Dock Street, Philadelphia
Ilargi: And neither do I. I have a broken fan in my laptop that makes so much noise it paints the picture of working in the steam engine rooms of the Titanic. So don’t read me, read instead the first bunch of articles, if nothing else, to see how relevant my theme yesterday, namely "debt", is fast becoming.
I understand that many of you will think: what's new with that theme? Hasn't debt always been the issue?
Well, what’s new is that now, unlike say, 6 months ago, the stock markets are rising, but at the same time our debt problems are growing at an exponential rate. There is a disconnect between the markets and the population that was not there before. And that disconnect, when the markets come crashing down to reality in a few months time, will make the population even much poorer than it already is. Suckers and rallies.
If that poverty is hard to fathom, when you today see malls filling up with shoppers, when people buy homes and get loans for them, please do this little thought experiment: try to imagine what the economy would be like today if there were NO credit available at all. That, basically is what we would have if the government wouldn't lend our own -future- money back to us -at interest- in the present.
If the economy would start growing considerably soon, that would be a danger, but we might be able to paper it over. If the economy does not, and I say it can’t, the mayhem will be hard to oversee. Our societies will just about literally drown in debt, even in the interest payments on our debt.
California has 50 days left. The rest of us have maybe 5 months. California has by far the better chance at survival, since it's big, but not so big that the federal government can't use everyone else's money to bail it out to an extent. After all state programs for the poor, the sick, the young and the old have been guttered. None of those carries a strong enough electoral vote. Highway maintenance will trump people’s life expectancies. Democracy at its best and finest.
Bailing out California so it can maintain its highways is what the administration will do. And that will add yet more to your debt, and kill off those our economies don't need.
The culling of the herd has started. Where were you when it did? What were you doing? It''s a moment like JFK's assassination, or 9/11. Make it one to remember.
US Budget Deficit Hits Monthly Record At $189.7 Billion
The federal budget deficit soared to a record for May of $189.7 billion, pushing the tide of red ink close to $1 trillion with four months left in the budget year. The rising deficit reflects increased government spending due to the recession, and billions of dollars spent on bailouts for banks and other troubled companies. The Treasury Department reported Wednesday that the red ink so far this year totals $991.9 billion. The administration is projecting the deficit for the budget year that began Oct. 1, will total a record $1.84 trillion. That would be more than four times the amount of last year's record deficit.
As a share of the overall economy, the deficit this year would be the highest since 1945, when the government was borrowing heavily to win World War II. Because of the recession, spending has increased for benefit programs such as unemployment compensation and food stamps. Outlays also have risen because of the $787 billion economic stimulus package that President Barack Obama pushed through Congress earlier this year. The new Treasury report showed government spending totals a record $2.37 trillion through the first eight months of the budget year, 18 percent more than the year-ago period.
At the same time, the economic downturn has cut into tax revenues. The report showed that government receipts total $1.67 trillion through May, down 18 percent from last year. Rising unemployment and struggling businesses have meant a drop in both income and corporate taxes. Last month's imbalance compared with a $20.9 billion deficit in April, the first time that happened in 26 years. April is a month when the government normally runs surpluses reflecting tax payments. The $991.9 billion deficit so far this budget year is more than triple the amount of red ink incurred during the year-ago period.
Under the administration's budget estimates, the $1.84 trillion deficit for this year will be followed by a $1.26 trillion deficit in 2010, and will never dip below $500 billion over the next decade. The administration estimates the deficits will total $7.1 trillion from 2010 to 2019. Economists are worried that such large borrowing needs could trigger steep increases in interest rates if domestic and foreign investors start demanding a higher return for holding Treasury debt. Treasury Secretary Timothy Geithner traveled to Beijing last week to reassure officials in China, the single-largest holder of U.S. Treasury debt, that the administration is serious about getting control of the deficits once the current downturn and financial crisis have passed.
So much for de-leveraging. The Fed published its latest Flow of Funds report today. One key takeaway: While total debt is growing more slowly, it is still growing. Since Q3 ‘08 households have cut their debt (slightly), but the federal government is borrowing so rapidly, overall debt continues to expand.
By the way, the Fed only includes publicly held debt when calculating total federal government borrowings, $6.7 trillion at the end of Q1. This excludes over $4 trillion owed to the Social Security "trust fund." More importantly, it excludes $60 trillion of unfunded future liabilities for Medicare and Social Security. The second chart puts the data into perspective. As a percentage of GDP, debt continues to expand, from 368% at the end of Q4 to 375% at the end of Q1.
It’s been said that the income statement is the past, but the balance sheet is the future. Our balance sheet is getting worse. Those who see "green shoots" believe the crisis is abating. But they don’t understand its origin: a credit bubble that, in the aggregate, continues to inflate. The equity value of our economy is going down—think the stock market and housing equity (see below). At the same time our debt is going up. In other words, America’s leverage continues to expand.
The only way to climb out of a debt-induced depression is to pay down debt or to write it off. Levering up only delays the inevitable. Unfortunately Americans, and lately the Obama administration, have shown absolutely no political will to do this. Republicans decry growing deficits, but do you ever hear them enumerate cuts they would make? Clearly our plan is to keep borrowing until our lenders cut us off.
Speaking of crashing equity…
The last chart plots the amount of equity Americans have in their homes. This figure has been crashing as house prices fall while mortgage debt stays roughly constant. At the end of 2007 the figure was 49%, at the end of last year 43%. It now stands at 41.4%. And as CR notes: "approximately 31% of households do not have a mortgage. So the 50+ million households with mortgages have far less than 41.4% equity."
New jobless claims at 601K; continuing claims keep rising to new records
The number of newly laid-off Americans filing jobless claims fell more than expected last week and retail sales grew in May for the first time in three months. But a rise in the number of people continuing to receive jobless aid signaled that an economic recovery is still far off. The Labor Department said Thursday that initial claims for unemployment benefits fell last week by 24,000 to a seasonally adjusted 601,000. That's below analysts' estimates of 615,000.
Still, the number of people claiming benefits for more than a week rose by 59,000 to more than 6.8 million, the highest on records dating to 1967. The department also revised last week's data on continuing claims, replacing what had been a drop of 15,000 with an increase of 6,000. That means continuing claims have set records for 19 straight weeks. The data lag initial claims by a week. Retail sales rose for the first time in three months in May, as a rebound in demand at auto dealerships and gas stations helped offset weakness at department stores. The Commerce Department said retail sales increased by 0.5 percent last month, in line with economists' expectations. It was the largest increase since sales rose 1.7 percent in January following six straight declines.
Excluding autos, retail sales also grew 0.5 percent in May, better than the 0.2 percent gain that economists had expected. Consumers may be spending a bit more and layoffs may be slowing, but companies are reluctant to hire amid the longest recession since World War II. That makes it harder for the unemployed to find work. Jobless claims are a measure of the pace of layoffs and are seen as a timely, if volatile, indicator of the economy's health. The four-week average of claims, which smooths out fluctuations, fell to 621,750, down from a high of about 658,000 in early April. Many economists see the decline as a sign that layoffs have peaked and the recession is bottoming out.
Still, the levels are far above what is customary in a healthy economy. Initial claims stood at 388,000 a year ago. The department said last week that companies eliminated a net total of 345,000 jobs in May. While steep, that's about half the monthly average of jobs lost in the first quarter. Yet the unemployment rate jumped to 9.4 percent in May, a 25-year high, as hundreds of thousands of people entered the labor market and began looking for work but couldn't find it, the department said. As college graduates and other new entrants start searching for a dwindling number of jobs, economists expect the unemployment rate to rise even as layoffs subside.
Some economists project the rate could near 11 percent by the middle of next year. And many families are saving more as they deal with layoff fears, as well as shrunken home equity and retirement accounts. Because rising gasoline prices aided last month's retail sales gain, "a meaningful consumer recovery remains some way off," Paul Dales, U.S. economist at Capital Economics in Toronto, wrote in a research note. "It usually takes a few months for households to curtail their discretionary spending in response to the higher cost of gas." Troubles in the automotive sector also could cause unexpected fluctuations in jobless claims. General Motors Corp. filed for bankruptcy protection June 1, joining Chrysler LLC, which filed April 30.
GM said it will close about a dozen plants as part of its restructuring. The closings, which will take place through the end of 2010, will cost up to 20,000 workers their jobs. In addition, the company said Monday that it plans to cut a production shift at a plant in Wentzville, Mo., in August, resulting in up to 900 layoffs. Among the states, Connecticut had the largest increase in claims of 816, followed by Louisiana, Tennessee, Arizona and Nebraska. The state data lag initial claims by a week. Florida had the largest drop in claims of 6,655, which it attributed to fewer layoffs in the construction, service and manufacturing industries. The next largest decreases were in Illinois, Michigan, California, and Texas.
Household Wealth in U.S. Fell by $1.3 Trillion in First Quarter
U.S. household wealth fell in the first quarter by $1.3 trillion, extending the biggest slump on record, as home and stock prices dropped. Net worth for households and non-profit groups decreased to $50.4 trillion, the lowest level since 2004, from $51.7 trillion in the fourth quarter, according to the Federal Reserve’s Flow of Funds report today. The government began keeping quarterly records in 1952. Americans are cutting back on spending as unemployment surges, home prices continue to drop and wealth evaporates, signaling any economic recovery will be slow to develop.
The drop in net worth is one reason Americans are boosting savings, blunting the effect of the tax breaks and income supplements from the Obama administration’s stimulus plan. "It’s going to be very difficult to have any recovery in consumer spending without jobs and incomes recovering first," said Christopher Low, chief economist at FTN Financial in New York. "The probability of a debt-financed consumer spending binge like we saw in the last expansion is essentially nil."
Retail sales rose in May for the first time in three months, an increase driven almost solely by U.S. shoppers returning to automobile showrooms seeking bargains and the rising cost of gasoline, a report today from the Commerce Department showed. One positive aspect of today’s Fed report is that the decreases in net worth are starting to ease. Wealth dropped by a record $4.9 trillion in the last three months of 2008. Americans have taken on less debt as the economic recession unfolds. While the jump in savings rate to 5.7 percent in April was helped by an increase in incomes linked to the fiscal stimulus plan, some economists are forecasting savings will continue to rise as consumers hold back on spending.
Real-estate-related household assets decreased by $551.1 billion, following a $974.5 billion decrease in the fourth quarter. Net worth related to corporate equities fell by $347.8 billion the first three months of this year. Owners’ equity as a share of their total real-estate holdings decreased to 41.4 percent last quarter from 42.9 percent in the fourth quarter, today’s Fed report showed. Consumer debt fell at a 1.1 percent annual pace following a 2 percent decrease in the fourth quarter that was the first drop on record.
Mortgage borrowing was unchanged from January through March, the first time in a year it didn’t fall, the Fed’s report showed. Stabilization in real-estate lending adds to evidence that the housing slump is easing. Total borrowing by consumers, businesses and government agencies increased at an annual rate of 4.1 percent last quarter compared with a 6.2 percent gain the prior quarter. The gain was paced by a 23 percent surge in borrowing by the federal government, reflecting spending linked to the stimulus plan. Business borrowing decreased at a 0.3 percent pace after rising 1.5 percent the prior quarter, the Fed said.
Borrowing by state and local governments increased at a 4.9 percent rate. The economy contracted at a 5.7 percent annual pace in the first quarter and consumer spending rose at a 1.5 percent pace. Economists surveyed by Bloomberg News this month forecast unemployment will climb to 10 percent by the end of the year and lowered their projections for consumer spending in the second half of the year to an average 1.1 percent annual pace. For all of 2009, purchases will drop 0.7 percent, the worst performance since 1974, according to the Bloomberg survey.
U.S. Foreclosure Filings Top 300,000 as Bank Seizures Loom
U.S. foreclosure filings surpassed 300,000 for the third straight month in May and may hit a record 1.8 million by the first half of the year, RealtyTrac Inc. said. A total of 321,480 properties received a default or auction notice or were repossessed last month, up 18 percent from a year earlier, the Irvine, California-based seller of default data said today in a statement. One in 398 U.S. households received a filing last month. "The foreclosure bucket is filling faster than it’s emptying," Jay Brinkmann, chief economist of the Washington- based Mortgage Bankers Association, said in an interview. "It will continue through next quarter at least."
Job losses and falling property prices are delaying the housing recovery as more homeowners are unable to pay the mortgage or have difficulty selling or refinancing. The unemployment rate climbed to 9.4 percent in May, the highest since 1983, the Labor Department said last week. Prices in 20 U.S. cities dropped 18.7 percent in March, according to the S&P/Case-Shiller home-price index. More home loans originated in 2005 or before are likely to default as unemployment climbs, said Rick Sharga, executive vice president for marketing at RealtyTrac.
A record 1.37 percent of all loans entered the foreclosure process in the first quarter, with 29 percent tied to borrowers with prime, fixed-rate mortgages, the MBA reported May 28. Homes in foreclosure totaled 3.85 percent of all loans in the quarter, up from 2.47 percent a year earlier, MBA said. "The numbers are getting bigger and that’s what is bothering me," said Patrick Newport, economist at IHS Global Insight in Lexington, Massachusetts. "You have banks holding these toxic loans, which means bank balance sheets are in even worse shape with the increase in delinquencies."
Additional U.S. home foreclosures will probably total 6.4 million by mid-2011, and inventories of foreclosed homes awaiting sale will probably peak in mid-2010 at about 2 million properties, JPMorgan Chase & Co. analysts led by John Sim wrote in a June 5 report. U.S. prices will likely drop 39 percent on average, they said. The May total was the third-highest in RealtyTrac records dating to January 2005. Nevada had the highest foreclosure rate, one in every 64 households, more than six times the national average. California ranked second at one in 144 households.
