically hedge their exposures by purchasing credit-default swaps that act like insurance against corporate defaults. "A shorter tenor provides visibility into how credits perform and gives banks the option to reassess the situation in 12 months," says Jonathan Burn, head of the high-grade loan syndicate at Barclays Capital in New York. "This happens in every downturn and this downturn is going to be more significant than in the past." The strictures with business credit lines are akin to lenders' new policies for credit-card customers. Many institutions are hitting cardholders with higher fees and tougher terms. Bankers say companies have little choice but to accept the new terms as they balance their needs for rainy-day loans with the higher cost.
Toyota Motor Credit is one company facing an interest rate tied to the value of credit default swaps on its bonds. Investors bid up the price of these when they believe a company's financial health is deteriorating. The credit-default swap link provides protection for banks because Toyota probably would only tap the credit line at a time of stress, which would be reflected in the market by higher swap spreads. Toyota Motor Credit's new 364-day revolver will allow it to borrow up to $5 billion at a rate tied to its credit-default swap "spread," ranging from one percentage point to four percentage points over Libor. This spread, which is determined by derivative traders, reflects the cost of insuring the debt from default over one year, and is currently 3.55 percentage points for Toyota Motor Credit, according to Markit, a credit-markets data provider.
"We were fine with the new rate because we don't need the money right now and we were able to renew for the full amount of the previous facility," says a spokesman for Toyota Financial Services. Toyota Motor Credit is the U.S. financing arm of Toyota Financial Services, which is part of Toyota Corp. As the economy weakens and conditions in the broader credit markets remain tenuous, the safety net that revolvers provide has become more important. Last fall, when financial markets seized up, a flurry of corporations drew down some or all of their revolvers, including Sprint Nextel Corp., General Motors Co., Tribune Co. and Gannett Co. The moves sparked worries that dozens of other companies and struggling firms would jump on the opportunity to draw down cash while they could at easy terms banks agreed to in earlier years, creating more problems for strained banks. Bankers and analysts say those fears haven't been borne out for the most part, and banks were able to provide the cash when called upon. According to LPC data, U.S. companies drew $38.5 billion from their revolvers in 2008 and $8 billion so far this year.
US mortgage cuts to boost spending
US homeowners could save up to $18bn on their mortgage payments this year as record low mortgage rates allow millions of borrowers to refinance into cheaper home loans, according to economists at Freddie Mac. The savings could contribute to a turnround for the US economy by giving consumers more money to spend on goods and services, say analysts. Wilbur Ross, the billionaire turnround investor, said in an interview with the Financial Times that the positive knock-on effects of giving consumers additional disposable income were already being felt. "It's already having hundreds of billions of dollars of impact. The consumer is 70 per cent or thereabouts of the economy, so those are high velocity dollars," he said.
The savings are based on borrowers with mortgages backed by Freddie Mac and rival Fannie Mae refinancing to home loans with a 5 per cent interest rate. In the market for mortgages not backed by Fannie and Freddie, few borrowers will be able to refinance. Mortgage rates for home loans larger than Fannie and Freddie's loan limits remain high. Many borrowers with subprime or other risky mortgages will not qualify for refinancing, and borrowers who modify their mortgage terms will be kept out of foreclosure, but will probably not have much additional disposable income. In the market for Fannie and Freddie mortgages, the payment savings from refinancing done during the first quarter were about $160 (£107) a month on a $200,000 loan, said Frank Nothaft, chief economist at Freddie. "In aggregate, this adds up to about $2.5bn in extra spending cash in the pockets of those homeowners to spend over the coming year," said Mr Nothaft.
Falling Wage Syndrome
Wages are falling all across America. Some of the wage cuts, like the givebacks by Chrysler workers, are the price of federal aid. Others, like the tentative agreement on a salary cut here at The Times, are the result of discussions between employers and their union employees. Still others reflect the brute fact of a weak labor market: workers don’t dare protest when their wages are cut, because they don’t think they can find other jobs. Whatever the specifics, however, falling wages are a symptom of a sick economy. And they’re a symptom that can make the economy even sicker. First things first: anecdotes about falling wages are proliferating, but how broad is the phenomenon? The answer is, very. It’s true that many workers are still getting pay increases. But there are enough pay cuts out there that, according to the Bureau of Labor Statistics, the average cost of employing workers in the private sector rose only two-tenths of a percent in the first quarter of this year — the lowest increase on record. Since the job market is still getting worse, it wouldn’t be at all surprising if overall wages started falling later this year.
But why is that a bad thing? After all, many workers are accepting pay cuts in order to save jobs. What’s wrong with that? The answer lies in one of those paradoxes that plague our economy right now. We’re suffering from the paradox of thrift: saving is a virtue, but when everyone tries to sharply increase saving at the same time, the effect is a depressed economy. We’re suffering from the paradox of deleveraging: reducing debt and cleaning up balance sheets is good, but when everyone tries to sell off assets and pay down debt at the same time, the result is a financial crisis. And soon we may be facing the paradox of wages: workers at any one company can help save their jobs by accepting lower wages, but when employers across the economy cut wages at the same time, the result is higher unemployment. Here’s how the paradox works. Suppose that workers at the XYZ Corporation accept a pay cut. That lets XYZ management cut prices, making its products more competitive. Sales rise, and more workers can keep their jobs. So you might think that wage cuts raise employment — which they do at the level of the individual employer. But if everyone takes a pay cut, nobody gains a competitive advantage. So there’s no benefit to the economy from lower wages.
Meanwhile, the fall in wages can worsen the economy’s problems on other fronts. In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don’t go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more than they have in a decade — but as wages fall, they’re chasing a moving target. And the rising burden of debt will put downward pressure on consumer spending, keeping the economy depressed. Things get even worse if businesses and consumers expect wages to fall further in the future. John Maynard Keynes put it clearly, more than 70 years ago: "The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period." And a rise in the effective interest rate is the last thing this economy needs. Concern about falling wages isn’t just theory. Japan — where private-sector wages fell an average of more than 1 percent a year from 1997 to 2003 — is an object lesson in how wage deflation can contribute to economic stagnation.
So what should we conclude from the growing evidence of sagging wages in America? Mainly that stabilizing the economy isn’t enough: we need a real recovery. There has been a lot of talk lately about green shoots and all that, and there are indeed indications that the economic plunge that began last fall may be leveling off. The National Bureau of Economic Research might even declare the recession over later this year. But the unemployment rate is almost certainly still rising. And all signs point to a terrible job market for many months if not years to come — which is a recipe for continuing wage cuts, which will in turn keep the economy weak. To break that vicious circle, we basically need more: more stimulus, more decisive action on the banks, more job creation. Credit where credit is due: President Obama and his economic advisers seem to have steered the economy away from the abyss. But the risk that America will turn into Japan — that we’ll face years of deflation and stagnation — seems, if anything, to be rising.
Lobbyists prosper in downturn
They're furloughing many city workers for eight days this summer. They've cut staffing by about 5 percent. Now officials in Tracy, Calif., are trying another way to help make ends meet in these tough economic times: They've hired a Washington lobbyist. It's an idea that seems to be spreading. Senate lobbying records show that dozens of cities and counties signed up with lobbying firms in the three months of this year. Their goal is to get a greater share of the money flowing out of Washington, from a record federal budget to the $787 billion economic stimulus package. Some of the communities hiring lobbyists have done so before and are simply shuffling their lineup or adding to it. But others are getting into the lobbying game for the first time. "This is a new venture for the city. This is a relatively conservative community and has a high degree of self-reliance, but we also understand there's also a great opportunity for all communities, Tracy included" said Leon Churchill, city manager for the suburban community about 60 miles east of San Francisco. "The opportunity was too immense to bypass."
The city paid $10,000 to Patricia Jordan and Associates in the first quarter. Disclosure reports filed with the Senate show the firm lobbied lawmakers and the Federal Highway Administration on a highway spending bill. It also lobbied the Federal Emergency Management Agency for "emergency management" money. The stimulus bill provided the agency with hundreds of millions of dollars for grants to firefighters and improved transit and rail security. The city of Baytown, Texas, also hired a lobbying firm. While there was some concern from city council members that such action encouraged more federal spending, City Manager Garry Brumback argued that the money was going to get spent regardless and that Baytown should get its share. "The idea that they're going to lower your taxes if we don't accept any money is a little bit ridiculous," Brumback said.
The city will spend $40,000 for federal lobbying and $25,000 for lobbying at the state level. Expectations for the return on that investment are high. "If you're not getting at least 10-to-1, you've hired a bad lobbyist," he said. Lobbyist filed new registrations this quarter on behalf of major metropolitan areas such as Cook County, Ill., St. Louis and Seattle. But they also went to bat for scores of small towns as well. For instance, the village of Deer Park, Ill., with a population of 3,200 and a budget of about $3.5 million, hired a lobbying firm to help it get money for road and drainage projects. "We were looking for a way to make up some of the shortfalls we see for the next couple of years until we get out of this recession," said Scott Gifford, president of the village's board of trustees. In all, the community will spend about $60,000 this year on lobbying. "The vote was 4-2 but the majority of the board felt it was worth the risk of spending $60,000 to potentially bring in $1.3, $1.5 million," Gifford said.
The city of Hartford, Conn., has used Washington-based lobbyists before, but decided to spend its money elsewhere in 2008. This year, it's back in the game. "That's where the money's coming from right now and we need to get our piece of the pie," said Sarah Barr, director of communications for the city. Cities and counties hiring lobbyists tend to spend in the tens of thousands per year, about what they would spend for hiring one employee. For that money they get a team of lobbyists, each of whom serves multiple clients. The team can include lawyers, former congressional aides and even former lawmakers. For example, former Rep. Nancy Johnson, R-Conn., is one of three lobbyists looking out for Hartford. Former Rep. Bill Brewster, D-Okla., is a lobbyist for the town of Glenpool, Okla. Former Rep. Bob Livingston, R-La., is one of the lobbyists working for the state's Morgan City Harbor and Terminal District. The stimulus legislation called for an extra $787 billion in spending, but President Barack Obama also put strict rules on what lobbyists can do to steer money their clients' way.
Lobbyists cannot converse with federal officials or meet with them about specific stimulus projects. They can submit written statements advocating specific proposals for stimulus spending, which federal agencies must post on the Internet within three days. Still, with Obama proposing spending $3.7 trillion for the budget fiscal year, local governments sense plenty of opportunity to secure federal money for their clients. H. Stewart Van Scoyoc, president and chief executive of Van Scoyoc Associates, said he's definitely noticing more interest from local governments in hiring lobbyists. "They're actively, aggressively looking for outside funding sources to help relieve the pain a little bit," Van Scoyoc said. The change in administrations has spurred interest, too. The Bush administration was viewed as less supportive of aiming federal tax dollars at local initiatives. Cities and counties now believe they have a better shot at securing federal money. "It's pretty much an unprecedented level of spending, a lot of it targeted toward state and local governments," Van Scoyoc said. "I think everybody is struggling to understand exactly how to react to it, how to access it and how to then effectively implement spending and go through all the auditing the feds are putting in place."
GM Bankruptcy Probable as Obama Shields UAW Benefits
General Motors Corp. may be more likely to end up in bankruptcy based on the Obama administration’s willingness to place Chrysler LLC into court protection to safeguard union health-care benefits. With GM and its biggest bondholders at odds over resolving $27 billion in unsecured claims by a June 1 deadline, the Chrysler model indicates that President Barack Obama may resort to bankruptcy to end any impasse over that debt, said Martin Fridson, chief executive officer of New York-based credit investment firm Fridson Investment Advisors. Chrysler filed for protection April 30 after the U.S. was unable to persuade secured lenders to swap $6.9 billion in claims for $2.25 billion in cash. A union retiree health-care trust was offered a 55 percent stake in Chrysler. "This confirms the fear, which right along has been that the Obama administration is more sensitive or beholden to the unions than the bondholders," Fridson said. "It makes it clear that GM bondholders aren’t likely to be able to work out anything outside of bankruptcy."
GM bondholders proposed April 30 they get a 58 percent ownership stake in the Detroit-based automaker in exchange for their $27 billion in unsecured claims. Bondholders are objecting to GM’s proposal they get a 10 percent share of GM equity while a union health fund would get $10 billion in cash and as much as a 39 percent stake for $20 billion in unsecured claims. Renee Rashid-Merem, a GM spokeswoman, Roger Kerson, a UAW spokesman, and Jenni Engebretsen, a Treasury spokeswoman, declined to comment on the matter. Nevin Reilly, spokesman for the ad hoc committee of GM bondholders, also declined to comment. The group said last week its counteroffer would allow GM to "avoid a lengthy and difficult bankruptcy process." GM said last week it must cut $44 billion in obligations from its books, including $10 billion of loans from the U.S. government, to return to an operating profit next year. It wants to win permission from the Obama administration to keep $15.4 billion in loans and receive $11.6 billion more.
"There’s no question Chrysler" acts as a dry run for GM, said Sean Egan, president of Egan-Jones Ratings Co. in Haverford, Pennsylvania. "It was designed that way because Chrysler is a much more manageable entity. The impact on the economy, on employment, is a microcosm of what is likely to happen with GM." GM’s $3 billion of 8.375 percent bonds maturing in July 2033 traded at 8.75 cents on the dollar on May 1, yielding 93.7 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The shares gained 2 cents to $1.83 at 9:37 a.m. in New York Stock Exchange composite trading. GM proposed that bondholders exchange 225 shares of stock for each $1,000 of principal. At least 90 percent must accept the offer for the automaker’s debt-reduction plan to work. In their counterproposal, the bondholders said that in addition to their receipt of a majority stake in a reorganized GM, 41 percent of the stock would go to a union health-care trust and the last 1 percent to existing shareholders.
The bondholders committee had been in contact with about 100 institutions representing $12 billion in GM debt including San Mateo, California-based Franklin Resources Inc. and Loomis Sayles & Co. of Boston, a person familiar with the negotiations has said. Even if there is appetite for an agreement, it’s unlikely the thousands of GM bondholders can be pulled together in time, said John Casesa, managing partner at New York-based consulting firm Casesa Shapiro Group. "The Chrysler bankruptcy can either scare them into settling or maybe make them more likely to take GM into bankruptcy," Casesa said. "I don’t get the sense that the bondholders are ready to give in." Obama’s auto task force ousted Chief Executive Officer Rick Wagoner at the end of March, saying GM’s plan to return to profit wasn’t aggressive enough, and ordered new CEO Fritz Henderson to cut the automaker’s debt by more than initially demanded.
The U.S., which would hold at least half the equity in a reorganized GM in the automaker’s proposal, also ordered acting Chairman Kent Kresa to replace the majority of the GM directors as soon as possible.
"Obama has said the government doesn’t want to run a car company, so why not take the bondholders’ deal, which gets them out of ownership?" said Pete Hastings, a fixed-income analyst at Morgan Keegan & Co. in Memphis, Tennessee. "The 10 percent ownership offer is ridiculous, so their best shot is to try and win in court." The bondholders shouldn’t be surprised that the unions are getting preference over investors in an Obama administration, Egan said.
"If the government is providing money to these entities, they’re going to be looking out for labor’s interest first and foremost," he said. "You may claim it’s unfair, but that’s the political reality and the time and cost of suing the federal government is prohibitive in most cases." The government was more likely to get its way in Chrysler because a majority of lenders were already supportive of the U.S. offer for their debt, said Mirko Mikelic, who helps manage $19 billion at Fifth Third Asset Management in Grand Rapids, Michigan. Mikelic dumped GM debt last year and still manages some debt in GMAC LLC, the automaker’s former finance unit. There seems to be little likelihood of a similar majority agreement at GM, he said. The longer the GM bondholders have held out, the worse the offers have gotten, according to Egan. "You’re better off acting early," he said.