Florida had the third-highest rate at one in 148 households. Arizona ranked fourth with one in 158 and Utah was fifth with one filing per 316 households, RealtyTrac said. Other states among the top 10 highest rates were Michigan, Georgia, Colorado, Idaho and Ohio. California had the highest total number of filings at 92,249, 23 percent more than a year earlier. Scheduled auctions rose 18 percent from the previous month while bank seizures fell 1 percent and defaults fell 18 percent.
Florida had the second-highest total with 58,931 filings, up 50 percent from May 2008. Nevada was third with 17,157 filings, up 83 percent, as bank seizures there rose 23 percent from the previous month. Arizona, Michigan, Ohio, Illinois, Georgia, Texas and Virginia rounded out the top 10, which accounted for 77 percent of total U.S. filings, according to RealtyTrac. New Jersey had the 24th highest rate, one in 794 households, and 4,408 filings. Connecticut ranked 33rd, with one in every 1,301 households in some stage of default. The state had 1,106 filings. New York was 37th, with one in 1,646 households getting a filing for a total of 4,825.
Las Vegas had the highest foreclosure rate among metropolitan areas with a population 200,000 or more. One in 54 households got a notice, up 78 percent from a year earlier and up 4 percent from the previous month. California had six cities among the top 10. Stockton, Modesto, Riverside-San Bernardino and Merced ranked second through fifth, respectively, Bakersfield was seventh and Vallejo-Fairfield was ninth. Florida had three cities in the top 10: Cape Coral-Fort Myers ranked sixth, Orlando-Kissimmee was eighth and Miami-Fort Lauderdale-Pompano Beach was tenth, according to RealtyTrac, which collects data from more than 2,200 counties representing 90 percent of the U.S. population.
Ilargi: Please note that the uptrend in the line is pure fiction. Or shoudl I say presumption? Faith? Belief? Charity? Also note that the Japan chart has no such uptrend.
The US Housing Bust Looks Like Japan's
Robert Shiller recently warned homeowners that it could be a long time before the housing market turned up again, noting that Japan's housing bust took place over 15 years. That seems hard to fathom here, especially considering everything the government's doing to re-inflate the market. But there are certainly similarities. This chart, via the Pragmatic Capitalist, overlays the 10 city Case-Shiller index with Japanese condo prices, when they had their boom. As you can see, the cycle has an eerily familiar look and feel.
Ilargi: A great tool to figure out, at least partly, what is wrong with the US stress tests. Bank Of America, you’re dead.
Rortybomb’s DIY Stress Test 2: Final Spreadsheet
To get a sense of where and how we found the data, check out the previous entry in the DIY Stress Test.
UPDATE: There’s a lot of crazy changing things that shouldn’t be changed in the google doc version. I suppose I was asking for that. I’m trying to keep up reverting the incorrect errors, but I’ve been requested to provide a version that is correct and uneditable so people can download something they know is working. Here is a lockdown version of the spreadsheet that is both correct and uneditable. Click “File -> Export -> .xls” to modify locally on your computer. You’ll have to recreate the graph if you want that.
The Rortybomb DIY Stress Test.
So without further ado, the google doc Rortybomb DIY Stress Test.
Type in the U3 average you expect will happen in 2010 in the top yellow box. Now ideally you type in the U3 that only has a 10% chance of happening, not what you actually expect to happen, because of the good risk management practices discussed in the previous entry. The spreadsheet will extrapolate losses based on the two data points in the Fed’s document.
If you are feeling bold, type in your own estimates of losses next to it and the spreadsheet will use those instead. So if you think the 10.3 numbers are really good, but you expect housing and credit cards to do worse than expected, type 10.3 into U3 and then some numbers into the rightmost yellow row of boxes for housing and credit cards and see how the banks would have done.
Next look at the results below. You can see the results of the stress test that came out (the “adverse numbers” one) below along with your very own. It also has a total at the bottom representing the total amount of new capital the financial sector has to raise, and a chart showing the released stress test versus your own.
I’m leaving this as a google chart. Please don’t eat it. You can click “File -> Export -> .xls” to play around with it in excel. Do use xls format, as there are multiple sheets that talk to each other (if you have any problem, tell me and I’ll fix it, but it should work in excel). Also you can click on the upper left corner of the image to publish your results to the web, and hotlink to that.
And by the way, I said back when that the U3 adverse numbers should be like 12-13%. Here’s what the chart looks like with 12.5%:
How would the market have reacted if the Fed said that the banking sector needed $390bn instead of $76bn?
Linear interpolation, aka drawing a line, is nonsense here.
Yes. It assume the increase in losses between 8% and 10% U3 is the same increase as the losses between 10% and 12%. But notice that this biases against banks losing money, as the growth in losses are going to be positively, not negatively correlated with each other.
In addition, I simply add the increase in loss % to each individual firms loss %. Again I believe this biases against individual banks losing money, because the errors won’t be identical here – this will tend to underestimate the bad parts of each portfolio.
There are variables other than Unemployment used in the Stress Tests.
True, but I only have two pieces of data here. If you feel that there will be green shoots in, say, Commerical Real Estate that won’t be reflected in the U3 number, go ahead and lower the U3 number a bit. Or just see the projected CRE numbers and adjust them downwards. I’d love to get into all kinds of crazy modeling here for each macro variable, but we go to war with the army we’ve got.
I would have done it this way…..
Please leave critiques in the comments or contact me directly. I think I covered most of the bases with this though. I’m a little uncertain about how to calculate the buffer capital stock remaining for those banks that didn’t need cash infusions in the stress test, but I think I went with the approach that was most generous to the banks. And “other” category doesn’t have % loss in the original numbers per bank, so I treat that as a zero intercept. At the end, these turned out to be a rounding error though.
These numbers make no sense at low unemployment, they are all zero.
Yes. Just like unemployment, there is some “natural level” of losses that we aren’t going to be able to get at with the data at hand. I wouldn’t trust this for U3 under the baseline, 8.8%.
Wow, it really seems if you go out a bit all the losses are with a few specific banks, and maybe we should look into breaking them up before they become even more of a rotting albatross on our economy’s neck.
Yup. Sure looks that way. I was actually surprised – I assume turning up the numbers a bit would cause everyting to start leaking red ink. Instead it seems that if there is an additional slight downturn in the economy, we know the firms that will have all the problems. They are the ones that are too big to fail. Funny that. But I’d be curious as to your interpretations!
Ilargi: Good item, good find, and Tyler Durden is a great addition to the part of the web we roam about in. But I do have to ask: how can anyone smart clamor for a Fed Transparency Petition? What do we think the Fed is, and what our say in it is?
The Fed Would Be Shut Down If It Were Audited
Some key soundbites:
- "If the Fed examiners were set upon the Fed's own documents—unlabeled documents—to pass judgment on the Fed's capacity to survive the difficulties it faces in credit, it would shut this institution down."
- "The Fed is undercapitalized in the same way that Citicorp is undercapitalized."
- "I think zero is the wrong rate for almost any economy."
- "So great is the slack in the economy that it will be years before there is anything like a murmur from the inflation front."
- "15 out of 16 primary government bond dealers are in agreement that the Fed will not move before the year end."
- "There are no bad bonds, just bad prices. Treasuries at 2% were a toxic asset."
- "Citibank is a rogue bank."
Schwarzenegger threatens to shut down state government
Gov. Arnold Schwarzenegger vowed Wednesday to let California government come to a "grinding halt" rather than agree to a high-interest loan to keep the state afloat if he and the Legislature do not close the yawning budget gap in coming weeks. At the same time, the governor reversed himself on a proposal to end health insurance for families of police officers and firefighters who died in the line of duty. Schwarzenegger called the plan, first reported by The Times on Tuesday, a "terrible screw-up" that is being corrected.
The proposed cut was tucked away in a list of regulations that would be suspended if Schwarzenegger's latest budget revisions are adopted. It would have saved the state $1 million in 2009-10. State finance officials say California coffers will be empty in late July unless the projected $24-billion budget shortfall is resolved quickly. Schwarzenegger said that emergency borrowing would be too expensive and that his threat to block it was necessary to prod lawmakers into swift action.
A loan would only "give them another reason why we don't have to do it now," the governor said. "What we need to do is just to basically cut off all the funding and just let them have a taste of what it is like when the state comes to a shutdown -- grinding halt." The comments, made in an interview with The Times' editorial board, represent the governor's latest salvo in the battle over California's budget. An emergency loan -- not routine short-term borrowing but a longer-term, higher-interest loan -- would require the governor's approval but not that of the Legislature, unlike his proposed budget solutions. He approved the initial step for such borrowing last year and can revoke it at any time.
In the wide-ranging interview, Schwarzenegger challenged legislative Democrats to resist the influence of special interests fighting the deep program cuts he has proposed to help balance the budget. Clearly alluding to labor unions that oppose the cuts, the governor said: "Do they want to protect the workers that provide the services, or do they want to protect the people that get those services? The choice is up to them." Schwarzenegger reiterated his support for a constitutional convention to overhaul state government, calling it "the only hope that I have" for substantive reform. He also took aim at some other elected officials, characterizing them as obstructionists in his quest for change.
Mostly, however, he expressed frustration over the financial crisis that threatens to overshadow the final year and a half of his governorship. All sides -- legislative Republicans, Democrats and the governor -- have pledged to plug California's deficit by the end of June. The new fiscal year begins July 1. "We will meet the July 1 deadline," Senate leader Darrell Steinberg (D-Sacramento) said in an e-mail to The Times. If lawmakers fall short of that goal, as they have many years, Schwarzenegger's refusal to borrow would leave the nation's most populous state with no way to pay its bills.
"Payment deferrals and IOUs -- that's all we would be left with," said Hallye Jordan, a spokeswoman for state Controller John Chiang, who monitors California's cash flow. Chiang reported Wednesday that the state's revenues have fallen $827 million below projections made only weeks ago. Amid a cash crunch earlier this year, the state deferred some payments, including taxpayer refund checks. But California has not issued IOUs since the early 1990s.
Schwarzenegger has proposed slicing deep into public schools and eliminating college student grants, health insurance for 930,000 poor children and the state's welfare-to-work program. But the Democrats who dominate the Legislature have countered that they will not disassemble California's social safety net. In the Senate, Democrats have sketched a counter-proposal that would drain the state's reserves and rely on hopes for a rosier economic future to hold off the deepest of the cuts. Their plan would resolve up to $20 billion of the projected $24-billion deficit.
The governor called that approach "hallucinatory" on Tuesday and "irresponsible" on Wednesday. "We have not hit the bottom" of the economic crisis, he told The Times. Some rank-and-file Democrats are holding out hope of raising taxes to close the deficit. And the state's largest labor group, the Service Employees International Union, launched a $1-million TV advertising campaign Wednesday to press for more taxes on oil, tobacco and liquor. Eliseo Medina, SEIU's national executive vice president, said the governor "ought to be worrying about trying to maintain services instead of trying to kill the messenger."
Support from some Republican lawmakers, most of whom have said no to further taxes, would be needed for such proposals to pass the Legislature. Schwarzenegger said the financial crisis should be the impetus for a leaner and more functional state government. But he said he had no confidence in the Legislature to change the status quo and hoped a constitutional convention -- the radical notion of tossing out California's oft-amended legal framework to start from scratch -- would. One area Schwarzenegger singled out: the array of elected statewide officials -- controller, treasurer, schools superintendent, etc. -- who can hail from different political parties and have different philosophies. The system was intended to create checks and balances, but the governor complained that the others sometimes get in his way.
"I say we should decrease the state employees' salaries, and the controller says, 'Nah, I don't think it's necessary,' " Schwarzenegger said, recalling a legal battle with Chiang that the governor eventually won. "If I want to . . . create a vision for California, you can't have a team around that's trying to derail you," the governor said. "I always get my lessons from sports," he said. "Look at the Lakers, look at all the great teams. When they are together and connected, then they have a better chance of winning."
California nears financial "meltdown" as revenues tumble
California's government risks a financial "meltdown" within 50 days in light of its weakening May revenues unless Governor Arnold Schwarzenegger and lawmakers quickly plug a $24.3 billion budget gap, the state's controller said on Wednesday. Underscoring the severity of California's cash crisis, Controller John Chiang, who has previously warned the state's government risks running out of cash without a budget deal, said revenues in May fell by $1.14 billon, or 17.7 percent, from a year earlier.
Additionally, the revenues of the government of the most populous U.S. state fell short of estimates in Schwarzenegger's budget plan by $827 million, Chiang said. He warned California's state government is speeding toward a financial disaster unless officials act urgently to balance its books. "Without immediate solutions from the governor and legislature, we are less than 50 days away from a meltdown of state government," Chiang said in a statement.
California's revenues have been on a dramatic slide as a result of recession, rising unemployment and its lengthy housing downturn. The state's revenues from personal income taxes tumbled by 39.3 percent in May from a year earlier while revenues from corporate taxes fell by 52.1 percent and revenues from sales taxes sagged by 7.6 percent, according to a report released by Chiang's office. "A truly balanced budget is the only responsible way out of the worst cash crisis since the Great Depression," Chiang, a Democrat, said.
Schwarzenegger, a Republican, has proposed filling the state's budget gap with deep spending cuts, borrowing from local governments and by scrapping some state programs, including its welfare program. Democrats who control the legislature are crafting a rival budget plan that includes spending cuts and saves programs Schwarzenegger has proposed eliminating. They instead would use reserves estimated in his budget to narrow the budget gap. State Senate President Pro Tem Darrell Steinberg said on Tuesday he wants a budget agreement by the end of this month.
California's new fiscal year begins on July 1. The sooner the state has a budget the better poised it will be to raise short-term cash to fund its operations by selling revenue anticipation notes, or RANs, on the municipal debt market. If pressed, California could sell revenue anticipation warrants, or RAWs, an idea floated by Schwarzenegger when he unveiled his budget plan last month. But he quickly shelved it amid opposition from lawmakers.