GM: The Government Is in Charge
...Whether it wants to or not
The White House task force in charge of salvaging the carmaker is using a heavy hand. Is it hurting or helping? The Obama Administration has "no desire to run an auto company on a day-to-day basis," says White House spokesman Robert Gibbs. If so, somebody forgot to tell the team of Treasury Dept. staffers and management consultants now camped out at the Detroit Renaissance Center, a hotel and office complex anchored by General Motors' headquarters. There, GM executives are mapping out a survival strategy ahead of a government-imposed June 1 deadline to squeeze concessions from bondholders and the United Auto Workers union or face bankruptcy. Make no mistake: The White House and the task force overseeing the restructuring of both GM and Chrysler since February are calling the shots. The latest GM plan unveiled on Apr. 21 to slash more jobs and dealerships, shut down the Pontiac brand, and swap up to $27 billion in unsecured debt from bondholders for equity has heavy government input.
Treasury has a couple dozen staffers and executives from Boston Consulting Group (BCG) scrutinizing operational details at the car company. (BCG is getting paid $7 million from the government for its work on both GM and Chrysler.) Auto task force leaders Steven Rattner and Ron Bloom, both seasoned investment bankers, talk to GM CEO Frederick A. "Fritz" Henderson almost daily, weighing in heavily on big financial decisions. Elsewhere in the company, GM managers say they are encountering all manner of suggestions from the government. Henderson, who disputes the idea that the government is micromanaging, does liken Washington's role to that of a "private equity player" with ultimate veto power over its investment. GM can't complain too loudly. After all, it has received $15.4 billion in government loans and needs much more to survive. Plus, without government pressure, GM likely would not have made some critical restructuring moves.
In fact, GM is about to embark on a crash diet that will leave it a much diminished though more focused company, whose dominant shareholders could ultimately be the government (50%) and the United Auto Workers (39%). Some GM insiders fret that Treasury's key players have precious little industry experience. On the flip side, they do bring a new perspective. Car czar Rattner is co-founder of the Quadrangle Group and has gained unwelcome attention of late for his alleged connection to a scandal involving a New York State retirement fund. Rattner's No. 2, former United Steelworkers negotiator Bloom, has restructured plenty of companies but not carmakers. The lone exception at the top is Xavier Mosquet, head of BCG's Detroit office and an auto industry consulting veteran. Rattner and Bloom, both financial pros, have spent the past two months flying to and from Detroit. They worked closely with Henderson in crafting a plan in which GM will ask bondholders to swap $27 billion for a 10% equity stake, which works out to payment of about 5 cents for every dollar of debt.
If bondholders don't agree, GM says it will file for bankruptcy, and these creditors may get less. Henderson says approval by Treasury officials wasn't required for this plan, but adds: "We had to make sure they were comfortable." Other advice has been less welcome. During the week of Apr. 13, about a dozen Treasury staffers and outside consultants arrived at GM's sprawling technical center north of Detroit. They reviewed the company's lineup of brands. At that point, GM had announced plans to phase out three weak brands—Hummer, Saab, and Saturn—out of a total of eight. BCG pushed GM to go further and dump Buick and GMC, even though both make money and get much better pricing than mainstream brand Chevrolet. One source close to the review said the consultants took a view that since Toyota (TM) sells just two brands—its namesake line and the top-shelf Lexus cars—why couldn't GM just sell Chevy and Cadillac? "They wanted to know if we have a robust plan for each one," says Mark LaNeve, GM's vice-president for North American sales and marketing.
GM pushed back saying that Buick and GMC not only make money but also bring in different buyers than Chevy or Cadillac. Plus, Buick will get three new sedans—two of which are sold in China—and could boost profits by garnering more global sales volume. The BCG team didn't demand that the brands be killed, but sources say the review was intense and GM executives felt pressured by the government's hired guns. By the third week of April, GM had satisfied the feds that its four core brands—that is, Buick, Cadillac, Chevrolet, and GMC—had value. But Henderson decided GM couldn't keep Pontiac with its weak sales outlook. GM managers were caught off guard by other questions from the task force. One issue was when the Chevrolet Volt electric car, a product designed to leapfrog the current field of hybrid-electric cars, came under scrutiny. "They couldn't imagine why we were spending the time and money to do the Volt," says one senior GM product developer. Another example: One Treasury official asked when the new Chevy Malibu sedan goes on sale. It has been in showrooms for 18 months. Inside GM, executives have little choice but to adapt. "It's an indictment of our management that they're here," says one designer. But this bizarre alliance is probably GM's best hope for survival.
The Fiat Follies
I don't get the lingo. If we know anything about Fiat, it's that the company doesn't actually have any money. It picked up the opportunity to obtain for free a 35-percent stake in a Chrysler rising from its Chapter 11 ashes. And now AP (via The New York Times and the Washington Post) is reporting that Fiat is in discussions to "buy" Opel, General Motors' European brand, based in Germany. Fiat will not be "buying" Opel. The GM unit needs $4.3 billion to survive, and as with Chrysler, Fiat CEO Sergio Marchinonne's gambit is to pitch Fiat as a willing partner with the German government. He doesn't have a choice, because Fiat's debt situation in onerous, and it's sales have suffered along with everyone else's during the downturn in the car business.
Having pulled Fiat itself back from the brink of bankruptcy, Marchionne is under no illusions about what a global carmaker needs to survive: massive infusions of public cash! He's been thinking about playing with house money all along, anyway, as the Italian government would be under enormous pressure to
bail outrecapitalize Fiat if the company's financials get any worse. You have to wonder when people are going to stop shaking their heads in disbelief at Marchionne's negotiating moxie and pondering his fashion sense and start talking about him as the canniest business man on Earth.
Fiat CEO aiming to create global auto powerhouse
Fiat Group SpA will be on the path to becoming a global automotive powerhouse if Chief Executive Sergio Marchionne has his way. Marchionne is set to meet Monday in Berlin with German economic and foreign ministers to discuss Fiat's offer for General Motors Europe's German unit, Opel. Fiat confirmed Sunday that it is in talks to buy most of General Motors Corp.'s European operations. It also said it is evaluating the possible spinoff of its auto business to form the core of a new company. GM has been trying to find investors for its noncore and unprofitable assets to help stave off collapse. Germany is keen to safeguard the future of Adam Opel GmbH, a core part of GM's European operations, which employs about 25,000 people at four plants in Germany.
Fiat Group Automobiles includes the Fiat, Alfa Romeo and Ferrari brands. In addition, Fiat is in the process of acquiring U.S. automaker Chrysler LLC without putting up any cash. Marchionne was quoted in the Financial Times on Monday as saying of his company's plan: "From an engineering and industrial point of view, this is a marriage made in heaven." The new auto company, which according to Fiat would have $105 billion in annual revenue, would put the Italian automaker in markets where it has little or no presence, including North America, traditionally the largest market in the world. "They're going to be a global powerhouse, I guess. Who would have thought?" asked Erich Merkle, an independent auto industry analyst in Grand Rapids, Mich. "They seem to be on a buying binge right now, looking for cheap and distressed assets like Chrysler and Opel."
Fiat is not Opel's only suitor, however. Last week, Canadian car parts maker Magna International Inc. presented German Economy Minister Karl-Theodor zu Guttenberg with what the minister called a "rough concept for a commitment with Opel." The German government has said it doesn't foresee giving direct state aid but could help an Opel investor with loan guarantees. The Chrysler deal, which must still be approved by a U.S. bankruptcy court, would be in exchange for giving Chrysler access to Fiat's small-car and engine technology. Chrysler cars and trucks also would be sold by Fiat through its global distribution network. The deals would make Fiat a big global player, but that might not be the best thing for the Italian automaker, which might be overreaching with the acquisitions, said Merkle. "This is a lot to take on, quite honestly," Merkle said.
"When you start looking at Chrysler, it'll make them a very large automaker, but we've seen that large isn't necessarily indicative of success." It will take years, Merkle said, for Fiat to gain any synergies by globalizing design, engineering and manufacturing operations with Chrysler and the GM units. GM Europe also includes the British company Vauxhall and the Swedish carmaker Saab. Saab may not be included in the deal, however. The company is being reorganized under Swedish law and is likely to be separated from the rest of GM's European operations. Saab declined to comment on whether Fiat was one of the roughly 10 bidders who have expressed serious interest in the Swedish brand. Saab spokeswoman Gunilla Gustavs said the sales process is continuing according to plan and that a deal is expected to be signed before the end of June. "We are now entering a process where we are narrowing down the number of interested bidders. There are around 10 who are more serious, with whom we have held deeper talks and shared more information," she said.