"No one wants to issue RAWs for our cash-flow borrowing," said Tom Dresslar, a spokesman for State Treasurer Bill Lockyer. "Everyone would prefer to issue RANs for the obvious reason: It costs less." Lockyer, a Democrat, supports a budget with the reserve Schwarzenegger has proposed. That would increase confidence among investors that California has cash to pay the $7 billion to $9 billion in short-term debt notes that Lockyer's office assumes the state will need to sell, Dresslar said.
Fear of "Perfect Storm" pension crisis grows as study shows more workers raiding savings
More than 20% of the world's workers have dipped into their savings to pay down debt and 13% have stopped saving altogether, according to a study of retirement trends over the past year. In Britain, China, India and the US, the study suggests, savings have taken a back seat to maintaining living standards threatened by the global downturn. According to research by HSBC, almost nine out of 10 people feel they are unprepared for retirement, and three-quarters do not know what income they can expect when they stop working.
Even in countries where the population is relatively young, there is a degree of panic among legislators keen to prepare for the day when over-65s outnumber schoolchildren. According to HSBC's head of insurance, Clive Bannister, China is drafting plans for a nationwide scheme based on an occupational pension model established in Hong Kong. At the moment, most Chinese workers fall outside the limited number of occupational schemes and must rely for a retirement income on younger family members or their own small savings. Last year, Britain reached the point at which 65-year-olds outnumbered 16-year-olds.
Bannister said the report, which was based on interviews with 15,000 people in 15 countries, showed there was a "downturn deficit" that the state alone could not solve. He said: "the recession means that people are worrying more about surviving from day-to-day than they are concerned about the future". He added that the situation in fast-growing economies such as India and China was more difficult. "We can see the state retreating across the globe as the number of older people increases quite dramatically. There simply won't be enough workers to support a retired population through taxation. In emerging economies, falling state benefits means that, more than elsewhere, individuals must look after themselves."
The last six months has seen a severe downturn in projections for retirement savings after a torrid two years for world stock markets and steep declines in interest rates. The problem is compounded by increases in life expectancy in most countries that mean pension planning must be extended to cope with a longer retirement. Several countries, including Britain, have sought to raise the retirement age, but the burden of working longer has, in the main, been shifted by the current generation of over-50s to younger workers.
Previous HSBC studies have shown that workers from China to Britain expect to work beyond the age when they receive state pensions. But while many workers will remain fit enough to keep working into their 70s, others will find that they are unable to carry on and could fall into poverty. The reluctance to save in the downturn adds to the "unpreparedness gap" being felt in every major economy, the bank said.
Stephen Green, the bank's chairman, said: "A perfect storm is confronting pensions planning, created by an ageing population, falling pension fund values, a drop in state and employer contributions and an economic downturn which is forcing people to make financial choices." Green wants governments to support education schemes and financial advice centres for workers to make informed choices about their retirement planning.
US bond yields spark concern
US long-term interest rates continued to test psychologically important levels on Thursday morning as investors worried about the level of national debt and whether the Federal Reserve might have to raise interest rates to combat inflation. The yield on a 10-year Treasury note, the benchmark rate for US mortgages, briefly traded above 4 per cent, only to attract buyers once more, after weekly jobless claims and retail sales data were published in line with expectations. The 10-year note was recently trading at 3.97 per cent, up 3 basis points, having hit 4 per cent during Wednesday after an auction of $19bn in 10-year government debt came at higher than expected yields.
The next test of the US Treasury’s issuance programme looms on Thursday with the sale of $11bn in 30-year bonds. An auction of 30-year bonds last month went badly as investors signalled their concerns about the budget deficit. "That did not go well last time, so there is also some additional concern," said Dominic Konstam, head of interest rate strategy at Credit Suisse. The yield on the 30-year bond was up 6bp at 4.81 per cent early Thursday. Last week, the yield was trading below 4.50 per cent. "Once the 30 year is out of the way, the market should have a window to rally," said analysts at MF Global. "The bull story rests in higher mortgage rates slowing the recovery."
On Thursday, the 30-year mortgage coupons rose to a peak of 5.12 per cent, and has surged from 3.90 per cent over the past month. This week, the latest survey form the Mortgage Bankers Association showed that its mortgage refinancing application index fell 12 per cent to its lowest weekly level since mid-November. That was prior to the Federal Reserve’s announcement of its plan to buy mortgages. Concerns about the growth of government borrowing on Wednesday forced the US Treasury to give investors in an auction of $19bn in 10-year notes a yield of 3.99 per cent – 4 basis points higher than the yield available before the auction. That constituted the biggest yield markup since a 10-year auction in May 2003, said Morgan Stanley.
Traders said the good news of the day was that buyers entered the market when yields reached 4 per cent. "There should be natural support for the 10-year note around 4 per cent," said Mr Konstam. "We are seeing traders draw a line in the sand at 4 per cent" on 10-year notes, said Tom di Galoma, head of US rates trading at Guggenheim Capital Markets. In recent months, auctions have often been awarded at higher-than-expected yields, with dealers and investors being asked to buy higher amounts of debt as the US Treasury seeks to fund a growing budget deficit.
The rise in yields pressured equities and the S&P 500 index fell 0.4 per cent and futures on Thursday were indicating a modest rebound at the open for stocks. Sentiment for equities on Wednesday was also hurt by a disappointing Beige Book survey on the economy by the Federal Reserve. Its report on the health of the economy revealed that economic conditions "remained weak or deteriorated further" from mid-April through May. Steven Ricchiuto, chief economist at Mizuho Securities, said the report "paints a picture of an economy still in the process of finding a bottom and not having hit one".
Last week, Ben Bernanke, chairman of the Federal Reserve, said US exports could start to benefit if recent signs of stabilisation in foreign economic activity proved accurate. However, several districts reported in the latest Beige Book that shipments for steel and wood products remain depressed, especially outside of Asia. According to the Fed, five out of its 12 US districts said the prolonged downturn was showing signs of moderating, with the outlook improving for manufacturing and housing in some areas.?But,?it?said,?credit remains tight, the labour market continues to suffer from flat or falling wages and commercial property vacancy rates are rising.
Interest-Only Defaults to Mount on $62 Billion Commercial Mortgage Bonds
Investors in bonds that packaged $62 billion of debt for U.S. offices, hotels and shopping malls are bracing for more loan defaults through 2010 as Bank of America Merrill Lynch says landlords’ monthly payments may jump 20 percent or more. Principal is coming due on the so-called partial interest- only loans as an 18-month-old recession saps demand for commercial real estate. About $179 billion of such loans were written between 2005 and 2007 and bundled into bonds, according to data from Bank of America Merrill Lynch.
With soaring vacancies and falling rents, some cash- strapped borrowers will fail to cover the higher costs, said Andy Day, a commercial mortgage-backed securities analyst at Morgan Stanley in New York. About 87 percent of mortgages sold as securities in 2007 allowed owners to put off paying principal for several years or until maturity, compared with 48 percent in 2004, Morgan Stanley data show. "The worst is yet to come," MetLife Inc. Chief Investment Officer Steven Kandarian said yesterday in a Bloomberg Television interview. "Typically there’s a lag between when the economy softens and when the defaults actually occur."
Investors have already seen prices on top-rated senior debt drop below 70 cents on the dollar from 95 cents a year ago, according to Aaron Bryson, a commercial mortgage-backed securities analyst at Barclays Capital in New York. Interest-only mortgages were designed as a stopgap to allow owners to do renovations and absorb other costs. Owners delay paying principal for the first several years, lowering their initial monthly expenses. Partial interest-only loans allow for postponement of principal payments for a portion of the term. Full-term interest-only deals require the principal at maturity.
Loans that postpone principal payments had become the norm by the time the commercial-mortgage bond market peaked two years ago, said Frank Innaurato, managing director of analytical services at Realpoint LLC, a Horsham, Pennsylvania-based credit- rating service. "The proliferation of interest-only loans was symptomatic of the loose underwriting standards of that time," Innaurato said. "Borrowers were taking advantage of the best terms possible."
Property owners turned to Wall Street to finance office towers, apartment complexes and hotels as banks bundled the debt and sold it to investors. A record $230 billion in commercial mortgage-backed securities were sold in 2007, up from $93.3 billion in 2004, according to Morgan Stanley data. About $750 billion of such debt is outstanding, bank data show. A similar type of loan fueled the U.S. residential housing boom, allowing people to borrow more than they could afford as they assumed home prices would keep going up. The collapse of the subprime mortgage market, which led to almost $1.5 trillion in losses since the start of 2007 at banks and financial companies worldwide, was triggered in part when owners defaulted as their payments rose.
Interest-only loans raised concerns "as an example of excessively aggressive underwriting during 2006 and 2007," said Kent Born, senior managing director at PPM America, an investment manager in Chicago. "But commercial real estate fundamentals were good, and there was a huge demand for these bonds." The jump in monthly payments on commercial property won’t be as severe as in the residential market, though it will still sting, according to a May 1 report from Bank of America Merrill Lynch in New York. The mortgages may be one of the "significant contributors" to delinquencies on loans in commercial mortgage- backed bonds, the analysts said.
Concern that commercial real estate is poised for a protracted slump comes as credit markets thaw. Borrowers have sold a record $615 billion of investment-grade U.S. corporate bonds this year, according to data compiled by Bloomberg. Junk bonds, which are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s, have rallied 33 percent since March 9, Merrill Lynch & Co.’s U.S. High-Yield Master II index shows. The yield gap, or spread, relative to benchmark interest rates on top-rated bonds backed by commercial real estate has fallen 3.8 percentage points to 7.8 percentage points since the Federal Reserve said on March 23 that it would lend to investors to purchase securities sold before Jan. 1, 2009, as part of its $1 trillion program to unlock credit, according to Bank of America Corp. data.
Spreads on the debt have widened 1.5 percentage point since before S&P said on May 26 that it may cut ratings on top-ranked commercial mortgage-backed debt, rendering the bonds ineligible for the program. A year ago, the debt was trading at about 1.6 percentage point more than the benchmark. While the U.S. services industry contracted at a slower pace in May and the number of Americans collecting jobless benefits shrank for the first time in almost five months, unemployment will continue to depress non-residential real estate, said Mitchell Stapley, chief fixed-income officer for Fifth Third Asset Management.
"The notion that the rate of decline has slowed, and that we are seeing improvement, doesn’t change the fact that the consumer is retrenching," said Stapley, who oversees $22 billion in Grand Rapids, Michigan. "We need job growth, not just slowing job losses. There are massive fundamental issues." Delinquencies on commercial mortgages placed into securities have climbed to the highest levels ever, according to data from RBS Securities Inc., the Royal Bank of Scotland Group unit based in Stamford, Connecticut. The late payment rate on them is 2.77 percent, up from 0.47 percent at the end of 2007.
"Interest-only loans will be a problem for borrowers who can’t reach targets on rent growth, or have been hit by vacancies," said Morgan Stanley’s Day, who is based in New York. "The added burden increases the likelihood of these properties defaulting, translating to losses on CMBS investments." Scaffolding surrounds the ground floor of a 26-story tower at 1775 Broadway in New York. The 1928-vintage building on 57th Street is being refitted with a glass facade and renamed 3 Columbus Circle in a $60 million renovation. Newsweek, the magazine that’s cutting the circulation rate base of its U.S. edition by 42 percent to 1.5 million by January, vacated 203,000 square feet of the building last month. The unit of Washington Post Co. accounted for 34 percent of the space, according to loan documents. The publication relocated downtown to 395 Hudson St. in Greenwich Village.
"Filling that much space will be extremely difficult in this environment," said John Levy, a principal at John B. Levy & Co., a real estate investment banking firm based in Richmond, Virginia. "That will require several good-sized tenants in a market where most people aren’t making decisions. There is no penalty for indecision. There is no pressure to do anything, and people think it might get cheaper if they wait." Overall occupancy has decreased to about 30 percent, according to loan documents. The building was 98 percent occupied in January 2006, when the Moinian Group took out a $250 million interest-only mortgage, according to loan-service documents reviewed by Bloomberg. When principal starts coming due early next year, the monthly bill will climb by $225,000, or 18.4 percent, to $1.45 million, the documents show.
Joseph Moinian, 55, the chief executive officer of Moinian Group, declined to be interviewed, said Roxanne Donovan, president of Great Ink in New York, which represents the firm. Moinian Group owns more than 20 million square feet of space in office, residential, retail and hotel properties, 13 million of which is in Manhattan, according to the company’s Web site. New York-based Moinian Group’s mortgage was wrapped into a $3.9 billion bond with 304 other commercial property loans across the U.S. and marketed in February 2006 by Wachovia Corp., now part of Wells Fargo & Co., according to the prospectus. More than half of those contained in the bond delayed paying principal for part of the term, the documents show.
Across the U.S., office vacancies climbed to 15.5 percent in the first quarter from 13.3 percent a year earlier, according to CB Richard Ellis. The U.S. government has made reviving the market for commercial mortgage-backed bonds a cornerstone of the program to get credit flowing and end the recession. Sales of the bonds plummeted as investors shunned the debt and the cost to sell them became too high for investment banks to profit, choking off funding to borrowers that need to refinance. There have been no sales of the bonds so far this year, and only $12.1 billion were sold last year, according to Morgan Stanley.
The portion of the plan aimed at creating commercial mortgage-backed bonds is intended to avert a wave of defaults because "getting refinancing for existing commercial projects is very, very difficult," Fed Chairman Ben S. Bernanke said in congressional testimony on June 3. "Even with government support, the commercial real estate fundamental picture will continue to get worse before it gets better," said PPM America’s Born, who holds about $7 billion in commercial mortgage-backed bonds as part of a fixed-income portfolio. "Interest-only loans that start to amortize in this environment are one more piece of that picture."