GM also makes and sells small Chevrolet-badged cars in Europe that are designed in South Korea by the company's Daewoo unit, and it's unlikely to sell that because that would be GM's only remaining foothold in Europe, Merkle said. General Motors has been trying to find investors for its noncore and unprofitable assets as part of a restructuring in which it has received $15.4 billion in aid from the U.S. government to avert collapse. Opel has said it needs $4.3 billion to get through the economic crisis. The German government has said it doesn't foresee giving direct state aid. Chancellor Angela Merkel has suggested the government could help an Opel investor with loan guarantees. Fiat said that over the next few weeks, Marchionne will be looking "to assess the viability of a merger of the activities of Fiat Group Automobiles (including the interest in Chrysler) and General Motors Europe into a new company."
"As part of this process, the group would evaluate several corporate structures, including the potential spinoff of Fiat Group Automobiles and the subsequent listing of a new company which combines those activities with the activities of General Motors Europe." In an interview Sunday with Corriere della Sera, Fiat Chairman Luca Cordero di Montezemolo called GM's Opel an "ideal partner" and a possible takeover by Fiat an "extraordinary opportunity." Fiat, meanwhile, has pressed ahead with a takeover of Chrysler. Chrysler is seeking to sell substantially all of its assets to Fiat, but must gain approval from a New York bankruptcy court. In addition to Fiat Group Automobiles, the Fiat Group also includes its agricultural vehicles branch CNH and its Iveco trucking unit, as well as a media arm.
Fiat May Spin Off Auto Division If It Buys GM Europe
Fiat SpA, the Italian carmaker taking a stake in Chrysler LLC, may spin off its automobile division following a purchase of General Motors Corp.’s European unit. Chief Executive Officer Sergio Marchionne will seek "over the next few weeks" to assess the viability of a combination and a new company, the board of the Turin, Italy-based carmaker said yesterday in a statement. GM says it’s open to offers for the Germany-based Opel division, which is running out of cash and seeking 3.3 billion euros ($4.4 billion) in German aid. Another potential investor is Magna International Inc., North America’s largest auto-parts maker. A spinoff of Fiat Automobile, which accounted for 45 percent of Fiat’s 2008 sales, would leave Italy’s largest manufacturer with assets such as the CNH Global NV agricultural and construction-equipment unit, and Iveco trucks.
"Instead of defending its niche market in Italy, Fiat decided to be a predator worldwide," Luca Peviani, managing director at P&G Sgr in Rome, said. "Italy will remain just an appendix of the empire."
Fiat already plans to take control of Chrysler, based in Auburn Hills, Michigan, in a deal announced by President Barack Obama last week. Marchionne said last week he regards Opel as an "ideal partner" and would concentrate on buying that part of Detroit- based General Motors after the unveiling of the Chrysler agreement. A combined company would have 80 billion euros in annual sales, the board said yesterday. "The group would evaluate several corporate structures, including the potential spinoff of Fiat Group Automobiles and the subsequent listing of a new company which combines those activities with the activities of General Motors Europe," it said in the statement.
Fiat rose as much as 56 cents, or 7.5 percent, to 8.08 euros and traded at 8 euros as of 1:15 p.m. in Milan, giving the carmaker a market value of 9.6 billion euros. A spinoff or an initial public offering of the auto division "could unlock Fiat Auto value and could eliminate the risk of rights issue," Massimo Vecchio, an analyst at Mediobanca Securities in Milan who has an "outperform" rating on Fiat, wrote in a note today. Marchionne is scheduled to present Fiat’s plan for Opel to German Economy Minister Karl-Theodor zu Guttenberg and Foreign Minister Frank-Walter Steinmeier in Berlin today. Speaking to reporters before the meetings, Guttenberg said the discussions will be "very open." Fiat is also looking at GM’s operations in emerging markets, people familiar with the matter said. GM is negotiating with automotive companies and investors interested in Opel and is separately talking to Fiat about tie-ups involving GM operations such as those in Latin America, they said.
Turin-based Fiat sold 2.15 million autos last year and adding Auburn Hills, Michigan-based Chrysler will lift the total toward 4 million. While that’s still short of the number Marchionne says will guarantee long-term viability, GM last year achieved 1.5 million sales at Opel, 1.3 million in Latin America and 1.5 million in the Asia-Pacific region. "If Marchionne gets GM’s organization in China, he potentially has the volume he reckons he needs," said Peter Schmidt, an analyst at Automotive Data in Leamington Spa, England. "Or GM Russia, and use that as a springboard to neighboring countries." Magna last week held talks with German officials about a purchase of Opel. Magna and carmaker OAO GAZ, owned by Russian billionaire Oleg Deripaska, are interested in taking over the bulk of GM’s European unit, the people said. Magna declined to comment after initially denying interest.
GM is reviewing potential bids for Opel, the German unit’s managing director Hans Demant told reporters in Eisenach, Germany today. Offers for Opel still need to be refined, and a final decision will be taken in the coming weeks, Steinmeier said at the same briefing. "We are not just talking about Opel but we’re talking about Germany’s position as an industrial center," Steinmeier said. Bidders for Opel, based in Ruesselsheim outside Frankfurt, will meet with GM this week to seek clarity over financial data before each presenting an "industrial plan," Guttenberg said April 28. Other parties interested in Opel include sovereign wealth funds Abu Dhabi Investment Council and the Government of Singapore Investment Corp., and three private-equity funds, according to one of the people familiar with negotiations.
GM and Chrysler have been kept afloat with U.S. government aid. As part of the deal for Chrysler to seek court protection and begin handing over the reins to Fiat, the No. 3 U.S. automaker will get as much as $3.5 billion in operating loans from the government. Fiat has agreed to make engines and cars in the U.S. Fiat will start with 20 percent of the new Chrysler, and gain another 15 percent by hitting three goals: providing international distribution for Chrysler vehicles, building a car that gets 40 miles per gallon in the U.S. and making a new fuel- efficient engine at a U.S. plant. The Italian manufacturer can then buy an additional 16 percent when government loans are repaid. Unlike the Chrysler deal, in which U.S. and Canadian unions agreed to concessions to help save the company, a Fiat purchase of Opel is opposed by German unions. The state of Rhineland- Palatinate, where Opel has 3,400 workers at an engine factory, also is against a tie-up. GM may also be forced to sell other assets as it faces filing for bankruptcy protection unless it reorganizes out of court by June 1.
Berlin sets out conditions for Opel sale
Opel’s future owners may have to set up headquarters in Germany in order to obtain financial support from the German government, according to an internal paper by Frank-Walter Steinmeier, vice-chancellor and foreign minister. According to the paper obtained by the Financial Times, all potential Opel buyers would have to state where they intended the company’s headquarters to be located and where it would pay tax. The condition is one of 14 criteria Mr Steinmeier will use to evaluate any offer for the German arm of carmaker General Motors, which has attracted interest from Italy’s Fiat and a consortium led by Austrian-Canadian parts supplier Magna, among others. Other criteria mentioned include the number of expected job losses, the future of Opel plants in Germany, the suitor’s past experience in conducting similar transactions, the solidity of the financial concepts and the buyer’s degree of acceptance among Opel’s workers.
Berlin has no say in which suitor will secure Opel, a decision that rests solely in the hands of General Motors. Yet the government has promised to support the future owner with credit guarantees and, as evidenced by the Steinmeier paper, is using its influence to shape the transaction. Sergio Marchionne, Fiat chief executive, was in Berlin on Monday to present his plan to Karl-Theodor zu Guttenberg, the economics minister, and to Mr Steinmeier following a similar presentation by Magna last week. The fate of Opel has become part of the German electoral campaign ahead of the general election on September 27. The contest will pitch Angela Merkel, chancellor and chairman of the Christian Democratic Union, against Mr Steinmeier, who is heading the Social Democratic ticket. Both sides would have to agree for the government to issue credit guarantees.
But the political rivalry has seriously complicated the talks between potential investors and the government, forcing suitors to approach both Mr Guttenberg, as de facto representative of Ms Merkel, and Mr Steinmeier. It has also led to heated exchanges between the two ministers. Mr Guttenberg has accused Mr Steinmeier of siding too closely with Opel’s worker representatives, who have expressed misgivings about the Fiat approach, as part of his strategy to rally trade union support for his candidacy. In a weekend interview, he said the foreign minister had "little command of the details" of the Opel situation and was being "groundlessly prejudiced against one possible investor." He had earlier criticised Mr Steinmeier for giving hasty guarantees to the Opel workforce about Berlin’s backing for the company. Mr Steinmeier, for his part, has accused Mr Guttenberg of endangering Opel’s future by ruling out a partial nationalisation of the carmaker. His SPD would support the acquisition of a government stake in Opel.
Berlin issues ultimatum to Landesbanken
The German government has issued an ultimatum to the country’s seven Landesbanken to agree by July to consolidate the troubled state-owned banking sector or face exclusion from Berlin’s plan to take toxic assets off banks’ books. Government officials told the Financial Times that four of the banks held so many troubled assets that it was "impossible" to see how their owners – German regional governments and municipal savings banks – could save them without Berlin’s help. For the first time, Berlin had "a very good chance" of forcing the Landesbanken to shrink their balance sheets and merge into "one, two or three" banks by 2012, an official said. They would be "German players with some European scope". The merger of the sector into one federally-owned Landesbank would create one of the world’s biggest banks by assets, although any resultant entity would have to shrink rapidly.
The Landesbanken are wholesale banks with roots in the business of supporting regional companies and economies. But many have come undone after expanding into high-risk investments abroad. They account for the bulk of the €816bn ($1,082bn) of toxic and illiquid assets afflict Germany’s banking sector. The hardest-hit Landesbanken – WestLB, HSH Nordbank, LBBW and Bayern LB – have already been bailed-out during the financial crisis by the state governments and the savings banks, known as Sparkassen, that own them. Some face further needs for capital and officials in Berlin said the banks now recognised they could not continue alone. Officials said Peer Steinbrück, finance minister, made the ultimatum in a meeting with state politicians in Berlin last week.
They said the finance ministry would set a deadline of early July for the states to sign up at a further meeting today. The top-level conclave is meant to advance plans to help banks shunt illiquid and near-worthless "toxic" assets off their books into government-backed "bad banks". "The federal government does not have any preference as to how the Landesbanken consolidate," an official said. "But we want a clear and binding agreement that they will do so by the time we sign-off on bad-bank legislation in July." Consolidation has been discussed for years but always failed because state governments feared a loss of prestige, influence and jobs.
Australian Annual House Prices Fall Record 6.9%
Australian house prices fell by a record annual amount in the three months through March as the nation’s first recession since 1991 and surging unemployment sapped demand for property. An index measuring the weighted average of prices for established houses in the eight capital cities slumped 6.7 percent from a year earlier, after dropping a revised 3.9 percent in the fourth quarter, the Australian Bureau of Statistics said in Sydney today. It was the biggest decline since the bureau began recording prices in 1986. To prevent Australia’s property market suffering a U.S.- style slump as the nation enters its first recession in two decades, central bank Governor Glenn Stevens cut borrowing costs last month to a 49-year low of 3 percent. The government also tried to stoke demand for homes by increasing grants in October for first-time buyers to as much as A$21,000 ($15,500).
"It’s a sizeable drop and isn’t surprising," said Matt Robinson, an economist at Moody’s Economy.com in Sydney. "We had a period where people just didn’t know how bad things were going to get, and no amount of monetary policy stimulus and first-home-owners grants were going to encourage them to buy." The Australian dollar traded at 73.68 U.S. cents at 12:42 p.m. in Sydney from 73.59 cents just before the report was released. The two-year government bond yield was unchanged at 3.26 percent. Prices fell 2.2 percent from the fourth quarter, when they declined a revised 1.2 percent. The median estimate of 15 economists surveyed by Bloomberg News was for no change. Economists also forecast a 3.9 percent annual decrease. While annual declines in Australian house prices have accelerated since the December quarter, falls in the U.K. have slowed. The average cost of a home in England and Wales fell 0.3 percent in April, the smallest drop in 12 months, Hometrack Ltd. said on April 27. Prices fell 10.1 percent from a year earlier, after sliding an annual 10.3 percent in March.
The drop in home prices in the 20 major U.S. cities slowed in February for the first time since 2007. The S&P/Case-Shiller index’s 18.6 percent decrease compared with a record 19 percent decline the month before.
Australia’s biggest quarterly drop was in Perth, where prices fell 10.1 percent in the first quarter from a year earlier. Prices fell 7.3 percent in Sydney, 6.7 percent in Melbourne, 6.3 percent in Brisbane, 5.1 percent in Canberra and 1.9 percent in Adelaide. Darwin rose 10.8 percent and Hobart increased 0.6 percent. "Our forecast is for house prices to fall 10 percent from peak to trough" in Australia, said Helen Kevans, an economist at JPMorgan Chase & Co. in Sydney. "The acute shortage of new homes and accelerating population growth will, however, prevent falls similar to those in weaker offshore markets." Demand for property may be curbed as the unemployment rate climbs. The jobless rate probably rose to 5.9 percent last month, the highest level in almost six years, according to the median forecast of 19 economists surveyed by Bloomberg News. The employment figures will be released on May 7.
A separate report published today by Australia & New Zealand Banking Group Ltd. showed job advertisements in newspapers and on the Internet tumbled 7.5 percent in April, taking the decline from a year earlier to a record 49.9 percent. The worsening employment market also shows signs of eroding pricing power for landlords. TD Securities Ltd. said today that rents fell 2 percent in April, after sliding by around 3 percent in the previous two months. Stevens and his board will keep the overnight cash rate target at 3 percent tomorrow to gauge whether a record 4.25 percentage points of rate cuts since early September and government spending will spur the economy out of a recession, according to 18 of 19 economists surveyed by Bloomberg.
Easy Credit and the Depression
What caused this recession? We still don't have a simple explanation. Such is the uncertainty sapping the country's confidence that in a recent Rasmussen Reports poll only 53% of Americans said they prefer capitalism to socialism; 27% were unsure and 20% preferred socialism. Before seeking political asylum in free-market Hong Kong, consider reading a new book that critiques what went wrong with capitalism, written in order to save it. Judge Richard Posner's "A Failure of Capitalism: The Crisis of '08 and the Descent into Depression" is noteworthy. As a longtime University of Chicago professor and father of the free-market-based law-and-economics movement, Judge Posner makes an unlikely critic of capitalism. But as author of some 40 books and as the most frequently cited federal appeals court jurist, he is also one of our most original and clearheaded thinkers.
Who's to blame and who's responsible for the recession? Judge Posner, who calls it a depression, distinguishes between the roles played by government and the private sector. "Although financiers bear the primary responsibility for the depression," he writes, "I do not think they can be blamed for it -- implying moral censure -- any more than one can blame a lion for eating a zebra. Capitalism is Darwinian." A pragmatic explanation for behavior that looks irrational in retrospect shows that it was logical, based on incentives at the time. Blame lies elsewhere: "The responsibility for building the fences that prevent an economic collapse as a result of risky lending devolves on the government." As Judge Posner told me in an interview, "The role of bankers is to operate banks, which is inherently a risky business. It's not to save the economy." But he disagrees that government is chiefly responsible. Banks are responsible in the sense that as each financial firm made rational choices for itself, such as embracing new credit instruments, these choices in aggregate created huge risk to the system.
Unlike responsibility, blame goes to those in government for creating the credit bubble, and then failing to have a contingency plan when the economy was headed off the rails. "Even if the risk of this depression was 1%, the effect of it occurring was so serious that the blame must go to regulators who were too slow." The conventional wisdom is that very smart bankers misunderstood their own interests. In a capitalist system, if you can't trust self-interest, what can you trust? Judge Posner instead reminds us that shareholders would have punished individual banks that failed to take advantage of low interest rates and seemingly safe, mortgage-backed securities. Likewise, consumers acted rationally over the years to accept offers of mortgages they couldn't afford, given the low risk of a burst bubble. "At no stage need irrationality be posited to explain what happened," Judge Posner writes. Instead, this was a case of "intelligent businessmen rationally responding to their environment yet by doing so creating the preconditions for a terrible crash." He chiefly blames the Federal Reserve, for "cheap credit."