Retail landlords need a "reality check"
U.S. mall operators have to work with their tenants and make concessions if they want to avoid more store closings to avoid feeding a cycle of vacancies, a retail real estate expert said on Wednesday. "It's inevitable there will be a consolidation of the shopping center market," Nina Kampler, executive vice president at Hilco Real Estate, told the Reuters Global Retail Summit on Wednesday.
"I think that with a reality check across the board, landlords would be more compromising and landlords (would be) understanding that they have to help to keep this industry viable."
The economic crisis has swept away a number of U.S. retailers such as electronics chains Sharper Image and Circuit City, jewelry and housewares chain Fortunoff, and department store Mervyn's. But now it is hitting retail landlords such as: Simon Property Group Inc, Developers Diversified Realty Corp and bankrupt General Growth Properties.
Kampler, who works with companies trying to dispose of troubled retail locations, expects more retail bankruptcies in the coming months, as consumers continue to file for personal bankruptcy. She forecast the 2009 holiday season would be even bleaker than last year's as shoppers cut back on purchases. That could lead to an uptick in store closures, which would squeeze landlords further, Kampler said.
Retail tenants often include co-tenant or adjacency clauses in their leases, which require the landlords to keep a certain number of stores in the mall to be occupied. "The consumer is disincentivized by a dark miserable experience," Kampler said. "It is depressing to be in a place where nobody else is." Landlords will have to more flexible in their negotiations to avoid one tenant's departure indirectly causing others to flee, Kampler said.
"Retailers can't pay that rental stream with a smaller amount of stuff coming off their shelves," Kampler said. Kampler said that malls and shopping centers are frequently facing vacancy rates of 10 to 15 percent now, but only a handful of chains that would want to take their place. In 2008, the amount of space occupied by U.S. retailers fell for the first time since 1980 and has yet to recover, according to research firm Reis. Retailers that would have added new locations this year have taken the year off, waiting for consumer spending to level.
"I would love for the landlords to take a reality pill and all wake up tomorrow as a group and say 'Ok, we don't like this, but there are a lot of things in life we don't like ... and rather than say unless I get my $80 a foot I'm not renting to you... I wish the landlords would say, 'Ok, I need you here. Let's work something out.'" But at the same time, Kampler said tenants should not to think of the recession as a "landlord bloodbath" but recognize that landlords also have to repay their lenders and as partners both sides could share some of the upside when the economy recovers.
The FDIC To Start Dumping Toxic Assets, Banks Could Feel The Pain
Contrary to popular belief, the Public-Private Investment Program, a centerpiece of the government's strategy to rescue the nation's banks, is not dead. The PPIP may be in critical condition, but the FDIC is planning what it hopes will be a miracle cure--a new pilot program to unload toxic assets under the supervision of new advisers who will structure and oversee the sale to qualified investors, the agency told the Huffington Post.
The new pilot is similar to the original PPIP that failed so spectacularly earlier this month, when banks resoundingly refused to sell any toxic--or err, um, "legacy"--assets to private investors. But this time around, rather than the banks unloading toxic debt from their balance sheets, it will be the FDIC that sells its own hard-to-price assets, which it acquired when it seized failing banks. The program could establish a price floor for illiquid toxic assets, which have so far been nearly impossible to value. This could have an impact on those banks that have till now avoided pricing these assets for fear the transparency will force further write-downs, rendering some of them insolvent.
"We want to test the funding mechanism that we were contemplating for banks with PPIP, to get a structure in place so that if the program is needed down the road, we are prepared," Joseph Jiampetro, a senior FDIC advisor, told the Huffington Post. He added that the agency is currently hiring several advisers to structure the deal, find qualified investors and oversee the sale. The original PPIP, or Public-Private Investment Program, was launched in March to enable banks to rid themselves of risky, valueless debt. Under the program, banks could unload subprime mortgages and other loans that have lost value in the recession to private investors.
To entice these investors to buy the risky debt, the FDIC agreed to offer them cheap financing to fund the purchases--an amazing 6:1 deal. Still, the program collapsed recently when banks refused to lower the prices of these assets sufficiently to interest the investors. Or perhaps some say it was the fear of pricing transparency that could have led to hits on their balance sheets. There was also concern that Treasury Secretary Tim Geithner, who was key overseer of the program, would impose limitations on those who participated in PPIP. Since calling for restrictions on banks that accessed TARP funds, Geithner has had a chilly relationship with the private sector. This time around, however, oversight of the pilot program will shift to FDIC Chair Sheila Bair, a Republican who is admired by Wall Street.
"The private sector is a lot more comfortable with Sheila Bair and the FDIC then they are with Tim Geithner and the Treasury," says Dan Greenhaus, an analyst at Miller Tabak & Co. "There is less worry that if they participate in the plan with the FDIC it will suddenly require pay caps or other limitations." Another key difference in the pilot plan is that rather than the banks selling their assets, the FDIC will sell its own risky loans--which it has acquired through bank seizures--while simultaneously providing funding to these buyers.
Critics say that while the basic principle is the same, it misses the original purpose of PPIP by failing to help banks rid themselves of bad loans. "The purpose of this new program is to save face, to postpone the PPIP funeral," says Bert Ely, a banking consultant and principal of Ely & Company. "Cosmetics are very important in politics, and not just on the face of candidates." Market observers also say that the FDIC has seized relatively few banks during this recession--just 62 in the past two years compared to more than 700 during the S&L crisis--so the FDIC has very little in the way of toxic assets to necessitate this program.
For its part, the agency says it has 59,000 assets worth $27.7 billion as of March 31, which it needs to unload. But the more pressing issue is to find out whether the program could help establish a price floor for the many millions of dollars in toxic assets that plague the market. The FDIC also says that while there have been relatively few takeovers of failed banks so far during this recession, it is possible that many more could come down the pike.
This is because in this downturn, the residential real estate market collapsed first. The large banks were the ones that mostly gobbled up this stuff, including subprime loans and mortgage-backed securities. And these institutions have largely staved off failures thanks to TARP. Smaller, regional banks, however, invested far more heavily in commercial real estate. This market is only now beginning to show weakness, and so these smaller banks could potentially fail in increasing numbers as the down cycle progresses. With TARP less likely to be applied to these banks, the FDIC may become much more active, making this program more critical.
Still, while there is some hope this PPIP pilot has more chance of succeeding than its predecessor, skepticism remains. "There were hundreds of banks every year being taken over by the FDIC during the S&L crisis, but so far in this cycle, it has only taken over a handful," Richard Bove, an analyst at Rochdale Securities, said. "Whatever they say, something is wrong with this picture. And I don't see how this latest program will do anything to fix it."
BofA, Merrill Drama Revives Talk Of MAC Clauses
Testimony by Bank of America Corp. (BAC) Chief Executive Ken Lewis about threats to scuttle the Merrill Lynch deal has again focused attention on "material adverse change" clauses in merger agreements. The use of these legal loopholes, known as MAC clauses, can allow would-be acquirers to get out of a transaction if they want out. In fact, they've played a part in most of the failed deals of the past two years, as the financial crisis punished many companies to the point they were no longer the attractive targets their buyers had thought. Some of the buyers, though, had to pay a steep price to unwind the deals.
For instance, Finish Line Inc. (FINL) got out of its acquisition of rival shoe seller Genesco Inc. (GCO) by paying $175 million and 12% of its stock.
Penn National Gaming Inc.'s (PENN) private-equity suitors wound up settling, backing out of the deal but paying even more than the pact's breakup fee would otherwise have entitled Penn. Conversely, SLM Corp.'s (SLM) failed leveraged buyout saw the student-loan company receive no cash, but resulted in SLM securing a large and much-needed line of credit. "We've seen an obvious uptick since the economic crisis in people invoking the MAC clause," said Jim Smith, a partner with Dewey & LeBoeuf who co-chairs the firm's securities litigation group. "This is an escape hatch, theoretically."
He pointed out that MAC clauses have picked up since the big M&A boom that peaked in 2007. Those that bought at the tail end of that boom use MACs to get out of paying high breakup fees, though they still pay a steep price to unwind the deals. "When things were go-go with a lot of private-equity deals, there was a lot less need for MACs," he said. "Then everything hit the wall, and suddenly people with extreme buyers' remorse were relying on them more frequently than they otherwise would."
Lewis, echoing earlier statements, said during congressional testimony that BofA considered invoking the MAC clause because of staggering, unforeseen losses at Merrill. BofA ultimately capitulated to government pressure, and with some new government-backed financial guarantees, went ahead with the merger. As in many matters, efforts to terminate mergers all come down to the details. And there are many unusual aspects to Bank of America's acquisition of Merrill Lynch. For one thing, the deal finalized under government pressure; moreover, unlike most acquisitions, this one had no breakup fee written into the deal.
In the case of the Merrill purchase, the MAC clause was open to loose interpretation because it stipulated that factors like general economic downturns, in and of themselves, don't constitute a MAC. Therefore, BofA would have had to argue that Merrill did something specifically to itself that caused its results to be worse than the credit crisis alone would have made them. Presumably, Merrill and the government would have taken the opposite stance.
Few, if any, of the recent MAC-related merger bailouts actually were decided by the courts, and many even settled before the legal wars were fought. Lewis suggested in his testimony that, while a legal victory would have been a win, a loss may have seen a court foist upon BofA a ruined Merrill that collapsed into bankruptcy after BofA backed away from the deal.
Option ARMs Threaten Housing Rebound as Resets Peak
Shirley Breitmaier’s mortgage payment started out at $98 when she refinanced her three-bedroom home in Galt, California, in 2007. The 73-year-old widow may see it jump to $3,500 a month in two years. Breitmaier took out a payment-option adjustable rate mortgage, a loan popular during the housing boom for its low minimum payments before resetting at higher costs later. About 1 million option ARMs are estimated to reset higher in the next four years, according to real estate data firm First American CoreLogic of Santa Ana, California. About three quarters of those loans will adjust next year and in 2011, with the peak coming in August 2011 when about 54,000 loans recast, the data show.
Option ARM borrowers hit with unaffordable monthly payments are another threat to the housing recovery and the economy, said Susan Wachter, a professor of real estate finance at the University of Pennsylvania’s Wharton School in Philadelphia. Owners who surrender properties to the bank rather than make higher payments for homes that have plummeted in value will further depress real estate prices and add to the inventory of properties on the market, she said. "The option ARM recasts will drive up the foreclosure supply, undermining the recovery in the housing market," Wachter said in an interview. "The option ARMs will be part of the reason that the path to recovery will be long and slow."
Option ARM recasts will mean more pain for California, the state with the most foreclosures in the U.S. More than $750 billion of option ARMs were originated in the U.S. between 2004 and 2008, according to data from First American and Inside Mortgage Finance of Bethesda, Maryland. California accounted for 58 percent of option ARMs, according to a report by T2 Partners LLC, citing data from Amherst Securities and Loan Performance. Shirley Breitmaier took out a $315,000 option ARM to refinance a previous loan on her house.
Her payments started at 3/8 of 1 percent, or less than $100 a month, according to Cameron Pannabecker, the owner of Cal-Pro Mortgage and the Mortgage Modification Center in Stockton, California, who is working with Breitmaier. The loan allowed her to forgo higher payments by adding the unpaid balance to the principal. She’ll be required to start paying principal and interest to amortize the debt when the loan reaches 145 percent of the original amount borrowed. Breitmaier, who has been in the home for 45 years and lives with her daughter, now fears she will lose the off-white stucco house that’s a hub for her family.
"I wish the government would bail us out like the banks and the car businesses," she said. "I’d like to go from here to the grave next to my husband." Paul Financial LLC originated the loan and it was sold to GMAC, Pannabecker said. "This loan is a perfect example front to back, bottom to top, of everything that has gone wrong over the last five to seven years," Pannabecker said. "The consumer had a product pushed on them that they had no hope of understanding." GMAC is working with Breitmaier and will review all of her options, said Jeannine Bruin, a spokeswoman for the company. Bruin declined to be more specific, citing the firm’s customer confidentiality policy.
Peter Paul of Paul Financial, based in San Rafael, California, said he wasn’t familiar with Breitmaier’s loan agreement but disagreed with Pannabecker’s characterization. "The problem is, real estate values went down," Paul said. Paul said he’s winding down the company and hasn’t made any loans since the fall of 2007. Option ARMs typically recast after five years and the lower payments can end before that time if the loan balance increases to 110 percent or 125 percent of the original mortgage, according to a Federal Reserve brochure on its Web site. These home loans were primarily marketed to people with good credit scores, said Dirk van Dijk, director of research at Zacks Investment Research in Chicago. They were also sold to the elderly and immigrants who were lured by inexpensive payments, said Maeve Elise Brown, executive director of Housing and Economic Rights Advocates in Oakland, California.
Refinancing is impossible in many states given the nationwide drop in prices. Mortgage rates are also rising. The average 30-year rate jumped to 5.59 percent in the week ended June 11 from 5.29 percent a week earlier, Freddie Mac said today. In California, the median existing single-family home price dropped 37 percent in April to $256,700 from a year earlier, according to the state Association of Realtors. "Once you start amortizing that loan, the payment is going to shoot up," said David Watts, a London-based strategist with research firm CreditSights. The delinquency rate for payment-option ARMs originated in 2006 and bundled into securities is soaring, according to a May 5 report from Deutsche Bank AG.
Over the past year, payments 60 days late or more on option ARMs originated in 2006 have almost doubled to 42.44 percent from 23.26 percent, Deutsche Bank said. For 2007 loans, the rate has climbed from 10.1 percent to 35.25 percent. "We’re already seeing much higher levels of delinquencies of these option ARM loans even before you reach the point of the recast," said Paul Leonard, the California director of the non- profit Center for Responsible Lending. The threat of soaring payments has counselors at Housing and Economic Rights Advocates busy. "There’s a level of hopelessness to the phone calls now," said Brown.