Judge Posner, who shares an influential blog with Chicago Nobel prize-winning economist Gary Becker, proposes a partly psychological definition of a depression: "A steep reduction in output that causes or threatens to cause deflation and creates widespread public anxiety and, among the political and economic elites, a sense of crisis that evokes extremely costly efforts at remediation." The causes include failures of information at many levels. "Even though the financial industry has more information bearing on the likelihood of a depression than the government does, it has little incentive to analyze that information," Judge Posner writes. The models for assessing the riskiness of mortgage-backed securities failed, but at any one time the chances of a bubble resulting in a depression were remote. Likewise, "investors had limited information about the riskiness of individual mortgages, and there was insufficient experience with large-scale subprime lending to enable the risk of default of subprime mortgages to be assessed with confidence."
If we can agree that the private sector is responsible but the government gets the blame, we can move on to prevention. A streamlined set of regulators with access to public and private information should be charged with tracking systemic risk. We also need clear, predictable rules for how the Federal Reserve and other regulators would respond to various risk situations, which would give financial markets clearer rules of the road. Under this view, Washington's on-the-fly approaches to banks, autos and other industries risks further undermining confidence. Even capitalism's staunchest supporters recognize that it cannot function unless government plays its proper part. If all the players, including regulators and bankers, can accept their rightful share of blame and responsibility, we can begin to prevent future failures.
Picture me, if you will, as I settle at my desk to begin my workday, and feel free to use a Vermeer image as your template. The pale-yellow light that gives Dutch paintings their special glow suffuses the room. The interior is simple, with high walls and beams across the ceiling. The view through the windows of the 17th-century house in which I have my apartment is of similarly gabled buildings lining the other side of one of Amsterdam’s oldest canals. Only instead of a plump maid or a raffish soldier at the center of the canvas, you should substitute a sleep-rumpled writer squinting at a laptop. For 18 months now I’ve been playing the part of the American in Holland, alternately settling into or bristling against the European way of life. Many of the features of that life are enriching. History echoes from every edifice as you move through your day. The bicycle is not a means of recreation but a genuine form of transportation. A nearby movie house sells not popcorn but demitasses of espresso and glasses of Dutch gin from behind a wood-paneled bar, which somehow makes you feel sane and adult and enfolded in civilization.
Then there are the features of European life that grate on an American sensibility, like the three-inch leeway that drivers deign to grant you on the highway, or the cling film you get from the supermarket, which clings only to itself. But such annoyances pale in comparison to one other. For the first few months I was haunted by a number: 52. It reverberated in my head; I felt myself a prisoner trying to escape its bars. For it represents the rate at which the income I earn, as a writer and as the director of an institute, is to be taxed. To be plain: more than half of my modest haul, I learned on arrival, was to be swallowed by the Dutch welfare state. Nothing in my time here has made me feel so much like an American as my reaction to this number. I am politically left of center in most ways, but from the time 52 entered my brain, I felt a chorus of voices rise up within my soul, none of which I knew I had internalized, each a ghostly simulacrum of a right-wing, supply-side icon: Ronald Reagan, Jack Kemp, Rush Limbaugh. The grim words this chorus chanted in defense of my hard-earned income I recognized as copied from Charlton Heston’s N.R.A. rallying cry about prying his gun from his cold, dead hands.
And yet as the months rolled along, I found the defiant anger softening by intervals, thanks to a succession of little events and awarenesses. One came not long ago. Logging into my bank account, I noted with fleeting but pleasant confusion the arrival of two mysterious payments of 316 euros (about $410) each. The remarks line said "accommodation schoolbooks." My confusion was not total. On looking at the payor — the Sociale Verzekeringsbank, or Social Insurance Bank — I nodded with sage if partial understanding. Our paths had crossed several times before. I have two daughters, you see. Every quarter, the SVB quietly drops $665 into my account with the one-word explanation kinderbijslag, or child benefit. As the SVB’s Web site cheerily informed me when I went there in bewilderment after the first deposit: "Babies are expensive. Nappies, clothes, the pram . . . all these things cost money. The Dutch government provides for child benefit to help you with the costs of bringing up your child." Any parents living in the country receive quarterly payments until their children turn 18. And thanks to a recently passed law, the state now gives parents a hand in paying for school materials.
Payments arrive from other sources too. Friends who have small children report that the government can reimburse as much as 70 percent of the cost of day care, which totals around $14,000 per child per year. In late May of last year an unexpected $4,265 arrived in my account: vakantiegeld. Vacation money. This money materializes in the bank accounts of virtually everyone in the country just before the summer holidays; you get from your employer an amount totaling 8 percent of your annual salary, which is meant to cover plane tickets, surfing lessons, tapas: vacations. And we aren’t talking about a mere "paid vacation" — this is on top of the salary you continue to receive during the weeks you’re off skydiving or snorkeling. And by law every employer is required to give a minimum of four weeks’ vacation. For that matter, even if you are unemployed you still receive a base amount of vakantiegeld from the government, the reasoning being that if you can’t go on vacation, you’ll get depressed and despondent and you’ll never get a job.
Such things are easy for an American to ridicule; you don’t have to be a Fox News commentator to sneer at what, in the midst of a global financial crisis, seems like Socialism Gone Wild. And stating it as I’ve done above — we’ll consume half your salary and every once in a while toss you a few euros in return — it seems like a pretty raw deal. But there’s more to it. First, as in the United States, income tax in the Netherlands is a bendy concept: with a good accountant, you can rack up deductions and exploit loopholes. And while the top income-tax rate in the United States is 35 percent, the numbers are a bit misleading. "People coming from the U.S. to the Netherlands focus on that difference, and on that 52 percent," said Constanze Woelfle, an American accountant based in the Netherlands whose clients are mostly American expats. "But consider that the Dutch rate includes social security, which in the U.S. is an additional 6.2 percent. Then in the U.S. you have state and local taxes, and much higher real estate taxes. If you were to add all those up, you would get close to the 52 percent."
But to ponder relative tax rates is only to trace the surface of a deeper story. In fact, as my time abroad has coincided with the crumpling of basic elements of the American economic and social systems, and as politicians, commentators and ordinary Americans have cast about for remedies or potential new models, I have found myself not only giving the Dutch system a personal test drive but also wondering whether some form of it could be adopted by my country. One subtext of the World Economic Forum at Davos in January was the question of whether, amid the derailing of American-style capitalism as we have known it, the European approach, which marries capitalism and social welfare, and which in times of economic crisis seems to offer more stability both to individuals and to society, could suit the United States. President Obama’s initial budget called for a $634 billion fund over the next 10 years for revamping the health care system: an attempt to make good on his campaign promise of moving toward universal coverage, which of course is a basic component of the European social system. Two years ago, the Bush administration sent an emissary to examine the Dutch health care system in particular, thanks to its novel blend of public and private elements.
With the political atmosphere in Washington in flux, there is no saying what kinds of changes will come. But most people seem to agree that something has to happen. And in talking both with American expats and with experts in the Dutch system, I hear the same thing over and over: American perceptions of European-style social welfare are seriously skewed. The system in which I have embedded myself has its faults, some of them lampoonable. But does the cartoon image of it — encapsulated in the dread slur "socialism," which is being lobbed in American political circles like a bomb — match reality? Is there, maybe, a significant upside that is worth exploring?
Let’s focus first on the slur. I spent my initial months in Amsterdam under the impression that I was living in a quasi-socialistic system, built upon ideas that originated in the brains of Marx and Engels. This was one of the puzzling features of the Netherlands. It is and has long been a highly capitalistic country — the Dutch pioneered the multinational corporation and advanced the concept of shares of stock, and last year the country was the third-largest investor in U.S. businesses — and yet it has what I had been led to believe was a vast, socialistic welfare state. How can these polar-opposite value systems coexist? A short stroll from my apartment suggests the outlines of an answer. In about six minutes you reach the Dam, the wide plaza that is the Times Square of Amsterdam. It is no misnomer: after groups of settlers decided, around 1200, to make their homes at this spot where the Amstel River flowed into the inland bay called the IJ, they blocked up the river in order to control the water (hence the city’s name: Amstel . . . Dam). Beneath the Dam is, thus, an actual dam. The square is the center of the city’s history. Rembrandt, Spinoza and troops of Dutch Masters-looking gents trod these paving stones in the 17th century. One grim day in May 1945, just after the Nazis surrendered the city but before they left, German soldiers fired into the celebrating crowds on the square, killing 20 people.
The Dam is therefore a reminder not only of the country’s past but also of its ceaseless battle with water. And that battle turns out to be the key to understanding the Netherlands’ blend of free market and social welfare. The Low Countries never developed a fully feudal system of aristocratic landowners and serfs. Rather, sailors, merchants and farmers bought shares in trading ships and in cooperatives to protect the land from the sea, a development that led to the creation of one of the world’s first stock markets and helped fuel the Dutch golden age. Today the country remains among the most free-market-oriented in Europe.
At the same time, water also played a part in the development of the welfare system. To get an authoritative primer on the Dutch social-welfare state, I sat down with Geert Mak, perhaps the country’s pre-eminent author, to whose books the Dutch themselves turn to understand their history. The Dutch call their collectivist mentality and way of politics-by-consensus the "polder model," after the areas of low land systematically reclaimed from the sea. "People think of the polder model as a romantic idea" and assume its origins are more myth than fact, Mak told me. "But if you look at records of the Middle Ages, you see it was a real thing. Everyone had to deal with water. With a polder, the big problem is pumping the water. But in most cases your land lies in the middle of the country, so where are you going to pump it? To someone else’s land. And then they have to do the same thing, and their neighbor does, too. So what you see in the records are these extraordinarily complicated deals. All of this had to be done together."
There were political movements in the 20th century — like the sexual and social revolutions of the ’60s — that gave the country its reputation for no-holds-barred liberalism. But by Mak’s reckoning these developments were little more than varnish on the surface. The nation today embodies a centuries-old inclination toward collectivism, which one writer characterized as "the democracy of dry feet." "We are still in the polder, always searching for agreement among all parties," Heino van Essen, former chairman of PGGM, one of the largest Dutch pension funds, told me. "Even our pension system is collectivist, in which employers, employees and the government collaborate." The collaboration goes all the way to the top, where something called the Social Economic Council — consisting of trade-union, business and government representatives — advises the government on major issues. "It’s possible because our trade unions still play a prominent role," said Alexander Rinnooy Kan, the chairman of the council. "In the U.S., the relationship between employers and unions is adversarial, but here we’ve learned there’s a joint interest in working together."
There is another historical base to the Dutch social-welfare system, which curiously has been overlooked by American conservatives in their insistence on seeing such a system as a threat to their values. It is rooted in religion. "These were deeply religious people, who had a real commitment to looking after the poor," Mak said of his ancestors. "They built orphanages and hospitals. The churches had a system of relief, which eventually was taken over by the state. So Americans should get over ‘socialism.’ This system developed not after Karl Marx, but after Martin Luther and Francis of Assisi."
If "socialism" is then something of a straw man — if rather than political ideology, religious values and a tradition of cooperation are what lie beneath the modern social-welfare system — maybe it’s worth asking a simple question of such a system: What does it feel like to live in it? In 1992, Julie Phillips flew from her home in New York to visit a friend from college who lived in Amsterdam. She found that she liked the city. "You don’t know any nice, single, straight men here, do you?" she asked her friend. He said he knew one and introduced her to Jan. Julie married Jan, and Amsterdam became her home. Julie is a friend of mine, part of my American expat cabal in Amsterdam. She’s a fellow writer, and the second of her two children, Jooske, was born at home. Julie told me she isn’t a "hard-core granola type," but giving birth at home, with the help of a midwife, is a longstanding Dutch tradition, so, she said, "I was very when-in-Rome about it." She is now a fan of home birth. "It was incredibly pleasant," she said. Bart ("one of the Netherlands’ only male midwives," according to Phillips) showed up at her door at 11 in the morning. The baby was born a few hours later. "It was just me and Bart and Jan. Later, I was with the baby in the bedroom, listening to them yakking in the kitchen. I thought, Here I am with my baby in my bed, and everyone is having a nice time in my house."
The Netherlands has universal health care, which means that, unlike in the United States, virtually everyone is covered, and of course social welfare, broadly understood, begins at the beginning. In Julie and Jan’s case, although he was a struggling translator and she was a struggling writer, their insurance covered prenatal care, the birth of their children and after-care, which began with seven days of five-hours-per-day home assistance. "That means someone comes and does your laundry, vacuums and teaches you how to care for a newborn," Julie said. Then began the regimen of regular checkups for the baby at the public health clinic. After that the heavily subsidized day care kicked in, which, Julie told me, "is huge, in that it helps me live as a writer who doesn’t make a lot of money." The Dutch health care system was drastically revamped in 2006, and its new incarnation has come in for a lot of international scrutiny. "The previous system was actually introduced in 1944 by the Germans, while they were paying our country a visit," said Hans Hoogervorst, the former minister of public health who developed and implemented the new system three years ago. The old system involved a vast patchwork of insurers and depended on heavy government regulation to keep costs down. Hoogervorst — a conservative economist and devout believer in the powers of the free market — wanted to streamline and privatize the system, to offer consumers their choice of insurers and plans but also to ensure that certain conditions were maintained via regulation and oversight.
It is illegal in the current system for an insurance company to refuse to accept a client, or to charge more for a client based on age or health. Where in the United States insurance companies try to wriggle out of covering chronically ill patients, in the Dutch system the government oversees a fund from which insurers that take on more high-cost clients can be compensated. It seems to work. A study by the Commonwealth Fund found that 54 percent of chronically ill patients in the United States avoided some form of medical attention in 2008 because of costs, while only 7 percent of chronically ill people in the Netherlands did so for financial reasons. The Dutch are free-marketers, but they also have a keen sense of fairness. As Hoogervorst noted, "The average Dutch person finds it completely unacceptable that people with more money would get better health care." The solution to balancing these opposing tendencies was to have one guaranteed base level of coverage in the new health scheme, to which people can add supplemental coverage that they pay extra for. Each insurance company offers its own packages of supplements.
Nobody thinks the Dutch health care system is perfect. Many people complain that the new insurance costs more than the old. "That’s true, but that’s because the old system just didn’t charge enough, so society ended up paying for it in other ways," said Anais Rubingh, who works as a general practitioner in Amsterdam. The complaint I hear from some expat Americans is that while the Dutch system covers everyone, and does a good job with broken bones and ruptured appendixes, it falls behind American care when it comes to conditions that involve complicated procedures. Hoogervorst acknowledged this — to a point. "There is no doubt the U.S. has the best medical care in the world — for those who can pay the top prices," he said. "I’m sure the top 5 percent of hospitals there are better than the top 5 percent here. But with that exception, I would say overall quality is the same in the two countries."
Indeed, my nonscientific analysis — culled from my own experience and that of other expats whom I’ve badgered — translates into a clear endorsement. My friend Colin Campbell, an American writer, has been in the Netherlands for four years with his wife and their two children. "Over the course of four years, four human beings end up going to a lot of different doctors," he said. "The amazing thing is that virtually every experience has been more pleasant than in the U.S. There you have the bureaucracy, the endless forms, the fear of malpractice suits. Here you just go in and see your doctor. It shows that it doesn’t have to be complicated. I wish every single U.S. congressman could come to Amsterdam and live here for a while and see what happens medically."