Mortgage Rates in U.S. Rise to Highest Since November
Fixed U.S. mortgage rates rose to the highest since November, signaling that the Federal Reserve’s plan to lower borrowing cost is stalling. The average 30-year rate jumped to 5.59 percent from 5.29 percent a week earlier, Freddie Mac, the McLean, Virginia-based mortgage buyer, said today in a statement. The 15-year rate averaged 5.06 percent. Rising rates may deepen the U.S. housing slump by sidelining people who want to refinance or purchase a house. U.S. mortgage applications fell last week to the lowest since February and shares of the largest homebuilders have dropped 11 percent since May 1 on concern more expensive home loan payments will turn away prospective buyers.
"The economy doesn’t need higher mortgage rates because that will depress the level of home sales, cut off refinancing, and keep consumer spending sluggish," said Patrick Newport, an economist with Lexington, Massachusetts-based IHS Global Insight. The increase in rates announced today was the biggest weekly jump since October. Rates were last higher in the week ended Nov. 27, when they were 5.97 percent. The Federal Reserve said March 18 it would purchase as much as $1.25 trillion in securities from mortgage-buyers Fannie Mae and Freddie Mac to help drive borrowing costs lower.
Yields on Fannie Mae and Freddie Mac mortgage securities rose yesterday to a level not seen since the Fed announced its plan. The program helped push rates to a record low 4.78 percent twice in April. Now rates are climbing along with Treasury yields on investor concern that a greater supply of government debt being sold to fund federal spending will fuel inflation. The central bank’s purchases of mortgage bonds guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae initially brought down the yields on those securities, allowing lenders to reduce rates on new loans and still sell them at a profit.
The Fed has bought a net $507.1 billion of mortgage bonds so far, including $25.5 billion in the week ended May 27, according to Bloomberg data. Rates are rising as home prices continue to drop and foreclosures rise. U.S. foreclosure filings surpassed 300,000 for the third straight month in May and may hit a record 1.8 million by the first half of the year, RealtyTrac Inc. said today. A total of 321,480 properties received a default or auction notice or were repossessed last month, up 18 percent from a year earlier, the Irvine, California-based seller of default data said in a statement. One in 398 U.S. households received a filing last month.
Home prices in 20 major metropolitan areas fell more than forecast in March as defaults surged. The S&P/Case-Shiller home- price index decreased 18.7 percent from March 2008, matching the drop in the year ended in February. The measure declined 19 percent in January, the most since data began in 2001. The Mortgage Bankers Association’s index of applications to purchase a home or refinance a loan dropped 7.2 percent to 611 in the week ended June 5. Purchase applications rose 1.1 percent while requests to refinance fell 12 percent.
Treasury to Set Executives’ Pay at 7 Ailing Firms
The Obama administration’s sweeping new proposal to restrict executive pay is likely to be a humbling exercise for seven of the nation’s largest companies, which have received billions of dollars in federal assistance to survive the economic crisis. But for most other companies, the plan is expected to have only a marginal effect on pay practices for now. The Treasury Department on Wednesday appointed a well-known Washington lawyer, Kenneth R. Feinberg, to oversee the compensation of employees at the seven companies — the American International Group, Citigroup, Bank of America, General Motors, Chrysler and the financing arms of the two automakers.
He will have broad discretion to set the salaries and bonuses for their five most senior executives and their 20 most highly paid employees. The new plan also calls on Congress to adopt legislation that would let shareholders vote on pay levels and require public companies to strengthen the independence of board panels that set executive pay. But for most companies — both those receiving taxpayer support and those that are not — the proposal is the result of a compromise that largely lets them off the hook. The rules reveal a strong reluctance among some of President Obama’s advisers to intrude more deeply into corporate boardrooms, government officials said.
The 10 large banks that received permission on Tuesday to exit the bank rescue program, for example, will face no mandatory changes to their compensation structures. There is no such reluctance, however, when it comes to deeply troubled companies. The new rules illustrate the humiliating downfall of the once proud giants, now wards of the state whose leaders’ compensation will be set by a Washington paymaster.
From his nondescript office in Room 1310 of the Treasury building where he will serve with the unwieldy title of special master for compensation, Mr. Feinberg will set the salaries and bonuses of some of the top financiers and industrialists in America. The list includes Vikram S. Pandit, the head of Citigroup, whose total pay came to $38 million in 2008; Kenneth D. Lewis, the chief executive of Bank of America, who last year received $9 million in total compensation; and Fritz Henderson, the chief executive of G.M., who got $8.7 million last year when he was president of the company.
While there is no salary cap at the seven companies, the plan offers an incentive for companies to adopt a voluntary cap. If they limit executive pay to no more than $500,000, Mr. Feinberg’s approval will be automatic. Mr. Feinberg will also have the right to review the compensation for the 100 most highly paid employees and any other executives. For other financial institutions that have received federal assistance, Mr. Feinberg will play an advisory role in establishing the overall compensation structure, but without setting the exact level of pay. The goal is to reduce excessive risk-taking by executives whose compensation is tied to company performance.
Mr. Feinberg will also determine whether it would be in the public interest to force executives at companies receiving assistance who might have been overpaid — for example, if their pay was based on revenue and profit that turned out to be illusory — to return the money. "This financial crisis had many significant causes, but executive compensation practices were a contributing factor. Incentives for short-term gains overwhelmed the checks and balances meant to mitigate against the risk of excess leverage," Timothy F. Geithner, the Treasury secretary, said Wednesday.
"By outlining these principles now, we begin the process of bringing compensation practices more tightly in line with the interests of shareholders and reinforcing the stability of firms and the financial system," he added. Rather than decide compensation levels at the seven companies himself, Mr. Geithner decided to appoint Mr. Feinberg, a mediator whose last major assignment was putting a financial value on the lives of victims of the Sept. 11 attacks. Under the new rules, the seven companies will have 60 days to submit the pay packages of the 25 top executives. Mr. Feinberg would then have 60 days to review those plans.
In weighing the appropriateness of the pay, Mr. Feinberg is to consider such criteria as the profitability of the company, the general marketplace for compensation, the ability of the company to repay their taxpayer loan and the extent to which the pay packages encourage excessive risk-taking. For the smaller institutions that remain in the Troubled Asset Relief Program, executives face some restrictions, but there are loopholes. Many of the new rules, for instance, will not apply to companies that received the relief funds before February — the vast majority of companies in the program.
The compensation and perks of executives at some of the companies receiving aid provoked a political firestorm this year. In revising a February proposal to set pay limits, the Obama administration has decided to leave the success or failure of its effort to tame excessive compensation largely to Mr. Feinberg. (Mr. Feinberg himself will not receive any compensation for his job.) The latest plan tries to satisfy public demand for controlling excessive pay while not spooking Wall Street, which the administration is relying on to help buy the troubled mortgage-backed assets at weaker banks.
Mr. Geithner told reporters on Tuesday that financial institutions remain worried about "political risks" including more government regulation of compensation, if they participate in the Public-Private Investment Program to buy those assets. The announcement is the third effort by Washington to respond to public outrage over outsize pay packages. On Feb. 4, the Obama administration announced a proposal to set a $500,000 cap on cash compensation for the most senior executives at troubled companies getting "exceptional assistance," and restrictions on cashing in stock incentives.
That plan did little to quell public sentiment as details of bonuses were disclosed at major companies receiving federal assistance. Two weeks after the Obama plan was announced, Congress approved a $787 billion economic stimulus bill that included tougher restrictions. That provision, inserted by Senator Christopher J. Dodd, the Connecticut Democrat, over the objections of the Obama administration, instructed Treasury to come up with rules for the five top officers and the 20 highest-paid executives at the largest of the troubled companies. The legislation also barred top executives from receiving bonuses exceeding one-third of their annual pay. Moreover, any bonus would have to be in the form of long-term incentives, like restricted stock, which could not be cashed out until the company repaid the government.
China's Exports, Imports Plunge Drastically Again in May
The decline in China's exports continued to deepen in May, new data show, emphasizing how hopes for a recovery in the world's third-largest economy remain pinned on the effectiveness of the government's stimulus program. Merchandise exports in May fell 26.4% from a year earlier, China's Customs agency said Thursday, accelerating from April's 22.6% decline as global demand remained weak. China's imports also extended their fall, dropping 25.2% in May from a year earlier after shrinking 23% in April. The weak export performance is shrinking China's trade surplus, which at $13.39 billion for May is more than a third smaller than in the same month last year.
China's leadership is working to counter the global downturn with a massive program of public works and industrial aid, financed by a huge wave of bank lending as well as direct government spending. Other data issued Thursday showed stimulus money continuing to flow into the economy. Fixed-asset investment, China's main measure of capital spending, rose 38.7% in May and is up 32.9% for the year so far. That's the fastest growth since the investment boom of 2004 – but activity still remains concentrated in the areas benefiting from the government measures.
"Government has the power to keep the economy from declining, but not to make an effective recovery," Fan Jianping, chief economist of the State Information Center, a government think tank, wrote in an article this week. "A solid rebound in the economy still needs the endogenous growth momentum from the market, especially private-sector investment and the steady growth of household consumption." There's little question that the state is leading the way in spending so far this year.
Fixed-asset investment by state-owned enterprises is up 40.6% in the first five months of the year, while capital expenditure by foreign companies showed little or no growth. But growth in real estate investment, much of which is driven by the private sector, picked up to 12% in May as a continued rise in property sales encouraged new construction of housing. That has raised hopes that companies are becoming increasingly willing to invest in things besides government infrastructure projects.
"Amidst continued weakness in external conditions, China will likely remain reliant on domestic investment for growth in the short term," Morgan Stanley economists said in research note Thursday. "The most encouraging recent development, in our view, is actually the rebound in activity in the property sector." The heavy investment spending is supporting China's purchases of key commodities. Those continued to run at high levels in May, though many analysts suspect some of the growth is coming from stockpiling that will taper off later in the year. Imports of iron ore slipped somewhat from April's level but at 53.46 million metric tons were still 38% higher than a year ago. Net imports of crude oil were also up 3.8% from a year earlier in May, and are running at a pace of 3.45 million barrels a day over the past 12 months.
Getting a read on consumer activity that could help boost China's imports of things besides raw materials is more difficult. In addition to vibrant housing sales, another positive sign of consumer spending is passenger car sales, which rose 42.4% in May from a year earlier to 591,300 units. Government subsidies and tax breaks for automobile purchases have aided those gains. But some indicators of consumer confidence have fallen back recently, and economists say the full impact of job losses and wage cuts has probably not yet been felt.
Ilargi: Something doesn't add up here. Imports and exports are off a steep cliff, but property sales surge? I think the hand of Beijing is behind this. Sales are up 45.3%, but prices are down 0.6%. That doesn't fit.
China’s Property Sales Surge, Add to Recovery Signs
China’s property sales and investment accelerated, adding to signs that growth in the world’s third-largest economy is recovering. Sales rose 45.3 percent to 1 trillion yuan ($146 billion) in the first five months of 2009 from a year earlier and real- estate investment growth quickened to 6.8 percent, the National Bureau of Statistics said in a statement on its Web site today. Sales grew 35.4 percent in the first four months. The Shanghai Composite Index has climbed 55 percent this year as investors bet that Premier Wen Jiabao’s 4 trillion yuan ($585 billion) stimulus package, record loans and stronger investment will drive faster economic growth. Gross domestic product grew 6.1 percent in the first quarter, the slowest pace in almost a decade, as exports slid.
"As developers run down inventory rapidly, they will soon start to buy land and increase spending again," said Frank Gong, chief China economist and strategist at JPMorgan Chase & Co. in Hong Kong. "Property investment, which accounts for 10 percent of China’s GDP and is a trigger for growth in related sectors, will become a strong driving force in China’s recovery." Shanghai’s stock index closed 1 percent higher. The China Se Shang Property Index fell 1.6 percent, paring this year’s gain to 116 percent. Zhang Xiuqi, a strategist at Guotai Junan Securities Co. in Shanghai, said investors were "taking some profit before another run-up."
China’s consumer prices fell 1.4 percent in May, a separate report showed today, making it easier for the government to keep interest rates low to stoke growth. The companies benefiting from the revival in property include China Vanke Co., the nation’s biggest listed developer, which said on June 8 that sales in May rose 20 percent from a year earlier. As part of the stimulus plan, the government has pledged to build 5.2 million low-rent homes over the next three years and subsidize housing for 7.5 million poor urban families by 2011. China last month lowered the amount of funds developers have to put up for property projects to spur construction after cutting transaction costs for home buyers last year.
The 6.8 percent increase in property investment to 1 trillion yuan in the first five months compared with a 4.9 percent gain through April, the statistics bureau said. "Stronger than expected property investment growth means that fixed-asset investment growth in May could surprise on the upside and that investment growth in 2009 may also be stronger than most people expect," said Sun Mingchun, chief China economist at Nomura Holdings Inc. in Hong Kong. Urban fixed-asset spending expanded 30.5 percent in the first four months and data through May will be released tomorrow. A property development climate index rose for a second month in May, after declining for the 16 months through to March, the statistics bureau said.
Land sales in Beijing in May exceeded the total amount sold in the first four months of the year, the China Daily newspaper reported today, citing the city’s land reserve center. Property sales by value doubled in Beijing, surged 68.5 percent in eastern Zhejiang province and climbed 61.9 percent in Shanghai during the five-month period from a year earlier, the statistics bureau said today. Nationwide, sales by floor area increased 25.5 percent. Property prices dropped 0.6 percent last month in 70 Chinese cities from a year earlier, the smallest decline in five months. Prices jumped 0.6 percent month-on-month in May, the bureau said.
'New' Chrysler Shielded from 'Old' Product Liability
Chrysler won't be liable for product defect claims on vehicles sold before it emerged from bankruptcy. Will the "new" GM win the same protection? Chrysler's bankruptcy will leave lots of people empty-handed. Among them are accident claimants who seek compensation when a faulty Chrysler vehicle causes injury or death. Under terms approved on June 1 by U.S. Bankruptcy Court Judge Arthur J. Gonzalez, the "new" Chrysler emerging from bankruptcy won't be liable for product defect claims involving any cars sold before it came into existence. This issue drew only minor attention during the recent jockeying by various groups over whether the U.S. Supreme Court should intervene in the case.
Now that the justices have stayed out of the case, and Chrysler's alliance with Italy's Fiat (FIA.MI) closed on June 10, it appears that anyone with a pending injury claim against Chrysler has no hope of a recovery. What's more, under Gonzalez's order, the newly constituted Chrysler is shielded from suits filed by anyone injured in a future accident involving the 31 million Chrysler vehicles currently on the roads. A looming question now is whether a postbankruptcy General Motors will win the same liability protections. In filings accompanying the failed effort to persuade the Supreme Court to review the Chrysler case, groups representing consumers and accident claimants noted that it "could provide the roadmap for subsequent bankruptcies in this troubled economy," including GM's. About 74 million GM vehicles are now on U.S. roads, according to the Insurance Institute for Highway Safety.
Lawyers for the consumer and accident victim groups argued that cutting off all avenues of redress for injury victims violates the bankruptcy law and the U.S. Constitution. And the number of victims is large, they contend, citing federal statistics showing that 5,940 people were killed in crashes involving Chrysler vehicles in 2007. "Many thousands more" were injured, their court filing said. In a Mar. 5 filing with the Securities & Exchange Commission, GM said that based on historical experience, it had recorded liabilities of about $1 billion a year in 2007 and 2008 to cover product liability claims. (Similar data are not available for Chrysler, since it was a private company.)
"Most consumers have no idea that their rights and the rights of their family members have been eliminated should something happen as a result of a defect in one of these cars," says Joanne Doroshow, executive director of the Center for Justice & Democracy in New York. Even those who have already won judgments appear to be out of luck. Jeremy Knowles, an Alexander City (Ala.) attorney, points to the family of Vickie Mohr, who was killed in a collision involving her 2000 Dodge Caravan. In 2005, a Shelby County (Tenn.) jury found the van defective and awarded Mohr's family $52 million, mostly in punitive damages. The idea that Chrysler can walk away from that liability—reduced to $13 million by an appeals court—doesn't sit well with Knowles, whose firm handled the case. "People with personal injuries or life-ending injuries should be at the top of the list, not the bottom" in a bankruptcy proceeding, he says. "There should be more justice than that."
The way personal injury claims are typically dealt with in bankruptcy is surprisingly varied, say attorneys and academics in the field. While all lawsuits against a company are halted when it enters Chapter 11, a judge may let pending accident claims move forward but only allow payment in cases where there is insurance; when there's not, victims must get in line with other creditors. The rights of people who might have claims against a company in the future may not be addressed at all. "It ends up getting sorted out in a kind of muddled way," says David Skeel, who teaches bankruptcy at the University of Pennsylvania Law School. In a few instances, when a huge pileup of injury claims was what drove a company into insolvency, special trusts have been set up to compensate victims.
That's what happened in the bankruptcies of several asbestos manufacturers, as well as contraceptive maker A.H. Robins (WYE) and breast implant manufacturer Dow Corning. Insurers in those cases funded portions of the trusts. But the Chrysler bankruptcy has been unlike any other, in part because of the federal government's unprecedented role in orchestrating and financing the process. For accident victims, there have been particular problems. One is that there is essentially no insurance to tap. That's because Chrysler self-insured the first $25 million of each accident, according to Barry E. Bressler, a Philadelphia attorney who represents injury claimants.
Without outside insurance, plaintiffs are left to pursue an insolvent enterprise. "What people have to remember is that bankruptcy was really the only option that was offered to us to create a viable company," Chrysler spokesman Mike Palese says. "The alternative would have been liquidation of the company. In liquidation, the outcome would have been far worse for all stakeholders." From the outset, the Obama Administration has stressed that it wouldn't micromanage the automakers' day-to-day operations, or even many aspects of their bankruptcies. In a statement, the Treasury said the agency wasn't involved in the decision on liability, but called it "consistent with conventional bankruptcy practice," adding that "unfortunately, the outcome would have been far worse had the government not intervened in the restructuring and Chrysler had liquidated."
The expedited procedure Chrysler used to restructure—known as a 363(f) sale for the section of the bankruptcy code that authorizes it—also meant that accident victims and others had far less opportunity to participate in the process and advocate for their interests than they would in a typical reorganization. Lynn M. Lopucki, a bankruptcy law professor at the University of California, Los Angeles, says courts have allowed the process to be overly favorable to companies trying to shed their obligations. "The 363 sale is too good to be true—too good for management," says Lopucki.
The idea that the automakers can walk away from paying on injury claims has reached Congress, where legislators heed the public-relations fallout from tragic accident stories in their hometown newspapers. "The 363 bankruptcy is god-like in how it works," Senator Bob Corker (R-Tenn.) said on June 10 at a hearing of the Senate Commerce Committee. The committee questioned Ron Bloom, an adviser to the U.S. Treasury and one of the most influential members of the Obama Administration's auto industry task force assisting GM and Chrysler through bankruptcy. Bloom testified that the process is designed specifically to remove liabilities from companies, and admitted that personal injury awards would be less to victims going forward because they will have to seek compensation from the "old" Chrysler. That entity will remain in bankruptcy, comprised of hard-to-sell assets such as factories and real estate that could take years to liquidate.
"It is clearly a terrible thing for those victims, but we don't have an alternative unless we want to be writing an endless check" for future liabilities, Bloom said. In its successful effort to persuade the Supreme Court to stay out of the case, Chrysler swatted away arguments that its postbankruptcy operation should not be shielded from product liability damages. The court's decision to do so, Chrysler said in a June 7 filing, did not put accident victims in any worse position than if the company had been liquidated. Those with current injuries would be "unlikely to receive any money because there are secured creditors ahead of them with billions of dollars in unmet claims." As for those seeking to preserve assets for future claims arising from the 30 million-plus Chrysler vehicles still being driven, the automaker said: "The unfortunate but unavoidable fact is that future [injury] claimants…simply have no value to be protected."
World Bank sees steeper global economy contraction
The global economy will contract in 2009 by more than initially thought, given rising unemployment and underutilization of capacity, World Bank President Robert Zoellick said on Thursday. Speaking before a weekend meeting in Italy of finance ministers from the Group of Eight major industrial nations, Zoellick said indications were that the world economy would shrink by close to 3 percent, worse than the previous estimate of 1.75 percent. Zoellick's remarks came as a G8 source told Reuters that the International Monetary Fund had raised its 2010 global growth estimate to 2.4 percent from 1.9 percent and confirmed its 2009 forecast for a 1.3 percent contraction.
There was no comment from the IMF, which will release its World Economic Outlook update on July 7. "I personally believe you might be able to see some aspects of recovery in 2009 and 2010, but from a policy point of view, that isn't the core question because we have a large degree of uncertainty," Zoellick told reporters. He said while developed economies have previously recovered rapidly from downturns, there were concerns that the process this time around would be slow because of very low capacity utilization and questions about sources of demand.
The global recession, which has its roots in the collapse of the U.S. housing market, has been marked by a surge in unemployment as companies respond aggressively to the slump in demand. Even with growth expected to return in 2010, Zoellick said most developing countries would continue to be buffeted by the aftershocks and faced increasingly bleak prospects unless the slump in their exports, remittances and foreign direct investment was reversed by the end of 2010.
"There is much more we need to do in the coming months to mobilize resources to ensure that the poor do not pay for a crisis that is not of their making," said Zoellick. "There is a big price to pay if you don't support these countries." He said he would push for continued support for poor countries at the G-8 summit. Warning of a potential increase in defaults, Zoellick said the World Bank estimated the overall financing gap for developing countries will be between $350 billion and $635 billion in 2009.
"Low-income countries that have limited borrowing capacity due to low reserves and drained national budgets will face particular difficulties in getting sufficient finance in the next few years," Zoellick said. "Because of this, lending from the World Bank, the IMF and other sources will become increasingly important as the crisis rolls across low-income countries." Zoellick said the World Bank's International Development Association, which focuses on 78 of the poorest countries, had seen a flood of requests for assistance, adding that he would urge countries to honor their pledges to the fund.
IDA grants and interest-free loans are expected to exceed $13 billion, a record, for the fiscal year ending June 2009. This compares to $11.2 billion the previous period. Zoellick said demand had also increased at the International Bank for Reconstruction and Development, which is part of the World Bank group that supports creditworthy low- and middle-income countries. Loan volumes were expected to rise to a record $33 billion this fiscal year from $13.2 billion last year.
Countrywide exec warned on loans at Fed '06 meeting, contradicting Bernanke
The chief risk officer of Countrywide Financial Corp, the poster-child company for the loose U.S. home loans that staggered the world economy, was warning against them even when it put him at odds with his own company -- and with Fed chairman Ben Bernanke. At a time when many in the U.S. home loan industry were offering money to almost anyone who walked in the door, John P. McMurray publicly warned about the risks of such lax lending.
McMurray pointed out the risks at the Federal Reserve Bank of Chicago's annual conference on bank structure and competition on May 18, 2006 -- less than a year before the housing sector and mortgage lending industry began collapsing, leading to a credit crunch that spread around the world. Such lending practices also eventually collapsed Countrywide into a fire sale takeover and led to charges of fraud and insider trading being brought against company co-founder Angelo Mozilo.
McMurray's presentation on the home lending boom contrasted with comments Federal Reserve Chairman Bernanke had made in the event's keynote address about 90 minutes earlier. Bernanke said home finance innovation did carry risk but provided significant net benefits. "Borrowers have more choices and greater access to credit; lenders and investors are better able to measure and manage risk; and, because of the dispersion of financial risks to those more willing and able to bear them, the economy and the financial system are more resilient," Bernanke said, according to a transcript of his speech.
McMurray, who was on a panel about home finance innovation, had a different view, highlighting an internal Countrywide study that showed the realities of mortgage delinquency and the dangers of lending to people who couldn't afford to take on their loans. But even as he cautioned the world, emails show, McMurray was losing a battle in his own office to convince top brass at the largest U.S. mortgage lender to curb its lending practices.
Last week, the Securities and Exchange Commission charged Mozilo with securities fraud and insider trading, and McMurray's emails were a critical element in the lawsuit. Countrywide's former president David Sambol and chief financial officer Eric Sieracki were also charged with fraud. McMurray has been called a "hero" by at least one advocate for whistleblowers for trying to raise red flags in Countrywide as its lending standards rapidly went downhill.
The deterioration in its credit quality eventually triggered big losses that forced it into the arms of Bank of America, which bought it at a fraction of the price it was once worth. Some of the same warnings McMurray gave to higher-ups at Countrywide about relaxed lending practices bled into his presentations at the 2006 conferences, which were attended by industry leaders, academics, investors, economists and the media, as well as Fed officials. "He got it," said Jim Callahan, the executive director of Connecticut-based PentAlpha Capital Group, who moderated a panel that included McMurray at an American Securitization Forum in January 2006 in Las Vegas. "He was not trying to oversell a positive story."
Callahan said McMurray appeared "balanced" in his statements at a time when many others in the industry were "wearing rose-colored glasses." At the Fed conference, McMurray gave an almost academic presentation that included 29 slides packed with graphics and charts on the risks and causes of mortgage delinquency. He explained how larger loans, lower credit scores, higher loan-to-value ratios, and less required documentation from loan applicants were coinciding with greater delinquency, wrote Cabray Haines, who summarized the conference for the Chicago Fed Letter.
"McMurray pointed out that this finding is particularly worrisome, given the recent popularity of loans that require little to no documentation of borrowers' income and credit history," Haines wrote Countrywide's internal study included about 10 million mortgages and examined them on a number of variables that helped approximate risk for lenders, Haines wrote. The presentation touched on the types of loans that accompany the most risk and how lenders could adjust course.
McMurray, who declined to comment, left Countrywide in August 2007, a month after the company's surprise disclosure that it had drawn down an $11.5 billion credit line because it had trouble selling short-term debt. On August 31, 2007, Washington Mutual announced it had hired McMurray as chief credit officer. Countrywide announced his replacement within a week. McMurray, who was promoted in April 2008 to chief enterprise risk officer at WaMu, is no longer with the company, whose banking units were acquired by JPMorgan Chase & Co after it failed and was seized by federal authorities last September.
Mike Fratantoni, an economist who reported to McMurray at WaMu, calls him "an extremely impressive guy" who "fully understands every aspect of risk management." "My observation was that he could work well with management at any level of an organization," Fratantoni said. "He was respected, but he was also very persistent. If he saw something he thought was a problem, he would keep pushing at it until he got it fixed." On May 1, McMurray began working as a senior vice president and chief risk officer with the Federal Home Loan Bank of Seattle, a cooperative that provides liquidity to help make affordable housing available to the public.
ECB fears bank crisis in 2010 as recession drags on
The European Central Bank is paying close attention to mounting difficulties at 25 banks deemed crucial to the health of the eurozone financial system, fearing another wave of bank turmoil next year if the recession drags on. Dejan Krusec, the ECB's financial stability expert, said the banks are strong enough to weather the current downturn so long as there is a rapid "V-shaped" recovery but not if it takes longer to refloat the economy. "If this is 'U-shaped', the banks will have problems. There are 25 banks we monitor that are strategically important," he told a Fitch Ratings conference on Eastern Europe. "The problem is not 2009. Euro-area banks are well enough capitalised to cover losses. The problem is 2010. We are concerned about the length (of recession)."