I’ve found that many differences between the American and Dutch systems are more cultural than anything else. The Dutch system has a more old-fashioned, personal feel. Nearly all G.P.’s in the country make house calls to infirm or elderly patients. My G.P., like many others, devotes one hour per day to walk-in visits. But as an American who has been freelance most of his career, I find that the outrageously significant difference between the two systems is the cost. In the United States, for a family of four, I paid about $1,400 a month for a policy that didn’t include dental care and was so filled with co-pays, deductibles and exceptions that I routinely found myself replaying in my mind the Monty Python skit in which the man complains about his insurance claim and the agent says, "In your policy it states quite clearly that no claim you make will be paid." A similar Dutch policy, by contrast, cost 300 euros a month (about $390), with no co-pays, and included dental coverage; about 90 percent of the cost of my daughter’s braces was covered.
Health care is maybe the most distinguishable part of social welfare, but the more time I spend in the Netherlands, the less separable health care becomes from the whole. Which is to say that to comprehend this system is to enter a different state of mind. People have a matter-of-fact belief not in government — in my experience the Dutch complain about government as frequently as Americans do — but in society. As my Dutch teacher, Armelle Meijerink, said: "We look at the American system, and all the uninsured, and we can’t believe that a developed country chooses for that. I have a lot of American students, and when we talk about this, they always say, Yes, but we pay less tax. That’s the end of the discussion for them. I guess that’s a pioneer’s attitude."
Decent housing is another area where the Dutch are in broad agreement. As does nearly every Western nation, the Netherlands has a public housing system, in which qualified people get apartments for below-market rents. About one-third of all dwellings in the country are "social housing." But here again, attitudes are different from those in the United States. I was surprised to learn, for example, that a friend who is a successful psychologist lives in a social-housing apartment, which he has had since his student days. It turns out the term does not have the stigma attached to it that "public housing" does in the United States. ("In the U.S., public housing is a last resort, but here it’s just a good, cheap house," said Fred Martin, an official at Impuls, an Amsterdam social-services organization.) Beyond that, while my friend obviously can afford to pay more than his bargain-basement rent of 360 euros ($470), the system doesn’t require him to move on, and one reason is that there is perceived to be a value in keeping a mix of income levels in the units.
Social housing differs from much of the public housing in the United States in that the government does not own or manage the properties. Rather, each is owned by an independent real estate cooperative. The system is not-for-profit, but it pays for itself. The housing market, then, is actually two real estate markets running alongside each other, one of which operates at government-mandated cheaper rates. This points up something that seems to be overlooked when Americans dismiss European-style social-welfare systems: they are not necessarily state-run or state-financed. Rather, these societies have chosen to combine the various entities that play a role in social well-being — individuals, corporations, government, nongovernmental entities like unions and churches — in different ways, in an effort to balance individual freedom and overall social security.
So here is a little epiphany I had through the experience of living in Europe. Maybe we Americans have set up a false dichotomy. Over the course of the 20th century, American politics became entrenched in two positions, which remain fixed in many minds: the old left-wing idea of vast and direct government control of social welfare, and the right-wing determination to dismantle any advances toward it, privatize the system and leave people to their own devices. In Europe, meanwhile, the postwar cradle-to-grave idea of a welfare state gave way in the past few decades to some quite sophisticated mixing of public and private. And whether in health care, housing or the pension system (there actually is still a thriving pension system in the Netherlands, which covers about 80 percent of workers), the Dutch have proved to be particularly skilled at finding mixes that work.
O.K., enough euphoria. It’s true that I have grown to appreciate many aspects of this system. But honesty compels me to reveal another side. There is a mood that settles into me here, deepening by degrees until its deepness has become darkness. It happens typically on a Sunday afternoon. I’ll be strolling through a neighborhood on the outskirts of Amsterdam, or cycling in a nearby small town, and the calm, bland streets and succession of broad windows giving views onto identical interiors will awaken in my mind a line from Camus’s "Myth of Sisyphus" that struck me to the core when I first read it as an undergraduate: "A man is talking on the telephone behind a glass partition; you cannot hear him, but you see his incomprehensible dumb show: you wonder why he is alive."
Something about this place rekindles the existential rage of my youth. Why are we here? How does a person achieve contact with his soul? Or in somewhat less grandiose terms: What do you do with yourself on a lazy Sunday afternoon? You pop into a shop. You sit at a cafe and read. You linger in a bookstore. Is this not why we have cities? Alas, such activity is largely impossible on a Sunday in my adopted city. A collusion of two forces in the mid-20th century — the workers’ movement and the church — resulted in a policy of restricted business hours, and the conservative Dutch system is resistant to change. The supermarket in my tiny hometown in western Pennsylvania is open 24 hours a day. I challenge you to find anything open 24 hours a day in this supposedly world-class city. Indeed, most shops close by 6 p.m. — precisely when people leaving work might actually want to patronize them.
This rant has a couple of deeper points behind it. For one, the sameness suggests a homogeneous population, which the Netherlands long had. A broad social-welfare system works if everyone assumes that everyone else is playing by the same rules. Newcomers, with different ways of life and expectations, threaten it. This is one reason the recent waves of non-Western immigration have caused so much disturbance. Can such a system work in a truly multiethnic society? Then, too, one downside of a collectivist society, of which the Dutch themselves complain, is that people tend to become slaves to consensus and conformity. I asked a management consultant and a longtime American expat, Buford Alexander, former director of McKinsey & Company in the Netherlands, for his thoughts on this. "If you tell a Dutch person you’re going to raise his taxes by 500 euros and that it will go to help the poor, he’ll say O.K.," he said. "But if you say he’s going to get a 500-euro tax cut, with the idea that he will give it to the poor, he won’t do it. The Dutch don’t do such things on their own. They believe they should be handled by the system. To an American, that’s a lack of individual initiative."
Another corollary of collectivist thinking is a cultural tendency not to stand out or excel. "Just be normal" is a national saying, and in an earlier era children were taught, in effect, that "if you were born a dime, you’ll never be a quarter" — the very antithesis of the American ideal of upward mobility. There seem to be fewer risk-takers here. Those who do go out on a limb or otherwise follow their own internal music — the architect Rem Koolhaas, say, or Vincent Van Gogh — tend to leave. So where does this get us? If the collectivist Dutch social system arises from the waters of Dutch history, how applicable is it to American society, which was shaped by the wagon train and the endless frontier? And why would a nation raised on "You can go your own way" and "Be all that you can be" even want to go Dutch? To the first point, there are notable similarities between the two countries. The Dutch approach to social welfare grew out of its blend of a private-enterprise tradition and a deep religious tradition. The ways in which the United States seeks to fix its social system surely stem from its own strong tradition of religious values, and also from a desire to blend those values with its commitment to private enterprise.
And while I certainly wouldn’t wish the whole Dutch system on the United States, I think it’s worth pondering how the best bits might fit. One pretty good reason is this: The Dutch seem to be happier than we are. A 2007 Unicef study of the well-being of children in 21 developed countries ranked Dutch children at the top and American children second from the bottom. And children’s happiness is surely dependent on adult contentment. I used to think the commodious, built-in, paid vacations that Europeans enjoy translated into societies where nobody wants to work and everyone is waiting for the next holiday. That is not the case here. I’ve found that Dutch people take both their work and their time off seriously. Indeed, the two go together. I almost never get a work-related e-mail message from a Dutch person on the weekend, while e-mail from American editors, publicists and the like trickle in at any time. The fact that the Dutch work only during work hours does not seem to make them less productive, but more. I’m constantly struck by how calm and fresh the people I work with regularly seem to be.
I’m not the only American to note this. "The thing that impressed me from Day 1, 25 years ago, is the sense of community," said Buford Alexander, the former McKinsey director. "They know how to work and how to live. That’s why I stayed." Geert Mak, the Dutch author, insisted that happiness is tied directly to the social system. We were sitting at his favorite cafe, a hangout of Dutch journalists since the end of World War II, and the genial, old-wood setting of the place, as well as its location, around the corner from the Dam and the center of the city’s history, added a bit of luster to his words and reminded me, for the thousandth time, why I’m still here, despite the downside. "One problem with the American system," he said, "is that if you lose your job and are without an income, that’s not just bad for you but for the economy. Our system has more security. And I think it makes our quality of life better. My American friends say they live in the best country in the world, and in a lot of ways they are right. But they always have to worry: ‘What happens to my family if I have a heart attack? What happens when I turn 65 or 70?’ America is the land of the free. But I think we are freer."