The ECB has slashed its forecasts, predicting a 4.6pc contraction this year and a further fall of 0.3pc next year, with no recovery until mid-2010. This precludes any chance of a V-shaped rebound. The clear implication is that the ECB is battening down the hatches for another storm as rising defaults eat into bank capital. This aligns the ECB with the International Monetary Fund, which has called for urgent action by EU authorities to clean up Europe's banks and disclose likely damage. Piroska Nagy, an adviser to the European Bank for Reconstruction and Development, said the danger is that West European banks will retreat from Eastern Europe, "causing a collapse of the banking sector" across the region. The EBRD and the World Bank have put together a €25bn (£21bn) fund for use as an "incentive" to discourage banks from abandoning subsidiaries. "It is a respectable amount, but not nearly enough," she said.
Some 30pc of fund managers polled at the Fitch conference said they expect defaults in several Eastern European states. A further 11pc expect a full-blown "systemic" meltdown. West European banks have $1.6 trillion (£977bn) of exposure to the region, led by Austrian, Belgian, Swedish and Dutch lenders. While attention has been focused on Latvia’s currency peg, large losses are building up in Hungary, the Balkans, Russia and Turkey. "Survival is going to be very tough for the majority of privately-owned banks in Ukraine," said James Watson, Fitch director in Moscow. In a "worst case" scenario, write-offs will amount to $135bn in Russia, $46bn in Ukraine and $38bn in Kazakhstan. Even the "base case" entails losses of $122bn for these three states alone. Russia’s private companies borrow in dollars because it is hard to issue rouble bonds. They must roll over $145bn of foreign debt this year, and pay interest from revenues in devalued roubles. Construction firms face the worst crunch.
There is no quick fix for Eastern Europe. "It is going to be even more difficult for them to export their way out of trouble than it was for East Asia in the 1998 crisis," said Edward Parker, Fitch’s head of emerging Europe. This time the whole world is in recession. Besides, Latvia, Estonian, Lithuania and Bulgaria are trapped with currency pegs at over-valued rates, implying harsh deflation. "There is a limit as to how much pain can be borne in democracies," he said. Russia's central bank rattled the global bond markets by warning that it planned to cut the share of US Treasuries in its foreign reserves. The news caused the yield on benchmark 10-year bonds to spike to almost 4pc, a level that risks crimping mortgage finance and short-circuiting recovery. Russia's reserves have fallen by almost a third since the peak of the oil boom last year but it still boasts $404bn, the world's third largest reserves. Roughly 30pc is held in US Treasuries.
Oil's 'Endless Bid' Returns
It's baaack! The endless bid for oil. Oil has been rallying because of the weakness of the dollar and because of the specter of impending inflation. Or at least that is what I continue to hear. Yet in the last several sessions, the dollar has found some amazing strength, and gold, the best proxy for inflation, has come down quite a bit. So what is going on with oil? What's driving oil now? It's the endless bid.
Goldman Sachs recently revised its oil targets for 2009 and 2010, raising its $52 target price for the near three months to $75. It gets worse, according to Goldman. Year-end targets for the crude barrel in 2009 were revised up to $85 and a $95 target was set for 2010. How do they come up with these figures? Goldman analysts cite increased demand. Yet there is absolutely no sign that demand is increasing, quite the contrary. Goldman argues that oil is rallying on expectations of increased demand along with similar expectations of recovering economies in the second half of '09 and into 2010.
Even if this gargantuan leap of faith were true, why isn't natural gas, a perfectly wonderful and plentiful energy source, rallying as well? Why is it languishing at a mere $4s/mmBTU, while crude streaks ever higher? And how do those Goldman oil analysts even create these mythical target prices? It's so hard to gauge the strength of the endless bid. The endless bid is what I've begun to call the incessant, unrelenting and often unreasonable desire of investors to have exposure to oil. In commodity index funds, through ETFs and directly in futures markets, there is a renewed interest in having oil as a part of every investor's portfolio.
The oil market is a delicate market. Even more importantly, it is a relatively puny market. New York Mercantile Exchange crude oil futures, the most widely quoted, relied-upon price gauge for oil, have about 1.3 million contracts of open interest. The average price per barrel is about $70. Therefore, the entire notional value of crude oil traded on the Nymex is a little under $100 billion. That sounds like a lot. But not if you consider that the notional value (market capitalization) of even one oil company like Chevron is 40% more. The market cap for Exxon Mobil is 3.5 times more. Intuitively, we can expect that even a relatively little amount of new investment interest in oil futures is going to have a huge impact on the price. That's the endless bid.
We saw the endless bid fuel the run-up in oil to $147 in July 2008. We saw the endless bid withdraw just as quickly in late 2008 and through February of 2009 with a resultant low of $32 a barrel. And now, it's baaack ... and makes any estimate of a target price for oil a total shot in the dark, a complete guess, practically unrelated to any economic forecasts or supply/demand estimates. And where will it end? It's an important question we'll save for the next column.
The Problem with the GM Gamble
The problem with the GM Gamble is not that the government is involved. There is every indication that government involvement is not that bad. Medicare and the notion of public guarantees of medical care are not noxious. And the President has, in the case of GM, said he will leave the nuts and bolts up to those who know about business. I know that is a weak assurance but it shows that in the Obama world, government involvement is not going to be the problem. The problem is the car.
There are times when I think Obama is playing a game which is utterly necessary, given the obtuseness of our media and the knee-jerk capacity of the populace to take umbrage if an idol comes close to toppling.
The game is not the change Obama will bring. It is the change that is coming willy nilly that no one wants to see. Take the current "recession" which is really a readjustment and a signal to the market. What few want to see is that the readjustment is in the direction of the public over the private, the reclamation of public space over private space, the creation of public options over private ones. We are being thrown together whether we like it or not.
What Obama cannot say, though he has in fact talked all around it, is that we will no longer be a privatized commuter society where driving a private car and living in a detached house is the norm. What Obama cannot say, though it is implicit, is that the design of our schools, of our hospitals, of our human settlements is a problem, because it is all predicated on the car and cars are going to be less and less the norm. What will become the norm is seamless transit within communities and new modes of transit between them. Michael Moore has a good piece from which I will draw the salient statements with which I profoundly agree:3. Announce that we will have bullet trains criss-crossing this country in the next five years. Japan is celebrating the 45th anniversary of its first bullet train this year. Now they have dozens of them. Average speed: 165 mph. Average time a train is late: under 30 seconds. They have had these high speed trains for nearly five decades -- and we don't even have one! The fact that the technology already exists for us to go from New York to L.A. in 17 hours by train, and that we haven't used it, is criminal. Let's hire the unemployed to build the new high speed lines all over the country. Chicago to Detroit in less than two hours. Miami to DC in under 7 hours. Denver to Dallas in five and a half. This can be done and done now.
4. Initiate a program to put light rail mass transit lines in all our large and medium-sized cities. Build those trains in the GM factories. And hire local people everywhere to install and run this system.
5. For people in rural areas not served by the train lines, have the GM plants produce energy efficient clean buses.
6. For the time being, have some factories build hybrid or all-electric cars (and batteries). It will take a few years for people to get used to the new ways to transport ourselves, so if we're going to have automobiles, let's have kinder, gentler ones. We can be building these next month (do not believe anyone who tells you it will take years to retool the factories -- that simply isn't true).
7. Transform some of the empty GM factories to facilities that build windmills, solar panels and other means of alternate forms of energy. We need tens of millions of solar panels right now. And there is an eager and skilled workforce who can build them.
8. Provide tax incentives for those who travel by hybrid car or bus or train. Also, credits for those who convert their home to alternative energy.
The car was and remains the central chip in the game. Cheney and Company cannot see beyond a world where Oil and The Car are objects of worship and cause for war. The American people are not ready yet to be told that the private car is the idol that needs to be shattered. Obama is left with the need to temporize. And I suppose the real question is whether he sees the new road beyond the spaghetti bowl world of today. I believe the answer has to be yes, because it remains true that we are at the beginning of a new stage where the world is creating a new option for living. The nation that understands that will prosper. The nation that believes the answer lies in selling enough private cars to turn a profit is whistling in the wind.
$145 billion in US government securities seized from Japanese nationals, not clear whether real or fake
Italy’s financial police (Guardia italiana di Finanza) has seized US bonds worth US 134.5 billion from two Japanese nationals at Chiasso (40 km from Milan) on the border between Italy and Switzerland. They include 249 US Federal Reserve bonds worth US$ 500 million each, plus ten Kennedy bonds and other US government securities worth a billion dollar each. Italian authorities have not yet determined whether they are real or fake, but if they are real the attempt to take them into Switzerland would be the largest financial smuggling operation in history; if they are fake, the matter would be even more mind-boggling because the quality of the counterfeit work is such that the fake bonds are undistinguishable from the real ones.
What caught the policemen’s attention were the billion dollar securities. Such a large denomination is not available in regular financial and banking markets. Only states handle such amounts of money. The question now is who could or would counterfeit or smuggle these non-negotiable bonds. In order to stop money laundering Italian law sets a ceiling of 10,000 euros per person for importing or exporting money without declaring it. The penalty for violating the law is 40 per cent of the money seized.
If the certificates were real, for Italy it would be like hitting the jackpot. The fine alone would amount to US$38 billion, five times the estimated cost of rebuilding quake-devastated Abruzzi region. It would help Italy’s eliminate its public deficit. If the certificates are fakes the two Japanese nationals could get a very lengthy jail sentence for fraud. As soon as the seizure was made the US Embassy in Rome was informed. Italian and US secret services were called in to assist the Italian financial police. Some important international financial newspapers had already reported on the existence of ‘funny money’ circulating on parallel, i.e. unofficial, financial markets.
For AsiaNews a few points need considering:
1. When it comes to Italy the world press has tended to focus on Italian Prime Minister Berlusconi’s personal problems rather than on stories like the bonds smuggling affair which has been front page on Italian newspapers.
2. The fear of counterfeit bonds and securities has spread across Asia with the result that real securities are also considered with suspicion.
3. During the Second World War several countries at war printed and put in circulation perfectly counterfeit enemy money. It is also historically established that some central banks, like the Bank of Italy 65 years ago, issued the same securities twice (identical registered number and code). This way they could print more money with legal tender than they officially declared. The main difference though is that 65 years ago the world was involved in a bloody war, which is not the case today.
Concerns mount over sharp rise in food costs
After a year worrying about the piggy bank, the world economy is turning its attention to the cupboard. Almost unnoticed, agricultural commodities prices have returned to levels last seen at the start of the 2007-2008 food crisis, prompting concerns about a fresh rise in food costs. The increase in soyabean, corn and wheat prices – to their highest level in eight to nine months and up more than 50 per cent from their December lows – comes on the back of strong Chinese demand, a forecast of lower supply due to reduced planting, and the impact of a drought in Latin America. Argentina's crops have been devastated.
"Agricultural markets are fairly nervous," says Sudakshina Unnikrishnan, an agricultural commodities analyst at Barclays Capital in London. "We are not in the comfortable food surplus environment of the 1980s and 1990s." The price of soyameal – critical for fattening livestock such as chickens and hogs – has moved above $405 a tonne, a level only seen for a brief period in 1973 and during four weeks at the peak of last year's crisis. The rise has pushed the price of ready-to-cook chicken in the US to the highest in a decade. Traders say hedge funds and other big institutional investors, including sovereign wealth funds from the Middle East, have poured money into the agricultural market, helping to drive commodities prices higher as the US dollar weakens.
A repetition of last year's food crisis, when sharply rising prices sparked rioting in some countries, seems unlikely, however. Even after their surge, soya, wheat and corn prices are well below last year's peaks. Rice is trading about $550 a tonne, well below its peak last year of more than $1,000 a tonne. Beef, pork and milk prices remain depressed, further capping the potential for a rise in overall food costs,. The United Nations' Food and Agriculture Organisation is relatively optimistic, saying that "barring major crop setbacks ... the food economy looks less vulnerable" to a price spike.
"In spite of strong gains in recent weeks, international prices of most agricultural commodities have fallen in 2009 from their 2008 heights, an indication that many markets are slowly returning into balance," it says.
But private sector analysts and industry executives are less relaxed. In rare public comments, Christopher Mahoney, a director at Glencore Grain, the secretive trading house based in Rotterdam, warned last week that supplies of some agricultural commodities such as corn and soya were "pretty tight". Lewis Hagedorn, an agricultural commodities analysts at JPMorgan in New York, describes the situation as one of anxiety but not yet alarm.
"We are approaching a level of concern with respect to inventories in some areas, although we are not presently in a crisis mode. We are not well prepared from a supply and demand balance sheet perspective to absorb any weather-related surprise." Food companies are taking precautionary measures, building positions in the commodities futures market to hedge against further price rises, says Luke Chandler, director of agricultural commodity markets research at Rabobank in London. "There is a lot more attention among food companies, particularly after the pain experienced last season," Mr Chandler says.
The immediate concern is soya, both because of its use as food but even more as livestock feed. Strong Chinese consumption, as the country's diet moves from vegetables to meat, and the crop failure in Argentina, the world's third largest exporter, have created extraordinary pressure on US supplies, sending inventories down to the lowest level in 40 years. Soyabean prices on Tuesday hit $12.45? a bushel, a fresh nine-month high. Soya is trading at the level of April 2008, after rising almost 60 per cent from its December's low. Soya is, nonetheless, still below last year's record of $16.5 a bushel.
Looking at the 2009-10 season, analysts fear a drop in cereals production, in corn and, to a lesser extent, in wheat, as farmers cut their planted acreage in response to low prices last autumn, higher cost for inputs such as fertiliser and pesticides, and difficulties securing finance in some countries. Production in countries such as Ukraine and Brazil is down because farmers did not have access to credit. The International Grain Council, an inter-governmental organisation, forecast that global grains supplies would fall in the 2009-10 season, which starts at the end of the month, to 1,721m tonnes, down 3.4 per cent from 1,782m tonnes in 2008-09.
"World grains production is expected to fall short of use in 2009-10, eroding some of the gains in stocks achieved after the bumper 2008 harvests," the IGC said in its latest monthly report, forecasting a drop in stocks to 328m tonnes, down 4.3 per cent from 2008-09's level of 343m tonnes. Global grains demand will rise to 1,736m tonnes in 2009-10, up 0.8 per cent from 2008-09 season, the IGC says. With the US the world's largest corn exporter and wet weather disrupting planting in areas such as Illinois, Mr Mahoney of Glencore, says: "It is essential that we have a good US growing season this year."
The combination of worries is propelling cereal prices. Corn is trading at the level of January 2008 at the start of the food crisis – about $4.5 a bushel, but still well below last year's record of $7.5 a bushel. Wheat is lagging behind, trading at the level of October 2007 – at about $6.25 a bushel, still far below the 2008 peak of $13 a bushel. Even if supply is set to drop this year, a large carry-over from last season will cap any price rally. "The wheat supply-demand picture is considerably less tight," Mr Mahoney says.
The surge in prices is a reminder of how the world's food security has deteriorated, after years of comfortable surpluses, analysts and executives say. Mike Mack, chief executive of Syngenta, one of the largest manufacturers of chemicals for agriculture, echoes a widely held view when he says that although the "headlines from the past year on the food crisis have been replaced by those on the economic crisis", the "long-term challenge to produce enough food" has not disappeared.
Ilargi: Good Vanity Fair story on the Obama team's approach of the dinosaurs, i.e. the printed press. Last night, Jason Jones for the Daily Show was at the New York Times. See here>, here for Canada. The whole item is dean-on-pan. At one point he’s talking to an big shot editor and asks why the "Aged News" the NYT serves up is better than real news. The guy first says he's never heard the term, and then that the NYT is not "aged news". Jones responds by picking up that day's copy of the paper, and saying: "Show me one thing in there that happened today". That is one powerful line.
The Power and the Story
The Obamas may have the smartest, most finely calibrated press operation in White House history, parceling out scoops (The New York Times), partisan talking points (the Huffington Post), and First Family tidbits (the celebrity mags) to a desperate media. Just don’t ask them to admit it.
Bill Burton is the baby-faced political op with a little too much junk food under his belt—and, at 31, with one of the political world’s longest résumés in media relations—who runs the pressroom at the White House. He’s got possibly the littlest office in the West Wing, but it’s where you want your West Wing office to be, guarding somebody more important than you. Burton is guarding his boss, the president’s press secretary, Robert Gibbs—who guards the president—from me.
The Obama presidency is striving to be the most open and available in modern history, hence—and I am here on the 98th day—its first 100 days of remarkable staging, including dogs, wife, children, mother-in-law, bailouts, and handshakes and bows with dubious world leaders. But what it doesn’t want to be open about is the staging itself. One of its least favorite subjects is media. As much as the Obama-ites don’t want to be as defensive and recalcitrant as the Bushes were when it came to the press, having methodically reviewed all lessons from recent administrations, they also don’t want to seem as clever, pleased with themselves, and publicity-crazed as the Clintons, who talked endlessly of media strategies—precisely because they are much more clever and publicity-crazed.
Even though I’ve been invited to the White House for a talk with Gibbs, there’s an abrupt cancellation when, after some chitchat with Burton, it becomes clear that my interest is in process rather than, per se, message. And then a kind of sudden vaporization—no Gibbs, according to Marissa Hopkins, his assistant, "for the foreseeable future." "The process aspect of media, the insider stuff, is not—it’s not our thing," says Burton, whose entire career in the press offices of Dick Gephardt, Tom Harkin, John Kerry, and Obama during his Senate term has been about nothing but media process. "We won’t miss it if you don’t do the story." Big cheesy smile.
There it is: the keynote affect of this most brilliant and successful and certainly calculated White House press operation is, We’re artless, really. Pay no attention to what we’re doing here—it ain’t nothin’ much. The Clintons used the talk of great strategy as a way to mask the fact that they really had no strategy (and, too, according to one former Clintonite, because it "makes the individuals involved feel smart when they tell you how cleverly they’re manipulating the media"); the Obama team doesn’t want to talk about the meticulous calibration of everything to do with retailing its image and message because it is all so meticulously calibrated.
In part this meticulousness is just good management. The Obama administration has started with 14 professionals working in the office of the press secretary—and an astounding 47 more devoted to other aspects of media and message—which is significantly more than the communications staffs of many Fortune 500 corporations. But the media operation goes deeper than that. It’s more central than in any previous administration, and run more knowledgeably. Gibbs may be personally closer to the president than any press secretary in history; Rahm Emanuel, the president’s chief of staff, is not only a press hound himself but a master at manipulating the media with juicy leaks (unlike, say, Bush’s Andy Card, who may never have had a one-on-one conversation with a reporter before becoming chief of staff); and David Axelrod, the administration’s main media strategist, is a former reporter for the Chicago Tribune.
But even a president predisposed to the press (and with a press predisposed to him) is sooner or later going to snap. And, worth noting, no president, after years of campaigning, is all that predisposed. Presidents, on a good day, regard almost all members of the press as mean-spirited, lazy, and only occasionally useful. All presidents begin with a theory on how to tame the beast. The Clinton administration came to Washington with the logical, if boneheaded, idea that the best way to deal with the press was to move it out of the West Wing and keep it at arm’s length—a gambit which cost the Clinton White House, from the get-go, the goodwill of the people whom, next to Congress, it needed most.
The Obama approach has been more subtle but, in its way, more threatening. Even before formally taking possession of the White House and pressroom, the team began to talk about keeping Obama’s much vaunted peer-to-peer network of millions of small contributors in place, of making it a central outlet of its communications strategy. The implication seemed clear: newspapers and networks had a swiftly declining market, while the Obama administration had created an audience that it could reach through its own distribution prowess and that hung on its every word. Even given the isolation and provincialism of the Washington press corps, with the cracker-barrel feeling of the White House pressroom itself—the obvious languor and boredom of people hanging around the same small space and having the same conversations year after year, administration after administration—it would be impossible, at this recessionary moment, for the Fourth Estate to feel anything less than pure dread.
The pressroom is top-heavy with anachronisms. There are the urban dailies, such as the Chicago Tribune, The Boston Globe, the Baltimore Sun, the L.A. Times, each a paper whose closing could be imminent. Then the networks, whose commitment to the evening news is ever less sure. There’s the newspaper division of the Washington Post Co., which lost $53.8 million in the first quarter and which is increasingly overshadowed by Kaplan, the educational-testing company that supplies most of the revenues for its parent company ("If The Washington Post still exists, that would be news to me," said one new Web entrant in the Washington press corps). And then The New York Times, traditionally the single most important factor in the setting of the political agenda, now in the midst of a business crisis from which few expect it will emerge intact.
The balance of power has surely shifted—although you won’t get anyone in the White House to say that. Except every day you can read it in press secretary Gibbs’s cockiness and condescension. You have to understand the primitiveness of the daily briefing—it’s a ritualistic sumo of dominance and submission. At least since the Bush-father administration (after the brilliance of the Reagan press operation), it’s mostly been the press dominating whoever the press secretary is, and the press secretary trying to avoid being broken as he or she does the job of trying to avoid giving out information. Among press secretaries in recent memory, there’s been the drowning George Stephanopoulos, the angry Ari Fleischer, and the hapless and tongue-tied Scott McClellan. (Exceptions include Tony Snow, the Fox News anchor, who continued to act like a television host, and Mike McCurry and Joe Lockhart, whose approach was, at nearly any cost, to please the press.)
Gibbs has reversed this dynamic. It’s not just that he successfully holds the pressroom at bay. It’s that he clearly doesn’t take the press very seriously. Gibbs is perfectly affable and even, in his way, courtly. And yet he seems to be not quite listening. Nothing touches him. This is no doubt partly because everybody understands he’s in like Flynn. Unlike with most press secretaries, where the press has the leverage of often knowing more than the press secretary, who is usually a relatively weak West Wing link, Gibbs really knows all, apparently—he’s as present as anyone in the creation of Obama policy.
There is too the Obama 30-point advantage—he’s got America eating out of his hand. Gibbs has, at least so far, an easy product to sell. And then there’s the personal insecurity on the part of members of the incredible shrinking press—their days are numbered and they know it. All of which might have something to do in the dominance-and-submission equation with why, at the president’s 100-day press conference, there were no questions about the bailouts or Afghanistan, perhaps the two most intractable issues facing the administration. When the other guy is strong and you are weak, you try to behave yourself.
And yet, a funny thing: Gibbs, who surely knows something about the dwindling life of the establishment media, who as Obama’s campaign spokesperson was part of the most sophisticated new-media outreach program in politics, who is, with his own personal access and his boss’s overwhelming popularity, beholden to nobody, nevertheless appears to be playing the press game as straight and as conventionally and, in a sense, as humbly as it’s ever been played. "His M.O.," says David Corn, a longtime Washington reporter who is a regular at the daily briefing, is "to talk to the dinosaurs."
The established news organizations may have almost no pulse left in them, but you wouldn’t get an inkling of such a reversal in fortunes from the White House’s ritual obeisance. The hierarchy evidently remains as fixed as it’s ever been. The "change" guys have altered nothing. It might as well be, say, 1995, with the Times, the Post, the networks, CNN, the newsweeklies, and even 88-year-old Helen Thomas (I say 1995 because that was before the advent of Fox News, which, unlike in the Bush administration, where it was the first point of contact and virtual mouthpiece, hardly exists in the Obama media point of view) all given a regal pride of place.
In fact, it almost seems as though the Obama people have abandoned that grail of all White Houses, to bypass the mainstream media and go directly to the people, to get the message out, pure and unfiltered—which, with their millions of e-mail addresses and Twitter followers, never seemed so possible as now. Instead, they’re wooing The New York Times as assiduously as Pierre Salinger did on behalf of John Kennedy in 1962. And, perhaps not surprisingly, The New York Times woos back—rewarding the president with a lavishness of coverage not seen since, well, J.F.K. in 1962. It’s an establishment lovefest.
It’s some perfect re-creation of a relationship between president and news media that has not been seen since the White House pressroom was a clubby place with reporters invited into the press secretary’s office for whiskey and cigars. It’s cozy. Rahm Emanuel and David Axelrod, who would have been, in previous administrations, the highest and most exclusive White House sources, have become almost casual quotes for the Times. It is, curiously, a return to a time when the press was so much more dependent on the goodwill, and susceptible to the care and feeding, of the president. Indeed, The New York Times, and the rest of the established press, needs Barack Obama a lot more than he needs them.
Courting the dinosaurs, the Obama people feed the increasingly hungry new media the scraps—and manage, mostly, to have them thankful for them. The Huffington Post has become an ideal back door for the most partisan stuff. It’s being used in a way that suddenly seems not all that dissimilar to how the Bush White House used Fox News. It’s as obvious and as unfiltered. "The Times, it appears, gets soft, thoughtful, and complicated stuff. HuffPo gets the mean and simplistic," says Michael Tomasky, The Guardian’s Washington-based American editor-at-large. In other words, the Obama people have purchase on both established media and partisan media. If the Bush people ran a singular, blaring, drumbeating message, the Obama people are running a message across numerous spectra of purpose and subtlety and payoff.
Indeed, while the Times seems reserved for the more weighty exegesis, and the HuffPo for its attacks, Politico, the politics-focused site that began during the last political campaign and is now trying to build an off-election-cycle business, has become the prime outlet for Obama White House gossip—the fuel of the day’s political kibitzing, the candy by which an odd intimacy is created with both the media and the political hard core. It’s politics as a short take—politics as an item. "They use it for the quick pops. They get the headline out there. They short-circuit analysis. They keep momentum going. All day, rat-a-tat-tat," says one pressroom-watcher. "They essentially write it themselves." "That Whiteboard ain’t going to write itself," Bill Burton reportedly observed about Politico’s Whiteboard, a moment-by-moment chronicle of White House activity.
And this may not even be the most powerful part of the White House press strategy. If most of the press is failing, one part is rising: the celebrity press. Now, the central formulation of the celebrity press, codified in the early days of People magazine by its first and legendary editor, Dick Stolley, is that, in the descending preference of who makes a good cover, from movie star to television star to sports figure to sick child, the one category of celebrity you ought never to choose is politician. Arguably, the celebrity press came into existence and has grown with such force as a reflection of America’s disenchantment with and lack of interest in politics and politicians. Civic life lost its connection to popular culture. Until Obama. Now, in the hierarchy of celebrities, nobody ranks as high, or is as cover-worthy, as the president and his family.
Inside Edition, the syndicated tabloid show which specializes in the frothiest celebrity news and goriest celebrity scandals, now looks for an Obama angle on whatever story it’s pursuing. "Any story gets hotter if you’ve got Obama in it," says a producer on the show. As for Michelle Obama, she may seem to be everywhere—the most revered and omnipresent woman in the land—but this is in fact a function of her lack of availability. The First Lady appears in public only about three days a week. Exclusivity and unattainability make the brand. Indeed, the efforts at control—negotiating all the nuances of celebrity coverage—by the White House press team are pretty much at the levels of Brad Pitt and Angelina Jolie.
Of course there are changes going on, but we’re message focused—we believe our message will find its audience," says young Burton as the press clamors outside his small office. It’s a cat-that’s-eaten-the-canary kind of thing. They have been handed a most remarkable historical moment—in which they get to remake the media in their own image. They have the power and they are the subject. These people in this White House are in greater control of the media than any administration before them. The only thing is, they mustn’t let on that they know it.